David Merkel

Image credit: Diverse Stock Photos || Would that those shiny coins were the real thing. Metal coins are real. Code, not so. As I have said before, look at the underlying economics of an investment rather than its external form. It doesn’t matter whether it is public or private. The form of an investment does not affect its returns, for the most part. I grew up in investing as a risk manager within life insurance and fixed income. We faced three main risks: credit, liquidity, and duration. We had lesser risks as well, like FX, sovereigns, convexity, etc. My main goal was to see the firm survive under all reasonable circumstances. My secondary goal was to improve profitability over those same circumstances. In doing that, we could make some small “side bets.” Buy an underpriced Canadian dollar bond. Buy a broken convertible bond of a beaten down company. Buy underpriced MBS where the models are overstating refinancing risk. Things like that. We could not make those side bets too large, but we could put a few on to try to make some money for the firm. We would match assets against our likely liability cashflows. We knew that 99%+ of the time, we would be fine. I can’t imagine what the so-called crypto banks are thinking. Much as they deride banking generally, they don’t have the vaguest idea of what they are doing. They should hire an investment actuary to limit what they do. Imagine a world where banks don’t care about currency risk, and some fail because the temptation to reach for yield causes them to buy asset in currencies that are weak… leading them to lose capital on net. This is the nature of crypto lending and borrowing. As Aristotle might have said, “Crypto is sterile.” It doesn’t produce anything. So don’t lend out crypto for a return… you may lose you principal in the process. There is no good reason why you should earn a return exceeding Treasuries plus 1% in lending crypto. But no one in crypto considers risk control. In one sense, I’m not sure how it could be done, unless you limit yourself to one major cryptocurrency — Bitcoin or Ethereum. The grand questions should be: Can I be sure of making payments over the next three months?Is my leverage low enough that the mélange of assets that I own will be able to cover my liabilities? Is there anything I can do to promote long-term survival? With cryptocurrency banks and stablecoins these concerns are ignored. They take risks that no bank or insurance company would take and with far less capital than would be reasonable. I encourage you to sell your crypto and buy gold, stocks, bonds, and other dollar-denominated assets.

Image credit: All images belong to Aleph Blog Well, finally the bear market… at 3/31/2002 the S&P 500 was priced to return a trice less than zero in nominal terms. After the pasting the market received today, that figure is 3.57%/year nominal (not adjusted for inflation). You would likely be better off in an ETF of 10-year single-A rated bonds yielding 4.7% — both for safety and return. I will admit that my recent experiment buying TLT has been a flop. I added to the position today. My view is that the long end of the curve is getting resistant to the belly of the curve, and thus the curve is turning into the “cap” formation, where the middle of the curve is higher than the short and long ends. This is a rare situation. Usually, the long end rallies in situations like this. The only situation more rare than this is the “cup” formation where the middle of the curve is lower than the short and long ends. I will have to update my my old post of “Goes Down Double-Speed.” We’ve been through three cycles since then — bear, bull, and now bear again. People get surprised by the ferocity of bear markets, but they shouldn’t be. People get shocked at losing money on paper, and thus the selloffs happen more rapidly. Bull markets face skepticism, and so they are slow. What are the possibilities given where the market is now? When the market is expecting 3.57% nominal, give or take one percent, what tends to happen? Most of the time, growth at these levels for the S&P 500 is pretty poor. That said, market expectations of inflation over the next ten years are well below the 4.7% you can earn on an average 10-year single-A rated corporate bond. Those expectations may be wrong — they usually are, but you can’t tell which way they will be wrong. I am still a believer in deflation, so I think current estimates of inflation are too high. There is too much debt and so monetary policy will have more punch than previously. The FOMC will panic, tighten too much, and crater some area in the financial economy that they care about, and then they will give up again, regardless of how high inflation is. They care more about avoiding a depression than inflation. They will even resume QE with inflation running hot if they are worried about the financial sector. The Fed cares about things in this order: Preserve their own necksPreserve the banks, and things like themFight inflationFund the US GovernmentPromote nominal GDP growth, though they will call it reducing labor unemployment. The Fed really doesn’t care about labor unemployment, or inequality. They are a bourgeois institution that cares about themselves and their patrons — those who are rich. I know this post is “all over the map.” My apologies. That said, we in a very unusual situation featuring high debt, high current inflation (that won’t last), war, plague, and supply-chain issues. How this exactly works out is a mystery, especially to me — but I am giving you my best guess here, for whatever it is worth. It’s worth than double what you paid for it! Full disclosure: long TLT for clients and me

Photo Credit: Marco Verch Professional Photographer || With some private investments, you can’t tell what the value truly is. Third party professional help occasionally assists dishonesty Part of my career was based on concealing volatility. I sold Guaranteed Investment Contracts. I helped design and manage several different types of stable value funds. Life insurance contracts get valued at their book value, regardless of what the replacement cost of an equivalent contract would be like presently. Anytime an investment pool with no current market price has a book value above the underlying value of the investments that it holds, there is risk to those holding the investment pool. The amount of risk can be small yet significant with some types of money market funds. It can be considerably larger in certain types of pooled investments like: Various types of business partnerships, including Private REITs, Real Estate Partnerships, Private Equity, etc.Illiquid debts, such as private credit funds, and notes with limited marketability, whether structured or not.Odd mutual funds that limit withdrawals because they offer “guarantees” of a sort. That applies to Variable Annuities with riders offering guaranteed benefits, if the life insurer becomes insolvent.One-off investment liquid partnerships that are secretive and unusual, like Madoff. The underlying may be illiquid, but the accounting may be fraudulent. Or, the accounting may be fine, but the assets listed are not what is in custody. (With small funds, analyze the auditor, trustees, and custodian.)The value of a company touted by a SPAC promoter may be worth considerably less than what is illustrated.Any investment in public equity or debt pool where the positions are concentrated, and they own a high percentage of the float, or a high amount of the securities relative to the amount that gets traded in an average month. Think of Third Avenue Focused Credit, or Archegos. I have consistently encouraged readers to “look through” their pooled investments, and consider what the underlying is worth. If you only have a vague idea of what the underlying investments are, look at their public equivalents. A rising tide lifts almost all boats, and a falling tide does the opposite. There is a conceit within private equity, private credit and private real estate funds that they are less risky; there is no volatility, because we cannot produce an NAV. They have the same volatility as the publicly traded funds, but the volatility is concealed. If trouble hits the public markets 50-75% of the way through the life of a private fund, it will have difficulty selling their investments at levels anywhere near the book value previously claimed by the sponsors. With consent of the limited partners, perhaps they extend the life of the fund to try to recover value, but that also imposes an opportunity cost on holders who were expecting proceeds from the fund on schedule. Remember as well that in a scenario like 1929-1932, private funds will be wiped out with similarly leveraged private funds. Aleph Blog has consistently warned about the possibility of depression, plague, war, famine, bad monetary policy and aggressive socialism. We have gotten plague, war, and bad monetary policy. Famine in a sense may come from the Ukraine war and trade restrictions on Russia, at least for the African countries that buy from them. Thus I encourage readers to avoid private investments that promise no volatility, like the stupid ads for Equity Multiple that run on Bloomberg Radio. All investments involve some type of risk. Just because you can’t or don’t measure the risk doesn’t mean that there is no risk. Don’t listen to investment sales pitches which tell you to avoid the volatility of the public equity and debt markets, when they are taking the exact same risks in the private market, and they cannot or will not measure the risks for you, no matter how thick or thin the “disclosure” document is. There is no significant advantage in the private market over the public market. Indeed, the reverse may be true. (Yes, I meant all of the ambiguity there.) Look to the underlying, and invest accordingly. Look at fees, and try to minimize them. Prize transparency, because it reduces risk in the long run. Those who are honest are transparent.

Photo Credit: mark m || Every now and then, a change in tactics is justified In 1994, there did come a limit where valuations of long debt undershot and started to come back. After more thought, the short-term yield effect of convexity hedging probably peaks out around 2.5-3.0% on 30-year mortgages. Unless the Fed becomes an aggressive seller of the their long bonds, and now-long MBS, I don’t see long rates going past their recent highs. As such, I am likely to begin buying a little bit of long Treasuries as a hedge against market weakness induced by the likely Fed overshoot. Recently the short-term correlation between stocks and 30-year Treasuries has seemed to go back to stocks down, bonds up, and vice-versa. That’s all for now.

Image Credit: Aleph Blog with help from FRED || Look at the mortgage rates fly! Okay, you might or might not remember the last piece. But since that time, 30-year mortgage rates have risen more than 1%. Is the Fed dawdling? Maybe, but the greater threat is that they become too aggressive, and blow up the financial economy, leading us into another decade-long bout of financial repression. As it stands right now, mortgage rates are in a self-reinforcing rising cycle, and it will not end until the Fed raises the Fed funds rate until it inverts the Treasury yield curve. But if I were on the FOMC, I would ignore inflation and the labor markets, and I would watch the financial economy to avoid blowing things up. The FOMC won’t do this. They are wedded to ideas that no longer work, or may never have worked, like the Phillips Curve. They imagine that the macroeconomic models work, when they never do. They forget what Milton Friedman taught — that monetary policy works with long and variable lags. Instead, in tightening cycles, the FOMC acts as if there are no lags. And, in one sense, they are correct. The financial economy reacts immediately to FOMC actions. The real economy, with inflation and unemployment, may take one or two years to see the effects. And because the FOMC forgets about the lags, they overshoot. The FOMC, far from stabilizing the economy, tends to destabilize it. We would be better off running a gold standard, and regulating the banks tightly for solvency. Remember, gold was never the problem — bad bank regulation was the problem. ======================= One more thing — the Fed needs to be quiet. The chatter of Fed governors upsets the markets, as do Fed press conferences and the dot-plot. The Fed was most effective under Volcker and Martin. They said little, and let their actions be known through the Fed’s Open Markets Desk. That allowed the Fed to surprise and lead the markets. The current Fed (since Greenspan) made the mistake of following the markets. Following the markets exacerbates volatility, and promotes oversupplying liquidity. ======================= At present I am pretty sure 30-year mortgage rates will rise to 6%, and maybe 7%. No one is panicking enough on this, so it will likely go higher. MBS hedging is a powerful force, and will continue until people no longer want to buy houses at such high interest rates.

