"The biologist and intellectual E.O. Wilson was once asked what represented the most hindrance to the development of children; his answer was the soccer mom. But the problem is more general; soccer moms try to eliminate the trial and error, the antrifragility, from children's lives, move them away from the ecological and transform them into nerds working on preexisting (soccer-mom-compatible) maps of reality. They are now totally untrained to handle ambiguity." - Nassim Taleb from his book Antifragile
While the quote above is directed at soccer moms I personally think that it could just as easily have been directed at modern day dads or parents as a group. As parents we love to give our kids a helping hand and mostly this is fine but often times the giving is taken too far and for too long and not only does this jeopardize our retirement but it also gives our kids a false sense of entitlement and security (they become fragile) and this is bad for the parents and their offspring. A study showed that the average retiree in the United States has $111,000 in their retirement account at retirement age. A rule of thumb is that you can fund your retirement with roughly 4% of this balance each year meaning that the average American can only draw $4,440 a year or $370 a month from this balance. This is hardly enough to pay the groceries for a month let alone service the mortgage, car payments, taxes, medical care and any form of meals and entertainment. However regardless of this 1 in 3 parents are providing financial assistance to adult children. In comparison only 1 in 5 provides support to their parents so the argument that your kids will support you holds little water.
Well I am certainly not saying pull the rug out from under your children's feet but I would definitely make sure that you can afford the support that you are giving. I have numerous examples of couples in the retirement age bracket that continue to work 50 plus hours a week to not only maintain their life style but the life style of their grown kids. This is crazy. Not only does this hurt you but it also hurts the kids. It hurts you because you are unable to put aside the amount required to retire and it hurts your kids because you are teaching them to live a life beyond their means so when the day finally does arrive where you can no longer work both of you instantly have the rug pulled out from under you.
My thought is to allocate spending on your kids in ways that benefit them *(make them antifragile). Our job as parents is to give our kids the best chance to succeed and so for example spending on a child's education is certainly one way that can achieve this goal. On the flip side paying their rent, buying them chic clothes or a flash car is tantamount to feeding animals in the wild. It is detrimental to both of you - in the wilds not only does the animal become dependent on the handouts but it becomes aggressive attacking people when it becomes hungry. Now I am not opposed to the odd handout at say their birthday but making monthly payments to support a life style that neither they nor you can afford is completely ridiculous.
It appears that parents are doing everything possible to protect their kids from the evils of the world including making sure that when they leave the house that their baby is taken care of financially so they can live like they did at home. While an admirable goal it is foolish and does not help them in the long run. Worse still if you empty the piggy bank you are now a huge burden on them (assuming they actually help you which as the earlier paragraph shows is a long shot) and their income so you actually end up dragging everyone down with you. This I am certain is not what the intention is so in order to help everyone in the family make sure you are setting aside enough to remove this potentially huge burden. Help yourself to help them and who knows in the end they may receive a nice handout when you die and they find that the coffers are not empty. Now that would be far more beneficial to all!
Friday, March 20, 2015
Friday, March 13, 2015
Too Big to Save
"There aren't enough lifeboats. Someone is going to die. So you might as well enjoy the champagne and caviar." - Jamie Dimon, CEO of JP Morgan Chase to his staff the night before Lehman filed for bankruptcy
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
Friday, March 6, 2015
What's in a Number?
0 is the additive identity; 1 is the multiplicative identity; 2 is the only even prime number; 3 is the number of spacial dimensions we live in; ....; 5,000 is the largest number whose English name does not repeat any letters; ...; 5,048 is the number of strongly connected digraphs with 5 vertices (and I thought it was the number associated with the all time NASDAQ high)
With the NASDAQ bumping up against its all time highs I thought it pertinent to take a look at the index and explain why the excitement regarding this number is really just a sales pitch rather than a meaningful indicator of the business and investment environment.
In March 2000 the NASDAQ hit its all time high of 5,048.62. Fifteen years later (almost to the day) the NASDAQ managed to reach 5,000 but has not managed to close above the all time high - YET. I say yet because it appears that the market manipulators are hell bent on getting all the indices to produce all time highs; it makes for better cheer leading opportunities!
