So far, 2011’s been a difficult year: Bulls can’t get much traction, and bears are wondering when the big drop will happen—it’s been a choppy, basically flat market so far, where neither big fears like sovereign debt nor big boons like blockbuster earnings are tipping the scale either way.
In my view as a Fisher Investments analyst, the rest of 2011 likely holds more of the same. Here are six things investors should look for the rest of this year:
- Investors will be haunted by the ghosts of sovereign debt. My boss Ken Fisher wrote about this in his most recent Forbes column (read “Ghosts Around Every Corner” 7/18/11 here). And I quote: “It feels like there are ghosts around every corner. In 2008 and 2009 we came to fear mortgage debt problems and expected more of them. Debt fears have persisted ever since.” Indeed. Whether it’s US debt default fears, municipal debt fears, PIIGS fears, consumer over-indebtedness or some other debt fear, expect them to persist in the popular media but have a lesser and lesser effect on markets as the bull market goes on. It can be tough to see this but is plainly true—stocks have rallied strongly since March 2009, despite all the debt fears that persisted and morphed in that same period.
- Few will realize this isn’t a recovery. A simple, stark truth: We’re no longer in a recovery but an expansion. Nominal GDP—both in the US and the globe—is near or at all-time highs. Reading today’s headlines this seems almost impossible. But it is so. The global economy has recovered from the recession and is in expansion mode.
- More Financials underperformance. Based on Fisher Investments research, it’s typical for a sector leading a bear market down to get a quick pop in the initial part of the new bull, but then lag afterward (think Energy in the early 1980s and Tech in the early 2000s). Financials fit this archetype indubitably. They continue to be everyone’s favorite villain, and are likely to continue struggling mightily relative to the rest of the market this year.
- A continuation of the first half. I wrote about this back in March (Click here for the full recap.) In a nutshell: I think some investors will remain skittish and unable to shake the yips from the 2008 bear, others will see the last two years’ great run and get too bullish (instead, the market’s treaded water). Pessimism about the global economy will be rampant, with the effects of the Japanese earthquake overwrought (the earthquake effects are already passing, and GDP in many regions is coming in ahead of expectations). Some will panic about inflation (there’s been scant sign of it this year, and likely won’t be for some time to come). Others will fall in love with covered call strategies. And, lastly, many will go overboard on emerging markets investments (which have underperformed so far this year, and yes, inflows into those assets this year have been big overall).
- More “can it continue?” earnings chatter. Earnings have been far better than most anyone predicted for a few years running now. So far, Q2 earnings for this year are simply crushing expectations. Corporations won’t trounce expectations forever, but 2011 is a year where earnings remain strong and ahead of expectations. (More on earnings from Fisher Investments MarketMinder here and here.)
- The China and Emerging Markets “hard landing/soft landing” debate will drone on. I don’t believe in “landings” for an economy. It’s a bad economic metaphor (once an economy “lands”, then what?). As I said in March, don’t go overboard with emerging market stocks in your portfolio—sentiment is very high on them right now, which may limit upside potential in the near term. But I think you should expect their economies to continue driving strong corporate earnings and global GDP to new highs. Parts of emerging markets will thrive, some will dive, and some will tread water. But overall their growth probably won’t tank in 2011.
A flattish year in the stock market doesn’t mean it won’t be choppy—ups and downs are common and there won’t be any reprieve. But on balance, I think the rest of 2011 has neither great nor doomsday expectations. By the time we get to December, expect pundits aplenty to ask, “Where to now?” for the markets. They will cite “uncertainty” about 2012— uncertainty about the elections, about earnings, about the global economy. But when were markets ever certain looking into the future?
We’ll deal with 2012 when we get there. For now, steer clear of these common investing misconceptions for the rest of 2011.
The Clash of Civilizations and the Remaking of World Order
Samuel P. Huntington
The Next Decade: Where We’ve Been…and Where We’re Going
If it wasn’t obvious by now, the death of Osama Bin Laden was a market non-event. Headlines on Monday morning, May 2nd, touted the event as the reason stocks were up that day…only to see stocks broadly close slightly lower by session’s end.
Geopolitics is a thorny, tricky issue for investors. It’s virtually always in the news and consistently feels(and can be) hyper-relevant—but actually causes a huge number of investor errors.
The overwhelming majority of geopolitical events—including armed conflict—don’t whack the markets the way folks tend to fear. And that’s the real rub: Geopolitics is mostly a source of investor fear. Change in the order of things causes uncertainty, especially changing the fabric of government and law. But consider: How many geopolitical events have triggered a true, sustained bear market in stocks? You can count them on less than one hand in the modern era—which is profound. It generally takes truly humungous stuff, like world wars. Also consider: When has there been a year in your life where there wasn’t unrest somewhere? Israel, for instance, has been in conflict for all of my life (and that probably won’t change if I live to be 100), yet stocks can, and have, risen despite it.
