Thursday, November 13, 2014

The Truth Hurts

Yes, I admit that I am surprised, that The People are surprised, that Bank FX Desks routinely (and I emphasize 'routinely') predated customer orders. This is, judging by the long list of things diddled when People have the opportunity(s) and incentive(s) do do so, Standard Operating Procedure, endemic not just to Banks, but, more or less, I am sad to say, most of the human enterprise. Banks undoubtedly are eyebrow-raising, less for their routine seeking of advantage at others' expense (let's term this 'business'), but rather for the breadth and magnitude of their repeated gluttony in a profession where trust is, I daresay, rather crucial to the entire undertaking.

Yet, what I, personally, find most surprising about The Banks, and the cast of characters who run, and inhabit them, is that they are incredulous, and somewhat mystified, to the suggestion that people really do hate them. Take the case of one of the largest American money-center banks where an uncle of mine was engaged to help them understand how to exploit opportunities on their newly-embarked-upon course of "Bancassurance". Specifically, he was asked by their Board to help them understand how to cross-sell insurance services from their newly-acquired insurance arm, into their existing customer base. My uncle, being a pioneer in focus groups, and brand-extension, did what he does best: conductive exhaustive focus-group study of the issue and analysis before presenting his findings to the Board. His results were categorical. He told them, in no uncertain terms, they had almost no chance of selling their subsidiary's insurance to their existing customers. "On what basis?" they asked rather angrily. He said it was obvious: all his research showed that people HATE their bank. It almost didn't matter which one. Most people think the other banks are better than their own, so you actually have a far better chance of selling their subsidiary's insurance to anyone BUT their customers. Awkward silence ensued. Meeting was quickly adjourned. Contract abruptly terminated shortly thereafter. And (unusually for him) no further work from this giant Bank. The truth is painful, yet people in general, and it would seem, bankers in particular, go to great lengths to avoid it.

(NB: The American experiment in Bancassurance, like Mitterand's disastrous nationalization of the French banks was eventually reversed, the ill-informed "guilty" architects, of course, inculpable, and unpunished.)

Wednesday, November 12, 2014

"Bear's Anonymous" - Finance's Answer to A.A.

The following is a voyeuristic peek into a meeting of the Stamford, CT branch of "Bears Anonymous", duly held a Rippowam High School….recounted in 2007 and rediscovered, and ever so apt in 2014.

(Camera pans on participants taking their chairs , seated in a circle in a school room (a dozen or so men and women of varying ages. The moderator, a clean-cut optimist, who is always "fully invested" clears his throat and begins...)

Moderator: I'd like to welcome everyone this evening. I understand this is a big step for most of you: but the mere act of admitting you have problem is the first step to overcoming it. We have a number of new faces here tonight and I'd like to welcome all of you, as well as those who are returning. First and foremost, we are here to share our problems, support each other, so we can begin the road to recovery. Remember: there are many faces to our affliction, but the only requirement for 'BA' membership and attendance is that you must refrain from "going Short". In time, you may even learn to appreciate the liberating exhilaration of being long. (Moderator turns to early-thirties man) Let's start with you, Sir. Please Introduce yourself and begin...

Chuck: Hi everybody. My Name is Chuck, and I am a bear. I have had a bearishness problem for a long time. Not just a predilection for the usual contrarian stuff, which when I look back I have had since I've been a child, but a real nagging and pressing fear that the financial sky is about to fall at any moment.

I don't know where it first began. Maybe it was 1987. Yeah, that scarred me. I was naive, I guess, and long, and got slapped 20% that day in Oct 87. I tried to get out, but ended up exiting at levels near where it closed. A couple of years worth of savings just vaporized, that was!! But as things recovered, I was out of the market and then I didn't get back in because it looked to me like the world was really was going to end with thirld world debt, the S&L crisis, and the massive commerical real estate crash that seemed bound to cause a depression. Then, in 1991 when the UAL deal exploded - you know all those Reagan deficits coming home to roost - I thought that we were set for an ever deeper recession, but I was wrong, and again uninvested when the market started rallying. Come 1994, the bond market exploded and it looked like the end again - budget deficits, trade deficits, political gridlock and remember we were still working off the thriftbank and S&L issues, not to mention the near-destruction of the Texas oil patch and US agricultural sectors. Damn! If that wasn't enough to keep me out of the market, I don't know what is, but it did, and I was sure that I'd get a better opportunity to get in later.

Then came large cap cap growth and technology speculation. Germany and Japan were in near-depression, yet investors were paying silliest prices for big-pharma and global large cap growth. Who would thought they could continue to grow like that and justify the high prices? Not me. I missed it again.

All the while, I told myself: "It's ok. It's good to be prudent. The reckless will suffer like the Okies of the 30s. And, after all, it's only opportunity cost. Better one in hand than none in the bush". And I probably had a hundred other justifications and rationalizations for my bearishness, just in case I gnawed through these.

1998 came along and finally, finally, I was proven right with the unraveling of LTCM and bitch-slapping of Russia! Now we would witness the frightful reckoning, the deleveraging-yielding-to-parsimony that was needed to return assets to Graham & Dodd value and redeem America's sense of thrift! So I sat on the sidelines, waiting for the real blood in the streets that was imminent. But the Fed cut rates for fear of Y2K, the tech bulls ploughed ever-more money into the market. Some said don't fight the Fed, but I rationalized my bearishness that the Fed was "pushing on a string" and their efforts would have no effect.

The market did crash in 2000 - the tech and dotcom market anyway - and the broader market stood at 5 year lows, but I looked back to the financial history of the 30s and thought that when it hit its lows in 2002 that this could continue for a decade, especially with the Gulf War imminent and, with near-zero rates, it really looked like the Fed was pushing on the proverbial string. So I sat tight, waiting for a better entry point that was certainly around the corner.

Then weak dollar, credit bubbles, twin deficits, foreign accumulation of US reserves, muddling war in Iraq, incessantly rising energy prices and peak oil, and on each occasion - Aug 04, Mar and Nov 05, May and Nov 06, Feb 07 the market swooned, corrected, only to rally even more strongly out of the trough as if it were teasing me, taunting me, seducing me then mocking my now increasingly irrational fears and bearishness. And they were irrational, they must have been irrational right? for the market continued its inexorable rise on each occasion, laying waste to the rationalization or justification of the day for NOT being long long long.

In 2008, I felt vindicated. All my fears were realized. The world WAS going to on. It was so bad, I took all my money out of the bank, for fear of their collapse, and put it under my mattress. But be careful what you wish for. Things became so bad, I was afraid even money wouldn't have value, so I went out and bought gold (coins). Even the Fed rescue looked like it might not work. And then, there were new bank regulations which made it impossible to get a loan, all that shitty foreclosed housing to work through, and of course the EURO - oh my god - the EURO was bound to cause the biggest upheaval since the Panic of 1907, and Japan was imploding with deflation, while the Chinese were creating the largest bubble the world had ever seen. Would YOU have invested"??

It's taken nearly twenty-five years - almost the entire length of this grand new experiment in seemingly unlimited and unrestricted credit - for me to realize that this really and truly is MY problem. The world is just the world, and it's not going to end tomorrow, and that its better to suffer with the fools in the event the system unravels, than sit idly by and watch alone, a big pile of savings become a small pile of savings. Where o' where is joy in THAT?