So digging into the NASDAQ a number of things pop right out. First off the index now only consists of 43% tech stocks whereas back in 2000 it was almost 65% technology. Second the index constantly changes the companies that it incorporates into the index. Had the same companies remained in the index that were there in 2000 the index would still be miles from its high. Back then companies like PMC Sierra, JDS Uniphase, Sycamore and Juniper Networks were pushing the index at a huge clip. Today Sycamore is gone completely and the other three are limping along at fractions of their all time highs. Only tree of the top 10 companies from 2000 are still in the top 10 now (Microsoft, Intel, Cisco) and all three of them are still a long way from the heady highs of 2000. So the index now relies on a new breed of companies to generate returns. Apple has sprung from almost non-existent to the largest company in the world; Google, Facebook and Amazon have all come through the ranks and now fill up the top five spots with Microsoft.
A third difference is that (according to the pundits) the Price to Earnings ratio (P/E) is far lower today than it was then so there is no bubble. now while I am not contending that a bubble exists the P/Es are still elevated. Apple is at 18, Google at 26, Facebook at 72 and Amazon does not have one as it is not profitable (sound familiar). When you raise up the hood to take a deeper look and find companies like Twitter, Tesla and others it starts to look almost identical! So while it might appear that things are different this time in terms of valuation they are scarily similar.
Fourth, in terms of a recovery, making it back to 5,000 is hardly a resounding success. Factoring in a mild form of inflation would mean that the index should be at around 7,000 for an investor to break even and we are a long way from there. To think that it has taken more than $4 Trillion in Federal Reserve stimulus and all we have to show is the media frenzy over a meaningless number is sad to say the least and with the reduction in Fed stimulus it appears that 5,048.62 may be the hardest hurdle to cross but I have to believe that having forced the bar this high they will not stop until the trumpets are sounding from Wall Street.
So when it comes down to it this number is meaningless unless you are a marketing person on Wall Street. It is not going to change the economic landscape and it is not signalling a new investment era but rather, scarily, it might be signalling a return to the bad old days.
With the NASDAQ bumping up against its all time highs I thought it pertinent to take a look at the index and explain why the excitement regarding this number is really just a sales pitch rather than a meaningful indicator of the business and investment environment.
In March 2000 the NASDAQ hit its all time high of 5,048.62. Fifteen years later (almost to the day) the NASDAQ managed to reach 5,000 but has not managed to close above the all time high - YET. I say yet because it appears that the market manipulators are hell bent on getting all the indices to produce all time highs; it makes for better cheer leading opportunities!
So digging into the NASDAQ a number of things pop right out. First off the index now only consists of 43% tech stocks whereas back in 2000 it was almost 65% technology. Second the index constantly changes the companies that it incorporates into the index. Had the same companies remained in the index that were there in 2000 the index would still be miles from its high. Back then companies like PMC Sierra, JDS Uniphase, Sycamore and Juniper Networks were pushing the index at a huge clip. Today Sycamore is gone completely and the other three are limping along at fractions of their all time highs. Only tree of the top 10 companies from 2000 are still in the top 10 now (Microsoft, Intel, Cisco) and all three of them are still a long way from the heady highs of 2000. So the index now relies on a new breed of companies to generate returns. Apple has sprung from almost non-existent to the largest company in the world; Google, Facebook and Amazon have all come through the ranks and now fill up the top five spots with Microsoft.
A third difference is that (according to the pundits) the Price to Earnings ratio (P/E) is far lower today than it was then so there is no bubble. now while I am not contending that a bubble exists the P/Es are still elevated. Apple is at 18, Google at 26, Facebook at 72 and Amazon does not have one as it is not profitable (sound familiar). When you raise up the hood to take a deeper look and find companies like Twitter, Tesla and others it starts to look almost identical! So while it might appear that things are different this time in terms of valuation they are scarily similar.
Fourth, in terms of a recovery, making it back to 5,000 is hardly a resounding success. Factoring in a mild form of inflation would mean that the index should be at around 7,000 for an investor to break even and we are a long way from there. To think that it has taken more than $4 Trillion in Federal Reserve stimulus and all we have to show is the media frenzy over a meaningless number is sad to say the least and with the reduction in Fed stimulus it appears that 5,048.62 may be the hardest hurdle to cross but I have to believe that having forced the bar this high they will not stop until the trumpets are sounding from Wall Street.
