Photo Credit: Ewen Roberts || What is the sound of one hand clapping? It is when you are sitting around in a quiet house at night, and you realize the motor of the refrigerator just turned on.

This piece may be a little discursive, so please bear with me. When did US economic policy begin going badly wrong? There were two major errors, and both happened in the (drumroll) Reagan administration.

Error 1 was ceasing to run balanced budgets. Error 2 was appointing Alan Greenspan as Fed Chairman. The second error was the bigger one. (Dishonorable mention goes to the Greenspan commission on Social Security, which made our future problems there worse.) Greenspan did not let recessions do their work, eliminating malinvestment. He cut recessions short, and as malinvestment increased, GDP grew slower than it otherwise would have. The resultant trajectory of interest rates went down creating the problem that as they got lower monetary policy got closer to the zero bound, where changing interest rate became less and less effective.

What was worse, was that the Fed began imbibing the idea that they needed to protect all of the securities markets. After Black Friday in 1987, rather than saying that the Fed would provide liquidity as needed, he should have said that the stock market, aside from setting margin limits, is not within the purview of the Fed.

The same would apply to the pseudo-bailout of the banks that came from the 3% Fed funds rate in 1992-1993, and the ultra-steep yield curve that came as a result. That created pressures in the mortgage markets, such that when the Fed started tightening, a self-reinforcing cycle arose that made long rates rise dramatically as bond investors found they needed to sell long bonds as mortgage-backed securities lengthened.

The Fed post-Volcker has been a sorcerer’s apprentice, ever and always. They appear so confident, make huge mistakes, and deflect blame. (They remind me of a certain President. Now who could that be?)

Meddling with Long Term Capital Management, providing huge amounts of liquidity during the dot-com bubble, including the debacle during Y2K, which gave the market a blow-off top. Then, not learning from their error from keeping rates too low in the early 90s, they made the same mistake 2003-2004 keeping monetary policy weak far longer than necessary (Fed funds near 1%), leading to another panic in the mortgage markets when they started tightening policy.

And that was the point of no return. It would no longer be possible for normal monetary policy to operate, because the Fed never let recessions do their good work of wiping out bad investments. Much as I don’t think much of Bernanke or Yellen, they inherited the mess that Greenspan created. They did not initiate the problem. They did find ways to make it worse.

As such, under Powell, Yellen, and Bernanke, unless they were willing for the US to suffer an immediate depression, they had to run an ultra-loose monetary policy. The side effects of this policy are:

• An asset bubble
• A debt bubble
• Increasing instability
• Slower future GDP growth
• Lower monetary velocity and lower inflation
• Savers get punished
• Rich prosper, Poor suffer

My conclusion is that the Fed thinks it has no choice but to continue to inflate assets via QE, even as the policy has less and less impact on the economy. At some point it will press to be able to buy Treasury securities directly in the primary markets. At that point, inflation will kick in, and the idiotic policies of the US Government, including the Fed, will move into the endgame.

US inflation will spike, and Modern Monetary Theory [MMT] Banana Republic Monetary Theory [BRMT] will be revealed for what it is a that point, as the results of extreme borrowing come crashing down, and the rest of the world concludes that it does not need the US to clear its transactions, and serve as a place to invest proceeds from exports. I’m not sure if it will be called a depression, but it will be a mess. It depends on what governments decide to default on their debts, and whether they do it externally, internally, or both.

Would you want to live in Venezuela? Brazil? Argentina? Zimbabwe? Turkey? South Africa? This is the way that policy is headed in the US, EU, Japan and China, to varying degrees. A lot depends of who fails first. Those that have not failed will get viewed as safe havens for a time, and capital will flow out of the failure and into the survivor(s).

We’ve been playing with fire for the last 40 years. The economy should not as a rule require stimulus. But today it needs stimulus lest a depression come. But it will come eventually, and the longer we put it off the worse it will get.

You can’t get something for nothing. That much is obvious, but it flies in the face of those who propose stimulus. Get the government out of the economy, aside from prosecuting fraud, and punishing those who do things are are prima facie illegal.

I would love to slowly bleed the leverage out of the system, but it is impossible. As such a process starts, others would front-run the process and cause a depression. There’s no good way to do it. As such, do you want to gamble? At present there is a whiff of inflation, and the Fed says it will not tighten. Do you trust the Fed to keep their word? Will you play for gain until the Fed says “NO MORE,” and the stock market corrects sharply in real terms?

In the relative peace of what we have now, will you reduce risk? My client portfolios are at their most risk-averse levels, and I am invested along-side them. Take action before you regret not taking action.

