Previous posts in this discussion:
PostChina-Russia-Iran Axis: What Do They Have in Common? (Tor Guimaraes, USA, 11/07/19 11:34 am)
My deepest regrets for posting about threats to our nation, which I believe are being severely neglected by our media and the American people. However, I feel the duty to call them as I see them. After all, if we are still a democracy, people need to be informed about major threats. Good news take care of themselves; all we need to do is enjoy them.
JE commented on my post of November 5th: "Iran, Russia, and China have one thing in common: antagonism to the US. But is there anything else that really binds them? My immediate answer is no."
I totally disagree with that view. This is not an "axis" like in WWII; it is a huge social trading economic block with dozens of countries involved, connected by a common logistical infrastructure totaling trillions of dollars. The motivation for creating this block is commerce but also a new financial infrastructure. Furthermore, JE is severely underestimating the China-Russia relations today: Chinese investments in Russia are in the hundreds of billions level, the cultural integration programs have been stepped up considerably, and Putin and Xi have become personal friends. This is clearly not business as usual.
JE comments: Sino-Russian relations never stay good for long, but maybe I am indeed underestimating the situation today. Tor, please tell us more about the financial infrastructure you mention above.
US Financial Hegemony and Alternative Systems
(Tor Guimaraes, USA
11/08/19 4:16 AM)
John Eipper (JE) asked more information about what I suspect is the early building of an alternative financial system to get around the US financial hegemony, which enables it to implement crippling sanctions on any nation going against its interests.
By now we all know about the power of having the major reserve currency, allowing the use and abuse financial credit at will: Argentina and Zimbabwe might get punished by free money production, but the US has been immune to the same. Various countries have tried to build an alternative system based on gold. To my great surprise, Gaddafi tried to develop an African Union with its own gold-based currency and we know what happened to him. Iran tries and also did not get very far. Lately Russia and China have bought huge amounts of gold to replace their US dollar reserves and back up their own currencies. Why would they do that unless they think the US dollar is going down the drain?
From a totally different area I heard that China, which understandably went out of its way to help bail the US from the 2008 crisis, is not going to do it again. Probably given Trump's rhetoric and bully attitude, the US should expect difficulty selling Treasury securities to them as they did in the past. Hopefully Japan and some others may step in?
When I look around I see too many clues that we are in for big financial, economic trouble, much bigger than 2008. That is all by our own doing. I would love to be wrong on this, but the evidence keeps piling up. Also to some extent I feel very chagrined that the world seems to be following the leadership of Russia and China while we just bicker among ourselves in a dysfunctional way. Major threats and dysfunctional behavior, or no intelligent reaction, is a very bad combination.
JE comments: Gold is a static asset, but the yield of Treasurys isn't much better. Still, the example of '08-'09 is telling: when things got really shaky, money fled to US notes, not away from them.
Might things be different in the next panic, Trump's policies and bullying notwithstanding?
Ric Mauricio on Negative Yields, Warren Buffett, Contrarianism
(John Eipper, USA
11/09/19 4:00 PM)
Ric Mauricio writes:
Tor Guimaraes's and José Ignacio Soler's recent insights into economics always gets my thought processes going. So let's discuss speculation vs. production, negative yields, inverted yield curves, Central Banks, and economic predictions.
I have one comment on John E's comment on Warren Buffett that he has "produced nothing but paper." I disagree somewhat. He owns businesses (yes, owning a stock is owning a business) that sells chocolate (See's), ketchup (Kraft Heinz), castings (Precision), smartphones (Apple), drugs (Teva), and retailers (Amazon, Costco). While I own stocks, I also own a business, a gym and one can say it is represented by a piece of paper in the form of an LLC. Financial institutions like Goldman Sachs are based more on speculation. And yes, Warren Buffett does own the speculative Bank of America and Wells Fargo, so one has to say that Buffett does both. But when anyone opens a business, are we not speculating that we are able to produce and sell a product?