Even ostensibly “good” changes to the geopolitical landscape cause investor worry. The fall of soviet Russia, for instance, fuelled investor uncertainty. Right now is a case in point: Strife in the Middle East and North Africa is underpinned by the idealistic energy of what we Westerners champion most—liberal democracy. But such a “good” development is right now cause for investor fear because what happens if oil supplies from that region get disrupted?
So, how to view geopolitics as an investor?
Much of investing success is about understanding historical context. Knowing history doesn’t tell you what happens next—it tells you what’s precedented and unprecedented and how people (the substrates of markets) tend to react. To navigate geopolitical strife, you want to give yourself as much context as possible. And among the main, indubitable lessons is: There’s never a dull moment—somewhere in the world there is always something bad geopolitically going on, and most of the time markets march on in spite of it. This works both ways: Geopolitical events have trouble changing the tide of bulls and bears alike.
On that basis, two excellent books:
First, Sam Huntington’s Clash of Civilizations. Originally published in 1998, it’s still ultra-relevant, perhaps more so than ever. Huntington was (and is) part of a fierce debate over the last decades: Is liberal democracy a tide that will sweep over the world, or will cultural differences ultimately preclude it? At the time, Huntington was in opposition to Francis Fukuyama’s End of History. Fukuyama believed that with the fall of Soviet Russia would come an overwhelming tide of democracy across the world. Huntington disagreed, positing that differing cultures across many lands would not readily accept such governance.
Whatever you believe, it doesn’t matter. Put yours and Huntington’s views aside—Clash of Civilizationsis foremost a spry and engaging primer on how geopolitical dynamics work and the basic overlay of cultural conflict and interests in the world today. The first portion of the book analyzes the basic categorizations we tend to take for granted about geopolitics: What exactly is the “West”? And how is it different and/or opposed to the “East” in culture, philosophy, economics, etc.? This discussion alone is fruitful in revealing just how complicated such things are. The second part of the book is a rundown of all the world’s regions, perspectives on their cultures, their salient motivations/goals, and how those tend to clash.
The second book is George Friedman’s The Next Ten Years. I reviewed his book The Next Hundred Years last year. This one is every bit as good as the first. By now, Friedman’s writings have become must-reads for me—his pragmatic approach to geopolitics includes history, geography, and analysis of those in power with a consistently pragmatic, well-balanced view. Simply, I am better informed after reading his work.
The Next Ten Years is essentially a rundown of current geopolitics and probable implications for the next decade. Again, the value is not in the accuracy of what Friedman foresees per se, but in the discussion itself. To read this short book will educate you about current global geopolitics as well as any primer out there.
Taken together, Huntington’s book provides a crash course in geopolitical thought and Friedman adds to it with a cogent analysis of here and now. Pick them up to better equip yourself to deal with such events vis-à-vis your investments.
*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.
Don’t Count on It!: Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes — John C. Bogle
The Investor’s Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between — William J. Bernstein
I spent the last week or so reading just about everything John Bogle ever published. And man, is that guy cynical about the investing world! The title of his newest book, Don’t Count on It! is a mantra, almost self-help guru-ish in its repeated invocation, to be dubious about anyone or anything in investing. The book is a sort of “greatest hits” of speeches and excerpts from Bogle’s career. In this, it ebbs and flows—his personal reflections on building the Vanguard funds can be engrossing. But at 603 pages, one wonders about the editing—the book is frustratingly redundant, often repeating whole passages.
Bogle believes investing today is populated with products that overcharge and under-deliver; the system is overrun with marketing and lacks stewardship; and virtually no one can outperform the markets over time. So the best thing to do is get market-like returns via ultra-low cost index funds.
Well, that’s certainly a populist view. And a lot of his proclamations (getting rid of quarterly results for public companies, earnings restatements, etc.) go too far. But there’s much gold to be mined in Bogle’s views too. It’s a jungle out there for novice investors: The proliferation of products, not knowing who to trust…it’s daunting and folks do get burned. Heck, stock brokers at this point don’t even have a fiduciary duty to serve their clients’ best interests! And it’s at least plausible to argue expenses at many plain-vanilla type mutual funds could be lower. Vanguard, if anything, is simply spectacular at providing the public well-constructed index funds at low cost. (For years, my boss Ken Fisher has railed publically about the shortcomings of mutual funds and the like for many of the same reasons Bogle does.)
But there’s a rising tide in the industry countering all this: fee-based separate account management. (Full disclosure: That’s what we folks at MarketMinder do.) Registered investment advisers manage clients’ accounts separately (by far a more efficient thing than pooled mutual funds), have fiduciary duty to serve their clients’ best interests, take compensation as a percentage of assets managed (so there’s a big incentive to do well and right by the client), and can in fact long term beat the markets net of fees. I know this because I work for such a place. This simple framework, to my mind, solves most of the stewardship and cost problems Bogle rails against.
If you can’t (or don’t want to) find a manager you believe will consistently do those things, indexing can be fine enough. Just one problem: you still must decide on asset allocation (a trickier business than it often seems) and have the guts to stick with the strategy. A passive all-equity strategy went down just as much as the market in 2008. In other words, it’s still YOU who must be disciplined and sit tight when the world feels like it might be ending—that might be the toughest thing of all in this business. I, for one, witnessed many die-hard passive investors lose their gumption, sell out, and miss the big rally of 2009—doubly damaging. So, behaviorally, passive investing has its problems.