So when it comes down to it this number is meaningless unless you are a marketing person on Wall Street. It is not going to change the economic landscape and it is not signalling a new investment era but rather, scarily, it might be signalling a return to the bad old days.
Friday, February 27, 2015
The Good, the Bad and the Ugly
Blondie: "If you shoot me, you won't see a cent of that money."
Angel Eyes: [frowning] "Why?"
Blondie: "I'll tell you why." [He kicks the coffin lid open] "Cause there's nothin' in here!"
A scene from the movie The Good, the Bad and the Ugly released in 1966.
There is so much talk of deflation taking over the world that I thought it a good idea to explore the good, the bad and the ugly of the potential beast and to see just how precarious the situation has become.
First let's look at the good. In certain cases deflation can help an economy particularly when the deflationary pressure comes from either technological advances or temporary pricing shocks. With the oil price decline the relief that the consumer in the United States is feeling is a definite plus and akin to a tax break; it is putting much needed dollars into consumers' pockets and this is starting to have the effect of jollying along the economic recovery. This is good deflation as it allows the Federal Reserve to let it run while reaping the benefits of accelerated economic growth. In the case of the United States as the consumer makes up roughly 70% of the country's GDP more money in their pockets can really help. Now the reason that this kind of deflation is good is because it is temporary. The oil price relief will not last as even if the price remains low for an extended period the benefit will eventually be lost to other inflationary forces such as rising taxes, medical and insurance costs, food expenses and the like. So while the immediate reaction is to fear for deflation, this kind of deflation is just what the United States needs right now.
Next is the bad kind of inflation and this brings me to the quote above. Change the names of the characters from Blondie to Consumer and Angel Eyes to the Federal Reserve and you can see my point. Should the Federal Reserve jump to the conclusion that deflation is here and it needs to be contained then they will raise rates prematurely. This raising of rates will destroy any benefits received from the good deflation effectively killing the Consumer. Once the Consumer is dead spending curtails and the result is that deflation then takes a firm grip. Once it moves from temporary to longer term it has now become a problem and has now moved into bad category.
Finally the ugly part of deflation is that once it turns bad it can be next to impossible to extricate the economy out of its clutches. In the case of Europe and Japan deflation there is ugly. In Europe deflation has been caused by government austerity and requirements imposed by the EU. By not allowing the rules to be bent in the face of adversity the very rules themselves have driven Europe to the brink of deflation without giving it the tools to extract itself. More austerity means worse conditions and an acceleration into deflation's black hole. As I showed last week yields on large swathes of European debt have already turned negative and even this is not helping. Also as we have seen in Japan, once in a deflationary spiral it can take decades to extract oneself and even now, after trillions of Yen have been spent, the results are still miserable. This is the ugly side to deflation, once it takes hold investment and spending shrivels while the mountain of debt remains intact eroding future investment and crimping the economy further.
The key right now is for the Federal Reserve to realize that it holds the global economy in the palm of its hand. The only bright star in the global economy at present is the United States consumer who is benefiting from lower prices at the pump and low interest rates. Raising interest rates too soon (as it is hinting) will kill the consumer pushing the entire world into the deflationary abyss. My hope is that they are smarter than that and even though history has not shown them to make the wisest decisions I still fully expect rates to remain low for the rest of 2015. Even Angel Eyes worked that one out!
Angel Eyes: [frowning] "Why?"
Blondie: "I'll tell you why." [He kicks the coffin lid open] "Cause there's nothin' in here!"
A scene from the movie The Good, the Bad and the Ugly released in 1966.
There is so much talk of deflation taking over the world that I thought it a good idea to explore the good, the bad and the ugly of the potential beast and to see just how precarious the situation has become.