Negative yields. Currently, there are negative mortgages in Denmark. How does that work? Every month, the principle goes down by a certain percentage. The mortgagee still has to make some kind of payment, but his mortgage principle goes down faster than if there was interest really charged to him. Oh, that's sweet, you say. But for every action, there is a reaction. Since the banks are not really making much money if any on these mortgages, the mortgages available are limited, thus placing a cap on housing prices. By the way, the reason the US President would love negative yields is because he loves to borrow. Whether that borrowing is on real estate or government borrowing, it doesn't matter to him. So how do the banks make money in a negative rate environment? Well, if you notice, your credit card interest rates are still at 18% to 21%. Nice margin when you borrow from the Fed at zero. Hey, people, please use your credit cards and buy stuff you don't really need because the banks, manufacturers, and retailers need you to spend, spend, spend. But who loses the most from negative yields? Well, first of all, CD rates and bank rates and treasuries will be paying next to nothing, if anything. So with inflation at 3% (historical average) and your dollars earning zero, you are losing 3% on your money every year. Great investment, those dollars. I keep teaching my kids and grandkids this concept of losing money. Another issue with negative yields is that the Social Security trust fund is mandated by law to only hold Treasuries. So with zero or negative interest rates and more and more people collecting social security with COLA adjustments, the trust fund will run into a true deficit a lot sooner than predicted. Those on social security should plan for a 20% reduction in benefits sooner rather than later. For those wondering why your COLA (this year it is 1.6%) is so much lower than their own personal increase in spending, it is because it is based on expenses incurred by the younger population, thus the CPI-W (wage earners) doesn't cover many of the increased expenses incurred by retirees (such as healthcare).
Inverted yield curves. Several months ago, the 2/10 (2 year treasures vs 10 year treasures) went negative. History tells us that when this happens it portends a recession. Trouble is, when. Looking at the charts (like a crystal ball looking backwards rather than forwards), the recession could hit anywhere from 12 to 18 months down the road. Makes sense, considering a slowing global economy due to the trade war. But the President will fix that right before the election, right?
Central Banks. Ah yes, Central Banks. Oh, those financial institutions entrusted with the creation of fiat money and economies. Interesting, those financial institutions are actually owned and controlled by companies such as Goldman Sachs and in Europe, Deutsche Bank (one of the crookedest financial institutions in the world ... oh, is that why the President does most of his business with them?}. People often ask me about the crypto-currencies. My response, oh you mean like the dollars (or Euros or Yuan, wherever you are domiciled) you have in your pocket?
And now: economic predictions. Oftentimes, economic predictions are based on one's perceptions on what is happening in the world, often supported by the media. And much of the "facts" reported by the media (financial news networks are the worst) are fed to them by financial institutions. I noticed one time when Goldman Sachs fed the media that oil will go up to $200 a barrel, yet they were shorting oil. Happens every day with stocks as well. I bought Apple when the news was negative on it, due to the news that the Chinese were not buying iPhones as much as they would (by the way, when I was in the Beijing Apple store, I noticed their prices were much higher than ours, even though the iPhones are manufactured there). I learned this lesson of buying on pessimism from Sir John Templeton. The opposite is also true, "sell when there is maximum optimism." Think dot com.
But I have lots of fun with predictions. In 2011, economists warned that the economy was on the verge of spiraling into another Great Depression. Gold bug Peter Schiff predicted gold would hit $5,000 an ounce by 2012. On November 27, 2011, Financial Times columnist Wolfgang Münchau predicted that "The eurozone has 10 days at most." That would have signaled the collapse of the European Union. The world turned out very differently. The second Great Depression never happened. Gold barely nudged above $2,000, let alone $5,000.
These misfired predictions hurt investors' portfolios. The doom and gloomers, like Ravi Batra and Howard Ruff, promised to "crash-proof" their clients' portfolios with investments in gold and foreign markets. They should have stuck with investing in simple US index funds. So how can you improve your investment decision-making? First, keep it simple. This advice flies in the face of conventional wisdom on Wall Street. That's because Wall Street thrives on complexity.