In turning over a new leaf, and recognizing that I have a perpetual bearishness problem, I have terminated my newsletter subscriptions and vowed never again to watch or read Marc Faber, David Tice, Dr. Hussman and Fred Hickey. I will not read ZeroHedge, Peter Schiff, Max Keiser, anyone named "Rickards" and especially anyone like Mike Shedlock who wraps their politics so deeply into their strategy vision, they cannot possibly provide objective counsel. And I will make Investors Business Daily my read of choice in the financial markets. I will personally go and apologize to Abby Cohen, Vic Niederhoffer and Charles Gave for all those less-than-nice things I said about them. Further, I have vowed to place 50% of my money into a Vanguard global equity Index Fund, and also have vowed not to look at its asset value more than once a quarter. I have taken 25% of my funds and placed in them in a global balanced fund, and earmarked the balance for disciplined allocation on any subsequent drops, to momentum strategies. I have also asked my doctor to prescribe some little blue pills that will help me see the bright side of life, and stop being so pessimistic. And I have told my secretary NOT to hang up on salesmen that cold call for you never know when a good idea might fall on one's lap through a seemingly altruistic phone call. And I am going to stop all that stupid exercising and dieting in a bid to be "fat and happy", enroute to my ultimate goal of being fat, happy, AND lucky!!

My name is Chuck. And I have a bearishness problem. But I have now acknowledged my problem in hope that such recognition is the first step towards getting better. Thank you.

(applause of other members, camera pans on circle and focuses in on upon late twenties girl with tears in her eyes; Camera fades out, other members get up and give Chuck a group hug - but not a 'Bear-Hug'.)

(NB: While the author neither admits nor denies having a bearishness problem, the above account is entire (well, mostly anyways) fictional.

Tuesday, October 28, 2014

Perception of Reality vs. Objective Reality

A recent article in the New York Times cast a seemingly jealous eye upon the Dutch pension system. Why? By comparison with the US, the Dutch system appears scrupulous, fair, but most of all typically Dutch in the brutal honesty with which they objectively deconstruct and tackle contentious issues. In America, by contrast, even after bi-partisan commissions comprised of eminent panel members try to get to the bottom of something, we seem no more enlightened as to where truth lies (no pun intended) or how to tackle it for the greater good of the public's interest.    

Pensions speak volumes about contrasting national characters. Sober-minded Danes and Dutch have transparent and logical approaches that attempt to maximize reality in actuarial analysis, funding and benefit requirements, while minimizing the fantasy of projecting above-market returns, and limiting the ability of pigs to feed at the trough. Canadians, too, have well-run, transparent systems that reflect their earnest, solutions-minded national character. Germans's rely almost wholly on pay-as-go reflecting their confidence to make tough fiscal choices when required, while the UK institutionalizes the rape and theft of savers and beneficiaries for the advantage of the City and her Managers, a legacy microcosm of UK class-based inequity. America's system reflects her faith in hope and fantasy over preparation and analysis, and plagued by the same byzantine structure incrementally etched by lobbyists and interest groups, that makes America's healthcare system The Very Best In The World. The New York Times is of course to polite, and would appear too partisan were it to represent the image of the US system as such.  

I, must admit that I, too, am jealous of the Danes and The Dutch. So much acrimony over public policy would be disarmed if more peoples were capable of similar detached objectivity. So much angst would veritably disappear from our broadsheets and evening news. The energy could then be rightfully focused upon coping with what might often be a painful solution requiring shift and behavioral change, rather than exhausting oneself in an attempt to avoid confronting the problem itself.
A striking analogy springs to mind from the realm of industrial sociology, that is worthy of recounting, for it was a vivid attempt to objectively measure our national perceptions against a benchmark of some objective reality. Some three decades ago, researchers used driveshaft manufacturing within the auto-parts industry, as a baseline. If memory serves me correctly, the german conglomerate Bosch had plants manufacturing more or less the identical piece in four different countries - Holland, Spain, the UK and USA. Each of the plants, similarly equipped, had precise data on their quality as measured by their defect rates. The consultants set out to measure the workers attitudes towards the quality and effectiveness of their work, by asking them questions that measured their perception of the quality of their work. This might have value to firm when faced with wage demands, or consolidation decisions. The results, were striking, though not  unsurprising.     

The Dutch workers had a high opinion of the quality of their work. This was set against a low defect rate, giving the Dutch perception of reality a characteristically close approximation to objective reality (as measured by the defect rates). The British workers had a low opinion of the quality of their work. This was exemplified by high defect rates, making their perception of reality reasonably-close to the  objective reality of their work. Workers at the Spanish plant had a reasonably low opinion of their work  , which was at odds with the high quality of their efforts evidenced by a low defect rate. This was an interesting result - probably one there company would prefer to keep hidden from their Spanish workers.  Perhaps @Ibexsalad can verify whether self-deprecation is endemic to the Spanish national character.  At the American plant, survey results showed workers had a very high opinion of the quality of their work, completely at odds with the relatively high objective defect rates of the output of the plant. And it is precisely this gulf - between perceived reality and objective reality - which has proven problematical to overcome whether in politics, public policy, or, as in this topic, pensions. To be entirely fair, it is the stuff that helps put men on the moon, and cure cancer, but it also is the stuff that gives us Enron, 'AAA' sub-prime securitisations, Detroit, Puerto Rico, and ant-fuckingly irrelevant public-policy obsessions with creationism, same-sex marriage, and abortion while proverbial Rome burns and decays.  

Thursday, October 23, 2014

AAMC: How's That Working Out For You Guys


TO:        Luxor, SAB, White Elm, Tiger Eye et. al. 
FROM:      Cassandra
DATE:      24 October 2014
SUBJECT:   AAMC Altisource
In Feb 2014, I was curious as to the investment thesis(if there was one) underpinning the large positions you (individually and collectively) held in Altisource Asset Management (AAMC), and the Ocwen related entities. 
Despite my pleas, and promise to publish any such theses, no readers (or interested parties) came forth to enlighten me regarding the allure (investment or otherwise) that caused you (but not only you) to buy more and more shares, at high, and higher prices, culminating in a crackerjack-of-a-year-end mark, up more than 10-fold from beginning of the CY. 
The tone of my curiosity, was, unashamedly skeptical for reasons described in the post. Outsized positions, acquired with investors' capital, in illiquid  stocks, moving their price by eyebrow-raising amounts in the process of accumulation, with performance fees crystallizing at a single-point-in-time, which doesn't reflect liquidity or prospective unwind or investment risk, does raise potential conflict-of-interest questions, however unfounded they may be.  
So, here we are in October 2014, and I am certain many observers are wondering just how that's working out for you guys? 

Wednesday, October 22, 2014

In Memorium: Nelson Bunker Hunt

Farewell then

You were 
born with
a Silver Spoon
in your 

But, apparently
was not
enough Silver.

You said
"I was
just trying
to make 
some money"

Your catchphrase 
have been: 
"Never squeeze
the people 
that can 
change the rules.

(with apologies to Private Eye & EJ Thribb)

Wednesday, October 15, 2014

The Risk That Will Bite You Next Is NOT The One That Bit You Last

Traumatic and painful events burnish their effect upon our brains. This happens profoundly in childhood, as well as in relationships, and most definitely as readers will know,  in the financial markets. As a result, we alter behavior, and do things differently in the future. Tokyo real estate was no longer Japan's risk once it plunged skewering banks and investors in the process. Latin-American debt from the recycling of petrodollars, once a mammoth exposure has been throttled long ago. Asian countries are no longer held hostage by fickle hot-money flows. And it probably won't be large company malfeasance (like Adelphia, MCI, or Enron) drilling holes in investor portfolios that gets one fired for being contrarian. Nor is it probable that dodgy liar-loan mortgages packaged together into dubiously-annointed 'AAA' CDO's will set in motion a catastrophic global unwind. No. Rather, we will (and undoubtedly we already are) well-into the process of doing too much of precisely that thing which we shouldn't. And what ever it is, or will be, it won't be Japanese Real Estate, NT or JDSU or carelessly conjured CDOs, or whatever that thing was that buggered you soooooo much that it still hurts.