Photo Credit: Tim Green || Once my friend Jose Pedro Marcos de Fuentes said to me “A centavo for your thoughts.” I said, “Peter, I don’t deal in fractions of cents.” He said, “You certainly deal in fractions of sense.”

Since I mentioned my old friend Peter Fuentes, who I haven’t heard from in 35 years, let me tell you a funny story that he once told me. He had immigrated to the US, and came from a trilingual family in Mexico where they spoke Spanish, French, and English fluently. One day he was walking in the streets of LA, and he realized that an INS agent was following him. He had forgotten to bring his immigration documents with him and he wondered what he should do. The INS agent came up to him and said to him in perfect Spanish, “May I see your papers?” Peter replied in French, “I do not understand what you are saying.” The INS agent blinked and left.

Peter was a dear friend of mine during my graduate student days at the University of California at Davis. We had many discussions on intellectual topics as we shared a suite together with two other students from Brazil and South Korea. Most other suites were strictly US residents, but somehow I had the fun of interacting with a very interesting group of people who were not born in the US.

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Recently a client of mine asked me how he could buy fractional shares of stock for his grandchildren. He wanted to give them exposure to the S&P 500. I did some digging. The best Idea I ran across was perfectly free… buy an open end mutual fund from FIdelity that has no setup fees, no transaction fees, and no management fees. These are the Fidelity ZERO funds. The UGMA/UTMA accounts are free as well.

There was a surprise to me — one grandchild was older than 18, so I suggested an account in the client’s name, with transfer on death to the grandchild.

The original request from the client was an account that buys fractional shares. In this case, the shares could be of SPY or VOO. Those would cost nine and three basis points of management fees, respectively. I recommended the zero cost option above.

As I researched fractional shares, I found more than a dozen firms that did them. Given that most firms have Buffett envy, and don’t want to split their shares, fractional shares become a way to allow small investors to buy into a company.

Some of the firms that dd this were payments companies. Others were robo-advisors. Some were brokers. Regardless of what they were, the markets sell shares as units. They don’t sell fractions of shares. So when one of these entities allows the purchase of fractional shares, the entity has to purchase a whole share, and then parcel out the fractions to the various clients, and they hold onto the remainder. Now personally, I wonder what would happen if a broker became insolvent. How would custody work there? Could fractional ownership be less secure than owning fractional shares of an open end mutual fund? Who owns the share that has been split up?

Are fractional shareholders a sign of a market top? Perhaps. But they aren’t big enough to move prices. They may be “dumb money,” but they are a sideshow as far as the market as a whole goes.

What is likely more significant now is first the Fed is blowing asset bubbles through the creation of excess bank reserves. This benefits the wealthy versus the poor, at least on the face of it. Here’s the rub: the current value of assets may rise, but the ability to turn the assets into an annuity does not. The absolute level of what an annuity will deliver is mostly invariant to moves in bond yields.

Then there is the second reason: Leveraged speculation among unseasoned investors. One reason the volatility index has remained high amid a rising market is the high amount of call buying from retail investors. Now, I haven’t documented this myself, but I give you this link from Knowledge Leaders Capital, where they have shown this extensively. This is highly speculative behavior, akin to what you see near the top of bull markets.

Just as losses from call options eat capital, so does the inability of highly valued companies to grow enough destroy/eat capital. Throw into that the zombie companies that aren’t earning their cost of capital among those deep in junk bond territory. The Fed can throw out all the liquidity that it can, but it can’t fix companies that are fundamentally broken — it can only give them a lingering, painful death.

Well, this drifted beyond fractional shares. Just realize that in the present environment that there are many risks. The Fed does not control everything, nor does the US Government. Use your own good judgment and reduce risk in your portfolios as you see fit. Or, raise risks if you think I am wrong. But think for yourself. The financial media has is own bullish bias, and I am not talking about CNBC, I am talking about Bloomberg. I listen to Bloomberg a lot and not CNBC.

Photo Credit: John Graham || Many poisons are pleasant initially, but lead to death.

The subtitle I would give to this series would be “Have the courage to do up-in-credit and shortening trades.” This very irregular series dates back to the first real post at this blog. There are times when the bond market is running so hot that it seems those who are prudent risk-takers are fools, as they are collapsing risk positions and conserving capital to play for another day.

Back in 2002, it was as if I was on a seesaw. Managing money for the fastest growing life insurer in the US, I ran two up-in-credit trades and two down-in-credit trades where I moved a large portfolio many 2-3 credit notches trading individual bond issues on the bond markets, while at the same time managing interest rate risk. During the up-in-credit phases, the passphrase was “yield is poison.” Really, we couldn’t find much that we liked, so we would trade lower rated bonds for higher rated bonds, and give up a small amount of yield.

