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.
Photo Credit: BiblioArchives / LibraryArchives & Yousuf Karsh. Library and Archives Canada, e010751643 || Nevah give up! Nevah give up! Nevah give up!!!
I may be off by a year but sometime in 1997 I was invited by Ted Aronson to come meet with him at his office in downtown Philadelphia. We talked for 90 minutes about a wide number of topics related to value investing and quantitative finance. I asked at the end of the conversation, “Why did you invite me to come talk with you? What’s the advantage to you?” He said (something like), “You’re a bright and interesting person, and I benefit by talking with such people.”
I met Ted through the CFA Society in Philadelphia. Sarah Lange, at that time the Chief Investment Officer of Provident Mutual, was president of the Society that year, and I did some small things to bring in some programs for the Society.
I met Ted at least twice more at a variety of CFA events, including the one where I was representing Baltimore at the Boston meeting where the Eastern US Societies met to oust the leader of the CFA Institute for malfeasance in 2003. I also met Harry Markopolos at that time, as he was President of the Boston Society that year.
And as such, given the talk that I had with him that day, the details of which I can’t remember, but it was a lot of fun, I was surprised to see this article:
Meet Ted. Ted is a value investor. Ted admits his recent performance hasn’t been so great. Ted would like you to have your $10B back. https://t.co/Zq1HAjRGhE I met Ted in 1997, and then a few times after that. Bright guy, but like me and all value investors we've gotten whacked
I was shocked. The one thing I remember about his conversation with me was that he called his method “price-to-zipcode.” From others things that he said, I backed into the idea that he was doing some form of multifactor value investing, which was not far from what I was doing and continue to do.
I was reminded of when I wrote this:
You’ll know a market top is probably coming when:
a) The shorts already have been killed. You don’t hear about them anymore. There is general embarrassment over investments in short-only funds.
b) Long-only managers are getting butchered for conservatism. In early 2000, we saw many eminent value investors give up around the same time. Julian Robertson, George Vanderheiden, Robert Sanborn, Gary Brinson and Stanley Druckenmiller all stepped down shortly before the market top.
We’ve seen a lot of value managers give up in the present era also, and temporarily that depresses “value stocks” as the value managers close their firms, sell stocks, and return capital to shareholders.
Eventually this will come to an end. I agree with David Einhorn who says that tech stocks are in an enormous bubble. It’s not the same as 2000, where tech stocks had no profits. It is different, as tech stocks have extremely high valuations relative to their profits. And that may be no difference at all, as the sum of the weights of technology and communication stocks have hit an all time high this year. The highest weight sector tends to underperform. The only question is when does the momentum fail.
I’m not giving up. My principles have a strong theory behind them. My efforts are not just value, but deep value, and I have gotten my share of kicks to the gut as a result.
At some point the tide will turn, even if it is private equity absorbing value stocks out of the market. The investment math is hard to break. If companies are cheap on net worth and earnings, they will appreciate.
In closing, I thank Ted Aronson for talking to a then young investment actuary who had a lot of ideas but few prospects. He treated me very well, and for that I salute him, even as he shuts his firm down.
PIcture credit: Aleph Blog, and the same for all the graphs and charts in this post. All liability for mistakes here is mine.
This post is different than any other I have done at Aleph Blog. I will try to write this in a nice way even though it is a strong and out-of-consensus opinion on a topic that many are edgy about.
I realize I might be wrong here, but I will present to you what I think, along with what I think are the limitations of my analysis. Part of my reason for writing this is that I think that most of the reporting on COVID-19 is subject to a bias common in our culture among politicians, lawyers, bureaucrats, and the media: an extreme bias toward safety because the costs of being wrong on the optimistic side are high than the rewards for being right. (Example: NOAA overpredicts disasters, and so do most hurricane forecasters.)
This post will be structured like this:
Summary of findings and recommendations
Limitations of the analysis
Breaking down the results by groups of countries
A discussion of the “Second Wave,” with policy recommendations
Closing comments
Appendix for math nerds
Summary of findings and recommendations
The First Wave of the crisis will pass more quickly than most expect. Most countries with a large number of COVID-19 cases will have 99% of their First Wave cases reported by mid-April.
Of the 13 countries with the most cases of COVID-19, the least of them has reported 41% of their likely First Wave cases. Of those same nations, none are expected to have more than 0.3% infected with COVID-19.
The real challenge will come in dealing with the Second Wave of the crisis. How do governments deal with a smallish number of new cases, and keep them from growing into a new epidemic?
In the Second Wave, governments should selectively tell some to stay home, while telling most people to get about their normal work.
