David Merkel – Page 21 – The Aleph Blog

The Best of the Aleph Blog, Part 35

Posted on 31 May 2018 by David Merkel

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In my view, these were my best posts written between August 2015 and October 2015:

Learning from the Past, Part 6 [Hopefully Final, But It Won?t Be?]

The currently final episode on my investing errors, covering the last eight years.? Note that Valero has made me five times on my initial investment, though, and I still own it now.? This piece has more of the bright side of what I learned.

Musings on the Wealth Effect

“None of the ways I mentioned for getting more money for spending out of investments is likely to produce a lot of additional spending in aggregate across the economy. ?As a result, I think that the Executive Branch, the Congress, and the Federal Reserve should be cautious of trying to make asset values rise, or encourage more borrowing against assets. ?It will likely not have any significant effect to grow the economy over the intermediate -to-long term.”

The Surprise Dividend

A hypothetical piece for a company that wants to pay its shareholders more, but wants to do it in a more tax-efficient way.

Thinking About Pensions, Part 1

Thinking About Pensions, Part 2

This is a very realistic look at the issues surrounding retirement, and how to fund it.? it is very frank, and accurate in terms of what is possible.

Quarterly Financial Reporting is Needed, Productive, and Good

Why Companies SHOULD Offer Earnings Guidance

Quarterly earnings reporting is necessary for proper oversight.? If we did not have earnings guidance, a cottage industry would grow up to give it because investors want to know whether companies are performing adequately or not.

The Importance of Your Time Horizon

This is one of the most important concepts in financial planning.? When will you need the assets to provide spending money?

Buying The Next Hot Idea

This is an idea that rarely works.? Why do people fool themselves and chase fads?

When to Deploy Capital

A full answer to the question, “When do I invest cash balances?”? Hint: a middling solution is usually best.? Don’t be too bold or too timid.

When to Double Down

This is a tough question, but I give a clear answer:

Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years. ?In other words, I haven?t done it often. ?I?turn a single-weight stock into a double-weight stock if I know:

The position is utterly safe, it can?t go broke

The valuation is stupid cheap

I have a distinct edge in understanding the company, and after significant review I conclude that I can?t lose

Plan and Act, Don?t React

In general, the best investing anticipates likely changes.? By the time a change is revealed, it is too late to make investment decisions.

Too Many Vultures, Too Little Carrion, Redux

I suggested at the time that there were too many investors buying distressed energy assets, many of which went broke.

The Incredible Chain of Lending

Why to be careful when the financial sector grows too large.

A Bigger Brick in the Wall of Worries

I suggest that nonfinancial corporates may be the next financial crisis.? This is looking more likely now.

Volume Is Usually Low At Turning Points

This is a less-known truth: you can’t catch the bottom or the top, particularly if you have a large portfolio to manage.

Modeling Financial Liquidity and Solvency

Why most bank cash flow testing stinks, and how to improve it.

Don?t Worry About Public Bond Market Illiquidity

Bonds are illiquid, aside from the cash that they regularly throw off.? That’s normal; get used to it.

How Much is that Asset in the Window?

How Much is that Asset in the Window? (II)

A theoretical discussion about what assets are worth, settling on the unhappy idea that it is utterly relative, and that changing macroeconomic situations can affect things markedly.

At Least Build A Small Buffer

Having a small cash hoard is better than no cash hoard

Commissions Matter

I disembowel the idea that it doesn’t matter how large the salesman’s commission is.

Long-term Relationships and Credit Scores

An interesting piece on marriage, and how to make things work out, even when there are economic disagreements.

One Dozen Thoughts on Dealing with Risk in Investing for Retirement

“The basic idea of retirement investing is how to convert present excess income into a robust income stream in retirement. ?Managing a pile of assets for income to live off of is a challenge, and one that most people?are not geared up for, because poor planning and emotional decisions lead to subpar results.”

The Best of the Aleph Blog, Part 34

Posted on 23 May 2018 by David Merkel

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In my view, these were my best posts written between May 2015 and July 2015:

Learning from the Past, Part 5b [Institutional Stock Version]

Learning from the Past, Part 5c [Institutional Stock Version]

How I did a bad job for Hovde on Scottish Re and National Atlantic Holdings.? Also, what I did to mitigate the errors.? (And I am supposed to be really good with insurance companies…)

The SEC Pursues a Fool?s Errand

On why the Consolidated Audit Trial [CAT] is a bad idea.? Preventing “flash crashes” is not a desirable goal; they teach people not to use market orders, and to be careful.? The market is a place for big guys, not little guys.