Photo Credits: Jen and www.david baxendale.com with help from pinetools || The casino is exciting. The scale is honest and unrelenting. I want to give an update to one of the major concepts of Ben Graham, in order to make it fit the modern era better. Ben Graham said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”https://www.goodreads.com/quotes/831517-in-the-short-run-the-market-is-a-voting-machine quoted from The Intelligent Investor So let me modify it: In the short run, the market is a casino, but in the long run, it is a scale. Is this an improvement? Probably not, but speculation has become so rampant that it may be a necessary modification to change voting machine to casino. The voting machine makes sense, but typically we think of voting as being democratic. We only get one vote per person. Markets are different. Someone who brings a little money to the market will not have the same influence as the one who brings a lot of money to the market. Thus my analogy of the casino, though typically casinos will place limits on how much the casino will wager. They want to avoid random large losses so that they can live to extract money from rubes for many years to come. The winner can brag that he “broke the bank,” but the casino survived to play on. Bill Hwang and his CFO were formally charged with fraud today. What did they do? They synthetically borrowed a lot of money from investment banks to own huge amounts of a few companies. Their buying pushed the prices of the stocks higher, allowing them to borrow more against the positions. But eventually as the stocks they owned had some bad results, the margin calls on his positions wiped him out as the stock prices fell. The scale trumped the casino. The same is true of crypto and meme stocks. Cryptocurrencies require a continuing inflow of real cash (admittedly fiat money) in order to appreciate. If people stop buying crypto on net, and that may be happening now, cryptocurrencies will decline. The scale says crypto is a zero — no intrinsic value. The casino begs for more people to bring real money to buy fake money. That applies to meme stocks as well. You can throw a lot of money at a stock and it will rise. But for it to stay there or rise further, it will need increasing free cash flows to validate the value of the firm. Going back to crypto, it lacks any link to the real economy. Crypto will only become legitimate when you can buy groceries and gasoline at a fixed amount of bitcoin that varies less than the same price in US dollars. As a final note on the Scale versus the Casino, I give you Elon Musk. He borrows against his shares of Tesla to buy Twitter. He either did not realize or ignored the fact that he could lose his stake in Tesla if the price of Tesla falls enough. Do you really want the margin desk to control your fate? This may not totally impoverish Musk, but it is not impossible that he could the entirety of his holdings of Tesla in order to keep his holdings of the unprofitable Twitter. All it would take is for short sellers to push Tesla below $740, and then the margin desk starts selling his shares into a falling market. Momentum, aided by an agreement leading to forced selling. The market abhors a vacuum. So it is for those who assume that things will continue to go right for them.

Photo Credit: John.U || Look at all those eggs in one basket! The owner *is* watching it carefully, right? Jason Zweig recent wrote an article on owning stock in the company that you work for. Then today in his WSJ newsletter he asked the following question: What’s the most concentrated investment position you’ve ever had? (In other words, what single investment made up the greatest proportion of your portfolio?) Did it work out well or poorly? What did you learn from it? I have one article to answer both questions called Life with Wife. It’s a cute article which runs through two times in my life where I had an overly concentrated investment position. The first one was regarding The St. Paul (acquired by The Travelers), where I took my first big bonus, and put it all into shares of The St. Paul. I got derided for doing that by my colleagues in the investment department, but with a AA balance sheet, trading at 55% of tangible book value, and 8x forward earnings, I felt I had a reasonable provision against adverse deviation — a margin of safety. If you read the article, you will see that I almost doubled my money in six months, then sold. At the peak it was half of my net worth, and I had a mortgage then. So should you invest in your own company? Well, are you working for Tesla or Enron? I am being facetious here, as the guys at Enron thought they were working for a cutting-edge company like Tesla. But any analyst worth his salt would have seen that free cash flow at Enron was deeply negative. I have a neighbor who is a Tesla mechanic. As I was mowing my lawn one day, he waved me over. He wanted advice. He hinted to me how much his Tesla shares were worth. He had consulted an investment advisor who had told him to sell the wad, and the advisor would create a growth and income portfolio allowing him to retire (he is in his 60s). But he was conflicted, because Tesla was doing so well. He asked me what I would do if I was in his shoes. (Note: the TSLA shares were likely 95% of his net worth.) I said, “Do half, or sell 10-20% per year over time, until you do sell half.” Doing that frees you from the binary decision that you might regret. After selling half, if the price goes up, you still have more capital gains. If the price goes down, you sold some at a good time. You can be happy with yourself no matter what. I have no idea what my neighbor did. Hopefully he sold some. The second situation in Life with Wife regarded my only significant private equity position, Wright Manufacturing, which makes the best commercial lawn mowers in the world. At that point, my holdings were 15% of my net worth, with no mortgage. The founder was throwing everything into growth, and sacrificing safety. If he hadn’t been my friend, I probably would not have invested with him. As it was, when I sold half, I had recouped my investment. After the Life with Wife article, I bought out several of the founder’s relatives, ending up with 2.2% of the company. I’ve made 5x on my money here, with distributions, and using the very thin “market” for shares. One of the founder’s sons leads the company now, and he is a far better manager than his father. I like this company, and am more likely to buy more than to sell at this point. But at this point, it is only 10% of my net worth. I may offer to buy more, but I am thinking about it. It trades at 6x earnings, with a stronger balance sheet than the founder worked with, and a stronger competitive position. The most recent price is still below where I sold it to the second largest shareholder. Price discovery is tough when there are only 20 shareholders, and new shareholders may only enter at the pleasure of the board of directors. Closing So, over my life, I have reduced the relative amount at risk on my biggest positions. Does that make sense? Of course — I have less time to make up for mistakes as I grow older. The only people who should be taking high risks when they are old are who are ultra-rich. If they fail, they will still have enough for a moderate existence. Be careful with concentrated positions. You need certainty about safety most, earnings second, and growth third. Otherwise you are a gambler, and most gamblers lose.

Photo Credit: House Photography || I always read a lot when I was young This a is follow-up to When I was a Boy… which I wrote ~5 1/2 years ago. It is also a response to an article posted by Jason Zweig, who I have talked with once or twice, and emailed a little more than that. In that article, he asks the question: How did you learn how to invest? Did you take a class, play a stock-market game in school, have a friend or family member as a mentor?How Should Kids Learn to Invest? If you read the original article, you would know that my original start was from two gifts of stock that male relatives in my extended family gave me in the 1960s. They picked two high-fliers — Litton Industries and Magnavox. Bought and held, by the mid-1970s both generated >80% losses when they were bought by another company. Did I ever play the stock market game in school? Yes, once when I was in seventh grade (early 1973). Our school decided to play around and do an intersession between the two semesters. It was a two week course called “Bulls and Bears. How this Little Piggy Went to Market.” My favorite science teacher was teaching it. I realized that the game was utterly short-term and so I put all of my play money into AT&T warrants, knowing that if AT&T stock rose, the warrants would zoom up. Was I a smart kid, or what? What. Well, AT&T when nowhere for those two weeks, and the same for the warrants. They were at the same price at the contest end, thus losing the commissions on both sides, and this was when commissions were high, prior to deregulation. The three main things that taught me about investing were watching Wall Street Week with my Mom, borrowing books on investing at the Brookfield library, and reading the Value Line subscription that she purchased. I probably read 10 books on investing before I was 18. Louis Rukeyser was an affable guide to the markets, including the elves, the guests, etc. (As an aside, Frank A. Cappiello, Jr. was a founding member of the Baltimore Security Analysts Society, and a frequent guest on his show. After all, where is Owings Mills, Maryland?) With Value Line, I began to understand how corporations worked. The one-page descriptions of companies were just big enough to give me a good idea of what was going on, while not over-taxing a kid 12-21 years old. I remember as a student at Johns Hopkins earning 16% on my money market fund in my freshman year.  I was only at Hopkins for three years 1979-1982, but those were tough years, particularly in the Midwest “Rust Belt.”  My father’s business earned little, but my Mom’s investing paid off.  Though not “working” she was making more off the family portfolio than my Dad was earning off his business.  As it was, to help my family then, I paid the last semester of tuition.  (My Mom later paid me back for that.)  I came back home in 1982 with $5 in my pocket.  Then I learned that I overdrew my bank account, costing me $10. Oh, one more thing the clever and distinguished Carl Christ, who signed my Master’s Thesis at Hopkins, taught a class on investing in my junior year. I learned a lot, but the main thing I remember was writing a research report on a firm that made specialty paper — James River. My mother had owned it for a long time, but had sold her stake at an opportune time. When I wrote the report, she did not own it, and the stock had fallen from where she sold it. Dr. Christ had never heard of James River, an was fascinated at what was at that time a midcap firm in a underfollowed industry. I got an “A.” When I showed the report to my Mom, she bought it again, and made money of it. Also, in my senior year, I wrote my thesis on stock splits. As I said there: This brings me to my conclusion: stock splits are a momentum effect, but it is larger when companies are still have a cheap valuation. Perhaps splits have no effect on stock performance — it is all momentum and valuation. To me, that is the most likely conclusion, and my thesis anticipated quantitative money management by 10+ years.On Stock Splits In the summer of 1982, I remember sitting down with Value Line in my family’s living room (quiet place, no TV) and selecting a paper portfolio of 40-50 stocks. I went through all 1700 stocks. I recorded the prices in the Milwaukee Journal, and then went to Grad School at UC-Davis. Over the next year the stocks in my “portfolio” appreciated at double the rate of the market. At that time, I was a TA for a Corporate Financial Management class. I showed it to the professor, and he said, “Oh, you have a beta of two.” I said, “No, this portfolio has stocks that are not as risky as the market. This is alpha, not beta.” Several years later, I participated in the Value Line Investing Contest. I placed in the top 1%, but not good enough to win. When my dissertation committee dissolved, I was forced to abandon my Ph. D. I took three actuarial exams on the fly in early 1986 and passed. I had an informational interview at Pacific Standard Life which sponsored the exams, and they hired me on the spot. (My boss’ secretary told me that the boss said, “No one can pass the first three exams on the first try.” Then a fellow employee told me later, “You didn’t negotiate hard enough. They would have hired you regardless.”) When I worked for Pacific Standard Life, and later AIG, I got investment-related projects, because I was the one actuary that understood investing. During this time, I was managing my own portfolio, sometimes better, sometimes worse. I bought stocks, and mutual funds investing outside the US. I had a CTA in my portfolio. I tried investing in spectrum with the FCC, but that was a bomb. I settled on small cap value investing in the mid-1990s, which was a bad era for small cap value. Still, I managed to keep pace with the S&P 500. In 2000, I had an email exchange with Kenneth Fisher (yes, the big guy of Fisher Investments). This led to he creation of my eight rules. As I wrote on portfolio rule three: Let me give you a little history of how the eight rules came to be. In 2000, I had an e-mail discussion with Kenneth Fisher. I explained to him what I had been doing with small-cap value, and how I had done well with it in the 90s. He told me to forget everything that I’ve learned, especially the CFA syllabus, and look for the things that I can do better than anyone else. We exchanged about five or so e-mails; I appreciate the time he spent on me. So I sat back and thought about what investments had worked best for me in the past. I noticed that when I got the call right on cyclical industries, the results were spectacular. I also noticed that I lost most when investing in companies that didn’t have good balance sheets, no matter how “cheap” they were in terms of valuation. I came to the conclusion that size and value/growth were not the major determinants of my investing success. Instead, industry selection played a large role in what went right and wrong with my investment decisions. So, I decided to formalize that. I would rotate industries with a value bias. But that would have other impacts on how I invested. One of those impacts is rule number three. Over the next ten years, I tore up the pavement, and would have been in the top percentile of mutual fund managers. And so I opened my own shop in 2010, to find for the next eleven years that value investing was overrated. My life is bigger than my little company. I am a happy man. I know Jesus Christ; I have eternal life. Have there been disappointments? Of course. The one main positive I can say about my investing is that I rarely have big losses on any security. This is not due to stop losses; I pay attention to balance sheets and the cyclicality of markets. Even at the age of 61, I am still learning. I am not a boy, obviously, but I am still absorbing new ideas. To all who read me, be life-long learners. I am closer to the end to my life than my beginning, but invest! Take your opportunities to learn and capitalize on them! And remember, Judgement Day is coming. Are you ready? Investments will help you for now, but will be useless in the hereafter.

