Picture Credit: Kailash Gyawali || There are times when despair is rational

“There are two hard things in trading — buying higher, and selling lower.”

Currently I am selling out my position in an illiquid stock. I am patient, but I can tell that my selling is having an impact on the market.

Back when I was a corporate bond manager, I quickly learned that I had to scale in and out of positions. Even for the most commonly traded bonds, the market isn’t that liquid. While not lying to the brokers, learning to disguise your intentions, or at least frame them properly took some effort. One method I commonly used worked like this: “We need some cash. If you have someone wanting to buy $2-5 million, we will offer these at the 10-year Treasury + 150 basis points, $6-10 million T10 + 140 bps, and if they want to buy the whole wad (say 20-30 million), T10 + 125 basis points. Prices would ascend with size in selling. Prices would descend with size in buying, particularly for troubled bonds that we liked.

Usually the brokers appreciated the supply or demand curves that I gave them. Frequently I ended up selling the “the wad,” which we were usually selling because our credit analyst had a reason.

But life is not always so happy. Sometimes you have an asset that either you or the organization has concluded is a dud. Many people think it is a dud. How do you sell it? Should you sell it?

There are options: you could hold an auction, but I will tell you if you do that, play it straight. Your reputation is worth far more than if the auction succeeds or not. You can set a reservation price but if the auction doesn’t sell, you will lose some face.

Or you can test the market, selling in onesies an twosies ($1-2 million) seeing if there is any demand, and expand from there if you can.

What I tended to do was go to my most trusted broker on a given bond and say, “I don’t have to sell this, but we need cash. Could you sound out those who own the bonds and see what they might like to buy a few million?” If we get an interested party, we can sound them out on buying more a an attractive price.

But life can be worse, imagine trying to sell the bonds of Enron post default. Yes, I had to do that. And I had to sell them at lower and lower prices. (Kind of like the time I got trapped with a wad of Disney 30-year bonds.)

And there is the opposite. You want to have a position in an attractive company, and you can’t get them at any reasonable price. You could give up. You could “do half.” Or you could chase it and get the full position, only to regret it.

If you invest with an eye toward valuations, this will always be a challenge. All that said, if you focus on quality, these issues probably won’t hurt you as much.

In any case, do what must be done. If something must be bought, buy it as cheaply as possible. If something must be sold, sell it as dearly as you can. Hide your intentions, while offering deals. In doing so, you may very well realize the most value.

Picture Credit: Ron Mader || Humility is underrated. Without it everything is a fight.

“Size expectations to resources and you will rarely be disappointed.”

I would think that this one would be “common sense,” but I have another saying, “Common sense isn’t.” Many people engage in magical thinking, overspending and assuming that things will work out in the end. Under most conditions, it does not work out in the end.

Living in reality is a key to happiness. Delay gratification, have a buffer, and invest for the future. What could be simpler?

You might or might not be surprised at how many let short-term pleasure dominate over long-term well-being. I think it is hard if one is single to have the gumption to think long-term. There is a temptation to play when there is no one else relying on you.

The lessons of the Great Depression have been lost. Be self-reliant, or family-reliant.

Patience and humility are underrated virtues. Perhaps it seems like those who are proud and impatient do better, but that’s just the unequal signal problem. What’s the unequal signal problem, you say? Those that publicly succeed get more notice than the many more that privately fail because they offend others with their pride and impatience.

I’m not saying don’t take moderate risks to improve your position in life. I am saying that trying to hit home runs begets a lot of strikeouts. If you are not capable of bearing the losses of strikeouts, don’t try to hit home runs. Instead, try to hit singles more reliably.

This is one reason why I say to diversify. Here’s something I haven’t said before, but when I was a kid, I used to read Value Line. They would talk about cash as a diversifier, and highlight stocks that were growth at a reasonable price, and had momentum of earnings and price. It’s good to keep short bonds (cash) on hand for the opportunity to invest at lower prices when they become available. Or, to use the cash in an emergency, because you can’t always be sure of future spending needs.

Investing in stocks requires patience. Holding cash (short bonds) requires humility. With patience and humility you can take on the markets and not worry much about the future. You know you can hold your positions. You know you can meet surprising cash needs. You are ready for anything, because you have enough slack in your asset allocation to hold onto your risk positions under almost all circumstances.

For me, humility meant paying off my mortgage debt early, even though my investing was going well. My investing went well because I didn’t have to worry in market downdrafts about how we would live. Really, I haven’t had a significant personal economic worry in 18 years.

Patience for me meant slowing down buying and selling stocks. Hold them longer. Think harder about the purchase decision. Business plans take time to develop. Owning stock is owning a business. Real success comes over time, not by day-trading.

