3Q GDP

Our prediction that the recession ended in the 2nd quarter was bolstered by yesterday’s GDP data, with its advanced estimate of 3.5% growth. What’s more, GDP is likely to surprise to the upside in coming quarters – there’s even a small chance of seeing a six handle in the quarters ahead. As a result, we expect employment trends to bottom out in 4Q09 or 1Q10. 

This optimism tends to surprise a lot of people, but let’s keep in mind that %GDP is a measure of change, not level. Yes, domestic production is still well below where it was in recent years, and both demographic and policy trends look unfavorable for pure private sector activity. But a steep fall in output induced by a massive credit crunch, followed by a healthy dose of fiscal stimulus and inflation (reflation) of bank reserves, is invariably going to cause a snap back in economic activity. High rates of positive change on much lower levels of output than we saw two to three years ago does not mean that the crisis didn’t happen. But they do indicate a better direction for economic activity.

URLs:

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

http://www.bea.gov/newsreleases/national/gdp/2009/pdf/gdp3q09_adv.pdf

http://online.wsj.com/article/BT-CO-20091029-717021.html

Hacking Supplants the FOIA; Defending Maxine

Why go through the burdensome process of a Freedom of Information Act request when you can just hack your way into sensitive government material?!? According to AP, a report on preliminary inquiries by the House Ethics Committee was stolen from a junior employee’s computer via exploitation of a connection to a P2P file sharing network. 

The report included the cases of Rep. Maxine Waters and Rep. Laura Richardson. Rep. Waters’ case was already public. She allegedly used her position to help a smaller bank, OneUnited, which her husband is involved with, gain access to Treasury officials and thus TARP funds. OneUnited still had to go through the application process, and was required by Treasury to raise $20M of equity capital in order to qualify for $12M of TARP funds. That may sound like an unseemly use of access and privilege, especially to those who detest Rep. Waters’ politics, but let’s be fair – a small African-American owned bank is far less likely to have a hotline to the Treasury or the Fed than a large investment or money center bank. Rep. Waters acted as that conduit — which is sort of the idea in a representative democracy, isn’t it? In our view, it would only demonstrate poor ethics if other small banks in her district, that she or her husband were not stakeholders in, requested similar efforts from her and were refused.

The Richardson case sounds a lot like Sen. Dodd’s personal mortgage dealings with Countrywide, which is a bigger lapse in our view, as she would have been the primary beneficiary of her actions.

Not surprisingly, the largest number of inquiries have to do with defense spending.

A fun question for voters to reflect on: Apart from obvious concerns over more sensitive government data, was this hack a good thing or a bad thing? Was it a heroic act, a criminal act, or a little of both?

URLs:

http://finance.yahoo.com/news/Ethics-report-leaked-apf-1026316031.html?x=0&sec=topStories&pos=main&asset=&ccode=

http://online.wsj.com/article/SB123258284337504295.html

https://www.oneunited.com/

PLEASE NOTE: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and may earn a percentage of any sales generated by clicking through to the Amazon.com website from links on our website.

H1N1 Update

AP is reporting that “some people who aren’t at high risk for swine flu complications got the much-in-demand vaccine…healthy adults or senior citizens instead of kids, pregnant women and people with health problems.”

Should that be cause for alarm? On the one hand, public health officials and members of at-risk populations should be proactive about getting the vaccine, and others should be supportive of those efforts. But on the other, the greater the number of vaccine administrations, the lower the risk of H1N1 to the rest of the population, including at-risk groups. As the article reports:

One of the doctors who helped draw up guidelines for vaccine priority groups also isn’t surprised at how things are unfolding.

The government’s vaccine advisory panel “did not expect vaccine police to be set up around the country,” said Dr. William Schaffner, a flu specialist at Vanderbilt University Medical Center, who is on the panel.

If vaccine demand is low in some locations, it makes sense for non-priority groups to get it instead of wasting the supply.

“I don’t consider it a problem,” said Schaffner. “I consider it more of a problem if vaccine is left unused.”