Picture Credit: Kailash Gyawali || There are times when despair is rational “There are two hard things in trading — buying higher, and selling lower.” Currently I am selling out my position in an illiquid stock. I am patient, but I can tell that my selling is having an impact on the market. Back when I was a corporate bond manager, I quickly learned that I had to scale in and out of positions. Even for the most commonly traded bonds, the market isn’t that liquid. While not lying to the brokers, learning to disguise your intentions, or at least frame them properly took some effort. One method I commonly used worked like this: “We need some cash. If you have someone wanting to buy $2-5 million, we will offer these at the 10-year Treasury + 150 basis points, $6-10 million T10 + 140 bps, and if they want to buy the whole wad (say 20-30 million), T10 + 125 basis points. Prices would ascend with size in selling. Prices would descend with size in buying, particularly for troubled bonds that we liked. Usually the brokers appreciated the supply or demand curves that I gave them. Frequently I ended up selling the “the wad,” which we were usually selling because our credit analyst had a reason. But life is not always so happy. Sometimes you have an asset that either you or the organization has concluded is a dud. Many people think it is a dud. How do you sell it? Should you sell it? There are options: you could hold an auction, but I will tell you if you do that, play it straight. Your reputation is worth far more than if the auction succeeds or not. You can set a reservation price but if the auction doesn’t sell, you will lose some face. Or you can test the market, selling in onesies an twosies ($1-2 million) seeing if there is any demand, and expand from there if you can. What I tended to do was go to my most trusted broker on a given bond and say, “I don’t have to sell this, but we need cash. Could you sound out those who own the bonds and see what they might like to buy a few million?” If we get an interested party, we can sound them out on buying more a an attractive price. But life can be worse, imagine trying to sell the bonds of Enron post default. Yes, I had to do that. And I had to sell them at lower and lower prices. (Kind of like the time I got trapped with a wad of Disney 30-year bonds.) And there is the opposite. You want to have a position in an attractive company, and you can’t get them at any reasonable price. You could give up. You could “do half.” Or you could chase it and get the full position, only to regret it. If you invest with an eye toward valuations, this will always be a challenge. All that said, if you focus on quality, these issues probably won’t hurt you as much. In any case, do what must be done. If something must be bought, buy it as cheaply as possible. If something must be sold, sell it as dearly as you can. Hide your intentions, while offering deals. In doing so, you may very well realize the most value.

I don’t watch movies much. Usually I think they are a waste of time. Recently I watched the movie Belle with my wife, and we both enjoyed it. This was the first film we had watched in a theater together in 35+ years. Anyway, here is my review of the movie Belle. ========================== There are a number of reasons why the reviews for Belle are all over the map.  I saw both the Japanese version with English subtitles on a small screen, and the English dub at a theater.  I read a lot of manga and manhua, and occasionally I watch anime, but less so because it eats up too much time. The reason I think the reviews vary so much relates to personality differences and willingness to think deeply.  If you ever look at comment threads on manga sites, you will run into a lot of shallow people who only can appreciate action-packed manga, don’t understand what the victory conditions are for the main character, and cannot wrap their minds around people who don’t act the way they would act. The plot of Belle revolves around two people, Suzu (Belle) and Kei (The Dragon), who have been hurt so badly in their lives that they have cut off as many people as they possibly can in order to avoid future hurt.  Now, is this an attractive pair to build a movie around? No, and that is the design of the movie, to make you sense the alienation.  Another aspect of the alienation is the characterization of rural Japan, where transportation options are becoming scarcer; travel to school is arduous for Suzu.  The movie implicitly asks a bunch of questions.  Is what you are assuming true or not?  Suzu assumes that the beautiful and talented girl Luka is happy, popular, and stuck-up.  Suzu assumes her Dad doesn’t care, and also Shinobu, whom she wishes would be her boyfriend.  She assumes that Luka likes Shinobu. She assumes that people would not like Belle if she openly revealed who she was.  Yet later in the movie she realizes that all of those assumptions are wrong. The most fundamental question of the movie is “Who are you?” Who is Belle? Who is the Dragon?  Everyone wants to know who they are in the real world.  So, does the metaverse U create a new you?  Though Suzu gets fame, and Kei gets infamy via U, if anything, U intensifies their problems, which need to be solved in real life. U seems to work at the beginning, but it doesn’t truly pay off. One theme for both Suzu and Kei is that their mothers died.  Suzu’s mother died rescuing an unknown girl from drowning, saying, “I have to go or she’ll die,” and then drowns after saving the girl. There is a parallel near the end of the movie, where Suzu knows that she has to find Kei or he might die, and saves him at the risk of her own life. She gets hurt in the process and does not die.  This is a story of becoming brave enough to love. The Dragon saves Belle in U.  Suzu saves Kei in the real world. The final theme is singing.  When Belle sings in U it affects people, as many have felt loss and rejection.  This is a change for Suzu, who loved to sing with her mother, but could not sing after her mother died. A turning point of the movie comes when Shinobu says to her when she wants to rescue Kei, “How can you get through to them if you are not yourself?” She then realizes that she needs to sing inside U not as the beautiful Belle, but as ordinary Suzu.  And after that she once again can happily sing on her own wherever she is. It is well-known that when the Japanese version of Belle (w/English subtitles) premiered at Cannes, it received a 14-minute standing ovation, which is rare.  If the international film community thought it was that good, it probably is stupendous.  To that end, ignore the shallow comments of those that did not understand the movie.

Image Credit: Aleph Blog with help from FRED || Believe it or not, I used FRED before it was a web resource — it was a standalone “bulletin board” that I woul dial into on my computer modem I’ve talked about this here: Estimating Future Stock Returns, December 2021 UpdateTime for Another Convexity Crisis?The First Priority of Risk Control (2009, this tells the story of what I did during the 1994 crisis.) And recently I have tweeted about it. Mortgage rates are surging faster than expected, prompting economists to lower their home sales forecasts https://t.co/IiX2gPlAnI 1994 scenario re-occurring. Falling prepayments makes MBS lengthen, leading indexed bond managers to sell low-coupon MBS forcing rates still higher— David Merkel (@AlephBlog) March 22, 2022 We may be in the 1994 scenario where mortgage durations are extending, dragging the long end of the yield, as those that hedge duration are forced to sell, setting up a self-reinforcing move up in yields.— David Merkel (@AlephBlog) March 22, 2022 The MBS coupon stack is a lot flatter in 2022 than in 1994. There is more than 4X the mortgage debt now than in 1994. Lots of pent-up negative convexity. I lived through that in 1994, and made money off it.— David Merkel (@AlephBlog) March 22, 2022 Then from the piece Classic: Avoid the Dangers of Data-Mining, Part 2 “In 1992-1993, there were a number of bright investors who had “picked the lock” of the residential mortgage-backed securities market. Many of them had estimated complex multifactor relationships that allowed them to estimate the likely amount of mortgage prepayment within mortgage pools. Armed with that knowledge, they bought some of the riskiest securities backed by portions of the cash flows from the pools. They probably estimated the past relationships properly, but the models failed when no-cost prepayment became common, and failed again when the Federal Reserve raised rates aggressively in 1994. The failures were astounding: David Askin’s hedge funds, Orange County, the funds at Piper Jaffray that Worth Bruntjen managed, some small life insurers, etc. If that wasn’t enough, there were many major financial institutions that dropped billions on this trade without failing. What’s the lesson? Models that worked well in the past might not work so well in the future, particularly at high degrees of leverage. Small deviations from what made the relationship work in the past can be amplified by leverage into huge disasters.“ Finally from the piece What Brings Maturity to a Market: Negative Convexity: Through late 1993, structurers of residential mortgage securities were very creative, making tranches in mortgage securitizations that bore a disproportionate amount of risk, particularly compared to the yield received. In 1994 to early 1995, that illusion was destroyed as the bond market was dragged to higher yields by the Fed plus mortgage bond managers who tried to limit their interest rate risks individually, leading to a more general crisis. That created the worst bond market since 1926. ================================================== I am not saying it is certain, but I think it is likely that we are experiencing a panic in the mortgage bond market now. Like 1994, we have had a complacent Fed that left policy rates too low for too long. Both were foolish times, where policy should have been tighter. This led to massive refinancing of mortgages, and many new mortgages at low rates. But when that happens with most mortgages being low rate, if the Fed hints at or starts raising rates, prepayments will fall and Mortgage-Backed Securities [MBS] will lengthen duration while falling in price. Bond managers, most of whom are indexed and want a fixed duration, will start selling long bonds and MBS, leading long rates to rise, and the cycle temporarily becomes self-perpetuating. This is likely the situation that we are in now, and it very well may make the Fed overreact as they did in 1994. All good economists know the monetary policy acts with long and variable lags. But the FOMC for PR reasons acts as if their actions are immediate. Thus they become macho, and raise their rates too far, leading to a crash. (Can we eliminate the Fed? Gold was better, if we regulated the banks properly. Or, limit the slope of the yield curve.) I’m planning on making money on the opposite side of this trade if I am right. I will buy long Treasuries after the peak. I am watching this regularly, and will act when it is clear to me, but not the market as a whole, which in late 1994 to early 1995 did not know which end was up. Anyway, that’s all. The only good part of this environment is that my bond portfolios are losing less than the general market.

