Monday, January 31, 2022

Through The Cycle Investing

 

A discussion of The Hedged Economist’s approach to managing a portfolio through market cycles can be found that “Portfolio Performance Through The Cycle: A Retiree's Roth IRA” @ (https://seekingalpha.com/article/4482981-portfolio-performance-cycle-retirees-roth-ira). As the title implies, the article uses a Roth IRA to illustrate the approach.

As has been mentioned in previous postings, The Hedged Economist approach involves investing in companies, rather than trading stocks. Thus, the posting does not address trying to time the cycle. Rather, it discusses having a portfolio that invests in companies that respond differently to market and economic cycles.

 

Tuesday, January 25, 2022

The Implications of Inflation for Portfolio Management

 

If you would like to see The Hedge Economists view of the implications of the current inflation on portfolio management, they have just been posted on Seeking Alpha  @(https://seekingalpha.com). The posting focuses on implications for a traditional IRA.

The posting explains the philosophy and objectives behind the management of the traditional IRA. It then discusses the portfolio implications of the current inflation in general terms. It describes the types of companies that the Hedged Economist believes should be added to the portfolio. The actual portfolio is then used as an example of those types of adjustments. The rationale for adding and trimming positions is described in terms of the portfolio and its objectives. It concludes with a discussion of the implications of the current inflation for the future stock market and economic outlook.

Wednesday, January 19, 2022

What's Does Inflation Data Tell Us?

 Understanding inflation is important to interpreting labor market conditions.

It also affects one's perception of income trends and consumers’ well-being.

Inflation distorts the economy and masks economic incentives.

It makes market price signals unreliable.

It distorts investment decisions and creates risk.

Inflation isn't always measured year-over-year. Generally, one will hear the year-over-year increase and the monthly increase. One will also frequently hear a reference to the month-to-month change in the annualized monthly rate.

Regarding the impact of supply chains on inflation, it is important to remember that price is always the product of the interaction of supply and demand. Quite often those who blame supply for the current inflation are trying to deflect attention away from their own actions which create demand beyond the economy's capacity to deliver.

Some components of the inflation are highly volatile while others change more slowly and arguably more persistently. Further, inflation can be measured in a number of different ways. However, the CPI is a widely quoted and easily understood measure of inflation.

Those who would like to minimize the perception of the negative effects of inflation will often quote data that is not inflation adjusted. By doing so they can often make the disastrous results of policies look positive. In order to look through this political propaganda, it is often necessary to go to the source data.

To illustrate this twisting of the meaning of data consider the following:

“Over the past 12 months, average hourly earnings have increased by 4.7 percent.”  

(Source: Employment Situation Summary, Bureau of Labor Statistics@ Employment Situation Summary - 2021 M13 Results (bls.gov)

 And from another report:

“The Consumer Price Index for All Urban Consumers (CPI-U) …. Over the last 12 months, the all items index increased 7.0 percent….”

(Source: Consumer Price Index News Release, Bureau of Labor Statistics@ Consumer Price Index (CPI) News Release : U.S. Bureau of Labor Statistics (bls.gov)

 

Reporting these data separately makes it possible for the current administration to point to the 4.7% wage growth in dollar terms as if it were progress. However, when the two reports are considered, what is really being reported is an over 2% (4.7%-7.0%) fall in real wages over a period of 12 months. If one cares to look at the detail of the data, one also finds that the fall in real wages is even more severe for wage earners and clerical workers:

“The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) increased 7.8 percent over the last 12 months….”

(Source: Consumer Price Index News Release, Bureau of Labor Statistics@ Consumer Price Index (CPI) News Release : U.S. Bureau of Labor Statistics (bls.gov)

That conclusion is based on data from one single agency, The Bureau of Labor Statistics. These two particular reports were chosen because they are considered timely and authoritative, and they are both from the same federal agency. However, they are not the only sources of data that confirm the trend of falling real wages.

