Category Archives: Fellow Collegiant

Buy and hold no more?

Baruch has long held that the academic finance industry has produced nothing of lasting worth. Or at least nothing that has helped anyone make money consistently, which is, after all most of the point of the exercise, isn’t it? In fact the impact of the academics on markets has probably been on balance pernicious, contributing to overconfidence, instability and perdiodic crisis as much as it has shed light on the inner workings of anything. I’m thinking of course of Black and Scholes, portfolio insurance, hard Efficient Market theories and the large number of ” new paradigms” we have had in the past 30 years, which invariably ended in disastrous crashes, with yet looser money in their wake and another round of inevitable “new paradigms”. All of them, I guarantee you, had the solid imprimatur of some finance professor somewhere or other.

It is not all hopeless, however, because the academic study of finance has also produced Andrew Lo, whose “adaptive market hypothesis” seems to Baruch to sum up better than most how things actually work. Insofar as Baruch understands it, the general idea borrows from biology and behavioural economics. It is that markets are crucibles for evolution and adaptation, like an ecosystem, and while they can be efficient they are so only periodically and then only in bits. Strategies that work well will only do so for a time; only punters able to identify changes in the environment rapidly enough and (more difficult perhaps given the current animus against “style drift”) able to adapt their style of investment to profit, or at least not blow up, will survive. That, by the way, survival, appears to be the name of the game in the adaptive market; sticking around long enough to make it to retirement. It’s not an easy place to hang out in. As Spinoza was fond of saying, we also know this from experience to be true.

The point is, I always watch out for something from Lo and read it avidly. I was therefore very surprised to find myself disagreeing with something he was saying in an interview with CNN Money (HT I am sure either Josh or Tadas, like everything else), which was that the increased use and democratisation of technology in financial markets has led to higher levels of volatility and instability that make “buy and hold” no longer viable:

Buy-and-hold doesn’t work anymore. The volatility is too significant. Almost any asset can suddenly become much more risky. Buying into a mutual fund and holding it for 10 years is no longer going to deliver the same kind of expected return that we saw over the course of the last seven decades, simply because of the nature of financial markets and how complex it’s gotten.

Baruch worries that Lo, while likely spectacularly right in general with his highly convincing theory, may be wrong in the particular here.  Continue reading

Do let’s be optimistic . . . even if we don’t feel like it

 

Tis (or, by the time I finish this post, ’twas) the season for pundits to give specific predictions for 2012 and a more pointless exercise has yet to be devised. Baruch isn’t going to waste your time doing this, for various reasons. The main one is that Baruch has long been convinced he is almost always wrong about almost everything. His only solace (and it is a big one*) is that everyone else is always wrong as well, and unlike him they don’t know it.

This year prediction seems a lot more difficult anyway. If Baruch is at all representative of bien pensant investor opinion the overriding emotion among practitioners today is a lack of confidence in anything, especially themselves. This is because almost without exception everyone traded like an idiot in 2011, both on the hedge fund side, where “slightly down” is the new “up”, and on the side of benchmarked long only funds. As you may know, Baruch is a professional investor and helps run one of these latter things. Looking at his peer group he is amazed, despite a mild underperformance, to find himself firmly in the top quartile in YTD relative returns. Despite this, he feels like a schmuck. How much worse must the average PM have fared, he asks himself. Just why has everyone done so badly this year?

Baruch has some ideas about why this is; a lot of it can be put down to the narrative of the year and investor positioning.  Overall, the majority of the active management community were extremely badly positioned for the key moves in the market in the back half of 2011. They were mostly long for the big August swoon associated with the US credit rating cut, and many compounded this by adding exposure into the decline too early — catching falling knives, in the parlance. Having finally understood the appalling ramifications of the European debt crisis, investors were nice and short, or in cash, for the quick but steep October rally that brought the major indices almost back up to the point at which they had broken down back again in August. Shellshocked, with what seemed had seemed a decent year now in tatters, all they were able to do in November and December was curl up in a foetal position, to derisk, and hope the kicking stopped.