I blame the rise of spreadsheets and quantitative investing. Financial analysts insist that the more complex the financial model, the more accurate its predictions. But let me share the dirty little secret of financial analysis. Any financial analyst worth his or her salt can build a model to justify almost any valuation.
Less than two months ago, Goldman Sachs placed a valuation of $96 billion on office rental giant WeWork. Today, WeWork is valued at about $8 billion. And it's on the verge of bankruptcy. Don't know where Masayoshi Son went awry.
Enter the fundamental insight of psychologist and former University of Chicago professor Gerd Gigerenzer. He argues that "fast and frugal decision making" trumps complicated predictive models every time. Goldman Sachs's elaborate models are more wrong more often because they are so complicated. But even though they are wrong more often, they make money because they push paper around.
Gigerenzer offers the example of how an outfielder in baseball makes a decision. To model how an outfielder catches a ball requires calculus. But an outfielder doesn't do calculus in his head in deciding where to run to catch a fly ball. Instead, he uses "fast and frugal decision making"--that is, he keeps the angle of the ball in relation to his line of sight constant. In the same situation, the Goldman Sachs analyst would build a model and by the time the model is done, the ball would have dropped onto the field.
To summarize, I do enjoy reading negative news, because more often than not, it provides opportunities for profit. Oh, my, does that make me an evil capitalist (speculator)?
JE comments: Ric Mauricio's "keep it simple" wisdom is probably the wisest/WAISest financial advice around. Oh yes, and the trick is to zag when others zig. By the by, when was the last time anyone made a killing in precious metals? I'm sure Ric could give a fascinating (and fascinatingly simple) answer to this question.
Investing 101: Keep it Simple
(Jordi Molins, Spain
11/11/19 10:09 AM)
I wholeheartedly agree with Ric Mauricio's rules on investing (10 November). First, keep it simple. Second, buy cheap and sell expensive. Easier said than done.
I only want to point out that the "keep it simple" rule usually means, in practice, to invest in a passive index, such as the S&P 500. Analyzing companies in order to add value in liquid markets, such as American ones, has been proven again and again to be a worthless, or even detrimental, endeavor.
But if one considers the second rule, "buy cheap and sell expensive," there is some conflict: GMO, a well known money manager, forecasts a -3.5% yearly return for American large caps, for the next seven years. On the other hand, little-known companies in Emerging Markets are expected to yield 9.8% yearly, also for the next seven years. GMO uses models that historically work well on the long run (7 years) but they are mostly worthless on the short to medium term.
The paradox is resolved by realizing that the "keep it simple" rule does not need to mean to invest in an American passive index only. In fact, Nobel Prize-winning research shows the optimal way to invest (in the sense of maximizing the risk-reward profile of an investor) is to invest in global passive indices. As a consequence, the "keep it simple" rule should imply a portfolio composed of American passive indices for sure, but not 100% of it, with the rest distributed among passive indices of other Developed Markets, Emerging Markets and Frontier Markets.
But it is hard to really invest globally. Even supposedly global indices, such as the MSCI World Index, only comprise 23 countries around the world. The MSCI All Country World Index, 47. Let me recall there are 193 countries within the United Nations. It seems reasonable to expect that a more WAISly (i.e. global in nature) investment approach is needed.
JE comments: Jordi, we need to launch a WAIS Global Fund...Interested?
My understanding of "Emerging Markets" is that they are the first to suffer when a worldwide panic sets in. Do the GMO predictions for the next 7 years allow for a (sadly, historically overdue) recession?
Ric Mauricio's Investment 101: Indexes and Gold
(John Eipper, USA
11/17/19 4:15 AM)
Ric Mauricio writes:
Ah, I agree with Jordi Molins (November 11th) that most people think of "simple" as investing a generic S&P 500 index. But that index serves as a benchmark to measure one's investment returns against. If you can't beat an imperfect index such as that, then you are wasting your time.