That seems to make sense. Also, flu trends being reported by the CDC are scary enough this year that we can understand people’s temptation to avoid chivalrous conduct. Based on the latest data released for Week 41, which ended October 17th:

• Just about all of the reported and tested flu cases this season appear to be H1N1 (“swine flu”).
• The proportion of deaths relative to the number of hospitalizations has run between roughly 3% and 8%. Granted, this is a hospitalization-fatality rate, not a case-fatality rate. But imagine you have a severe enough case to enter the hospital, and have a 5% chance of not returning home. And while the proportion of deaths appears to be trending down since late August, the number of hospitalizations is up over 500%, so a lower percentage of fatalities out of a much larger number of hospitalizations provides little comfort — for example, the number of deaths in week 41 was up more than 200% over week 35.
• The number of flu deaths per week has been increasing exponentially since 2006, and to paraphrase George Soros, it’s gone ‘parabolic’ this year. There were 1.5 deaths per week in 2006-07, 1.7 in 2007-08, and 2.23 in 2008-09, while the current run rate for 2009-10 is 7.6! [We divided by fifty two because the flu didn't take its normal seasonal break this summer; the actual number of deaths per week during flu seasons would be higher than those figures.]
• According to this chart of expected versus actual cumulative hospitalizations and deaths, it’s not apparent that any age groups are at higher risk  than any others. In fact, one could argue that the 18-49 group should be at the front of the line! As we pointed out previously, this mimics the ‘W shaped’ global influenza pandemic of 1918 that killed many, many millions of people, and a far greater number of healthy adults than a typical influenza virus.

H1N1 is not only scary enough at the moment to excuse some people elbowing their way to the front of the line for the vaccine. You can actually make a sound argument, based on historical evidence and current data, that healthy twenty to forty year olds should be included in the target population for the vaccine. Perhaps that’s one reason why the CDC is not up in arms about the lack of ‘vaccine police’.

URLs:

http://news.yahoo.com/s/ap/20091030/ap_on_he_me/us_med_swine_flu_vaccine_cheaters

http://www.cdc.gov/flu/weekly/

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/AHDR41.htm

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/IPD41.htm

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/EIP41.htm

http://www.cdc.gov/ncidod/eid/vol12no01/05-0979-G2.htm

http://www.cdc.gov/ncidod/eid/vol12no01/05-0979.htm

http://www.amazon.com/gp/product/0971542821?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0971542821

PLEASE NOTE: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and may earn a percentage of any sales generated by clicking through to the Amazon.com website from links on our website.

Roubini re USD Carry Trade – Back to the Future

Via an Edward Harrison post on Seeking Alpha, we learned of Nouriel Roubini’s recent comments that the USD is fueling the “mother of all carry trades” and creating multiple global asset bubbles.

Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.“We have the mother of all carry trades,” Roubini, who predicted the banking crisis that spurred more than $1.6 trillion of asset writedowns and credit losses at financial companies worldwide since 2007, said via satellite to a conference in Cape Town, South Africa. “Everybody’s playing the same game and this game is becoming dangerous.”

The dollar has dropped 12 percent in the past year against a basket of six major currencies as the Federal Reserve, led by Chairman Ben S. Bernanke, cut interest rates to near zero in an effort to lift the U.S. economy out of its worst recession since the 1930s. Roubini said the dollar will eventually “bottom out” as the Fed raises borrowing costs and withdraws stimulus measures including purchases of government debt. That may force investors to reverse carry trades and “rush to the exit,” he said.

“The risk is that we are planting the seeds of the next financial crisis,” said Roubini, chairman of New York-based research and advisory service Roubini Global Economics. “This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.”

There is plenty of truth in what Roubini said, but it’s nothing new — carry trades have been a recurring feature of the post-WWII global financial system, especially since the 1960s, when the breakdown of the Bretton Woods global gold exchange system began. And as we have noted for some time, the U.S. is in a long (perhaps multi-decade) cycle where monetary policies appropriate to domestic economic conditions will have inflationary consequences abroad, and thus some residual stagflationary effects at home. This is the inverse of the 1980s and 1990s, and parallels experiences of the 1960s and 1970s. And while we previously believed that fiscal, regulatory, and other economic policies were the only important drivers of such outcomes, we now believe that demographic trends play a major and possibly decisive role. If true, we expect with near certainty that current trends will remain intact through the next decade, based on global demographics. Economic policies certainly play a critical role, but their effects unfold at the margin, i.e., outcomes can be made marginally better or marginally worse by policymakers’ decisions (though history shows that there is always the possibility of policies going off the rails, and thus having more than just marginal effects).