Quarantine those who are sick with COVID-19 and those who have been with them, until they are tested and have a negative result. Continue to disallow international travel, or insist on a two week quarantine upon returning.
Let healthy people return to their work. All businesses are necessary businesses.
Avoid bizarre stimulus programs that are harmful in the long run. Tell the Fed that monetary policy can’t solve everything, and not to play favorites.
Limitations of the analysis
I am not a public health specialist. I am a statistician with a background in econometrics, which has its similarities with biometrics.
My analysis assumes that processes for finding new cases of COVID-19 are constant, or mostly so. That is not always true — an example is when China announced a large amount of new cases all at once.
I use an inverse logistic curve for my analysis. All functional forms have their limitations, and for the nations analyzed as of this date, the minimum pseudo-R-squared is 79.4%, and the highest is 98.5%. That said, this is a common functional form for epidemics.
The model assumes that there is one wave. That will not prove to be true, as can be seen from China and South Korea.
All sorts of things can go wrong that are not in the data now — mutations, civil disobedience, large bureaucratic errors, large policy errors, etc.
Analysis By Group
Those that are though the First Wave
We have two in this group: South Korea and China. I don’t trust China’s data. In each case, though, you have the First Wave go through their nation and burn out, followed by an excess number of new cases where the public health authorities may not be catching up with what could be the Second Wave. I’ll talk more about the Second wave below.
The unusual case of Iran
Really, I don’t know what is going on in Iran on COVID-19 but it looks like the initial new cases started to slow down, and then they let up on restrictions too soon. New cases hit a new high yesterday, which doesn’t fit the paradigm of a consistent response the the crisis. COVID-19 seem to be out of control in Iran.
Those that are close to done
Italy and Germany are past the halfway mark in the epidemic, and are having lower new cases on average daily.
In general, the policy responses of a nation influence the amount of the population subject to infection, and the ability of the infected to interact with the broader society.
The rest
These are the nations that have not certainly passed the 50% mark as of today as I estimate the infection. As I have watched this develop over the last week, the most difficult aspect of estimation comes when you are near the halfway point. Small changes in actual new cases make a big difference in estimated new cases. An example is the United States, who has had significantly lower new cases than expected for a preponderance of the last week. The US got off to a slow start in its reaction to the crisis, but seemingly has caught up and then some.
WIth these countries, the odds of being wrong is the highest. Thus all conclusions with them must be considered tentative. But with so many of them following nearly the same pattern, despite very different responses to the crisis, gives more certainty to this analysis.
A discussion of the “Second Wave,” with policy recommendations
When you look at the data of CHina and South Korea, you see how the epidemic went through the s-curve, and then has persistently high new cases thereafter. I call this the “Second Wave.” Iran seems to be a case where their society inadequately stops transmission, and so instead of following an s-curve of an exponential, it seems to keep increasing in a way that is almost quadratic — slow but steady.
This will be the grand problem for most countries. How do you eradicate the virus after you have had large success in interrupting its transmission? Looking at the relative success of South Korea in the First Wave I would say that you do the following:
Test and quarantine aggressively.
Of those who test positive for COVID-19, quarantine all of their contacts, and test them. Continue quarantine for those who test positive, and quarantine/test their contacts as well. Repeat as needed.
But don’t quarantine everyone. Let those who are healthy work. Encourage those who are old or have compromised immune systems to stay home for the duration of the crisis, and give some assistance to them.
Don’t assist all of society because that is way too expensive and not needed — get them back to work. Don’t give into the idea of denying people work and then offering meager assistance. It is an inferior idea for those who are healthy.
This applies to the actions of the Federal Reserve as well — don’t harm the value of capital by artificially creating more capital that has no earnings capacity.
Closing comments
This analysis shows the the slowest of the nations written about here is passing the middle of the crisis quite rapidly, and the practical end of the crisis is in mid-April, when 99% of all First Wave new cases will have been realized. The real challenge will come in dealing with the cases after that, which will be sporadic and localized. How do we keep that from becoming a semi-permanent bother to the world, because the cost of putting life on hold is high, as is the cost of losing lives.
Quarantining and testing aggressively is the best solution, together with letting the healthy work. This should be the guiding star for all policymakers, because we need to strike the right balance between breaking the social connections that lead to disease transmission, and allowing people to labor to support themselves. We are not trying to save the financial markets; we are trying to protect people who work.