Actually, the indexers inadvertently prove one of the most important lessons for active portfolio managers and stock investors generally: At a minimum you want a strategy that captures the baseline long-term return of equities. To do that, you have to be in stocks. Most get this backwards: people fear losses way too much (now is a classic era for that). The simple reality is that, over time, stocks run circles around the hesitant. You can’t ease into stocks figuring there will eventually be a lower point to get in. That might feel intuitive after a decade of flat returns, but in practice it fails more than it works. This has been proven statistically over and over, but the investing community consistently turns a deaf ear to it.
Which brings us to Mr. Bernstein. There’s sort of a mutual admiration society between Bogle and Bernstein. You can’t read their work interchangeably, but most of it’s in the same ballpark. They cite each other often as influences. Bernstein’s latest, The Investor’s Manifesto, is really an update from his past books, The Four Pillars of Investing and The Intelligent Asset Allocator.
Bogle righteously emphasizes simplicity in a world of rising complexity. Bernstein says his Manifesto is the simplified version of his views, but a layperson will be befuddled after a few chapters. He seems to mistake brevity (and the book is brief) for complexity of concepts. Statistical explanations of how equity risk premiums are supposed to work, why (to Bernstein’s view) small cap stocks are better than large, and so on, will vex neophytes. Mr. Bernstein seems to sense this—which is probably why he argues it’s so difficult to outperform the market, so few can do it, and most are best served passively investing in index funds, a la Bogle.
But there’s some worthwhile wisdom in there too. Bernstein is one of the few to (rightly) favor being a student of market history and, as such, see that “the more you study market history, the fewer black swans you see.” Absolutely correct. And Bernstein interestingly discusses the “narrative” of a company. He advocates knowing the fundamental macro forces really driving share price—a story of the stock that explains why you hold it—instead of toying with the statistical gerrymandering that is valuation and financial statement analysis these days. Bernstein says investors tend to go for the sexy story, the sexy stock (Apple, anyone?), but often miss the companies that are less popular but really drive the economy—your heavy Industrials, Materials, commercial banks, and so on.
Bogle and Bernstein recognize that most folks planning for retirement (or are in it) need a lot of stocks to fight the effects of fees and inflation and achieve any decent return. Yet, they recommend a lot of bonds. This conventional wisdom has always been tough to justify when really scrutinized. It’s about as close as investing gets to a physical law (to my mind) that the long-term return on stocks is better than bonds. So, by definition, the more of a lower returning asset you hold, the lower your total expected return. Period. Yes, stocks are more volatile—a feature of the higher expected returns. But if your time horizon is long (which it is for most folks even in retirement), that can be ok. A good adviser, even if they don’t call every market environment rightly, should be able to help you navigate those times of rough volatility—not allowing you to get too high when stocks soar, but also not allowing you to panic when they fall a lot.
In the end, indexing can be a viable and low-cost way to get a well-diversified portfolio. But it doesn’t relieve individual investors of decision-making responsibility—no getting around it. For those who don’t want the onus, seek the help of a good advisor. Contrary to today’s cynicism, there are in fact many fine and responsible stewards who can help build your wealth over time.
*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.
With the ebullient bond buying going on (near record low yields on Treasuries, record bond issuance for corporations, record low yields for long-terminvestment grade bonds), an interesting story has fallen through the cracks:
What!? Remember, just months ago, the financial world perpetually bemoaned Chinese ownership of US debt? And how, if the Chinese decided to start selling, it would be chaos for said US debt? Yields would spike, prices would plummet! And then the world would implode on itself. Or something.
Well, why isn’t it happening? One , China doesn’t hold as much US debt as you might think. In the neighborhood of 10%, which is big but not ridiculous. Actually the US —its citizens, its institutions—own way more…as in well over a third. Second, the sovereign bond market is one of the largest, deepest global markets in the world. There are many, many forces at work at any given time. Simply, there are other demand factors that are overwhelming Chinese US debt sales.
If China decided to dump all its US securities at once, of course that would bring big disturbance. But in reality, as China diversifies its holdings and works—in baby steps—to open its capital markets and un-restrict its currency, we’re much more likely to see this kind of measured action. It’s so benign it barely hits the popular media’s radar.
As is so often the case, “We worried about it, but nothing happened” never makes a good headline. This is a prime example.
I had every intention of winding down my reading on the crisis, but it just seems to keep going—books from worthy authors are still arriving weekly on the topic. So, let us press forward, then, with John Taylor’s Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis. This dainty 92 page book is not light reading, nor will it appear on any bestseller lists. But actually, these scant few pages are as cogent and clear as any I’ve encountered in describing the mechanics of the financial problems that caused the panic.