A time of derisking, by the way, is a terrible time for those who are not derisking to make money. It means PMs selling positions that they like, and buying the ones that they hate. If everyone is doing this it makes for the market of Bizzarro World, where down is up and up is down. Good stocks, at best, make no traction, while bad stocks are likely to squeeze. November and December were marked by this worst of enviroments, what Baruch calls “high amplitude chop”. This had the effect on putting the kibosh on the few players left who still had any profits, and who had thus been less inclined (the fools) to join the mass huddle.

By the end of 2011, then, the performance-led derisking must have been largely complete, and at least some investors, if not the majority of them, are probably looking at trying their luck in a new year, with slates wiped clean, and having another go at earning those management fees again. Indeed the last datapoint in 2011 from ISI, who tracks these things, had the gross at hedge funds (a measure of how much of their capital they have deployed in short and long positions) at the same level as June 2008 — ie very low, crisis levels. Not at all what you would expect at the end of a year in which the S&P was only flat.

Just off that then, it would seem that maybe we don’t have to worry too much, and we could have a return to something approaching a normal environment where active management works again. In fact it is necessary to be mostly optimistic in this business, as a general rule. But then again I suspect I am merely trying to reassure myself because while people may be underinvested, there is also a very high degree of nervousness out there. It won’t take much to bring us back to derisk mode again, and if 2012 is another chop-filled  year like 2011 for active managers, well the only people who are going to be happy are the indexers. And they’re the enemy.

I would like to end the blogpost right there, and not talk about the things which are actively making me worried, such as $200bn in dodgy European sovereign paper to roll over, the apparent Chinese slowdown, nasty commodity trends and record high corporate margins etc etc, because thinking about these things makes me stressed out.

Happily, others have done that better than me**. So I sign off and wish my reader(s) a very happy and prosperous new year.

* knowing that whatever thesis you have in your head is likely to be wrong makes it much easier to discard it when it gets falsified, or when you think of something better. Knowing also that you are really quite thick makes it harder to worry about looking stupid (why live a lie?), and more money is lost trying not to look stupid than in any thing else you are likely to do in the stockmarket.

** Baruch is not sure whether The Interloper makes him want to retire from blogging or want to blog a lot more. Either way, it is grand he is around to be read. If he wants a hand on Euro Telcos he can drop me a line.

Homicidal zombie markets reconsidered

Baruch received old media brickbats for his bloggy frettings last year about the impact and meaning of QE2. At the time, while understanding why people thought it was necessary, he worried that we were opening a can of worms which were going to wriggle off in all sorts of undesirable directions. He wrote:

in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat  was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).

The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.

Pointing to potentially horrible unknown unknowns tends to capture the imagination much less than pointing to the definitely unpleasant known knowns of an imminent economic slowdown. The QE2ers’ argument at its core was the eternal and seductive call that Something Must Be Done. No less than James Suroweicki at the New Yorker picked up Baruch’s idea of the “undead homicidal zombie market”, tautology and all, and lumping me in with the Tea Partiers, House Republicans and the other dead-end no-brained foes of QE, labelled us  “hysterical”. Baruch loves the New Yorker, but knowing their editorial stance and lack of track record when it comes to advising macro funds and governments, Baruch concluded their love of QE was less a well-thought-out economic analysis, and more a gleeful response to finding their political foes against an idea that felt “right”, Colbert-like, in their gut. In his response, (Felix also had a good one) Baruch bemoaned the politicisation of monetary policy by anyone. This hasn’t got any better — having an (admittedly Texan) presidential candidate threatening the Chairman of the Federal Reserve with a tarrin’ and a featherin’ if he buys any more bonds doesn’t seem conducive to a mature conversation on the subject.

So, was Baruch right? Or were the Suroweickians? An interesting thought experiment would be to think of where we would be without that second round of easing. With the benefit of hindsight I’m inclined to think we would have been better off right now had we not done QE2. Why? Continue reading

No Second Chances

Baruch has been reading Asymco, a fascinating techie site he was put onto by Jean-Louis Gassé at Monday Note, and those interested in tech investing should really have a look at it. You can now see the site popping up on more generalist econo-investing sites like AR. Anyway, introductions over; there was something Asymco’s proprietor Horace Dedieu wrote earlier this month that made Baruch sit up and think.  “The post-PC era,” he wrote, ” will be a multi-platform era,

The thesis that one dominant platform wins the mobile “war” is naive.  . . Developers already understand this. Platform vendors know this. It’s time to unlearn the lessons of the PC era.

