Just Don’t Invert the Yield Curve

Photo Credit: Brookings Institution

================================ Jerome Powell is not an economist, and as such, has the potential to try to remake the way the Fed does monetary policy.  Rather than hold onto outmoded ideas ideas like the Phillips Curve, which may have made sense when the US was a more insular economy, there are better ways to think of monetary policy from a structural standpoint of how financial firms work. (Note: the Phillips Curve relies on a very simple assumption that goods and services price inflation stems from wage inflation, and that wage inflation occurs when domestic unemployment is low.  In a global economy, those relationships are broken when labor can be easily added from sources outside of the US.) Financial firms tend to grow rapidly when the yield curve is steeply sloped.  Borrowing short and lending long is profitable, at least in the short-run.  Continue reading "Just Don’t Invert the Yield Curve"

Why I Like Foreign Small Cap ETFs

Photo Credit: amanda tipton || It may not be foreign, and not an ETF, but it IS a small cap

====================== This should be a short post.  When I like a foreign market because it seems cheap (blood running in the streets), I sometimes buy a small cap ETF or closed-end fund rather than the cheaper large cap version.  Why?
  • They diversify a US-centric portfolio better.  There are several reasons for that:
  • a) the large companies of many countries are often concentrated in the industries that the nation specializes in, and are not diversified of themselves
  • b) the large companies are typically exporters, and the smaller companies are typically not exporters. Another way to look at it is that you are getting exposure to the local economy with the small caps, versus the global economy for the large caps.
  • They are often cheaper than the large caps.
  • Continue reading "Why I Like Foreign Small Cap ETFs"

Estimating Future Stock Returns, December 2017 Update

The future return keeps getting lower, as the market goes higher

================= Jeff Bezos has a saying, “Your margin is my opportunity.”  He has found ways to eat the businesses of others by providing the same goods and services at a lower cost.  Now, that makes Amazon more productive and others less productive.  The same is true of other internet-related businesses like Google, Netflix, etc. And, there is a slight net benefit to the economy from the creative destruction.  Old capital gets recycled.  Malls that are no longer so useful serve lower-margin businesses for locals, become homes to mega-churches, other area-intensive human gatherings, or get destroyed, and the valuable land so near many people gets put to alternative uses that are better than the mall, but not as profitable as the mall prior to the internet. Laborers get released to other work as well. 
Continue reading "Estimating Future Stock Returns, December 2017 Update"

Getting a Job in Insurance

Photo Credit: Boston Public Library

Well, I never thought I would get this question, but here it is:
Thank you for your dedication to your blog. I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions? Thank you for your time. Kind regards,

There are many things to do in insurance.  Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.  Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.  Then there are the drones in customer service and claims.  Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions. Before I begin, I

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Continue reading "Getting a Job in Insurance"

Surprise! Return to RT Boom/Bust

After almost three years, I returned to RT Boom/Bust on Tuesday.  There are many changes at RT.  Many new people, and a growing effort to put together an alternative channel that covers the world rather than just the US or just the developed world.  They are bursting at the seams, and their funding has doubled, so I was told. I get surprised by who watches RT and sees me.  My  congregation is pretty conservative in every way, but I have some friends working in intelligence come up to me and say, “Hey, saw you on RT Boom/Bust.”  And then there is my friend from Central Africa who says, “The CIA has you on their list.  Watch out!”  He’s funny, hard-working, but very earnest. I’ve never seen anything in what I have done where there is any hint of editorial control.  Maybe it Continue reading "Surprise! Return to RT Boom/Bust"

Monitor Financial Accounts Regularly

================= Fewer laws protect you now. In some ways, the laws are more virtual than real, and only apply to real situations, and not virtual ones. Let me explain. Though checks make up an increasingly smaller fraction of transaction volume in the US, they are still a lot higher here than in Europe.  As such, federal and many state legislators have not caught up with the effects of a hybrid system, where they attempt to regulate electronic banking transactions under the same rules as paper checks. Many people like making mobile deposits, rather than going into the bank, or snail-mailing the deposits in.  But what happens if a check gets mobile-deposited to two banks?  Or, since many banks don’t actively check mobile deposits closely, what if someone repeatedly deposits a check to his bank, while altering the check number? The latter scenario happened Continue reading "Monitor Financial Accounts Regularly"

The Rules, Part LXIV

Photo Credit: Steve Rotman || Markets are not magic; government economic stimulus is useless with debt so high

Weird begets weird
I said in an earlier piece on this topic:
I use [the phrase] during periods in the markets where normal relationships seem to hold no longer. It is usually a sign that something greater is happening that is ill-understood.  In the financial crisis, what was not understood was that multiple areas of the financial economy were simultaneously overleveraged.

So what’s weird now?

