Author: David Merkel
David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does -- on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better. David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm. Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog. Merkel holds bachelor's and master's degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth.

Issues Associated with the Current Election

Posted on by David Merkel

Picture Credit: derek visser (modified to exclude extraneous comments) || Trump and Harris are more similar than different. Both favor the rich, they lie, they are for abortion and against immigration.

1) For those that follow my Twitter feed, you know that I don’t like Trump or Harris much. Trump has bad character and evil policies.  Harris is an accidental candidate that initially sparked some excitement among Democrats, but has proven to be a low quality campaigner.  Had Biden not sought re-election Harris would not have been the choice of the Democrats.  She would have failed the same way she did in the 2020 primaries. She also has the baggage of having concealed Biden’s mental infirmity, when she should have invoked the 25th amendment as her duty.  Other problems: Endorsing all the actions of the Biden administration. Also, a history of such a wide range of policy positions that you really don’t know what she stands for.  Finally, she is a Democrat so she has evil policies as well.

For ethical reasons, I can’t vote for either of them.  Since I live in Maryland, my vote doesn’t mean anything, anyway.

2) A while ago, I wrote a piece called NOTA Bene, and followed it with NOTA Bene, Redux. NOTA: None Of The Above.  The idea is that “None Of The Above” would exist as a choice in every race, and if it wins, the election must be reheld, with none of the prior candidates allowed to run, and (in the more severe version) that none of the parties represented can nominate a candidate.

Think about it.  The far left and far right would gain no advantage from running polarizing candidates, because they would lose to NOTA.  We need to create a NOTA-type law or amendment to the Constitution.  It ended the Soviet Union; it could end our lousy politics.

3) One other thing NOTA might help end is the “Purple Party.”  The Purple Party governs America on behalf of the rich.  Both Trump and Harris are part of the Purple Party.  In general, the wealthy get what they want as result of the structure of the tax code. They pursue a global dominance policy that protects American and allied business interests, rather than the simpler concept of defense.  They are the party of big government; the Republicans long ago forsook shrinking the government and the deficit.  If we had more moderate conservatives, centrists, and moderate liberals in office, we might be able to work out some of the harder issues.

4) Fideism: “If I believe it, it is true.” We have more and more people engaging in wishful thinking.  An example is Modern Monetary Theory, which I call Banana Republic Monetary Theory.  There are no limits to borrowing?  Tell that to Zimbabwe, Venezuela, Argentina, Turkey, and many other developing nations who borrowed far too much money and ruined their economies.

What makes the US different? Neither Harris nor Trump sees any reason to not expand the deficit further.  For now, other countries want us to buy their goods, so they take in our government debts to make the books balance.  But less and less of the world is doing so. Russia, China, and a few other nations are limiting their use of US dollars, and dollar-denominated debt.

Fideism is a Trump specialty.  He makes up his own truth. The 2020 election was not stolen.  The State GOP chairmen to a man in Arizona, Georgia, Pennsylvania, and Wisconsin all stated there was no election fraud to the degree of changing the results.  If anything, the one trying to steal the election in 2020 was Trump.  After losing, and being told by many of his subordinates that he lost, he did everything he could to change the result.  It’s one thing to file lawsuits with hard evidence; it’s another thing to do it with vague allegations.

But fideism is across the political spectrum, amplified by the far right and far left media.  They feed people what they would like to be true.  Me?  I read from the moderate right to the moderate left.  I have a reasonably good idea of what those who disagree with me think.  If you don’t understand your opponents, you probably don’t understand your own position so well.

5) And why not say, “Let us do evil that good may come”?—as we are slanderously reported and as some affirm that we say. Their condemnation is just. [Romans 3:8 NKJV]

I have some words for my fellow evangelical Christians here.  Choosing the lesser of two evils is choosing to do evil.  It is not copping out to say, “I am not playing this game.”  Just write in NOTA on every race where the main choice is voting for the lesser of two evils.  Voting for Trump or Harris is a sin.