On Partnership Investing

What do you have to be careful about if you are entering into a partnership?

On Risk-Based Liquidity and Systemic Risk

On how the Federal Government is making a mess of post-crisis policy.? The best policies would be:

Regulate banks, money market funds and other depositary financials tightly.

Don?t let them invest in one another.

Make sure that they have more than enough liquid assets to meet any conceivable liquidity withdrawal scenario.

Regulate repurchase markets tightly.

Raise the amount of money that has to be deposited for margin agreements, until those are no longer a threat.

Perhaps break up banks by ending interstate branching. ?State regulation is good regulation.

Advice to a Friend on a Concentrated Private Stock Position from His Employer

How to analyze a large position in your employer’s stock.? Lots of potential for gain and loss because of the lack of diversification in one stock.

There?s a Reason for Risk Premiums

Some academic literature implicitly treats risk premiums as “free money” if you hold it long enough.? But there’s the problem: can you hold it long enough?? Also, sometimes the extra returns are so small that they are not worth the risk.

On Bond Market Illiquidity (and more)

On Bond Market Illiquidity (and more) Redux

Some things aren’t meant to be highly liquid, and it is foolish to worry about the lack lack of liquidity.? The second article covered some good questions that I got asked, including bonds that are predominantly “bought and held,” and the limitations on investment banks to hold inventory post-crisis.

Yes, Build the Buffer

More reasons why you should keep a supply of cash on hand.

Coping With Zero

In this period, I couldn’t find any new stocks to buy.? What should I do?

Stocks or Bonds?

What do you recommend when stocks and bonds are likely to return the same amount over the next ten years?? I leaned toward the bonds, which so far has been the wrong call.

The Phases of an Investment Idea

Sixteen Implications of ?The Phases of an Investment Idea?

How to analyze the cycles that investment ideas go through.? People think about it linearly, which helps lead to the booms and busts.? The second article gives 16 practical applications of the idea to illustrate the general theory.

Avoid Indexed Life Insurance Products

Why indexed insurance products give subpar returns with reduced volatility, assuming the insurer stays solvent.

Asset-Liability Mismatches and Bubbles

In this article, I argue that China has been indirectly encouraging its banks to run huge risks by financing illiquid assets with liquid liabilities.? Again, the risk hasn’t materialized yet.

How To End Index Gaming

?…in this short post I would like to point out two ways to stop the gaming.

Define your index to include all securities in the class (say, all US-based stocks with over $10 million in market cap), or

Control your index so that additions and deletions are done at your leisure, and not in any predictable way.

Gundlach vs Morningstar

I discussed the unwillingness of Doubleline to cooperate with Morningstar to analyze certain Doubleline funds, and why it was reasonable in some ways for Doubleline to refuse, and Morningstar to not give favorable ratings.? That said, I concluded that Morningstar should apologize to Doubleline.? This article earned me polite calls from both sides, and one request to take the article down voluntarily.? I politely refused.

What is Liquidity? (Part VIII)

The occasional series that never ends.? Ten things that affect the liquidity of an asset, and explaining the Treasury “flash crash.”

It?s Difficult to Make Predictions, Especially About the Future

It is a fatal attraction, but if you are going to write about investing, you will have to make some predictions about markets.? Just try to keep them from being too outlandish.

We Eat Dollar Weighted Returns ? VI

In which I analyze the Hussman Strategic Growth fund and the large negative difference between time-weighted and dollar-weighted returns.

Stock Valuations: Micro and Macro

Can valuation measures applied to individual companies be used to value the market as a whole?? Under what conditions, or, is there a better way?

The School of Money, First Grade

This was the first of what was going to be sixteen articles.? I was thinking of turning it into a book.? Things have been too busy for that.? This article is about figuring out what you want to do in life.

Pick a Valid Strategy, Stick With It

Many amateur investors give up on a strategy just as it is about to start succeeding, and choose a strategy that has performed well, only to watch it underperform.

Bid Out Your Personal Insurance Policies!

I give you at least five reasons why you should bid out your personal insurance policies every three years or so.? Underwriting rules and premiums change, and some companies take advantage of loyalty.