  • Most major government running deficits, and racking up huge debts, adding to overall liability promises from entitlements.
  • Most central banks creating credit in a closed loop that benefits the governments, but few others directly.
  • Banks mostly in decent shape, but nonfinancial corporations borrowing too much.
  • Students and middle-to-lower classes borrowing too much (autos, credit cards)
  • Interest rates and goods and services price inflation stay low in Continue reading "The Rules, Part LXIV"

NASDAQ Composite Hits an Inflation-Adjusted High

Hey, it only took 18 years to eclipse the prior high in purchasing power terms! Better than the Great Depression!

  This is an update of a post I did less than three years ago.  In that relatively short time, the NASDAQ Composite hit an all-time record in purchasing power adjusted terms.  Quite an ascent in the last two years.  I never would have predicted it.  If you took the other side of my advice you did better. That said, the S&P 500 is forecast to return 3.4%/year prior to inflation for the next ten years.  Aside from one quarter during the go-go years (1968), the only period with lower anticipated returns was during the dot-com bubble.  The levels you see today will be revisited going the other way.

Are you too “chicken” to buy the NASDAQ Composite? Then you are like me.

Continue reading "NASDAQ Composite Hits an Inflation-Adjusted High"

On the Migration of Stock

This should be a brief article.  I remember back in 1999 to early 2000 how P&C insurance stocks, and other boring slower-growth industries were falling in price despite growing net worth, and reasonable earnings.  I was working for The St. Paul at the time (a Property & Casualty Insurer), and for an investment actuary like me, who grew up in the life insurance business it was interesting to see the different philosophy of the industry.  Shorter-duration products make competition more obvious, making downturns uglier. The market in 1999-2000 got narrow.  Few groups and few stocks were leading the rise.  Performance-conscious investors, amateur and professional, servants of the “Church of What’s Working Now,” sold their holdings in the slower growing companies to buy the shares of faster growing companies, with little attention to valuation differences. I remember flipping the chart of the S&P Continue reading "On the Migration of Stock"

On a Letter from an Old Friend

Photo Credit: jessica wilson {jek in the box}

David: It’s been a while since we last corresponded.  I hope you and your family are well. Quick investment question. Given the sharp run-up in equities and stretched valuations, how are you positioning your portfolio? This in a market that seemingly doesn’t go down, where the risk of being cautious is missing out on big gains. In my portfolio, I’m carrying extra cash and moving fairly aggressively into gold. Also, on the fixed income side, I’ve been selling HY [DM: High Yield, aka “Junk”] bonds, shortening duration, and buying floating rate bank loans. Please let me know your thoughts. Regards JJJ
Dear JJJ, Good to hear from you.  It has been a long time. Asset allocation is always a marriage between time horizon (when is the money needed for spending?) and expected returns, with some adjustment for risk.  I suspect Continue reading "On a Letter from an Old Friend"

Since 1950, the S&P 500 in 2017 Ranks First, Fourth, Tenth or Twenty-third?

Credit: Roadsidepictures from The Little Engine That Could By Watty Piper Illustrated By George & Doris Hauman c. 1954

========================================= I wish I could have found a picture of Woodstock with a sign that said “We’re #1!”  Snoopy trails behind carrying a football, grinning and thinking “In this corner of the backyard.” That’s how I feel regarding all of the attention that has been paid to the S&P being up every month in 2017, and every month for the last 14 months.  These have never happened before. There’s a first time for everything, but I feel that these records are more akin to the people who do work for the sports channels scaring up odd statistical facts about players, teams, games, etc.  “Hey Bob, did you know that the Smoggers haven’t converted a 4th and 2 situation against the Robbers since 1998?” Let me explain.
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Continue reading "Since 1950, the S&P 500 in 2017 Ranks First, Fourth, Tenth or Twenty-third?"

On Finding a Job in Finance

I was approached by a younger friend for advice.  This is my response to his questions below:
Thank you for agreeing to do this for me. I would love to have an actual conversation with you but unfortunately, I think that between all of the classes, exams, and group project meetings I have this week it would prove to be too much of a hassle for both of us to try to set up a time. 1. What professional and soft skills do you need to be successful in this career and why?
2. What advice would you give to someone considering working in this field?
3. What are some values/ethics that have been important to you throughout your career?
4. I understand that you currently run a solo operation, but are there any leadership skills you have needed previously in your career? Any examples?
Continue reading "On Finding a Job in Finance"

Favorite Aleph Blog Post of 2017?

As you might recall, I was invited to participate in The Best Investment Writing, Volume 1. Well, volume 2 is being discussed. This time, I thought I would let my readers offer their opinion on the matter. So, let me know, you can take this poll — oh, and can vote for as many as you like. Thanks, David Note: There is a poll embedded within this post, please visit the site to participate in this post's poll.