Evidence for this? Microsoft Windows Mobile platform apps are growing at a percentage growth rate that is faster than WM users grow, who collectively make up so little of the pie of smartphone users that the slice representing them would be mostly invisible. It’s not getting any better. WM activation rates are 1/28 of that of Android smartphones. The platform is continuing to lose share with subscribers yet, strangely, still seems to be gaining relative share in apps.

What appears responsible for this is the previously unheard-of ease of transferring apps from one platform to another, software tools such as Microsoft’s that allow the rapid creation of new apps and their adaptation for different operating systems, and an economic system that is set up to make writing software for mobile applications a “cottage industry” with a thousand points of light, rather than an industrial enterprise with 2 or 3 dominant players. The marginal cost of creating apps and sharing them between platforms seems to be very low indeed.  So why not make or adapt apps for Windows Mobile? You never know, it might come back. Mango, the new version which will be Nokia v.2’s adopted OS, might be the Apple or Android killer Microsoft hopes it will be.

If the ability to run the largest number of apps determines success then, far from being a returns to scale market like the one for PCs, the implication is that the market for smartphone platforms will be fluid, with nothing written in stone. There will be room for their relative shares to ebb and flow, variously dominating, fading and coming back repurposed for the new new thing in mobile computing: on this reading, it will be something like the game console market today, where 3 viable platforms survive.

What this means in its most practical sense is that there is hope for the platforms falling behind now, such as HP’s WebOS, RIM, and for OEMs like Nokia, for whom Mango is the only game in town. The implications for stocks are major. The option value in RIMM and Nokia would be much much higher than current share prices imply. This would make a lot of people who are short these stocks very unhappy.*

Comfortingly for them, however, there are equally compelling arguments that mobile computing will end up more like the PC industry than anything else. Firstly I suspect that, contra Horace, the profusion of WM apps has more to do with the sponsorship of Microsoft and its deep pockets than a sudden developer interest in championing losing platforms.  Secondly, its not just developers who decide who wins; operators remain in the mix. Their atavistc promotions and subsidy policies can also determine which platform sells. Don’t forget, moreover, that O/Ses are free! Android makes it so you can’t underprice zero to gain market share for your new platform. That helps to freeze things in place and mitigate against fluidity.

But most of all, the apps game remains secondary to the real goal of platform competition. The aim of the game, the whole schlemiel, remains to sell hardware, not software. Apple’s app store revenue is negligible in comparison to their hardware revenues, and will be for some time to come, at least until Apple finds a way to persuade people to buy higher ASP apps. Frequent purchase of 90c apps won’t move the needle against a $600-$900 hardware sale, even if everyone buys Angry Birds (and they probably already have). Until the dynamics of the mobile computing market stop being hardware heavy,  platforms are still vulnerable to hardware death spirals of the sort we’re seeing in RIMM and Nokia right now, where scale returns and operational leverage go into reverse

Don’t think either that just because is easier to write apps for a platform it is going to make it break out. The fact is that if all apps were available on all platforms rather than freeing up competition it would be likely to freeze the status quo in hardware into place. What killer app can Microsoft’s Mango offer me that I can’t get on my iPhone? What could possibly make me change my Android phone? A more functional OS? Better hardware at a cheaper price? Possibly. More likely that in the absence of anything significantly better than what I have currently I won’t change at all. Ecosystems are grabbing territory now that it will be hard to dislodge them from.

The dream of a fluid ecosystem for mobile computing is nice, especially for software developers tired of being the bitches of the hardware dudes. But it looks far off still. Mobile looks subject to the same laws that have governed tech markets throughout  history. That law is: no second chances. Value investing in consumer or enterprise tech very very rarely works. This is the key message for those who read Baruch’s last post and have fired their retail brokers and dumped their index funds, and who may be tempted to go off any buy RIMM at a 5x PE (don’t let me stop you, but do let me help you think before you do it)**. The graveyard of history is littered with those names that didn’t come back. For those that did, such as IBM, and indeed Apple, we forget just how low the low point was, and how wrenching it was to do the right thing so as to eventually re-emerge.