The Pips are Squeaking

Posted on 15 May 2018 by David Merkel

Photo Credit: sid=================

This should be a short post.? I just want to note the degree of stress that many emerging market countries are under.? The Fed raises rates, and something blows up.? That is often the class of debt that has grown the most in the bull phase of the cycle, or, the one that has financed with short-term debt.? This is the “volatility machine” that Michael Pettis wrote so well about.

The Brazilian stocks I own have been falling.? A little lower, and I will make them double-weight positions.? Five times earnings for utilities that cannot be done without?? Wave the shares in.

Look at Argentina, Indonesia, and Turkey.? Fundamentally misfinanced.? Maybe own assets there that have enduring demand.? I own IRSA [IRS].

Russia is fundamentally sound.? I own shares in RSXJ, which is not so connected to the energy sector.

Buy the emerging markets generally, avoiding those markets are fundamentally misfinanced.? Or wait, and buy later.? Emerging market selloffs are often sharp and significant.? I’m not sure what is the right way to do it, so you could buy half now, and wait.? If it rallies, be glad you got some cheap.? If it sells off more, buy the full position.

There are some good values now; they could get better later.? Buy a little and wait like my “do half” strategy says.? Don’t get greedy, look for decent gains over 3-5 years.

And now for something completely different:

https://www.youtube.com/watch?v=gLyoBCIBCW8?t=1343

I appeared on RT Boom/Bust two weeks ago, and offered my thoughts on Wells Fargo at the end of the show.? I think they still have more problems to be revealed.? That said, things aren’t getting worse, so this might be a good time to buy the shares of Wells Fargo.

Full disclosure: My clients and I own shares of IRS, SBS, ELP, BRF, and RSXJ

Thoughts on Bank Debt

Posted on 11 May 2018 by David Merkel

I have long said that until an asset class goes through a “failure cycle,” risk-based pricing will be weak toward the assets in question.? One asset class that has become popular of late is bank debt.? Bank debt is a loan to a corporation that typically has first priority to make claims on the company in bankruptcy, ahead of the bondholders, much less the preferred stockholders and the common equity.

Though it is called bank debt, often the loans are arranged by banks and allow others to lend alongside them.? This has become popular among closed-end funds and ETFs like BKLN.? What are the advantages?

In the past credit losses have been low, partially because of strong covenants and low availability.
The loans have floating rates, so if interest rates rise, you get paid more, assuming the company does not choke on higher interest rates.

Recently a friend wrote me, asking:

Hi David:

Hope everything is well.

Quick investment question, if you don’t mind.

Wanted to get your thoughts on the leveraged loan asset class. From my perspective, there are both positive and negative factors at play currently, e.g., higher interest rates (positive), weaker covenant packages (negative), among other things.

Would love to get your opinion.

He has a decent summary of the situation.? My view is similar to this analysis at Bloomberg.? Underwriters of the loans have become less choosy, and as such have allowed loans to be made with weak covenants.? As a result, more loans have been made,? increasing their size versus bonds at junk-rated corporations.

I can tell you one thing with certainty.? When the losses of this cycle come, it will be decidedly worse than the prior cycles that had light losses.? That is due to the weaker covenants and the increase in the proportion of financing coming from bank debt.? When the debt had more parties taking losses in front of them, their losses were lower.? Even without the change in the covenants, the larger relative size would lead to greater losses.

I summarize it this way: those throwing money into bank debt do so to earn money but not take interest rate risk.? In the process they absorb more credit risk than prior generations of bank debt investors took on.

I have often invested in bank debt in the past, but I am not doing so now.? I think the credit risk is a lot higher than before, and not worth taking the risk in order to get a floating rate for returns.? Instead, I have invested in short-term bond funds with high credit quality.? Less yield, but more security.

Why I Watch the Thirty

Posted on 19 April 2018 by David Merkel

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I like long bonds.? I am not saying that I like them as an investment.? I like them because they tell me about the economy.

Though I argued to the Obama Administration that they should issue Fifties, Centuries and Perpetuals, the Thirty-year bond remains the longest bond issued.? I think its yield tells us a lot about the economy.

How fast is nominal growth?? Look at the Thirty; it is highly correlated with that.

