The Longer View, Part 2

When the market gets wonky, I write more about current events.  I prefer to write about longer-dated topics, because the posts will have validity for a longer time, and I think there is more money to be made off of the longer trends.  Before I go there tonight, I would like to say that at present the Fed says that it is ready to act, but it hasn’t done much yet.  As for the Bush Administration, and Congress, they have done nothing so far, and the few credible promises are small in nature.  My counsel: don’t be surprised if the markets stay rough for a while.

Onto longer-dated topics:

  1. Perhaps this should go into my “too many vultures” file, but conservative players like Annaly can take advantage of bargains produced by the crisis.  My suspicion is that they will succeed in their usual modest conservative way.
  2. Falling rates?  Falling equity prices?  Pension funding declines.  This issue has not gone away in the UK, and here in the US, the PBGC is still struggling.  As it is, FASB is facing the issue head on (finally), and the result will likely be a diminution of shareholders’ equity for most companies with defined benefit plans.
  3. China is a capitalist country?  Eminent domain can be quite aggressive there.  At least now they are promising compensation, but who knows whether the government really follows through.
  4. Any strategy, like quant funds, can become overcrowded.  As a strategy goes from little known to crowded, total returns rise and then flatten.  Prospective returns only fall as more and more compete for scarce excess returns.  As the blowout occurs, total returns go negative, and more so for the most leveraged.  Prospective returns rise as capital exits the trade.  Smart quants measure prospective return, and begin liquidating as prospective returns get too low.  Not many do that for institutional imperative reasons (investor: what do you mean cash is building up?  What am I paying you for?), but it is the right strategy regardless.
  5. This is a useful graph of sector weights in the S&P 500.  If nothing else, it is worth knowing what one is underweighting and overweighting.  I am overweight Energy, Basic Materials, Staples, Utilities, and (urk) Financials, and underweight the rest.  My portfolio, right or wrong, never looks like the market.
  6. I’ve written about SFAS 159 before.  Well, we may have a new poster child for why I don’t like it, Wells Fargo.  Mark-to-model is impossible to escape in fixed income, but I would treat gains resulting from changes in model assumptions as very low quality.  Watch SFAS 159 disclosures closely with complex financial companies.  If we wanted to repeat the late 90s headache from gain on sale accounting, we may have created the conditions to repeat the experience in a related way.
  7. How dishonest is the P&C insurance industry?  It varies, as in most industries.  Insurance is a bag of complex promises, which leaves it more open to abuse.  This article goes into some of that abuse, and teaches us to evaluate a company’s claims paying record.  You may have to pay more to get Chubb or Stancorp, but they almost always pay.
  8. China’s financial system is maturing slowly; one example of that is reduced reliance on bank finance, and issuing bonds directly.
  9. I don’t care what regulations get put into place, capitalist economies are unstable, and that’s a good thing.  There are always information asymmetries, and always crowd behavior, such that risk preferences change precipitously.  That’s the nature of the system.  The only true protection is to be aware of this reality, and adjust your behavior before things get crazy.
  10. A firm I was with had an early opportunity to invest in LSV and we didn’t do it.  The two members of our committee that read academic research thought we ought to (I was one), but the practical men of the committee objected to investing with unproven academics.  Oh, well, win some, lose some.
  11. Speaking of academic research, here’s a non-mathematical piece on cognitive biases.  Economists believe that man is economically rational not because of evidence, but because it simplifies the models enough to allow calculations to be made.  They would rather be precisely wrong than approximately right.
  12. Bit by bit, the efficient markets hypothesis get chipped away.  Here we have a piece indicating persistence of excess returns of the best individual investors.  For those of us that have done well, and continue to plug away in the markets, this is an encouragement.  It’s not luck.

I have enough for two more pieces on longer dated data.  It will have to come later.

Tickers Mentioned: NLY WFC CB SFG