* you may think that this group of people includes Baruch. You may think that if you wish. But I couldn’t possibly comment.

** as I have said before, if you take anything you read on a blog written by an anonymous author as actionable investment advice, you may not be too bright. I can do nothing for you.

The stockmarket is still where it’s at

Baruch is more pleased than he can say to see his pal Felix get a spot on the NYT’s op ed page. But I wish he had written about bonds, or art or something else. He knows I don’t like it when he is rude about stocks.

Felix uses the occasion of the takeover of the NYSE by Deutsche Börse to claim the US stockmarket has become somehow “irrelevant”. Far from being the “bedrock” of American capitalism, he writes, instead

the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money. . . a noisy sideshow that churns out increasingly meager returns.

Well.

Excuse me, but when any stockmarket not been full of speculators trying to outdo each other? Algobots are new, to be sure, but they don’t change the market’s essential nature, other than giving bad or unlucky traders another mealy mouthed excuse as to why they lost money. I think the great traders of stockmarket history, Jesse Livermore, Bernard Baruch and our own George Soros would be amused to be thought of as something other than speculators.

Yes, sometimes stocks can go up when economic growth is only so-so; the link between the two is indirect. Eventually they correlate, but the period when they don’t mesh can be pretty long. Increasingly though, as companies globalise, they reflect global economic growth. And you all have to get used to the fact that the US economy isn’t as relevant as it once was.

Sure, it might be that the number of listed companies has fallen. Baruch hasn’t counted. But so what if there are fewer? Is that bad? I would imagine that after a period of prolonged weakness, such as we have come through, when IPOs were hard and bankruptcies and mergers common, the number of listed entities would fall. It’s a bit like speciation in biology; every now and then we get Cambrian-like explosions, and periods of higher extinction levels. Let’s not draw conclusions from low samples. And anecdotally it is simply not true that there are no IPOs out there, and no small IPOs. Baruch has been positively plagued with them in the past 12 months, from second rate brokers pushing illiquid crap I wouldn’t go near with my worst enemy’s money, to once in a lifetime opportunities the Goldmans and Morgans have to beat the investors off with sticks. There was a great one the other day, and Baruch would love to tell you about it. But he won’t.

Where Felix is right is when he says that there are lots of interesting companies out there who don’t want to go public; its a complete pain, having to explain yourself to people like me. There are certain things about how investors think, their collective expectations, the behaviours they force companies into, that make Baruch’s toes curl. But there is one very important reason for going public which still proves, ultimately, irresistible to entrepreneurs, and it is this: it’s the only way to pay yourself and your people stock options. It is still the easiest way of making a lot of people very rich, and keeping them rich.

And ultimately whether Facebook goes public or not won’t change the central importance of stockmarkets. They are still the cockpit where it all happens, where the key society-shaping corporate entities of our time, such as Apple and Google, keep score against each other and their competitors. The power of a massive market cap doesn’t necessarily get used in all-stock M&A or when it raises money; it is a latent power, it is potential financial energy, which you don’t want to waste. You typically don’t want to use your equity to raise money as it dilutes you. But your stockmarket valuation sure as hell counts when and if someone wants to buy you.

Does the stockmarket allocate capital as efficiently as it used to? I have no idea, but frankly if you think you know better than the stockmarket how to allocate capital in a complex economy, I suggest you get back in your time machine and return to the 1970s to see how well that worked out last time.

I think far from being irrelevant, stocks are the asset class of the future; we had the years where bonds ruled in the noughties, and it ended badly. The Asian countries which are leading global growth now are debt averse, and their main focus is on their own equity markets which are getting almost as important, and just as liquid and vibrant, as the NYSE, with world leading companies like TSMC, Samsung, and Infosys trading billions of dollars on their local exchanges every day. Meantime, this is Baruch’s advice: stop worrying, and go buy an actively-managed mutual fund or go research a selection of stocks in spaces you know about, with the aim of holding them for a few years. Make sure that at least some of them are listed in a different country (but you can still buy the ADRs). Try not to listen to brokers. Keep reading Felix’s blog, though.