This is, in itself, one of the best arguments why Sarbanes-Oxley, and Dodd-Frank, EMIR and AIFMD are such abominable wastes of time, effort and money (for everyone except the lawyers feeding at the trough). Not that the risks they attempt address weren't risks, or that people were harmed by them. They were. It's just highly contentious whether they still are,  or will be in the future and so worthy of the draconian regulatory regime(s) imposed ostensibly to control them. It will be a VERY long time before investors, again, plough double-digit billions into a Madoff-like purported secret money-machine with no transparency and audited by some guy in a 2nd story walk-up named "Dave", or take liquid collateral held against short-duration loans to clients, and shoot-the-moon by swapping it for illiquid long-duration mortgage bonds in a suicidal reach for yield.  The germane observation here is that you cannot legislate against stupidity. And since it is stupidity (generously laced with greed) in the general sense that is at the root of risk, it will undoubtedly surface again in some other market endeavor,  asset class or investment meme,  such as myopic share buy-backs, insurance-linked securities, collectible art, high-end London Real Estate, or over-the-top deal prices with  Frankensteinian capital structures paid for Private Equity investments. Who knows?

Because we know it is more or less deterministic, that bad things ultimately result when greed mates with stupidity, ruminating upon important yet-to-be encountered risks is a worthwhile undertaking, for risk-managers and portfolio managers alike. I would add that their bosses and investors, respectively would also benefit from meditating upon the question of "what risk will bite you in the ass - tomorrow?", but if the past is a guide, its urgency will be lost in the process. So what might be tomorrow's Big Risk? High equity prices? Tight credit spreads? Generalized relative valuation levels of asset classes to historical norms? ZIRP? Exiting ZIRP? Student or auto loan-backed ABS? China growth stall? Threats of War?  Eurozone sovereign debt kerfuffle? Bank capital ratios? Ted Cruz or Nigel Farage? The diminutive age of the average HF analyst? A butterfly somewhere in the highlands of Mexico? The homogeneity of the average Finance MBA, and the curriculum studied? I daresay they are all candidates worthy of consideration…. all potentially destabilizing…but….but….

….But I think that the big risk to be concerned about - the one that sets the present apart from the past,  - is the nature of risk itself. We feel more comfortable than ever in measuring much risk, for we have PhDs with powerful computers and software, all developing unpronounceable but impressive-sounding risk models spawning more acronyms than used by the armed forces. We use our DMAs to link directly to markets, giving the illusion of abundant liquidity that results from framing our references during subdued times, modeling it on observed turnover, bolstered by the presence of HFTs and dark pools. And yet despite these advances, we appear to understand little more than we ever did (or at least ignore it the same as ever). So while everyone does as they did before, they ignore the profound difference in the structure of liquidity,  leverage, and the interplay and consequences upon both of risk-model herding and position crowding, the latter far more subject to the destabilizing whims of short-term agent-shepherds.

Dealers and banks are providing less liquidiity, and warehousing less risk than ever, precisely at a moment in time when the amount of systemic liquidity sloshing about, trading discretionarily on a leveraged basis is highly elevated relative to historical experience. These market-making activities have been meaningfully excised - a casualty of the Volcker rule and other regulatory demands from authorities - replaced by more discerning and more discretionary liquidity providers on the buy-side.  One can argue (perhaps rightly) that both specialists and market-making securities dealers, during times of elevated vol, have always stepped away from making prices. And so they have, or least widened spreads and diminished quote size to the same effect.

But going back fifteen years to LTCM, what one saw "under the hood" was that the entire Street generally acted as a counter-trend buffer with vast liquidity-providing positions contra the flow. They were not stupid positions but attractive, positive-carry relative-value inventory accumulation. The reason they [street creditors] jointly "administered" LTCM into a managed unwind was precisely NOT to have these liquidated into an open market where they were themselves "full-up". Imagine the carnage and dislocation in their absence. The important distinction here is that the street were principals with permanent capital - NOT agents. While they may withhold the both quantity and levels at which they supply, they were, in practice, their own masters. Outsourcing the liquidity provision to HFs, or other agents raises the question - like in 2008 - whether even those that are dedicated to such opportunistic pursuits, as agents, will be in the position to what they may wish to do. With ultimate investors - whether individual, institutional or otherwise - being behaviorally hard-wired towards gamma-negative tendency, one would be challenged to imagine anything other than the classical response of pulling in one's proverbial horns, and redeeming, or putting in protective redemption notices given the lengthy notification requirements. One can imagine the destabilizing demands upon liquidity, in the absence of decisive principal capital to take the other side. I think this will translate into fatter highly-kurtotic left-tailed returns at the mere hint of serious demand flow.

But that is only part of the story. Coincidentally, we now have near-uniformity in model risk in the name of VAR, and an increasing deployment of risk-parity approaches. Both of these are profoundly gamma-negative. Volatility, suppressed by abundant liquidity, infers diminished risk as measured by VAR, encouraging a complacent accumulation of risk using available leverage. Risk-parity often results in a similar rear-view risk-assessment, and acquisition of leverage. Faced with a spike in volatility accompanying almost any potential event (exogenous or endogenous), The Market's aggregate positioning and leverage will deterministically trigger demands for liquidity, most likely in the same direction as the shock, into a veritable vacuum, replete with classical feedback loops. This is before considering the large increase in mimetic trend-following, momentum and CTA strategies' relative size and importance within market ecosystems, and the large army of discretionary day-traders waiting for set-ups and breakouts. These are unmitigated amplifiers of already-gamma-negative feedback loops. The paradoxical result, in a world with more risk-managers than ever, using better measurement and technology, with more position limitations, thresholds, and more-than-abundant capital is a market that is likely to prove more brittle than ever before. For not only will the modern liquidity providers intent on avoiding costly adverse selection step out of the way, they too will turn and trade in the direction of the impulse. LOR's Portfolio Insurance, will, by contrast, appear benign.

To most fundamental equity, fixed-income, FX, and commodity traders, the Quant Wreck of 2007 hardly registered.  To those running systematic model-driven equity long/short strategies, recalling these mid-summer events is likely to trigger PTSD-like responses. But the lessons they burnished, worth heeding in regards to today's broader systemic structure are clear. Everything's fine until its not. Models, while useful, are always flawed. Participants habituate behavior basis the recent past - and are not forward-looking.  Leverage is poison. Participants caught in risk/margin/redemption crosscurrents cannot discriminate and can only unwind their positions. Gamma-negative behavior outweighs gamma-positive behavior by a large margin. The exit is always smaller than perceived in aggregate before the theatre fills with smoke. Feedback loops cause dramatic overshoot.  Out of the wreckage arises amazing opportunity. Dry powder is essential for credit is often impossible to obtain when the opportunities are the juiciest.

Monday, October 13, 2014

Pay Dirt ??!?

I do not admire Paul Singer. In  fact, I rather think he's a tool, and that there are sufficient honest ways to make money - both investing and arbing markets - which contrary to Financial Carpetbagging, do not leave the world worse off than before one structured one's trades.  Neither do I admire nor share most of Mr Singer's politics, which I would characterize as conceptually opposing the existence of The Public Interest. The notion that "no public interest is the best interest"  is, I believe, profoundly corrosive and destructive as a point of political departure.

Declaring my views in advance, I  nonetheless find the treatment heaped on  Elliot and its un-named beneficiary in today's Guardian's piece today utterly assinine. Not because I think he's "worth" GBP38mm (or anyone else for that matter), but because The Guardian, rather than decrying money earned, should be rejoicing that the employee took it down in the UK (and presumably will be subject to UK income tax) and didn't [apparently] use any obvious manner of deferral or avoidance scheme.  That Singer's management company paid GBP1mm in UK corporation tax, while having demagogic shock value, is irrelevant in such a global service business because it is ultimately taxed on its profits in the US, and should be be seen no differently than Silchester's Butt's large pay, who as founding principal of a similar service business, takes his down in the UK, to the benefit of HM Treasury.  While one can certainly take aim at the relative merits of performance fees in fund management (the source of excess), or the wisdom of investors' fee arrangements with Elliot (a number of whom are likely UK public and private pension funds),  Mr Singer's arrangement with one of his employees is ultimately a private affair, and should be of no more concern than what Mr Abramovich agrees to pour into Fabregas' bank acccount, Mr Beckham's privately negotiated endorsement fees, Elton John's stream royalties, or the price Steve Cohen is willing to pay to Damien Hirst for a lucite-encased shark, provided they are in line with rules set forth in law.