For example, there is the Wage and Salary component of the Gross Domestic Product (GDP) reports and the GDP Deflater. The Department of Labor also publishes the Employment Cost Index.  However, both of those sources and a number of other very comprehensive sources suffer from the amount of time taken to generate them and methodological quirks needed to accommodate their intended use.  Nevertheless, they make it clear that wages are not keeping up with inflation. A timelier source is the Current Population Survey. The Atlanta Fed uses it to construct a Wage Growth Index that is fairly timely. It too shows that wages are not keeping up with inflation.

So, for a very large portion of the population that works for a living, wages aren't keeping up with inflation. They aren't the only ones. Again, by quoting nominal information rather than inflation-adjusted information, retirees may be misled about Social Security. Social Security benefits are increasing 5.9% this year. That sounds good unless one considers that in the previous year the real value of Social Security benefits decreased by 7% based on the CPI. However, Social Security beneficiaries are not the typical consumer represented by the CPI. Medical costs and food represent a larger portion of their expenditures. The real value of their benefit is being negatively impacted by inflation despite the dollar increase in the benefits.

Seeing through the fiction that policies are benefiting people doesn't always necessitate the comparison of different reports. Take for example the Employment Report, the first one quoted above. Considerable effort is put into measuring labor market performance in all its dimensions because of its importance to the well-being of the population.

The Employment Report is based on two sources of data: the Employer Survey and the Household Survey.    That leaves plenty of room to spin the data. In some instances, it can make the headline numbers contradictory.

As discussed in the previous posting, The Employment Report Simplified, in last month's Employment Report job growth underestimated the strength of the labor market. This month the number of jobs added to payrolls is almost the same as the previous month, only about 200,000.  Yet, this month the entire report was as dismal as the disappointing headline jobs number would imply.

However, it was possible to focus on the unemployment rate as if it indicated strength. In order to do that misinterpretation of the unemployment rate, one had to ignore a few facts:

“The labor force participation rate was unchanged at 61.9 percent in December…. The employment-population ratio increased by only 0.2 percentage point to 59.5 percent in December….”

(Source: Employment Situation Summary, Bureau of Labor Statistics) Employment Situation Summary - 2021 M13 Results (bls.gov)

 It's one thing to have anemic job growth when the labor market is expanding because of increases in labor force participation by self-employment as happened last month. That's quite a different situation from anemic job growth when the labor market didn't grow, and labor force participation remained the same.

The administration chose to pretend that this month's employment report represented further progress rather than a slowdown in the economy's recovery. Further, it's a fiction for the administration to talk about creating new jobs when the number of people employed is still below the previous peak. It is not economic growth until the previous peak is exceeded. It's just a recovery and a recovery that is slowing down.

Further, the job growth number for last month was not revised up enough this month to reflect a healthy economy. There is a possibility that it will be revised up at some future date, but for now, the anemic recovery in employment seems to be real. Also, the December report seems to confirm that the strength of the Household Survey in the previous report largely reflected people being forced to become self-employed rather than being attracted to self-employment. In other words, the good news in the November report was that people were learning to hustle for a living rather than depending on policy to encourage employers to create good jobs.

One doesn't need the complication of the two different employment surveys in order to find opportunities to spin the data. The same was done with the CPI report. The headline number was clearly bad news. A 7% inflation rate is not good news under any circumstance. When one looks at the detail, it appears even worse than is implied by the headline number. For example, the report showed that:

“Increases in the indexes for shelter and for used cars and trucks were the largest contributors to the seasonally adjusted all items increase…. The food index also contributed….”

