Category: Real Estate and Mortgages

Redacted Version of the July 2014 FOMC Statement

Redacted Version of the July 2014 FOMC Statement

Posted on by David Merkel
June 2014 July 2014 Comments
Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months. Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter. This is another overestimate by the FOMC.
Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated. Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. More people working some amount of time, but many discouraged workers, part-time workers, lower paid positions, etc.
Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. No real change

 
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Inflation has moved somewhat closer to the Committee’s longer-run objective. Longer-term inflation expectations have remained stable. Finally notes that inflation has risen.? TIPS are showing slightly higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.60%, up 0.14% from June.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. Adds in inflation, also changes measure of the labor market to broaden it from ?conditions? to ?indicators,? not that that will help much.

They can?t truly affect the labor markets in any effective way.
The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat. CPI is at 2.1% now, yoy.? They shade up their view on inflation?s amount and persistence.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 billion per month. Reduces the purchase rate by $5 billion each on Treasuries and MBS.? No big deal.

 
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. No change.? But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings No change.? Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.? Monetary policy is like jazz; we make it up as we go.? Also note that progress can be expected progress ? presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. No change.? Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo. Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Plosser dissents.? Finally someone with a little courage.
  Voting against was Charles I. Plosser who objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals. Thank you, Mr. Plosser.? The end to easing is coming, but what will happen when it starts to bite?

?

Comments

  • The two main points of this FOMC statement are: 1) ?The Fed recognizes that inflation has risen, and is likely to persist. 2) ? Despite lower unemployment levels, labor market conditions are still pretty punk.? Much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.? Wage growth is weak also.
  • Markets don’t move much on the news. ?Really, not a lot here.
  • Small $10 B/month taper.? Equities and long bonds both rise.? Commodity prices rise.? The FOMC says that any future change to policy is contingent on almost everything.
  • Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • The FOMC needs to chop the ?dead wood? out of its statement.? Brief communication is clear communication.? If a sentence doesn?t change often, remove it.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent improvement in labor market indicators, much higher inflation, or a US Dollar crisis.
The Tails of the Distribution do not Validate the Mean

The Tails of the Distribution do not Validate the Mean

Posted on by David Merkel

17 months ago I wrote a post?How to Become Super-Rich?? Now, many of my articles are timeless — they will still have value 10 years from now. ? I like to write for the long-run. ?Teaching basic principles is what this blog is about.

The surprise for me is that article is the most?popular one at my blog. ?That says something about the desires of mankind. ?Now, if you do want a chance to become super-rich, you create your own company, and focus your efforts on it exclusively. ?Diversification is not ?a goal here. ?We are swinging for the fences here.

But just as in baseball the guys who swing for the fences to hit home runs, they also tend to strike out the most. ?The same is true of businessmen. ?Many start companies, put their all into it, and end up broke. ?Many end up with marginal businesses that give them a living, but not much more. ?A few prosper and become moderately wealthy. ? A tiny amount of them create a hugely profitable company that makes them super-rich.

Anyway, after I was cold-called by Militello Capital, I reviewed articles on the blog, including one called?CRACK THE WEALTH CODE. ?I’ll quote the most relevant portion of the post:

According to?Get Rich, Stay Rich, Pass It On: The Wealth-Accumulation Secrets of America?s Richest Families?by Catherine McBreen and George Walper Jr, ?Building up a nest egg with the equity in your home is a fine thing. But what distinguishes the model for getting rich, staying rich and passing it on is its emphasis on investing in current and future income-producing real estate?. Andrew Carnegie, the wealthiest man in America during the early 20th century, said that ?90 percent of all millionaires become so through owning real estate.? If that?s not enough to peak your interest, consider this: ?The major fortunes in America have been made in land?, coined by John D. Rockefeller. What does he know?..his net worth in today?s dollars is?onlyaround $300 billion. Invest in areas you know. Real estate gives you the opportunity to visit and connect with your investment. When?s the last time you connected with your mutual fund?

Don?t forget about the second part of the winning combo: private companies. Open your eyes to entrepreneurial opportunities. McBreen and Walper advise that at least one-quarter of your investment dollars should be in enterprises that develop products and services or invent breakthrough technologies. In?10 things billionaires won?t tell you, number seven?s title, ?We didn?t get rich investing in stocks?, hits the nail on the head. Billionaires like Steve Jobs, Bill Gates, and Mark Zuckerberg made their fortunes in start-ups, says Robert Klein, founder and president of Retirement Income Center, a retirement and income planning firm in Newport Beach, California. The article confirms that ?you?re far more likely to become a billionaire in Silicon Valley than on Wall Street.?

In one sense, I agree with what they say. ?If you want to become super-rich, pursue one goal with your one company. ?Less than 1% will succeed. ?Maybe 5-10% will attain to being multi-millionaires. ?Most will muddle or fail.

Running your own business, including real estate investing, is not a magic ticket to riches. ?A lot depends on:

  • Solving problems people didn’t know they had.
  • The time period that you invest during — were financial conditions favorable for speculation?
  • The ability to manage a large enterprise is an uncommon skill.
  • The ability to be an entrepreneur is also not common. ?Most people don’t want to take that much risk.
  • Discipline, hard effort, taking time away from family and friends.

There is a cost to trying to be super-rich, and most people die at that altar of greed. ?I suspect that most that succeed, did not aim to be super-rich, but pursued that task because they found it interesting. ?They were idealists who happened to be in business, and their ideals matched up with what would enable society to pursue its goals more effectively.

So does it make sense for average people to invest in private equity funds or private real estate funds because the wealthy ran their own companies and invested in commercial real estate?

No. ?First, remember that the super-wealthy were swinging for the fences. ?They were the rare success stories.