Appendix for math nerds
The above was how I structured my analysis. It followed a logistic curve, which has the following benefit: infections begin exponentially, but get retarded by two factors: one is that even if people do almost nothing as in 1918, the uninfected population shrinks, which blunts further growth. Second, people act to blunt further growth. They separate themselves from each other, and particularly those who are infected. This is is akin to removing fuel from the fire.
The logistic curve has a number of advantages for estimation. It notices the slowing down of the percentage growth in total cases, while media and politicians continue to panic.
Remember that that the media and politicians selfishly like to maximize their influence, and try to create panics — it is good for them to maximize fear. The same is true for many in public health. Truly, we should spend more on public health, but it is one of those things that governments naturally neglect… because they are short-sighted, and will not spend money on something the lowers risk, but does not bring any present good. (Note to Christians: in the Old Testament public health was a function of their government via the priests. It should be a normal function of government to deal with contagion.)
Final note: I did not write this with Donald Trump in mind. I did not vote for him and will not vote for him. That said, he is on the right track when he says the cure should not be worse than the disease.
It is foolish to warp monetary policy and fiscal policy when healthy people are perfectly capable of working. Don’t destroy ordinary incentives and rack up tons of debt by keeping people idle. Test, quarantine, test, quarantine, etc. , but leave the main body of society alone, particularly for a virus that does not harm the healthy working population much.
To that end, I ask that Republicans be real Republicans, and not expand the deficit further. I ask that the Federal Reserve stop trying to be God, and be content with merely having a currency with a consistent value.
Government is best when it is small. We are not facing the Black Death, nor the Spanish Flu. We will get through this, God willing. We don’t need to panic.
Photo Credit: Gage Skidmore || Unless things change, Democratic Party Elites should get comfortable with Sanders being their nominee for President
This is a rare post on politics at Aleph Blog. I am not taking a position on any candidate here, nor their effect on the economy. As an applied mathematician, I want to point out the implications of three factors:
Bernie Sanders is getting roughly 30% of votes in the primaries/caucuses, and the next five split the rest in an uneven way.
These Democratic contests typically award delegates based on the vote in each area as defined by a state, and the state as a whole. The delegates get split pro-rata to a candidate’s share of the vote in each area if the candidate gets over 15%. It’s a little more complex than that if no one gets more than 15% of the vote, but that’s not likely to happen in 2020.
If Sanders gets over 35% of all the pledged delegates, it will get increasingly ugly to not give him the nomination the nearer his delegate total gets to 50% of pledged delegates. No one wants a convention where over 1/3 of the delegates feel cheated. If you need examples where there wasn’t cheating, but there were sure a lot of hard feelings, you can think of Ford/Reagan in 1976, Carter/Kennedy in 1980, and Clinton/Sanders last election.
Add in one more bit of data — in an internet age, it is easy to keep a campaign on life support. Candidates with low funds can nominally hold on for a long time subsisting off of what free media and a skeleton staff can give them.
I ran a few simple simulations yesterday. With six main candidates altogether, if Sanders gets 30% of the vote on average, and the other five split the rest in a lopsided way, on average Sanders will end up with roughly 45% of all of the delegates. But suppose one of Sanders’ opponents drops out, and the other assumptions remain similar — Sanders would get 36% of the delegates. If one more opponent drops out, the effect is a lot smaller — Sanders would get 33% of the delegates.
The most unlikely assumption not to change is that Sanders doesn’t pick up support from voters when opponents of his drop out, particularly if the ones dropping out would be Warren or Buttigieg. I would expect that Sanders might pick up more support if one of them dropped out, as opposed to Biden, Bloomberg or Klobuchar.
But the main effect going on here is with so many opponents to Sanders splitting the remaining votes, few of them get above the 15% threshold, and Sanders gets a decidedly higher allocation of delegates than what he got in the popular vote — not as big of a difference as in the GOP’s winner-take-all primaries, but this is still a considerable advantage unless one of his challengers breaks out of the pack.
Thus, when I read an article like No,?You?Drop Out: Why Bernie?s Rivals Are All Stubbornly Staying in the Race I realize that most of Sanders’ opponents would like others to drop out of the race, but no one sees a decent reason to do so. Everybody thinks it’s nice to get more cars off the crowded highway, as long as it is not them.
Thinking back to 2012 when I wrote Searching for the Not-Romney, I noted how virtually every GOP candidate had had a surge and fall versus Romney. After each surge, there wasn’t a second surge. Voters had given them a limited window of time when they reviewed them — they weighed them in the balance, and found them wanting. No second chances.