The market as an analysis-free zone

Baruch has noted a curious thing about this results season, dear readers. Sell side analysts seem to have stopped doing as much research as they used to. I think it’s because, in the light of the SEC’s insider-trading investigation and a lack of certainty between what constitutes legitimate insight and illegal information, they are keeping a low profile. If it continues it could give great power to some of the market’s worst actors, and create a lot more single-stock volatility. Already this earnings season there seemed to be a lot more violent moves in stocks than usual. Hopefully Baruch is imagining it, and if he isn’t, let’s hope it is temporary.

It was most obvious when F5 blew up in late January. The print was merely in line, and the guidance, sin of sins, was weak. FFIV opened down 20% and stayed down. This sort of move off a quarter can happen in tech, and is not at all uncommon. What was vaguely unusual, however, was  the extent of the surprise: there was no warning. The company had made no hints it had seen any weakness, and none of the analysts covering it had done the usual checks with their sources. Worse, no-one really knew what everyone else was expecting. There were no “whisper” numbers out there. Frightened of being accused of insider trading , no one had done the work. Continue reading

Baruch: big in Japan

Imagine what Baruch found in his daily Abnormal Returns troll last thrusday, Bento! It seems 2 academic dudes, one Yuqing Xing and another Neal Detert at the Asian Development Bank Institute in Japan, took a look at the iPhone and the US-Chinese trade deficit, and realised that high tech products such as the iPhone, which are merely assembled in China, distorted the picture. Very little of the value of the iPhone comes from, or remains in China, yet the full value of the iPhone is counted as a Chinese export for the purposes of deficit calculation. The official numbers are wrong, therefore, and the “real” deficit is much lower.

All well and good, and jolly interesting too. So much so that it was picked up by the WSJ, Paul Kedrosky, and of course, Tadas at AR.

Baruch certainly found the article interesting, as these were thoughts very similar to those he set down over one year ago in a blogpost here called What’s an export? Seriously. In it, after examining the supply chain of the iPhone* in some detail, he concluded that high tech products which are merely assembled in China distorted the picture. Very little of the value of the iPhone comes from, or remains in China, yet the full value of the iPhone is counted as a Chinese export for the purposes of deficit calculation. He wrote

Presumably to work out the real trade balance in terms of where trade flows, or where the wealth generated by iPhones goes, classifiying it as a {Chinese} export for the purposes of assessing a trade balance is misleading . . . Where there are totally integrated global supply chains, I suspect that the definitions of “import” and “export” begin to lose meaning.

Baruch was confused: why did economists and politicians harp on about the trade deficits like this when it  assessing the true value of the deficit was so obviously problematic? The post ended with a plea:

If there are any professional economists left reading UB, please help.

“Help” in this case, did not mean “purloin my idea and publish it in your own name for the glorification of your career without so much as citing poor old Baruch.”

What do you think Bento? Can I sue?

*happily, Xing and Detert also make a hash of the foodchain of the iPhone. Toshiba does NOT make the touchscreen and display module of the iPhone, though may be implicated in the NAND memory; touch module is left to an obscure-ish Taiwanese company called TPK, the screen could come from a whole passel of suppliers, but probably not Tosh; the apps processor is only “fabbed” by Samsung but is a design owned by Apple, Infineon does not make the “camera module”, though does make the baseband and some other stuff. Etc etc.

Baruch the political football

James Suroweicki is using Baruch’s (rather good) line, the “undead homicidal zombie market”  as grist to his anti-anti QE2 mill.

What’s most striking about the attacks on QE2 is how hysterical they are. People aren’t just suggesting that the Fed’s policy—which is quite modest relative to the size of the U.S. economy—might be ineffective or mildly inflationary. Instead, they’re accusing the Fed of “injecting high-grade monetary heroin” into the system, pursuing a policy that “eviscerates” the middle class, and potentially giving birth to an “undead homicidal zombie market.”