John Taylor is a noted economist of this era in his own right, but is most often referred to as a friend of Milton Friedman (provocative because he’s critical of Uncle Alan in this book). Taylor’s pedigree includes stints (as either a student or professor) at Princeton, Stanford, and Columbia. In the early 90s he coined the Taylor Rule (more on this momentarily), and he’s been a part of many prestigious economic counsels (as economists with sterling pedigrees are wont), including multiple presidential administrations.
Taylor’s book makes a very clear and pointed proposition: The government caused the financial and market ills of 2008, and played a key role in exacerbating those problems. He is right to blame the government for worsening the panic, but wrong to point such a strong finger for causing it. Or, rather, when he blames the government for causing it, he tends to blame the wrong parts. Let me explain.
Taylor Rule for Everyone!
The Taylor Rule is a “guide” to central banks on how to determine interest rates. It tracks inflation, output, and employment, recommending a higher interest rate when inflation is above comfortable levels and/or when full employment and capacity is reached. When inflation and/or output are low, the rule argues for a low interest rate. (There’s plenty of mathematics to this, which we’ll abstain from here.)
Much of this book is a case study articulation of the theory. Specifically, that the rule was ignored for much of the last decade (Greenspan kept interest rates too low for too long). This inaction was a principal cause of the overheated boom and bust in housing, which eventually caused the panic and recession. Taylor might be a little bit right in this, but it’s far too bombastic a claim. It’s much more reasonable to say perhaps monetary looseness exacerbated some of the frothiness. Taylor is more right in pointing a finger at the moral hazard atrocities that are (and continue to be) Freddie and Fannie.
Still, amazingly, there’s no mention of FAS 157 and the dubious features of Sarbanes-Oxley. These two causes alone so obviously account for so much of Financials’ problems that it boggles the mind we don’t hear about them more often. If we are to successfully assign government blame for the origins of the downturn, we must go there, and prominently. Taylor doesn’t.
More importantly, such hard and fast economic equations as Taylor’s often fail in practice, and blind adherence to them is a recipe for chaos. Taylor readily cops to the fact that we cannot put our faith in a theory, and that we must be versatile and aware of the peculiarity of each circumstance. But this is the problem with all rigid quantitative economics—in practice it works until it doesn’t, at which point there you are, stuck with an equation that’s somewhat mercurial in its forecasting power, and ultimately still requires a qualitative decision. Whether such equations help those decisions or obfuscate them is debatable.
Risk versus Liquidity
Although Taylor sometimes mis-assigns blame for the origins of Financials’ problems, he gets as close to correctly assigning causality for the latter stages of the panic as anything I’ve so far read. He makes an important distinction about the crisis, one that few have drilled down to: The problem wasn’t liquidity in the beginning—first it was risk and then liquidity.
What does this mean? Differentiating between risk and liquidity might seem like hair-splitting. Certainly, in the marketplace risk and liquidity can be siblings, and at times seem nearly interchangeable. We’re better off calling late 2008 a period of “uncertainty” instead of risk.
Why? Economist Frank Knight illuminated this issue brilliantly. He said that risk and uncertainty are two different things. Risk is what happens when you know the odds. If you flip a coin, there’s a 1 in 2 chance of coming up heads. That’s risk—you know the probabilities and can make a bet on it. But uncertainty is totally incalculable: these are situations where there is no way to know the odds—the probability of an outcome is just a wild guess.
Indeed, the Fed and its cohorts innovated tremendously to provide liquidity to banks, but never actually took uncertainty off the table until way late in the game. In fact, they probably increased uncertainty by acting so haphazardly—each inconsistent reaction creating mounting uncertainty over the latter half of 2008. Who would they save? Who would they watch fail? What tactics would they use? Each reaction was different (from Bear Stearns to AIG and all in between) and thus, by the time we got to September ‘08, uncertainty about what happens next was at all-time highs. This is deadly poison for markets, which always look ahead. When even the next few hours are opaque, liquidity dries up. No one is willing to put money on the line when the government seems to be making the rules up as they go. And there you have your panic.
As with any event in a hugely complex global economy, there are multiple reasons for the cause of everything—the best we can do is figure out how much each factor mattered. Of course, that will always be a matter of opinion, hence the never-ending debate on such issues. With this book, Taylor does better than most at sluffing off the inane tendency to blame “greed” and stupidity for the panic. In an era when we seem to keep looking to the government for answers, this is an important perspective about its ills. But if this book proves anything, it’s that the very causes of this era in financial history are still very debatable and in doubt in the public forum, and will be for decades to come.
*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.
Running low on Shekels? Wish you could afford that nice goatskin your wife’s been asking for? Are you covetous of the new model mule—the one with 0.5 horsepower? Do you desire your cup to runneth over with libations? What about that designer robe of fine cloths that caught your eye in the bazaar last week? Tired of the same old salted meats and dry grains when you could be enjoying the rare spices of the world? Then have I got a book for you!
One of the longest running and bestselling investing books of all-time, The Richest Man in Babylon is attributed to George S. Clason, but there were probably many authors. The book first popped up in the mid 1920s as a series of short anecdotes widely circulated by financial institutions, and was eventually compiled and released as a book. It’s a series of allegories set in ancient Babylon meant to convey the “timeless” wisdom of finance.