(Source: Consumer Price Index News Release, Bureau of Labor Statistics@ Consumer Price Index (CPI) News Release : U.S. Bureau of Labor Statistics (bls.gov)

The weighting of different items in the CPI  @ 2020.htm : U.S. Bureau of Labor Statistics (bls.gov), shows that that simple statement implies that the most important items in the cost-of-living were the ones that were escalating in price the most

In addition, the reported CPI understated the negative impact of inflation on many consumers. Specifically, consumers looking to buy a house know that the CPI index for shelter is grossly underestimating the inflation they are facing. The increase in the component for shelter would have been much larger if calculated using the methodology in place before 1982.  In 1982 the methodology was changed to stop using house prices to estimate homeowners’ housing costs. If you're looking to buy house, home prices would seem to be a more appropriate measure.

House prices were up 19% from those a year earlier, according to the most recent S& P Core Logic Case-Shiller Composite Index. The current CPI doesn't use that 19%. Instead, it uses an estimate of what homeowners would be willing to pay to rent their homes. That estimate was up only 3.8%. Adjusting the homeowners’ costs for actual prices would have added 3.5 percentage points to the reported 7% rise in the CPI.

Despite the obvious bad news in the CPI report, the administration chose to focus on slowdowns in the month-to-month rate of increase in the prices of highly volatile components like food and gasoline. However, gasoline and motor fuels have a weighting of only about 3 to 3 1/2% in the CPI calculation. Gas prices are highly visible but not necessarily important. They don't represent a large portion of consumers expenditures. Consequently, the slowdown in the month-to-month rate of increase in gas prices is not significant, but neither is the doubling of gasoline prices over the last year. However, calling attention to the slowdown in the monthly rate of increase only draws attention to the near doubling of gas prices under the current administration’s energy policies.

The significance of that policy failure highlighted by the CPI can be minimized by pretending that the report implied better future news. However, the details of the report don’t support the argument that the report indicates improvement in the inflation situation. The inflation situation may improve, but this month's report didn't show signs of it. A substantial portion of the inflation was due to major components of CPI and arguably components that are sticky as opposed to the volatile components. Further, when the rate of inflation goes from an annualized rate of 1.6% to an annualized rate of 7% during one year of an administration, it's hard to see how arguing improvement in a single month is positive. It is clear inflation will be at least 5% or 6% for the next year and perhaps longer.

The contortions the administration went through to try to make the current monthly Employment Report and Inflation Report sound positive only contributed to people's distrust of the government. They make it clear that the administration sees economic data as a tool to be used to further its economic agenda rather than as a tool to be used to formulate those policies. From a politician's perspective, advancing their agenda might be the appropriate use of the data because inflation actually short-circuits the ability to use much of the economic data in formulating better policies.

For example, retail sales are reported in dollar terms and are viewed as a current indicator of the economic health of consumers. However, when inflation is important, the retail sales data becomes difficult to interpret. Is there real growth represented or is it all just price increases? One cannot use the inflation data from the CPI to understand that issue. The weights in the CPI don't reflect current retail sales. In fact, the chain-weighted CPI is specifically designed to shift the weights to reflect changes in consumption patterns. So, retail sales data becomes useless as a timely quantitative measure of economic health of consumers.

There are alternatives from the National Income and Product Accounts. To adjust for inflation, one can use the consumer expenditures data after deflating it. However, what that gains in accuracy is achieved at a considerable cost in timeliness. Further, even when released, the data are subject to frequent revisions.

Any data on economic flows that are denominated in dollars becomes suspect. Can the dollar value of those flows be appropriately deflated? The CPI, the GDP Deflator, prices for particular commodities, and prices for selected goods all have to be brought to bear in order to determine whether a flow represents real change or just inflated prices.

The same applies data about stocks of goods and financial stocks. For example, there are classic accounting problems associated with valuing inventories. One cannot use the cost of acquiring an inventory as a reliable gauge for its value. That's always an ongoing problem in business, but inflation just aggravates it.

So, for example, the preliminary GDP report showed an increase in inventory investment. This could be interpreted as businesses are starting to stock up and moving away from just-in-time inventories. However, it could also just be that the value of their inventories increased due to inflation and that increase in value is what is being reported. Even switching to a measure of the flow of dollars into the acquisition of inventories doesn't eliminate the problem. The increase in the flow dollars in the acquisition of inventories may just reflect price increases.

