The Independent Market Observer

9/30/13 – Here Comes the Shutdown

September 30, 2013

Here we go again. I’ve written something to that effect several times over the past couple of years, what with the 2011 debt ceiling debate, the 2012 fiscal cliff, and now this. Governmental dysfunction has been normalized.

The phrase that comes to mind is “defining deviancy down,” from a 1993 paper by Daniel Patrick Moynihan, one of the great statesmen of American politics. The idea is similar to the boiled frog theory I described last month: with every ratchet down in behavior, the new low becomes somehow normal, and any subsequent changes are perceived as being less bad (compared with the new “normal”) than they would have been otherwise. Another way to describe it is a behavioral downward spiral—that is, behavior that formerly would have been thought absolutely disgraceful is now seen as somewhat embarrassing.

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9/30/13 – The Inflation Problem, Part 4: Like the Salesman Says, Think Quality, Not Price!

September 29, 2013

As discussed in the previous installment in this series, adjustments are at the core of the debate about inflation, but another way to look at the problem is to consider exactly what’s being measured here. Substitution, of one type of good for another, is a clear case of something being different. What about when you’re talking about the same item, though—say a TV set? Is an HDTV with a flat screen and built-in Internet access the same as an old tube TV without a remote?

These adjustments—for quality, utility, or both—are known in the trade as hedonic adjustments. Again, Shadowstats leads the charge against the current adjustment method, using government-mandated gasoline additives as the poster child for fraudulent adjustments. In its response, the Bureau of Labor Statistics outlines its methodology and gives two examples: a candy bar, which is selling for the same price as before but now weighs half an ounce less, and a TV, which is now available only as an HD model at twice the price. Is an adjustment necessary? If yes, how should it be calculated?

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9/27/13 – The Government Shutdown, the Debt Ceiling, and the Markets

September 27, 2013

I have to be honest: I’ve been putting off writing about this for the past couple of days, for both good and bad reasons. One good reason is that, really, there hasn’t been much news. Congress is playing games, everyone is shouting at each other, and nothing is getting done. The other good reason is that there’s not much we can do to prepare, given the level of uncertainty that prevails. No news, no action items, no need to comment.

The bad reason I have for putting this off is that, quite frankly, it’s depressing. We’ve been through this before, in both 2011 and 2012, and the fact that we’re going through it once again is just ridiculous. Be that as it may, though, here we are, so let’s deal with it.

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9/27/13 – The Inflation Problem, Part 3: Political Statistics?

September 27, 2013

“I gather, young man, that you wish to be a Member of Parliament. The first lesson that you must learn is, when I call for statistics about the rate of infant mortality, what I want is proof that fewer babies died when I was Prime Minister than when anyone else was Prime Minister. That is a political statistic.” — Sir Winston Churchill

There are three significant criticisms of the Consumer Price Index (CPI) methodology. The first is that the substitution of items in the basket of goods is not appropriate (the “hamburger versus steak” argument). The second is how to account for changes in the quality of goods sold. The third is the use of rental equivalence to measure housing costs and their contribution to the CPI.

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9/26/13 – The Inflation Problem, Part 2: Diving into the Details

September 26, 2013

“Facts are stubborn things, but statistics are more pliable.” — Mark Twain

Economic statistics are backward looking, not forward; in that sense, they always reflect the past. Moreover, given data collection time lapses, costs, and other issues, the data is always incomplete and more or less out of date. Finally, in a vast and heterogeneous economy, the applicability of one statistic to everyone is impossible. These are the general issues that any statistical service wrestles with. No figures are going to be perfect. At the same time, it’s important to know where the numbers you depend on come from, and what their strengths and weaknesses are.

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9/25/13 – The Inflation Problem, Part 1: Defining the Problem

September 25, 2013

I wrote about inflation risk at length back in January of this year. Although inflation wasn’t a concern at the time, I noted that we would have to be watchful when three things happened: a decrease in the unemployment rate, a resumption of bank lending/consumer borrowing, and faster growth in GDP. All three of these are happening now, so it’s time for another look.