Remember Jesus is King over all, sitting at the right hand of the Father in Heaven. God has already won, and this election is of no consequence to Him.  He does care about what his Church is doing, and in supporting Trump, he sees the sins of the Church.  We can engage in politics, but on Christian principles, not those of the Republican (now Trump Nationalist) Party.

It was good to fight for ending abortion on demand. Roe vs Wade was badly decided in 1973.  This should have been worked out by the states.  Many intelligent people thought the 1973 opinion was thought out badly.  Even RBG thought that.  But when the Supreme Court reversed Roe vs Wade, the predictable thing happened.  Many states passed laws to allow abortion on demand, and many Republicans (who were always half-hearted about opposing abortion because it was only about keeping evangelicals and other religious people who opposed abortion in the GOP) abandoned the pro-life cause.  It was now a vote-loser. 

Christians, you did your best, but the culture of America has changed.  We are a much more cruel society than we once were.  Abortion is cruel, killing the weakest of people in their mother’s womb.

But America is cruel in another way.  My ancestors came to America when immigration was lightly regulated.  They would refuse those who were diseased, and exile immigrants that committed felonies.  Why do I have the right to live here, and those who want to get away from oppressive governments don’t?

I favor of the relatively free immigration that existed before the Protestants acted to keep Roman Catholics, and those of other religions out. Those who come to US fleeing persecution now get locked up in US jails with fewer rights than felons, and the grand majority of them get deported back the country from which they fled.  Who is to blame for this? Trump, Biden and Harris, and their parties.

It is a myth that immigrants take jobs away from others.  If anything, they create jobs.  The jobs they do most Americans don’t want to do.  And, many of them build their own businesses, employing others.  The skills that it takes to flee your home country and get to America are similar to those that you need to run a business.  You have to be flexible, adapt, and be determined to achieve your goal.

The Bible teaches us fifteen times that we are supposed to take care of the widow, orphan, and stranger.  Turning away people who are seeking to live safely in the US is cruel.  Yes, if someone is known to be a spy, or commits a felony, exile them. 

Christians, also remember that Leviticus 24:22 says, “You shall have the same law for the stranger and for one from your own country; for I am the LORD your God.”  To that end, either immigrants get access to welfare programs, or we end those programs for everyone.  America should be the beacon of freedom to the world that it was back in the late 19th century.

Conclusion

Today I go to the polls and vote.  I will be writing in NOTA a bunch of times.  I will vote against the proposal to enshrine abortion in the Maryland Constitution. Will it matter? Yes.  God is watching me.  That is what matters.

Upside-Down?

Posted on by David Merkel

Picture Credit: National Library of Ireland on The Commons || Interest rates always move in lockstep, right?

So the Fed loosened 0.50%. Long past the time it should have done so. What was the result on the long end of the Treasury yield curve?

Well, look at that! As the Fed cut the short-term policy rate, yields in the portion of the yield that matter more rose. And as an example, yields on 30-year MBS (mortgage backed securities) rose by 0.04% in yield. 15-year MBS rose by 0.02%. All of the yield curve rose from 1 year our to 30 years.

50 basis points of loosening was an upward surprise, so I take the steepening move in the yield curve as an expression that the market expects fewer cuts in the future, perhaps due to rising inflation, or just an unwillingness to lend more without additional compensation. I mean you two horrendously lousy presidential candidates making extreme promises to make the deficit even bigger. The GDP of the US grew faster when we ran balanced budgets — admittedly long ago. But fools think national credit is unlimited, and the grand enabler of that fantasy is the Federal Reserve.

Now, this just a day. Let ‘s watch what happens. The steepening could reverse, and even more so. But if this persists and goes further, you could see the Fed questioning whether they want to loosen more. Remember, the Fed is a slave to the bond market, not vice-versa.

Anyway, watch the slope of the yield curve. It tells you more about what is going on than the yammering of the Fed.

A Suggestion to the CFA Institute

Posted on by David Merkel

Image Credit: Andy Kobel || Remember, the market is mostly a weighing machine, not a voting machine

There are three main gripes that I have with respect to the CFA Institute regarding the way they do exams.

