"One of the differences between the natural and the social sciences is that in the natural sciences, each succeeding generation stands upon the shoulders of those that have gone before, while in social sciences, each generation steps in the faces of its predecessors." - David Zeeman
I recently was provided an essay by George Soros from a friend of mine. Now not everyone likes Mr. Soros but one thing is certain, he has a penchant for making money through investments. The basis to his investment thesis is that there is no such thing as an efficient market and therefore there are always opportunities to make a return that exceeds what is deemed possible under the efficient market hypothesis. Any businessman would agree with that as otherwise why start a business?
The reason he declares is simple. Economics has attempted to create a science out of something that will always be a social science. People will always have a will of their own therefore to argue that there is a rational answer to a market place is absurd. First off what is rational? What may appear completely rational to you seems completely mad to someone else. Take the most basic example of a man and a woman. Anyone who has been in any form of a long term relationship will attest that there are vast differences between the two schools of thought. Which is rational? The answer is that they both are to that individual but neither are to the other. I constantly joke by saying that I am the most normal person that I know!
Now take this to the market place and then magnify this to the global economy. Add to this recipe a large dose of political posturing, add in different religious ideologies, mix in the radical element and blend this together with numerous laws, taxes and military strength and viola you have a global souffle that is anything but efficient!
Looking at this then and convert that to the current economic crisis and you can quickly see why the risks to the current market run are massively skewed to the downside. When the global engine is purring along (even with all of this craziness still intact) it is one thing, however with the struggles that Europe is facing it is sheer lunacy to think that the various politicians and central bankers of the world will fix the problem. In all honesty a large part of the problem are the politicians who are so concerned about re-election that there does not seem to be one of them that is able to take a stand and put in place a decent economic reform package.
The European Union as it is currently known is on the verge of collapsing as there is no political unity on how to deal with the problems. At the time of its creation it was assumed that over time the political agenda would match that of the economic agenda but it is clear that this has not happened. Furthermore it is becoming more and more apparent that the leaders of the strong European economies are become more and more insular right when the opposite is required. If this union collapses it will make the recent financial crisis seem tame. In fact on Wednesday the FOMC came out with its updated statements and the main change that caught my eye was that they said the "Strains in global financial markets continue to pose significant
downside risks to the economic outlook" while on March 13 the statement said that "Strains in global
financial markets have eased, though they continue to pose significant downside
risks to the economic outlook." This means that while the United States is relatively well protected from a European meltdown it is not completely insulated how could it be?
In addition they reduce their GDP growth expectation to 2.2 percent from 2.5 percent a 12 percent haircut. I firmly believe that based on the fiscal drag this will be cut down to 1.5 percent by year end. These are not growth rates that will improve the job market any time soon. You need GDP growth of more than 4 percent to suck up all the new entrants to the job market AND make a dent in the unemployment rate and even at that growth rate it will take more than 5 years to reach full employment. High unemployment means that workers are not in a position of strength and therefore their earnings will languish while large corporations increase their profits. However in the end companies need people to buy their products so this gain in margins will be short lived.
In addition with lackluster GDP growth, companies are fighting to grow but the market is not therefore growth has to come at the expense of other company's market share. So while some winners will reap huge rewards it will come at the expense of many other companies. Just take a look at Apple's earnings versus all the other cellphone manufacturers to get the picture of how this economy skews the rewards into the hands of a few. Hardly an efficient market and certainly hard to deliver excessive returns through a diverse portfolio of stocks.
Alternatively secular bull markets occur when there is robust economic growth. In this environment everyone can increase revenues due to the fact that the total market is expanding and can accommodate the growth of numerous businesses that compete in the same space. Sure there will always be gaining and losing of market share but it is not as critical to survival as it is now and therefore it makes finding the winners far easier.
My hope is that the European problems do not spread across the globe and that somehow they can contain their problems and provide a sustainable solution that will give the global economy the leg up it needs. Until such time the risks to the market far exceed the opportunity of future gains and I would advise a high level of caution for the moment. Remember that hope is the worst of all four letter words in the investment world particularly when that hope rests in the hands of the politicians.
Friday, April 27, 2012
Friday, April 20, 2012
Bear, Bear Everywhere But The Market Continues To Rally
"The art of living lies less in eliminating our troubles than in growing with them." - Bernard M Baruch
The market has been dented in April but continues its resilience on the back of some robust earnings. The most prominent of these this week was Microsoft and General Electric both of whom provided the market with some cheer so why are so many people negative on the market and why do I continue to advocate that the market is not the best place to invest at present?