The main problem with this of course, is that this last bit never happened. No-one ever accused the Fed of potentially creating an undead homicidal zombie market.

What Baruch actually wrote (my emphasis) was:

“I’m not saying we’re in an undead homicidal zombie market,”

And there we could let it lie.

Although to be fair, I did add “though we may be” as quite frankly I was not very sure of anything at that particular moment. Communicating this lack of certainty was the point of the post, which was about feeling confused and worried. But nevertheless, in the offending line above, Baruch was trying to stop going too far down the path of a metaphorical flight of fancy about undead cats. To avoid, if you like, hysteria.

So James S. has it completely arsy-versy. Clearly he hadn’t actually read Baruch’s post, and by the way James, in the unlikely event you ever read this one, if you do choose to misquote me disapprovingly the least you could do would be to drop us a link, no? Probably you have an outdated editorial policy that prevents you from doing so, but still, this is the 21st century.

Calling one’s opponents “hysterical” is, moreover, quite a cheap rhetorical shot, a debating tactic much used by Straussian neo cons and WSJ op ed writers to close off a reasoned argument they are on the wrong side of. Different words that do the same job are “partisan”, and (Baruch’s favourite) “shrill”. If someone is hysterical it is much easier to ignore the points they make. Rather, the word implies, they just need a hard slap and a good shake. The word has the stench of politics about it.

That’s the wider context here, which I think we need to put James’ article into. QE2 has become politicised, and this is a mark of just how demented US political discourse has become. Domestic bond purchase programs elsewhere don’t generally create similar levels of controversy between parties; most politicians realise their central bankers are just following through with their mandates, as the Fed clearly is, without any regard for political advantage. Baruch thinks the blame for the politicisation lays squarely at the feet of congressional republicans. He also finds it highly amusing to find himself somehow lumped in with this lot, however indirectly, as he has yet to contemplate a more priceless, ill-intentioned, irresponsible and ignorant set of economic baboons.

But the worry is that if the republican baboons don’t like QE2, then it follows that those on the other side of the aisle will start to like it, not on the basis of a reasoned weighing up of pros and cons, rather because it gives them good talking points. The result will be the vaguely uncritical lumpen thinking we see in the New Yorker article, and at its worst, an item of pragmatic economic policy which should be debated on its merits will join the pantheon of topics of almost theological controversy in the US such as abortion, gun control, flag burning and gay marriage. Pretending that QE2 is a well established economic policy without risk of externalities is frankly as absurd as saying it is an unmitigated evil.

Felix, whose own position is not far from Baruch’s, does a much better job of tackling the article in this post. As he puts it, “the weird thing is that Surowiecki and I actually agree on most of the issues here.”

Indeed. As things stand right now, Baruch is very rapidly coming to terms with QE2: not particularly astonishingly, the thing might actually be working! There are green shoots everywhere he looks , from an apparent increase in volume at transaction processing companies, to semi makers guiding for much lower seasonality in the next quarter, to positive 2011 GDP revisions by the economists, to strategists telling me to buy cyclicals, etc etc. The price of gold even dropped a bit on thursday. He is pretty optimistic, certainly much more than he was last month, when his problem was that he could see the sufficient reasons for stocks to rise (QE2), but not the efficient ones (forward EPS estimates going up). That’s been solved, confusion lifted. Things are great!

Then again, that’s exactly what I’m supposed to feel, isn’t it? There’s nothing like turning up to a party with a hangover (swearing you’ll only stay for a bit), having that first drink and realising how much fun you’re going to have if you stick around. Thoughts of a potentially much worse hangover yet to come are far away.

Through the looking glass again

I’ve been catching up on my reading and dear Bento, if anyone tells you they have a clear view on what is going to happen to the econo-world from here, walk away briskly. As Ed Hyman of ISI* puts it, with the now imminent onset of QE2 we are in “scary times”, a world of “unintended consequences”.

The only intellectually honest position to take at this point, it seems, is to admit we haven’t a clue. Personally I, Baruch, am getting really confused. My default setting is that we will muddle through and everything will be OK. But the cone of potential outcomes that surround that base case is now as loose and flappy as a wizard’s sleeve.