Image credit: All images belong to Aleph Blog This should be a brief post. At the end of 2021, the S&P 500 was poised to nominally return -1.53%/year over the next 10 years. As of the close yesterday, that figure was 0.73%/year. The only period compares with this valuation-wise is the dot-com bubble. We are near dot-com level valuations, in the 98th percentile. And if you view the 10-year returns from the worst time of the dot-com bubble to now, you can see that the results they obtained are worse than what I forecast here. Of course, a lot of what will happen in nominal terms will rely on the actions of the Fed. Will the Fed: Allow a real recession to clear away dud assets that are on life support from low rates? (Collapsing the current stock/junk bubble.. they would never do this unless their hands were tied.)Risk the 1994 scenario where the compressed coupon stack in the Residential Mortgage Backed Securities [RMBS] market begins a self-reinforcing interest rate rise cycle on the long end as mortgage rates rise, prepayments drop, mortgage durations extend, leading to bond managers selling RMBS and long bonds with abandon to bring their duration risk down. The Fed chases the yield curve up, and the stock and housing markets both fall. The Fed chokes on their policy, and gives up tightening to save both markets.Or, if not the 1994 scenario, does the Fed dare to stop tightening before the yield curve inverts, and just wait for a flat curve to do its work? (Nah, that would be smart. The Fed always inverts the curve to prove their manliness, and blows some part of the market up in the process.)Or do they just accept financial repression, and punish savers to benefit wage earners (Will it really work? Dubious.), as the Fed keeps their policy rate low. I posed those scenarios to Tom Barkin, President of the Richmond Fed when he came to speak to the CFA Institute at Baltimore last week. He gave answers that were either evasive, or he didn’t get it. Anyway, this is an awkward market situation, but the one thing that is clear to me is that investors should be at the lower end of risk for their asset allocation. PS — As for me, I am living with value stocks, small stocks, and international stocks. Very little in the S&P 500 here.

Photo Credit: atramos || Inflation isn’t the most organized phenomenon, and investors often all want to be on the same side of the boat… I have a very irregular series called, “Problems with Constant Compound Interest.” Part of the idea of that series is that it is difficult to assure growth in capital in any sort of constant way. The simple models of the CFPs, and even actuaries that assume constant or near constant growth are ultimately doomed to fail if they try to exceed growth in nominal GDP by more than 2%/year. Because of the oddities in the current market environment, current interest rates and inflation have decoupled. They are separate processes. We all want to build value in real (inflation-adjusted) terms, but how do you do that in an environment where price to free cash flow multiples are sky high, nominal interest rates are low, and the prices of most commodities are high as well (leaving aside gold as an oddity). Mindless stock bulls talk of TINA [There Is No Alternative (to buying stocks)], as if there is no limit to how high stock prices can go when interest rates are low. I want to tell you about TIN. There Is Nothing (worth buying). This is the nature of financial repression. If you invest in short bonds, you get gouged by current inflation. If you buy long bonds, you run the risk that the Fed might start monetizing Treasury debt directly, and inflation really runs. With stocks you run the risk of any hiccup in the global economy (when is the omega variant coming so that we can move on to Hebrew letters?) can derail the market, particularly if it leads to higher interest rates. The Fed has gotten its wish and is forcing an asset bubble on the US to aid growth, however fitfully. All of the relationships of the present to the future are out of whack, because interest rates are too low. But if intermediate interest rates rose to the level of nominal GDP growth, we would see deficits grow even more rapidly as the US government would refinance at higher rates. The Fed is stuck in a doom loop of its own design ever since Alan Greenspan got the great idea to cut short recessions too soon. That has led us into a liquidity trap designed by the Fed. As I said to one of my clients this week (a bright man), “If you are not bewildered, you are not thinking.” About the only idea I can think of for investing at present is the intersection of high quality and low-ish valuations. As it says in Ecclesiastes 11:2 “Give a serving to seven, and also to eight, For you do not know what evil will be on the earth.” Diversify among safe-ish investments, with a few cyclicals that will do well if things run hot, and stable businesses, if things do not. That’s all.

Image credit: All images belong to Aleph Blog This should be a brief post. At the end of the third quarter, the S&P 500 was poised to nominally return -0.64%/year over the next 10 years. As of the close today, that figure was -1.83%/year, slightly more than the -1.84%/year at the record high last Friday. The only period compares with this valuation-wise is the dot-com bubble. We are above dot-com level valuations. And if you view the 10-year returns from the worst time of the dot-com bubble to now, you can see that the results they obtained are milder than what I forecast here. Of course, a lot of what will happen in nominal terms will rely on the actions of the Fed. Will the Fed: Allow a real recession to clear away dud assets that are on life support from low rates? (Collapsing the current asset bubble)Change the terms of monetary policy, and start directly monetizing US Treasury debt? (Risking high inflation)Continue to dither with financial repression, leaving rates low, not caring about moderate inflation, with real growth zero-like. (Zombie economy — this is the most likely outcome for now) In some ways the markets are playing around with something I call “the last arbitrage.” Bonds versus Stocks. The concept of TINA (There is no alternative [to stocks]) relies on the idea that the Fed will be the lapdog of the equity markets. If stocks are high, the Fed is happy. Phrased another way, if the Fed maximizes wealth inequality, it is happy. And the Fed will be happy. They live to employ thousands of macroeconomists who would have a hard time finding real employment. These economists live to corrupt our understanding f the macroeconomy, justifying the actions of the Fed. The Fed just wants to scrape enough seigniorage to pay the staff, and keep Congress and the Administration mollified. All taken out of the hides of those who save. So with the last arbitrage… interest rates have to stay low to keep the stock market high, even if it means slow growth, and moderate and growing inflation. The likely change promulgated by the Fed today, raising the short rate by 0.75% in 2022 will likely flatten the yield curve, leading to a crisis of some sort, and push them back into QE and near-zero short rates. The stock market will have a pullback and a rally, but what of inflation? How will people act when there is no way to save for the short-run, without inflation eating away value? Brave new world. The Fed is stuck, and we are stuck with them. Gold does nothing, and would be a kinder mistress than the Fed. Better to live within strict limits, than the folly of an elastic currency. But as is true with all things in America, we are going to have to learn this the hard way. PS — As for me, I am living with value stocks, small stocks, and international stocks. Very little in the S&P 500 here.

Image credit: All images belong to Aleph Blog This should be a brief post. At the end of the third quarter, the S&P 500 was poised to nominally return -0.64%/year over the next 10 years. As of the close today, that figure was -1.83%/year, slightly more than the -1.84%/year at the record high last Friday. The only period compares with this valuation-wise is the dot-com bubble. We are above dot-com level valuations. And if you view the 10-year returns from the worst time of the dot-com bubble to now, you can see that the results they obtained are milder than what I forecast here. Of course, a lot of what will happen in nominal terms will rely on the actions of the Fed. Will the Fed: Allow a real recession to clear away dud assets that are on life support from low rates? (Collapsing the current asset bubble)Change the terms of monetary policy, and start directly monetizing US Treasury debt? (Risking high inflation)Continue to dither with financial repression, leaving rates low, not caring about moderate inflation, with real growth zero-like. (Zombie economy — this is the most likely outcome for now) In some ways the markets are playing around with something I call “the last arbitrage.” Bonds versus Stocks. The concept of TINA (There is no alternative [to stocks]) relies on the idea that the Fed will be the lapdog of the equity markets. If stocks are high, the Fed is happy. Phrased another way, if the Fed maximizes wealth inequality, it is happy. And the Fed will be happy. They live to employ thousands of macroeconomists who would have a hard time finding real employment. These economists live to corrupt our understanding f the macroeconomy, justifying the actions of the Fed. The Fed just wants to scrape enough seigniorage to pay the staff, and keep Congress and the Administration mollified. All taken out of the hides of those who save. So with the last arbitrage… interest rates have to stay low to keep the stock market high, even if it means slow growth, and moderate and growing inflation. The likely change promulgated by the Fed today, raising the short rate by 0.75% in 2022 will likely flatten the yield curve, leading to a crisis of some sort, and push them back into QE and near-zero short rates. The stock market will have a pullback and a rally, but what of inflation? How will people act when there is no way to save for the short-run, without inflation eating away value? Brave new world. The Fed is stuck, and we are stuck with them. Gold does nothing, and would be a kinder mistress than the Fed. Better to live within strict limits, than the folly of an elastic currency. But as is true with all things in America, we are going to have to learn this the hard way. PS — As for me, I am living with value stocks, small stocks, and international stocks. Very little in the S&P 500 here.