Second, note that those who invest in?private equity funds or private real estate funds are diversifying. ?As such, they are seeking more certainty, and will not gain an abnormally large return.

Third, recognize the data bias. ?Those who succeed with?private equity funds or private real estate funds, their data exists, while those who fail disappear.

There is no advantage to being public or private as a business. ?Private businesses can keep things secret, but public businesses have a lower cost of capital.

Conclusion

Just because the wealthy got that way by making big bets that most people lose, does not mean that average people should do that. ?Alternative investments like?private equity funds or private real estate funds are not an automatic road to wealth, and are less transparent than their liquid alternatives on the stock exchanges.

Average people should avoid low probability bets — they tend to impoverish, with high probability.

PS — that said, I like commercial real estate as a diversifier, but it won’t make you rich.

Redacted Version of the June 2014 FOMC Statement

Redacted Version of the June 2014 FOMC Statement

Posted on by David Merkel
April 2014 June 2014 Comments
Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions. Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months. The FOMC has constantly overestimated GDP growth, They forecast badly because they serve their political masters, who demand optimism to delude the public.
Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated. No significant change.? What improvement?
Household spending appears to be rising more quickly. Business fixed investment edged down, while the recovery in the housing sector remained slow. Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Shades household spending down, raises their view on business fixed investment.

The FOMC needs to stop interpreting every short-term wiggle in the data.? They whipsawed on business fixed investment over the last three periods.
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. No change.? TIPS are showing slightly higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.46%, up 0.05% from April.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. No change.
The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. No change.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. No change.? CPI is at 2.1% now, yoy.? Hey, above the threshold, and no comment from the FOMC?
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month. Reduces the purchase rate by $5 billion each on Treasuries and MBS.? No big deal.

 
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. No change.? But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. No change.? Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.? Monetary policy is like jazz; we make it up as we go.? Also note that progress can be expected progress ? presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. No change.? Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo. Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo. Stanley Fischer is an interesting addition to the FOMC, because he would be capable of an independent opinion, not that he will ever do that.? Brainard and Mester are sock puppets.? If we see a dissent out of them, I will be shocked, and revise my opinion.

?

Comments

  • Small $10 B/month taper.? Equities and long bonds both rise.? Commodity prices rise.? The FOMC says that any future change to policy is contingent on almost everything.
  • They shaded household spending down, and raised their view on business fixed investment.? Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • The FOMC is ignoring rising inflation data.
  • The FOMC needs to chop the ?dead wood? out of its statement.? Brief communication is clear communication.? If a sentence doesn?t change often, remove it.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
Avoid Illiquidity

Avoid Illiquidity

Posted on by David Merkel

There are several reasons to avoid illiquidity in investing, and some reasons to embrace it. ? Let me go through both:

Embrace Illiquidity

  • You are offered a lot of extra yield for taking on a bond that you can’t easily sell, and where you are convinced that the creditor is impeccable, and there are no sneaky options that you have implicitly sold embedded in the bond to take value away from you.
  • An unusual opportunity arises to invest in a private company that looks a lot better than equivalent public companies and is trading at a bargain valuation with a sound management team.
  • You want income that will last for your lifetime, and so you take some of the money you would otherwise allocate to bonds, and buy a life annuity, giving you some protection against longevity. ?(Warning: inflation and credit risks.)
  • In the past, you bought a Variable Annuity with some good-looking?guarantees. ?The company approaches you to buy out your annuity at a 10-20% premium, or a 20-30% premium if you roll the money into a new variable annuity with guarantees that don’t seem to offer much. ?Either way, turn the insurance company down, and hold onto the existing variable annuity.
  • In all of these situations, you have to treat the money as money lost to present uses. ?If there is any significant probability that you might need the money over the term of the asset, don’t buy the illiquid asset.

Avoid Illiquidity

  • Often the premium yield on an illiquid bond is too low, or the provisions take value away with some level of probability that is easy to underestimate. ?Wall Street does this with structured notes.
  • Why am I the lucky one? ?If you are invited to invest in a private company, be skeptical. ?Do extra due diligence, because unless you bring something more than money to the table (skills, contacts), the odds increase that they are after you for your money.
  • Often the illiquid asset is more risky?than one would suppose. ? I am reminded of the times I was?approached to buy illiquid assets as the lead researcher for a broker-dealer that I served.
  • Then again, those that owned that broker-dealer put all their assets on the line, and ended up losing it all. ?They weren’t young guys with a lot of time to bounce back from the loss. ?They saw the opportunity of a lifetime, and rolled the bones. ?They lost.
  • We tend to underestimate how much we might need liquidity in the future. ?In the mid-2000s people encumbered?their future liquidity by buying houses at inflated prices, and using a lot of debt. ?When everything has to go right, the odds rise that everything will not go right.
  • And yet, there are?two more?more reason to avoid illiquidity — commissions, and inability to know what is going on.

Commissions

Illiquid assets offer the purveyor of the assets the ability to pay a significant commission to their salesmen in order to move the product. ? And by “illiquid” here, I include all financial instruments that carry a surrender charge. ?Do you want to know how much the agent made selling you an insurance product? ?On single-premium products, it is usually very close to the difference between the premium you paid, and the cash surrender value the next day.

Financial companies build their margins into their products, and shave off a portion of them to pay salesmen. ?This not only applies to insurance products, but also mutual funds with loads, private REITs, etc. ?There are many?brokers masquerading as financial advisers, who do not have to?act strictly in the best interests of the client. ?The ability to receive a commission makes them less than neutral in advising, because they can make a lot of money selling commissioned products. ?In general, it is good to avoid buying from commissioned salesmen. ?Rather, do the research, and if you need such a product, try to buy it directly.