  • The exams cost far more than the marginal cost of providing them. CFAI is a nonprofit that acts like a for-profit enterprise. If you are a non-profit, why are you building up so much cash? Is it merely to employ people who have non-economic goals?
  • For the last 30 years, you have gone in search of novelty. Do students really need to learn derivatives? Alternatives? Do they have to learn about fads like ESG, which have little attachment to making profits over the long haul. Focus on the basics.
  • Why did you adopt a lousy testing method like multiple choice? Good exams are essay exams where you can see what the person is thinking and whether they can get to the correct answer via good reasoning, with out specifying possible answers.

I have an idea to improve things. Go ahead and continue to hold exams at testing centers via computers. Turn the exams into essay exams. Make them submit answers to essay questions. See if they get the right answer. See if they give the right logic. Have correct answer template, and use AI to see the degree to which the answers correspond to the template. Rank the answers from a given set of exams, question-by-question from 0 to 100.

We need to get CFA students thinking in a qualitative way, as it was when I passed the exams. This would not be hard, and would improve the quality of CFA Charterholders that pass the exams.

Please stop following fads, please create better exams, lower the fees, and stick to matters that CFAs genuinely care about.

Remember, we ripped out the head of CFA International back in 2003. We can do it again. I was at the meeting in Boston. We can have another revolution.

When Should the New Yew York Department of Financial Services have Rehabilitated American Transit Insurance?

Posted on by David Merkel

Hey! Maybe we can grow our way out of the problem! || All images from Aleph Blog

At one point in time, I was a Fellow in the Society of Actuaries, a Life Actuary specializing in investment issues. Eventually, I was hired by a hedge fund to analyze all types of insurance stocks. I knew some things about reserving outside of life insurance, but I had to learn more to become competent at understanding what made for good insurance stocks.

I learned that good P&C management teams state their financials conservatively, and aim for adequate margins over growth. They set reserves for the current year’s business high (conservative), so that in most cases reserves for business from prior years produce slight gains over time as the claims come in at less than the reserves.

I wrote an article about this back in 2014, Ranking P&C Reserving Conservatism. When I went back and looked at it after 3 years or so, those that had to strengthen reserves for prior year business did worse than those that could release their reserves for prior year business. Never published a second article on this, though.

Today I’m going to tell you about the worst P&C reserves I have ever seen, and tell you the story of how this came about. American Transit Insurance over the last few decades was the largest insurer of hired vehicles (taxis, black sedans, Uber, livery, and rideshare vehicles) in New York City. They gained a dominant market share by underpricing their insurance, and under-reserving. While market returns were high, that covered all or part of the underwriting losses.

ATI has been shaky for a long while. From this story at Insurance Journal:

“DFS said regulators made significant efforts to address ATIC’s financial problems, including filing multiple petitions to put the company into liquidation, starting back in 1979. The New York State Supreme Court denied that petition, a decision that was upheld by the Appellate Division and the State Court of Appeals in the 1980s, DFS said.”

Update: NYC’s Largest Cab Insurer Ordered to Explore Sale After Losses

And this story: “While ATIC is required by the state’s DFS to submit to an examination every five years, there are no publicly available exam reports for the company. A 1986 DFS evaluation obtained by Bloomberg described ATIC as insolvent by $6 million.”

New York City’s Biggest Taxi Insurer Is Insolvent, Risking Transit Meltdown

As a result, they raised $6.6 million of capital and continued in business. When the next five-year exam rolled around, NYDFS tried to take ATI into rehabilitation, but lost in the courts. From the first article:

“In 1991, the Insurance Department again tried to put the company into rehabilitation, prompting ATIC to seek an injunction to halt the proceeding. Ultimately, a special referee assigned to arbitrate the case suggested ATIC seek a capital infusion. A year later, the company and the state reached a settlement that allowed ATIC to remain in business, but stipulated the company keep surplus contributions and submit to enhanced state monitoring, DFS said.”