Photo Credit: duncan c || I know it is graffiti, but face it, most arguments regarding COVID-19 or politics are little better than graffiti There’s a popular argument going around about the VAERS [Vaccine Adverse Event Reporting System] database that the COVID-19 [C19] vaccines are killing a lot of people. I am here tonight to tell you that is likely false, but at minimum, that you can’t prove that through the VAERS database. First a digression: Out of group of one million picked at random in the US, how many people will die on a given day?  Using 2019 US crude mortality data, roughly 20.  So, out of 470 million vaccine doses administered, how many should have died for any reason within one day of receiving the dose of vaccine? Roughly 9,400.  Within two days? 18,800. How many deaths are in VAERS after one day? 1,921. Two days? 2,415. Expected deaths for any reason versus VAERS data after five days? 47,000 vs 3,244. Fourteen days? 131,600 vs 4,458. 30 days? 282,000 vs 5,629. There are 4,799 additional deaths 31 days and after, and those where no date was specified in the VAERS data. So, 10,428 deaths from COVID in the VAERS database. So, the VAERS data does not support the idea that the vaccine is killing people.  Now the VAERS database has inconsistent and uncontrolled reporting – it is a voluntary database, and anyone can post to it, makes any study design pretty useless, which is part of their disclaimers. Many allege underreporting but ask yourself “Could there be more than 25 deaths from the vaccines for every one reported?” Really, I doubt it. A big blip in the death rate from vaccination would get noticed – you couldn’t suppress it. The news outlets would be all over the story. We have never had a vaccination campaign of this size in the US before.  We should expect people dying post-vaccination at an ordinary rate.  Where VAERS could be useful would be looking at cause of death codes for a given vaccine, and seeing if there are any death causes that are unusual in proportion.  And that’s what the researchers mostly use the VAERS database for. From other statistical work I have done I can tell you that the vaccines are generally effective, and that if you don’t have a medical reason to not get vaccinated, you should get vaccinated. The vaccines reduce the likelihood of infection, severity of infection, and the likelihood of death from C19. And for my Christian friends who object because fetal tissue from abortions long ago were used in the process of creating the vaccines, I will ask you this: many drugs get tested or developed using the aborted fetal tissue, including aspirin, Tylenol, Ibuprofen, Lidocaine, Mucinex, Pepto Bismol, MMR Vaccine, Remdesivir, Tums, Maalox, Preparation H, Claritin, Robitussin, Lipitor, Zoloft, Aleve, Ex-Lax, Benadryl, Suphedrine, and Sudafed, among many others. Are you willing to make the moral claim and do without almost all drugs, not just the C19 vaccines? Those children are dead, and nothing can be done about it. The cells that comprised their bodies are long since gone. The cells existing today are many generations removed from the babies who were killed through the abortions. Not that they should have been killed (let’s end Roe v Wade), but they have indirectly done more good for mankind than most people (including me) will ever do. Public health is a proper province of government, unlike most matters that governments concern themselves with today, because it involves matters in health that can be made better via collective action. The Mosaic Law supports this idea. And so I say to my Christian friends, get vaccinated, and stop listening to the right wing media that milks you to make money via advertising.

Photo Credit: duncan c || I know it is graffiti, but face it, most arguments regarding COVID-19 or politics are little better than graffiti There’s a popular argument going around about the VAERS [Vaccine Adverse Event Reporting System] database that the COVID-19 [C19] vaccines are killing a lot of people. I am here tonight to tell you that is likely false, but at minimum, that you can’t prove that through the VAERS database. First a digression: Out of group of one million picked at random in the US, how many people will die on a given day?  Using 2019 US crude mortality data, roughly 20.  So, out of 470 million vaccine doses administered, how many should have died for any reason within one day of receiving the dose of vaccine? Roughly 9,400.  Within two days? 18,800. How many deaths are in VAERS after one day? 1,921. Two days? 2,415. Expected deaths for any reason versus VAERS data after five days? 47,000 vs 3,244. Fourteen days? 131,600 vs 4,458. 30 days? 282,000 vs 5,629. There are 4,799 additional deaths 31 days and after, and those where no date was specified in the VAERS data. So, 10,428 deaths from COVID in the VAERS database. So, the VAERS data does not support the idea that the vaccine is killing people.  Now the VAERS database has inconsistent and uncontrolled reporting – it is a voluntary database, and anyone can post to it, makes any study design pretty useless, which is part of their disclaimers. Many allege underreporting but ask yourself “Could there be more than 25 deaths from the vaccines for every one reported?” Really, I doubt it. A big blip in the death rate from vaccination would get noticed – you couldn’t suppress it. The news outlets would be all over the story. We have never had a vaccination campaign of this size in the US before.  We should expect people dying post-vaccination at an ordinary rate.  Where VAERS could be useful would be looking at cause of death codes for a given vaccine, and seeing if there are any death causes that are unusual in proportion.  And that’s what the researchers mostly use the VAERS database for. From other statistical work I have done I can tell you that the vaccines are generally effective, and that if you don’t have a medical reason to not get vaccinated, you should get vaccinated. The vaccines reduce the likelihood of infection, severity of infection, and the likelihood of death from C19. And for my Christian friends who object because fetal tissue from abortions long ago were used in the process of creating the vaccines, I will ask you this: many drugs get tested or developed using the aborted fetal tissue, including aspirin, Tylenol, Ibuprofen, Lidocaine, Mucinex, Pepto Bismol, MMR Vaccine, Remdesivir, Tums, Maalox, Preparation H, Claritin, Robitussin, Lipitor, Zoloft, Aleve, Ex-Lax, Benadryl, Suphedrine, and Sudafed, among many others. Are you willing to make the moral claim and do without almost all drugs, not just the C19 vaccines? Those children are dead, and nothing can be done about it. The cells that comprised their bodies are long since gone. The cells existing today are many generations removed from the babies who were killed through the abortions. Not that they should have been killed (let’s end Roe v Wade), but they have indirectly done more good for mankind than most people (including me) will ever do. Public health is a proper province of government, unlike most matters that governments concern themselves with today, because it involves matters in health that can be made better via collective action. The Mosaic Law supports this idea. And so I say to my Christian friends, get vaccinated, and stop listening to the right wing media that milks you to make money via advertising.

Photo Credit: eflon || All in all, you’re just another brick in the wall… In some ways, the Federal Reserve is the whipping boy of Congress. Congress can’t decide on anything significant, so the Fed fills in the blanks, and keeps things moving, even if it creates humongous asset bubbles in the process. That is what we are facing today. Overvalued stocks, housing, corporate bonds, private equity, and more. Inflation in goods and services may be transitory, but asset inflation is a constant. Whether by QE or rate policy, the Fed tries to end the possibility of recessions by making financing cheap, and blowing asset bubbles in the process. What of the future? The Fed will be dragged kicking and screaming to tightening. It will follow the stupid Alan Greenspan highway of 25 basis points per meeting. It will be all too predictable, which has little to no impact until it is too late, creating pro-cyclical economic policy, something the Fed specializes in. The Fed will be surprised (again) to see that the long end of the yield curve does not respond to their efforts. Are they stupid? Yes. the yield curve hasn’t worked in the classical way for over 20 years. In an overindebted economy, long rates are sluggish. Can the Fed abandon the dead orthodoxy of neoclassical economics to embrace the reality of overindebted economics? I doubt it. I asked two Fed governors three years ago when the Fed would abandon the failed Neoclassical economics. They looked like dead sheep for a moment, before they gave some lame defenses of the theory that can’t account for financial markets or marketing. What I expect is that the Fed will tighten the Fed funds rate to 1.5% or so, the long end sinking, and then something blows up, and they return to the prior policy of 0% rates, and QE… failed policies that inflate asset bubbles and increase inequality. We’re in a “doom loop” where there is no way to purge this system of its errors. We would be better off under a gold standard, with stricter regulation of banks. Would we have a recession? Yes, but eventually the economy would grow again organically, without the pollution of stimulus. That said, the Federal Reserve is not the main problem. The main problem is American culture that will not tolerate severe recessions. We need recessions to liquidate bad debts that hinder the economy from growing rapidly in the future. We need to accept the boom-bust cycle, and not look to the government or central bank to moderate matters. Bank regulation is another matter, as loose regulation of banks led to extreme booms and busts, particularly between 1870-1913, and 2004-2008. Conclusion The Fed will tighten and fail, returning us to the same morass that we are in now. Financial repression via the Fed will continue to create inequality with no smoking gun. Stupid people will finger other causes, when the real cause is the Federal Reserve. We need to eliminate the Federal Reserve, and cause Congress and the Executive Branch to take responsibility for their failed policies. PS — there could be a currency panic, but I doubt it. Too many countries want to export to the US.

Photo Credit: eflon || All in all, you’re just another brick in the wall… In some ways, the Federal Reserve is the whipping boy of Congress. Congress can’t decide on anything significant, so the Fed fills in the blanks, and keeps things moving, even if it creates humongous asset bubbles in the process. That is what we are facing today. Overvalued stocks, housing, corporate bonds, private equity, and more. Inflation in goods and services may be transitory, but asset inflation is a constant. Whether by QE or rate policy, the Fed tries to end the possibility of recessions by making financing cheap, and blowing asset bubbles in the process. What of the future? The Fed will be dragged kicking and screaming to tightening. It will follow the stupid Alan Greenspan highway of 25 basis points per meeting. It will be all too predictable, which has little to no impact until it is too late, creating pro-cyclical economic policy, something the Fed specializes in. The Fed will be surprised (again) to see that the long end of the yield curve does not respond to their efforts. Are they stupid? Yes. the yield curve hasn’t worked in the classical way for over 20 years. In an overindebted economy, long rates are sluggish. Can the Fed abandon the dead orthodoxy of neoclassical economics to embrace the reality of overindebted economics? I doubt it. I asked two Fed governors three years ago when the Fed would abandon the failed Neoclassical economics. They looked like dead sheep for a moment, before they gave some lame defenses of the theory that can’t account for financial markets or marketing. What I expect is that the Fed will tighten the Fed funds rate to 1.5% or so, the long end sinking, and then something blows up, and they return to the prior policy of 0% rates, and QE… failed policies that inflate asset bubbles and increase inequality. We’re in a “doom loop” where there is no way to purge this system of its errors. We would be better off under a gold standard, with stricter regulation of banks. Would we have a recession? Yes, but eventually the economy would grow again organically, without the pollution of stimulus. That said, the Federal Reserve is not the main problem. The main problem is American culture that will not tolerate severe recessions. We need recessions to liquidate bad debts that hinder the economy from growing rapidly in the future. We need to accept the boom-bust cycle, and not look to the government or central bank to moderate matters. Bank regulation is another matter, as loose regulation of banks led to extreme booms and busts, particularly between 1870-1913, and 2004-2008. Conclusion The Fed will tighten and fail, returning us to the same morass that we are in now. Financial repression via the Fed will continue to create inequality with no smoking gun. Stupid people will finger other causes, when the real cause is the Federal Reserve. We need to eliminate the Federal Reserve, and cause Congress and the Executive Branch to take responsibility for their failed policies. PS — there could be a currency panic, but I doubt it. Too many countries want to export to the US.