What should the Fed use for its monetary policy?? Look at the Thirty, and don’t let the Five-year note get a higher yield than it.? Also, don’t let the spread of the Two-year versus the Thirty get higher than 1.5%.? When things are bad, stimulus is fine, but it is better to wait at a high spread than goose the spread higher. Excesses in loose policy tend to beget excesses in tight policy.? Better to avoid the extremes, and genuinely mute the boom-bust cycle, rather than trying to prove that you are a genius/maestro when you are not.? Extreme monetary policy does not get rewarded.? Don’t let the yield curve get too steep; don’t invert.

Finally, the Thirty is a proxy for the cost of capital.? It’s long enough that it is a leap of faith that you will be paid back.? Better still for the cost of capital is the Moody’s Baa average, which tracks the bold bet of lending to low investment grade corporations for 20-30 years.

That said, the Thirty with its cousin, the long Treasury Inflation Protected Security [TIPS] gives you an idea of how long term inflation expectations and real rates are doing.? The thing that kills stocks is higher long term real interest rates, not inflation expectations.? The main reason for this is that when inflation rises, usually earnings do also, at least at cyclical companies.? But there is no reason why earnings should rise when real rates rise.

This is why I pay more attention to the Thirty rather than the more commonly followed Ten.? I know that more debt gets issued at a maturity of ten years.? Granted.? But the Thirty tells me more about the economy as a whole, and about its corporations.? That’s why I carefully watch the Thirty.

Notes on the Fed Announcements

Posted on 22 March 2018 by David Merkel

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Listening to the Fed Chair’s press conference, there was one thing where I disagreed with what Powell was saying.? He said a few times that they only made one decision at the FOMC meeting, that of raising the Fed Funds rate and the reverse repo rate by 0.25%.? They made another decision as well.?The decided to raise the rate of quantitative tightening [QT] by increasing the rate of Treasury, MBS and agency bonds rolloff by $10B/month starting in April. They did that by increasing the rate of reduction of MBS and agency bonds from $8B to $12B/month, and Treasuries from $12B to $18B/month. The total rate of QT goes from $20B to $30B/month.? This may raise rates on the longer end, because the Fed will no longer buy so much debt.

There was also a little concern over people overinterpreting the opinions of the Fed Governors, especially over the “dot plot,” which shows their opinions over real GDP growth, the unemployment rate, PCE inflation, and the Fed funds rate.? My point of view is simple.? If you don’t want people to misinterpret something, you need to defend it or remove it.

Personally, I think the FOMC invites trouble by doing the forecasts.? First, the Fed isn’t that good at forecasting — both the staff economists and the Fed Governors themselves.? Truly, few are good at it — people tend to either follow trends, or call for turns too soon.? Rare is the person that can pick the turning point.

Let me give you the charts for their predictions, starting with GDP:

The Fed Governors have raised their GDP estimates; they raised the estimates the most for 2018, then 2019, then 2020, but they did not raise them for the longer run.? I seems that they think that the existing stimulus, fiscal and monetary, will wear off, and then growth will return to 1.8%/year.? Note that even they don’t think that GDP will exceed 3%/year, and generally the Fed Governors are paid to be optimists.? Wonder if Trump notices this?

Then there is the unemployment rate.? This graph is the least controversial.? The short take is that?unemployment rate estimates by the Fed governors keep coming down, bottoming in 2019, and rising after that.

Then there is PCE Inflation.? Estimates by the Fed Governors are rising, and in 2019 and 2020 they exceed 2%.? In the long run the view of the Fed Governors is that they can achieve 2% PCE inflation.? Flying in the face of that is that they haven’t been able to do that for the duration of this experiment, so should we believe in their power to do so?

Finally, there is the Fed Funds forecast of the Fed Governors — the only variable they can actually control. Estimates rose a touch for 2018, more for 2019, more for 2020, and FELL for the long run. Are they thinking of overshooting on Fed Funds to reduce future inflation?

Monetary policy works with long and variable lags, as it is commonly said.? That is why I said, “Just Don?t Invert the Yield Curve.”? Powell was asked about inverting the yield curve at his press conference, and he hemmed and hawed over it, saying the evidence isn’t clear.? I will tell you now that if the Fed Funds rate follows that path, the Fed will blow something up, and then start to loosen again.? If they stop and wait when 10-year Treasury Note yields exceed 2-year yields by 0.25%, they might be able to do something amazing, where monetary policy hits the balancing point.? Then, just move Fed funds to keep the yield curve slope near that 0.25% slope.