Update: NYC’s Largest Cab Insurer Ordered to Explore Sale After Losses

Now for my graphs and efforts: I downloaded the Statutory Statements for 2023, 2018, and 2013. That enabled me to look at the Five-Year Historical Data Pages, which gave me data series on important aspects of ATI’s business from 2009-2023. If you look at the graph at the top of this article, you will see how surplus declined 2009-2013. Incurred losses and loss adjustment expenses [LAE] were higher than earned premiums, and that didn’t take into account underwriting, marketing, management, and other expenses.

Their consulting actuary said in her 2013 review: “In my opinion, based on the information available for my review, the stated reserve amount does not make a reasonable provision for the liabilities associated with the specified reserves.  It is my opinion that the $47,100,000  net  reserves  for  losses  and  loss  adjustment  expenses  are  deficient  by  approximately $31,000,000. It is my opinion that the $47,100,000 direct reserves for losses and loss adjustment expenses are deficient by approximately $31,000,000. Additional information or further changes in such items as the claim handling procedures could change my estimate of the deficiency.” The surplus of ATI was a little less than $31 million. ATI was insolvent. This information was available to the NYDFS. This was the last moment to rehabilitate ATI without taking significant losses.

ATI chose to ignore the consulting actuary, and did two things. First they rolled the dice and likely said, “Let’s grow our way out of the problem!” And so they doubled their underwriting over the next five years. (See graph above.) The second thing they did was lower reserving on new business. (See graph below.) From 2009-2013, the implied expected loss plus LAE rate for new business was 81.2%. Now they had never once achieved that rate in that era. They were under-reserving new business. But from 2014-2018, they dropped that rate to 60.7%. That allowed them to report statutory profits, and growing surplus (look at the top graph). This came at a price of under-reserving even more. Looking at the graph immediately above, losses from prior year business doubled 2014-2018.

In 2018, the company again ignored their consulting actuary. In their 2018 MD&A, they said: “The Company has rejected the reports for December 31, 2018 and 2017 from its independent actuary. The actuary has estimated that the Company’s reserves for unpaid losses and loss adjustment expenses as of December 31. 2018 and 2017 were understated by approximately $45,000,000 and $36,000,000, respectively, on its filed statutory financial statements after taking into account anticipated salvage and subrogation and anticipated investment income. No such adjustments have been reflected in the accompanying financial statements since the Company has rejected the reports.”

The consulting actuary definitely underestimated the amount of under-reserving, but at least she was consistent in telling the company that they were under-reserving.

2019-2023 was the last gamble for ATI, again akin to a Ponzi, where you rob the future to pay the present. They lowered the implied expected loss plus LAE rate for new business to 27.6%. No P&C insurance company has a loss rate that low. As such the under-reserving continued to build.

We compare company surplus to the authorized control level of risk-based capital. When the ratio gets below 100%, the insurance department can seize the company for rehabilitation. So, in early 2024, NYDFS could seize it. They have not done so, and ATI, finally listening to the successor consulting actuary (to the one in 2013, 2018 etc.) announced a $700 million loss for the second quarter of 2024. The jig is up.

Note: my “true” surplus figure above assumed a 95.8% loss and LAE ratio, which was the average 2009-2023, and said the deficit is the difference between that and the implied new business loss ratio times earned premiums. Now at the end, all underwriting was out of control, and so that ratio had to be a lot higher than 95.8%. But the graph above shows directionally how bad things were going, which could not be seen by the regulatory surplus vs ACL RBC ratio calculation.

NYDFS has told ATI to find a buyer. I can tell you they will not be able to sell the joint until after the guaranty association covers the claims that ATI cannot cover. I don’t think there is any franchise value in ATI, as their only selling point was an overly cheap premium that could not cover losses, much less generate a profit. They will go into liquidation, and other insurance companies writing auto business in New York will have to cover the tab. (You have my sympathies. I lost one year of profit when I was surcharged for the losses of Confederation Life to cover their group annuity losses. Adding insult to injury, the failure of Confederation, indirectly kicked me out of the GIC business, as credit rating standards rose, and my company could not meet it. That said, it freed me to do three projects that added 5% to the surplus of the company.)