Not Knowing What Is Going On

There are some that try to turn a bug into a feature — in this case, some argue that the illiquid asset has no volatility, while its liquid equivalents are more volatile. ?Private REITs are an example here: the asset gets reported at the same price period after period, giving an illusion of stability. ?Public REITs bounce around, but they can be tapped for liquidity easily… brokerage commissions are low. ?Some private REITs take losses and they come as a negative surprise as you find ?large part of your capital missing, and your income reduced.

What I Prefer

In general, I favor liquid investments unless there is a compelling reason to go illiquid. ?I have two private equity investments, both of which are doing very well, but most of my net worth is tied up in my equity investing, which has done well. ?I like the ability to make changes as time goes along; there is value to being able to look forward, and adjust.

No one knows the future, but having some slack capital available to invest, like Buffett with his “elephant gun,” allows for intelligent investing when liquidity is scarce, and yet you have some. ?Many wealthy people run a liquidity “barbell.” ?They have a concentrated interest in one company, and balance that out by holding very safe cash equivalents.

So, in closing, avoid illiquidity, unless you don’t need the money, and the reward is very, very high for making that fixed commitment.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Debt Markets

  • Leverage Addicts Get Junk-Loan Fix With Derivatives ETF?http://t.co/CWMxLXlz3v?Not much different than a HY closed-end fund or a CLO $$?Jun 01, 2014
  • Bond Market Flips the Script on Risk and Reward?http://t.co/3geslTXRMo?Difficult for rates 2 rise when monetary velocity keeps falling. $$?Jun 01, 2014
  • Shakeout Threatens Shale Patch as Frackers Go for Broke?http://t.co/pGj2CUiTxG?Not healthy 4 so many 2b financing w/high amount of debt $$?Jun 01, 2014
  • Bond Market to Fed: Your 4% Rate Forecast Is Way Too High?http://t.co/Ji55pmAlYZ?Forward rates r much lower than wrong Fed forecasts $$?Jun 01,
  • New Fund Stars Ride Junk Bonds to the Top?http://t.co/1WtqogYOZX?Junk credit & HQ long duration risks have paid off, what an odd couple $$?Jun 01, 2014
  • The Hidden Risks in Your Local Housing Market?http://t.co/7OcDXnTvGC?As the amount of debt behind housing rises, systemic risks rise also $$?Jun 01, 2014
  • Pimco Rehires Former Senior Executive Paul McCulley?http://t.co/7U71N8jO12?Wish he had stayed retired; I enjoyed him not publishing $$?Jun 01, 2014
  • And so it begins: Square is to start lending to customers?http://t.co/F7xDzGTxAQ?Harder than it looks 2b a lender; 2 much optimism $$?May 31, 2014
  • S&P, Moody?s Lose Bid to Block Calpers $800M Suit?http://t.co/crQdAbw2v2?Ratings r advice not guarantees, sophisticated investors know it $$?May 31, 2014
  • How to Manage Bankers Voracious Risk Appetites?http://t.co/yrwkZkQaHW?Criminal liability, clawback of pay, & boards holding mgmt acctable $$?May 31, 2014
  • Goldman Shuns Bonds Pimco?s Gross Favors in ?New Neutral??http://t.co/bTPbJpi6Me?Go with Goldman over Pimco; buy tails, short belly $$ $GS?May 31, 2014
  • You?re All Whales in Bond Market Now With Trading Volume Slump?http://t.co/ewXmldKzC5?It means that more Tsy notes r held 2maturity $$ $IEF?May 30, 2014
  • Pimco Rehires Former Senior Executive Paul McCulley?http://t.co/7U71N8jO12?Wish he had stayed retired; I enjoyed him not publishing $$?Jun 01, 2014
  • How to Manage Bankers Voracious Risk Appetites?http://t.co/yrwkZkQaHW?Criminal liability, clawback of pay, & boards holding mgmt acctable $$?May 31, 2014
  • Goldman Shuns Bonds Pimco?s Gross Favors in ?New Neutral??http://t.co/bTPbJpi6Me?Go with Goldman over Pimco; buy tails, short belly $$ $GS?May 31, 2014
  • You?re All Whales in Bond Market Now With Trading Volume Slump?http://t.co/ewXmldKzC5?It means that more Tsy notes r held 2maturity $$ $IEF?May 30, 2014

 

US Politics & Policy

  • Geithner’s Dubious Accounting?http://t.co/8uwwJyeKHo?”justifying the bailouts b/c a simplistic measure shows the govt made $$ is a stretch.”?Jun 01, 2014
  • Seven States Running Out of Water?http://t.co/pXpEU9Hu7K?All in southern west & midwest — CA, NV, NM, KS, AZ, OK, & TX $$?Jun 01, 2014
  • State Pension Transparency Is Right Message At Right Time?http://t.co/vwGqJn7ZDq?Read about troubles of North Carolina Public Pensions $$?Jun 01, 2014
  • ‘Pink Slime’ Makes Comeback as Beef Prices Spike?http://t.co/XmDfVz5zAB?”Finely textured beef” returns to cheap hamburger; ask yr butcher $$?May 31, 2014
  • Economy Shrank, U.S. Now Says?http://t.co/qm9rarCX9P?They’re blaming the weather which is always a weak reason 4 the structural slowdown $$?May 30, 2014

 

Rest of the World

  • Japan Begins Purposely Dumping 100s Of Tons Of Radioactive Water From Fukushima In2 The Pacific?http://t.co/TklIa4ECs2?Source fish w/care $$?Jun 01, 2014
  • Spain Sees Embers Glow in Wreckage of Property Crash?http://t.co/J1KWh56u0l?Prices finally gaining real money buyers $$?Jun 01, 2014
  • Escape From Tiananmen: How Secret Plan Freed Protesters?http://t.co/yAmoc6MfKT?Unlikely group of people risked their lives 2 aid escapees $$?Jun 01, 2014
  • Iran, Stable but Miserable?http://t.co/1HNuO03Ncv?@Steve_Hanke Once Govts start giving subsidies, is very difficult 2 end them $$ #bigbang?May 31, 2014
  • Aging Swiss Face Pension Funding Dilemma on Immigration?http://t.co/9k2X7Oeszf?Demographic eclipse faces Switzerland, needs immigrants $$?May 30, 2014
  • No, China Isn’t Really Rebalancing?http://t.co/HbR7rVIiOZ?@WilliamPesek notes quick return of stimulus measures in China as growth flags $$?May 30, 2014