My brokers would occasionally say to me something like this, “You’re different. You will do trades that most managers won’t do. Your trades are the ones we would do, but most bond managers are so yield hungry that they will never give up yield.” My comment back to them wassometing like, “When risks are not being appreciated, you can either give up yield, or give up capital. I have to protect capital.”

Now, I had a great staff of credit analysts behind me. I would never have as good without them. I also studied the corporate bond math to fully break down what made a good trade after my initial failure when thrust into the position of corporate bond portfolio manager. That enabled me to understand what the proper tradeoffs were, which made me realize that often a lower yielding bond was more valuable than a higher yielding bond. Thus, sometimes it made sense to lose yield, but gain something more secure.

Today we face low Treasury yields and low credit spreads. There isn’t much loss from aiming for safety. If you are aiming for income, why not take a step back for a year or two, and gain greater safety? Yes, you might see further tightening of credit spreads. You might see the Fed step in to do yield curve control, misguided as it is. There are always foolish momentum trades that perish at the end of bull markets.

The only real risk from not reducing bond market risk is that the Fed will eat up credit and duration risks until we have high inflation, a war, or currency controls (where we try to cheat foreign creditors).

You can improve the probability of being paid today without giving up much yield. Take this opportunity, and upgrade the credit quality of your portfolio.

Image Credit: Aleph Blog || No, abnormal monetary has many significant costs, not the least of which is an asset bubble that feeds a debt bubble.

Welcome to Wonderland, boys and girls. At the end of the third quarter, the S&P 500 was priced to return 2.92%/yr for the next ten years, with no adjustment for inflation. You might say, “But David, you’ve reported levels that low in the past, and you were concerned, but you never said ‘Wonderland.'”

True, but the market has rallied further since the end of the quarter, and the level of the S&P 500 now is priced to return 1.79%/yr for the next ten years, with no adjustment for inflation. That’s in the 97th percentile of valuations. Another reason I didn’t say ‘Wonderland’ in the past was that there were a few values in the 1960s that were comparable to valuations. Now the only comparables are from the dot-com bubble. Thus, welcome to Wonderland.

Now, the valuation levels of the Wonderland era lasted for 3 years and 3 months, from the end of the first quarter of 1998 to the end of the second quarter of 2001. It was a period where monetary policy was extremely loose, before tightening enough to send the market into a tailspin, even as many claimed that interest rates have no effect on growth stocks.

Let me post the rest of my graphs, and I will finish my thoughts.

Note that we are considerably closer to the maximum valuation levels than to the minimum levels. If we wanted to create a new maximum level, we would have to rally 19.4% from present levels.

Note: this model fits reality a lot more tightly than most models… but it is not a short run model. It is very accurate over ten years. My, but this model seems to be forecasting another “lost decade.”

There are only seven values from history that compare with present levels. I choose scenarios where the expected return then was within 1%/year of the expected return now. Now, the estimate for where the S&P 500 will be 10 years from now is 3,555, which is lower than today, but given a 2% dividend yield, that still gives a 1.79%/year total return.

But empirically, the seven comparable scenarios give a lower total return of 0.92%/year for the next ten years. Admittedly, this is the “Law of Small Numbers.” (Would that academic finance writers would have that humility when analyzing models that have only twenty years of data, which means their results might just be an anomaly of the short period — which is true of most ESG studies.)

So now that you have had a tour of Wonderland, what should you do? Perhaps you should buy some 10-year single-A corporate bonds. You will likely get more return and your risk will be a lot lower. And who knows? If there is another market crisis, which is likely given abnormal monetary and fiscal policy, with high valuations, you might get a chance to buy stocks a lot lower. The same logic applies to gold, or even T-bills.

I’m not saying move everything immediately. After all, there is momentum, so things can go higher still. The odds of getting new highs are highest near new highs. Besides, we haven’t had any significant bankruptcies that weren’t C19-related.

But eventually, the tide will turn. Me? I’ve already lightened up, and have dry powder to buy good companies at moderate prices. As in the dot-com bubble, value investing finally turned after so many threw in the towel. I own companies that make good earnings relative to their prices, and have strong balance sheets. They will prosper better than most through tough scenarios.

They do ring a bell during the topping process. The trouble is that most put in earplugs as a result of the festivities so that they can ignore the naysayers. As such, I say to you, make adjustments before you get scared and wish you had done it earlier.

That’s all for now.

Photo Credit: Andrew Steele || 42 (with apologies to the late Douglas Adams)

My last post generated its share of comments. Let me respond to a few of them, and add a little more.