Perhaps the Guardian's Mr Neate has a point to make somewhere outside of his rubber-necking at the number of zero's contained in the filing - a point that might highlight the lack of social responsibility , in modernity, by today's beneficiaries, in a winner-take-all economy, or unprecedented windfalls to rentiers resulting from asset price inflation while the same macroeconomic consequences squeeze median purchasing power. Or perhaps he might focus on more pernicious systemic gaming of the tax code, or inelastic demand curves by privatized monopolies. Just gawking, however, serves little purpose at best, and in the absence of any constructive conclusions, may result in reactionary anger and envy-driven policies that would likely be very sub-optimal.

Monday, October 06, 2014

A Rare Guest Post

Today, I am breaking convention by posting a piece as a favor to a reader who is restricted from publishing by his employer, but wished for comments from a thoughtful audience. On his behalf, I gratefully ask interested readers for their constructive comments.
* * * *

Some Consequences of Government Regulatory and Monetary Policy on the Private Sector and Capitalist Systems

There has been much speculation about the end game to the US Government Debt "build out" that found it's start in the Reagan era and continues unabated today. Doomists say it's the end of Capitalism, while Socialists claim it's the natural result of the central government's responsibility to it's people. I should start by acknowledging that this paper lacks in the exactness and completeness that would qualify it as academic. I would not qualify as an academic or an expert. As someone working my entire career in various segments of the capital markets, I've had the good fortune to observe the evolution of the system and the broad reaching impact that technology has had upon it. This missive is my attempt at tying together and unifying a number of seemingly disparate observations. My hope is that, in producing it, I inspire further thought and data gathering that might support (or for that matter refute) the system, as I describe it. My wish is that in doing so, we might find a way to adjust the system or better prepare for the outcomes. 
Money is a strange beast. It is everything and nothing at the same time. It is a placeholder for usefulness and a measuring stick of scarcity. It's creation is as mysterious to most as its destruction and it is the measure and means by which most everything is exchanged. In response to the outcome and effects of the 2008 financial crisis the US Federal Reserve embarked upon a policy course aimed at injecting the financial system with a massive dose of liquidity, with a goal to resuscitate a global system undergoing the equivalent of a massive heart attack. This policy was selected as the best choice to accomplish the following:` 
  1. The Government's creation of Money for the assumption of private sector at risk assets to revive the banking system through the public assumption of impaired collateral in exchange for the "good" collateral comprised of US Government obligations.
  2. The Government's creation of Money for the manipulation of rates to spur private sector investment and generate economic growth. Spur Lending by ensuring that the means to finance debt could be obtained cheaply and simultaneously encourage saved capital to take the risk needed to revive capital formation, and encourage employment.
  3. The Government's creation of Money to support its own public sector investment and enterprise and in this manner, directly spur employment through government funded projects.
Concurrent with the swift and decisive application of Monetary response, the public, though its elected officials, demanded that the Government implement a new set of more stringent banking regulations, in the hopes of ensuring that Banks would maintain the discipline and capital required to avoid future financial calamities. So under a changed regulatory regime, where does this liquidity go, what happens to it, and what are the side effects of its application? 
The Banking system effectively squirrels money away to support regulatory mandated de-leveraging of the Financial system. Changes in Banking regulations, accounting standards and Insurance Asset risk ratings, have increased the statutory pool of money needed to support a dollar of liabilities. As a result, the cost of debt-based risk capital increased to reach the equivalent hurdle rate per unit of capital supporting it, as lower leverage requires higher returns to equilibrate statutory capital returns. 
The unintended consequence of increased regulatory risk controls is the creation of the less regulated shadow banking system. Non-bank lending requires less statutory capital to support a unit of risk. While the intent of reducing systemic risk is noble on the Government's part, it is a blunt instrument approach and only results in the formation of alternative systems to which the risk now resides. In effect, many of the risks previously borne on depositors has shifted to the hands of shareholders. Unfortunately, lower rates of deposit return have also encouraged depositors, seeking higher yield, to become the unsecured shareholders to the very risks which regulators sought to have them avoid. 
The post 2008 world of lower economic growth (lower interest rates require higher levels of savings to produce the equivalent unit of purchasing power and unemployment reduces end demand) creates a conundrum for Corporate America. Corporations must satisfy shareholder's preference for growth in earnings. The means to do this can crudely be divided into three means: financial engineering (M&A, Stock Buybacks), the zero sum game for the consumption dollar (assuming no population growth), or the reduction in the unit cost of goods sold. The later has been the unprecedented beneficiary of technology based productivity gains. If returns generated by these gains are greater than the gains made per additional unit of employment or bricks and mortar enterprise expansion, then it logically follows that capital will flow into this segment of a corporation's enterprise. It is my contention that the availability of cheap capital as mandated by government monetary policy, intended to spur employment thru private sector economic expansion, has resulted in the systematic downsizing of the very labor force that capital was created to support. Simply put, investing in productivity has a higher return than investing in labor, the consequence of which is systemic under- and unemployment. 
Clearly, the investment in productivity, and the readily available capital to do so, favors the largest private sector players, with the lowers percentage of inelastic fixed overhead (inelastic meaning impervious to productivity gains). These companies not only have scale to maximize productivity at the expense of labor, but also have the capacity to create accretive value for equity holders in the acquisition market by transforming smaller, less productive companies. This transformative value proposition is supported by the our Government's current Monetary and Regulatory policies. The bifurcation of the corporate have's and have-not's is the logical outcome and, unsurprisingly, repeats itself in the distribution and movement of individual wealth. So the transfer of Money from the Public sector to the Private sector in the system described logically ends in the hands of the equity holders. These unsecured risk takers reap the biggest reward per unit of private sector profit. (debt holders returns are capped in exchange for seniority and thus security, in the capital structure). This has certainly been the case since the Shift in Monetary policy which began with the Reagan era. This private sector wealth increase has disproportionately fallen in the hands equity holders who had the economic means to own disproportionate equity, or the entrepreneurs who retained it. 
It's no surprise where the money flows next, once Government Liquidity has created disproportionate wealth. Asset inflation is, at the top end of Art, Wine, Real estate, Antiquities, Gems, Precious Minerals and other scarce goods, both unprecedented and perfectly logical. These items represent real insurance against the perceived risk of the current Monetary system to the beneficiaries of that system. The misperception that these assets are "uncorrelated" adds to their cache. The cruel irony here is that correlation may not be as risky as causality. 
This all brings us around to the "1%", the "extinction of the middle class", and the way I believe we need to think about inflation. Asset inflation and wealth created by lower cost of goods sold will perpetuate the concentration of wealth gains to those that can afford investment over savings ( as a means of income replacement for those who's purchasing power is eroded by lower wages). As systematic un- and under-employment proliferate, purchasing power will be eroded for those who are victims of productivity gains. As they become less useful, their only defense is to deflate their economic value in an attempt to compete. This creates what I call "relative inflation", defined as the shortfall in purchasing power that occurs when the aggregate unit cost of labor decreases at a faster rate than the cost of finished goods. By example if todays milkshake costs $1 and I earn $1 after tax, I can buy a milkshake. If tomorrow's milkshake costs $1 and I earn $0.95, I have 3 choices if I want a milkshake; I can borrow $0.05, erode my savings by $0.05, or misappropriate the $0.05 or the milkshake its self. The poverty effect created by relative inflation will no doubt erode savings and increase crime. As regulations prevent increased borrowing by those who's wealth is eroded, few if any choices remain. 
In summary, current Government policies (both Monetary and regulatory) combined with advances in technology, have had the perverse effect of increasing the systematic unemployment and wealth gap they were put in place to address. Rather than creating a level corporate playing field, they have actually increased the too big to fail risk while shifting economic credit risk from the regulated to the unregulated. These policies force risk aversion thru the erosion of purchasing power resulting in an ever-increasing wealth bifurcation in our population.
By investing in higher education the Government can perhaps slow down the effects of productivity on systematic unemployment, but I do not believe it would be sufficient to end the cycle. Labor shortages would only be maintained at the bleeding edge of technology, where supply requires levels of understanding that may not easily be translated to mass education. 
A tighter monetary policy resulting in higher interest rates rates would negatively effect asset inflation but would benefit savers. This would be a logical way to fight relative inflation, but the economic thought consensus needed to prosecute such a policy would require a shift in economic thinking. It is my personal belief that only by understanding the interconnection of public debt, regulation and their collective effect on wealth creation and destruction, can our policy makers begin to make effective choices with intended outcomes.

