The Butterfly Effect... (video)

My business requires me to stay in tune with the financial market narrative du jour: If only to help our clients---through my written commentary as well as during face-to-face meetings---see through the media haze and maintain what I view to be a healthy long-term perspective. As personality after personality offer up their predictions (and, thus, their portfolios' positions) through the financial networks, I find myself asking the TV; "How the heck can you possibly know that? By what magic can you know at what level the S&P will close out the year? Aren't there way too many variables?" Of course, were I actually addressing those self-anointed gurus, my questions would be purely rhetorical: I absolutely know that they absolutely cannot know. For me to believe otherwise would be detrimental to the investors who rely on our services.

With that in mind, I have re-posted below an article I wrote exactly a year ago today titled The Butterfly Effect. If you at all listen to the prognosticators, I  suspect that you can't help but wonder if maybe, just maybe, the one who claims to have forecast that we'd be precisely where we currently be has it all figured out. If so, please read the following in its entirety. I found the video to be particularly interesting:

 

THE BUTTERFLY EFFECT, July 15, 2012

I have expressed here in numerous articles my belief, I should say “the empirical truth”, that the near-term directions of economies and markets are impossible to predict. There are infinite and ever-changing variables at play. Think of a feather drifting in the breeze; the slightest invisible current can alter its direction without warning. A butterfly in India can flap its wings and set off a chain of events that will one day destroy a neighborhood in Midwestern United States. Think of seven billion individual human beings, each pursuing his and her own separate interests, each setting off chain reactions affected by invisible currents too numerous to count and too ephemeral to follow.

Economists and gurus of all stripes will (virtually) never cop to their (of course it’s everybody’s) cluelessness. For economists, it’s forever the counterfactual. The champions of fiscal stimulus told us that without the $800+ billion spending package unemployment would go north of 8%. Well, with the package, the jobless rate went north of 10%, and remains north of 8% today. Of course, to them, this only proves that we needed the stimulus even more desperately than they originally forecast. They now claim, in arrogant I-told-you-so fashion, that without it, unemployment would've gone into the teens. Shame on us for ever doubting them.

But the market gurus take the cake. They’ll make 200 guesses over 10 years, get lucky on 81, then feature one or more of those 81 in every article and ad selling their newsletter subscription, newest book or, worse (and scariest) yet, their money management services. The sad thing is, a few of these guys and gals have some decent insights to offer.  But they forever kill it with me the moment they claim to have foretold (for example) back in the early 2000s just how the last ten years would play out—as yet another (my 81 out of 200 example—who has 1.5 million subscribers to his newsletter) tried recently. I have yet to Google even one of these prognosticators  (there are newsletters that record and track their every prediction) without finding him or her to be sorely misleading (by professing predictive prowess) his or her readers. Not that the claim in question isn't valid, it’s just that for every one lucky guess I’ll discover three others where he or she entirely missed the mark. I mean think about it; if they indeed could accurately forecast anything, why the hell would they forecast it for you and me? They’d be trillionaires. And they’d confine their predictions to their own trading accounts (for their strategies wouldn't work if everyone followed them), while on their yachts sipping Dom Perignon and/or curing world hunger.

So what are we, as investors, to do? In my too-humble-to-forecast opinion we default to the cyclical nature of all things, to fundamental fiscal values and to fundamental valuations. Cyclicality, in economic terms, would be the movement between expansion and contraction—intensified or muted in both directions by man’s (our elected and appointed officials’) efforts to control nature, and, at times, by Mother Nature herself (see video). In financial markets that would be your bull and bear markets—intensified in both directions by man’s greed (tech in the 90s, real estate in the mid 00s) and by his fear (tech in the early 00s, real estate in the late 00s). Fundamental fiscal values—the values of fiscally sound families, companies and countries—come into play when we’re talking public policy: Policymakers simply can’t borrow beyond their countries’ means, centrally plan their economies and subsidize the efforts of their cronies without ultimately exacting great suffering onto those who naively voted them into office (think today’s Europe). Fundamental valuations for stocks would be the price of shares relative to earnings, earnings growth, book value, free cash flow, dividends, liquidity and interest rates. For bonds it would be simply where yields sit (historically speaking) relative to maturities and credit quality.

Today’s snapshot:

The global economy recently suffered what’s been dubbed the “Greatest Recession Since the Great Depression”. Current pace notwithstanding, I don’t suspect man has yet entirely circumvented the economic cycle. Egregiously poor public policy is playing out in Europe (shame on us here in America if we can’t recognize where they went wrong and keep from making the same mistakes). Stocks have rebounded measurably from their 2009 lows, yet valuations remain relatively (historically speaking) compelling while bond prices are trading at valuations I never imagined (prices extremely high, yields extremely low).