1. Yes, I live outside Baltimore. I have lived more of my life in or near Baltimore than anyplace else. Am I a critic of Baltimore? Of course, everyone near/in Baltimore is a critic of Baltimore. But Baltimore is more complex than most outsiders can understand. It is a “city of neighborhoods.” Positively, it means that if you are in a good area, you can rely on that. Negatively, it means that if you are in a bad area, you can rely on that. It is not a consistently good or bad city, and that was true when I went to Hopkins as well. I lived one year in a relatively bad area of Baltimore, and during that time worked in a different bad area of Baltimore. They are still bad, almost 40 years later, and Baltimore is no better off on the whole. What Baltimore needs is not more money, but a consistent set of directions for the police, such that they can act to the extent desired by the communities that they serve. That said, the amount of Baltimore that is unsafe is maybe 10% of the city, and everyone who lives there understands that.
2. Maryland has some of the best medical assets in the country, including Johns Hopkins (my alma mater), University of Maryland, and NIH. As a result, we have a large portion of the state devoted to healthcare and biotechnology. Other outstanding industries of Maryland include software, defense/intelligence, REITs, and hotel management. These are the overweighted industries of Maryland. Do I have friends in these businesses? Of course, but I have little knowledge of what they do, and I am not a defender of these industries per se.
3. Telling your children not to “Blame the Ump” is indeed correct. Children and adults need to respect the governing authorities, even when they are wrong in minor ways. One reason our society is weak is that we don’t have respect for authority. We respect the office, even if the person holding it is a jerk. FIghting over small matters is not a virtue. With respect to the Presidential election, I say what I always say — if there is genuine evidence, it will be undeniable. Conspiracies rarely happen. THere is too much profit to be made from disclosing a conspiracy for it to happen. Also, when there are many parties looking over the details it is hard for a conspiracy to exist.
4. The same logic applies to those who deny the spread of the C19 virus is not real. I have too many friends of friends who have become very sick or who have died from it for it not to be true.
5. On #6, my bond management strategy is twofold. One, I try to keep costs low, and because I am small, that means using ETFs and closed-end funds. Two, I focus on mispriced risks and prevailing trends. I hold a variety of short bond funds for liquidity, which is around 50% at present. I earn less than 1% on those assets. I have 25% of the assets in TSI which yields around 6%. Then there are the two ETFs invested in short foreign government bonds and emerging market sovereigns denominated in dollars. The first pays off because of US dollar deterioration. The second does well because of their relatively high yields.
6. The 10-year estimate for equity returns on the S&P 500 is now 1.88%/year not adjusted for inflation. We are now in the 97th percentile. Should you be concerned? Yes, particularly if you are invested in growth stocks, particularly the hot FANGMAN stocks.
7. Much as the US is a free market place, there is a dislike in the government for companies that become too powerful. I remember as a youth reading articles about how the US should break up GM (pitiful company that it ended up being). Often those sentiments come at or after the apex of the company — the government may not really need to act, as the “Alexander effect” may kick in — they have conquered all that they can, and there are “no more worlds left to conquer.” That may sound aggressive with respect to Apple, Amazon or Google, but that legislators or government executives are musing about breaking them up should give everyone pause — not because they will be broken up a la AT&T, but that the interest of the government is often an indicator that their market cap has outgrown their relevance.
8. Regarding #13, I agree with the comments of Publius left at the blog. Monetary stimulus should not affect relative prices much, but with assets, lowering financing rates will allow marginal businesses to survive so long as easy conditions continue. That makes it harder for the Fed or other central banks to easy hyper-easy policies, even though they should bite the bullet, and just let weak firms die. Creative destruction has to do its work, or we will have a slow growing economy where capital is not deployed to achieve the best returns.
9. On the inequality part of the comments on #13, I don’t mean to be a controversialist. I mean to tell the truth in a way that most aren’t willing to face. My long forgotten piece called Rethinking Comparable Worth is still correct. Think of the spread of income across the world as a whole. Yes, for some activities, there is more capital investment in some places than others, requiring higher educated workers than in other places, with those workers earning higher wages for now. But as technology improves, those same benefits come to those with lesser skills. That brings a slow but persistent equalization of wage rates as the technology “de-skills” skilled workers. Who benefits? Lesser skilled workers, and the creators of technology. As wage levels equalize for occupations over the world, the world becomes more equal, but for the lower skilled in the developed world, it leads to losses for them. That leads to the nationalism that is rampant in Europe and the US — why are our relative incomes suffering?! They suffer because what they are doing is in excess supply, and they should retrain for something better rather than carping to the government. No one owes you a living. Plan ahead, and look for something better rather than imagining that the government has your back. It doesn’t.
10. Though I agree with Lacy Hunt and Gary Shilling regarding deflation, where I am a little different is what might change matters. QE loses potency with repeated use. There is only so much that you can lower rates, and the effect on stimulating GDP declines. Eventually the government will reach for something with more firepower, like forcing the Fed to buy new issues of government debt. Remember that central bank independence is a myth during stressful times. They are a creation of the government, and not independent from them. When things are calm, we can indulge fantasies of central bank independence as we enjoy s’mores around the campfire and let ourselves get scared as we tell each other ghost stories.
11. If I had to phrase it in a different way, pretend national and local governments don’t exist. That is the way the global economy is heading regardless of government policies. Positively, one thing that it has changed (temporarily reversed by C19) is that the worst poverty in the world is being reversed by the triumph of capitalism. There are genuinely fewer people in such grinding poverty. Fewer people with hunger problems, aside from those that self-cause their problems.
12. Immigration to the US mostly does not absorb existing jobs, but performs jobs that most Americans don’t want to take on, like picking produce. They take on the hard work but low pay positions. Do any of you want that? Maybe the children of immigrants will compete with the children of “natives” but in general most immigrants don’t compete with existing Americans for their jobs. Yes there are some technologically skilled that get hired in the US, but that is because we don’t produce enough technologically skilled young people from the “natives.”
13. Not all of my children listened to me. The ones that listened to me are doing well, and ones that didn’t are not. (A few of them are in-between.) I say the same to all those who read me. Pursue skills that are differentiated, and are not easily obsoleted. Anything that can be replaced by technology or offshored is not a safe place to be.
14. One last comment, which I posted in response to a LinkedIn post by Christof Leisinger, who I have some respect for. Here is the response:

It is a future risk when the ECB and Fed intervene in the repo funding markets, that the markets would become dependent on the Central Banks. It would be difficult to wean the repo markets off their assistance, but in one sense it makes sense for the Central Banks to do it permanently if you are going to have repo markets.

Repo markets are inherently unstable because you are financing long-term assets with short-term liabilities, and accounting for them as a short-term loan. It works fine until you have a crisis in the long asset, with prices falling hard, and the scam is exposed.

Now, the bad thing about the Central Banks taking over the repo markets is that it removes one more price out of the free markets, and will allow repo markets to balloon as they become riskless to outsiders. This is the same as people not paying much attention to bank deposits because of the existence of the FDIC.

I realize we are in the “brave new world” where Central Banks are imagined to be omnipotent, but if there is a significant financial crisis that the ECB or Fed feels that it has to bail out amid rising consumer price inflation, the creation of additional credit at that time will prove toxic.

LinkedIn Post

To my readers: I ask that you interact with my posts civilly and pertinently. I keep comments open on my blog, and I have done so for 13 years, amid a general closing down of comments across the web. Don’t abuse the freedom I offer here by going off-topic, or being abusive in your speech.

WIth that, let me say that appreciate my readers and commenters. Thanks for your efforts, and let’s keep things constructive.

Full Disclosure: Long TSI for my clients and me

Photo Credit: Hernán Piñera || All in all, you’re just another note on the wall.

When I started blogging, I did more posts that were a series of ideas. I’m doing that tonight.