First let's look at the good. In certain cases deflation can help an economy particularly when the deflationary pressure comes from either technological advances or temporary pricing shocks. With the oil price decline the relief that the consumer in the United States is feeling is a definite plus and akin to a tax break; it is putting much needed dollars into consumers' pockets and this is starting to have the effect of jollying along the economic recovery. This is good deflation as it allows the Federal Reserve to let it run while reaping the benefits of accelerated economic growth. In the case of the United States as the consumer makes up roughly 70% of the country's GDP more money in their pockets can really help. Now the reason that this kind of deflation is good is because it is temporary. The oil price relief will not last as even if the price remains low for an extended period the benefit will eventually be lost to other inflationary forces such as rising taxes, medical and insurance costs, food expenses and the like. So while the immediate reaction is to fear for deflation, this kind of deflation is just what the United States needs right now.
Next is the bad kind of inflation and this brings me to the quote above. Change the names of the characters from Blondie to Consumer and Angel Eyes to the Federal Reserve and you can see my point. Should the Federal Reserve jump to the conclusion that deflation is here and it needs to be contained then they will raise rates prematurely. This raising of rates will destroy any benefits received from the good deflation effectively killing the Consumer. Once the Consumer is dead spending curtails and the result is that deflation then takes a firm grip. Once it moves from temporary to longer term it has now become a problem and has now moved into bad category.
Finally the ugly part of deflation is that once it turns bad it can be next to impossible to extricate the economy out of its clutches. In the case of Europe and Japan deflation there is ugly. In Europe deflation has been caused by government austerity and requirements imposed by the EU. By not allowing the rules to be bent in the face of adversity the very rules themselves have driven Europe to the brink of deflation without giving it the tools to extract itself. More austerity means worse conditions and an acceleration into deflation's black hole. As I showed last week yields on large swathes of European debt have already turned negative and even this is not helping. Also as we have seen in Japan, once in a deflationary spiral it can take decades to extract oneself and even now, after trillions of Yen have been spent, the results are still miserable. This is the ugly side to deflation, once it takes hold investment and spending shrivels while the mountain of debt remains intact eroding future investment and crimping the economy further.
The key right now is for the Federal Reserve to realize that it holds the global economy in the palm of its hand. The only bright star in the global economy at present is the United States consumer who is benefiting from lower prices at the pump and low interest rates. Raising interest rates too soon (as it is hinting) will kill the consumer pushing the entire world into the deflationary abyss. My hope is that they are smarter than that and even though history has not shown them to make the wisest decisions I still fully expect rates to remain low for the rest of 2015. Even Angel Eyes worked that one out!
Friday, February 20, 2015
Paying to Play (or Losements)
"A nickel ain't worth a dime anymore." - Yogi Berra
In the investment world, paying to play is synonymous with pretty much all investments - you have to put up the money to buy and pay the broker to cross the transaction with the seller. Both of these require you to pay up and then you are playing the game. After that you expect that the investment will produce a return commensurate with the risk - the risk free rate of return plus the risk premium, If you do an exceptional job then the total rate of return exceeds the expected return earning the investor so called Alpha or return in excess of the risk of the investment.
In the world of loans and bonds the investment is relatively simple, lend the borrower money, write down the terms of the investment which include the interest rate, monthly payments of principal and interest (or sometimes interest only) and the date at which the investment matures. During the term of the note, particularly if it is to a high quality borrower, things pretty much go according to plan and at the end of the term the money is freed up to invest in the something new. Nowadays though not only are the bond investors paying to play but they are paying to lend! A nickel sure ain't worth a dime anymore Yogi!
While this phenomena has not yet reached the shores of the United States, in Europe and Japan government bond yields have turned negative. It may be that this is a temporary thing but recently the Swiss 10-year, the German 5-year and the Japanese 3-year bonds were all producing negative yields meaning that if you were to buy these investments that the return at the end of the rainbow would be negative - you would receive back less than what you invested, guaranteed!
Now why would anyone in their right mind make that investment? Why would anyone invest knowing that they are guaranteed to lose money? The first reason is that the security of those notes is considered exceptional so while you will lose some money you are guaranteed to receive the majority of it back which for some offsets the risk of placing it in a bank or beneath your mattress.