Classic: Wrecking Ball Looms for Big Housing Spec

==================== I thought this old post from RealMoney.com was lost, never to be found again.  This was the important post made on November 22, 2006 that forecast some of the troubles in the subprime residential mortgage backed securities market.  I favored the idea that there there would be a crash in residential housing prices, and the best way to play it would be to pick up the pieces after the crash, because of the difficulties of being able to be right on the timing of shorting could be problematic.  In that trade, too early would mean wrong if you had to lose out the trade because of margin issues. With that, here is the article: ==================== I have tried to make the following topic simple, but what I am about to say is complex, because it deals with the derivative markets. It Continue reading "Classic: Wrecking Ball Looms for Big Housing Spec"

Estimating Future Stock Returns, September 2017 Update

Another quarter goes by, the market rises further, and the the 10-year forward return falls again.  Here are the last eight values: 6.10%, 6.74%, 6.30%, 6.01%, 5.02%, 4.79%, and 4.30%, 3.99%.  At the end of September 2017, the figure would have been 4.49%, but the rally since the end of the quarter shaves future returns down to 3.99%. At the end of June the figure was 4.58%.  Subtract 29 basis points for the total return, and add back 12 basis points for mean reversion, and that would leave us at 4.41%.  The result for September month-end was 4.49%, so the re-estimation of the model added 8 basis points to 10-year forward returns. Let me explain the adjustment calculations.  In-between quarterly readings, price movements shave future returns the same as a ten-year zero coupon bond. Continue reading "Estimating Future Stock Returns, September 2017 Update"

Notes from an Unwelcome Future, Part 1

============================================================== Dear Readers, this is another one of my occasional experiments, so please be measured in your comments.  The following was written as a ten-year retrospective article in 2042. ============================================================== It was indeed an ugly surprise to many when the payments from Social Security in February 2032 did not come.  Indeed, the phones in Congress rang off the hook, and the scroll rate on incoming emails broke all records.  But as with most things in DC in the 21st century, there was no stomach to deal with the problem, as gridlock continued to make Congress a internally hostile but essentially passive institution. Part of that gridlock stemmed from earlier Congressional reforms that looked good at the time, but reduced the power of parties to discipline members who would not go along with the leadership.  Part also stemmed from changes in media, which Continue reading "Notes from an Unwelcome Future, Part 1"

The Crisis Lending Fund

=================== Last week, there was an article in Barron’s describing how many mutual fund families take advantage of a provision in the law allowing them to have funds lend to one another.  Quoting from the article:
Under normal circumstances the Securities and Exchange Commission bars funds from making “affiliated transactions,” but there’s a loophole in the Investment Company Act of 1940 for funds to apply for an exemption to make such “interfund loans.” Until recently, few fund families applied for this exemption. None had before 1990. From 2006 to 2016, the SEC approved just 18 interfund lending applications. But since January 2016, the agency has approved 26. Most major fund families—BlackRock, Vanguard, Fidelity, Allianz—now can make such loans. Stiffer regulations of banks, which are now less willing to offer funds credit lines, partly explain the application surge.

I’m here tonight to suggest making a virtue Continue reading "The Crisis Lending Fund"

Short-Term Rational, but Intermediate-Term Irrational

Don’t look at the left side of the chart on an empty stomach

================== This will be a short post.  At present the expected 10-year rate of total return on the S&P 500 is around 4.05%/year.  We’re at the 94th percentile now.  The ovals on the graph above are 68% and 95% confidence intervals on what the actual return might be.  Truly, they should be two vertical lines, but this makes it easier to see.  One standard deviation is roughly equal to two percent. But, at the left hand side of the graph, things get decidedly non-normal.  After the model gets to 2.5% projected returns, presently around 3100 on the S&P 500, returns in the past have been messy.  Of course, those were the periods from 1998-2000 to 2008-2010.  But aside from one stray period starting in 1968, that is Continue reading "Short-Term Rational, but Intermediate-Term Irrational"

The Little Market that Could

Picture Credit: Roadsidepictures from The Little Engine That Could By Watty Piper, Illustrated By George & Doris Hauman | That said, for every one that COULD, at least two COULDN’T

====================================== So what do you think of the market?  Why are both actual and implied volatility so low?  Why are the moves so small, but predominantly up?  Is this the closest impression of the Chinese Water Torture that a stock market can pull off? Why doesn’t the market care about external and internal risks?  Doesn’t it know that we have divisive, seemingly incompetent President who looks like he doesn’t know how to do much more than poke people in the eyes, figuratively?  Doesn’t it know that we have a divided, incompetent Congress that can’t get anything of significance done? Leaving aside the possibility of a war that we blunder into (look at history), what if Continue reading "The Little Market that Could"

The Little Market that Could

Picture Credit: Roadsidepictures from The Little Engine That Could By Watty Piper, Illustrated By George & Doris Hauman | That said, for every one that COULD, at least two COULDN’T

====================================== So what do you think of the market?  Why are both actual and implied volatility so low?  Why are the moves so small, but predominantly up?  Is this the closest impression of the Chinese Water Torture that a stock market can pull off? Why doesn’t the market care about external and internal risks?  Doesn’t it know that we have divisive, seemingly incompetent President who looks like he doesn’t know how to do much more than poke people in the eyes, figuratively?  Doesn’t it know that we have a divided, incompetent Congress that can’t get anything of significance done? Leaving aside the possibility of a war that we blunder into (look at history), what if Continue reading "The Little Market that Could"