Tuesday, September 23, 2014

The Rule of Law is Vastly Under-Priced

When people prattle-on about tax, it is mostly made from ground-level, with a focus on tax rates. When my most rabid libertarian friends weigh in on the subject, discussion extends to the moral realm.  Some of these debates are constructive, a few downright stimulating, though most such arguments descend into demagoguery that take kernels of truthy-sounding platitudes about freedom, and the morality of taxation's coercive nature, profoundly at odds with the sensibility and logic of the entente that secures from the hordes the very property from which they derive their benefits.  

Those benefitting most from the secure property rights might be forgiven for conceptual ignorance - introspection being a scarce commodity amongst the wealthy - but the vociferous and cynical denial of the asymmetric benefits of securing property rights, both intra- or inter-generationally, whether due to some combination of attribution bias, feigned religious belief, or simple greed is less excusable. In a new gilded age,  the idea that the rule of law is vastly underpriced by those who benefit most should be anything but contentious.

Few doubt we humans are animals. Few outside the most fundamentally-religious wing-nuts would doubt that our social, political, and economic structures as well as our mores, values, responsibilities to others are, for the most part, man (and woman) made.  We have done so NOT out of altruism, but out of BOTH necessity and expediency, whether collectively agreed or imposed by force.  They have evolved hand-in-hand with the ascent of civilization. And they have contributed handsomely to the progress and advancement of the species. 
Some more than others, indeed, but it's difficult to argue against their importance, and resulting increase in overall economic welfare derived from the general rule of law, and attendant property rights conferred. 

So why is it so seemingly difficult for the uber-beneficiaries of the rule of law to reconcile their (mostly fiscal) responsibilities to the entente with The People which is the very fount that allows them, and increasingly one might argue, their less-deserving progeny, to maintain a position in the stratosphere of power and control, with a recognition that the very legitimacy of their reign is conferred by The People through the rule of law? Indeed, the more remote this concept becomes, the greater the probability that the entente and rule of law itself corrodes to the point where mob rule, or some equally nasty alternative somewhere along the continuum of possibilities, will emerge.   

In the absence of the entente, with its benign rule of rule, entropy typically yields either unpleasant and economically sub-optimal forms of authoritarianism or the so-called law of the jungle. We have seen many faces of authoritarianism, and rarely is anyone content outside the authoritarian himself and immediate cadre.  And while the classical expression may have been militaristic. modernity increasingly enables dystopic Atwoodian visions of The State, captured by narrowly-powerful economic interests, employing all manner of surveillance technology and distortion of law, to maintain and consolidate their power and control.  At the other pole, Libertarian and conservative morality, questioning the very nature of the entente, and undermining the edifice upon which is rests, philosophically descends into a chaotic, Darwinian jungle. By calling into doubt the existence of the entente, they are, in effect either relying upon something magical (think of Dawkin's Dennett's "skyhooks" - tnx Bob S.) to maintain their place at the pinnacle of power and control, or, they are, in their neglect, saying: "Bring it on…!!".    

To make my point, one should consider an example from the animal kingdom, where competition, rule and survival of the fittest reigns in its purest, and most unadulterated form. The sea-lions of Galapagos would, for this purpose, be archetypical.  Picture a kilometer-long idyllic beach. Waves rolling in from a cool, deeply-sapphire ocean, under a shining sun and a stiff breeze. The sea-lions share the beach and nearby shallows with others (birds, lizards, dolphins etc.) but the sea lions dominate. When not feeding, they mostly lay about in the sun. They have no rule of law, per se.  But they certainly have structure and custom. A dominant male sits atop the herd, and occupies the choice real-estate on the beach, surrounded by a scattered harem of females each with their pups. He is known as the beach-master and is typically the biggest and baddest sack of blubber around, which is how he became beach-master. He protects his harem, and his reward (apart from the privilege of residing on the choicest beachfront real-estate) is the right to mate with the cows and sire progeny. He is truly master of the universe….for the moment.

As the male pups grow they go from being tolerated to marginalized. They play in the waves in sight, but staying out of the way of the BeachMaster. They practice their intimidation and battle skills with the other pups and larger, older males, also marginalized. Occasionally, they sneak on the beach. Try their luck with the randier females when the Beachmaster is sleeping or otherwise engaged. But a scowl from the Big Bull and movement in their direction is often sufficient to shoo them away. Sometimes the growing pups coordinate and move to opposite ends of the beach presenting a dilemma to the Beachmaster to their advances. But they, too are eventually stared down. The largest ascendant bulls periodically challenge the Beachmaster, not infrequently, outright, or by trying to seduce one of his harem. This is a classic duel, and only one will win.  Usually it is the fittest which is often the largest and strongest. Initially, this is likely the Beachmaster. But, it is very tiring work without the rule of law. While the cows and pups lounge idyllically, the BeachMaster is defending his turf. There are NO property rights. In this realm, the rule of law is the rule of the Beachmaster for as long as the Beachmaster can maintain it. So stressful is it to remain Master of His Universe, being continually on guard, and warding off challengers, his reign is terribly short. There is no entente to secure his property rights. Nothing is assured to HIS prodigal pup. It is literally, the law of the jungle (beach).     

This provides some perspective to the natural state of the world without the Rule of Law. The mob, as they have done in the past, will take what they wish, when they wish it. Because, at certain junctures,  they can. There is nothing, other than the rule of law, to prevent those that are powerful, or can organize the power of others, from taking it.  The [benign] rule of law preserves, consolidates, and institutionalizes power so all things that benefit therefrom can blossom, including its own persistence. For it to work, the rule of law must nearly be universally accepted, which is not a hard sell - since its benefits are, even in its weak form, profound and widespread. One need only look at extreme failed states such as Somalia at one end, or North Korea at the other, should one have any doubts. Reality, of course, is a continuum of possibility in-between: from fascism, fragmented rule by war-lords; including a corporate police state.  But make no mistake: as a social construct there is an implicit contract - a ceding of some things in exchange for some other things. THIS contract, unlike many others facilitating the rule of law, while man-made, is unwritten. We may under-appreciate its nature during good times, but it will be evident should it dissolve. 

Particularly virulent deniers and those self-interested proponents of regressive fiscal regimes may contest that the law of the jungle, or authoritarian imposition of power is the entropic outcome. However, it seems to me that such arguments will deterministically assume away the asymmetries and rigidities that prevent the law-of-the-jungle competition, whilst protecting the benefits of the rule of law. It is at this nexus where the value of the rule of law should rightfully enter the equation.  The boundaries are necessarily wide. There is no single formula. But it seems that detached economic observers can identify whether prevailing policies and their outcomes are moving the nexus towards, or away from, some approximation of the point at which the entente is becoming more stable or less stable.  This is intricately tied to the debate on inequality and the opportunities for mobility, and whether the rule of law itself errs on the side of greater fairness, or greater parochial interest to, and institutionalization of, the super-beneficiaries of the rule of law.  