On the bright side, the CEO, Director and 3 former directors own 56% of the equity, and it will go out at zero. They may face various lawsuits from creditors not covered by the guaranty association. Perhaps the no-name auditor may also face some lawsuits. They earned a lot of fees, but did they hire a consulting actuary to validate the reserves? Did they talk to ATI’s consulting actuaries?

This brings up one final point: ignoring actuaries. In the life insurance business, management teams can’t push around their appointed actuaries (at least not much). Why do P&C management teams get to ignore their actuaries? Actuaries are bright, and they have an ethics code that they have to follow. P&C management teams should have to have actuaries that set the reserves, and they can do nothing about it.

Now I’m not going to tell you that I am a genius, all of the figures presented here are “spit-in-the-wind” estimates, and I know a trained FCAS (Fellow in the Casualty Actuarial Society) could do a lot better than me. But these estimates could be done easily at any State Insurance department with ease, as they take just seven variables from the Five-Year Historical Data Pages, and can flag reserving problems easily. NYDFS did not do what it took me three hours to do. This could have been caught in 2013 or earlier. The evidence was there.

The Best of the Aleph Blog, Part 43

Posted on by David Merkel

Picture Credit: sevoo || I’m not dead yet…

In my view, these were my best posts written between August 2017 and January 2018:

The Crisis at the Tipping Point

A reprise of what some people knew in advance of the Great Financial Crisis. Includes a link to what I wrote 10 years earlier, where I got a lot right, and a lot wrong.

Where Money Goes to Die

Wrong at least in the medium-run: Bitcoin. Right in the short-run: shorting the VIX, which blew up five months later.

The Many Virtues of Simplicity

Eight reasons why simplicity in investing works. Avoid anything that relies on options, or trading strategies. Buy and hold. Reduce turnover. Focus on quality.

Notes from an Unwelcome Future, Part 1

The best of the bunch, and my prediction that no effective action would happen with respect to Social Security has proven true so far. Seven years have burned away. Eight years until the crisis. The Greenspan Commission hosed Americans by raising “contribution rates” when it really didn’t need to do so. Nothing should have been done in the early 1980s, leaving the Social Security system to face insolvency in the mid-2000s decade. There could have been a reasonable reckoning then. As it is, we are still facing a train wreck in 2032, and Greenspan drained our pockets unnecessarily.

The Crisis Lending Fund

Cute idea, but it never saw the light of day. A way for mutual fund companies to reduce systemic risk, while allowing investors to make money during crises. On the other hand, maybe we should have some funds that pay on credit default swaps.

On Finding a Job in Finance

I get this question a lot. This is a specific answer to five questions a reader asked.

Since 1950, the S&P 500 in 2017 Ranks First, Fourth, Tenth or Twenty-third?

Written just before Volmageddon, I deal with factoids in the ultra-smooth 2017 market, and try to point out how “The Little Market that Could” was not as good as it was celebrated.

That’s all for now. I will put out some more posts, including “best of” posts in the short-run.

Estimating Future Stock Returns, December 2023 Update

Posted on by David Merkel

Credit: Aleph Blog || Really, we should be expecting a bubble as the Baby Boomers retire.

As of December 31st, 2023, the S&P 500 was forecasting a return of 1.34%/year over the next ten years, with no adjustment for inflation. As of the close on May 10th, 2024, that figure was 0.32%/year.

Why so glum? US entities are overinvested in stocks and private equity. Since 1945, the fraction of total wealth in stocks today is in the 98th percentile. The pension funds of many states are counting on equities to allow them to fulfill their promises. They have the added advantage of higher interest rates to aid them as well, but those rates may fall, because the US Government needs low rates to limit its deficit. The Fed is not independent; it does what the US government wants it to do.