Despite Roubini’s protestations, it’s not clear how far USD fueled asset speculation might go. Harrison rightly points out that Japan’s quantitative Yen easing in recent years coincided with bubbles in mortgage finance. But as we have pointed out in prior assessments of the crisis, that carry trade was amplified substantially by historic leverage ratios in the U.S. and parts of Europe among investment banks, some of their clients, and private households. This was due primarily to regulatory lifting of leverage limits and public support of mortgage markets, as well as bankruptcy reform legislation that made lending to consumers more attractive (or so it seemed at the time!).  That’s clearly not the trend at present: deleveraging continutes apace in the private sector, offset only partially by governments as they try to ameliorate declining resource utilization. Furthermore, some beneficiaries of the current carry trade are behaving rather soberly, at least for now. For example, Brazil recently instituted capital taxes to act as a brake on hot flows. That’s precisely the opposite of what homeowners, consumer credit borrowers, investment banks, private equity funds, hedge funds, and many others did during the height of the Yen trade.

Unfortunately, the global financial system is a rather efficient beast these days; not necessarily at finding the best targets and optimal levels of investment, but at finding and over-exploiting any pockets of demand for credit flows it can find, and at keeping sounder regulatory constraints at bay. And if a sounder regulatory framework and capital standards are not imposed globally – a risk that seems to have a rising probability at the moment – then Roubini will certainly be proven right, and our global financial system will impose substantial social costs on billions of people yet again. The more this song repeats itself, the worse the public’s demand for retribution will be on the other side of any future crisis. Bonus caps today, firing squads tomorrow?

URLs:

http://www.creditwritedowns.com/

http://seekingalpha.com/article/169364-is-u-s-dollar-carry-trade-replacing-the-one-in-japanese-yen?source=article_lb_articles

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=atlyygQuBLUI

http://symmetrycapital.net/idlespeculation/20090209.pdf

WebCPA: IRS Steps Up Enforcement on the Rich

WebCPA is reporting that the IRS is planning to step up enforcement efforts against complex tax sheltering strategies employed by wealthy taxpayers.

While we generally support such an idea, we also wonder (1) if these actions will be combined with any kind of tax rate flattening strategies from Treasury and (2) how fairly it will be implemented (i.e., will there be any ’operational exemptions’ for politically connected taxpayers?).

WebCPA also reported that Congress’ Joint Committee on Taxation is drafting legislation that would force offshore account data to be provided to the IRS.

Philosophically, we agree with this idea too, but there are some risks associated with it. First, and perhaps most obvious, are the credibility issues around Rep. Rangel’s involvement, given his personal tax issues and the apparent kid glove treatment he received from the IRS. Second, a measure like this may intensify perceptions that the U.S. government is becoming increasingly burdensome to deal with in international financial transactions, as occurred in the wake of the Patriot and Anti-Money Laundering Acts. Lastly, there’s some risk, perhaps remote, that this pushes human capital away from the U.S. To the extent that any future expatriates are simply tax evaders who have no ethical qualms about enjoying public services paid for by less wealthy taxpayers, it’s probably a plus. But to the extent that productive citizens who simply feel that they are being asked to pay more than their fair share start turning in their U.S. passports, it could be a serious problem, one that we’ve raised caution flags about before.

Finally, it strikes us that there’s an interesting parallel at work here, as a looming global war over tax revenues might be seen as echoing the global war that loomed over natural (and financial?) resources in the 1930s. The difference in this episode is that the U.S. is the open aggressor. Congress and the Treasury are clearly walking a tightrope on tax issues at the moment.