The most basic data can be subverted by inflation. The basic distinction between consumption and savings can be clouded. While it was a short-term phenomenon, the fall in retail sales in December after a strong October and November is being blamed on advanced buying for Christmas. Fears of price increases and especially shortages, according to this narrative, pushed forward Christmas shopping.

Now that seems trivial, but rapid inflation can cause people to make purchases as a form of savings that normally would be considered consumption. We recently ran into that as people stocked up on certain commodities during the Covid outbreak. That stocking up was a minor phenomenon, but during the 70s it was not unusual for people to want to make purchases before prices increased.

The most extreme form of this occurred during the hyperinflation in Germany when people would leave work on payday in order to go spend the money as quickly as possible. In that instance, it may have been for consumption, but it is equally conceivable that it would simply be a way to invest the money that has a return that is greater than the zero interest rates currently available on savings.

So, with all the uncertainty the inflation interjects into the meaning of economic data, perhaps politicians who view it just as a propaganda opportunity are on to something. However, if that's the case, it calls into serious question why the population allows the government to spend as much as it does to generate the data.

Bad policy based on bad data is only one of the costs of inflation. Inflation undermines the basic purpose of prices. Prices are designed to reflect relative value. However, if all prices are being inflated, the issue becomes whether the change in price truly reflect an increase in value of the item being priced or just a decrease in the value of the money. Unfortunately, general price deflators fall short of being able to sort out relative prices. The basic design of inflation measures is to reflect overall prices, not changes in relative prices. So, inflation is like sand in the pricing mechanism of a functioning economy.

Perhaps the most serious negative impact of inflation is its impact on investments. The result of that impact is a marked negative effect on the productivity of the economy through the distortions that inflation introduces into investment decisions.

Inflation makes it hard to interpret investment data. Its impact on interpreting inventory data has already been discussed. But what was said about inventory flows being hard to interpret in an inflationary environment is equally true of flows into any other investment. For example, a forecast that the stock market will increase in the low single digits implies a negative real return if inflation is above that low single digit.

A comment about liquidity that could be invested in stocks has to be adjusted for the decline in the value of those liquid assets that might be invested. Further, if 7% more money is invested in the stock market at the end of the year than at the beginning, the real investment is the same if there has been 7% inflation.

Earnings forecasts have to be adjusted for inflation. To say earnings will grow at a certain rate has to be explained as either a dollar rate or a real rate. In a 7% inflation environment a 7% increase in profits is standing still in real terms.

Every financial professional is familiar with the concept of a hurdle rate. It's the rate of return on an investment that has to be exceeded in order for the investment to be justified. Companies usually measure it as their cost of capital. Investors measure it against their alternative uses of the money. In both cases, inflation can set a floor under the hurdle rate.

Consider for a moment the impact that statement implies for investing. Much of the literature on investing argues that an investment is justified if its risk-adjusted expected return exceeds the risk-free rate of return. Previous postings have argued that the risk-free rate of return is a potentially meaningless construct without a concrete definition. For example, when discussing solvent risk on April 1, 2010 in The Hedged Economist: Beware the risk-free return:

“The concept of a risk-free rate of return is like a cancer that has invaded modern financial economic theory. Usually, Treasuries Bills are used as a quantitative expression of the mythical risk-free rate of return. Every time “risk-free” appears in a formula or in print, stop! Ask: “What does the author really mean? Are they really saying anything? What concept really should be used? What assumptions have to be made in order for the formula or phrase to make sense?” All sorts of issues get brushed aside through the simple assumption that risk-free returns are an acceptable substitute for addressing some very volatile behaviors.”