Photo Credit: Chris Blakeley || Always optimistic when things are growing, and in the dumps when it falls apart Over the years, I have suggested that two firms should break up on a number of occasions: AIG & GE. Both are now in the process of completing their breakups. The news on GE dropped today, and I was surprised that the media did not pick up on one significant question on the GE breakup. Who gets the insurance liabilities that have been a real pain to GE even after selling off Genworth. As I tweeted: General Electric to Split Into Three Public Companies – WSJ https://t.co/BR8uXhhDVJ Notably missing from all the $GE press coverage is who has to pay off the insurance liabilities: Aviation, probably the weakest of the three. Could gore those relying on the guarantee… pic.twitter.com/qhT0y4gfXL— David Merkel (@AlephBlog) November 9, 2021 How could they miss this? I think I first suggested that GE should break up in a comment in RealMoney’s Columnist Conversation sometime back in 2005, but that is lost in the pre-2008 RealMoney file system, and exists no more. In terms of what I can show I will quote from this old post from 2008: 5) File this under Sick Sigma, or Six Stigma — GE is finally getting closer to breaking up the enterprise.� It has always been my opinion that conglomerates don’t work because of diseconomies of scale.� As I wrote at RealMoney: David MerkelGE — Geriatric Elephant4/27/2007 1:16 PM EDT First, my personal bias. Almost every firm with a market cap greater than $100 billion should be broken up. I don’t care how clever the management team is, the diseconomies of scale become crushing in the megacaps. Regarding GE in specific, it is likely a better buy here than it was in early 1999, when the stock first breached this price level. That said, it doesn’t own Genworth, the insurance company that it had to jettison in order to keep its undeserved AAA rating. Which company did better since the IPO of Genworth? Genworth did so much better that it is not funny. 87% total return (w/divs reinvested) for GNW vs. 28% for GE. A pity that GE IPO’ed it rather than spinning it off to shareholders… But here’s a problem with breaking GE up. GE Capital, which still provides a lot of the profits could not be AAA as a standalone entity and have an acceptable ROE. It would be single-A rated, which would push up funding costs enough to cut into profit margins. (Note: GE capital could not be A-/A3 rated, or their commercial paper would no longer be A1/P1 which is a necessary condition for investment grade finance companies to be profitable.) Would GE do as well without a captive finance arm (GE Capital)? It would take some adjustment, but I would think so. So, would I break up GE by selling off GE Capital? Yes, and I would give GE Capital enough excess capital to allow it to stay AAA, even if it means losing the AAA at the industrial company, and then let the new GE Capital management figure out what to do with all of the excess capital, and at what rating to operate. Splitting up that way would force the industrial arm to become more efficient with its proportionately larger debt load, and would highlight the next round of breakups, which would have the industrial divisions go their own separate ways. Position: none, and I have never understood the attraction to GE as a stock Over the years, I continued to write about GE and Genworth (I grew bearish over LTC after analyzing Penn Treaty. I was always bearish on mortgage insurance). I never thought either would do well, but I never expected them to do as badly as they did. Optimistic accounting ploys from the Welch years bit into profits of Immelt, as he was forced to reset accruals higher again and again. Overly aggressive financial and insurance underwriting similarly had to be reversed, and losses realized. After today, all but the successor firm for GE (Aviation) has a chance to do something significant, freed from the distractions of being in a conglomerate. They can focus, and maybe win. As for GE Aviation, because of the insurance liabilities they will probably receive a valuation discount. Maybe they will sacrifice and pay up, selling the liabilities to Buffett with significant overcollateralization. American International Group I first suggested that AIG break up back in 2008. Only M. R. Greenberg had the capability of managing the behemoth, and once he was gone, lower level managers began making decisions that Greenberg would have quashed, which led to short-term gains, and larger long-term losses. After AIG was taken over by the Fed, bit-by-bit they began selling off the pieces — Hartford Steam Boiler, ILFC, AIA, Alico (to MetLife), and more. They were left with a portion of the international P&C business, and the domestic life and P&C businesses. They are now planning on spinning off the domestic life companies, which will leave AIG as a P&C insurer with relatively clean liabilities (They reinsured Asbestos and Environmental with Berkshire Hathaway). Where do we go from here? Is there a lesson here? Avoid complexity. Avoid mixing mixing industrial and financial. Avoid mixing life and P&C. (Allstate is finally splitting that.) That said, there may be another lesson for the future. What of the extremely large companies that are monopolies? Some of them aren’t complex; they just dominate a large area of the economy as monopolies. Governments want to do one of two things with monopolies. They either want to break them up, or turn them into regulated utilities. Why? The government doesn’t like entities that get almost as powerful as them, so they limit their size, scope, and subject them to regulation. So be aware if you hold some of the largest companies in the US or the world, because governments have their eyes on them, and want them to be subject to the government(s). Full disclosure: long MET

Photo Credit: Chris Blakeley || Always optimistic when things are growing, and in the dumps when it falls apart Over the years, I have suggested that two firms should break up on a number of occasions: AIG & GE. Both are now in the process of completing their breakups. The news on GE dropped today, and I was surprised that the media did not pick up on one significant question on the GE breakup. Who gets the insurance liabilities that have been a real pain to GE even after selling off Genworth. As I tweeted: General Electric to Split Into Three Public Companies – WSJ https://t.co/BR8uXhhDVJ Notably missing from all the $GE press coverage is who has to pay off the insurance liabilities: Aviation, probably the weakest of the three. Could gore those relying on the guarantee… pic.twitter.com/qhT0y4gfXL— David Merkel (@AlephBlog) November 9, 2021 How could they miss this? I think I first suggested that GE should break up in a comment in RealMoney’s Columnist Conversation sometime back in 2005, but that is lost in the pre-2008 RealMoney file system, and exists no more. In terms of what I can show I will quote from this old post from 2008: 5) File this under Sick Sigma, or Six Stigma — GE is finally getting closer to breaking up the enterprise.� It has always been my opinion that conglomerates don’t work because of diseconomies of scale.� As I wrote at RealMoney: David MerkelGE — Geriatric Elephant4/27/2007 1:16 PM EDT First, my personal bias. Almost every firm with a market cap greater than $100 billion should be broken up. I don’t care how clever the management team is, the diseconomies of scale become crushing in the megacaps. Regarding GE in specific, it is likely a better buy here than it was in early 1999, when the stock first breached this price level. That said, it doesn’t own Genworth, the insurance company that it had to jettison in order to keep its undeserved AAA rating. Which company did better since the IPO of Genworth? Genworth did so much better that it is not funny. 87% total return (w/divs reinvested) for GNW vs. 28% for GE. A pity that GE IPO’ed it rather than spinning it off to shareholders… But here’s a problem with breaking GE up. GE Capital, which still provides a lot of the profits could not be AAA as a standalone entity and have an acceptable ROE. It would be single-A rated, which would push up funding costs enough to cut into profit margins. (Note: GE capital could not be A-/A3 rated, or their commercial paper would no longer be A1/P1 which is a necessary condition for investment grade finance companies to be profitable.) Would GE do as well without a captive finance arm (GE Capital)? It would take some adjustment, but I would think so. So, would I break up GE by selling off GE Capital? Yes, and I would give GE Capital enough excess capital to allow it to stay AAA, even if it means losing the AAA at the industrial company, and then let the new GE Capital management figure out what to do with all of the excess capital, and at what rating to operate. Splitting up that way would force the industrial arm to become more efficient with its proportionately larger debt load, and would highlight the next round of breakups, which would have the industrial divisions go their own separate ways. Position: none, and I have never understood the attraction to GE as a stock Over the years, I continued to write about GE and Genworth (I grew bearish over LTC after analyzing Penn Treaty. I was always bearish on mortgage insurance). I never thought either would do well, but I never expected them to do as badly as they did. Optimistic accounting ploys from the Welch years bit into profits of Immelt, as he was forced to reset accruals higher again and again. Overly aggressive financial and insurance underwriting similarly had to be reversed, and losses realized. After today, all but the successor firm for GE (Aviation) has a chance to do something significant, freed from the distractions of being in a conglomerate. They can focus, and maybe win. As for GE Aviation, because of the insurance liabilities they will probably receive a valuation discount. Maybe they will sacrifice and pay up, selling the liabilities to Buffett with significant overcollateralization. American International Group I first suggested that AIG break up back in 2008. Only M. R. Greenberg had the capability of managing the behemoth, and once he was gone, lower level managers began making decisions that Greenberg would have quashed, which led to short-term gains, and larger long-term losses. After AIG was taken over by the Fed, bit-by-bit they began selling off the pieces — Hartford Steam Boiler, ILFC, AIA, Alico (to MetLife), and more. They were left with a portion of the international P&C business, and the domestic life and P&C businesses. They are now planning on spinning off the domestic life companies, which will leave AIG as a P&C insurer with relatively clean liabilities (They reinsured Asbestos and Environmental with Berkshire Hathaway). Where do we go from here? Is there a lesson here? Avoid complexity. Avoid mixing mixing industrial and financial. Avoid mixing life and P&C. (Allstate is finally splitting that.) That said, there may be another lesson for the future. What of the extremely large companies that are monopolies? Some of them aren’t complex; they just dominate a large area of the economy as monopolies. Governments want to do one of two things with monopolies. They either want to break them up, or turn them into regulated utilities. Why? The government doesn’t like entities that get almost as powerful as them, so they limit their size, scope, and subject them to regulation. So be aware if you hold some of the largest companies in the US or the world, because governments have their eyes on them, and want them to be subject to the government(s). Full disclosure: long MET