It is simple really - the global economic engine is weak and spluttering while stocks in America are close to (within 10% of) their all time highs. An economic study the Proust Index revealed that five years after the economic crisis a third of the 184 countries that the IMF follows are poorer than they were in 2007. Of the group of seven most advanced economies in the world, only one, Germany, is ahead (thanks to all its exports into Europe since the Euro was created). The measure looked at real GDP per person which strips out the negative effect of a shrinking population. This is increasingly worrying when you take into account the ballooning levels of sovereign debt. A government relies on inflation and GDP growth to make its debt payments manageable but neither of these is happening while the debt levels continue to spiral upwards.
What is needed is growth to reset the economic clock and that is happening in certain industries but many industries will not and should not recover. Innovation is key to America and as innovation accelerates more efficiency will be found causing growth in company profits even while revenues falter. The problem is that this will not aid unemployment. With unemployment still weak people need to be retrained to handle the more technically advanced jobs. This training comes from schools and therefore it is highly unlikely that government funding for schooling will be removed (tweaked maybe but never removed completely).
Added to the cost of education the government is strapped with a budget deficit of more than $1.5 trillion and this deficit does not look likely to shrink any time soon particularly if you factor in slow growth for the foreseeable future. To this you have to add the European problems as they are a major contributor to global growth. If they had a magic wand and could repair the damage in a day I would change my view of the American outlook but they cannot and it appears likely that the next negative shock will come either from them or from the middle east and an oil shock.
Spain is rapidly turning into the next problem and behind that France is looking very vulnerable particularly when those running for office are talking of taxing the wealthy upwards of 75% of their income. While I firmly believe that we should all pay our fair share of tax, 75% would cripple their already weak economy as there would be little incentive to work and earn a decent living. Problems in France and Spain would cause global consequences not even imaginable at present but for now we have time and it appears that Wall Street is acting on the thin ice it was given by advancing relatively uninterrupted for close to two years.
However it appears that the tape is loosing momentum and looking at the monthly chart it looks highly likely that the market could be rolling over. If it does and based again on the charts it certainly looks like the 667 lows of the S&P could be in jeopardy. If I am wrong and Europe manages to stave off a crisis and global growth resumes without the hydraulic jack of government support, I would expect that there will be a long and extended secular bull market that will give us all plenty of time to make money, but the risks continue to outweigh the short term gains particularly when there are alternatives to investment that can provide you a safer option and a better long term outlook.
The market has been dented in April but continues its resilience on the back of some robust earnings. The most prominent of these this week was Microsoft and General Electric both of whom provided the market with some cheer so why are so many people negative on the market and why do I continue to advocate that the market is not the best place to invest at present?
It is simple really - the global economic engine is weak and spluttering while stocks in America are close to (within 10% of) their all time highs. An economic study the Proust Index revealed that five years after the economic crisis a third of the 184 countries that the IMF follows are poorer than they were in 2007. Of the group of seven most advanced economies in the world, only one, Germany, is ahead (thanks to all its exports into Europe since the Euro was created). The measure looked at real GDP per person which strips out the negative effect of a shrinking population. This is increasingly worrying when you take into account the ballooning levels of sovereign debt. A government relies on inflation and GDP growth to make its debt payments manageable but neither of these is happening while the debt levels continue to spiral upwards.
What is needed is growth to reset the economic clock and that is happening in certain industries but many industries will not and should not recover. Innovation is key to America and as innovation accelerates more efficiency will be found causing growth in company profits even while revenues falter. The problem is that this will not aid unemployment. With unemployment still weak people need to be retrained to handle the more technically advanced jobs. This training comes from schools and therefore it is highly unlikely that government funding for schooling will be removed (tweaked maybe but never removed completely).
Added to the cost of education the government is strapped with a budget deficit of more than $1.5 trillion and this deficit does not look likely to shrink any time soon particularly if you factor in slow growth for the foreseeable future. To this you have to add the European problems as they are a major contributor to global growth. If they had a magic wand and could repair the damage in a day I would change my view of the American outlook but they cannot and it appears likely that the next negative shock will come either from them or from the middle east and an oil shock.
Spain is rapidly turning into the next problem and behind that France is looking very vulnerable particularly when those running for office are talking of taxing the wealthy upwards of 75% of their income. While I firmly believe that we should all pay our fair share of tax, 75% would cripple their already weak economy as there would be little incentive to work and earn a decent living. Problems in France and Spain would cause global consequences not even imaginable at present but for now we have time and it appears that Wall Street is acting on the thin ice it was given by advancing relatively uninterrupted for close to two years.