Negative treasury rates should have convinced the academics who publish investment literature that the concept of a quantifiable risk-free return is highly suspect. Yet, the concept persists and influences the thinking of central bankers. Much of their thinking about the impact of interest rates on the economy hinges on treasuries being a primary competitive alternative investment. However, investing in treasuries has considerable risk, especially with zero interest rates. There is the risk that the actual value of the treasury will fall previous to maturity. But there is also the risk with inflation that the return at maturity will have been reduced in value. It's that risk that is being referenced when people referred to the inflationary expectations having an effect upon long-term interest rates.

Inflation and the risk of inflation are important components of the risk to treasuries. In an inflationary environment there are investments with a lower risk than treasuries. Basically, items that normally would be considered consumption and are durable or long-lasting have a risk-free return if their price increases along with inflation. The classic example is the overinvestment in farmland that occurs in many developing economies during periods of hyperinflation.

One doesn't need to go to that extreme for examples.  Inflation makes the purchase of commodities viable as a risk-free return or at least makes them competitive with productive investment. The purchase of another company with hard assets that won't decrease in value may be viewed as an alternative to increasing productive capacity. So might purchase of the company's own stock become appealing if it is expected to increase in value at least as fast as inflation. It is that cramping of productive investment that reduces growth during periods of inflation. It's why one can have stagflation or depressions during periods of inflation.

So, while inflation may in some cases be a symptom of an overheated economy, it can also be a depressive that ends the overheating. The risk of that happening is only increased by the confusion of the data that inflation causes.

During an expansion, nominal growth, that is growth in current dollar terms, can continue while inflation is exceeding the growth rate in current dollar terms. This period of real decline usually appears late in the cycle. From an investment perspective it's a phase where financial assets, like stocks, can decline even while the economy is growing. There is a good chance we will witness that in 2022 even though we are still early in the recovery phase of the cycle.

Monday, December 6, 2021

The Employment Report Simplified

 

The total number of employed people is rising, and the unemployment rate is dropping.

The key to understanding the employment report is defining employment.

The employer survey isn't reflecting the strength of the labor market.

The divergence between the household survey and employer survey is a cyclical phenomenon.

The potential of a monetary or policy mistake is very high.

 

Both the household survey and the employer survey showed a rise in the number of employed people. However, there is a substantial difference in the degree to which they reflected labor market conditions.

Both the household survey and the employer survey showed a rise in the number of employed people. However, there is a substantial difference in the degree to which they show the employment gain. One survey showed that about 1.1 million more people were employed in November than in October. (The household survey showed 1,136,000 more workers,) The other surveys show only about 200,000 more people were employed. (According to the employer survey total nonfarm payroll employment rose by 210,000 in November.)

The difference hinges on how the two different surveys define employment. One is dependent upon a definition of employment that involves an employee and employer. (The easy way to collect that data is to survey employers. There are less of them to be surveyed than employees.) The other depends only upon whether an individual considers himself or herself gainfully employed with or without an employer. (The household survey which is actually a survey of individuals is the only way to collect data based on the second definition.)

Each survey has its strengths and its weaknesses. Clearly, the employer survey can only measure one dimension of the functioning of the labor market. That dimension is employer hiring. Employer hiring is usually the most important dimension to measure. However, it is not true that it is the only measure or that it's equally important at all points in the business cycle. Further, it is not really measuring employment. It's measuring the number of people employers have hired.

In November the number of unemployed persons fell by 542,000 to 6.9 million. The unemployment rate fell by 0.4 percentage point to 4.2 percent in November. Saying that over 500,000 fewer people are unemployed sounds quite different from saying that there were only 200,000 more employed.

That is particularly true when one notes that the labor force has actually grown. The labor force participation rate edged up to 61.8 percent in November. Almost 600,000 people joined the workforce. In other words, there were 600,000 more people who were either unemployed or employed. The employment-population ratio increased by 0.4 percentage point to 59.2 percent in November.