I don’t think that’s a perfect paradigm. Second chances ARE possible for the opponents of Sanders, but I think they are unlikely. The candidate would have to give voters a reason to think, “Huh, I guess I didn’t understand him right the first time.” Getting a lot of people to change their minds is difficult after a first impression is made. Thus in the present state of matters, I assume that Sanders will be the nominee of the Democrats.
And, since I can’t resist making at least one comment regarding the economic implications of that, yesterday the market went down hard because of the coronavirus, something that I think is transitory, and should have little effect. Perhaps the drop was due to Sanders’ convincing win in Nevada. That would certainly have more effect on the economy, particularly profits, for a longer period of time.
It might be wise to check your risk position, and ask yourself whether you feel comfortable given an increased likelihood of Sanders being the next President of the USA.
Photo Credit: David Lofink || Most things in life have limits, the challenge is knowing where they are
I was at a conference a month ago, and I found myself disagreeing with a presenter who worked for a second tier ETF provider. The topic was something like “Ten trends in asset management for the next ten years.” The thought that ran through my mind was “Every existing trendy idea will continue. These ideas never run into resistance or capacity limits. If some is good, more is better. Typical linear thinking.”
Most permanent trends follow a logistic curve. Some people call it an S-curve. As a trend progresses, there are more people who see the trend, but fewer new people to hop onto the trend. It looks like exponential growth initially, but stops because as Alexander the Great said, “There are no more worlds left to conquer.”
Even then, not every trend goes as far as promoters would think, and sometimes trends reverse. Not everyone cares for a given investment idea, product or service. Some give it up after they have tried it.
These are reasons why I wrote the Problems with Constant Compound Interest series. No tree grows to the sky. Time and chance happen to all men. Thousand year floods happen every 50 years or so, and in clumps. We know a lot less than we think we do when it comes to quantitative finance. Without a doubt, the math is correct — trouble is, it applies to a world a lot more boring than this one.
I have said that the ES portion of ESG is a fad. Yet, it has seemingly been well-accepted, and has supposedly provided excess returns. Some of the historical returns may just be backtest bias. But the realized returns could stem from the voting machine aspect of the market. Those getting there first following ESG analyses pushed up prices. The weighing machine comes later, and if the cash flow yields are insufficient, the excess returns will vaporize.
In this environment, I see three very potent limits that affect the markets. The first one is negative interest rates. There is no good evidence that negative interest rates stimulate economic growth. Ask those in nations with negative interest rates how much it has helped their stock markets. Negative interest rates help the most creditworthy (who don’t borrow much), and governments (which are known for reducing the marginal productivity of capital).
It is more likely that negative rates lead people to save more because they won’t earn anything on their money — ergo, saving acts in an ancient mold — it’s just storage, as I said on my piece On Negative Interest Rates.
Negative interest rates are a good example of what happens you ignore limits — it doesn’t lead to prosperity. It inhibits capital formation.
Another limit is that stock prices have a harder time climbing as they draw closer to the boundary where they discount zero returns for the next ten years. That level for the S&P 500 is around 3840 at present. To match the all time low for future returns, that level would be 4250 at present.
Here’s another few limits to consider. We have a record amount of debt rated BBB. We also have a record amount of debt rated below BBB. Nonfinancial corporations have been the biggest borrowers as far as private entities go since the financial crisis. In 2008, nonfinancial corporations were one of the few areas of strength that the bond markets had.
One rule of thumb that bond managers use if they are unconstrained is that the area of the bond market that will have the worst returns is the one that has grown the most during the most recent bull part of the cycle. To the extent that it is possible, I think it is wise to upgrade corporate creditworthiness now… and that applies to bonds AND stocks.
Of course, the other place where the debt has grown is governments. The financial crisis led them to substitute public for private debt in an effort to stimulate their economies. The question that I wonder about, and still do not have a good answer for is what will happen in a fiat money world to overleveraged governments.
Everything depends on the policies that they pursue. Will the deflate — favoring the rich, or inflate, favoring the poor? No one knows for sure, though the odds should favor the rich over the poor. There is the unfounded bias that the Fed botched it in the Great Depression, but that is the bias of the poor versus the rich. The rich want to see the debt claims honored, and don’t care what happens to anyone else. The Fed did what the rich wanted in the Great Depression. Should you expect anything different now? I don’t.
As such, the limits of government stimulus are becoming evident. The economic recovery since the financial crisis is long and shallow. The rich benefit a lot, and wages hardly rise. Additional debt does not benefit the economy much at all. We should be skeptical of politicians who want to borrow more, which means all of them.
One of the greatest limits that exists is that of defined benefit pension plans vainly trying to outperform the rate that their risky assets are expected to earn. They are way above the level expected for the next ten years, which is less than 3%. Watch the crisis unfold over the next 15 years.