 

Market Impact

  • Bad Credit No Problem as Balance-Sheet Bombs Rally 94%?http://t.co/6xLjaGnBCp?A backward-looking insight, one common 2 late bull markets $$?Jun 01, 2014
  • Reynolds Aims to Oust Fidelity in Push to Gain 401(k)s?http://t.co/CO9RF3YZsk?401k financial servicing is a scale game 4 Great-West Fin’l $$?Jun 01, 2014
  • Bets on Higher Food Costs Reach 11-Week Low: Commodities?http://t.co/Bqi5PPkTsS?Time for food costs to move up $$?Jun 01, 2014
  • Neff?s do?s and dont?s?http://t.co/Sx2oExlAHb?The thinking of John Neff is underrated in my opinion; this article summarizes some of it $$?Jun 01, 2014
  • Top 10 Valuation Ratios and How to Use Them?http://t.co/bbdT2lMHeI?Worth a read $$?Jun 01, 2014
  • Dragon King beats Black Swan: Ted Talk with Didier Sornette?http://t.co/QMJNGE3N8w?Listen to Sornette; black swans can be predicted $$?Jun 01, 2014
  • New Rules 2 Alter How Companies Book Revenue?http://t.co/3siTlXkluz?Mostly liberalizes revenues, lowers earnings conservatism, watch $$ flow?Jun 01, 2014
  • Nasdaq Nears 13-Year High as Technology Becomes Loved?http://t.co/0Q7VrPsnUy?Note unprofitable IPOs coming 2 market eating sideline cash $$?Jun 01, 2014
  • Dennis Gartman: We Were Wrong Calling for a Correction?http://t.co/IhmICbVO2M?Few more capitulations & then the topping process will end $$?Jun 01, 2014
  • Managing a Portfolio I – Stop Wasting Time, Start Adding Value, Part V?http://t.co/2z2bLQV7zK?A very good series, very worthy of a read $$?May 31, 2014

 

Other

  • Little Children and Already Acting Mean?http://t.co/4RRva4OVu1?Should only surprise if u think ppl r natually good; good must b trained $$?Jun 01, 2014
  • The Myth of the Climate Change ‘97%’?http://t.co/BCsHXfzudX?I know science Ph.D.s who don’t agree, but how 2do a fair count? $$?Jun 01, 2014
  • How Many Kidneys Is an NFL Career Worth??http://t.co/EdaeHVt8zW?Gives reasons to eliminate team doctors; players, get yr own doc 4 safety $$?May 31, 2014
  • Mementos of triumphs make a return to bankers? desks?http://t.co/1fetPsXSrc?Deal toys made of Lucite return to Wall Street $$ $GS $MS $XLF?May 30, 2014
  • My Resume?http://t.co/lkMocQczJB?James Altucher spills all of the beans on his business career & life. A train wreck in slow motion $$ $SPY?May 30, 2014
  • Railcar Shortage in US Pushes Up Lease Rates?http://t.co/bcaqp0DvwV?If pipelines aren’t built, more crude will flow by rail $$ $GATX $TRN?May 30, 2014

 

Wrong

  • Wrong: SEC Set to Spur Exchange Trading?http://t.co/jU2JJvc3vi?This may help mutual fund managers, but it won’t help small investors $$?Jun 01, 2014
  • Wishful thinking: Is Hillary Clinton Too Old for the White House??http://t.co/Fy0qYw11a6?People, particularly women live longer than b4 $$?Jun 01, 2014
  • Wrong:Annotated History Of The World’s Next Reserve Currency?http://t.co/XtCSg2WQPt?Only free countries w/open markets r reserve curncies $$?Jun 01, 2014
  • Fink Says Leveraged ETFs May ?Blow Up? Industry?http://t.co/cVTubsqeiY?More likely they blow themselves up, & not the all mutual funds $$?Jun 01, 2014
  • Wrong: Paper money is unfit for a world of high crime and low inflation?http://t.co/XC4pAWjHf2?We need 2get currency out of govt hands $$?May 31, 2014
  • Wrong: Borrowers Show in Rush to Grab US Rate Break?http://t.co/H8yJX9TCQQ?Funny how everyone keeps saying rates will rise $$ FD: + $TLT?May 30, 2014
  • Wrong: Make more money by dumping your investment adviser?http://t.co/8hSPQqgDlr?Investment advisers can prevent panic & greed $$ $TROW

?

Retweets, Replies & Comments

  • RT @ReformedBroker: Nice that we printed a new record S&P 500 high today. Too bad so few stocks are involved. Via @allstarcharts?http://t.c??May 26, 2014
Yet Another Letter from a Reader

Yet Another Letter from a Reader

Posted on by David Merkel

I get a lot of interesting letters — here is another one:

First, let me say how much I appreciate your blog. I started my career in sellside research covering life insurers (after interning in insurance M&A). Your posts on insurance investing were invaluable in developing my understanding of the industry. My superiors did not have time to teach me the basics – I would have had a hard time getting started without your blog.?

?I’m now in equity research at a large mutual fund company, also covering insurers (and asset managers). However, I do not have an actuarial background. So I am very interested in why you think financial & mortgage insurers don’t have an actuarially sound business models.?