Photo Credit: Paul Kagame || Hail Emperor Xi, the greatest since Qin Shi Huang! Ready for a cold winter? Much of the world is not. Many places have discouraged using hydrocarbons to produce power, ostensibly for environmental goals, whether those are valid or not. Whether by the fiat of the Chinese Communist Party, or because some Eurocrats push a green agenda, many people are facing a winter where power/heat may be limited. And even if there may not be absolute shortages everywhere, higher prices for all forms of energy, will pinch the budgets of many in the lower middle class and below this winter in the Northern Hemisphere. Part of this stems from central planning. China is the easiest example. Xi Jinping has arrogated to himself more and more power over time, changing the dynamics of the Communist Party, which once at least had some factions, to a unitary party that has only one leader, Emperor President Xi. Some of it came about by eliminating corrupt rivals, but the rest from instilling fear within the Party. Almost every evening, my wife and I read the Bible together. Recently we have been going through the post-exilic portions of the Old Testament where the Jews live under the rule of the Babylonian and Medo-Persian Empires. Those rulers were typically absolute monarchs: do what I say or die! In going through Esther, my wife commented that it was stupid to have laws that cannot be altered. (The same thing is stated in the Book of Daniel.) My comment back to her was if you were an absolute monarch in that era, you were God walking on earth, and could never be wrong. Thus no decree of an Emperor could be wrong. And so it is for President Xi: everything he says is right. He may be an atheist, but to the Chinese in Red China, he is “God walking on Earth” in at least the Hegelian sense. As such, he makes a decree, and those serving him are scared to do anything more or less than he wants. But with vague directives, what does he want? Unilateral authority is particularly vulnerable to making mistakes. In the intermediate-term, China is likely to get weaker because of the increasing concentration of power of President Xi. That’s not to say that capitalist democracies can’t run off the rails, but typically with enough dissenting voices, the worst outcomes don’t usually take place. There are exceptions though. The first exception is regulators with too much discretionary authority. By pursuing one limited goal in the short-run, such as long-term environmental objectives, they may harm the interests of ordinary people in developed markets by making it hard to get food, fuel/energy, and other necessities. And applying the same rules in foreign policy, they may well condemn the developing world to permanent poverty. The developing world thinks the developed world doesn’t care. They are right, and they will ignore what their current leaders have promised in order to curry temporary favor with the developed world. Now where there is the ability to self-correct, eventually societies will remove regulators, politicians, etc. That said, some things are more entrenched than others. I speak of the cult of stimulus. What is more untouchable than the central banks? It’s hard to think of anything more unaccountable. They may technically be beholden to the local parliament, but practically, no one ever messes with them aside from despots pursuing hyperinflation (Venezuela, Turkey, Lebanon, etc.). What gores me is that the unaccountable central banks never ‘fess up to errors. Listen to this: “Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall,” the Fed said in its twice-yearly Financial Stability Report released Monday.Fed Warns of Peril in Run-Up of Risky Asset Prices, Stablecoins That serial blower of bubbles, the Fed, warns us about the height of risky asset prices. Fed policy works via encouraging economic actors to borrow less or more. They have been running a more aggressive monetary policy than they ever needed to, and in the process have inflated housing prices, stocks, bonds of all sorts, private equity, etc. This is not just true of the Fed in the US, but in most developed country central banks. This was an unforced error. Monetary policy could have been tightened in mid-2020, and I mean raising the Fed funds rate, not just stopping QE. When the equity markets race to new highs so rapidly, why should any stimulus exist at all? We don’t need stimulus from Congress either. When demand is so strong that supply chains creak, buckle, and seize up, it is not time to stimulate more, rather, it is time to balance the budget. I would like to think that supply-chain troubles, inflation, and growth are all transitory. But if in an effort to force growth higher than it should be in the short-run, the growth will still be transitory, but the supply-chain troubles and inflation will persist. Beware the experts that say they run things for your good; they likely don’t know what they are doing. ============= Ending note: one more thing, beware the inflation numbers, particularly on items in short supply. If the economists reduce the weights on those things in short supply, it will artificially understate inflation.

Photo Credit: Paul Kagame || Hail Emperor Xi, the greatest since Qin Shi Huang! Ready for a cold winter? Much of the world is not. Many places have discouraged using hydrocarbons to produce power, ostensibly for environmental goals, whether those are valid or not. Whether by the fiat of the Chinese Communist Party, or because some Eurocrats push a green agenda, many people are facing a winter where power/heat may be limited. And even if there may not be absolute shortages everywhere, higher prices for all forms of energy, will pinch the budgets of many in the lower middle class and below this winter in the Northern Hemisphere. Part of this stems from central planning. China is the easiest example. Xi Jinping has arrogated to himself more and more power over time, changing the dynamics of the Communist Party, which once at least had some factions, to a unitary party that has only one leader, Emperor President Xi. Some of it came about by eliminating corrupt rivals, but the rest from instilling fear within the Party. Almost every evening, my wife and I read the Bible together. Recently we have been going through the post-exilic portions of the Old Testament where the Jews live under the rule of the Babylonian and Medo-Persian Empires. Those rulers were typically absolute monarchs: do what I say or die! In going through Esther, my wife commented that it was stupid to have laws that cannot be altered. (The same thing is stated in the Book of Daniel.) My comment back to her was if you were an absolute monarch in that era, you were God walking on earth, and could never be wrong. Thus no decree of an Emperor could be wrong. And so it is for President Xi: everything he says is right. He may be an atheist, but to the Chinese in Red China, he is “God walking on Earth” in at least the Hegelian sense. As such, he makes a decree, and those serving him are scared to do anything more or less than he wants. But with vague directives, what does he want? Unilateral authority is particularly vulnerable to making mistakes. In the intermediate-term, China is likely to get weaker because of the increasing concentration of power of President Xi. That’s not to say that capitalist democracies can’t run off the rails, but typically with enough dissenting voices, the worst outcomes don’t usually take place. There are exceptions though. The first exception is regulators with too much discretionary authority. By pursuing one limited goal in the short-run, such as long-term environmental objectives, they may harm the interests of ordinary people in developed markets by making it hard to get food, fuel/energy, and other necessities. And applying the same rules in foreign policy, they may well condemn the developing world to permanent poverty. The developing world thinks the developed world doesn’t care. They are right, and they will ignore what their current leaders have promised in order to curry temporary favor with the developed world. Now where there is the ability to self-correct, eventually societies will remove regulators, politicians, etc. That said, some things are more entrenched than others. I speak of the cult of stimulus. What is more untouchable than the central banks? It’s hard to think of anything more unaccountable. They may technically be beholden to the local parliament, but practically, no one ever messes with them aside from despots pursuing hyperinflation (Venezuela, Turkey, Lebanon, etc.). What gores me is that the unaccountable central banks never ‘fess up to errors. Listen to this: “Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall,” the Fed said in its twice-yearly Financial Stability Report released Monday.Fed Warns of Peril in Run-Up of Risky Asset Prices, Stablecoins That serial blower of bubbles, the Fed, warns us about the height of risky asset prices. Fed policy works via encouraging economic actors to borrow less or more. They have been running a more aggressive monetary policy than they ever needed to, and in the process have inflated housing prices, stocks, bonds of all sorts, private equity, etc. This is not just true of the Fed in the US, but in most developed country central banks. This was an unforced error. Monetary policy could have been tightened in mid-2020, and I mean raising the Fed funds rate, not just stopping QE. When the equity markets race to new highs so rapidly, why should any stimulus exist at all? We don’t need stimulus from Congress either. When demand is so strong that supply chains creak, buckle, and seize up, it is not time to stimulate more, rather, it is time to balance the budget. I would like to think that supply-chain troubles, inflation, and growth are all transitory. But if in an effort to force growth higher than it should be in the short-run, the growth will still be transitory, but the supply-chain troubles and inflation will persist. Beware the experts that say they run things for your good; they likely don’t know what they are doing. ============= Ending note: one more thing, beware the inflation numbers, particularly on items in short supply. If the economists reduce the weights on those things in short supply, it will artificially understate inflation.

Photo Credit: miketransreal || Truly when the small seems big, and the big seems small, reality may intrude and reverse matters Today I tweeted: Fed's Preferred Libor Replacement: SOFR Rate Drop Fuels Jitters Over Transfer https://t.co/oqHADuh2YZ As SOFR gets bigger it could screw up short-term lending markets.— David Merkel (@AlephBlog) October 21, 2021 What I am about to say is speculative. For the last nine years, I have thought that the move away from LIBOR could be a case of “The cure is worse than the disease.” If you are going to have an index for short-term lending it can be created in a few ways: Off of surveys, like LIBOR.Off of transactions, like SOFR [Secured Overnight Financing Rate], or the on-the-run Treasury yieldOff of a liability yield, like a cost of funds index One of the virtues of a non-transactional benchmark is that you won’t have to deal with the problem where the market generating the index is smaller than the market using the index. When that is the case, you can have those in the market using the index attempting to hedge in the smaller market generating the index, leading to distortions, volatility, etc. Though the small market was created to control the large market, when hedging starts, the large market will dominate the small one, and maybe games will get played in the small market to influence the large market. As I wrote nine years ago in The Rules, Part XXXII: Dynamic hedging only has the potential of working on deep markets. Arbitrage pricing can reveal proper prices in smaller less liquid markets if there are larger, more liquid markets to compare against. The process cannot work in reverse, except by accident. The SOFR market is a lot smaller than all the floating rate financing that goes on, which is transitioning from LIBOR to SOFR. My fear is that as the conversion from LIBOR to SOFR grows, and SOFR-based new issuance expands, that hedging by taking the opposite side of a SOFR trade will come to dominate that market, leading to volatility, and the taint that comes from the appearance of playing games. Again, I am not certain here, but I think we may regret the transition from LIBOR to SOFR.

Picture Credit: WyldKyss || The greatest mistake of economics is thinking we can influence the economy to make it do more over the long haul than it otherwise would do. I am not a liberal; I am not a conservative. I wish the Balanced Budget Amendment had been passed in the1970s, such that we would not be making such grandiose as a result of legislative/bureaucratic tinkering. I think the government should not try to solve economic issues, and should focus on Issues of justice. The US government has never done well managing the economy. Set some basic boundaries to define fraud, and then let the economy run. But in the present environment, i like anything that hinders the US Government from borrowing more. Most government spending reduces real GDP. You want infrastructure? Build it locally. Tax the area needing it, and see if they really want to pay the price. Don’t do it at the Federal level, where no one understands what is in any omnibus spending bill. It is all a waste, where those in Congress engage in a form of fraud telling their constituents what they got for them. If they really needed it, their state, county, or city should have done it. Projects should be done at the lowest level of government possible. Think of the situation regarding ports. We have spent 10x+ more money on ports on the east of the US rather than the west, and far more freight comes to the west. If these decisions were not federalized, we would not make such stupid choices. Bring back the sequester. Bring back anything that restrains the idiocy of the Congress and the last four Presidents. The high level of debt makes the economy unstable. You want more and more crises? Keep adding to the debt. The US and the World grew faster in real terms when the rule was balanced budgets and restrictive monetary policy. As such, I appreciate any measure that restrains the ability of the US government to borrow more.