Finally, consider the continued speculation that shorts equity volatility. You would think that after the disaster that happened in 2018 that shorting volatility would have been abandoned, but no. The short volatility trade is back, bigger and badder than ever. Watch out for when it blows up.
Summary
Be ready for the market decline when it comes. It may begin with a blowout with equity volatility, but continue with a retreat from risky stocks that offer low prospective returns.
…what should a the managers/board of a closed end fund do if it persistently trades at a large premium to its net asset value [NAV]? ?I can think of three ideas:
1) Conclude that the best course of action is to?minimize the eventual price crash that will happen. ?Therefore issue stock as near the current price level as possible, and use it to buy non-inflated assets, bringing down the discount. ?What?s that, you say? ?The act of announcing a stock offering will crater the price? ?Okay, good point, which brings us to:
2) Merge with another closed end fund, trading at a discount, but offering them a premium to their NAV, hopefully a closed end fund?related to the type of closed end fund that you are. ?What?s that, you say? ?Those that manage other closed end funds are financial experts, and would never agree to that? ?Uhh, maybe. ?Let me say that not all financial experts are equal, and who knows what you might be able to do. ?Also, they do have a duty to their investors to maximize value, and for those that?sell above net asset value this is a big win. ?In the meantime, you have reduced your effective economic discount for those that continue to hold your fund.
3) Issue bonds or preferred stock convertible into common stock at a level that virtually guarantees conversion. ?Use the proceeds to invest in your ordinary investment strategy, bringing down the effective discount as dilution slowly takes place.
Of all the ideas, I think 3 might work best, because it would have the best chance of allowing you to issue equity near the overvalued level. ?If the overvaluation was 50%, maybe you could get it down to 25% by doubling the asset base, in which case you did your holders a big favor. ?If it works, maybe repeat it in two years if the premium persists.
Tonight, I want to suggest a fourth method, which would work and for the most part not upset existing holders. It would also benefit the fund manager. Do a rights offering.
A rights offering would give each shareholder a certain number of rights per original share held, allowing them to buy shares of stock at a price lower than the current price at the time of the announcement. The rights are typically tradeable, so someone not wanting to put more money in can trade their rights away — to them it is like a dividend. Others can buy the rights traded away, and buy shares in the offering. There are sometimes “oversubscription rights” which allow those subscribing in the rights offering to get additional shares at the offering price pro-rata to their subscriptions, if there are shares not purchased in the rights offering. Finally, rights not exercised expire worthless on the closing date of the offering.
Sound like a fun game? I participated in a number of these in the ’90s, particularly with some small-cap mortgage REITs that were busted from playing around with interest only securities using borrowed money. Messy stuff, but they had tax losses that were worth more than the price of the stock. The rights offerings were a means of raising capital to give them breathing room so that they could wind up their operations on more favorable terms than a forced sale that would endanger the value of the tax losses. But I digress…
Rights offerings are typically a small-cap phenomenon. They are one of the financing methods of last resort. But they could play a meaningful role in bringing down the premium over NAV of a closed-end fund.
Picture Credit: Aleph Blog
In this case, every old share receives one right, and it takes $15 plus four rights to buy a new share. The above assumes that all rights are used, and all the additional 2.5 million shares are subscribed.
Two things happen: the closed-end fund gets bigger, and the premium to NAV drops. Now, there is no guarantee that the price would not be affected by the rights offering — some people might mistakenly sell out in a panic, or the shareholders might bid up the price back to $21, illogical as that might seem. But if everyone behaved rationally in an offer like this, the premium over NAV would fall, and more so if fewer rights were needed to buy a share.
Now the managers of the fund would have more assets to manage, but might find that they can’t absolutely replicate the prior composition of the fund — many funds that trade at a premium are relatively high yielding bond funds. It’s possible that as a result of the additional money to put to work that the yield of the fund might fall, inducing some people to sell, and the premium to NAV would drop further.
It would be in the interests of the managers to try something like this to monetize the premium of the fund. If fund investors are rational, they wouldn’t lose any money in the process. But would the managers ever try doing it? Time will tell.
The first thing that fascinates me is how different these articles are. Second, the first two articles are old — 2011 and 2008 respectively. There are a few math pedagogy articles at my blog, but not many. It is something near to my heart as math was my favorite subject as a boy, followed by science and the social sciences.
It also highlights the peculiarity of my blog. I cover a lot of ground, and I am fairly certain that every post loses some of my audience. Anyway, it is nice to be doing this again. I hope you all enjoy it. And to Tadas Viskanta at Abnormal Returns, thanks for taking note of my return. That meant a lot to me.