?And as a former life insurance analyst, I am curious what aspect of life insurance reserving you view as liberal – I’m guessing secondary guarantees on VAs??

?Finally, to digress, do you have any views on medical malpractice insurance? I’ve been looking at PRA, and find it pretty compelling at first glance: massive excess capital, consistently conservative and profitable underwriting, and a relatively reasonable valuation. 90% of policies are claims made. There are headwinds: Obamacare, the reserve releases from mid-2000s accident years rolling off, and a diversifying business model (although PRA has historically proven competent at M&A). My only concerns are management continuing to underwrite at too low a level (currently writing at 0.32x NPW / Equity; regulators would be fine with up to 1.0x), and potentially squandering that capital.?

In the interest of full disclosure, I own no insurance stocks personally for compliance reasons.

Thanks for writing. ?Let’s start with mortgage and financial insurance. ?It’s not that there isn’t a good way to calculate the risk (in most cases), it is that they do not choose to use those models. ?The regulators do not subscribe to contingent claims theory. ?They do not look at default as an option, even if it is not efficiently exercised. ?They should use those models, and assume efficient execution of default risk.

Even if they use approximations, the recent crisis should have forced reserves higher for mortgage credit, and other credit exposures.

Credit and mortgage insurers are bull market stocks. ?When I was a bond manager, I sold away my few financial insurer bonds from MBIA and Ambac, and avoided the mortgage insurers. ?The possibility of default was far higher than he market believed.

With respect to Life Insurers, it is secondary guarantees of all sorts, especially with variable products. ?Options that have a long duration are hard to price. ?Options?that have a long duration, and involve significant contingencies where insureds may make choice hurting the insurer are impossible to price.

On Medmal, I have always liked PRA, but it has never been cheap enough for me to buy it. ?Always thought they were the best of the pure plays. ?They have survived many other companies by their clever management. ?I would not begrudge them their conservatism, Medmal is volatile, and it pays to be conservative in volatile businesses.

Redacted version of the April 2014 FOMC Statement

Redacted version of the April 2014 FOMC Statement

Posted on by David Merkel
March 2014 April 2014 Comments
Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions. Weather is always a weak reason for a bad result.? You almost never see anyone claim good weather boosted results.

Didn?t they see today?s weak GDP report?
Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. No significant change.? What improvement?? Note: this is the one remaining place where they mention the ?unemployment rate.? Shh.
Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow. Household spending appears to be rising more quickly. Business fixed investment edged down, while the recovery in the housing sector remained slow. Shades household spending down, lowers their view on business fixed investment.
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. No change.? TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.41%, up 0.15% from March.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. No change.
The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. No change.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. No change.? CPI is at 1.5% now, yoy.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month. Reduces the purchase rate by $5 billion each on Treasuries and MBS.? No big deal.

 
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. No change.? But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. No change.? Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. Monetary policy is like jazz; we make it up as we go.? Also note that progress can be expected progress ? presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. No change.? Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. No change.
With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements.   That sentence lasted only one month.? Note that the phrase ?unemployment rate? is close to being banned by the FOMC.? The dual mandate is not so dual, at least in the old sense.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.

 

 Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo. Kocherlakota rejoins the majority, even with no change to the ?fifth paragraph? of the March statement.
Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.   Thus ends the lamest vote against an FOMC decision that I have ever seen.? The differences between the last statement?s fifth and sixth paragraphs were minuscule.

Comments

  • Small $10 B/month taper.? Equities and long bonds both rise.? Commodity prices fall.? The FOMC says that any future change to policy is contingent on almost everything.
  • They shaded household spending down, and lowered their view on business fixed investment.? Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • At least they are abandoning the unemployment rate as their measure of labor conditions.
  • They missed a real opportunity to simplify the statement.? More words obfuscate, they do not clarify.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
Why it is Hard to Win in Investing

Why it is Hard to Win in Investing

Posted on by David Merkel

Before I start this evening, I want to say something about many investment books that I have been reading of late. ?In terms of information toward the stated goal of the book, there is often a lot of build up, some of it necessary, some not, some of it interesting, some not, occasionally some unique insights, but most of the time not. ?Much of it is filler that could be eliminated. ?And, if you eliminated the filler, and boiled down the part of the book that attempts to prove the stated goal, you would have something the size of a long-form blog post. ?That’s why there is the filler — you would have a hard time selling a single chapter book, even though that contains the real value of the book, and would save your reader the time of wading through filler material.

Also, when I review books, I read them in entire. ?If I don’t read them in entire, I state that plainly at the beginning of the review, along with why I thought I could review the book without reading it. ?But after some of the books I have read lately, editing to condense the volume and stick to the topic at hand would be a help.

Finally, if the author doesn’t prove his case in an ironclad way, maybe the book shouldn’t be written. ?I often get to the end of a book disappointed, because the author promised a significant result, and did not deliver.

Onto tonight’s topic:

When is the best time to invest? ?When everyone else is scared to death of investing. ?It’s when friends come up to you and say, “I’m never investing in stocks ever again.” ?When the magazine covers proclaim “The Death of Equities,” it is time to invest.

Guess what? ?Very few people do invest then. ?It’s too painful to contemplate throwing away your money when nothing is going right, and losses are cascading. ?Remember, we are not rational, we are mimics.

When do people like to invest? ?When it’s popular to do so. When prices have been rising for a while, and the lure of “free money” is in the air. ?Books on easy money flipping homes proliferate, and there is a brisk business in seminars teaching an easy road to riches. ?It’s that time when people say, “Let the market pay your employees.”

I’ve talked about the fear/greed cycle many times before. ?I’ve also talked about time-weighted vs dollar-weighted returns before. I’ve talked about vintage years in lending before, and about absolute return investors before. ?I’ve talked about industry rotation before, as well as long-term mean reversion. ?These are all manifestations of the same phenomenon in investing — it is best to invest in any given area when few are doing so, and worst to invest when almost all are doing so.