1. These last four years have been happy ones for me. Three of my children have gotten married, and I funded each wedding, even one for a son because the bride was estranged from her parents. I can’t know fully what went on there, but she is a wonderful daughter-in-law, and I can’t imagine that it was her fault. I made the mistake of trying to reconcile daughter-in-law and parents, but the parents were not receptive, to say the least.
2. In the process, I now have two grandsons. This is fascinating to me. The older grandson really likes me, and when he sees me, he walks to me and puts up his hands for me to hold him. It’s really special. He just turned one. The other is one month old, and though big for his age, is so tiny. We forget how small newborns are.
3. We’re celebrating Thanksgiving on Friday this year as a result. We gave ordinary Thanksgiving to our children’s spouse’s families. We’re happy to accomodate them. On Friday, I am making the turkey, stuffing, gravy, and mashed potatoes. I may throw in some Columbian salt-crusted potatoes as well. My married children who live near me love hanging out together, whether with my wife and me, or without us. We are happily surprised to have them dropping in unexpected. We have dinner together every Wednesday night before going to prayer meeting.
4. Now you know more about me. On to the economy and markets. My stock market model is currently predicting 2.01%/year nominal returns for the next ten years. The only era with higher valuations was the peak of the dot-com bubble. Are you happy with the idea that you will earn the return of a single-A corporate bond, but with a lot more volatility? Well, I’m not, even though the stocks I own have far better cashflow yields than the FANGMAN stocks.
5. I have proposed to Interactive Brokers the idea that they should offer a bite-sized version of indexed credit default swaps, but only allow retail accounts to short credit, and not go long credit. An alternative to this idea which is a little more expensive is to buy puts on HYG or JNK. Shorting credit is the cheap way to hedge a long equity portfolio, and a few hedge fund managers made big money on it in March.
6. My bond strategy yields more than 2%, and has a duration of less than 2 years. I have to admit that I am considering switching some of my equity funds to that strategy. That said, I am not running to do that.
7. Now, many have attributed the current rally to Biden getting elected. I am no fan of Trump. Trump and Biden have different and offsetting problems. As such, I think the entirety of the rally stems from the emergence of effective and safe vaccines. It’s even possible that the rally might have been greater if Trump had won, but who can tell?
8. I am not impressed with Janet Yellen as Treasury Secretary. This is for one simple reason: she is an academic economist. Academic economists are like people who have a Matchbox car, and think they can repair real cars because they understand a Matchbox car. The economy defies being expressed by aggregates and equations that depend on the aggregates. Studying academic economics is a waste of time.
9. Everyone is praising the Fed, except a minority that includes me. I still believe that deep recessions are a good thing that liquidates bad investments and prepares us for higher growth in the recovery. The current Fed can’t bear the least diminution of growth, and so we limp along barely growing as the Fed creates asset bubbles through QE, benefiting the rich, and harming the poor.
10. Tell Trump “Don’t Blame the Ump.” Give it up, man. If there were obvious bits of election fraud, it would be obvious to more than a few. There is too much money that could be made from a book, “How I Fought the Election Fraud.” If you have real facts, they are stubborn things. (SIde note: I always used to tell my kids, “Don’t Blame the Ump.” If you lost by the narrow margin of the final call of the ump, it is your fault that you didn’t play better. And I know this well, watching my daughter getting called out on a strikeout, when it was obviously a ball, and it was the last out of the championship game. As scorekeeper for our team I sat directly behind the umpire.
11. On the path-dependency of life, Trump is an excellent model. He wasn’t all that great of a businessman, and has declared bankruptcy multiple times for his corporations. Still, he surfed through it, and managed to make himself known during a time when reality television was cool. Though relatively liberal, he reinvented himself to express the frustrated desires of lower-middle class Americans who were suffering from lowered opportunities, telling them it was not their fault, but that of immigrants and foreign powers. Now, what he said was utterly wrong, but you have to understand: most people live so that they can say “It’s not my fault.” The true Prime Directive (sorry, Star Trek) is to find ways to excuse our own sins/faults. That is what it is to be human, and Trump is one of the prime example of this as he is never wrong.
12. But path-dependency applies to C19 as well. Trump erred by having his C19 briefings where he said said what he thought, regardless of the truth of it. He promised an effective and safe vaccine before election day, even though any rational calculator (excuse the Russians and the Chinese, who don’t care about their people) would have thought it impossible. On the bright side, we have two effective mRNA vaccines coming up, but it is after the election. Trump may have sped up the vaccines. He also discouraged people from playing it safe in terms of their conduct to avoid infecting others.
13. “Never has so much done so little.” That is my tagline for the Fed. They create much credit in the form of bank reserves, and all they do is blow an asset bubble. The banks don’t lend more, and so no inflation arises. Nor does GDP grow faster. If you want to have a target regarding inequality — it is the Fed. Now that said, the real culprits on inequality stem from information technology and foreign trade. The world as a whole is becoming more equal, but the developed nations and China are becoming less equal, because wage rates are slowly becoming more equal. Think of it: why should a steel worker in America earn more than a steel worker in China, adjusted for capital investment, and the skill to use the capital?
14. As I have said before, though it is unpopular, those that did not study hard in school, and presumed that growing up in a developed nation would give them a superior income are getting disappointed. The post-WWII experience of US superiority was a one-time event, and now things are reverting to normal. If you do unskilled work, expect to get paid unskilled wages. It doesn’t matter what stupid laws get passed by localities for minimum wages — the same total amount will be paid in wages, but it will be paid to fewer people, while many end up unemployed.
15. To those who are in the media, do you want someone with a different voice? Someone who will tell you the consensus is wrong? If so, send me an email. I am available to interact with your questions, and it WILL be different than the common drivel that I hear in the media.
16. Biden’s appointees make me think that he is not going to do much. Sorry, Progressives.