However it appears that the tape is loosing momentum and looking at the monthly chart it looks highly likely that the market could be rolling over. If it does and based again on the charts it certainly looks like the 667 lows of the S&P could be in jeopardy. If I am wrong and Europe manages to stave off a crisis and global growth resumes without the hydraulic jack of government support, I would expect that there will be a long and extended secular bull market that will give us all plenty of time to make money, but the risks continue to outweigh the short term gains particularly when there are alternatives to investment that can provide you a safer option and a better long term outlook.
Friday, April 13, 2012
The Death of Diversification
"Wide diversification is only required when investors do not understand what they are doing." - Warren Buffett
The above quote from Warren Buffett flies in the face of convention. Armies of financial planners and legions of schools all teach the same thing, diversify, diversify, diversify. It is the only way to protect your assets. Diversification (investing in numerous asset classes or spreading your wealth among many investments to limit the risk of any one asset destroying your portfolio) is the tool used to protect your nest egg against disaster. If something goes down then something else is probably going up and this will average out to a positive rate of return. Don't put all of your eggs in one basket in case you drop that basket. All of this is very prudent advice but recently I have questioned this as it relates to the stock market. At present there seems to be a high correlation between all stocks which gives it the feeling of being manipulated. In other words, all stocks seem to move together rather than based on their individual merit.
Now while I agree that there will always be some correlation between assets that are fairly similar in nature there should be some benefit to a diverse portfolio of stocks. This however does not seem to be the case. In the past a portfolio of stocks would be spread among sectors and classes. The idea was that an oil company was not in any way related to a technology company so buy some of each would just expose you to market risk and not sector or stock specific risk. Further diversification into small cap stocks and large cap stocks also increased your diversification as they seemed to move to the beat of different drummers. However with the invention of Exchange Traded Funds (ETF's) anyone with a pulse can drop a few dollars into an ETF and buy the whole market. It is cheap, easy and you do not have to fight with your financial planner over which asset class to buy. This lead to a boon in ETFs as the wire houses invented more and more of them. Nowadays you can buy an ETF for anything even if you bet the market will go down. In fact you can lever this up three times by buying the 3x bear fund!
The problem with these products is that they have all but eliminated stock diversification as a tool to protect your portfolio. A new study showed that since 1998 correlations between stock classes has closed from almost 50% to virtually nothing. Everything is moving together as swathes of money blindly buy an ETF which in turn blindly buys the underlying stocks with no thought to value or sector. With the removal of this benefit it jeopardizes most portfolios as the supposed protection is gone.
Furthermore in other studies it has been shown that just when diversification is needed most it disappears. The time diversification is required is when there is a market melt down however it has been shown that during market downturns, most, if not all asset classes fall together removing the safety net right when you miss the trapeze. Just think back to 2007 and trying to find an asset class that actually went up!
Review your strategy and make sure that you are not overly exposed to stocks as if and when people start to dump their ETFs everything will go down together and this time it looks like it will be worse than before. Think outside of the box and look to alternative asset classes as this is the only remaining way that your portfolio can be protected against the next downturn.
The above quote from Warren Buffett flies in the face of convention. Armies of financial planners and legions of schools all teach the same thing, diversify, diversify, diversify. It is the only way to protect your assets. Diversification (investing in numerous asset classes or spreading your wealth among many investments to limit the risk of any one asset destroying your portfolio) is the tool used to protect your nest egg against disaster. If something goes down then something else is probably going up and this will average out to a positive rate of return. Don't put all of your eggs in one basket in case you drop that basket. All of this is very prudent advice but recently I have questioned this as it relates to the stock market. At present there seems to be a high correlation between all stocks which gives it the feeling of being manipulated. In other words, all stocks seem to move together rather than based on their individual merit.
Now while I agree that there will always be some correlation between assets that are fairly similar in nature there should be some benefit to a diverse portfolio of stocks. This however does not seem to be the case. In the past a portfolio of stocks would be spread among sectors and classes. The idea was that an oil company was not in any way related to a technology company so buy some of each would just expose you to market risk and not sector or stock specific risk. Further diversification into small cap stocks and large cap stocks also increased your diversification as they seemed to move to the beat of different drummers. However with the invention of Exchange Traded Funds (ETF's) anyone with a pulse can drop a few dollars into an ETF and buy the whole market. It is cheap, easy and you do not have to fight with your financial planner over which asset class to buy. This lead to a boon in ETFs as the wire houses invented more and more of them. Nowadays you can buy an ETF for anything even if you bet the market will go down. In fact you can lever this up three times by buying the 3x bear fund!