There would be enough slope to allow prudent lending to go on, but not enough to go nuts.? Much better than the present policy that amplifies the booms and busts.? The banks would hate it initially, and regulators would have to watch for imprudent lending, because there would be no more easy money to be made.? Eventually the economy and banks would adjust to it, and monetary policy would become boring, but predictably good.

Just Don’t Invert the Yield Curve

Posted on 21 March 2018 by David Merkel

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Jerome Powell is not an economist, and as such, has the potential to try to remake the way the Fed does monetary policy.? Rather than hold onto outmoded ideas ideas like the Phillips Curve, which may have made sense when the US was a more insular economy, there are better ways to think of monetary policy from a structural standpoint of how financial firms work.

(Note: the Phillips Curve relies on a very simple assumption that goods and services price inflation stems from wage inflation, and that wage inflation occurs when domestic unemployment is low.? In a global economy, those relationships are broken when labor can be easily added from sources outside of the US.)

Financial firms tend to grow rapidly when the yield curve is steeply sloped.? Borrowing short and lending long is profitable, at least in the short-run.? This provides a lot of credit to the economy, which in the short-run, encourages growth, as businesses borrow to build supply, and consumers borrow, which temporarily boosts demand.

Financial firms tend to shrink?when the yield curve is flattish and certainly when negatively sloped.? Borrowing short and lending long is unprofitable, at least in the short-run.? This reduces credit to the economy, which in the short-run discourages growth, as businesses don’t borrow to build supply, and consumers borrow less, which temporarily reduces demand.

If there are misfinanced (too much short-term borrowing) or over-indebted areas of the economy, there can be considerable economic failure with a flat or inverted yield curve.? As I have said before, when the FOMC tightens without thinking about the financial economy, they keep tightening until something blows up, and then they loosen too much, starting the next cycle of over-borrowing.? I said this at RealMoney in 2006:

One more note: I believe gradualism is almost required in?Fed?tightening cycles in the present environment ? a lot more lending, financing, and derivatives trading gears off of short rates like three-month LIBOR, which correlates tightly with fed funds. To move the rate rapidly invites dislocating the markets, which the FOMC has shown itself capable of in the past. For example:

2000 ??Nasdaq

1997-98 ? Asia/Russia/LTCM, though that was a small move for the Fed

1994 ? Mortgages/Mexico

1989 ? Banks/Commercial Real Estate

1987 ? Stock Market

1984 ? Continental Illinois

Early ?80s ? LDC debt crisis

So it moves in baby steps, wondering if the next straw will break some camel?s back where lending has been going on terms that were too favorable. The odds of this 1/4% move creating such a nonlinear change is small, but not zero.

But on the bright side, the odds of a 50 basis point tightening at any point in the next year are even smaller. The markets can?t afford it.

Position:?None

I also commented that housing was likely to be the next blowup in a number of posts from that era.? Sadly, they are mostly lost because of a change in the way theStreet.com managed its file system.

As such, it behooves the Fed to avoid overly flattening the yield curve.? In late 2005, I wrote at RealMoney.com that the Fed should stop at 4%, and let the excess of the economy work themselves out.? By mid -2006, they raised the Fed Funds rate to 5.25%, flattening to invert the yield curve, which collapsed the leverage in the economy in a disorderly way.

It would have been better to stop at 4%, and watch for a while.? Housing prices had peaked, and I wrote about that at RealMoney.com as well.? The Fed could have been more gradual at that point.? There really wasn’t that much inflation, and the economy was not that strong.? Bernanke may have felt that he needed to prove that he wasn’t a dove on inflation.? Who knows?? The error was unforced, and stemmed from prior bad practices.

In this case, the Fed does have an alternative to crashing the economy again.? I would encourage the FOMC to not raise rates over 2.5%.? When they get to 2.5%, they should start selling the longest bonds in their portfolio (note: I would encourage them to end balance sheet disclosure before they do this, after all, the Fed suffers from too much communication not too little.? The Fed was better managed under Volcker and Martin.)

This would test the resilience of the economic expansion, and if the economy keeps growing as long bonds rise in yield, then match the rises in long yields with rises in the Fed Funds rate.? This is a neo-Wicksellian method of managing monetary policy that could match the ideas of Jerome Powell, who was more skeptical than most Fed Governors about about Quantitative Easing [QE].