Another reason to revisit inflation is the Fed. One of the arguments for maintaining the Fed’s stimulus program, albeit one that hasn’t gotten a lot of play, is that inflation is still well within a reasonable range. With the stimulus set to continue, we can reasonably expect inflation to continue at current levels, and quite possibly to increase. This is actually a goal of the Fed’s—and it usually gets what it wants.

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9/24/13 – Gratitudes for America

September 24, 2013

As I mentioned yesterday, the countdown to fiscal meltdown is back on. Washington, DC, has once again formed a circular firing squad, busily loading weapons and aiming across the circle, oblivious to the fact that the guy on the other side is doing the same thing.

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9/23/13 The Good, the Bad, and the Ugly

September 23, 2013

The past week has been interesting, with lots of developments. Rather than trying to cover just one, I thought we should look at several of the most important.

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9/20/13 – The First Question

September 20, 2013

You may have noticed a relatively new feature on the blog, “Ask Brad” (on the right side of the page). The first question that came in was a good one from Tim Bourdon, who wrote: “You mentioned that we are in better shape now than five years ago, but Europe is still in a much riskier position. If their market falls apart, are we strong enough to withstand that?”

This is a good question because it cuts to the core of how much risk has actually been reduced, post-financial crisis. The real danger, in 2008 and 2009, was that the financial markets around the world would seize up as banks refused to lend to each other. That would have led to a cascading series of defaults as banks, unable to get their money back from where they had lent it, would in turn be unable to pay their creditors. A downward spiral would result, bringing down the whole system. Europe was a key part of this, and it is this risk that I highlighted in my earlier post.

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9/19/13 – Fed to Economy: “You Can’t Handle the Taper!”

September 19, 2013

To the surprise of many, the Federal Reserve decided yesterday to continue its stimulus program at the current levels, buying $85 billion of Treasury and mortgage-backed bonds per month. Not only did it opt to continue buying at current levels, but Chairman Bernanke repeatedly went out of his way to note, in the press conference afterward, that the Fed reserves the right to continue stimulus, no matter what the various metrics it had previously used as targets do. He seemed to be walking back much of the guidance he had previously provided, trying to make the Fed harder for the market to predict. With this action, he succeeded.

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9/18/13 – More Thoughts About Tesla and Energy

September 18, 2013

Yesterday’s post about Tesla and the valuation of its stock prompted some second thoughts after I sent it off, particularly the offhand mention of déjà vu. I stand by the conclusion that Tesla’s stock is probably overvalued, but I think it’s worth spending some more time talking about the company as a bellwether for very positive changes in the U.S. economy. What Tesla means extends well beyond whether the company makes it or not.

Let’s set the wayback machine to the dot-com boom. I remember it well, as I was running a start-up in Seattle at the time, among other things. The world looked like it was changing for the better; the new economy was going to make us all rich. People were going to play, shop, and communicate online.

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9/17/13 – A Look at Apple and Tesla: Cool Technology and Market Value

September 17, 2013

My wife, Nora, is a gadget freak. She had (and used) a PalmPilot. She is all over her iPhone. She used her MacBook Air laptop so much and so effectively that I ended up getting one as well. She has a TDI Clean Diesel VW and optimizes her mileage with the way she drives.

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9/16/13 – Uncertainty and the Federal Reserve

September 16, 2013

The big news this weekend was the dog that did not bark: Larry Summers withdrew his name from consideration for chairman of the Federal Reserve. There are headlines on this in both the New York Times and the Wall Street Journal, among others, and it was a lead question I discussed on CNBC this morning.

Which, of course, makes the average person ask, “So what?” Why do I care that an economics professor and former government official isn’t going to apply for a job? How does this affect my life?

A good question, and the short answer is interest rates. The longer answer is that it affects how much you pay to buy a house or a car, and how many jobs are created, as well as many other aspects of your daily economic life.

Of the candidates for the chairmanship of the Fed, Larry Summers would have injected the most uncertainty into the system. As a former Treasury Secretary and academic superstar, he unquestionably has the firepower to do the job, but there were questions about his ability to work well within the system. As a Federal Reserve outsider, he lacked the connections a long-term internal candidate would have, and it wasn’t clear that he could work effectively with people who disagreed with him.