And, find happiness where you are. Retirement can be fulfilling even if you don’t have a lot of assets. Find work that isn’t too taxing, and keeps you in touch with others. Having purpose in life aids happiness. Then use your assets carefully to aid your life over the long haul. Remember that longevity is a risk, so don’t overspend.

Does this sound hard? Yes, it does. And that is our lives. Humility helps at this point, realizing that growing old isn’t easy. But if you size your expectations to your resources, it will be easier, recognizing that you did your best, and that you are getting a reasonable living in your old age.

Picture Credit: Infoletta Hambach || I suppose Euros are manna from somewhere, though not Heaven. After all, they appear out of nowhere [ECB], and there is no guarantee that any government will receive them in the long run.

“The lure of free money brings out the worst economic behavior in people.”

David Merkel, often said at Aleph Blog

Where is there “free” or at least “inexpensive” money?

• Jobs that are overly compensated compared to the skills needed.
• Demanding that the government give free money to people.
• Constraining interest rates to be low.
• Various “one decision” investment ideas.
• The prices of houses only go up.
• The government bails out bad investments.
• Various investments involving derivatives where one is implicitly short volatility

I started writing this two weeks ago, and then the idea for “Welcome to our Country Club!” came into my head, partially stimulated by a young friend of mine becoming a lifeguard at a swanky country club. It made me think back on my time as a youth being a caddy at a similar club. (And being one of the smallest guys there, I had to learn to defend myself, but that is another story.)

A number of parties have directly and indirectly mused about what I what analogizing in “Welcome to our Country Club!” Real Clear Markets put up a Bitcoin logo. I commented there:

Well, you made explicit what I left implicit. Good job, but you can also throw in penny stocks, meme stocks, some SPACs, etc. Thanks for mentioning me.

Me

In the bullet point above, I listed seven classes of cases where there is free money, or at least subsidized money. I’ll take them in order.

Jobs that are overly compensated compared to the skills needed

There’s always some of that naturally, but it tends to adjust over time unless the government does something to achieve a social goal. That can be unions with a closed shop as an example, or restricting the ability to enter into a simple business, if licensing is too tight. There are corrective mechanisms for both, but they take a long time. Technology can reduce the need for labor in certain types of simple jobs. Or, it can create a competitor to those in a regulated industry (think of Uber, Lyft, Airbnb). In some cases businesses move to non-union venues whether a different part of the US, or another country.

Demanding that the government give free money to people

I’m not in favor of Universal Basic Income. I’m fine with non-subsidized unemployment insurance (though I never tapped it the three times I was out of work — desperation is a good thing).

Many quotes are attributed to Ben Franklin than he actually said. Here’s an alleged one that is interesting:

However, when McHenry made the story public in the 15 July 1803 Republican, or Anti-Democrat newspaper, it had evolved. Now the exchange was:

Powel: Well, Doctor, what have we got?

Franklin: A republic, Madam, if you can keep it.

Powel: And why not keep it?

Franklin: Because the people, on tasting the dish, are always disposed to eat more of it than does them good.

How Dr. McHenry Operated on His Anecdote

If the quote is accurate, it fleshes out the ideas that Republics have to be limited in scope to survive, and that once people that they can use the republic for their self-interests. Even in the recent mini-crisis, knew of a lot of organizations that got PPP loans that didn’t really need them — they profited from the free money. They were organized, with clever accountants, and milked Uncle Sugar while he was throwing money around. (Here’s a particularly notable case.) But there are other places where this happens as well — corporations have gotten very good at slipping ta preferences into the tax code. Even if the US Government wants to encourage a certain behavior, if they are generous, they get overused. This applies to many mass programs as well such as Crop Insurance and Flood Insurance, both of which are subsidized.

The list goes on and on, whether for the upper classes, who benefit the most from this, and the lower classes, who get enough to blunt desperation.

Constraining interest rates to be low

With the Fed following a theory close to Modern Monetary Theory Banana Republic Monetary Theory, it has inflamed three areas of the bond market — Treasuries, Conforming Mortgage Backed Securities, and Junk Corporates. This has pushed housing prices higher, and facilitated high government budget deficits (and the unrealistic spending goals of many), and aided malinvestment by firms that have access to cheap capital, when they should have gone broke.

As Cramer would say, it’s time for me to ‘fess up. I was wrong on my piece Hertz Donut. Cheap capital and the end of the C19 crisis gave equity holders a big win. I know I will sound like the Grandpa from Peter and the Wolf, “What if Peter had not caught the wolf? What then?” To those who didn’t listen to me and won, congratulations. To those who listened to me and lost, I’m sorry. I gave orthodox advice that worked 99% of the time over the prior 60 years. I will give the same advice next time, because you can’t rely on the capital markets to do a favor for you.

When the history books are written 30 years from now, the historians will point at the easy monetary policy of the Fed from Greenspan to date as the major reason US markets overshot and crashed in real terms, along with underfunded promises made by the US and State governments.