I am VERY interested to have your opinion on this.? First a few assumptions.? While equality of opportunity in a free market economy is ideal and a goal to be pursued, equality of outcome is both impossible and not something to be pursued for many reasons, including the consequences of stifling innovation and competition.? ? The question – While there will always be income inequality in a free market economy, does crony capitalism have the effect of increasing income equality by means of subsidies, regulations, protection of monopolies, etc? ? The reason for the question is this:? I think that my lefty friends are on to something when they point out the gross disparity of income that exists in our country.? They believe that the solution is bigger government and something that looks more and more like socialism.? I am arguing that smaller government, more local control, and slowly killing crony capitalism will result in more fairness.?? ? In this Forbes article from May of last year, the author notes that a typical CEO in the 1950s earned about 20x the amount of the average worker whereas today the number is 361x.? Is this actually deserved?? I understand that there is and should be a disparity here but isn’t some part of this disparity due to distortion of markets caused by government policy?? Brink Lindsey in this National Review article makes the case that it is and that conservatives need to recognize it. ? What say you?
This may sound a little noncommittal, but inequality of income is partly due to the government, technology, culture, and part is unavoidable, regardless of the technology, or social or governmental structures. Let me take each in order.
Yes, big government likes big labor and big business, and it tends to squeeze out smaller businesses. Part of this is a matter of convenience — if you are big, it would be nice to have a “one stop” solution. It is a lot more expensive for small businesses to comply with regulations in relative terms.
I recognize that problem as a state-regulated RIA. If I wanted to get bigger, the initial phase of it would require a lot more work. I can stay at the level I am, and do it all myself, and keep my offering simple. Personally, I like that, because I think it is best for my clients, but if I just wanted to gather assets to enrich myself, the next phase would be difficult. Once you are big, it gets a lot easier. You can spread the fixed costs of regulation over a much wider revenue stream.
Also, the government is focused on creating “jobs.” Though politicians may inveigh about creating high-paying manufacturing jobs, the statistical apparatus measures all jobs, and that is what receives the most attention. Unemployment is low, but the share of total income going to labor is also low.
When enterprises get larger, the pay differential will naturally increase, as those in a hierarchy derive some income from the oversight of those below them, whether it is done well or not. Enterprises are larger now than in the 1950s.
Technology can encourage or discourage income inequality. Information technology has helped to eliminate a lot of middle income jobs, as information technology allows the same things to be done with lesser-skilled people, whether here in the US, or abroad.
This brings up another unpopular point: though inequality may be increasing in the developed world and China, it is decreasing globally, as lower paid workers abroad get much better pay doing work that otherwise would be done in developed countries. Since we increasingly have a global economy, and that economy is becoming more equal, why should we be so concerned about the local effects in the US?
That brings up the social and unavoidable aspects of inequality, which are less popular to consider. Many younger people in developed nations consider prosperity to be their birthright, and work less hard in school than their peers in developing nations. Is it any surprise that incomes to those who are lazy lag, or even decline? This phenomenon is well-known, all the way back to ancient Greece, if not further. “Shirtsleeves to shirtsleeves in three generations” is well-known phrase, expressing how the children of the wealthy get lazy, and wealth is lost.
This is the main reason why I doubt that the same families will maintain their dominance, even as inequality persists. The elites rotate over time, as Pareto taught. It is not a fixed class structure, as in the times where ownership of land dominated, but the names and faces change as fortunes are won and lost.
Our current educational establishment is turning out children that are less bright than their parents. If the children are less bright or motivated than their competition, will their incomes not sag? America does better than most other countries in aggregate as we give people more freedom, and teach them to be flexible. But that doesn’t mean that the children will do better than their parents.
We also accept more immigrants (as does Canada) who are motivated by the freedom to grow their enterprises. This is another aspect of some of the xenophobia in the US as some rural natives resent wealthy immigrants who don’t share their values.
Summary
I tried to teach my children to be industrious, smart, and pursue occupations that would make a difference for them and their families. Only a few of them listened, and they are doing well. That is America in microcosm.
Yes, you can argue about big government, labor, and business, but that is only a part of the puzzle. Incomes might become more equal if Uber, Lyft, and Airbnb could level the taxi and hotel industries, which have government regulations protecting them. Removing regulations tends to gore those in the middle class that are protected by the regulations versus those that want to be in the middle class that would like to compete against them.
