Leading Indicators & the Growth Debate

The Conference Board’s Index of Leading Economic Indicators rose again in August, extending a five month streak of gains. Clearly, the U.S. economy has troughed and is poised to expand, and it still looks likely that the expansion will surprise to the upside. This supports the position we staked out in early June, which marked a turn from our pessimistic outlook of 2008:

[T]hese signs [a recruiter survey and payroll data] confirm what credit markets and unemployment claims have been indicating during the second quarter, and we continue to see a very high probability of the recession ending this year. In fact, there’s even a reasonable probability of the recession ending this quarter (ie, by the end of this month). And while it’s likely to be some time before we return to the level of economic activity that prevailed before this downturn, the rate of growth from current levels looks like it could surprise to the upside.

Some of the pundits quoted in an AP story about the LEI sound almost giddy about economic prospects, others still very skeptical. We agree with the skeptics a least in part, as they agree with the caution we expressed in June:

The caveat, as before, is how durable the recovery will be, and on that count, we still see plenty of risks to the U.S. economy in late 2010 and beyond. Such a cycle would reminiscent of both the late 1970s and the late 1930s.

But as noted above, we now place a very high probability on the ensuing expansion surprising to the upside, and perhaps the evidence we base this on is causing the giddiness among some commentators. If so, we would urge some sobriety — as we have been pointing out in recent months, high growth magnitudes are not desirable if they are a symptom of economic volatility.

URLs:

http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

http://symmetrycapital.net/index.php/blog/2009/06/recruiter-confidence-and-economic-outlook/

http://www.symmetrycapital.net/idlespeculation/20080925_policy_mix.pdf

http://news.yahoo.com/s/ap/20090921/ap_on_bi_ge/us_economy

D.C. Insider Trading

There’s a governance revolution afoot in the world. Beltway and other capital denizens should be careful to take notice.

We posted that claim in January 2007, and 2009 has provided some interesting evidence in support. Furor over lawmakers’ fringe benefits in the U.S. and the U.K. has been a recurring theme, and now we’ve learned of a story that flew below our radar until a segment on CNBC’s “Street Signs” today. Apparently, a bill has been proposed that would subject legislative activities to insider trading rules. The following description is from the website of co-author Rep. Brian Baird, D-WA (emphasis added):

Insider trading should be illegal on Capitol Hill. While that might seem like common sense to some, there is currently no legislation that prohibits Members of Congress or their staffs from enriching their portfolios with the nonpublic information they are able to glean from their day to day jobs. [On July 13, 2009] Congresswoman Louise M. Slaughter (D-NY-28) and Congressman Brian Baird (D-WA-03) took an important step to closing this loophole by testifying before the House Financial Services Committee about their legislation: the Stop Trading on Congressional Knowledge (STOCK) Act. When passed, the bill will make Members of Congress and their staffs subject to the same regulations that the general public is subject to.

“Members of Congress and their staffs should not be above the law when it comes to profiting from sensitive information. The American people expect their public servants to represent their interests, not fatten theair stock portfolios,” said Congressman Baird. “The STOCK Act is an important step to restore integrity and public trust in two institutions that badly need it: the financial industry and Congress.”

“This bill is about transparency and fairness,” Slaughter said. “As it stands today, neither Members of Congress nor their staff can be held legally accountable for making personal investment decisions based on non-public information. This bill changes that by opening those individuals up to be included under insider trading rules.”

This is fascinating stuff, and near and dear to our hearts — it captures the importance of legislative activities and the significance of agency risk in the political domain. As we’ve argued elsewhere, actions and expected actions in the public sphere — legislative changes regarding taxes, regulations, etc — can have powerful effects on asset values, and this idea is a key part of our investment process. There is also a novel but growing body of research regarding the the performance impact of privileged legislative information, and it was reported during the CNBC segment that sizable fees are paid to lobbyists and public sector employees by private investors (alleged to be primarily hedge funds) in order to obtain access to it. However, one thing that we really like about the Slaughter-Baird bill is that it focuses directly on the conduct of members of Congress, and does not try to lay most of the blame on private parties extending fistfuls of dollars.

Our philosophical position is that an investor can benefit by (1) understanding how significant a role government plays in investment returns and (2) making well grounded assessments regarding the course and consequences of public actions. But despite what we wrote in 2007, we did not hold out much hope that the outsized investment returns accruing to political insiders and/or their private sector contacts would become the focus of regulatory or legislative scrutiny this soon. We tended to agree with the pessimistic view expressed by James Surowiecki in 2005:

[The American people] don’t seem all that interested in doing much about it…Perhaps we want to keep the insider’s advantage intact because we all want to be inside. The choice is between a system in which people get rewarded for the work they do and a system in which people get rewarded for who they know or for what they’re lucky enough to stumble into. And in Washington today that’s no choice at all.