Alright, so not many people would make this investment so there must be more to it than that and the next reason is that these countries are struggling with the very real threat of sustained deflation. In this environment with prices falling faster than the losing investment you actually come out ahead. As an example if you invest $100,000 for five years in the German Bund and receive $99,000 back at the end of the term but the BMW that you were considering buying has dropped in price from $100,000 to $90,000 in the same time then you have come out ahead and you effectively earned roughly 10% on the investment. Not bad considering the low risk.
Another reason for buying these investments (it is really hard form me to call them that, maybe I should change them to losements) is that you have an expectation that the yield will drop further making it a profitable trade. As you know as the yield drops the price of the bond rises so by buying them there may be a trade worth making if the rate drops even further. I would think this a risky bet but there are those that will trade anything, which leads me to my final reason; there are many funds that are forced to invest a certain amount of their funds into these assets due to the way that their prospectuses are written. In order not to fall out of compliance they continue to plow money into these losements (that felt better).
At present there is almost $4 trillion in these losements and as the world struggles to keep deflation at bay, more and more of these bonds are coming to market because central bankers continue to print money in an effort to stave off deflation. Looking at these numbers it is pretty easy to see why the 10-year Note in the United States continues to lower yields even as the economy starts to recover and the stock market breaks to all time highs. While it is hard to imagine we in the Unites States may find in a few years time that we are wishing for 1.90% on the 10-year Note just like people are lamenting now about the 3.00% level of a few years ago.
In the investment world, paying to play is synonymous with pretty much all investments - you have to put up the money to buy and pay the broker to cross the transaction with the seller. Both of these require you to pay up and then you are playing the game. After that you expect that the investment will produce a return commensurate with the risk - the risk free rate of return plus the risk premium, If you do an exceptional job then the total rate of return exceeds the expected return earning the investor so called Alpha or return in excess of the risk of the investment.
In the world of loans and bonds the investment is relatively simple, lend the borrower money, write down the terms of the investment which include the interest rate, monthly payments of principal and interest (or sometimes interest only) and the date at which the investment matures. During the term of the note, particularly if it is to a high quality borrower, things pretty much go according to plan and at the end of the term the money is freed up to invest in the something new. Nowadays though not only are the bond investors paying to play but they are paying to lend! A nickel sure ain't worth a dime anymore Yogi!
While this phenomena has not yet reached the shores of the United States, in Europe and Japan government bond yields have turned negative. It may be that this is a temporary thing but recently the Swiss 10-year, the German 5-year and the Japanese 3-year bonds were all producing negative yields meaning that if you were to buy these investments that the return at the end of the rainbow would be negative - you would receive back less than what you invested, guaranteed!
Now why would anyone in their right mind make that investment? Why would anyone invest knowing that they are guaranteed to lose money? The first reason is that the security of those notes is considered exceptional so while you will lose some money you are guaranteed to receive the majority of it back which for some offsets the risk of placing it in a bank or beneath your mattress.
Alright, so not many people would make this investment so there must be more to it than that and the next reason is that these countries are struggling with the very real threat of sustained deflation. In this environment with prices falling faster than the losing investment you actually come out ahead. As an example if you invest $100,000 for five years in the German Bund and receive $99,000 back at the end of the term but the BMW that you were considering buying has dropped in price from $100,000 to $90,000 in the same time then you have come out ahead and you effectively earned roughly 10% on the investment. Not bad considering the low risk.
Another reason for buying these investments (it is really hard form me to call them that, maybe I should change them to losements) is that you have an expectation that the yield will drop further making it a profitable trade. As you know as the yield drops the price of the bond rises so by buying them there may be a trade worth making if the rate drops even further. I would think this a risky bet but there are those that will trade anything, which leads me to my final reason; there are many funds that are forced to invest a certain amount of their funds into these assets due to the way that their prospectuses are written. In order not to fall out of compliance they continue to plow money into these losements (that felt better).
At present there is almost $4 trillion in these losements and as the world struggles to keep deflation at bay, more and more of these bonds are coming to market because central bankers continue to print money in an effort to stave off deflation. Looking at these numbers it is pretty easy to see why the 10-year Note in the United States continues to lower yields even as the economy starts to recover and the stock market breaks to all time highs. While it is hard to imagine we in the Unites States may find in a few years time that we are wishing for 1.90% on the 10-year Note just like people are lamenting now about the 3.00% level of a few years ago.