Timeless, maybe, but in some ways it feels dated—stuff like IRAs, 401Ks, savings accounts, and the general notion of investment as a venue for retirement is hugely popular today…probably at least a little because of this book’s longevity and popularity. All this is certainly in the public consciousness by now (of course, whether folks heed the advice or not is another matter entirely).
What I like is the spirit it conveys—equating financial prudence with wisdom and teaching that achieving wealth is often a matter of personal responsibility. In today’s world, where populist anger equates wealth almost exclusively with greed, we could use a reminder that riches for most folks are the result of a lifetime of work ethic, discipline, and prudence. As such, it’s a great book for budding graduates and other young adults who need such lessons.
But it’s hammy. The characters speak like a cross between Hamlet and Yoda, and often descend into aphorism, banal platitudes, and a sort of prophetic righteousness that will elicit more than a few chuckles. In its own way, this feature contributes to the fun of the book more than it detracts. For instance, the “Seven Cures for a Lean Purse” feature great one-liners like, “Start thy purse to fattening,” “Make of thy dwelling a profitable investment,” and “Guard thy treasure from loss.” Even a perpetual sourpuss has to smile a little at these.
For some reason, ever since the King James Bible folks seem to think all cultures before about 1800 AD spoke the King’s English (A favorite quote: “Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field”). I guess the lofty language gives the sheen of wisdom. There’s always been the fantasy that “ancient” means wise. But none of these folks spoke this way in ancient Babylonia. Barely anyone could read or write. Yes, languages of antiquity were fairly well developed, but on balance were rough and far less sophisticated than much of what we have today. (Language is a technology too, and differing dialects have differing usefulness, particularly in fields requiring exactitude like the sciences and finance. But I digress.)
As allegories go, Babylon is fairly entertaining and drives its points home. But generally allegory is used to nuance and juxtapose lessons so as to broaden and deepen the teaching. I’m not sure there’s a lot of nuance in this book: save, be frugal but enjoy your life, and invest in things that generate income—we hear these dictums over and again.
Importantly, the story and its ancient setting actually obfuscate some of the finer points of today’s investing landscape. For instance, I doubt your average Babylonian citizen particularly had a long enough time horizon to see the benefit of compounding interest. Sure, some lived long and grew fat with years, but when you’re looking at an average lifespan of well below 50, and the occasional plague or famine, well, that starts to alter your long-term plans. Also, what’s magic about 10% as an appropriate savings rate? Why not 15% or 5%? There’s no discussion of such things, or of other basics like diversification (probably because diversification as a formal finance theory was still decades away in the 1920s). But not putting all your shekels in one clay wine jar is really important for novice investors to know.
Another example is gold. “The Five Laws of Gold,” which comprises a large chunk of the book, is sometimes misleading. I think what’s really meant here is “the five laws of money”, or capital. This seems like quibbling, but it’s an important distinction because much of this book is about how to generate future income. Well, gold is not a productive asset—it’s just a thing, a commodity. You have to do stuff with it to get income, that is, to create value. That’s different than owning a stock, for instance, which is ownership in a share of an enterprise that exists to create value.
You can have a lot of fun with Babylon. Where Warren Buffett would say something boring like, “I only invest in businesses I understand”, here you’ll get, “Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those who are skilled in its keep.” But I’d advise sticking with a modern dialect when discussing your investments with your advisor, lest you end up with a portfolio denominated in goatskins.
Joshua Cooper Ramo’s The Age of the Unthinkable, ends up missing the mark, but for the right reasons.
Several clients have brought Joshua Cooper Ramo’s new book to my attention: The Age of the Unthinkable: Why the New World Disorder Constantly Surprises Us And What We Can Do About It (long enough title?).The author is a distinguished guy: Managing director at Kissinger Associates, a “geostrategic” advisory firm (I’m not entirely sure what that means), and former assistant managing editor of Time magazine. But this review is going to be detailed, and very critical. It’s not that the book is so bad, it’s just that it’s so close to being right…but isn’t. Its subject is geopolitics and not expressly capital markets, but Ramo throws them all into the same bucket—saying they’re all “complex” systems (more on this in a bit). Complexity theory is a great venue to study such things, but both Ramo’s premises and conclusions are shaky.
That’s hugely frustrating, and warrants some attention because complexity theory is the “hot new thing” in a lot of economic alcoves, and is threatening to hit the mainstream more readily in years to come. Thus, it’s good to know what works and what doesn’t when thinking along these lines. In terms of style and readability, this is a fine and entertaining read. Ramo is an excellent writer and journalist.
Let’s take a look under the hood.
The Problem Is the Premise
The real problem with this book is its premise: That today is the beginning of an age where culture, technology, government, economies—the whole world—are experiencing rapid and accelerating change that will have effects no one can anticipate or understand, and that vast upheavals will result.