Thus, Reps. Slaughter and Baird’s bill is a welcome and courageous initiative, even if execution would involve some degree of wind mill tilting (more detail regarding the bill is available on Rep. Baird’s website). Of course, at this point it’s just a bill, and it was also reported on CNBC that there is little likelihood of it coming up for a vote any time soon. However, where Surowiecki’s quote would seem to direct most of the blame towards the American electorate, we wonder if legislators simply enjoy too great of an asymmetry in power and information at present — in which case, while we stand by our opening quote, we don’t think that substantive reforms are likely to arrive any time soon — unfortunately.

In the meantime, if this topic is of interest to you, here are some interesting reads:

James Surowiecki, “Capitol Gains”, New Yorker 10/31/2005

Ferguson and Witte, “Congress and the Stock Market”, 3/13/2006

Ziobrowski et al, “Abnormal Common Stock Investments of Members of the United States Senate”, Journal of Financial and Quantitative Analysis, December 2004 (abstract only)

URLs:

http://symmetrycapital.net/index.php/blog/2007/01/a-seamy-trifecta/

http://symmetrycapital.net/index.php/blog/2009/06/tr2-parliament-and-congress/

http://www.cnbc.com/id/15838408/site/14081545/

http://www.baird.house.gov/index.php?option=com_content&task=view&id=960&Itemid=99

http://symmetrycapital.net/index.php/profile/#process

http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=4204676

http://www.newyorker.com/archive/2005/10/31/051031ta_talk_surowiecki

Dog Kisses, Wolf Vomit, and Investing

Our quote of the day is taken from a Time article about cutting edge research into canine cognition and behavior:

“If we happened to spit up whatever we just ate, I don’t think our dogs would be upset at all.”

The gist of the quote is found in the following passage:

The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection.

Believe it or not, this example is relevant to investing, finance, economics, politics, and pretty much every other human endeavor, as it nicely illustrates the gaps that can exist between beliefs, perceptions, and reality. When we interact with a dog, we can’t prevent ourselves from thinking human thoughts, thoughts that are also deeply embedded in our biological and cultural backgrounds. That means that for most of us, when another person kisses us excitedly about the face and mouth, they are demonstrating the affection they feel for us (though sometimes it’s other emotions, as Fredo Corleone could attest). And in most cases, that’s probably what the other person is thinking too. But apparently that might not have any resemblance to what a dog is thinking when it “kisses” you. Nonetheless, we tend to believe it is a “kiss”, primarily because receiving affection, real or perceived, makes us feel good. But it’s an interpretation that is probably not well grounded in reality.

In the investing world, decisions and behaviors are not always grounded in a solid assessment of reality either. For example, while it might have felt better to sell risky assets in February or March of this year and be done with it, the reality is that it would have imposed a severe performance cost (to this point, anyways). Likewise, it feels good to own assets that are in popular demand, like homes from 2003-2006, tech stocks from 1998-2000, and so on. The overwhelming use of “momentum” indicators in the investing business indicates that the majority of professional investors are prone to the same kinds of mistakes. While the continuing prevalence of herding behavior in financial markets might be comforting to individual members of the herd at most times, it’s almost certain to cause episodes of significant harm.

Studies of successful investors and traders have found that while they experience the same emotions and discomfort as every other person dealing with risk and uncertainty, they have developed skills that allow them to manage emotions with reason and discipline. Specifically, they have a firm grasp of the fact that they are involved in a probabilistic endeavor that may not turn out well in every case, and they apply consistent decision making processes, even when it would feel better to run the other way. While you may never need to develop the ice water veins of a successful trader, or the steely nerves of a contrarian investor,  there are a couple of old adages that, because they are well grounded in reality, should help all investors avoid excessive reliance on emotion when making financial decisions:

What goes up must (eventually) come down.

Don’t put all your eggs in one basket.

Of course, in the world of human-canine relations, it probably won’t cause any harm to believe that a dog kiss is, well, just a kiss. It sure beats the alternative!

URLs:

http://www.time.com/time/magazine/article/0,9171,1921614,00.html?xid=yahoo-feat

http://www.youtube.com/watch?v=FcFlp6kl508&feature=player_embedded

DISCLAIMER: Symmetry Capital Management, LLC is a Pennsylvania registered investment advisor. The foregoing is not a solicitation to buy or sell any security, or a recommendation to engage in any particular investment strategy.