The hidden assumption behind this model is that the return on assets in the US is mostly constant. What if the market is higher because of AI or GLP-1 drugs? Huge innovations, right?

Maybe. It’s unclear what genuine productivity enhancements will come from AI. Will rents, food and energy become cheaper? I doubt it. Negative side effects from GLP-1 drugs after long exposures are not yet realized. Away from that, gains in one industry may be matched by equal losses in another industry.

When we are overinvested in stocks, negative news will have higher impact. There is less slack capital to absorb the troubles.

Now, all that said, value stocks are cheap, and will be affected less by market events. Same for some small and midcap stocks. Lots of good opportunities over the long-haul if you look for them. Just ignore the large cap growth market leaders that are overvalued. They are the reason the market as a whole is overvalued.

So, add to safe assets, and cut back on large cap growth. This feels like June 2000, where everyone was so optimistic, sailing into the teeth of the storm. Get ready, because value and small are back.

A few thoughts

A few thoughts

Posted on by David Merkel

I know I haven’t been blogging for a while. I also haven’t been tweeting. I am shut out of X-Twitter because of two factor authentication issues. As such, I am doing a post today that is Twitter-like, giving my thoughts on a variety of news articles. Here we go:

President Xi’s hero, Chairman Mao said “Women hold up half of the sky.”  And, that randy guy Mao certainly “held up half the sky” with many of them.  But women in China will not “hold up half the sky” for President Xi.  Women in China increasingly do not want to marry and have children.  If present trends continue for 75 years (dubious to go out that far), India will be four times larger than China.  Even the US will be bigger than China.

Inside a Flaming Jet, 367 Passengers Had Minutes to Flee. Here’s How They Did It. This is very impressive, and shows how a highly conformist society like Japan has its advantages.

‘“Everyone was screaming from the initial impact and then everything got eerily quiet because everyone was confused,” Hayashi said. The passenger next to him appeared to know about emergency procedures. “She started yelling, ‘Put your head down, keep your seat belts on, stay in your seat,’ ” he said.’

From Bloomberg’s evening summary (1/2/24):

“The most common concern or belief we have heard from investors is that overbought conditions and euphoric sentiment will set up for a reversal to start 2024 in both bond yields” and stocks, said Dennis DeBusschere, founder of 22V Research. “The overbought conditions and sentiment readings are tough to argue with.”

Nobel Prize Winner Cautions on Rush Into STEM After Rise of AI

No, keep your eyes on the prize. STEM majors can do creative work. Humanities majors can’t do STEM.  Don’t go to college for a major that doesn’t pay you back.

LPs Doubt Venture Funds’ Startup Valuations

The incentives are perverse in setting marks for private equity.  There is a tendency to overstate values, and face the problem later when the fund winds up and has to admit losses versus the overestimated marks.

Xi’s Solution for China’s Economy Risks Triggering New Trade War

China’s investment-driven economy is much less productive than most think.  It overinvests in industries where the world already has too much capacity (think of what they did with steel), and creates product prices where their investments are practically wasted.  This leads to overstated GDP statistics, and greater inequality in China.  The Chinese Communist Party has a materialism fetish that makes them think only industry matters.  And so they impoverish most of their citizens.

China Leaders Sought Quick Zhongzhi Resolution to Shield Markets

Note that the CCP takes no blame for this.  While housing was a tailwind for their economy, they let the bubbles grow in multifamily housing, financial companies, and local government financing vehicles.  They only cared that headline GDP statistics kept growing, not the net economic welfare of their citizens.

2023 saw record killings by US police. Who is most affected?

“From 2013 to 2022, 98% of police killings have not resulted in officers facing charges, Mapping Police Violence reported.”

Unless you can get rid of police unions, this is not likely to change.  The unions take lower pay raises in exchange for making it difficult to fire officers.

Buying Home and Auto Insurance Is Becoming Impossible

Not so much impossible, but expensive. When the P&C insurance has back-to-back losses from underwriting, surplus is not adequate to write as much business at the same price.  Premiums rise for almost everyone, but more so in recent disaster-prone areas… and that goes extra for states that over-regulate insurance.