The eventual goal is to manage monetary policy aiming for a yield curve that has a low positive slope, allowing the banks to make a little money, but not a lot.? The economy would expand moderately, and not be as prone to booms and busts.

My summary advice for the FOMC would be this: before you flatten/invert the yield curve, start selling all of the long MBS and Treasury bonds with average maturities longer than 10 years.? That will slow down the economy more effectively than flattening the yield curve, and it is not as likely to lead to a crisis.

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I have no illusions — the odds of the FOMC doing this is remote.? But given past failures, isn’t a new idea worthy of consideration?

PS — there is another factor here.? What happens to the financing costs of the profligate US government?

Why I Like Foreign Small Cap ETFs

Posted on 15 March 2018 by David Merkel

Photo Credit: amanda tipton || It may not be foreign, and not an ETF, but it IS a small cap

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This should be a short post.? When I like a foreign market because it seems cheap (blood running in the streets), I sometimes buy a small cap ETF or closed-end fund rather than the cheaper large cap version.? Why?

They diversify a US-centric portfolio better.? There are several reasons for that:
a) the large companies of many countries are often concentrated in the industries that the nation specializes in, and are not diversified of themselves
b) the large companies are typically exporters, and the smaller companies are typically not exporters.?Another way to look at it is that you are getting exposure to the local economy with the small caps, versus the global economy for the large caps.
They are often cheaper than the large caps.
Institutional interest in the small caps is smaller.
They have more room to grow.
Less government meddling risk.? Typically not regarded as national treasures.

Now, the disadvantages are they are typically less liquid, and carry higher fees than the large cap funds.? There is an additional countervailing advantage that I think is overlooked in the quest for lower fees: portfolio composition is important.? If an ETF does the job better than another ETF, you should be willing to pay more for it.

At present I have two of these in my portfolios for clients: one for Russia and one for Brazil.? Overall portfolio composition is around 40% foreign stocks 40% US stocks, 15% ultrashort bonds, and 5% cash.? The US market is high, and I am leaning against that in countries where valuations are lower, and growth prospects are on average better.

Full disclosure: long BRF and RSXJ, together comprising about 4-5% of the weight of the portfolios for me and my broad equity clients.? (Our portfolios all have the same composition.)

Estimating Future Stock Returns, December 2017 Update

Posted on 14 March 2018 by David Merkel

The future return keeps getting lower, as the market goes higher

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Jeff Bezos has a saying, “Your margin is my opportunity.”? He has found ways to eat the businesses of others by providing the same goods and services at a lower cost.? Now, that makes Amazon more productive and others less productive.? The same is true of other internet-related businesses like Google, Netflix, etc.

And, there is a slight net benefit to the economy from the creative destruction.? Old capital gets recycled.? Malls that are no longer so useful serve lower-margin businesses for locals, become homes to mega-churches, other area-intensive human gatherings, or get destroyed, and the valuable land so near many people gets put to alternative uses that are better than the mall, but not as profitable as the mall prior to the internet.

Laborers get released to other work as well.? They may get paid less than they did previously, but the system as a whole is more productive, profits rise, even as wages don’t rise so much.? A decent part of that goes to the pensions of oldsters — after all, who owns most of the stock?? Indirectly, pension plans and accounts own most of it.? As I have sometimes joked, when there are layoffs because institutional investors representing pension plans? are forcing companies to merge, or become more efficient in other ways, it is that the parents are laying off their children, because there are cheaper helpers that do just as well, and the added profits will aid their deservedly lush retirement, with little inheritance for their children.

It is a joke, though seriously intended.? Why I am mentioning it now, is that a hidden assumption of my S&P 500 estimation model is that the return on assets in the economy as a whole is assumed to be constant.? Some will say, “That can’t be true.? Look at all of the new productive businesses that have been created! The return on assets must be increasing.”? For every bit of improvement in the new businesses, some of the old businesses are destroyed.? There is some net gain, but the amount of gain is not that large in aggregate, and these changes have been happening for a long time.? Technological progress creates and destroys.

As such, I don’t think we are in a “New Era.”? Or maybe we are always in a “New Era.”? Either way, the assumption of a constant return on assets over time doesn’t strike me as wrong, though it might seem that way for a decade or two, low or high.