It's easy to dismiss one source of data or the other as inaccurate. There are undoubtedly issues related to the accuracy of the reports that should be addressed. The most important of those is the degree to which the employment survey can be adjusted for changes in the universe of employers. If there are more small employers and the sample is not adjusted in real time to reflect that, the survey can become less accurate. (Inaccuracies of this type are often adjusted away in subsequent months.) Similarly, if the seasonal adjustments become inaccurate because of changes in the mix of employers by industry or size, they can lead to misleading data.

However, each survey is measuring what it was designed to measure. The question isn't which is accurate. The question is which is more important at this point in the business cycle. At some points in a business cycle unemployment and labor force participation are more important.

So, one has the option to view two employment reports from two different sources. One indicates how many employees have been added during the month (i.e., net hiring). The other indicates employment growth is coming from two different sources. About half is coming from a reduction in unemployment and the other half is coming from an increase in the labor force participation rate.

Regardless of the difference in the numbers reported as the result from each survey, one is providing more information about the health of the labor market than the other. The household survey is reporting on more dimensions of the health of the labor market. As was said above, which report is more important can change over the business cycle, but right now clearly the more important information is that about half the gain in employment is from reductions in unemployment and half is from growth in the labor force.

The reason the household survey is currently more important is that it provides a more accurate basis for assessing whether the growth in employment can continue. Note, the statement was “can continue”, not will continue.

The number of people who are unemployed can continue to fall. The number of people unable to work because their employer closed or lost business due to the pandemic is still reported as being quite high (3.6 million) and did not change despite the drop in unemployment. This represents a pool of unemployed individuals that can be reduced, and the existence of the pool is extremely important because it can offset the drop in number of people on temporary layoff.

There are also significant numbers of people who are still available to join the labor force. (The number in the labor force who currently want a job was 5.9 million and those marginally attached to the labor force was 1.6 million). Despite the rise in the labor force participation rate, the size of this pool that could be attracted into the labor market did not change significantly last month. So, the labor force participation rate could continue to rise and continue to add to employment.

Generally, the household survey becomes more important when confidence is rising enough for individuals to begin to feel that they can be gainfully employed without having to rely upon an employer. That is a cyclical phenomenon that I've written about before. (August 4, 2010 entitled "An Article about a Fiction and the Employment Report" and April 9, 2017 entitled “The Curious Case Of Friday's Employment Report).

It would be quite difficult to argue that confidence has been rising currently. Neither surveys of consumer confidence nor for surveys of employer confidence would support the argument. At the same time, there is considerable evidence that people are going out and starting a business or becoming self-employed instead of seeking employment with an employer. For example, the WALL STREET JOURNAL on November 30, a couple of days before the employer report, had an article entitled “Workers Quit Jobs In Droves In Order to Become Their Own Bosses.” The article recites a number of facts that support the argument that workers are choosing to be self-employed or start a business rather than seeking employment. The types of data it cites include:

The number of unincorporated self-employed workers has risen by 500,000 since the start of the pandemic, Labor Department data show, to 9.44 million. That is the highest total since the financial-crisis year 2008, except for this summer…. Entrepreneurs applied for federal tax-identification numbers to register 4.54 million new businesses from January through October”

It's worth noting that the article talks about people quitting jobs in order to form their own business, rather than unemployed individuals becoming self-employed. If that's an accurate reflection of what's happening, it would suppress the data from the employer survey regarding net new hires because these individuals are leaving their jobs to start a business. At the same time, it would increase the employment count in the household survey. So, the thesis of the article is totally consistent with the employment report. It's also consistent with the anomalous fact that both job openings and the rate at which workers quit jobs have been at record highs in recent months.

It is not, however, consistent with the idea that the phenomena being reported reflects increasing confidence. The article goes on to describe a number of cases of individuals who've taken this step and generally characterizes the step as resulting from “looking for flexibility, anxious about Covid exposure, upset about vaccine mandates or simply disenchanted with pre-pandemic office life.”