Various “one decision” investment ideas

This was the main point of “Welcome to our Country Club!” This can apply to the FANGMAN stocks, promoted stocks whether penny or meme stocks, private equity, cryptocurrencies, etc. There are no permanently good ideas in the markets. Every sustainable competitive advantage is eventually temporary. You don’t own a right to superior returns, at most you can temporarily rent it. Even the idea of buying and holding an S&P 500 index fund means that you will have to endure 50-70% drawdowns once or twice every twenty years or so.

Few truly have “diamond hands.” Perhaps Buffett could have them, but even he makes changes to his portfolio. Let me give a practical example: few people wanted to default on their mortgages during the 2007-2012 crisis, but many were forced to sell at an inopportune time because of unemployment, death, disease, disability, divorce, etc. And far more panicked. There are very few people (and institutions) that are willing to buy the whole way down, and concentrate their holdings into their best ones during a crisis. It hurts too much emotionally to do so, and looks stupid in the short run.

Don’t deceive yourself. Keeping some measure of slack capital (“dry powder”) helps keep you sane. You will look stupid at times like now, but over the long haul you will persevere.

The prices of houses only go up

At least we know from recent memory that residential housing prices can decline across the nation as a whole. On the bright side, current financing terms are not as liberal as they were in 2004-2008. Loan quality is reasonable. But the recent run-up in prices is considerable, in real terms higher than the financial crisis. If we have a significant recession, will there be another crisis?

The government bails out bad investments

One of the failures of the financial crisis was to protect industries that were larger than what was needed. Too many banks, too many houses, too many auto companies, etc. The government, including the Fed, could have protected depositors, but let those who speculated on the continual rise in housing prices fail. They bailed them out with two negative impacts: 1) unproductive investments continue, rather than bein liquidated, which slows growth, and 2) moral hazard — firms take more risk because they know there is a decent chance they will be bailed out in a crisis.

I feel the same way about the recent mini-crisis. We should not have bailed out anyone. The Fed should not have provided excess liquidity. If you don’t let recessions clean out those who have been taking too many chances, you end up with a lot of underperforming junk-rated companies that are non-dead zombies. Over the last 30 years, this is why GDP growth has slowed, we don’t let recessions eliminate subpar uses of capital.

Various investments involving derivatives where one is implicitly short volatility

This was the portion of Where Money Goes to Die that was right in the short-run. During bull markets, many short volatility strategies will make seemingly risk-free steady profits. There are other strategies like it that do well in bull and placid markets, but get killed in a bear market, even a mini-version like early 2018.

Avoid complexity in investing, and stick to simple investments like stocks, bonds, and cash. Stick to things where custody of the assets is almost certain. Cryptocurrencies and derivative strategies typically have weaknesses in custodial matters, such that there are sometimes losses from misappropriation.

Summary

Good investing and good work result from taking moderate risks on a consistent basis. Avoid situations where other are running after what is seemingly free or subsidized money — those situations often come to a bitter end.

And against the advocates for Modern Monetary Theory Banana Republic Monetary Theory, I will tell you that eventually all of the borrowing and spending will come to an end. As in the Great Depression, the rich will ask to have their claims honored at par, while the rest of the nation suffers. Whether the government goes with the rich or not is an open question. But one should not assume that inflation will be the way out… after all, that route could have been taken in greater degree in the Great Depression, but it wasn’t.

Picture Credit: m.robersonart || “When You Come to a Fork in the Road, Take It” attributed to Yogi Berra

Limit the timing of a person’s choice, and the person will think about choosing.

In 1992, I went to work in the Pension Division of Provident Mutual. It was a time of change as more and more pensions were being structured as defined contribution [DC] plans. Old products structured for defined benefit [DB] plans were being replaced at a slow rate. Immediate Participation Guarantee products were giving way to Guaranteed Investment Contracts, which would quickly give way to Synthetic Guaranteed Investment Contracts.

And for variable accounts, insurers were trotting out separate account products to try to challenge mutual fund companies as they competed for the business 401(k)s and other DC plans. Now old methods die hard. Many of the group annuities marketed to DC plans still had DB style features, which limited the number of times NAVs were calculated, and/or trading from one fund to another, which could only happen when NAVs were calculated.

As time went on NAVs were calculated with greater frequency, moving from annual, to quarterly, to monthly, to daily. Trading ability moved in lockstep, though some firms limited the total number of trades in a year that any participant could make.

And then a strange thing happened. When it was annual many people traded on the day it could be done. Moving to quarterly and monthly, not only did the percentage of people trading drop, the absolute amount dropped as well. Moving to daily, it was almost like people stopped trading. Because they could do it at any time, they stopped worrying about it and did not trade much until a panic hit. (Aside: when it moved to daily, a small group of people did trade frequently, but the grand majority would do nothing, or maybe do one rebalancing trade per year if they were disciplined.