His policy positions were also a key issue, with his work on Wall Street and positions on deregulation when he was Treasury Secretary prompting key Senate Democrats to announce they wouldn’t vote for him. Ultimately, it seems that opposition by the Democrats was what caused him to withdraw.

As I write this, stock futures are up and interest rates are down. On the surface, the market seems to be saying it’s glad Summers withdrew, but I don’t think it’s as simple as that. What the market is really saying is that it’s glad uncertainty has been reduced. As an outsider, Summers would have introduced an element of policy uncertainty about raising rates and reducing stimulus that an internal candidate wouldn’t have.

With Summers out, the most probable contender is internal. Janet Yellen, currently vice chairwoman of the Fed and previously the president of the Federal Reserve Bank of San Francisco, is a long-term Fed insider. As one of the Fed members perceived as most “dovish” on inflation—that is, one of the most tolerant of allowing inflation to increase—she’s thought to be most likely to continue the current policies and to leave stimulus measures in place for the longest. With its reaction, the market is saying that Yellen is a safe choice who’s unlikely to rock the boat, and who will continue the current policies, which the market is used to.

I’m not sure that’s the case, longer term, although I think the perception is probably correct in the short run. Yellen is perceived as dovish, and that has been true, but her policy preferences have been based on her prescient views on the weakness of the economy. She was one of the first senior Fed officials to recognize the pending housing crisis and was also way ahead of the curve on the slowness of the current recovery. I think it’s fair to say that her policy prescriptions, thought dovish at the time, have in fact been right on. When the recovery starts to gear up, I suspect she might be equally prescient in recognizing, and responding, to that.

She is not, however, the only candidate. Two other names have been floated: Donald Kohn, a former Federal Reserve vice chairman, and Timothy Geithner. Both have extensive central bank experience and excellent credentials, and both would be good candidates. As with Summers, however, they would introduce more uncertainty into the system merely by virtue of not being there right now, possibly driving rates up again as the market tries to assess what their candidacy would bring.

The interest rate and stock price reaction may be short lived, as other factors are certainly in play, with Syria being a key one. I also believe that the decline in rates is due, at least in part, to the market getting better at price discovery in the face of the impending taper in Federal Reserve stimulus to the bond market. Nonetheless, the fact that something like this can move rates and markets highlights the continuing importance of government actions to the economy.

I hope that the White House acts as quickly as possible to finalize its candidate, to remove at least that section of uncertainty from the market. And, once that candidate assumes the chairmanship, I hope the Fed also acts to remove itself from the economy as quickly as possible.

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9/13/13 – Five Years Later

September 13, 2013

Today is Friday the 13th, an apt day, perhaps, to consider the five-year anniversary of the collapse of Lehman Brothers, the event that touched off the most recent financial crisis.

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9/12/13 – Illiquid Asset Classes: Real Estate

September 12, 2013

This is the third installment in a series on alternative asset classes and your portfolio. The first covered strategies that use liquid underlying assets like stocks and bonds, which are freely tradable. Yesterday, we talked about how illiquid asset classes can also fit into a portfolio, with some examples, but didn’t really delve into details. Today, I want to discuss real estate as an example of an asset class that can be used in both liquid and illiquid forms.

The liquid form is known as a real estate investment trust, or REIT for short. REITs are publicly traded and are essentially stocks in every way except for the underlying asset, which is a portfolio of commercial real estate buildings, mortgages, or both. Investopedia offers a pretty good definition of REITs.

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9/11/13 – Illiquid Strategies and Your Portfolio

September 11, 2013

Following on yesterday’s post, we’ll continue looking at various types of alternative strategies that you might consider using in your portfolio. Since “alternative” covers a multitude of sins, I thought it would be useful to offer a brief overview of some of the strategies that fall under that umbrella.

Yesterday, we talked about long-only strategies, which we define here at Commonwealth as “core financial strategies,” and compared them with what we consider “alternative financial strategies.” Both use liquid underlying investments—that is, investments that can be freely bought and sold. The liquidity of the underlying investments is one of the principal determinants of whether a strategy is suitable for use in a mutual fund, which is where many of the strategies I discussed are being deployed.