Keep in mind that the S&P 500 index is US-centric, as Jordi points out, but also it is cap-weighted, thus overweighting the largest US companies and underweighting smaller large US companies. This can be solved by equally weighting the 500 (or so) companies that comprise the index and it has proven to be a better performer over the long run. But what about good mid- or small-cap US companies? What about good EMEA (Europe Mid East Africa) companies? What about emerging markets? Good Asian companies? Good Latin American companies? Yes, we can expand our investing universe by investing in the MSCI All-Country Index and an Emerging Markets index. I especially am fond of Frontier markets as a small part of my portfolio allocation.
But keep in mind that during the last decade, the S&P 500 has outperformed those expanded offerings and that most companies in the S&P 500 do bring in at least 50% of their revenue from outside of the US. Invest in Myanmar? No problem, Coca-Cola has done that for you. Keep in mind that over a 15-year period, only 3% of money managers have managed to outperform the "imperfect" S&P 500. There are a few "smart beta" funds that have proven over time to have beaten the imperfect S&P 500 index. One is the dividend aristocrats, companies that have paid and increased their dividends over 50 years.
Gold: Interesting post from Tor Guimaraes. However, might I point out that the $35 gold price was a price made up by the US government. It was not real. No one could buy or sell gold at that price. But when the market for gold did finally open up so that we (US citizens) could buy gold in January 1975, the price was $900 (give or take a few bucks). By 2001, the price was $400, a 56% drop in your investment. In the same time period, the dollar's purchasing power dropped an average 4.72% (70% for the entire period). In other words, what cost $100 in 1975 now cost $329 in 2001. So much for gold as an inflationary hedge. We're not even counting storage, insurance and assaying fees (for gold bars). Krugerrands only became available to American investors in 1991.
Now what blows my mind is that during the same period (I had to look at this three times), the "imperfect" S&P 500 increased 18 times.
OK, so why not buy gold in 2001 at $400 and sell at $2,000 in 2011? That's a great return for 10 years. But then anybody could look at any investment in 20/20 hindsight and say "what if." What if I bought $10k of XYZ options the day before XYZ stock announced it was being bought out, I could have made 5000% on my money in one day. Would that prove that buying options (or gold) is a great investment? Would that mean I am a genius or just lucky?
Mutual fund companies do this all the time in their advertising. They will say they outperformed the S&P 500 from October 19, 1987 to December 31st, 1987. What they don't tell you is that is the only time in their history that they outperformed the S&P 500.
JE comments: Think about it: can 97% of fund managers truly be "wrong"? Wouldn't the proverbial monkey at the dart board beat the index half the time? (Did anyone ever succeed at getting a monkey to throw darts?)
I'm curious if the managed funds do worse because of their higher fees, or simply because they're, well, wrong.
Dividend Aristocrats and Dividend Kings (from Ric Mauricio)
(John Eipper, USA
11/19/19 4:04 AM)
Ric Mauricio writes:
I need to make a correction to my post of November 17th. Dividend Aristocrats are companies that have increased their dividends over 25 straight years. Dividend Kings are those companies who have increased their dividends over 50 straight years. There is currently no easy way to participate in the Dividend Kings; you will need to purchase all 27 stocks (recommended in equal dollar amounts). One can easily implement the Dividend Aristocrats (currently 57 companies) methodology through ETFs (Exchange traded funds) or mutual funds.
Dividend Kings and Aristocrats have indeed outperformed the "imperfect" S&P 500 index. From 1991 to 2017, $100,000 invested in the S&P 500 would have grown to $1.4 million, while $100,000 invested in Dividend Kings would have grown to $3.2 million and $100,000 invested in Dividend Aristocrats would have grown to $2.4 million. So "simple" could simply be investing in a Dividend Aristocrats fund.
And yes, there is an international Dividend Aristocrats ETF with 79 companies in its portfolio. It is up 15% YTD vs the S&P's 26%.
JE comments: I always appreciated a nice dividend, especially at a time when interest rates are so low. The common wisdom is that dividend-paying stocks don't increase in value as quickly as those that don't pay. But Ric Mauricio's numbers tell a different story.
A question for our market historians: when (and how) did dividend stocks become "unsexy"? Was it during the ascendancy of the NASDAQ-listed tech stocks?