BuzzFeed’s ‘Dire’ Debt Problem

I know this is kind of “old school,” but don’t buy stocks that don’t earn profits.  I know this means I will miss rare unicorns.  But most people don’t buy them near the beginning, anyway.

It’s also wise to avoid highly indebted small-cap stocks, whether owning the stock or the debt.  It doesn’t take much to capsize a small company like $BZFD.

The Bond Market Rally Is Overlooking a Soaring $2 Trillion Debt Problem

I think deflation is more likely than inflation.  The US and other nations are likely to use financial repression (again) to deal with their debt issues.  Eventually that will fail in a messy way.

Trumponomics 2.0: What to Expect If Trump Wins the 2024 Election

More of the same, only louder and meaner.

Xi’s Chief of Staff Is Quietly Amassing Even More Power in China

Cai Qi – a man to watch. President Xi is losing touch with reality as almost no one dares to give him honest feedback.

Is private credit a systemic risk?

Probably not, unless investors as a whole underestimate their need for liquidity.  Still, remember that new fast-growing asset classes have to go through a failure cycle in order to mature into an asset class where risks are priced mostly right.

Google Lays Off Hundreds in Hardware, Assistant, Engineering

I worked a firm that did annual layoffs.  It really ruined employee morale.

There’s Finally Hope for the Office Real Estate Market

This might be a good opportunity. Things aren’t getting worse.

Iran Captures Oil Tanker Off Oman as Mideast Turmoil Deepens

Things are getting messy enough globally, and with US weapons stockpiles depleted, we could be on the edge of something that will prove hard to deal with.

Credit Card Delinquency Rates Climb to Decade High in Fed Study

Credit weakness on mostly the low end of the consumers.  There has also been an increase in buy now pay later activity mostly in this same demographic area.  It will be a mess, but not big enough to have material second order effects.

Larry Hogan Steps Down From Advocacy Group, Fueling Talk of 2024 Bid

He would be a good president – he’s the best governor the State of Maryland has had in my lifetime.

Fed Posts Largest-Ever Annual Operating Loss

If we are going to have fiat currency, let the Fed’s assets be only T-bills and gold. Don’t take on duration risk, including RMBS.

Taiwan Election Piles Pressure on Delicate U.S.-China Ties

Taiwan’s Raucous Democracy Is Another Challenge to Xi’s Ambition

Dolt that he is, Xi does not get that his recent actions have turned marginal Taiwanese away from reunification. Taiwan is very happy that it is a capitalist democracy. They don’t want to be ruled by authoritarians.  Taiwan will not join Communist China without a fight that will destroy most of the value of Taiwan.

Fed Tiptoes Toward Dialing Back Key Channel of Monetary Tightening

The Fed should stop playing around with the size of its balance sheet, and shift its assets to what it was pre-GFC.  Simplify. The Fed is doing too much, and as always, they don’t know what they are doing.

Reinsurers launching provisions amid continuing Middle East conflict

Insurers Seek to Exclude US, UK Ships From Red Sea Coverage

War is an undiversifiable risk.  Pseudo-wars are similar, so reinsurers are quickly updating new contracts to reflect that.

The Humiliation of Davos Man

Humanity does not want to be one big happy family on the terms of the developed countries.

Inside a Plan to Save Homeowners Hundreds of Dollars Closing Their Mortgages

“The alternative, called an attorney-opinion letter, allows a real-estate attorney to essentially attest that there are no problems with a property’s title. The average borrower relying on such a letter has saved more than $1,000 compared with more traditional title insurance, Fannie said.”

Probably would work, though title insurance is almost bulletproof.

The M.B.A.s Who Can’t Find Jobs

This happens from time to time.  When I was an undergrad (1982), out of curiosity I went to a presentation on whether you should get an MBA or not.  The advice then was don’t get it, many employers don’t want to pay up for an MBA, so get your BA and apply for work.