Let me give a bunch of parallel examples to make this clear.

Why do great mutual fund managers cease to be great? ?When they are great, they have less money to manage than their ideas could bear managing. ?But money follows performance because we are not rational, we mimic. ?Eventually enough money comes in ?such that the talented investor no longer has good places to put incremental money, and can’t just leave some of the money in cash, or an index fund… from a business angle, it would not fly.

Lest you think that this does not happen to passive investing, money follows performance there also. ?It also happens in open-ended index funds, ETPs, and closed-end funds of any sort (expressed through the premium or discount).

This also applies to quantitative investment strategies — even those with broad themes like momentum and valuation. ?Let me illustrate this with a slide from a presentation I have done before a large CFA Society:

Efficient Markets versus Adptive Markets

 

And this applies to lending whether securitized or direct. ?When money is being thrown at a sub-asset class, like subprime RMBS in 2006-7, or manufactured housing ABS in 2000-1, the results are bad. ?The best results occur when few are lending, and only the best deals are getting done. ?But that means that few get those high returns. ?That is the nature of the markets.

The same applies to corporate bonds. ?It is wise to avoid the area of the market where issuance is well above average. ?When I was a corporate bond manager, I sold out my auto bonds, and my questionable telecom bonds, amidst much issuance. ?I had many brokers puzzle over why I would not buy their deals, even though they were cheap relative to their ratings.

The same applies to private equity. ?When a lot of money is being applied there, it is a time to avoid it. ?As it is now, private equity is throwing money at promising companies, many of which hold onto the money for safety purposes, because they don’t have place to invest it. ?That doesn’t sound promising for future returns.

Finally, we have a few absolute return investors like?Klarman, Grantham, and Buffett. ?They are reducing allocations to risk assets, at least in relative terms. ?Opportunities are not as great, and so they wait.

Summary

The intelligent investor estimates likely returns, and invests if the returns are worth the risk. ?I am reducing my risk positions, slowly, as I see best for my clients and me.

Most profitable investing takes an uncomfortable view versus the consensus, and buys when the market offers good deals. ?If there are no good deals, profitable investing sits on cash, and waits for a better day.

Book Review: The Death of Money

Book Review: The Death of Money

Posted on by David Merkel

103729This is a hard book to review. I have respect for the author, and most of his opinions. ?But extraordinary claims require extraordinary proof. ?There is evidence here, but not extraordinary proof. ?I agree that we are in a bad spot, and that there is reason to be cautious. ?To claim that the current international monetary system will disappear by 2020 or so requires more than the book delivers.

Let me begin by saying the book is worth buying. ?It will make you think. ?Thinking is a valuable exercise in which few engage. ?Most of us imitate, which is far easier to do than thinking, and usually saves time on common issues.

The author focuses on the weaknesses of US economic policy, but is less critical of bad economic policies being pursued around the world, with the poster children being Japan, China, and the EU. ?The US has its problems, but also its unique strengths. ?Though I am a critic of US economic policy, we are better off than most other large nations.

One criticism of the book is that it is not focused. ?Make your case, and don’t go down many “rabbit trails.” ?That said, the rabbit trails are interesting, and you will learn a lot from them, though they don’t support the central thesis of the book. ?I think the book needed a better editor, because a tighter book would have made the case better.

Here’s the main difficulty: Okay, so the US Dollar is not a great store of value. ?Imagine another nation who wants a better store of value, who lets their currency rise, and their politically powerful exporters scream. ?Who will likely win? ?The exporters. ?At least, that has been the way it has worked for the last 30 years.

In order for a gold-backed currency to be introduced, there will be sacrifices, and under most conditions, it will produce some deflation. ?It is not at all certain that the nation(s) that might do this will take the short-term punishment. ?Our world is geared toward short-termism, and it harms us all.

Quibbles

The book is far too kind to the IMF, an incompetent institution, and far too kind to China, which faces a collapse in its financial system far more quickly then the US will see.

The book is also too kind to the EU, which continues the experiment of monetary union without political union, which has never worked ?before on a large scale.

Who would benefit from this book:?Anyone could benefit from this great book.? If you want to, you can buy it here:The Death of Money: The Coming Collapse of the International Monetary System.

Full disclosure: I asked the PR people for a copy of the ?book, and they sent it.

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Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Stocks & Industries