Now, this applies in a number of other areas. Often companies want people to forget that they are paying them for service. This applies to many financial products where fees are paid on a daily basis. It’s tiny on any given day, but adds up over time. If a financial advisor offers direct billing, it is definitely more noticeable when you pay it quarterly.

Other companies want you to pay them on an auto-renewing basis. They may even offer a discount for doing it. I don’t like auto-renew, and so if I do it, I put a tickler note on my calendar to consider non-renewal one month before renewal.

Other companies want you to pay automatically from your credit card or bank account. They don’t want you to think about the money you are sending them. Even though it is a minor hassle to write checks for things, paying for them personally makes you think about the product or service, and whether you think you are getting value for your money.

Service contracts for HVAC equipment can be like that as well. Any sufficiently complex service has some stickiness to it, and you have to plan in advance to replace it. Notes in the tickler file help to get you ready for the renewal dates. This year, for the first time in 10 years, I bid out my E&O coverage. And as I have said before:

“For those that are short on time, my basic advice is this: bid out your auto, home, umbrella and other personal lines property & casualty insurance policies once every three years, or after every significant event that changes your premium significantly.”

Bid Out Your Personal Insurance Policies!

The insurance companies count on the fact that you are asleep to raise your rates at renewal. And, for those that buy deferred annuity products (don’t do it), I can tell you that agents keep their own tickler file of the date that the surrender charge goes to zero. Then they call the policyholder up, saying they have a much better policy for them. I can tell you that the single most important factor in annuity surrender is the end of the surrender charge period. In the two years following it going to zero, 30-40% will surrender, and go to a new annuity, where they are locked in for another surrender charge period. The only winner is the agent. Both the policyholder and company would be better off if they didn’t surrender.

But life insurance products are sold, not bought, for the most part. The policyholder is probably better off saving something, rather than not saving.

My simple advice to you is take a look at your finances, and think about the places where you money is leaving you quietly. Then make a plan to evaluate every every product and service that is auto-paid, and ask whether you can do better — lower cost, better quality, or even “I don’t need that anymore.” Sometimes you might even find fraud. If you aren’t thinking, and defending your finances, product and service providers will find ways to quietly take advantage of you. Don’t be an easy target.

Photo Credit: jshrive It is why I tell everyone to avoid debt, or pay it down rapidly. Debt is a curse , as the Bible says, and you must fight it, or it will fight you.

When does a debtor look his best? Immediately after he has received the loan.

Eric Hovde, a beloved boss of mine who said many intelligent things.

We are in the midst of the biggest expansion of debt that the US and the world has seen. At present the credit markets are calm, as few are defaulting relative to expectations. Part of that is that the stock markets are high, and that credit is flowing freely. Defaults in the corporate bond market tend to come three years after corporate issuance has peaked.

In the same way, refinancing and defaults on residential mortgages start small, and 2-3 years out reach a normalized level in absence of a financial crisis like 2008-9. Most asset-backed lending is similar, with defaults arriving 20% of the way into the life of the loan.

Why is this? After the loan is made, a person or corporation has a new asset or cash, and his/its income is typically unchanged from when the loan decision was underwritten. WIth cash, there is new flexibility. WIth a new asset, there is often a lowering of maintenance costs versus older assets.

But that’s just for a time. Assets deteriorate without maintenance, and to some degree, even with maintenance. Cash usually gets used, but the debt is still there… did the debt fund something productive, or was the cash squandered?

We’re in an unusual situation now where there is a lot of fresh debt, and few defaults aside from areas where C19 is killing off certain businesses. With low interest rates and credit spreads, I expect most surviving corporations to term out their debt (replace short-term debt with long-term debt) and wait until the next recession hits. Most companies that default don’t choke on refinancing, but on making interest payments.

But what about government debts? Think of the nations of the world that have genuine failures. There aren’t that many of them, but they are all cases of governments that have borrowed too much in hard currencies, and the export sectors of their economies can’t produce enough hard currencies to service their debts.

But what of the hard currencies themselves? Can they not fail? I’m sure they can, but it will take a failure of confidence to the degree where other nations don’t care whether the failing nation exists or not… and this applies to all of the developed nations and China. Remember that the other nations will have to accept that the debts from a nation that is failing will hurt those in their nation that hold those debts. If they hold a lot of the debts, they will be unlikely to write them off so fast. Think of the LDC debt crises in the early 1980s.

In closing, I would encourage all readers to think hard about what they own, and avoid highly indebted firms. As for governments, the “cleanest dirty shirt” idea applies, unless you want to go for gold — which embeds a bet on inflation. It is quite possible that the next President of the US will struggle with deflation, and the Fed will remain impotent, inflating assets, but not goods and services.

So be careful, and only invest in things that have a significant provision against adverse deviation.