It is worth noting that the beneficiaries of the modern gilded age are not as mean-spirited as say, for example, the Russian landowning aristocracy was to their peasants. Few knowing observers shed a tear for what befell them. Nor is the plight of today's disadvantaged as dire as it was historically. Admittedly, this is not setting the bar very high, and it ignores the profound change in the direction of outcomes over the past three decades.  Most alarmingly, in the big picture, it appears as if  modern-day super-beneficiaries  have privatized the benefits of the rule of law, while more or less continuously diminishing their [mostly fiscal] responsibilities to finance it. THAT, in itself, says volumes about how much they collectively value the entente, or how ignorant they are in respect to its very existence.   

That is a great shame. Not because I worry for the future welfare of those deriving the greatest benefit, but because of the coarseness, and alienation it creates amongst the great majority of people, and the corrosion of that singularly-most-valued man-made creation, The Rule of Law.    

Wednesday, August 13, 2014

Farming Sucks

Rarely, in business, does everything proceed perfectly and according to plan. Conjure an image of the farmer. Winter rains are copious before tailing off. One is able to prepare the earth at the moment of perfection, and sow the crop, fencepost to fencepost, to one's apparently great advantage. The incessant rains of the winter that caused near universal grumbling gives way to sunshine. Germination is nearly total and growth proceeds like a lineup of thoroughbreds out of the gate. Temperatures stay mild. Frequent, but restrained showers continue to nourish the young plants. Financed inputs are applied at the right times and in the right proportions. The farmers' crops reach towards the sky with a rare virility, and he looks upon them with justifiable pride. Even casual observers cannot help but notice the unusual health of the fields, multiplied across the town, country, region, and yes, neighbouring countries. Drought and heat-waves remain elusive. Sufficient rain mixed with sun continues. Yields will approach the pinnacle of what man and nature can conspire to create. Natural disasters will be universally averted this year. The imminent harvest will, in all its preceding perfection, give way to, not the popping of champagne corks but to an........unmitigated disaster!!!! For sale prices will have halved, while fixed costs are ummm... errrr.... fixed. The bounty from nature's smile and their diligent hard work will be challenged to avoid profound financial loss. Rarely, in business, can things go so wrong, when paradoxically, everything goes so right. Rarely is the world so upside-down that bad is good and good, bad. Welcome to the world of the commercial farmer. And it's a right shitty one...

Thursday, July 03, 2014

Top 10 List: What It Takes To Become an Activist Investor

Cassandra's Exhaustive List of Prerequisites for Becoming an Activist Investor
Oh, and don't forget the Starbucks loyalty card. Happy agitating!

Tuesday, July 01, 2014

Another One Bites The Dust (mid-2014 Edition)

Things, people, and/or ideas believed to have integrity, now seemingly compromised...(the second third  fourth updated and expanded version). The bear market in integrity continues unrelentingly…2014 edition.

Jimmy Savile (tnx Anon)
Rolf Harris (tnx Anon)
US Veterans Administration
The Red Cross
Justin Bieber
The London Gold Fix
Chris Christie

US Govt Agency Data Release
The UK National Health Service
Swiss Train Safety
Nick Clegg
IM Confidentiality 
BBC Management & Oversight
Risk Parity
Segregated Customer Accounts
Investment Consultants
Bloomberg Privacy
Dark Pools
London FX PM Closing Prices
Meredith Whitney

Reinhart & Rogoff
Jérôme Cahuzac
Japanese Yen
Jamie Dimon/JP Morgan
Banca Monte dei Paschi di Siena 
IKEA Meatballs

Wen Jiabao as "Humble Servant of The People
Lance Armstrong
Top Ten Lists
Austerity as an Economic Panacea
Harvard Students' Academic Honesty
BLS Statistics
Cyclical Recovery
Book Reviews
Strong Computer Passwords
'Organic' Food
Money Velocity
Undecided Voters
The Food Pyramid
Purity of '.999 Fine Gold Bars
Penn State Football
"Top of the Pops" 
Fareed Zakaria
The "risk-free" rate
LIBOR as a Benchmark
Public Sector Pensions
HFT as a Beneficial Provider of liquidity
Diversifying properties of Hedge Fund's
Einstein's Theory of Special Relativity 
Celtic Rangers
Macroeconomic Forecasts
John Paulson
FRB Open Market Operations
Standardized Educational Testing
Swiss National Bank
A Relaxing Cruise
WTI as Oil Benchmark 
Olympus Corp.
Payment Protection Insurance
HM Revenue & Customs
Sony Playstation Network
Social Mobility
Actuarial Return Assumptions for Pension Funds
Ryan Giggs
France   AAA
Boob Jobs
David Einhorn
Nuclear Power
Deepwater Drilling
Tiger Woods
Professional Cricket
Professional Cycling
High-Frequency Trading
Professional Baseball
Professional Tennis
Municipal Bond Underwriting
The Catholic Church 
Track & Field Athletics
NCAA Sports
US Congress
UK Parliament
Analyst Research
Credit Ratings
Newtonian Physics
The Stock Market
The Food Pyramid
Incentive Stock Options
Reinsurance Brokerage 
Lou Dobbs
The Mortgage-Backed Securities Market
Hedge Funds
Social Security
Government Balance Sheets
Tooth Fairy

Errr ummm Professional Wrestling is starting to look good by comparison - at least it makes no pretensions to be anything other than it is. What's left?

Tuesday, June 24, 2014

Manna From Heaven

They call the JPX-Nikkei Index 400 smart beta. Ummmm, errrrr, yeah, sure, they can call it whatever they want, and perhaps, if they say it loud enough, and repeat it enough, some will adopt it as gospel. And God bless them - particularly the blithely gullible trustees. And my kids' trust fund blesses them - the latter benefitting large from (being as kind as kind can be) their rote sub-optimality. 

The JPX-Nikkei Index 400's  construction applies a straight-forward three-and-a-half stage process:  screen, score, score again, select by rank. Initial screening (from the TSE's website) looks like this and weeds out what, to some, is the detritus;

① Screening by Eligibility Criteria
Issues are excluded from selection if they fall under any of the following criteria. 
- Listed for under 3 years (excluding technical listings)
- Liabilities in excess of assets during any of the past 3 fiscal years
- Operating deficit in all of the past 3 fiscal years
- Overall deficit in all of the past 3 fiscal years
- Designation as Security to be Delisted, etc.
② Screening by Market Liquidity Indicator
The top 1000 issues will be selected from those eligible, excluding the above, in consideration of the following 2 items.
- Trading value during the most recent 3 years
- Market capitalization on the base date for selection

The first scoring covets OP, ROE and size, with bigger preferred to not-so-big.  The TSE calls this quantitative (noting the lower case "q" and italics, which are mine). It is a bit like an American vehicle MOT:  making sure it has four wheels (with tyres), the headlights that point straight, an engine that turns over when the fuel is ignited; the brakes stop the vehicle when in motion, and plumes of blue smoke are not being emitted from the exhaust. It is, yes, a car, in the least contentious sense.

The 1,000 issues selected in (1) will be scored according to the ranking of the following 3 items. (1st: 1000 points – 1000th: 1 point). Then, overall score is determined by aggregating those ranking scores with the following weights. (There are handling rules for the overall scoring with negative ROE and operating profit.) 
- 3-year average ROE: 40%
- 3-year cumulative operating profit: 40%
- Market capitalization on the base date for selection: 20%

The second scoring is qualitative, based on the admirable, but by no means universal, attributes of transparency, accounting standards, and oversight. For those that cannot distinguish what the second scoring is based upon as written,  it is "qualitative" with lower-case "q", italics and a tiny font size to highlight that this can only tweak the results by a maximum of 2%, a bit like smoking "lite cigarettes".

Following the scoring in (2), issues will be further scored based on the following 3 items. This score is complementarily added to the quantitative scores explained above (2)*.
- Appointment of Independent Outside Directors (at least 2)
- Adoption or Scheduled Adoption of IFRS (pure IFRS)
- Disclosure of English Earnings Information via TDnet (Company Announcements Distribution Service in English)
* The score is determined so that at most around 10 constituents are different from those chosen with only quantitative score above (2).