  • Invest In Stubs, Spin-Offs And Liquidations For Alternative Returns?http://t.co/ccezep0K9Y?Cites a Gabelli article http://t.co/xTrqEfmQeq $$?Apr 19, 2014
  • Real Estate Management Better Than Owning Real Estate??http://t.co/IFaDLiwTRa?Sometimes yes, sometimes no. Definitely adds more leverage $$?Apr 19, 2014
  • Wells Fargo Securities Lending Lawsuit Ends in Settlement?http://t.co/w3lSY4Cw8D?Low margin business that can go badly wrong in a crisis $$?Apr 19, 2014
  • Makani, a $GOOG subsidiary makes an airborne wind turbine that dramaticlly increases power generation efficiency?http://t.co/0Fug49o7gC?$$?Apr 18, 2014
  • Google to Buy Titan Aerospace as Web Giants Battle for Air Superiority?http://t.co/HjJ8wKtnjM?Makes me think $GOOG has 2much $$ 2spend?Apr 18, 2014
  • Profit Tastes Like Chicken in Hunt for Cheaper US Meat?http://t.co/drgQbwEiKR?With recent rise in beef & pork prices people substitute $$?Apr 18, 2014
  • Roads Versus Rail:The Big Battle Over Public Transportation?http://t.co/ydBxEglexC?Makes case that American will own fewer cars in future $$?Apr 18, 2014
  • Barclays Ups $LNC To Buy, Says $MET , $PRU Are Undervalued – Stocks To Watch?http://t.co/c7yNaVZqdp?Stock Market sensitive insurance cos $$?Apr 18, 2014
  • Bidding War Looming for Aspen? Analysts Say Don?t Count On It?http://t.co/iMotqyAgHv?Offer 4 $AHL looks pretty full 2me, dont look4more $$?Apr 18, 2014
  • Biggest LBO Demise Poised to Put Oncor in Play?http://t.co/d30djwOa5M?Buffett is unlikely 2 enter into bidding in a competitive sale $$?Apr 18, 2014
  • Target of Naked Short Sellers Is Angry, Confused?http://t.co/I3ZZDn5JNp?@matt_lavine takes on imaginary naked shorting in $LPHI $$?Apr 18, 2014
  • Radioactive Waste Is North Dakota’s New Shale Problem?http://t.co/BiMkO0ZdgK?Significant amounts of low level radiation from radium $$?Apr 18, 2014
  • The death of mortgage lending?http://t.co/u8uQBvZCuS?Loan yields must rise in order to compensate for higher required capital at banks $$?Apr 19, 2014
  • Kochs? Flood Insurance Opposition Becomes Campaign Issue?http://t.co/b1iuvoVhZK?1 of the few businesses the Kochs’ aren’t in is insurance $$?Apr 18, 2014
  • Office Markets Strengthen Where Tech, Energy Jobs Are?http://t.co/sESuHUeAVr?Helps explain the spottiness of commercial RE prices $$ $CMBS?Apr 18, 2014
  • Labor Shortage Threatens to Bust the Shale Boom?http://t.co/R1TctaTelD?Can’t find a job? Consider learning to weld; monotonous but pays $$?Apr 18, 2014
  • Koch Brothers Net Worth Tops $100B as TV Warfare Escalates?http://t.co/XgH0M6CNIR?Almost as wealthy as extended Walton family $$ $WMT $SPY?Apr 18, 2014
  • Big Banks Ramp Up Business Lending?http://t.co/83dMAPIQia?Signs of life spotted in big corporations, but r they just buying back stock? $$?Apr 18, 2014
  • How Can Yahoo Be Worth Less Than Zero??http://t.co/sr3owwkyNE?@matt_levine argues a breakup of $YHOO makes sense even if core biz loses $$?Apr 18, 2014
  • Wal-Mart Undercuts Rivals With New U.S. Money Transfer Service?http://t.co/a4vq0HYALi?Useful if u need 2 transfer $$ inside the US $WMT $SPY?Apr 18, 2014
  • How Chick-fil-A Spent $50M to Change Its Grilled Chicken?http://t.co/Q9kpXoSIbF?The marinade matters, but the grill design was the key $$?Apr 15, 2014
  • Small US Colleges Battle Death Spiral as Enrollment Drops?http://t.co/nHRhO4Gc1R?Too much capacity & affordability is a problem $$ $APOL?Apr 14, 2014

Outside the US

  • China GDP Gauge Seen Showing Deeper Slowdown?http://t.co/ntIxxdXcpO?If China increases consumption GDP growth will fall faster still $$ $FXI?Apr 18, 2014
  • Housing Trouble Grows in China?http://t.co/Z4tKUuqLFd?Overbuilding by Real-Estate Developers Leaves Smaller Cities W/Glut of Apartments $$?Apr 18, 2014
  • Suddenly, Europe Is Taking a Harder Line on Russia Sanctions?http://t.co/MnzxvMP3pe?Nations can solidify when they face a common threat $$?Apr 18, 2014
  • Las Bambas Copper Mine Purchase Shows China’s Still in the Hunt for Commodities?http://t.co/h1cqGERGCu?China may not b changing much $$?Apr 18, 2014
  • Forgetting How to Speak Russian?http://t.co/D0UwT6unki?Among former Soviet republics knowing Russian is less important for business $$?Apr 18, 2014
  • The Middle East War on Christians?http://t.co/BW1NwCAXuH?Israeli Ambassador 2 UN argues Israel is tolerant of Christians, not like some $$?Apr 18, 2014
  • Britons Struggle to Save for Home Down Payments as Prices Surge?http://t.co/M6vH0vDlDs?Space is constrained in London & foreigners buy $$?Apr 18, 2014
  • US Said to Warn Money Managers of More Russia Sanctions?http://t.co/rB8AUQTsnc?Putin knows Iran survived worse sanctions; Russia tougher $$?Apr 18, 2014
  • China Sentences Four Activists on Disturbing Public Order Charge?http://t.co/Tx95rrhWsb?Mostly, US has rule of law, China has rule by law $$?Apr 18, 2014
  • US govt isn’t perfect, but in principle the govt is subject to the Constitution & laws, & not merely able 2 use law 2 enforce its will $$?Apr 18, 2014
  • Frontier Fund Buyers Find It Pays To Look Under The Hood?http://t.co/JQ6khwYllJ?2much $$ is being thrown @ frontier mkts; crowded trade $FM?Apr 18, 2014
  • Why iShares? ?FM? Is About To Get Better?http://t.co/4FiqlfW0YS?Diversifies out of Middle East, but frontier market vals r stretched $$ $FM?Apr 18, 2014
  • Putin’s 21-Year Quest to Be Russian Guardian Began in Estonia?http://t.co/5oelLBHCmN?Father was betrayed by Estonians in WWI, almost died $$?Apr 15, 2014