URLs:

http://www.webcpa.com/news/IRS-Enforcement-Rich-52207-1.html?ET=webcpa:e551:5099a:&st=email

http://www.webcpa.com/news/Congress-Clamps-Down-Foreign-Tax-Evasion-52202-1.html?ET=webcpa:e551:5099a:&st=email

http://symmetrycapital.net/index.php/blog/2009/10/tr2-rangel-holds-onto-ways-means-post/

Grantham v Greenspan (and IT vs John Henry)

Jeremy Grantham provides the investment industry with a unique and insightful voice. While we don’t agree with him on everything, we try never to miss his quarterly missives. In his latest, he absolutely trashes former Fed Chairman Alan Greenspan, a man accustomed to more sycophantic and reverential treatment, given the 3+ laborious decades in which he used access to media and the halls of power to develop his global icon status and cult following. Using President Obama’s Nobel Peace Prize as a template for ‘rewards that do not reflect just desserts’, he wrote of the former Fed chairman:

Alan Greenspan receives the title of Maestro in the U.S. and is knighted by the Queen for thoroughly demolishing the integrity of the U.S. financial system. He overtly ignored the great threat of bubbles in asset classes and, in fact, encouraged them. He Ayn Rand-ishly facilitated the progressive dismantling of governmental restrictions on financial behavior, he deliberately kept real interest rates at zero for years, etc., etc., etc. You have heard it before. Now, remarkably, in his very old age he has become imbued with the spirit of Hyman Minsky: “Unless somebody can find a way to change human nature, we will have more crises.” Now he finally gets it. Too late! In his merely old age, he ignored or abhorred Minsky, and consistently behaved as though markets were efficient and the players were honest and sensible at all times. But for all of the egg on his face, the Maestro continues to consult with the rich and famous, considerably to his financial advantage. In the good old days, he would have been set in the village stocks, and not the kind you buy and sell. And I would have been right there, Alan, with very ripe tomatoes.

If there were a Nobel Prize for irreverence, Grantham would deserve to win it, hands down. What we most appreciate is that his firm, GMO, is a well known institutional money management shop, yet he is willing to invest some of its hard earned capital in ’speaking truth to power’.

 —

P.S. By the way…determining the origins of the phrase ’speak truth to power’ provides a wonderful opportunity to witness the promise and perils of information technology. IT is just as adept, if not more so, at disseminating misinformation as it is at disseminating factual information. Just take a look at the variety of responses to the question, “Who actually coined the phrase, ’speaking truth to power’?” at this website: http://www.faqs.org/qa/qa-6697.html. Contrast that site with this academic paper, or this blog post. In both of those cases, the authors did their homework before making any definitive claims, which is the (desired) complement to talking out of one’s rear end – which unfortunately we human beings are rather prone to, especially in today’s busy world. The academic paper provides the richest understanding of the phrase’s history and likely origins, but it obviously required a good deal of work.

So clearly, it takes more than just plentiful information to expand the depth and breadth of human knowledge (in fact, more plentiful information by itself might have a negative effect on human knowledge due to the increased presence of misinformation). It still requires good old fashioned labor. What IT offers then is an analogue to earlier forms of physical capital. For example, sticks, then shovels, then backhoes have made human labor far more productive, able to dig the same number of holes in much less time than it would take with bare hands (digging technologies have also greatly expanded the types of holes that humans are able to dig).

Likewise, information technology allows scholars, investigators, reporters, etc to develop insights in less time than it would otherwise take, as data and evidence can be gathered and shared far more efficiently (it also allows them to perform data integration and analysis that would have been impossible for their predecessors). And just as some people are better with a shovel than others, there are differing skill levels among those who use information to study real world problems (there’s also wide variation in motives, which are not always apparent or fully disclosed).

So what’s the relevance of all this? Essentially, it means that while there’s no guarantee that IT makes life any better, there’s no doubt that it makes it different. And as with any major technological innovation, human beings have to learn how to cope with the results, and that involves trial, error, triumphs, and tragedies, with little assurance that the pain and the pleasure will be shared equitably. Put in general terms, change requires adjustment, and the costs (and benefits) of adjustment are borne (and enjoyed) in differing measures. For example, backhoes displaced plenty of capable shovel wielders, much as steam technology did in the steel drivers’  ballad “John Henry”, but the overall efficiency gains conferred by steam and later combustion power cannot be denied. But the tradeoffs shouldn’t be ignored either.***

With IT, the sudden surplus of information requires adjustments and new practices from all of us. And in a more general sense, if the pace of technological innovation continues as it has for the past several centuries, those adjustments will keep coming fast and furious, and coping effectively will require significant and ongoing adaptations by everyone. Fortunately, that’s something human beings are pretty adept at.