What matters most is the culture of a nation, and how they are motivating the next generation to compete. We are doing that moderately badly, and that accounts for the relative loss of stature of the USA versus the rest of the world. This places the blame on the American people themselves, as they have not committed to having a culture of excellence, and getting their children to implement that.
Here’s another article that I edited at The Balance:?Short Selling Stocks- Not for the Faint Hearted.? The original author started out conservative on the topic, and I took it up another notch.
For this article, I:
added the information about changes to the uptick rule (which did not reflect anything post-2006),
corrected a small math error,
made the example more realistic as to how margin works in this situation,
added almost all of the section on risks
totally rewrote the section on picking shorts (if you dare to do it), and,
added the famous comment by Daniel Drew.
I have shorted stock in my life at the hedge fund I worked at, hedging in arbitrage situations, and very rarely to speculate.? Shorting is a form of speculation shorts don’t create economic value.? They do us a service by pruning places that pretend to have value and don’t really have it.
In general, I don’t recommend shorting unless you have a fundamentally strong insight about a company that is not generally shared.? That happens with me occasionally in insurance where I have spoken negatively about:
Penn Treaty
Tower Group
The various companies of the Karfunkels
The mortgage and financial guaranty insurers
Oh, and the GSEs… though they weren’t regulated as insurers… not that it would have mattered.
But I rarely get those insights, and I hate to short, because timing is crucial, and the upside is capped, where the downside is theoretically unlimited.? It is really a hard area to get right.
Last note, I didn’t say it in the article, and I haven’t said it in a while, remember that being short is not the opposite of being long — it is the opposite of being leveraged long.? If you just hold stocks, bonds, and cash, no one can ever force you out of your trade.? The moment you borrow money to buy assets, or sell short, under bad conditions the margin desk can force you to liquidate positions — and it could be at the worst possible moment.? Virtually every market bottom and top has some level of forced liquidations going on of investors that took on too much risk.
So be careful, and in general don’t short stock.? If you want more here, also read The Zero Short.? Fun!
It is very difficult to get a high real rate of return over a long time.? This article peels apart the math, and brings out the quantitative factors that play a role in the analysis.
Clarifying the return series that I use for my forecasts of future stock market returns, and is it likely for an investor to earn a 3% real return over a long horizon?
Because of underfunding, there will be more cuts. ?Depend on that happening for the worst funds, and at least run through the risk analysis of what you would do if your pension benefit were cut by 20% for a municipal plan, or to the PBGC limit for a corporate plan. ?Why? ?Because it could happen.
This is an underrated report from the US Government, but even it is forced to downplay how the situation is for Social Security and Medicare.? Things aren’t getting better, and time is running short.? The next time I write about this is when the 2018 report comes out.? Until then remember my more recent piece?Notes from an Unwelcome Future, Part 1.
Well, I never thought I would get this question, but here it is:
Thank you for your dedication to your blog.
I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions?
Thank you for your time.
Kind regards,
There are many things to do in insurance.? Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.? Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.? Then there are the drones in customer service and claims.? Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions.
Before I begin, I want to say a few things.? FIrst, if you work in insurance, be kind to the drones and helpers.? It is the right thing to do, but beyond that, they don’t have to go beyond their job description — they know their opportunities are limited — it is only a job.? Treat them with respect and kindness, and they will go above and beyond for you.? I learned this positively first-hand, and a few of them 20-30 years older explained it to me when I noticed they weren’t helping others who were full of themselves.
Second, the insurance industry does a lot to train drones, helpers, agents, marketers, underwriters, and younger people generally, if they are willing to work at it.? There are self-study courses and exams that vary based on what part of the industry you are in.? Take the courses and exams, and your value goes up — it is not obvious how that will work, but it often pays off.
Third, it is not a growing industry, but lots of Baby Boomers are retiring, and leave openings for others.? Also, drone and helper positions often don’t pay so well at the entry level, and turnover is somewhat high.? The same is true of agents — more on that later.
Fourth, watch “The Billion Dollar Bubble,” and episodes of Banacek if you want.? The actual practices of how they did things in the ’60s and ’70s don’t matter so much, but it gets the characterization of the various occupations in insurance right.
FIfth, insurance is a little like the “Six Blind Men and the Elephant.”? Actuaries, Accountants, Administrators, Marketers, Underwriters, and Investment Managers (and Lawyers and Programmers) each have a few bits of the puzzle — the challenge is to work together effectively.? It is easier said than done.? You can read my articles on my work life to get a good idea of how that was.? I’ve written over 30 articles on the topic.? Here are most of the links:
Sixth, it is easier to teach those with technical skills how the business works than to teach drones and helpers technical skills.? It’s kind of like how you can’t easily teach math and science to humanities and social science majors, but you can do the reverse (with higher probability).? It is worth explaining the business to computer programmers.? It is worth explaining marketing and sales to actuaries.? Accountants get better when they understand what is going on behind the line items, and maybe a touch of what the actuaries are doing (and vice-versa).