Whenever migration occurs, whether it's geographic migration or migration from an employer to self-employment, it is motivated by both push and pull, both positive attractions of the new status and repulsions of the previous status. If one looks at the data and reports of people refusing to discontinue remote work, refusing to get vaccinated, and afraid of front line Covid exposure, the balance seems to indicate that the push is more important.

In terms of push or pull it's easy to interpret wage data either way. One can argue that the increase in money wages, eliminates an incentive to try self-employment. However, a more sophisticated look that realizes that real wages are not increasing, but actually decreasing due to inflation, creates an incentive to try self-employment.

Regardless of how one interprets the move to self-employment, the differences between the motivations in this business cycle, with the presence of Covid and the dislocations it has caused, and previous business cycles, increases the risk of a policy mistake. That risk is higher currently than would normally be the case at this point in the business cycle because the recovery is more fragile at this stage than would normally be the case. An economy that is believed to be strong as evidenced by high levels of consumer and business confidence is much less fragile than one where both consumers and businesses are skeptical.

There's also a risk inherent in having to make decisions with data that isn't reliable; and where employment is concerned, clearly, there is some doubt as to what's going on. Some of it is a cyclical phenomenon, but some of it is unique to the current situation. For example, the pandemic has reduced response rates by employers, according to Labor Department figures, which could result in volatile data with wide revisions.

Seasonal adjustments are another potential source of error that is being affected by the pandemic. The industry makeup of employment is influenced by the fact that certain industries are now less appealing as a source of employment because of the associated Covid risk. Those are the industries that we referred to as employing frontline workers, hospitality and retail trade are just two examples. Without the seasonal adjustment, payrolls grew by 778,000 in November. So, the seasonal adjustments were large enough that if incorrect, they affect the picture that one gets from the data.

The risk of policy mistakes also rises when it is necessary to make policy decisions because one can no longer paper over problems with meaningless rhetoric. One of my favorites right now is Biden's (and the Fed’s) referring to the current inflation as a supply or a shortage issue. It seems to me that anybody who has taken even one economics course knows that prices are the product of the interaction of supply and demand.

It is absolutely silly to refer to it as being due to one or the other. Inflation is always a demand issue and a supply issue because it is the interaction of the two that changes price. It is much harder to develop a policy that responses to reality than to avoid facing reality by using language that pretends it doesn't exist. A policy that balances the need for increased supply while maintaining demand is far more complex than that implied by some mumbo-jumbo language to avoid the issue.

However, that's only a small example of the use of terms that are designed to paper over an issue. Another of my favorites was the use of the word transitory when describing inflation. It was completely meaningless, and thus, now that the Fed has finally admitted that inflation wasn't transitory people are treating it as if the change in wording means something. As long as they could paper over the issue with meaningless terms like transitory, no one had to address the more difficult issue of what the appropriate policy should be to reduce the rate of inflation. The complexity of that issue and the potential for a policy mistake is illustrated by Chairman Powell’s reference to the fact that there is uncertainty regarding the relative impact of Covid on supply and demand.

I also get a kick out of the use of the term stagflation. People ignore the fact that it was a product of a different period of time under a different regulatory environment. They pay no attention to the fact that regulation Q, limiting the interest rates banks could pay, and usury laws, limiting the interest rates banks could charge, were common during the period when inflation built up. There is a danger that a policy response to the current environment that resembles the policy response that was appropriate during the 70s would be totally inappropriate in the current regulatory environment.

Heaven help us if the demagogues like Elizabeth Warren get their way and start heavy-handed bank regulation. I have no confidence that they know what they're doing. I think no one should be allowed to talk about regulation unless they prove they can define the difference between insolvent and illiquid and explain why it's important. It's easy to conceive of Congress or the president enacting regulatory changes that would totally confuse the impact of either fiscal policy or monetary policy.