Image Credit: All images courtesy of Aleph Blog || Lookout below! I’ll keep this brief, as I’ve said it so many times before. This market is on borrowed time. The only comparable period for this market is from the fourth quarter of 1999 to the third quarter of 2000 — the dot-com bubble, which was another period of speculation fueled by loose monetary policy. Here’s a picture of what price returns were like from that era over the next ten years (but with a 2% dividend yield). And we are touching the sky at present. Though at the end of the quarter, the S&P 500 was priced to return -0.91%/year over the next ten years, at present that value is -1.41%/year. None of these figures are adjusted for inflation. At the recent high of 4,536.95 on September 2nd, the expected return was -1.73%/year for the next ten years. This graph shows how we are touching the sky: The actual line is touching the maximum line. The future line gives an idea of how valuations could normalize over ten years. The Dow 36,000 crowd will get their day in the sun, maybe even this year, or it might not happen until 2035. But even if it hits the level, it’s unlikely that it will stay above that level for most of the rest of the next 10 years. I’ll close with a quote from something I wrote recently: Though interest rates are low, they are not negative. 10-year investment grade bonds are competitive against domestic stocks at this point. Even if you are losing against inflation, you are losing less against inflation than the market as a whole. Same for cash. I don’t think that there is no alternative. Here are the alternatives: Investment grade bonds (market duration)CashValue stocksCyclical stocksForeign stocksEmerging market stocks and bonds So consider the alternatives, and consider hedging. I can’t nuance this anymore, as we are in uncharted waters. We are touching the sky. And I think even as the market falls, value should do well, as it did in 2000-2001. This piece from Bob Arnott at Research Affiliates makes a good case for it. So play it safe; it’s a messy speculative world out there. It wouldn’t take much for it to turn ugly.

Picture Credit: Wiley Publishing || Ah, the golden umbrella! This is a tough book to review. I don’t like the writing style — it is pompous, and drags you through a variety of “rabbit trails” that aren’t necessary to the core ideas of the book. Simplicity is beauty, so going on a travelogue of your philosophical interests detracts from the presentation of this book. As I have often said, the book needed a better editor who could overrule the author and say “That’s not relevant.” “That’s boring.” “Get to the point.” and “This is thin gruel.” Quoting from pages 4-5: ‘As this book is, in part, a response to those questions, I do want to ensure that expectations are set  appropriately  at  the start. This is not a “how-to” book, but it is a “why-to” as well  as a “why-not-to” book. Let’s be clear: What I do specifically as a safe haven  investor  is not  to be attempted  by  nonprofessionals (nor-perhaps  even especially-by  most professionals). Nothing that I could tell you in a book will change that. So, I will not be holding your hand and teaching you how to do it; I will not be revealing much in the way of trade secrets, and I have no interest in selling you anything as an investment manager. This book is not about the workings of a specific safe haven strategy, per se; nor is it an encyclopedic survey of all the major safe haven investments. Moreover, it has little if any current market commentary-as this would be entirely unnec­essary to the book’s point.‘ As such, the author talks in generalities, and does not give away his strategy. Do I blame him? No. I don’t blame him for not giving away his strategies. I do blame him for writing this book. Better to not write a vague book that is of no practical use to most who read it. Modeling Issues Then there are the modeling issues — a decent part of the book assumes that yearly returns are essentially random. Market returns are regime-dependent. There is momentum. There is weak mean reversion. The results in prior years affect the current year, both positively and negatively. Toward the end of his analysis the author recognizes the problem and then uses 25-year blocks of S&P 500 returns 1900-2019 (or so), without noting that it gives undue weight to the years in the middle that get oversampled. The grand problem is that we only have one history — and is it normal or an accident? We assume normal, but how can we know? Also, though we have 120 or so reliable years of performance for the pseudo-S&P 500, for options on the S&P 500, we only have ~35 years of data. For more esoteric diversifying investments, we have 10-40 years of data. We have no strong data on how they might have performed prior to their inception. Also, their modern presence may have affected the performance of the S&P 500. Simulation analyses have to be done ultra-carefully. It’s best to develop an integrated structural model, deciding what variables are random and how they correlate with each other. Then use pseudo-random multivariate values for the analysis. I used these to great value to my employers 1996-2003 when I was an investment actuary. What I Liked But I like the book in some ways. He makes the important point that hedging when the cost of the hedge is fair or even in your favor is an advantage. And this is well known by regulated financial companies. There are two ways to win. 1) Source liabilities at favorable terms. 2) Buy assets on favorable terms. This book is about the first idea: insure your portfolio when it pays to do so. Happily, the insurance costs the least during bull markets, when everyone is hyperconfident. It costs the most during bear markets, where everyone is hyper-scared. So hedge more when it is cheap, and less when it is expensive. Simple, huh? But the book leaves this idea implicit. It never states it this plainly. Second, I like his idea that the safest route is the one that maximizes expected wealth over time. That is underappreciated by asset managers. Third, I appreciate that he brings in the Kelly Criterion, which is one of the best ways to deal with the risk-reward question, which in this case, is how you size your hedges. Finally, he talks about maximizing the fifth percentile of likely outcomes, which in a well-structured model will keep the investor in the game, allowing the investor to cruise through bear markets, and stay invested. Hey, many actuaries have been doing that for life insurers over the last 25 years. Welcome to the club. The Central Conundrum He classifies his hedges as store-of-value, alpha, and insurance. Store of value is short-term savings that has no possibility of loss, which oddly he has at 7%/yr. That might be a long term average, or not, but when modeling the future, variables have to be forward-looking. There is no sign of 7% on the horizon at no risk. He includes gold in this bucket, and thinks it is a genuine diversifier, with which I agree. Then there is alpha, which for him is commodity trading advisors who are trend followers, who do well when volatility is high. He also briefly touches on a variety of investments that he has tested, and finds they don’t aid the growth of terminal net worth on average. Then there is insurance, which he never spells out exactly what it is, and the author says it is the most effective way to hedge, and profit. He hides his trade secrets. What he should have told you I will reveal here. The insurance he is probably talking about is put options on stock or corporate bond indexes (particularly high-yield), or paying for protection on indexed credit-default swaps (best, but only institutions can do this). Imagine paying a constant percentage portfolio value by period to protect your portfolio. When valuations are high, implied volatility is low, and the insurance is cheap when you need it. When valuations are low, implied volatility is high, and the insurance is expensive when you don’t need it. In that situation, your existing hedges might have appreciated so much that you sell them off and go unhedged. Implied volatility can only go so high, before it mean-reverts. When option prices get high, potential hedgers and speculators who would be option buyers sit on their hands, and don’t do anything. Quibbles Already stated. Summary / Who Would Benefit from this Book If you have read this book review, you have learned more than the book will give you. I really don’t think many people will learn much from this book. Full disclosure: The publisher kind of pushed a free copy on me, after I commented that I wasn’t crazy about the author’s last book.

Photo Credit: Crypto360 aka Cryprocurrency360.com [sic] || When will this stupid concept die? Recently as I was reading Barron’s online, I ran across the following article: Small-Cap Stocks Could Keep on Rising. There’s a ‘Wall of Cash.’ I’ve subscribed to Barron’s for at least 20 years of my life. Really, I expect better of them. The meme that money flows in and out of the market is hard to kill. Stocks rise; money must have flowed in. Stocks fall; money must have flowed out. Some of this comes from the impulse that journalists must find a reason for the market action of each day, when really — there’s a lot of noise. I have a few simple ways to explain this. Imagine that market player A wants to buy 100 shares of XYZ Corp at $50/share, and market player B wants to sell 100 shares of XYZ Corp at $50/share. Bam! Shares flow from B to A, and money flows from A to B. Total shares are the same. Total money in brokerage accounts is the same. The total amount of money is unaffected by trading. Now, there are commissions. At least, intelligent people pay commissions. When I was a corporate bond manager, if my broker said, “I’ll just cross them to you to get the deal done,” I would say, “No, I will give you a plus. (1/64th of a dollar per $100 of principal) My broker must always be paid.” Why did I do this? It kept the relationships neat. When brokers don’t get paid, they look for hidden ways to earn their money. I much prefer my costs be explicit and fixed. (And, as a corporate bond manager, I valued loyalty. I had good relationships with my brokers.) But by and large, trading does not affect aggregate cash levels. What does affect aggregate cash levels? Increases Cash DividendsMergers and acquisitions where cash is paid, whether partly or in full.Stock buybacksDecreases Cash Primary and secondary public offerings of stock.Conversion of convertible securities.Rights offeringsAnd, there are probably more than what I have listed here, but the key condition for aggregate cash levels to change is that money must flow into or out of corporations, and shares must flow the opposite way. But none of these changes happen through trading. They happen as a result of corporate actions. Then Why Do Stock Prices Change? Stock prices change because of two reasons, one minor, one major. The minor one: as trading goes on, either buyers or sellers are more desperate to get the trade done. Whichever side is more desperate pushes the price. The major one: when markets are closed, people change their minds. Data builds up, and before any significant amount of trading happens, prices shift to reflect changed estimates of what the securities in question are worth. To prove this, I will tell you that intraday trading is noise, and little return happens there. But while the market is closed — that is when returns happen. The difference between the prior close and the next market open explain all of the returns of the market over the last 20+ years. The difference between the current days open and close are close to zero. Most of the reason why stock prices change is that people as a group change their minds as to the value of stocks. Trading has a modest impact on that. But most of the change in value happens while the market is closed. (Remember that corporations mostly break news while the market is closed.) If you understand this, you get the following benefits: You will ignore most media explanations of moves in the stock marketThe primary market will guide you — looking at M&A and IPOs.You will ignore the so-called “wall of money” which does not exist.Instead, you might notice how much of the total assets in aggregate portfolios are in stocks versus everything else.Prices matter. Buy low, sell high. But don’t attribute anything to the “wall of money.” It is a bogus concept, and should be ignored. The biggest changes in prices happen when the market is closed, and trading is limited.