***In fact, the possibility that large scale dislocation has occurred as prevailing forms of capital favor certain skills over others shouldn’t be dismissed. For example, the increasing importance in the U.S. economy of intellectual capital (reflected in industries like law, medicine, technology, finance, etc) relative to physical capital (reflected in industries like agriculture, construction, manufacturing, etc) seems likely to increasingly favor the well educated over the less educated — something that census data certainly seems to bear out. And while educational initiatives around our “knowledge economy” are wonderful, most of the people being squeezed by these trends are well out of school.

URLs:

http://www.gmo.com/websitecontent/JGLetter_ALL_3Q09.pdf

http://www.faqs.org/qa/qa-6697.html

http://www.quaker.org/sttp.html

http://www.docstoc.com/docs/12869206/%E2%80%9CQuakers-Speak-Truth-to-Power-Bayard-Rustin-Race-and-Sexuality

http://eddriscoll.com/archives/010217.php

http://www.assoc-amazon.com/e/ir?t=symmetrycapit-20&l=as2&o=1&a=0300025815

PLEASE NOTE: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and may earn a percentage of any sales generated by clicking through to the Amazon.com website from links on our website.

Steve Wynn and U.S. Debt

Steve Wynn, chairman and CEO of Wynn Resorts Ltd., repeated a common argument to a CNBC reporter today — that the U.S. government, like any individual, could not continue to spend more money than it makes. While this is how most of us learn to think about consumer and other household debt, it’s worth a closer look.

First, a quick accounting primer. Assets, liabilities, and net worth (the balance sheet) are distinct from revenues and expenditures (the income statement). When expenditures exceed revenues over some period of time, a business (or a government or a household) runs a deficit. Deficits can be absorbed by assets such as savings (net assets are assets minus liabilities). If liabilities exceed an entity’s assets, then it is leveraged, or said to be in a ’negative asset position’. While this sounds bad, it simply means that if a sufficient number of the entity’s creditors demanded repayment of its obligations, it would be wiped out (this is essentially what happens in a bank run).  If that were to happen, then the entity must either raise capital or fold. It can raise capital by finding new lenders to loan it additional funds (creditors who are willing to assume the risk that future debt service will occur), or by finding investors who are willing to provide capital in exchange for an ownership stake (equity owners who are willing to put capital at risk in exchange for a claim on future profits). However, if creditors do not suddenly demand repayment in full, and the entity is able to service its debts from its operations, then it can survive and even do quite well. 

How does this apply to public finances? First, it tells us that public deficits are a pressing concern only if they threaten a society’s overall net wealth (net wealth being the assets left over if all debt were suddenly repaid). To determine that, we have to compare the level of debt to the level of assets. Estimating the underlying assets that a government has access to is difficult, but as a quick and dirty rule of thumb, we can multiply the government’s share of GDP by the net underlying assets in the economy. This gives us a rough idea of the level of discounted future output over which the U.S. Government has some (indirect) control. Unfortunately, as John Rutledge has pointed out, this is not an easy number to estimate, because federal economic statistics tend to focus on flows (like GDP) rather than assets. However, using recent Federal Reserve Flow of Funds data, we can conservatively estimate that the net asset position of the U.S. is somewhere north of $71 trillion (we’ve left out the net assets of governments, farms, and retirement funds).

Assuming that the federal government’s share of GDP is 20% and that this corresponds to its degree of control over economic assets, the U.S. government has access to roughly $14.2 trillion in assets. At 30% of GDP (a level which we believe could unfold in the coming decade), that number increases to $21.3 trillion. At an estimated $12.9 trillion in 2009, the gross U.S. national debt stands at 61% to 91% of net assets. And again, those asset figures are conservative. If they were more accurate, the debt percentage would almost certainly be lower.