The problem with these products is that they have all but eliminated stock diversification as a tool to protect your portfolio. A new study showed that since 1998 correlations between stock classes has closed from almost 50% to virtually nothing. Everything is moving together as swathes of money blindly buy an ETF which in turn blindly buys the underlying stocks with no thought to value or sector. With the removal of this benefit it jeopardizes most portfolios as the supposed protection is gone.
Furthermore in other studies it has been shown that just when diversification is needed most it disappears. The time diversification is required is when there is a market melt down however it has been shown that during market downturns, most, if not all asset classes fall together removing the safety net right when you miss the trapeze. Just think back to 2007 and trying to find an asset class that actually went up!
Review your strategy and make sure that you are not overly exposed to stocks as if and when people start to dump their ETFs everything will go down together and this time it looks like it will be worse than before. Think outside of the box and look to alternative asset classes as this is the only remaining way that your portfolio can be protected against the next downturn.
Friday, April 6, 2012
Unemployment Disappoints
"There's no such thing as shovel ready projects." - Barack Obama (Oct 2010)
After recording their best quarterly gain since 1998, stocks seem to have lost some of their luster. Today there is a moderate down turn in stock prices mainly due to the poor employment numbers. Non farm payrolls added 120,000 new jobs in March, down from adding 240,000 jobs in February and well below consensus expectation of 200,000 new jobs. The report was nothing short of disappointing. The unemployment rate fell from 8.3% to 8.2%, but the drop was due to 333,000 leaving the labor force and not from an improvement in employment. Weekly hours fell from 34.6 in February to 34.5. Combined with the paltry increase in payrolls, aggregate wages were flat after increasing 0.7% in February. This does not bode well for March consumption growth.
Definitely we are not in 1998! Back then the stock market madness that ended in the 2000 market collapse was just beginning. Economic conditions were good and were about to get a lot better as the government started to pour money into the technology sector spurring wild growth and the tech bubble. Most of us remember that period well if not fondly. You could buy any tech company and make money. Speaking to a friend of mine who was an analyst at the time he mentioned that market multiples were driven by the number of people viewing your website rather than any fundamentals. A monkey could have made money in the market and many of us did!
Fast forward to today. The global economy is teetering on the edge of a precipice and government funding has crowded out the market. This will lead to short term gains and a long term drag. These types of unemployment shocks will be common. Economic growth trends will be short lived while recessions will become more frequent and normal. As the quote above shows, while the government leaders may speak about job creation, the reality is that the trillions of dollars that have been spent to date are gone and have not created much of anything other than saving the financial markets.
While I know that I sound like a broken record and believe me I wish I could change my tune but it is still not time to risk your assets in a market that is based on government stimulus to support it rather than sound global economic activity. I would point you to the best risk related investment that I know right now and that is www.fixedratedeposits.com where you can earn a good rate of return on your cash while you wait for the storm clouds to pass.
After recording their best quarterly gain since 1998, stocks seem to have lost some of their luster. Today there is a moderate down turn in stock prices mainly due to the poor employment numbers. Non farm payrolls added 120,000 new jobs in March, down from adding 240,000 jobs in February and well below consensus expectation of 200,000 new jobs. The report was nothing short of disappointing. The unemployment rate fell from 8.3% to 8.2%, but the drop was due to 333,000 leaving the labor force and not from an improvement in employment. Weekly hours fell from 34.6 in February to 34.5. Combined with the paltry increase in payrolls, aggregate wages were flat after increasing 0.7% in February. This does not bode well for March consumption growth.
Definitely we are not in 1998! Back then the stock market madness that ended in the 2000 market collapse was just beginning. Economic conditions were good and were about to get a lot better as the government started to pour money into the technology sector spurring wild growth and the tech bubble. Most of us remember that period well if not fondly. You could buy any tech company and make money. Speaking to a friend of mine who was an analyst at the time he mentioned that market multiples were driven by the number of people viewing your website rather than any fundamentals. A monkey could have made money in the market and many of us did!
Fast forward to today. The global economy is teetering on the edge of a precipice and government funding has crowded out the market. This will lead to short term gains and a long term drag. These types of unemployment shocks will be common. Economic growth trends will be short lived while recessions will become more frequent and normal. As the quote above shows, while the government leaders may speak about job creation, the reality is that the trillions of dollars that have been spent to date are gone and have not created much of anything other than saving the financial markets.
While I know that I sound like a broken record and believe me I wish I could change my tune but it is still not time to risk your assets in a market that is based on government stimulus to support it rather than sound global economic activity. I would point you to the best risk related investment that I know right now and that is www.fixedratedeposits.com where you can earn a good rate of return on your cash while you wait for the storm clouds to pass.
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