Market Dynamics & Fundamentals

  • Bridgewater Founder Says 85 Percent Of Pensions will Go Bankrupt?http://t.co/YknEmyGgfJ?9% pension returns required, 4% is most likely $$?Apr 19, 2014
  • The Fitch Fundamentals Index Dashboard?http://t.co/OzI6KWUFfs?Interesting little utility 4 understanding where we are in the credit cycle $$?Apr 19, 2014
  • Rich Start-Ups Go Back for Another Helping?http://t.co/ZbFbpLVgmM?When capital is plentiful, bad decisions get made. expected returns low $$?Apr 18, 2014
  • Stumbling S&P 500 Reaches Worst Stretch of Election Cycle?http://t.co/zgJTynu2od?Interesting timing, wonder whether past is prologue? $$?Apr 18, 2014
  • How a 56-Year-Old Engineer?s $45K Loss Spurred SEC Probe?http://t.co/3HfdH2aqxK?Always read the risk factors in the prospectus or 10K $$?Apr 18, 2014
  • High-Speed Traders Said to Be Subpoenaed in NY Probe?http://t.co/2qxmrxeVd7?What level of technology is legitimate 2 gain an advantage? $$?Apr 18, 2014
  • Nuggets of Corporate Governance Wisdom From Charlie Munger?http://t.co/gMFIE9jlRM?Also c this paper: http://t.co/033v0bgdYr $$ $BRK.B $SPY?Apr 18, 2014
  • Global stock rally: World market cap reached record high in March, &is $2.4T above pre-recession, pre-crisis level?http://t.co/iMq0IoBhch?$$?Apr 18, 2014
  • Speed?the only HFT advantage? Not so fast?Flash?Boyshttp://www.cnbc.com/id/101586488?Algorithms may also be an advantage w/price patterns $$?Apr 18, 2014
  • Investor Alert – Exchange-Traded Notes?Avoid Unpleasant Surprises?http://t.co/NqhUr2whsJ?A helpful reminder 2b wary of exotic ETNs $$ $SPY?Apr 18, 2014
  • Americans Sold on Real Estate as Best Long-Term Investment?http://t.co/La4UROU0ie?Helps explain y retail investors lose on average $$ $GLD?Apr 18, 2014
  • Destroying Smart Beta 2: Ground Rules?http://t.co/uecYqZLCEe?Smart beta is a trendy but vapid concept, factors should be part of alpha $$?Apr 18, 2014
  • Gross Loses to Goldman in Hot Bond Strategy as Pimco Lags?http://t.co/VWv7UC72bS?Series of bad bets makes Pimco a laggard as AUM flees $$?Apr 15, 2014
  • Trillion-Dollar Firms Dominating Bonds Prompting Probes?http://t.co/RXZNkNwtFs?Concentrated markets can lead to bond pricing distortions $$?Apr 15, 2014

US Politics & Policy

  • What’s the Matter With Illinois??http://t.co/wmDiyWDN1e?They r the exemplary state for shortsightedness & corruption $$?Apr 19, 2014
  • Heartbleed Hackers Steal Encryption Keys in Threat Test?http://t.co/dYfezfXe8A?>6 people were able to extract private key of a website $$?Apr 19, 2014
  • Elijah Cummings, W/IRS, Targeted Tea Party Group True The Vote?http://t.co/TE5A1zTM0y?I live in his gerrymandered district; kick him out $$?Apr 18, 2014
  • Yellen Lays Groundwork for Rules on Short-Term Credit Markets?http://t.co/z03MWlpsqI?Fed doesn’t regulate the banks well, y try 4 more? $$?Apr 18, 2014
  • Schooling on a ‘Debit Card’?http://t.co/wwixbB0pqy?Arizona created a program so that special needs kids can get specialized schooling $$?Apr 18, 2014
  • IRS Among Agencies Using License Plate-Tracking Vendor?http://t.co/HTs5aEMNtK?Howard County Police use it & catch people 4 old crimes $$?Apr 18, 2014
  • Wealth Effect Failing to Move Wealthy to Spend?http://t.co/R3vfD5i94J?Wealth effect, if it exists, is small, FOMC is pursuing illusions $$?Apr 18, 2014
  • NSA Said 2 Exploit Heartbleed Bug for Intelligence for Years?http://t.co/9XvcLX9ZTE?NSA quietly knows security vulnerabilities; uses them $$?Apr 15, 2014
  • The Wall Street second-chances rule: scandal makes the rich grow stronger?http://t.co/8HhscWJjMN?What does not kill us makes us stronger? $$?Apr 14, 2014

Practical

  • How well do you know your insurance policy??http://t.co/szp3G8H4kN?Know what is covered & what isn’t, how much is covered & options $$?Apr 19, 2014
  • Attention Shoppers: Fruit and Vegetable Prices Are Rising?http://t.co/MMdPOLry9A?As are meat prices & most food prices $$ #agflation?Apr 18, 2014
  • How to start investing?http://t.co/yGyziE8Tac?Good advice from a credible source $$?Apr 18, 2014

Other

  • El Nino Signs Detected, Presaging Global Weather Change?http://t.co/D1uDLS9aJ0?El Nino exists 2 give us something 2 blame when frustrated $$?Apr 18, 2014
  • More People Pick Elimination Diets to Discover Food Sensitivities?http://t.co/ftQkzs3PxP?Fad and Science of Not Eating Entire Food Groups $$?Apr 18, 2014
  • SAT Adopts Real-World Questions and Jettisons Obscure Words?http://t.co/Mspw9EG3OV?In 2016, changes from intelligence to achievement test $$?Apr 18, 2014
  • Scientists Make First Embryo Clones From Adults?http://t.co/e5qlwyiWwj?Cloned cells 2create early-stage embryos, matching DNA tissue $$?Apr 18, 2014

Comments, Replies & Retweets

  • RT @howardlindzon: Funds still paying up (I say silly overpay) for private over public, this is spooking IPO ‘s for sure?http://t.co/mclSd9??Apr 15, 2014
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