This is both true and untrue. At best, we are in the middle of such an era. Starting at least with the Industrial Revolution, economies and governments of the world have undergone rapid and ever accelerating change—all of it unpredictable as it was happening. Those that were born about at the beginning of the 20th century saw bigger change than any generation before them—with a good bit of the world going from largely rural and agrarian to what we have today. That was the true beginning of accelerating change. There is nothing so special about the present moment in this regard, though many would like to think so tied to the financial and geopolitical chaos of the last decade.
Indeed, the foundational premise of this book is taken as given and without so much as a few pages to actually prove such a proposition. Ramo refers to a “hockey stick” graph, where the rate of change was constant for a long time, then suddenly—as in, now—the chart jerks upward and we see hyperbolic global change. Yet, there is no statistical evidence to support any of that. It may feel that way, yes, but it’s the tendency of folks to always feel the present era is getting beyond control. Again, if the hockey stick theory is right, it started well over a hundred years ago.
This book references a litany of thinkers and lauded studies—it’s intellectually dazzling in this sense—yet fails to reference the preeminent thinker on this topic: Ray Kurzweil. His book, The Singularity Is Near, shows in painstaking detail that accelerating change has been going on worldwide for a very long time and is not new.
What I believe this actually is, in disguise, is a fairly banal “new normal” argument. Ramo is saying that now is different, and so we have to think differently. Well, every era is different in its own way. There is nothing privileged about today’s difference. And the prevailing economic and capital markets recovery of the last year or more reflect that.
Complexity Theory, Misapplied
There’s an old philosopher’s joke, apt for this book. No matter how overmatched you might be, you can win any philosophical argument by simply saying, “Well, yes, but it’s actually more complex than that.” There’s no way a philosopher can surmount it! It’s always true!
Complexity theory, to my view, is one of the most exciting and important new theoretical fields in understanding economics. My own book, 20/20 Money, is based on its foundations. I was stunned when I read that Ramo co-chaired the Santa Fe Institute’s first working group on Complexity and International Affairs. The Santa Fe Institute is perhaps the world leader on complexity theory. I was stunned not because he held such a position, but that someone of that position could misapply complexity theory so greatly.
To tout complexity theory is a fine thing, to say that we can’t ever understand exactly how the world works because it’s too vast and complex to fathom, that there are interconnections in the global economy so deep no computer could ever suss them out fully—is righteous.
But that doesn’t mean there aren’t patterns to be discerned with real causality behind them. And even if the patterns of this world break down, they don’t do so “instantly”—they generally happen gradually and are replaced by new ones. For instance, correlations between stock market returns for countries can break down over time, but those trends can last for many decades. Complexity theory shouldn’t teach us that the world is unintelligible. The lesson is that we must exercise humility—we can’t know everything, we can often be wrong, and there can be anomalies to common patterns. Which makes forecasting across any complex system a matter of probability, not certainty.
Ramo’s principle example for complexity is the “sand pile.” I’ve heard a handful of economists and thinkers articulate this idea incorrectly. Essentially, that if you start a sand pile, adding one grain at a time, you get a structure that can become huge, but at some point one grain of sand will eventually topple the whole thing—each grain moving the others in ways no one can see, until the pile is decimated. And there’s no way to know which grain that will be, and how catastrophic the decimation will be because it’s too complex. This is sometimes referred to as the “fingers of instability.”
The sand pile is a wrong metaphor for thinking about human systems. One of the main, and vital, features of human systems is that self-directed volition (emotion, motivation, the ability to consciously affect an outcome, etc.) actually changes the whole game. It’s fine enough to use examples like sand piles and ant farms (as I do in my book) as starting points to understand complexity theory, but it’s not enough. Things change drastically when we layer on consciously directed systems, with self-aware participants to affect outcomes. This, for instance, is precisely what monetary policy is.
Also, the human psyche has universal features to it. One of the amazing things about capital markets is—regardless of time, place, and circumstance—investor behavior doesn’t vary that much. Panics are panics, bubble euphoria is too, no matter where you go (or when). Love and hate may take many forms, but there they are, everywhere. These things transcend culture and time. Which makes their patterns at least tacitly recognizable, if not often gamable.
So when we think of complex systems like our global economy, the lesson is not unintelligibility, it’s that we must think in probabilities—patterns can tell us something about the future, even though sometimes they break down or are misunderstood (because, yes, the stock market is a complex, self-organizing system). But even chaos theory has patterns. Really!
The Fantasy of Cataclysm
Most importantly of all, though, the metaphor of the sand pile is far too pessimistic. I view capitalist economies as a Complex, Emergent,Adaptive, Systems (CEAS). Ramo discusses adaptability and emergence, but tends to focus too narrowly on the possibility of ruin within them. He says that in an increasingly complex, global world, more interconnected things brings the possibility of more ruin since all things are linked and often in weird ways. It’s a fair enough point, but equal or more time should be devoted to the notion that a complex system doesn’t have to be so fragile—it can strengthen and reinforce itself through interconnection too. That’s the real story of capitalism and democracy through time.