The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”

Treasury: Stronger Capital, Liquidity Standards

The U.S. Treasury has telegraphed its objectives for reformed international capital standards (emphasis added):

The global regulatory framework failed to prevent the build-up of risk in the financial system in the years leading up to the recent crisis. Major financial institutions around the world had reserves and capital buffers that were too low; used excessive amounts of leverage to finance their operations; and relied too much on unstable, short-term funding sources. The resulting distress, failures, and government bailouts of these firms imposed unacceptable costs on individuals and businesses around the world. Going forward, global banking firms must be made subject to stronger regulatory capital and liquidity standards that are as uniform as possible across countries. Today the Treasury Department set forth the core principles that should guide reform of the international regulatory capital and liquidity framework to better protect the safety and soundness of individual banking firms and the stability of the global financial system and economy.

This is good stuff. Hopefully Secretary Geithner’s people will be able to get something like this done, and health care won’t prove to much of a distraction for the Administration — hopefully.

The bulletin claims that the standards should be agreed formally by the end of 2010, and regulations implemented by the end of 2012 — which unfortunately leaves plenty of time for another crisis or two to unfold, especially with the Fed and LIBOR rates being as easy as they are.

URLs:

http://www.treas.gov/press/releases/tg274.htm

SEC Chairman Bernie Madoff

“SEC Chairman Bernie Madoff”. The words just roll off the tongue, don’t they? Especially when your jaw is resting on the floor.

Investment News has posted a short article on findings of an internal SEC investigation into interactions between the SEC and Madoff’s firm, and it’s a noxious blend of surrealism, agency abuse, and wretched ethics.

The jaw dropper in the story is the possibility that, over a decade into his firm’s $50B fraud, Madoff believed himself to be outgoing chariman William Donaldson’s successor. Was he just delusional? Or was there a real possibility of such a tragic political appointment?

According to an executive summary of a report released yesterday by the Securities and Exchange Commission’s inspector general, Mr. Madoff told SEC examiners in 2005 that he was “on the short list” to become the next SEC chairman…

The following excerpts (emphases added), like the rest of the Madoff affair, will only reinforce the stubborn view that Wall Street is hopelessly stacked against the little guy:

Although the IG report summary details numerous dropped balls by SEC examiners and enforcement staff that allowed Mr. Madoff to conduct a massive Ponzi scheme over a period of years, his prominence in the securities industry may have helped him avoid scrutiny.

The report said that throughout a 2005 examination of his firm, “Bernard Madoff would drop the names of high-up people in the SEC” to SEC examiners.

When examiners in the SEC’s Northeast regional office complained to their assistant director about not getting cooperation from Mr. Madoff, “they received no support and were actively discouraged from forcing the issue,” the IG report said.

When the Northeast regional staff inquired about a similar exam that had been performed earlier by the Washington staff, a senior-level Washington examiner told junior-level examiners in the Northeast office that Mr. Madoff “was a very well-connected, powerful, person,” the report said.

When Northeast office examiners wanted to look beyond the issue of front running at Mr. Madoff’s firm, their assistant regional director denied their request, the IG report said.

A request to look into Madoff feeder funds was also denied.

Boy, with friends in high places, there’s nothing you can’t do…to other people especially!!!

Here’s the surreal part. Despite the implications of the foregoing findings, the SEC report concludes that “inexperience and poor training were key causes of the failure” of three examinations and two investigations to find any wrongdoing. Good grief…

There’s a disturbing possibility at work, which is that Madoff may have viewed an SEC chairmanship as providing some protection or cover for the criminal risks he was involved in. Had he taken over from Donaldson, the scandal could have put the SEC out of existence!

We can only hope that Madoff was a self-deluded name dropper and nothing more. Otherwise, Chairman Schapiro’s response to the Madoff scandal — “to hire new skill sets, [increase] internal training, and [seek] more resources to keep pace with financial fraudsters” — ignores the more glaring and fundamental need, which is to overhaul the culture, ethics, and agency risks inside the SEC.

We’re sure there’s more to come. Stay tuned.

URLs:

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090903/REG/909039994/1094/INDaily01

FP: 7 Myths About Alternative Energy

An interesting, sober assessment of alternative energy is available on Foreign Policy’s website: “Seven Myths About Alternative Energy“.

URLs:

http://www.foreignpolicy.com/articles/2009/08/12/seven_myths_about_alternative_energy?print=yes&hidecomments=yes&page=full