Really, I am not that worried over the election of Biden. We have had our share of lousy Presidents. The last good President was Reagan. The beauty of America is that we don’t let anyone national force their will on localities, except in the broadest ways. As such, we usually live happily amid the furor of the world as a whole.

Photo Credit: Penn State || Being at Penn State is better than being at State Pen.

Recently at my congregation, a bright young lady showed up who received an internship at a DC think tank. We’ve had a number of good conversations since that led her to ask me questions about mortality tables, and the causes of the Great FInancial Crisis.

On the Great Financial Crisis, I pointed her to this article that I wrote: Who Dares Oppose a Boom? This piece won third prize in a contest held by the Society of Actuaries. That said, I ended up giving a series of talks off of the article, about six in all. If there is demand for it, I will update my presentations page with all the slide decks from the talks I have given over the last ten years, and you can see that one as well.

Here are her questions for me:

What is regulatory capture? How does it contribute to/impact debt? 

When an industry has more sway over its regulators than the Executive Branch of the government does, the industry has captured its regulator and made the regulator to be its ally, rather than its adversary.

This happens more frequently than you might expect. Many high-ranking people working for the regulators know that there is a high-paying job waiting for them if they go easy on the firms that they regulate. After all, firms reward their friends. The government doesn’t, at least not to the same degree.

Most of the time, regulatory capture does not affect debt much, unless that capture is of the banking system. If banking regulators compromise on capital levels and allow banks to lend too much versus their capital, it will compromise the solvency of the banking system, as they did in 2004-2008.

I worked for a hedge fund at that time that was devoted to financials, mostly banks. The banking regulators were captured in two ways: first, banks could choose their regulator, which led many banks to choose to choose the weakest regulator, and the rest of the regulators, fearing a loss of relevance, began weakening their standards in order to retain banks to regulate. Second, legislators brought pressure on the regulators when banks complained to their legislators that persistent regulators were “business killers.”

As such, lending quality suffered. There is a saying in banking that there are three factors: quantity, quality and price. In a good environment, you can get two of them. In a bad environment, you can get one of them. And in 2004-2008, you could only get one of them if you wanted to grow, and that was quantity. Price and quality were out the window.

Do attempts to magnify “booms” accelerate their end?

Initially, no; they delay the bust. Bt eventually, yes, the bust comes with greater vengeance. As Warren Buffett once allegedly said, “What the wise do in the beginning, fools do in the end.” Most booms start with a good idea. In the great financial crisis, tha idea was “Let’s make it affordable for people to buy homes.” As people and firms pursue that idea, the initial ideas are typically useful. But as time goes along efforts to expand either increase debt, or compromise underwriting.

In the process housing prices were pushed up until the only way that marginal people could afford a house was through a loan that passed risks to the borrower — loans that offered a low interest rate for a few years, but at the end would reprice higher, making payments more than double. Borrowers were told, “Don’t worry, you can refinance into a new low rate loan.” By the time that most hit the refinance date, housing prices were falling, and no one would refinance them. This led to a lot of defaults, and falling housing prices generally.

The loose monetary policy of the Fed helped coax this along, but once the bubble bursts, the Fed is impotent. In general, all loosening of lending standards prolong the boom, but they make the bust more ugly when it comes. Time is delayed, but severity is increased.

Can mortality/should mortality tables be used as an indicator of economic health and prosperity?

Yes. Mortality tables can be used as an indicator of economic health and prosperity. That said, they don’t measure everything related to prosperity. The US is the great example in this. Because much of the US is given to hedonism, many people pursue pleasure without regard to how long they will live. What is prosperity, anyway? To Christians, it is living to serve God without any undue constraint from outside forces. To others it is pursuing whatever they please. For Christians, long life is a blessing from God. For others, long life is a burden. I personally expect suicides to increase among the elderly in the US over the next ten years.

As The Who sang, “I hope I die before I get old (talkin’ ’bout my generation)”

Reviewing the presentation, something that I was also thinking about was how mortality rates in the U.S. compare to other countries, and if those comparisons impact risk evaluation?

The US compares badly to most of the developed world on death rates, and longevity has actually been shortening in the US, while lengthening in most of the rest of the world.

The American experiment is interesting, but is a failure in many ways. SIgnificant freedom is offered to all, but many abuse it to their harm. Christianity, broadly understood, once dominated the culture of the US, but it never dominated its politics. It will take a Reformation to change things here, and a Reformation that cares more for the state of the souls of persons more than their economic well-being. The churches need to change first. Then maybe we can change the culture, and ultimately politics. Maybe my grandchildren will see it.

Going back, mortality rates are an indicator, not the indicator. In a good society, no one wants to die, and all fight death, aside from martyrs.