Ramo spends a great deal of time talking about the need for “resilience” in today’s rigid world, touting many notions and ideas—everything from natural weather systems to the philosophy of Chinese warfare to Hezbollah’s methods of political maneuvering. Yet, he fails to see or acknowledge the world’s biggest, most resilient system of them all: free market capitalism! That’s the greatest of all human complex systems—it’s dynamic, resilient, self-organizing, adaptive, and hugely complex. Again, this is a perspective issue. Ramo approaches the global economy today as a victim of complexity, whereas a more accurate view is that system itself has been resilient and stronger than most anyone believed despite a tremendous shock the last few years.
This view that increasing complexity is foremost potentially cataclysmic, that as the system gets bigger and less comprehensible it gets less stable, is more about the immediate anxiety of today’s times than reality. The world is in fact stronger, more durable, and resilient than ever before—and it can get more so. Does that mean upheaval is eradicated? Of course not. It means, when calamity does strike (as it did in 2008), the global economy can recover faster and stronger than most believe—as it has. But you can’t see that when you’re wrapped up in the fantasy of ruin.
If you took the fatalistic view, you could never be bullish—never participate in stocks’ (i.e. capitalism’s) tremendous long-term gains. That view has been wrong basically forever. Even passive investors, who just plunk their money in an index, gain over time, including successive big bears like in the last decade.
Analogies and Intellectualism
My boss Ken likes to say analogies are useful but always imperfect. Mr. Ramo is a hugely learned person and a fine writer, and he uses that acumen to heap on examples and ideas from all times and places to bolster his points—everything from modern art to meteorology.
I usually enjoy such an approach—to interconnect and reinforce ideas in ways strange and counterintuitive. Unfortunately, Ramo uses too many metaphors that not only obscure his points, they end up erroneous.
For instance, he argues we live in a world where many ideologies can prevail and multiple perspectives are key to a cogent view of reality. But he couches this idea in a series of misplaced examples. For instance, he says different-thinking artists often see “revolutions” in the world before others, then takes a multiple page jaunt into art and Modernism, using Picasso’s cubist period as an example of the “multiplicity” of thought we need to experience to set better public and geopolitical policy.
This is too treacherous an analogy. If we go one step further, it explodes. In the history of 20th century art and philosophy, the next move is to say with the recognition of multiple views it should be clear that all views have some claim to truth, and at the same time all views have essentially no claim to truth—they are all “perspectives,” that is, points of view. Thus, the greatest truth we can have is our fictions, our narratives. This is known as postmodernism. Perhaps Ramo is unaware of postmodernism, but I doubt that. More likely, it doesn’t fit the point he wants to make and therefore isn’t part of the grab bag of metaphors he dazzles us with. What all this art and philosophy does, instead, is reveal the shallowness of the idea he’s proposing.
As I warned, I’ve been quite harsh on this book. And I beg your forgiveness because complexity is such a dear topic to my own heart. The ideas and sheer breadth of intellectualism in this work will dazzle, but at core they rest upon a foundation of sand.
|*The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.|
Over the next year this column will review contemporary and classic economic, business, and investing books. I won’t endeavor to find the definitive investing “Bible.” There is no hallowed list or canon of investing literature. I’ve known many folks over the years—across a variety of disciplines—who search for “the” texts. As if an investing Holy Grail is out there waiting to be uncovered.
No such thing. The process of investing is about—at least in part—the spirit of exploration. Not just delving into today’s headlines and data, but also knowing what has come before and why. Traversing the territory of thought on just about any topic is adventurous—there’s a great deal of fluff, wrongheadedness, misdirection, brilliance, insight, and all in between. Plenty to agree and disagree with. Ultimately, a good investor shouldn’t ever be indoctrinated, but should know the context before forging one’s own path forward.
So let’s start with a read that’s a synthesis of my favorite kinds of books: Short, timeless, insightful, clear, and often witty—GC Selden’s Psychology of the Stock Market.
Originally published in 1912, this little 125-page book appeared just a handful of years after the Panic of 1907, and some parts are clearly a reaction to it. Yet, despite its old age, this work is still around. Why? When studying market history, often the starkest and most obvious truth is how much doesn’t change. Selden’s opening chapter, “The Speculative Cycle,” could appear in Forbes today and few would doubt it was penned expressly for the most recent bear. Of particular note is Selden’s often ignored observation (to this day) that markets in the short term can become both over- and under-valued—one of the prime lessons of 2009. Overshooting can (and almost always does) happen in both directions.
“The broad movements of the market, covering periods of months or even years, are always the result of general financial conditions; but the smaller intermediate fluctuations represent changes in the state of the public mind, which may or may not coincide with alterations in basic factors.”
Selden’s heart is that of a trader’s (he’s often concerned with liquidity, another important feature of the most recent bear), but his insight rings true for longer-term investors too.