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9/10/13 – Investment Strategies and Your Portfolio

September 10, 2013

I’m headed down to New York this morning to speak at a conference about alternative investing strategies, and it occurred to me that many investors have heard a great deal about alternatives—and perhaps know some of the fundamentals—but haven’t really looked at the types of strategies involved, why they might work, and how they are supposed to add value. Today, I want to focus on strategies that use liquid underlying investments (that is, investments that can be easily bought and sold), as these are the strategies that most investors will run into.

Long-only strategies
This type of strategy isn’t an alternative, but rather the baseline against which alternatives are judged. The idea here is to buy things—stocks or bonds—that will go up in price. Success depends to some extent on the manager’s ability to identify undervalued things to buy, but also to a great extent on how the market as a whole does. Returns don’t come only from price appreciation—coupon payments or dividends also contribute—but the price has to appreciate as well.

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9/9/13 – No News Is Good News?

September 9, 2013

My expectation, moving into September, was that all the economic issues that had been pretty much left alone during the summer would resurface. The debt ceiling, the situation in Europe, China—all would move back to the front pages.

Boy, was I wrong. Looking at today’s papers, I find no stories about economic problems on the front pages—none. The lead story is Syria, which makes sense. There’s also a story, in both the New York Times and the Wall Street Journal, with a retrospective of the financial crisis. Old news.

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9/6/13 - Market Thoughts for September 2013 Video

September 6, 2013 

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9/6/13 – The Employment Numbers and the Fed

September 6, 2013

I was in New York yesterday, meeting with clients and doing interviews, and the one thing everyone wanted to talk about was the employment numbers—the initial unemployment claims earlier in the week and today’s employment figures. Looking at the commentary, one paper called today’s release “probably the most scrutinized employment report in recent history.” So, now that they’re out, it seems only fair to take a look at the numbers.

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9/5/13 – Data-Driven Decision Making

September 5, 2013

In my last two posts, about data points that really matter, an implicit assumption is that the data in question (house sales and auto sales) actually drives decisions. Surprisingly, this hasn’t always been the case in many fields. Until fairly recently, many decisions have been largely based on expectations, plausibility, and bias.

Medicine is a great example. I don’t mean to pick on health care—after all, it’s the source of the current gold standard for effectiveness studies, the double-blind clinical trial—but think about the current debate on medical costs. One of the principal arguments for the availability of cost reductions is that no one really knows which treatments are most effective for many problems. Surgery rates for back pain, for example, vary widely among regions—which wouldn’t be the case, I hope, if there were one clearly superior solution. An entire industry, pharmaceuticals, is built around rolling out new treatments that, in many cases, offer little measurable benefit over existing treatments, at a much higher cost. Doctors hold onto their right to practice as they please, without regard for studies of industry best practices. The fact is, in many areas of medicine, we really don’t know what works best and why.

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9/4/13 – Data Points That Really Mean Something: Auto Sales

September 4, 2013

In yesterday’s post, I discussed why I think both house sales and car sales are good indicators for the economy’s performance over the next 6–12 months. I went into some detail about the housing market and why I believe it will continue to support growth; today we’ll do the same for auto sales.

To recap a bit, anyone buying a car is making a long-term commitment, as well as a long-term bet on his or her own earning power. To be willing to make the commitment is to have confidence in the future. At the same time, since most autos are bought with financing, a lender must also have confidence in the future. Rising auto sales therefore reflect both consumer and business confidence, and are based on what people are really doing at a given point in time, without much room for interpretation or adjustment.

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9/3/13 – Data Points That Really Mean Something: Housing

September 3, 2013

I wrote Commonwealth’s monthly market update this morning, and one of the topics I covered was the slowdown in the housing recovery. To be sure, I think this is just a slowdown to a more sustainable level of growth, but looking at it made me think about what I really consider some of the best indicators for future economic performance.

As you know, consumer spending represents more than two-thirds of the economy as a whole, so the consumer is paramount when considering where we’re going. We have multiple surveys of consumer confidence, which remains at high levels, and many data points on how much consumers are spending, but each of these is subject to revision, massaging, assumptions, and everything else that goes into the economic-statistics sausage grinder. It can be tough to see anything through the fog. What we need are simpler, easier data points that reflect underlying consumer demand in a clearer way.

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