Regardless of whether one thinks heavy-handed bank regulation or a potential response to another Covid wave are desirable, is clear they will complicate policy decisions surrounding how to lengthen the recovery. That, in a nutshell, is why the potential for policy mistake is higher. There is a strong potential that there will be conflicts between what's desirable depending upon the significance one attaches to different social objectives.

Thursday, January 25, 2018

We All Protect Our Own

The news is often very informative totally by accident. For example, today the Wall Street Journal and a number of websites that I frequent had references to the US placing tariffs on washing machines and certain solar devices. Those references were juxtaposition next to references to the European Union fining QUALCOMM in response to competitive practices the Europeans didn't like.

It's very interesting and one should not lose sight of the fact that European antitrust regulations are not designed to protect consumer. Rather, they are designed to protect European competitors. So, the question of the day is: Is there any difference between the European fines on QUALCOMM and the US tariffs on washing machines and solar devices? The honest answer is: No. Yet, that is hardly how the media would treat them. Is it bias or an inability to look beyond the surface?

Saturday, December 30, 2017

We all like Toys


It is the time of year when it seems appropriate to give gifts and share. So, in a posting on SeekingAlpha I've shared a link to two spreadsheets that I found useful. That posting was entitled “We All Like Toys And Retiring Rich,” Dec. 22, 2017. That posting provides a complete description of the spreadsheets and various ways they can be used. It also discusses some implications of the spreadsheets.

The two spreadsheets  are updates of spreadsheets first presented here in previous postings entitled “Investing PART 5: Oldies: When looking back is most valuable,” Dec. 25, 2010, and “Investing PART 6: Perhaps some seasonal music,” Dec. 29, 2010.

The first spreadsheet addresses the retirement balances they can be achieved using IRAs.   An interesting toy for the holiday. Please download it rather than using it where it is (IRA Spreadsheet). 

The second spreadsheet addresses what can be accomplished by using a 401k. Please download it rather than using it where it is.  So, have fun. (401k Spreadsheet)


Happy Holiday.

Monday, December 18, 2017

The Curious Way People Think

The last posting referred to the use of SeekingAlpha as a way to publish postings on stock investment. Frequently, that will be the case. However, I've noticed a curious aspect to the interest of readers on SeekingAlpha. On October 26, 2017, a posting entitled “Let Your Winners Run” discussed some general principles related to how to maximize one's return from stock investments.

It noted that one can't go broke taking a profit, but one can under-perform the market. The reason is quite simple: every stock won't be a winner, so it makes sense to maximize the size of the winners. The posting noted that the share of stocks that are big winners is quite small, and, consequently, an investor should hold onto those winners. They are few and far between. It explains how the small number of big winners among all stocks and the presence of the phenomena known as persistence of a rising stock price support the argument for holding onto winners. It also discussed the implications of data on the trading practices of the large number of individual investors as well as research into how people react to gains and losses.

In short, it provided general portfolio management advice that works, and it explains why it works. That posting was followed by a posting on December 15, 2017, entitled “Let Hitters Swing For The Fence." That second posting did nothing more than take a number of examples, three to be exact, and explained why the strategy of “letting winners run” will probably work with respect to those three stocks. The three stocks were Boeing, McDonald's, and 3M. The only general portfolio management discussion concerned a common approach to managing concentration risk: Frequently, there are references to not letting any particular stock represent more than 5% of one's holdings. In discussing those three stocks, the posting made the point that while 5% is a reasonable target for a maximum portfolio weight, it shouldn't automatically imply selling winners.

Now, here's what I find so curious. More than twice as many people read the posting that addressed how to manage positions in only three stocks as read the posting that discussed the general principle that applies to all stock holdings. The question is: Does that imply that investors are more focused on individual gains and losses from a specific holding than how to improve their overall portfolio performance?


That could be a totally new dimension to the interpretation of behavioral economic and psychological research regarding how people feel gains and losses. It raises the interesting question of whether, from a psychological perspective, people derive more gratification or pain from small changes that result from their actions than from far more massive changes that result from intentional inaction.