Friday, February 13, 2015
An Idea for you Future Centenarians
"A centenarian is a person who lives to or beyond 100 years of age. The term is associated with longevity." - Wikipedia
"Mere longevity is a good thing for those who watch life from the sidelines. For those who play the game, an hour may be a year, a single day's work an achievement for eternity." - Helen Hayes
and a follow on to the above quote (one of my favorites so I couldn't resist)
"Life is not a journey to the grave with the intention of arriving safely in a pretty and well preserved body, but rather to skid in broadside, thoroughly used up, totally worn out, and loudly proclaiming - WOW, what a Ride." - Anonymous
Since records began there are only 35 people who have indisputably reached 115. Now that is a great innings but even more amazing is that it is estimated that one third of all babies born in the United Kingdom in 2013 are expected to reach 100. Considering that the UK currently only has 21 out of every 100,000 people reaching 100, well behind Japan, the world leader, with a rate of 43, to think that the estimate expects 33,000 of them to reach 100 seems hard to believe. That said longevity is certainly something that most people want and are starting to expect. People are working and living longer and this is starting to have a prolonged impact on everyone's portfolios.
Making your portfolio last through your retirement is of high importance and few seem to have it adequately taken care of but it may be possible to insulate yourself by looking to the insurance industry. Now I am not an insurance person but I do believe that the industry has a number of products that can alleviate the problems of longevity. Of course this assumes that their actuaries continue to calculate the numbers correctly and the company remains afloat but this is a fair assumption so for the purposes of this blog we will expect that the annuities offered continue to pay out. Now annuities are not my favorite product as they tie up a lot of capital (sometimes all of it) and can remove the ability to access your capital if you ever need to draw on it (think a medical emergency) so I typically steer clear of them but one may be of interest - the Longevity Annuity.
With the longevity annuity you give the insurance company a lump sum today, they invest the proceeds on your behalf and at a pre-selected date many years in the future it starts to pay out an annual stream of cash through the life of the purchaser. Now the downside is if you die prior to the annuity kicking in the value of the annuity is lost so it is a bit of a game of cat and mouse trying to decide when it should be activated but it can be looked on as a sort of a living insurance policy (rather than life insurance which pays out when you die). So should you happen to live far longer than your retirement funds can support you then it kicks in to save the day. Due to the compounding of the returns inherent in the policy the longer that you can delay the activation date the larger the pool that you can draw on and hence the larger the annual payout. As an example if you are 50 today and you put in $100,000 into a longevity annuity that only starts to payout when you get to 90 you would achieve a benefit in the range of 20 times what you would receive today. This amount would grow to more than 35 times if you waited another 5 years but of course it is a risk that you may not even make 80 let alone 95.
However the power of this investment is that for a small fraction of your intended retirement budget you can put into place a net that will actually pay out a significant amount exactly at the time when you need it most. As we have seen above the longer the payments are deferred the larger the policy grows so if you can calculate a date at which your current retirement account will run out then you can purchase a plan that kicks in at that time. So in the event you live longer than expected (a good thing assuming you are in good health) or longer than you can afford (a really awful thought) this could alleviate a lot of the stress associated with retirement. A wonderful solution to a massive problem and one that might mean you actually live longer.
Now a few caveats before you rush out and buy one of these; shop around as you may find better offers from different insurers, make sure you use a tier one insurer as you are relying on them to be around to pay you out in 40 years or more and do not put more than 10% of your retirement funds into this product as you want to make sure you enjoy your retirement (see quotes above). So while I am not going to say this is the best investment ever, it seems to me to make sense for a lot of us to look into as a potential solution to a massive problem. Now where is my paddle, board and board shorts and I better start to watch my calorie intake as I plan to take full advantage of the extra time!!