Then, it is a simple matter of letting the proverbial chips fall, or rather, rank wherever  they may, combined with an "all-change" every now-and-again.

So despite my amusement at such an offering, and thankfulness for those allocating passively to it, I am neither derisive nor pejorative in its essential mechanics, and though some might, I do not call it "dumb". It just does what it does. On the other hand, one would be forgiven for thinking proponents a tad hyperbolic in terming it "Smart". It isn't.  Beta? Yes. "Smart"? Errrr, no.  For how can something of value, that is being exchanged amongst consenting adults many of whom are meant to be fiduciaries, be "smart" when it is completely, and totally untethered from any sense of value? It is likely worse than navigating by dead reckoning, and probably inferior to the piñata method of security selection. Make no mistake, at times, it might be attractive. But, given that investors already covet consistent and high profitability in relation to their equity, with good governance, and that companies qualify only AFTER  they have had it for a good spell, it is not unlikely to forecast that it might, more often than not, yield negative alpha. So what would YOU call "smart" beta, with negative alpha? I call it "winning the battle but losing the war".

For many, however, this IS, manna from heaven. For exchanges and index licensors it means incremental revenue where none existed before. For journos it means grist for the mill. For trustees, it is a simplistic (albeit highly sup-optimal) answer to a complex investment problem. For Japan Inc. it provides convoy cover for suspicious behavior change -  yet-to-be-fully-embraced. For me, it will create a fantastic variety of relative investment opportunity whether from inflows, outflows, or re-balancing, that will keep giving and giving and giving. Hallelujah! Yes, it is manna from heaven for everyone except those investors whose money is passively and naively be thrown at something mis-labeled as "smart", though which is anything but. Blessed be index-makers...

Monday, May 26, 2014

Euro-Election Post-Mortem...

UKIP supporters, along with those of the European right are angry. And nostalgic. Nostalgic for ....ummm .....errrr..... Johnny Halliday? Johnny Rotten ? Sir Lawrence Olivier? Georges Pompidou? Chaban-Delmas? Harold Wilson? Ted Heath? Free parking? No traffic jams? A Ford Cortina or a Renault 4? Ten-pounds-a-week rent? Fifty-P a pint? Greasy chips fried in oil t'aint been changed for weeks? Baked Beans 'n'toast for breakfast? Twiggy? Cliff Richard? A white guy (not a Russian) winning at boxing or sprinting? One-piece swimming costumes? Free university? A job-fer-life? Iconic red pay-phones booths smelling of urine? Phones with an umbilical cord? Single-race marriages? The Cold War? Clean beaches? High-streets free from foreign food? Holidays in Blackpool? Turnips and root veg? Chicory drinks? Maybe. B ut I think that they are nostalgic for rising or stable real wages; a settled feeling that accompanies slower technological change; a stable job that pays a good stable real wage, with an indexed pension, and that is not undermined by someone more educated or qualified or enthusiastic, willing to work harder, for less especially if they are foreign; Oh and lower taxes. All of which are under siege. Regretfully, for sensible public policy, this has little to do with Europe, or immigrants, or the decline of religion and general moral standards. But that won't stop the angry cocks from THIS.

Tuesday, May 20, 2014

More Jitney's Needed?

There is considerable debate in the state of New Jersey about whether Newark or Camden is the Garden State's armpit. True connoisseurs of sweat, however, would add another - the one that gave us The Diving Horse: Atlantic City. All three have long-passed their glory days.  AC, remains a hollow shell of its mid-20th century optimistic seaside-self, despite many billions of collective investment by private casino operators and public authorities.  Camden more closely resembles war-torn Mogadishu or the bombed-out Syrian frontline of Homs than it does prosperous archetypical suburbs like Darien, CT or Merion, PA.  Newark, alone, may rise once again, like a Phoenix, recalling Philip Roth's adolescent days, if only a result of its proximity to New York.  Yet, Atlantic City, for all its flaws, retains a pragmatic solution to public transport from which many public transport authorities can learn. It is called The Jitney, and is simply an uber-practical shrunken bus.

Nothing is more galling to a taxpayer than senseless avoidable waste. Cynical fraud can at least be seen in the context of benefits delivered. Some mean-spirited Libertarians see it everywhere. I am more generous, but nonetheless loathe stupidity, rigidity and tolerance for things abysmally-sub-optimal. Where I reside, in the leafy hilly part of Kent County, everyday I see huge, aged, empty buses plying their routes with growling Spitfire-sounding diesel's that would annoy Harley riders, struggling to climb steep grades as they make their way through the lanes and up hills of my area, belching smoke, wasting petrol, blocking or slowing traffic both on major arteries and B-roads, menacing cyclists with their overtaking. And outside of the rush hour/school runs, they are empty -  or appear virtually so given the ratio of passengers to available seats.  Ghost buses. And each and every time I see this, apart from my selfish desire for less polluted air, silence, and budgetary optimization, I feel as if a crime were being committed. And I wonder: where is the Jitney? One would have thought that, if one formed opinions on the basis of hyperbole, the private sector would have ingeniously invented and tailored market solutions that would quickly eliminate (or reduce) the horrifying waste described for all of these are private concessions (Arriva, MetroBus etc.) with, one would presume, the appropriate profit motives.  

France is not without its macroeconomic and social problems. However, when it comes to public sector policy solutions and their execution, be they infrastructure, public works, or healthcare, one should take notice, not because I say so, but because they tend to pursue non-ideological pragmatic solutions to policy conundrums that would baffle ideologues from both the right and left.  In contrast, to the smoke-belching rust-buckets on spartan routes subsidized by my UK County plying their neglected, pot-holed roads, my municipality in France, delivers multiple bus solutions that pragmatically balance efficiency, cost, with public needs in pursuit of the public interest. During busy hours, and in high-demand areas,  the public authority deploys modern quiet, bendy-buses while on smaller routes, they dispatch drivers with modern Jitney equivalents that navigate country lanes without endangering on-coming traffic (and cyclists thankyouverymuch!!) and that can climb hills without draining the public fuel depot and purse. While the agency combines the resources of 13 towns surrounding our main city, the public authority also cooperates and coordinates with the regional transport authority to run convenient routes that cross jurisdictions without, as the case in my UK village, having to change buses just because of splintered geography and fractured concessions. That is even before mentioning cost which is low by any standards, but benefits everyone:   passengers, business, non-passengers (less traffic and congestion on the road) and everyone else by lowering pollution.

Brits are a curious lot. Stoic. Patient. And, in the main, suspicious of collective activity as Orwell highlighted six decades prior, save for self-organizing their curiously peculiar pass-times such as birdwatching, needlepoint or plane-spotting societies. This suspicion of The Group Movement, he pointed out, insured that facism could never gain a foothold over these islands. For the mere sight of goose-steppers on the High Street with their earnestly-shined boots and silly rigid march would elicit derisive mocking laughter - a far greater deterrent than any form of counter-organization. The dark side of this combination of national traits is that the majority of people, and the public's interest  suffer at the hands of more intensely-motivated and greedy parochial interests. Private monopolists abuse inelastic demand curves with an inert and collusive political class and the result: USD$40 a train ticket into London for the scant 24 mile return journey ($50 if you wish to park your car), roads that are hopelessly pot-holed and in dis-repair despite some of the highest road taxes and fuel-surcharges in Europe; bus-service so poor and mis-fitted for purpose it makes you cry. And the people stoically, patiently, say nothing, and do nothing, as the carpet-baggers using the svengali-like mantra  of "free-market is best" empty the purses of the people extinguishing any hope of creating pragmatic efficient solutions to public policy issues. Like deploying efficient Jitney-like buses. Or maintaining authority and rectitude over monopolistic concessions sold or granted in the public's interest, rather than the Public Interest being treated like little fuck-boys of opportunists-run-amok.  And still, the monopolists continue to push, and take, and gorge, not realizing the risk they run for themselves and their investors. Even the Brits have their breaking point and make no mistake, stoic as they are, even though it's been more than eight centuries, they WILL "go postal".