All that said and you’re still desperate to know: When will stock prices trade where earnings (by historical norms) would put them?  And when’s the bond bubble going to burst?

Okay you win. Against my better judgment I’ll offer my forecast, but I’ll need a little time to formulate, then get back to you. And while I’m at it I’ll figure out precisely when the next hurricane will hit the Midwest, and how the world economy will fare as seven billion personalities allocate their diverse resources in the weeks and months to come.

What causes recessions - Or - Goods buy goods...

Here's a link to my contribution to last Saturday's edition of the US Daily Review. And here's a snippet:

So then, under whose command of resources should we expect the greatest likelihood of producing the right assortment of goods and services; self-serving producers of goods and services, or self-serving politicians? Certainly the market, all on its own, can produce the wrong assortment of goods or services. However, left to its own devices, and to natural consequences, the market will—painfully for some—adjust accordingly. Politicians, on the other hand, have a professional interest in circumventing the suffering of their supporters, and are therefore adept at neutralizing the natural consequences for the producers of the wrong goods by spreading the loss among the entire population. And, alas, they in effect compromise the redeployment of capital from areas where there is too little demand into areas where there will be demand for the goods produced: hence, a very slow recovery.

Made For America...

The "Made in America" segment of last night's CNBC's Kudlow and Company featured the CEO (Mitch Cahn) of Unionwear and New Balance's Director of Public Affairs (Matt LeBretton). Both companies proudly promote their U.S.-based manufacturing operations.

In the case of Unionwear (launched in 1992), its 115 employees produce 100% of its sportswear out of its Newark, NJ factory. More power to em!!

As for New Balance, well, it does manufacture 25% of its shoes here in the U.S., however, back in the '90s, that number was 70%. Larry (Kudlow), after citing the decline, asked "what's been the problem?" Mr. LeBretton replied with the obvious; "If we made all our shoes here in the U.S. we simply couldn't compete." However, interestingly, he added:

But I think a more important number than the percentage of shoes we make here is the amount of people we're employing in the U.S. We have over 1,300 people making shoes, which is today more than we've ever had making shoes in the United States. Our overall growth as a brand has grown as has our domestic capacity and our domestic production.

Hmm... So, over the past 20 years New Balance has off-shored the majority of its manufacturing and, yet, employs more Americans than ever. Amazing what can happen when smart-run companies are free to exploit every opportunity to compete on the global stage.

Of course there are those stories where entire manufacturing operations have emigrated to other shores. To them---on behalf of the U.S. consumer and business owner---I say "thank you!" Read on to see why...

Larry segued to Unionwear's Mr. Cahn: "Mitch Cahn, you're one hundred percent, tell me about that? That is the golden ring, one hundred percent made in America!" After confirming that they are indeed all U.S., Cahn explained:

For the last twenty years we've really been focusing on markets that would be willing to pay a premium for made in USA. That includes the U.S. military, the federal government, political campaigns, labor unions, and for the last two years we've seen a surge in business from corporations, from nonprofits, and from the garment industry.

Larry chimed in with "Are you unionized? You mentioned the garment industry. Garment workers really destroyed that industry at one point in time. Are you unionized?" After declaring "We are a union shop", Cahn explained how, through what he called "lean manufacturing", they can indeed compete with non-union shops in right-to-work states. Larry finished up by asking how they can beat the manufacturing operations out of China and Bangladesh? He answered "Well, we don't have to beat them because there are a lot of people who will pay twenty to twenty-five percent more for a domestic product."

Of course there's nothing wrong with exploiting those markets so enamored by your brand that they don't mind paying up---while thus limiting their patronage to the local companies that vie for their discretionary income, as well as limiting the capital they provide (through their savings and investment) for other growing enterprises to expand and create jobs right here at home (hence my "thank you" to the off-shorers who, while competing on price, indirectly support local enterprises). Although I have to admit, the fact that Unionwear owes a great deal of its success to "markets" that house society's most egregiously inefficient/irresponsible characters---those who spend other people's (taxpayers') money on other people---irks me to no end!

Thank goodness---on behalf of those 1,300 New Balance U.S. workers, and who knows how many New Balance U.S. customers, and who knows how many U.S. employees of who knows how many other U.S. businesses who vie for the discretionary income of those New Balance U.S. (and non-U.S.) customers---New Balance didn't go the all U.S. route! In other words, New Balance's lack of some captive market to exploit resulted in an utter flowering of economic activity, for America...