The beginning of the 20th century was a heady time: The US was on the cusp of superpower might, modernism was entering the culture, the Industrial Revolution (and thus capital markets) were thriving. Selden seems acutely aware of the prevailing intellectual movements of his time. Just to use the word “psychology” in the title is interesting—William James, Sigmund Freud, and others were just then giving birth to modern psychology. We can’t know if Selden studied those folks, but we can safely say he favored pragmatism over theory—he saw occasional anomaly where classical economics modeled most everything on rationality and “invisible hand” notions.
Indeed, Selden’s chapter, “Confusing the Present with the Future-Discounting,” is cutting-edge thinking for its time—ostensibly an affirmation of Louis Bachelier’s 1900 dissertation and generally accepted founding doctrine of the efficient market hypothesis, “The Theory of Speculation.” Those debates—on the role of behavioral psychology and market efficiency still rage to this day and aren’t as new as we often believe.
“The psychological aspects of speculation may be considered from two points of view, equally important. One question is, What effect do varying mental attitudes of the public have upon the course of prices? How is the character of the market influenced by psychological conditions? A second consideration is, How does the mental attitude of the individual trader affect his chances of success? To what extent, and how, can he overcome the obstacles placed in his pathway by his own hopes and fears, his timidities and his obstinacies?”
Selden was acutely self-aware, and this is where the majority of his wisdom emerges. He doesn’t claim to know what’s in the hearts of men—he just claims emotion is more than capable of overruling the rational. Ultimately, humans are at the core of markets—no matter the epoch or level of technological sophistication.
He preaches the notion of knowing oneself first and foremost—to gain mastery of one’s emotion and perspective. In a word, it’s discipline—the least sexy but possibly most important part of investing over the long term. Simply, Selden recognized his own limitations, what he could and could not know, and therefore how he could move within the market system. He’s nothing if not a pragmatist (a virtue, as the true vice of psychology is often to delve into the fanciful and theoretical). Over and again he recognizes implicitly that to forecast the stock market is brutally difficult, and that even the best at it will often be wrong.
It would be easy to call Selden a contrarian, but that isn’t nearly right. Not purely technical, not purely intuitive, Selden’s work is an amalgam of insight over years of experience in a time long before we had the mechanics of Ben Graham or even the “animal spirits” of Keynes. He offers a rare glimpse into a view less obscured by today’s hyper-defined investing categories and schools—and that makes his often still-valid wisdom all the more ingenuous today.
Darrel Huff was a very concise writer, so I will be too. His classic How to Lie With Statistics, first published in 1954, is still the best way for novices to enter the world of number interpretation, and their often latent distortions. Bowling shoes.
One of my all-time favorite comedic devices is the non sequitur—a deliberately illogical response or interjection for comedic effect. No one did this better than Monty Python or, for that matter, Samuel Beckett. Pancakes. Here’s a tremendous example. Strangely, How to Lie With Statistics is full of them (non sequiturs, not pancakes). As nearly as I can tell, the cartoonist who did the illustrations may have had no prior knowledge of the text—he/she just drew “stuff” with tangential relation to the text to fill pages. It’s amusing and more than a little bizarre.
I read this book once every couple years, but this time around it felt a bit stale—the examples are starting to feel old. Nevertheless, the wisdom doesn’t change: The real lesson of this book is not to learn the specific foibles of statistics so much as the spirit of skepticism one must bring to any statistic encountered. Huff takes a dim view of newspapers and reporting generally, which often borders on the cynical. But after years of watching the media and many, many thousands of articles read later, to my view, he’s right to fall closer to the cynical side than the credulous.
Another important lesson: Never fall in love with exactitude. Exactitude is often a sickness in the business of economics. Numbers are messy, economics are messy, the world is messy. When it comes to looking at huge economies, statistics are great to get a sense of things, and not much more.
If you want an adventure, take any economic indicator you like—from GDP to employment surveys—and see how it’s calculated. The number of assumptions, plugs, and other bizarre mathematic miscellany will boggle your mind. This isn’t to disparage those statistics—they are what they are and have their use. Eddie Van Halen in ballet shoes. But it will teach you very quickly not to quibble over 3.1% GDP growth versus 3.2%, for instance.
Before we go, a quick example on how statistics can fool us: Thomas Sowell’s most recent book, Society and Intellectuals, tackles the widely accepted notion “the rich are getting richer and the poor are getting poorer.” According to Sowell, the stats often used to bolster this idea don’t actually prove that particular point, instead they prove an entirely different one. What’s happening is that the categories of income are becoming more disparate. But Sowell’s insight is that people don’t stay in the same category through their careers—most move up the ladder over time! Manatee. Looking at categories of income is a much different thing than knowing whether folks in the real world are actually getting richer or poorer over time in a relative way. So at a minimum, the stats don’t say what most think they say. After all, I’m willing to bet you started your career at a low income bracket, and moved up over time too.
Ultimately, How to Lie with Statistics might be too facile for some—this is for the absolute square-one beginner. Today’s world is full of bell curves, T-tests, and multiple regressions. If you want to go a step further and introduce yourself to the kinds of statistical tools heavily used today,Statistics for Dummies, believe it or not, is a good place to look. Ben Bernanke wearing a scuba mask.