- A WAIS Investment Fund? (Jordi Molins, Spain 11/20/19 3:17 AM)
John Eipper asked on November 17th: "I'm curious if managed funds do worse because of their higher fees, or simply because they're, well, wrong."
For sure, one reason for the actively managed funds under-performance, with respect to their corresponding passively managed funds, is costs. A second reason is lack of diversification: when a portfolio manager selects a subset of the universe of stocks in his or her index, s/he is by definition losing the diversification benefits of the discarded stocks.
However, investors' overall under-performance is mostly due to behavioral biases: the average Joe or Jane tends to sell close to the lowest price in a crisis, and to buy at the top. This bias detracts thousands of basis points to his/her total performance, while fund costs and the lack-of-diversification under-performance represent just a few dozen basis points.
The problem "How should I invest?" has been effectively been solved: invest using passively managed funds, diversifying across world regions. As Ric Mauricio points out, a second refinement could be added to the first one: instead of investing in the broad universe of stocks within an index, choose the so-called factors, which select companies scoring highly in quality, low volatility, high dividend, value and/or momentum. But again, this problem is effectively solved, too, since there exist liquid passively managed funds that track those factors.
The key, unsolved problem is, "Why do I feel empty when I invest in financial markets?" There is a need to fill our lives with meaning, at all levels. In particular for financial investments, people want to "do good." ESG (Environment, Social and Governance) investing is getting its fair share of relevance in recent years. But "doing good" may be wider in scope than ESG investing per se.
For example, investing in Frontier Markets "does good" for society: it teaches to fish (instead of just giving fish). A Frontier Markets fund would bring capital from Developed Markets (where there is an excess capital, finding no good opportunities to deploy it) into Frontier Markets (where there is scarcity of capital, but lots of potential business projects to start). Frontier Markets firms would hire and train local workers, starting the virtuous cycle that occurred in the Developed World in the second part of the twentieth century.
However, even though investing in Frontier Markets is part of the "correct solution" to investing, there are very few funds active on those markets. Why is such an apparent inefficiency allowed to exist and persist? Investing in Frontier Markets is perceived to be risky, and the portfolio managers able to start such a fund (which requires about 3 years of track record before an institutional investor will consider investing in it) are the ones in big management firms, and those prefer to "keep up with the Joneses" rather than creating truly new types of investment vehicles.
WAIS was the world's first e-journal (1983). With the same spirit, may I ask if a WAISer has an idea of how to reach investors who would like to invest in such a project? If so, I would like to hear about that.
JE comments: Jordi Molins is the smartest finance professional I've ever met. As an aside, I always wondered why physicists by training (like Jordi) are so well suited for understanding the markets. How can the finance world mirror the physical world?
So should we WAISers put our money where are mouths are? Let's get a serious discussion going. Any WAIS Fund would of course be global in focus, but the "Frontier" markets present the challenge of uncertainty. Take Bolivia for example: lithium, essential for batteries, is the resource of the future. Yet at present there is a worldwide glut of the metal. If you invested $100K in lithium two years ago, you would now have about... $40K. And who knows what awaits investors with their money in Bolivia.
Jordi, how long has the term "Frontier" been used to describe the poorest developing nations? On the one hand it's a polite euphemism instead of "fourth world" or "destitute," but on the other hand it's condescending, as in the frontier between civilization and chaos.
Between Euphemism and Condescension: "Frontier" Markets
(Jordi Molins, Spain
11/21/19 3:54 AM)
John Eipper asked: "how long has the term 'Frontier' been used to describe the poorest developing nations? On the one hand it's a polite euphemism instead of 'fourth world' or 'destitute,' but on the other hand it's condescending, as in the frontier between civilization and chaos."
That is an interesting question, for which there is a precise answer: Farida Khambata coined the term "Frontier" in 1992, when she was the head of the capital markets department within the International Finance Corp., an arm of the World Bank.
Frontier Markets represent not only "poor" countries, but also relatively rich countries but whose financial markets are not very liquid, due to the country's size, such as Estonia or Croatia.