Add one to Krugman's "Always Wrong Club"

Paul Krugman cleverly dubbed the likes of John Taylor, Niall Ferguson and 21 other economists who warned, back in 2010, of potential dire consequences resulting from quantitative easing, the "Always Wrong Club" (the title of his yesterday's blogpost). Well, looks like the club needs to induct one more member, Krugman himself.

Here he is sharing his wisdom on the bond market to New York Times readers back on May 9th:

 Why, then, all the talk of a bond bubble? Partly it reflects the correct observation that interest rates are very low by historical standards. What you need to bear in mind, however, is that the economy is also in especially terrible shape by historical standards — once-in-three-generations terrible. The usual rules about what constitutes a reasonable level of interest rates don’t apply.

There’s also, one has to say, an element of wishful thinking here. For whatever reason, many people in the financial industry have developed a deep hatred for Ben Bernanke, the Fed chairman, and everything he does; they want his easy-money policies ended, and they also want to see those policies fail in some spectacular fashion. As it turns out, however, dislike for bearded Princeton professors is not a good basis for investment strategy.

And one should never forget the example of Japan, where bets against government bonds — justified by more or less the same arguments currently made to justify claims of a U.S. bond bubble — ended in grief so often that the whole trade came to be known as the “widow maker.” At this point, Japan’s debt is well over twice its G.D.P., its budget deficit remains large, and the interest rate on 10-year bonds is 0.6 percent. No, that’s not a misprint.

All in all, the case for significant bubbles in stocks or, especially, bonds is weak. And that conclusion matters for policy as well as investment.

You know, I happen to be in the financial industry and I promise you, I hold no hatred whatsoever for Ben Bernanke. Not even close! I'm sure he believes he's doing the right things; the fact that I disagree in no way suggests that I hate the man. And, please, make no mistake---while there are no doubt a few frustrated shorts out there---the last thing in the world "many people in the financial industry" want is Bernanke's policies to "fail in some spectacular fashion". Talk about cutting off your nose to spite your face!

As for investment strategies and the proclamations of bearded Princeton professors, well, let's see; Bernanke made his "Great Moderation" speech (a promise of economic smoothing attributed largely to sound monetary policy) in February 2004, just shy of four years before the onset of the worst recession since the Great Depression. OOPS! As for the bearded Princeton professor Krugman of May 9th, he would have his readers give nary a thought to a selloff in the bond market. OOPS!

And here's Krugman today suggesting that the other bearded Princeton professor "grossly misunderstood" the nature of the relationship between his statements and market expectations. Yet (big surprise) nowhere will he admit that, per his May 9 article, he grossly misunderstands markets in general:

Bond prices have plunged, and the Fed’s attempts to inform markets that they’ve got it all wrong have only modestly mitigated the impact.

What went wrong? The Fed grossly misunderstood the nature of the relationship between its statements and market expectations. It believed that the market was listening closely to the details of what it said. In fact, the market doesn’t — and probably shouldn’t. Instead, it listens to the tone of Fed statements, and also Fed actions; it’s more a matter of character judgment than mathematics. And what the Fed conveyed with the tapering talk was a sense that its heart really isn’t in this stimulus thing.

Bottom line folks; there are a few things in life that you just don't do. Such as:

Pee into the wind.
Lick a frozen lamp post.
Spit straight up.
Eat prunes when you're hungry.
Stand between a dog and a fire hydrant.
Take investment advice from bearded Princeton professors.
BUY BONDS WHEN INTEREST RATES ARE AT ALL TIME LOWS!!!!!!!!!!

The Great Distortion...

"To me Ben Bernanke is a great American hero", said once treasury secretary/Bernanke abettor Hank Paulson last week in a CNBC television interview. Like Superman saving the Earth from a rogue asteroid, the mild-mannered leader of the U.S. Central Bank turned man-of-steel in the eleventh hour and rescued us from ..... uh ..... what? The greatest recession since the Great Depression? Nope! That's precisely what occurred. Yet, according to Paulson, our greatest-recession-since-the-Great-Depression-experience was some super-human (or humane) monetary policy achievement. Bernanke, he proclaimed, saved us from the Next Great Depression. I strongly suspect that had we experienced the Next Great Depression, Paulson would herald Bernanke as the great American hero who rescued us from a Depression Greater than the Next Great Depression. Truly, there's no trough that can't be buoyed by a well-articulated counterfactual.