Large Backers of Private Equity Are Asking For Their Money Back

Many large LPs are telling GPs they won’t invest in their new PE funds unless they pay them off for old funds that are past the ending date.  PE is kind of like a life insurer that mis-reserved a block of their policies, allowing too much income to flow early, and then figures out too late that the block now has an embedded loss.

US Companies Pay Up to Hedge Debt After Interest-Rate Volatility Soars

Looks like many CFOs fear long rates rising again, and are willing to pay up for a cap on their financing rates.

Xi, Biden and the $10 Trillion Cost of War Over Taiwan

The $10 Trillion figure is a wild guess in my opinion, but this article is a good qualitative breakdown of all the risks involved.

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Maybe I will blog more in the future, but business has taken up a lot of time lately.

Estimating Future Stock Returns, June 2023 Update

Posted on by David Merkel

Image Credit: Aleph Blog || Has the return on assets for public equities permanently risen? The return on bonds has risen for now.

From the last piece: “At March 31st, 2023, the S&P 500 was priced to return 2.41%/year over the next ten years. Given the rally since then, that return has shrunk to 0.49%/year. Currently the 10-year Treasury yields 3.76%. In investment grade corporates, you could earn more than 5% with considerably lower risk.”

There was an error in that statement, the return had only shrunk to 1.64%/year. A similar adjustment would have to be made to the second graph, which would look more like the graph below.

At June 30th, 2023, the S&P 500 was priced to return 1.65%/year over the next ten years. Given the rally since then, that return has risen to 2.03%/year. Currently the 10-year Treasury yields 4.29% [bond-equivalent yield, add 0.09% to annualize]. In investment grade corporates, you could earn around 6% with considerably lower risk.

Here’s my current outcomes graph:

Image Credit: Aleph Blog || Upside capped, long left tail…

So, on average no price change for 10 years. You just collect your dividends.

There are several ways to get better outcomes from stocks. First, go abroad, there are much better values available in Europe, Japan, and in the emerging markets that respect the rule of law. Second, decouple from the high-tech growth stocks. I’m able to find a lot of stocks in the US with good balance sheets that are small-to-midcap that are cheap relative to growth prospects. Away from the “cool” sectors of the market there are many large-cap stocks with reasonable prices relative to prospects.

That’s all for now. I may blog more, I may not. Business is taking up more of my time. Watch your risks to keep your returns.

Estimating Future Stock Returns, March 2023 Update

Posted on by David Merkel

Image Credit: Aleph Blog || Has the return on assets for public equities permanently risen?

At March 31st, 2023, the S&P 500 was priced to return 2.41%/year over the next ten years. Given the rally since then, that return has shrunk to 0.49%/year. Currently the 10-year Treasury yields 3.76%. In investment grade corporates, you could earn more than 5% with considerably lower risk.

But, maybe it’s different this time. Yes, I know the danger of the phrase. What if AI increases total productivity of assets and labor by 1%/year on net, permanently? Will companies make more money as they need fewer smart people to do the same amount of intellectual work? Or, will we reach a new equilibrium as the smart people who are laid off start using AI to create totally new businesses, or create even leaner competitor businesses that eat into the profits of those slow to adapt?

Really, I don’t think AI will permanently increase productivity. The system should adjust and things should remain mostly the same.

Image credit: Aleph Blog

The graph above shows what the outcomes have been when the share of investor funds held in equities has been as high as it is now, 49.0%. (Range: 21.9% — 52.7%, average 35.6%) Returns have typically been poor.

So, maybe buy the 10-year investment grade bonds. Inflation is going down, and the US government can’t finance all its debt if rates rise too much. Bonds are a real alternative now.

One last note: the estimated rate of return over the next ten years more than you would ordinarily expect as the data series underlying this model made significant revisions to past data values.

Anyway, be cautious. Bond yields have risen, equity yields (E/P) have fallen. This rally is more speculative than most think… momentum blinds many people to stretched valuations. Unless, we are genuinely in a new era. Which I doubt.

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