"Mere longevity is a good thing for those who watch life from the sidelines. For those who play the game, an hour may be a year, a single day's work an achievement for eternity." - Helen Hayes
and a follow on to the above quote (one of my favorites so I couldn't resist)
"Life is not a journey to the grave with the intention of arriving safely in a pretty and well preserved body, but rather to skid in broadside, thoroughly used up, totally worn out, and loudly proclaiming - WOW, what a Ride." - Anonymous
Since records began there are only 35 people who have indisputably reached 115. Now that is a great innings but even more amazing is that it is estimated that one third of all babies born in the United Kingdom in 2013 are expected to reach 100. Considering that the UK currently only has 21 out of every 100,000 people reaching 100, well behind Japan, the world leader, with a rate of 43, to think that the estimate expects 33,000 of them to reach 100 seems hard to believe. That said longevity is certainly something that most people want and are starting to expect. People are working and living longer and this is starting to have a prolonged impact on everyone's portfolios.
Making your portfolio last through your retirement is of high importance and few seem to have it adequately taken care of but it may be possible to insulate yourself by looking to the insurance industry. Now I am not an insurance person but I do believe that the industry has a number of products that can alleviate the problems of longevity. Of course this assumes that their actuaries continue to calculate the numbers correctly and the company remains afloat but this is a fair assumption so for the purposes of this blog we will expect that the annuities offered continue to pay out. Now annuities are not my favorite product as they tie up a lot of capital (sometimes all of it) and can remove the ability to access your capital if you ever need to draw on it (think a medical emergency) so I typically steer clear of them but one may be of interest - the Longevity Annuity.
With the longevity annuity you give the insurance company a lump sum today, they invest the proceeds on your behalf and at a pre-selected date many years in the future it starts to pay out an annual stream of cash through the life of the purchaser. Now the downside is if you die prior to the annuity kicking in the value of the annuity is lost so it is a bit of a game of cat and mouse trying to decide when it should be activated but it can be looked on as a sort of a living insurance policy (rather than life insurance which pays out when you die). So should you happen to live far longer than your retirement funds can support you then it kicks in to save the day. Due to the compounding of the returns inherent in the policy the longer that you can delay the activation date the larger the pool that you can draw on and hence the larger the annual payout. As an example if you are 50 today and you put in $100,000 into a longevity annuity that only starts to payout when you get to 90 you would achieve a benefit in the range of 20 times what you would receive today. This amount would grow to more than 35 times if you waited another 5 years but of course it is a risk that you may not even make 80 let alone 95.
However the power of this investment is that for a small fraction of your intended retirement budget you can put into place a net that will actually pay out a significant amount exactly at the time when you need it most. As we have seen above the longer the payments are deferred the larger the policy grows so if you can calculate a date at which your current retirement account will run out then you can purchase a plan that kicks in at that time. So in the event you live longer than expected (a good thing assuming you are in good health) or longer than you can afford (a really awful thought) this could alleviate a lot of the stress associated with retirement. A wonderful solution to a massive problem and one that might mean you actually live longer.
Now a few caveats before you rush out and buy one of these; shop around as you may find better offers from different insurers, make sure you use a tier one insurer as you are relying on them to be around to pay you out in 40 years or more and do not put more than 10% of your retirement funds into this product as you want to make sure you enjoy your retirement (see quotes above). So while I am not going to say this is the best investment ever, it seems to me to make sense for a lot of us to look into as a potential solution to a massive problem. Now where is my paddle, board and board shorts and I better start to watch my calorie intake as I plan to take full advantage of the extra time!!
Friday, February 6, 2015
To the Laundry
"The US economy may be 'the cleanest dirty shirt' amongst a world of dirty shirts, but we should not forget that it is dirty nonetheless." - Fred Hickey
The jobs report came out today and it was (to me anyway) surprisingly strong. Headlines stated things like, "Strong Employment and Wage Gains in January Show Sluggishness in December Was not a New Trend." Non farm payrolls added 257,000 new jobs in January; on top of this wage growth surged 0.5% leading to an increase in aggregate wages of 0.7%. Economists lauded the report saying that undoubtedly consumer spending will follow and that the economy is now on firm footing. It is interesting then that at the time I am writing this that the stock market is not up hundreds of points, in fact right now it is actually down.