Contrast this to the company that Wynn heads. It has a net asset position, ex-intangible and other assets and deferred charges, of roughly $1.37 billion, and long term debt of $4.29 billion. Its debt is over 300% of net assets, which is some three to five times more levered than the federal government, according to our back of the envelope numbers (though both pale in comparison to the leverage ratios taken on by the financial industry in this decade). There are other important contrasts as well. Wynn Resorts will never have a cost of capital as low as the U.S. Treasury; it has to compete intensely for revenues, and its profitability is subject to many factors that are well beyond its control. The U.S. government has few if any competitors, and its revenues come about via legally enforceable obligations imposed upon the private sector.

I don’t mean to put forth the argument that the U.S. government should lever up to the level of a corporation like Wynn, or that it couldn’t quickly push itself into a more precarious financial position***. To be sure, like any other entity, it needs to service its debt from cash flows rather than assets whenever possible. And long term entitlement commitments are indeed an eight hundred pound gorilla. I’m simply pointing out that as things stand today, gross U.S. debt is hardly at an unmanageable level. Thus, widely agreeable public investments and expenditures should not be held hostage to hyperbole or anxiety over government deficits.  This should be kept in mind when thinking about what Treasury Secretary Geithner has called the “central economic choice of our time”. 

***OMB forecasts gross public debt of $18.35 trillion by 2018, a compound annual growth rate of almost 7.5%. This will surely surpass normalized annual GDP growth over the same period. But note that it’s well below the growth rate of household and some other types of debt in the 2004-2008 period, and still represents a reasonable proportion of today’s net economic assets.

IMPORTANT DISCLOSURES and DISCLAIMER: Symmetry Capital Management, LLC is a state registered investment advisor. Neither the firm, its principals, its employees, or its clients own securities of any companies mentioned. The foregoing information is for educational and entertainment purposes only. It does not constitute an offer to buy or sell any securities, or a recommendation of any investment strategy.

URLs:

http://en.wikipedia.org/wiki/Modigliani-Miller_theorem

http://www.reuters.com/article/GCA-Economy/idUSTRE59L4SQ20091022

 http://www.cid.harvard.edu/cidpublications/darkmatter_051130.pdf

http://www.federalreserve.gov/releases/z1/Current/z1r-5.pdf

http://rutledgecapital.com/2009/05/24/total-assets-of-the-us-economy-188-trillion-134xgdp/

http://www.whitehouse.gov/omb/budget/fy2010/assets/hist.pdf

http://finance.yahoo.com/q/bs?s=WYNN&annual

Wall Street Stuff

Barron’s cover story this weekend urges Fed Chairman Ben Bernanke to stop punishing savers and raise the Fed’s target overnight interest rate. To support their case, they use an array of market indicators, including the US Dollar index and the USD price of gold, arguing that “big investors have come to see the dollar, commodities and stocks as one-way bets.” A dramatically titled sidebar of charts (‘The Perils of Easy Money’) is provided, but beyond the rising price of gold, there’s nothing in them that offers primae facie evidence of either easy money or impending inflation.  Yes, the USD has declined almost 15% from its peak, but at current levels it is simply back to where it was at the end of 2007 and beginning of 2008. And while the S&P 500 has had a breath taking run off of its March 09 lows, it’s still roughly 20% below its peak.

What’s more, there’s little about the real U.S. economy that argues for higher nominal interest rates, and inflation (and deflation) can only arise from a misalignment of the financial system with the real economy. There’s still a considerable amount of private sector debt to be worked out in the coming years and decades; excessive household consumption has run its course; and U.S. demographics do not imply a high or rising ‘natural‘ rate of interest in the decade ahead. In fact, based on that latter point, we can sympathize (out of context) with Milton Friedman’s 1965 claim that “we are all Keynesians now”, as research into population demographics and their effects on economic output and asset pricing has produced some powerful (if tentative) insights. At the present time, the U.S. is simply not at a point where, demographically speaking or policy-wise, a low nominal rate of interest on overnight reserves is likely to produce rising asset prices or “excess demand” for goods and services in the same way that it did in the late 1970s. And for that reason, increasing investment in public goods, as many of today’s policymakers advocate, might be a good idea. It might even be inevitable, judging by the experience of Japan, a country ten years ahead of us on the demographic curve. At the very least, we can hope it will be done well (Art Laffer penned a supply side refutation back in May but did not address his underlying assumptions of perfect competition for — and full employment of — real resources).