As it is today, the S&P 500 is priced to deliver returns of 3.24%/year not adjusted for inflation over the next ten years.? At 12/31/2017, that figure was 3.48%, as in the graph above.

We are at the 95th percentile of valuations.? Can we go higher?? Yes.? Is it likely?? Yes, but it is not likely to stick.? Someday the S&P 500 will go below 2000.? I don’t know when, but it will.? There are enough imbalances in the world — too many liabilities relative to productivity, that crises will come.? Debt creates its own crises, because people rely on those payments in the short-run, unlike stocks.

There are many saying that “there is no alternative” to owning stocks in this environment — the TINA argument.? I think that they are wrong.? What if I told you that the best you can hope for from stocks over the next 10 years is 4.07%/year, not adjusted for inflation?? Does 1.24%/year over the 10-year Treasury note really give you compensation for the additional risk?? I think not, therefore bonds, low as they may be, are an alternative.

The top line there is a 4.07%/year return, not adjusted for inflation

If you are happy holding onto stocks, knowing that the best scenario from past history would be slightly over 3400 on the S&P 500 in 2028, then why not buy a bond index fund like AGG or LQD that could virtually guarantee something near that outcome?

Is there risk of deflation?? Yes there is.? Indebted economies are very susceptible to deflation risk, because wealthy people with political influence will always prefer an economy that muddles, to higher taxes on them, inflation, or worst of all an internal default.

That is why I am saying don’t assume that the market will go a lot higher.? Indeed, we could hit levels over 4000 on the S&P if we go as nuts as we did in 1999-2000.? But the supposedly impotent Fed of that era raised short-term rates enough to crater the market.? They are in the process of doing that now.? If they follow their “dot plot” to mid-2019 the yield curve will invert.? Something will blow up, the market will retreat, and the next loosening cycle will start, complete with more QE.

Thus I am here to tell you, there is an alternative to stocks.? At present, a broad market index portfolio of bonds will likely outperform the stock market over the next ten years, and with lower risk.? Are you ready to make the switch, or at least, raise your percentage of safe assets?

Getting a Job in Insurance

Posted on 7 March 2018 by David Merkel

Well, I never thought I would get this question, but here it is:

Thank you for your dedication to your blog.

I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions?

Thank you for your time.

Kind regards,

There are many things to do in insurance.? Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.? Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.? Then there are the drones in customer service and claims.? Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions.

Before I begin, I want to say a few things.? FIrst, if you work in insurance, be kind to the drones and helpers.? It is the right thing to do, but beyond that, they don’t have to go beyond their job description — they know their opportunities are limited — it is only a job.? Treat them with respect and kindness, and they will go above and beyond for you.? I learned this positively first-hand, and a few of them 20-30 years older explained it to me when I noticed they weren’t helping others who were full of themselves.

Second, the insurance industry does a lot to train drones, helpers, agents, marketers, underwriters, and younger people generally, if they are willing to work at it.? There are self-study courses and exams that vary based on what part of the industry you are in.? Take the courses and exams, and your value goes up — it is not obvious how that will work, but it often pays off.

Third, it is not a growing industry, but lots of Baby Boomers are retiring, and leave openings for others.? Also, drone and helper positions often don’t pay so well at the entry level, and turnover is somewhat high.? The same is true of agents — more on that later.

Fourth, watch “The Billion Dollar Bubble,” and episodes of Banacek if you want.? The actual practices of how they did things in the ’60s and ’70s don’t matter so much, but it gets the characterization of the various occupations in insurance right.

FIfth, insurance is a little like the “Six Blind Men and the Elephant.”? Actuaries, Accountants, Administrators, Marketers, Underwriters, and Investment Managers (and Lawyers and Programmers) each have a few bits of the puzzle — the challenge is to work together effectively.? It is easier said than done.? You can read my articles on my work life to get a good idea of how that was.? I’ve written over 30 articles on the topic.? Here are most of the links:

DId I leave out the one on insurance company lawyers?? Guess not.

Sixth, it is easier to teach those with technical skills how the business works than to teach drones and helpers technical skills.? It’s kind of like how you can’t easily teach math and science to humanities and social science majors, but you can do the reverse (with higher probability).? It is worth explaining the business to computer programmers.? It is worth explaining marketing and sales to actuaries.? Accountants get better when they understand what is going on behind the line items, and maybe a touch of what the actuaries are doing (and vice-versa).