How they managed to run an empire is baffling. In all likelihood, it would have baffled Cyrus and Darius too. Now, the home territories are neglected. Now, there is too little enlightenment. Too little wisdom. Too little pragmatism. And not enough Jitneys...

Monday, May 05, 2014

Edginess or Extrapolating The Unextrapolatable

Edginess. No, I am not referring to the one sought by my daughter by rolling her own and pushing boundaries (fortunately, for a parent, eschewing the tats, for now at least), but as in uneasiness, anxiety, disquietude, restiveness, worry, and an increasing sense of agitation of the type that George Soros wrote about in his journal as a feeling that gnaws at him from within his stomach.  

I am becoming more aware of my growing agitation - and rather than let it gnaw away, I will try to dissect and articulate it in order to share with you for I've been sanguine about equity risk for what seems like a long time, certainly one of the longest periods I've held my pessimism in check. During this hiatus from my natural state, I've derided perma-bears through the recovery -  through the Euro wobbles, US budget concerns, the ridiculous hyper-inflation/QE hysteria, and dismissed those both selling and wishing to buy tail risk insurance after the proverbial horse had bolted suggesting to those interested to heed Bob Litterman and SELL the insurance (SPX puts), rather than buy it. This is not because I am optimistic by nature, or otherwise bullishly inclined. Rather, it was because for much of the last five years -  scarred investors were underweight despite, in plain english, things more or less continually improving on all fronts, albeit not fast enough for those in search of instant gratification. "Up" has been the path of least resistance. Housing/construction/ was diminished, and financials were so cratered, they are still, only now, getting back to something resembling normal index weights. Couple that with much of large-cap tech undemanding at close to single digit forward multiples and the risk, as PensionPulse's Leo Kolivakis presciently called, moved more clearly to the right.  That was then. Over the past four year, investors have been squeezed in - and for the right reasons: absolute and relative valuations, cash-flows and earnings growth - all which have been more-than requited by their materialization, pwning the pessimists!!  

Now, it no longer is obvious that investors are under-invested. Now it appears that they are, en masse reasonably allocated. In the process they've taken forward-looking returns from rather attractive levels with large implied equity-risk premia, down to levels which don't leave much margin for "shit happening".  In the process, investors may very well have done too much of a good thing, inflating ratings (on a forward-looking basis) to pedestrian levels at best, or positively-unattractive ones - implying low to negative forward returns at worst.  In itself, this situation doesn't mean imminent danger, and can continue - given positive sentiment, piss-poor alternatives, supportive monetary and fiscal policy, and the chance that underlying growth may continue unabated (and even accelerate) without undue inflationary pressures, keeping the ratings high as stock prices increase further. For the avoidance of doubt, this is not a bubble in the popular sense of the word. We have indisputably had phenomenal corporate earnings growth justifying and supporting the reversion back to the reasonable from ostensibly cheap crisis levels.  In the process, investors have become comfortable increasing the rating of equities towards more historically-dubious levels, and in extrapolating forward, idiosyncratic boosters to earnings that I do not believe should be extrapolated.

Yes, I am gnawingly concerned  about the blitheness with which many investors assume that major contributions to past earnings growth will replicate themselves going forward, an occurrence that often presages an intersection of bloated expectation with the spartan-ness of a wetter and colder reality.

Imagining a classical "T" account to conceptualize my edginess, I place these positive contributors to earnings growth since 2009 on the left-hand side of my construct: 

* Sustained USD weakness. (USD weakness has flattered USD translated global sales and earnings)
* Constrained capex (Squeezing existing capital stock coincidental to prior capex depreciation rolling-off, dramatically boosts EPS; investors dazzled by and extrapolating EPS growth, but at CF level, multiples are getting heady. Eventually companies will have to re-invest which will hit both operating and bottom lines)
* ZIRPy interest rates. (Low rates have one-off refinancing benefits that benefit bottom line, and remain as long as ZIRP. Corp earnings now short put on rates for refi) 
* Wafer-thin credit spreads. (Ditto above: one-off refinancing benefits to EPS but forward profile is left-skewed risk)
* Buybacks/share count squeeze. (Buybacks - whether from cash-flow or debt have materially goosed EPS over last five years. But, with capex needs increasing, and valuation ratings elevated Co's will find it increasingly difficult to justify maintaing/curtailing buybacks). Yet, only NOW in typical gamma negative behavior are co's leveraging up to buy back stock.)
* Wage restraint (Corporate pricing power coincident to falling real wages will not last forever. With economy hollowed, and jobs already offshored, one would not be remiss forecasting  that we are at or near peak disparity. The wage squeeze has given Co's enormous operating leverage during the last five years of recovery. UK real wages ticked higher than inflation for first time in years, last print. In US, with @6.7% unemployment, the balance of power favoring Co's feels like it petering out. If so, this will hit operating and bottom-lines directly. With Piketty on top of best-seller list, one might also wonder whether this is another tell-tale of the end of the squeeze on labour. ) 
* Tax holidays/optimization.  (Firms are increasingly keeping money offshore and borrowing onshore to buyback stock or pay divs rather than repatriate and pay tax); They consolidate overseas earnings gross of tax, but with increasing scrutiny of avoidance/minimization they will have to bite the bullet sooner or later;  It looks like earnings have grown, but if you can't use them or return tim to shareholders without taking a hit, there appears to be an asymmetric outcome. At best, it is baked into the price; at worst investors have discounted potential liability over-stating realizable cash flows.   
* Pension holidays. (Higher asset prices thanks to recovery have allowed firms to get actuarially onside and reduce DB plan contributions, in many cases reducing contributions that directly flatter both operating and bottom line earnings. Never mind that with asset prices high, the actuarial assumptions of most DB plans are unrealistically optimistic. With so many asset classes fully valued, and forward expected returns low - see GMO forecasts - such holidays will end. And in true to gamma-negative feedback loops, one need only imagine what might be required were asset prices to fall…). 

And In fairness, one must take into account drivers on the other side of the "T" account that may continue to have legs such as: 

* Pricing Power.  (Increasing industry scale, concentration, oligpopoly have materially diminished competition, and created competitive moats that have buoyed both prices and margins across many industries. Toothless regulators, concentrated gain to collusion and diffuse pain make it unlikely that margin gains from such sources will reverse anytime soon. It remains more attractive to collude and bank immediate benefits with certainty than pay fines in the future, in which there is reasonable likelihood, it will go completely unpunished. ) 
* Productivity.  (Benefits from IT and FA, after years of disappointment have finally gained traction. They can continue to surprise to the upside offsetting reversals in the above.) 
* EM Growth. (Volume growth outside DMs has provided meaningful surprises, and may continue to pick-up slack resulting from other erstwhile disappointments).

Despite prolonged meditation, I make no claims that either side of the T-account is complete.  But I suspect that if one took the combined income statement of the SPX, non-exptrapolatable growth boosts explain a large portion of the upside growth Co's have seen in both operating and top-line earnings. Analysts (both top down and bottom up) are well known for more or less extrapolating priors, but I surmise that at precisely the time these are getting harder to reproduce, or are on the cusp of reversing, the ratings are getting extended, and this is a recipe for concern - not because 17x or 18x earnings is an awful return in  tame inflation environment - but because expectations are primed for more of the same dancing juice. This, and the gamma-negativity of some of the variables themselves has the potential to cause a more vicious negative feedback loop, inconsistent with a tame VIX, and extremely low historical vol., and for which markets are neither prepared nor positioned. 

This is why I feel edginess, despite having been a committed "probability-adjusted optimist"… 'till now. With that said, I historically have been early….and what with parabolic-like pops as we saw in Feb/Mar, it is likely there'll be additional opps to temper exposure or put in place more attractive conditional hedges.