I agree with John's comment about the term "Frontier" being condescending. However, Frontier Markets usually remind me of Star Trek's "The Final Frontier," of which I am a huge fan. Maybe this is one of the hidden psychological reasons why I am attracted to these markets.
Frontier Markets are quite volatile per se. However, Frontier Markets are quite uncorrelated to both Developed Markets and Emerging Markets equities (and Emerging Market equities are becoming quite correlated to Developed Markets equities in recent times). As a consequence, despite being risky on a stand-alone basis, the addition of Frontier Markets to a conventionally designed portfolio adds very little overall risk, or even maybe diminishes it, due to the diversification benefits provided by Frontier Markets.
As a consequence, a WAIS fund probably should not only be composed of Frontier Markets: the United States, Germany, Spain, the UK or Russia, for example, are an integral part of WAIS. WAIS, being global, deserves a fund investing in a wide array of countries, including Developed, Emerging and Frontier markets.
Finally, the subject called econophysics tries to bring methods from physics into financial markets. So far, despite suggestive analogies between both fields, there have not been any breakthroughs coming from this line of research. But maybe the future will be different.
JE comments: WAISers, let's hear your thoughts on the WAIS Global Fund. I like the sound of it. At first I took for granted that an investment-juggernaut WAIS would have to surrender its nonprofit status, but this may not be the case. Look at TIAA-CREF, the nonprofit that stewards the portfolios of most US academics.
Jordi, while I have your ear: when time permits, can you give us a short primer on econophysics?
- Good as Gold? The Ultimate Insurance Policy (Tor Guimaraes, USA 11/14/19 3:56 AM)
Regarding gold investing, my friend Ric Mauricio stated on November 10th: "In 2011, economists warned that the economy was on the verge of spiraling into another Great Depression. Gold bug Peter Schiff predicted gold would hit $5,000 an ounce by 2012... The world turned out very differently. The second Great Depression never happened. Gold barely nudged above $2,000, let alone $5,000."
That is true, but gold is a very complex investment. It should not be seen as a trade; it should be used as an insurance policy over decades or in case one expects a Great Depression or that your financial system is going to the dogs, making your currency depreciate severely over time. In every case, gold will supposedly hold its value. Further, just because gold bugs have been wrong up to now, because the US has had a reserve currency and the Fed flooded the economy with fiat money/credit at zero or negative rates, it does not mean they are going to be wrong. Everyone should know this is not sustainable.
John asked if anyone has made a killing with precious metals. Let's take a hypothetical and relative benign environment for example: The USA, before Nixon broke the peg, one gold ounce was $35 dollars. Today that ounce is worth around $1,500. If Ric is right you should have sold when the price was $2,000 per oz. The return would have been 57 times higher than your $35 investment. A 5,700 percent return over a 50 years period is around 114 percent per year.
Of course this is a major simplification and we need to consider how you kept your gold coin, etc. This is a hypothetical but it should help answer JE's question.
JE comments: The ideal scenario would have been to ride out that 1970s in gold, sell in 1980, and then buy Apple stock. Ah, hindsight. With my anti-Midas touch, I probably would have bought gold in 1980 and panic-sold at an eighth of the price in 2001.
This chart puts it all in perspective (the figures are adjusted for inflation). Gold is coveted because it's immutable, but this doesn't apply to its price:
- Good as Gold? The Ultimate Insurance Policy (Tor Guimaraes, USA 11/14/19 3:56 AM)
- A WAIS Investment Fund? (Jordi Molins, Spain 11/20/19 3:17 AM)
- Dividend Aristocrats and Dividend Kings (from Ric Mauricio) (John Eipper, USA 11/19/19 4:04 AM)
- Ric Mauricio's Investment 101: Indexes and Gold (John Eipper, USA 11/17/19 4:15 AM)
- Investing 101: Keep it Simple (Jordi Molins, Spain 11/11/19 10:09 AM)
- Ric Mauricio on Negative Yields, Warren Buffett, Contrarianism (John Eipper, USA 11/09/19 4:00 PM)