Seventh, only a few of the areas are close to global — the administrators, the underwriters, the actuaries, and the marketers — and that’s where the fights can occur, or, the most profitable collaborations can occur.

Eighth, insurance companies vary in terms of how aggressive they are, and the dynamism of positions and ethical conundrums vary in direct proportion.

So, back to your question, and I will go by job category:

Drones and helpers typically don’t need a college education, but if they show initiative, they can grow into a limited number of greater positions.
Computer programmers probably need a college degree, but if you are clever, and work at another insurance job first, you might be able to wedge your way in.? While I was an actuary, I turned down a programming job, despite no formal training in programming.
Lawyers go through the standard academic legal training, pass the bar exams, nothing that unusual about that, but finding one that truly understands insurance law well is tough.
Accountants are similar.? Academic training, pass the accounting exams, work for a major accounting firm and become a CPA — but then you have to learn the idiosyncrasies of insurance accounting, which blends uncertainty and discounting with interest.? The actuaries take care of a lot of it, but capturing and categorizing the right data is a challenge.
Actuaries have to be good with math to a high degree, a college degree is almost required, and have to understand in a broad way all of the other disciplines.? The credentialing is tough, and may take 5-10 years, with many exams, but you often get study time at work.
Agents — can you sell?? Can you do a high quality sale that actually meets the needs of the client?? That may not require college, but it does require significant intelligence in understanding people, and understanding your product.? Many agents can fob some bad policies off on some simpletons, but it comes back to bite, because the business does not last, and the marketing department either revokes your commissions, or puts you on a trouble list.? “Market conduct” is a big thing in insuring individuals.? The agents that win are the ones that serve needs, are honest, and make many sales.? Many people are looking for someone they can trust with reasonable returns, rather than the highest possible return.? One more note: there are many exams and certifications available.
Marketers — This is the province of agents that were mediocre, and wanted more reliable hours and income.? It’s like the old saw, “Those who cannot do, teach. Those who cannot teach, administrate.”? It is possible to get into the marketing area by starting at a low level helper, but it is difficult to manage agents if you don’t have their experience of rejection.? Again, there are certifications available, but nothing will train you like trying to sell insurance policies.
Underwriters — as with most of these credentials, a college degree helps, but there is a path for those without such a degree if you start at a low level as a helper, show initiative, and learn, learn, learn. Underwriters make a greater difference in coverages that are less common.? Where the law of large numbers applies, underwriters recede.? The key to being an underwriter is developing specialized expertise that allows for better risk selection.? There are certifications and exams for this, pursue them particularly if you don’t have a college degree.? Pursue them anyway — as an actuary, I received some training in underwriting.? It is intensely interesting, especially if you have a mind for analyzing the why and how of insured events.
Investment personnel — this is a separate issue and is covered in my articles in how one can get a job in finance.? That said, insurance can be an easier road into investing, if you get a helper position, and display competence.? (After all, how did I get here?)? You have to be ready to deal with fixed income, which? means your math skills have to be good.? As a bonus, you might have to deal with directly originated assets like mortgages, credit tenant leases, private placements, odd asset-backed securities, and more.? It is far more dynamic than most imagine, if you are working for an adventurous firm.? (I have only worked for adventurous firms, or at least adventurous divisions of firms.)? Getting the CFA credential is quite useful.
Administrators — the best administrators have a bit of all the skills.? They have to if they are managing the company aright.? Most of them are marketers, and? a few are actuaries, accountants,or lawyers.? Marketing has an advantage, because it is the main constraint that insurance companies face.? It is a competitive market, and those who make good sales prosper.? VIrtually all administrators are college educated, and most have done additional credentialing.? Good administrators can do project, people and data management.? it is not easy, and personally, few of the administrators I have known were truly competent.? If you have the skills, who knows?? You could be a real success.

Please understand that I have my biases, and talk to others in the field before you pursue this in depth.? Informational interviewing is wise in any job search, and helps you understand what you are really getting into, including corporate culture, which can make or break your career.? Some people thrive in ugly environments, and some die.??Some people get bored to death in squeaky-clean environments, and some thrive.

So be wise, do your research, and if you think insurance would be an interesting career, pursue it assiduously.? Then, remember me when you are at the top, and you need my clever advice. 😉