Okay, let's be fair, the greatest recession since the Great Depression indeed bottomed amid mammoth monetary stimulus, as did the stock market (after the major averages plunged some 50%). So did Bernanke save us from, say, a deeper bottom and, say, a 60% plunge in stocks? 70% maybe? Hmm.... I wonder what would've happened without the mammoth stimulus? Surely the economy would've bottomed, but sooner? Later? Deeper? As deeply? Surely the stock market would have bottomed as well, but sooner? Later? Deeper? As deeply? We can counterfactual till the cows come home but we'll never know the dates nor the depths. And we'll never know for sure whether central planners extinguished or exacerbated the Great Recession.

The Keynesian-hearted will credit the slightest growth to policy. The free-market-minded blame our historically-slight recovery on policy-induced uncertainty. What both sides should (but won't) agree on is that a great distortion in the pricing of bonds has resulted from Bernanke's (perceived) super-humane efforts. The question now is how will the markets ultimately correct this great distortion? And did last week offer up a sneak preview? Time will tell...

Crazy! Well, crony... (white board lesson)

I just don't get it. The Chinese steal our intellectual property, hack into our military systems, counterfeit our goods and renege on our extradition treaty --- and 230 of our "lawmakers" want to put an end to the one thing they (well, in this specific case Japan) do that purely and directly benefits us. That is, they (allegedly) purposely---through cheapening their currency---make their goods as affordable as possible for you and me.

That (attempting to influence our trading partners' currency policies), as you'll see below, is crazy! Well, crony, actually.

Note: In the following, as in the above, I reference China, rather than Japan, simply because we've been barraged by politicians (think 2012 presidential race), industries, trade unions, etc. on this same issue with regard to China. Plus, it allows for my clever opening paragraph above :). Also, in my attempt at brevity, I mention only the relationship between politicians and exporters, while I should have included---alongside the exporters---local manufacturers, trade unions, etc...

"The wealth effect isn't what it used to be." Hallelujah!!

The Washington Post's Robert Samuelson, in his June 16th column, wrote:

The “wealth effect” isn’t what it used to be. For those who have forgotten, this refers to households’ tendency to spend some part of their increased real estate and stock market wealth and thereby boost the economy. During the boom years, Americans borrowed lavishly against rapidly appreciating home values. One Federal Reserve study estimated the extra cash at $700 billion annually from 2001 to 2005. Now psychology has changed. Careless optimism has given way to stubborn cautiousness. Wealth gains don’t translate into similar amounts of higher spending.

The gist of what follows is that, having experienced the Great Recession, folks are of the mind that "lavishly" spending their equity leads to, well, great recessions. And that awareness somehow presents a challenging backdrop for the economy, or at least for the Fed, going forward.

His final two paragraphs:

There has been a stunning shift in behavior, notes Zandi. In 2006, at the peak of the housing boom, almost 90 percent of homeowners who were refinancing mortgages increased the size of their loan, according to data from Freddie Mac; they were borrowing against higher housing values. In 2012, 83 percent of refinancing homeowners either didn’t change the mortgage amount or lowered it. They were striving to pay off debt.

So the wealth effect varies by time and circumstances. Now it is a casualty of the financial crisis and Great Recession. We have yet another example of risk aversion dominating the economy. People eager to borrow have faith in the future; people eager to repay debts worry about the future. We are prisoners of psychology, which can change but is hard to manipulate. That is the predicament for policy and politics.

Now think about it; leading up to the recession, folks were cashing in their equity and spending galore, and, somehow, the fact that they're acting in what in their 2013 view they deem responsibly presents a political predicament? Hmm... The consumer, for the moment, apparently understands what policymakers do not; that economic success comes from saving and spending wisely. The fact that real world experience makes for a consumer who is hard for sheltered academics to manipulate should be music to our ears!

Doing Unto Others

So your seventh-grader comes home from school today and tells you how much she loved playing cross-fire (dodgeball to you/me) in P.E. because she hit Tyler smack in the face. Shocked at the sadistic nature of your little angel

The Dollar and Today's Market

The dollar/market relationship I wrote about Monday (dollar up/market down & vice versa) is clearly playing itself out today. In spite of very good reports from Google, etc., stocks look to be giving back a little ground.

The "experts" will site the disappointing housing starts number (which shows stabilization, but not rapid growth of late), and while that may be part of it, clearly today's strengthening of the greenback is giving the market a (albeit slight) headache.

Go to Monday's commentary - "Minnie Mouse, The Market and The Dollar" for a more thorough explanation of the current state of our currency and it's short and long-term implications...

Good Grief! Where Are All The Jobs?

It

Some upbeat economic news......

Last Monday the Dow tumbled 180 points, in spite of some upbeat economic news. So why, if the news was good, did the market take such a hit? Well some