Seventh, only a few of the areas are close to global — the administrators, the underwriters, the actuaries, and the marketers — and that’s where the fights can occur, or, the most profitable collaborations can occur.
Eighth, insurance companies vary in terms of how aggressive they are, and the dynamism of positions and ethical conundrums vary in direct proportion.
So, back to your question, and I will go by job category:
Drones and helpers typically don’t need a college education, but if they show initiative, they can grow into a limited number of greater positions.
Computer programmers probably need a college degree, but if you are clever, and work at another insurance job first, you might be able to wedge your way in.? While I was an actuary, I turned down a programming job, despite no formal training in programming.
Lawyers go through the standard academic legal training, pass the bar exams, nothing that unusual about that, but finding one that truly understands insurance law well is tough.
Accountants are similar.? Academic training, pass the accounting exams, work for a major accounting firm and become a CPA — but then you have to learn the idiosyncrasies of insurance accounting, which blends uncertainty and discounting with interest.? The actuaries take care of a lot of it, but capturing and categorizing the right data is a challenge.
Actuaries have to be good with math to a high degree, a college degree is almost required, and have to understand in a broad way all of the other disciplines.? The credentialing is tough, and may take 5-10 years, with many exams, but you often get study time at work.
Agents — can you sell?? Can you do a high quality sale that actually meets the needs of the client?? That may not require college, but it does require significant intelligence in understanding people, and understanding your product.? Many agents can fob some bad policies off on some simpletons, but it comes back to bite, because the business does not last, and the marketing department either revokes your commissions, or puts you on a trouble list.? “Market conduct” is a big thing in insuring individuals.? The agents that win are the ones that serve needs, are honest, and make many sales.? Many people are looking for someone they can trust with reasonable returns, rather than the highest possible return.? One more note: there are many exams and certifications available.
Marketers — This is the province of agents that were mediocre, and wanted more reliable hours and income.? It’s like the old saw, “Those who cannot do, teach. Those who cannot teach, administrate.”? It is possible to get into the marketing area by starting at a low level helper, but it is difficult to manage agents if you don’t have their experience of rejection.? Again, there are certifications available, but nothing will train you like trying to sell insurance policies.
Underwriters — as with most of these credentials, a college degree helps, but there is a path for those without such a degree if you start at a low level as a helper, show initiative, and learn, learn, learn. Underwriters make a greater difference in coverages that are less common.? Where the law of large numbers applies, underwriters recede.? The key to being an underwriter is developing specialized expertise that allows for better risk selection.? There are certifications and exams for this, pursue them particularly if you don’t have a college degree.? Pursue them anyway — as an actuary, I received some training in underwriting.? It is intensely interesting, especially if you have a mind for analyzing the why and how of insured events.
Investment personnel — this is a separate issue and is covered in my articles in how one can get a job in finance.? That said, insurance can be an easier road into investing, if you get a helper position, and display competence.? (After all, how did I get here?)? You have to be ready to deal with fixed income, which? means your math skills have to be good.? As a bonus, you might have to deal with directly originated assets like mortgages, credit tenant leases, private placements, odd asset-backed securities, and more.? It is far more dynamic than most imagine, if you are working for an adventurous firm.? (I have only worked for adventurous firms, or at least adventurous divisions of firms.)? Getting the CFA credential is quite useful.
Administrators — the best administrators have a bit of all the skills.? They have to if they are managing the company aright.? Most of them are marketers, and? a few are actuaries, accountants,or lawyers.? Marketing has an advantage, because it is the main constraint that insurance companies face.? It is a competitive market, and those who make good sales prosper.? VIrtually all administrators are college educated, and most have done additional credentialing.? Good administrators can do project, people and data management.? it is not easy, and personally, few of the administrators I have known were truly competent.? If you have the skills, who knows?? You could be a real success.
Please understand that I have my biases, and talk to others in the field before you pursue this in depth.? Informational interviewing is wise in any job search, and helps you understand what you are really getting into, including corporate culture, which can make or break your career.? Some people thrive in ugly environments, and some die.??Some people get bored to death in squeaky-clean environments, and some thrive.
So be wise, do your research, and if you think insurance would be an interesting career, pursue it assiduously.? Then, remember me when you are at the top, and you need my clever advice. 😉