One reason for this might be that the overall unemployment rate edged up to 5.7% from 5.6% but this was due to revisions to seasonally adjusted numbers so I doubt that this has an impact. Another reason could be that the market had baked in a higher number and that the rally of the past week was overdone. To me though the main reason is that the number has not taken into account the recent oil and gas layoffs and that either the market expects a big revision to these numbers or that future numbers will be weak. Oil and gas extraction worker layoffs amounted to only 1,900 in January and I expect that this number will balloon in the future as oil producers have cut capital spending budgets by $24 billion according to the Wall Street journal. Considering that the oil and gas industry employs 216,000 workers, the highest number in nearly 30 years, I would expect a large number of these to reach the unemployment tables in the coming months.
Furthermore with the strengthening of the dollar, exports are slowing and job reductions have been announced by P&G, American Express, JC Penney, US Steel, Caterpillar, IBM, HP, Cisco, EMC, Citrix and eBay among others. In fact according to Challenger, Gray & Christmas US employers job cut announcements soared 63% from December. One reason for this is that the consumer spending numbers were not as robust as expected over the holiday season. It turns out that the consumer is not opening their wallets to spend their gasoline windfall but are rather keeping it for the simple reason that earnings on their savings is so low that a little bit of extra income is being used to offset the loss of returns. In addition the cost to the consumer of insurance, health care, taxes and education is still biting into their meager pay increases and this is more than offsetting the oil bonanza.
Assuming that the oil price remains low (and it looks like it will) for an extended period of time, consumers may start to spend this extra income but that day has not yet arrived. Furthermore until the job participation rate improves from multi-decade lows consumer spending will continue to stagnate particularly as it is the younger worker that has the highest levels of unemployment and they are the engines of consumption.
So while the market reaction seems to be of interest it might be that stock traders are growing wary of the tired drum being beaten by the Federal Reserve and may actually realize that the shirt while clean in comparison to the others is still dirty.
The jobs report came out today and it was (to me anyway) surprisingly strong. Headlines stated things like, "Strong Employment and Wage Gains in January Show Sluggishness in December Was not a New Trend." Non farm payrolls added 257,000 new jobs in January; on top of this wage growth surged 0.5% leading to an increase in aggregate wages of 0.7%. Economists lauded the report saying that undoubtedly consumer spending will follow and that the economy is now on firm footing. It is interesting then that at the time I am writing this that the stock market is not up hundreds of points, in fact right now it is actually down.
One reason for this might be that the overall unemployment rate edged up to 5.7% from 5.6% but this was due to revisions to seasonally adjusted numbers so I doubt that this has an impact. Another reason could be that the market had baked in a higher number and that the rally of the past week was overdone. To me though the main reason is that the number has not taken into account the recent oil and gas layoffs and that either the market expects a big revision to these numbers or that future numbers will be weak. Oil and gas extraction worker layoffs amounted to only 1,900 in January and I expect that this number will balloon in the future as oil producers have cut capital spending budgets by $24 billion according to the Wall Street journal. Considering that the oil and gas industry employs 216,000 workers, the highest number in nearly 30 years, I would expect a large number of these to reach the unemployment tables in the coming months.
Furthermore with the strengthening of the dollar, exports are slowing and job reductions have been announced by P&G, American Express, JC Penney, US Steel, Caterpillar, IBM, HP, Cisco, EMC, Citrix and eBay among others. In fact according to Challenger, Gray & Christmas US employers job cut announcements soared 63% from December. One reason for this is that the consumer spending numbers were not as robust as expected over the holiday season. It turns out that the consumer is not opening their wallets to spend their gasoline windfall but are rather keeping it for the simple reason that earnings on their savings is so low that a little bit of extra income is being used to offset the loss of returns. In addition the cost to the consumer of insurance, health care, taxes and education is still biting into their meager pay increases and this is more than offsetting the oil bonanza.
Assuming that the oil price remains low (and it looks like it will) for an extended period of time, consumers may start to spend this extra income but that day has not yet arrived. Furthermore until the job participation rate improves from multi-decade lows consumer spending will continue to stagnate particularly as it is the younger worker that has the highest levels of unemployment and they are the engines of consumption.
So while the market reaction seems to be of interest it might be that stock traders are growing wary of the tired drum being beaten by the Federal Reserve and may actually realize that the shirt while clean in comparison to the others is still dirty.
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