The real problem with a low Fed Funds target, as we have pointed out previously, is that the USD is still the world’s primary reserve currency. Thus, while a low Funds rate might be appropriate for the U.S. economy, it can have inflationary consequences in parts of the world that have higher expected growth rates (the reverse can also happen, as it did in the 1990s – while a high funds rate and a strong dollar seemed appropriate for the U.S. economy, they wreaked deflationary havoc on much of the world). Rising prices for goods that are globally traded, and thus subject to the Law of One Price, will feed back into domestic U.S. price levels, providing a noticeable whiff of stagflation, much as gold, precious metals, and other commodities are doing now.  The global pressures caused by an easy Fed are also going to cause plenty of political consternation and some financial dislocation abroad, as recent salvos from global trading partners over the USD attest to. But we don’t expect broader inflationary pressures to unfold in the U.S. for quite some time, nor do we expect Congress to even entertain the possibility of revisiting Humphrey Hawkins; which means, in our view, that the Fed will remain easy for some time, probably well into 2010. In the meantime, should the USD continue its current trajectory, we might see some coordinated global interventions, as we did with the Plaza and Louvre Accords in the mid-1980s. But in those episodes, national treasury departments played the lead roles, not central banks.

There are also a couple of Investment News articles that illuminate some of the beefs we have with our industry. The first one is on a Morningstar study that found that over half of all mutual fund managers have no money in their own funds. There are some legitimate reasons why a percentage of mutual fund managers would not own shares of their own fund — but that percentage should be waaaaay below 51%. That’s bad enough, but what really stuck in our craw was the speculation that some fund managers might have their money in separately managed accounts that follow a similar strategy as their mutual fund, as they tend to offer lower expenses (they also offer greater transparency, potential tax advantages, and opportunities for customization). If we ran our Opportunistic Portfolio as a mutual fund, our firm’s principals and employees would own it as a mutual fund, period. As it is, we only offer it as a separately managed account, because that is a more advantageous approach for most investors, and because technology has made it possible for us to offer separate accounts to all of our clients (it’s also a heck of a lot cheaper than forming a mutual fund). I know this stuff goes right over most of our clients’ heads when we try to explain it. Suffice to say, we’re trying to do right by them, and by our industry, on each and every day, and we appreciate stories like this one as they lend support to a key piece of our competitive strategy.

The second article is somewhat innocuous, but offers a glimpse into the prevalence of momentum trading in our business, and the general fascination with market momentum. It quotes a large cap manager at ING as saying that ”There does seem to be something unorthodox about [current equity market behavior], but you ignore it at your own peril.” That’s not an objectionable statement, but the article’s headline was a bit stronger: “Market rebound may be illogical, but ‘ignore it at your own peril,’ manage of $1.7B warns”. Surely a similar thought occurred to each of the 20,000 bison shepherded off of Vore over the eons:

[The site hosting that image is pretty neat - you can read a history of bison and horses on the Great Plains while authentic cowboy/saloon music plays in the background.]

Our beef with momentum investing is that it rationalizes away everything but herd direction. If a manager buys momentum because the underlying investment thesis makes sense, there’s nothing wrong with that. But buying momentum for its own sake is the height of glamor boy laziness and stupidity. There’s too much of it in our business, and it contributes precious little to the economies and societies we operate in.

[The 'glamor boy' link will be nostalgic for anyone who was watching MTV in the late 1980s. While it's hard to take Corey Glover's claims of ferocity seriously while he's wearing a spandex suit and a marching band jacket, it's still a great song.]