Thanks for your questions. May the Lord bless your efforts at college.

David

Photo Credit: Don McCullough || The stock market, and even the bond market is more volatile than the economy is. This piece will explain why that is so.

The stock market, and to a lesser extent the bond market, is mystifying to most average people. Let me give you an example of this. I am the chair of my denominational pension board; after this year, I drop off the pension board. I help the pastors and staff of the RPCNA manage their retirement money. I am also an elder of my congregation in Maryland. That involves me in many aspects of my congregation, presbytery and the synod/denomination. One of the things that I work on is a small congregation in a nearby state in what is called a Temporary Governing Body.

Four elders serve on the TGB. Three are pastors, and I am the sole ruling elder. As we began our conference call on Monday evening, and we were waiting for one more to show up, I mentioned how much the market rose that day. The two pastors expressed amazement, and said, “Why did your stocks do so well?”

I told them that an effective virus for C19 had been found, which made them ask: “But why would that make the stock market go up?” I said, “The financial markets don’t react to the way the economy changed today, but they react to the way their view of the future has changed. The presence of an effective vaccine made economic participants in the market conclude that normalcy for non-tech businesses was nearer than they previously expected.”

They were surprised when I mentioned that the FANGMAN stocks had fallen on the same day. I told them, “These are the stocks that benefited from the fact that we have to work, shop, etc. over the internet. If things return to normal, they will do less well. They benefit from C19.”

And now to start an unfounded evil rumor: the FANGMAN companies conspired together to create C19. And this is not true, but I find it funny how both the far right and the far left love to distort things that may be somewhat true, and blow them up into memes that saturate an increasingly divided set of social media.

As an example, I offer this tweet:

Fact-Checked on Facebook and Twitter, Conservatives Switch Their Apps https://t.co/YPZvauh3aI I thought this would happen when Facebook and Twitter began treating messages unequally. I'm not saying $FB & $TWTR were wrong. Fragmentation in a digital era is inevitable w/fideism.

— David Merkel (@AlephBlog) November 12, 2020

As an aside for my readers, so that you don’t have to grab your dictionaries, fideism is is the idea the if you believe it, it is therefore true. Now, it’s a laughable concept, but in a world where scientists may have political/philosophical goals, and therefore may not be neutral, fideism is a genuine problem. People begin to distrust science because of non-neutral scientists.

Back to my main point. Markets react to how the view of the future has changed. That is a volatile thing. As such the moves will be volatile when there is a big event.

Personally, I wish the calling of the Presidential election for Biden, and the announcement of the Pfizer/Biontime vaccine had come on different days. We could have then had a better sense of what the changes were from.

My sense is that the reaction would have been greater if the calling of BIden had been delayed by a day. Yes, Trump is a lousy guy, and he harms foreign trade, but he won’t do the damage that Biden might do, unless the Wall Street Democrats intervene. They have done so before, and have kept the Democratic Party from being “as nasty as they want to be.”

This is why I am not worried much about Biden. The Wall Street Democrats control the party, not the progressives.

Ach, I keep getting lost in my train of thought. Back to the main point again: markets ask: “what’s it worth now?!” As perceptions of the future change, so does the market. When people see that things will be markedly better/worse in the future, the price will rise/fall respectively.

To that end, don’t be surprised when financial markets react quickly, and harder than you would expect. This is normal for financial markets, and you need to understand this.

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: Olgierd (3rd account) || Masks are a good idea, but they are not a great idea. Wear them for the good of others that you love.

Let me give you a table of how the US states are doing with respect to C19.

Sorry for the less than excellent graphics. My goal here is to give a view of the prevalence of C19 among US states, and how much it has increased over the last month. In order to smooth out lumpy data, I used data from weeks. My comparisons were from the most recent seven days and the seven days thirty days earlier.

I’m not a fan of the positivity rate. I am a fan of the rate of new infections as a ratio versus the population. That is a better measure of how C19 is spreading. I also like the monthly rate of increase in new cases, using 30 days as a month, and comparing the 7-day averages to minimize the variability.

The simple way to express the current problem is to say that the situation has flipped from March-May to now. The coasts were doing horribly earlier, and now the Midwest is doing horrible.

We have to do at least as well as Sweden. We should individually do our best to avoid spreading C19, and encourage others to do so. This is basic epidemiology. C19 is particularly pernicious because of its ability to spread asymptomatically. Protect yourselves and protect your friends. Wear masks when in public, it is better for your friends. Avoid large groups unless they are necessary.

You know that I was an optimist at the beginning of this crisis. I am now a moderate pessimist. As data changes, I change also.

So be careful, and protect yourself and your friends from C19.