URLs:

http://online.barrons.com/article/SB125573856421291217.html?mod=rss_barrons_this_week_magazine

http://s.wsj.net/public/resources/documents/BA-EasyMoney091019.pdf

http://www.frbsf.org/publications/economics/letter/2003/el2003-32.html

http://www.time.com/time/printout/0,8816,842353,00.html

http://economics.uwo.ca/econref/WorkingPapers/researchreports/wp2009/wp2009_2.pdf

http://frank.mtsu.edu/~berc/tnbiz/stimulus/laffer.pdf

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20091019/FREE/910199975/1094/INDaily01

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20091019/FREE/910199982/1094/INDaily01

http://www.wyomingtalesandtrails.com/buffalojump.jpg

http://www.youtube.com/watch?v=7XRpuhc9dgU

http://www.wyomingtalesandtrails.com/bison.html

Crowded Trades – A Video Analogue

Claustrophobic tendencies inform a key tenet of our investment philosophy — avoidance of overly crowded trades. We found a perfect video analogue of what a crowded trade looks like:

Thankfully, it’s not quite perfect. If it were, it would also show the train running off the rails.

Swine Flu’s “Very Sobering Statistics”

The AP is reporting that government officials are concerned about the virulence exhibited by swine flu to this point:

The swine flu is causing an unprecedented amount of illness for this early in the fall, with the deaths of 11 more children reported in the past week. And less vaccine than expected will be ready by month’s end, federal health officials said Friday.

Of the 86 children who have died since the new swine flu arose last spring, 43 deaths have been reported in September and early October alone, the Centers for Disease Control and Prevention reported. That’s a startling number because in some past winters, the CDC has counted 40 or 50 child deaths for the entire flu season — and no one knows how long this swine flu outbreak will last.

“These are very sobering statistics,” said the CDC’s Dr. Anne Schuchat.

Also disconcerting is that “about half of the child deaths reported since Sept. 1 have been teenagers.” The 1918 global flu pandemic caused so much devastation because of how it affected healthy adults, as opposed to the very young and the elderly. An interesting discussion of current flu epidemiology can be found here, and it amplifies the CDC’s “very sobering” assessment. For example, note in the second graphic that the 5-17, 18-49, and 50-64 year age groups are already at or above their expected hospitalization rates, and we’re only at the beginning of flu season.

The probability of a severe, 1918 style impact is unknown, with best guesses ranging from negligible to 20% to ‘know way of knowing’. But quantifiable or not, it’s an ongoing risk that deserves attention.

P.S. An interesting 2008 paper from Virology Journal was linked in the comments section of the Science Links article. It sets forth an interesting hypothesis that declining Vitamin D synthesis, due to decreased exposure to sunlight, is a significant factor in susceptibility to influenza, and thus its seasonality. The experimental evidence from humans is minimal (n = 104), but what there is seems pretty tantalizing. NOTE: We are not dispensing nutritional advice! If you’re interested in the idea of Vitamin D supplementation, we strongly suggest you seek out a qualified clinical nutritionist. Vitamin D toxicity is nothing to mess with.

P.P.S. This paper is truly mind blowing — the remarkable rise in deaths from coronary heart disease (CHD) in the mid-20th century might have been associated with exposure to the 1918 influenza: “…the data suggest that the 1918 influenza pandemic and the subsequent epidemics up to 1957 might have played a determinant role in the epidemic of CHD mortality registered in the 20th century.” If true, it raises the possibility that a staggering amount of resources invested over 50+ years in analyzing, screening, and treating other factors believed to be associated with CHD mortality might have been put to better use. Yikes!

URLs:

http://news.yahoo.com/s/ap/20091016/ap_on_he_me/us_med_swine_flu

http://en.wikipedia.org/wiki/1918_flu_pandemic

http://www.iayork.com/Images/2008/9-22-08/1918FluMortalityCDC.png

http://scienceblogs.com/effectmeasure/2009/10/why_the_epidemiology_of_swine.php#more

http://www.continuitycentral.com/news02524.htm

http://www.virologyj.com/content/pdf/1743-422X-5-29.pdf

http://en.wikipedia.org/wiki/Vitamin_D#Overdose

http://www.scielo.br/pdf/csp/v18n3/9286.pdf