Note also that even the “muddling through” scenario doesn’t presume any particular level of the S&P at the end of the next 12 months. Plus or minus 30% and in Baruch’s view we’d still be all right.

Where to start? Well, here’s a list of the factors that I think are going to make us move, in the form of a dialog in Baruch’s head. None or all of them could dominate. Maybe some are already priced in. Some of them I hope are  made up and will go away. There’s nothing particularly original here I admit, but I want, at this juncture, to sum up where we may be. Baruch’s future self might find it interesting. Here goes:

1) we are getting QE2! It will save us from Japanese-style deflation. Yayy!

2) Yes, but this is not necessarily a good thing. QE2 is the first move, the invasion of Poland if you like, in the coming currency war against everyone who is good at exporting, especially the Chinese. In the ensuing cycle of “bugger thy neighbour”, we will descend into massive disruption of trade and runaway inflation. Oh no!

3) But don’t worry. The Chinese are going to make structural reforms in their upcoming 5 Year Plan which will massively boost consumption over the next few years. The Yuan will rise anyway, no matter what the result of the horrible currency shenanigans, and their ensuing import boom will be the engine dragging the world out of debt-deflation! Yayy!

4) Hang on. I’ve just had some bad news. The financial system is insolvent again. All the mortgages securitised in the past X years stopped being asset backed, as they umm. . . lost the paperwork. The holders can’t foreclose, and the people who have been foreclosed on may have had their houses taken away illegally. Many may have to get their houses back. So stuff that the banks still own has to be written down again. Hell, even the people who can pay their mortgages have a big incentive not to any more. We’re totally fucked.

5) Don’t worry! All that crap’s been written off already or backed by the Feds! Isn’t it? They can’t be as stupid to have it still on their books, right? While we may have jeopardised a couple of banks, the Foreclosure Crisis may also have solved the US consumer debt problem! All the mortgages will be cancelled!! As long as a few banks can survive we still got QE2, massive Chinese consumption growth AND a reset to US private indebtedness. Those crazy Americans can now re-re-mortgage their houses and buy another round of LCD TVs for their McMansions, and reinstate the semi-annual holidays in Disney World! We can’t lose!!

6) Not so fast, cheeky monkey. The US banking system may be meta-fucked. Turns out the banks who securitised mortgages may have defrauded their customers and broken the law, because they secretly did in fact do some due diligence, and knew all the mortgages were rubbish. There is no better person to tell you about this than our old mate Felix; who says bloggers can’t do journalism? Good news: bankers may not be the total idiots we thought they were. Bad news: they were fraudulently criminal instead, and apparently may have to pay cash at par for all the stuff they all wrote down already, plus a bunch of extra fines.  Even if the SEC throws up its hands and the DoJ doesn’t want to prosecute, I imagine foreign prosecutors won’t be so shy if there’s a case to be heard. Certainly you would think a civil case would be worth a shot, and if proven, I can only imagine the settlements. I hope they remember to ask to have the checks made out in Yuan.

7) You poor sap. You ridiculous perma-bear. Bernanke has our backs! You don’t think he doesn’t know this stuff already? You were wondering why he was so keen to rush into QE2 despite the positive turn in the leading indicators, and pump us all up before the mid-terms. You got it now? We’re going to get the mother of all easings, bigger than the trillion dollars everyone’s expecting, something open-ended, maybe.

Anyway, that’s as far as I got. Any better ideas out there? Anything I missed? Is any of it wrong? Can you help poor old Baruch make sense of it all?

* ISI is the only macro strategist my team actually pays for, everyone else seems to offer their opinions for free

Myths about stockmarket myths that just won’t die

Baruch hasn’t stopped blogging. He’s just been busy at work. To be fair, there also hasn’t been that much he has wanted to write about.

That changes here! A recent and growing animus in the econoblogoverse to, of all things, equity markets, has woken him up. Baruch finds this fairly incredible. Equities, he is fairly convinced, are the asset class of the future. This anti-equities movement, led by jealous journalists and winking, cackling bond apologists with axes to grind, needs to be nipped in the bud, as it is dead wrong. The WSJ’s otherwise reasonable Brett Arends is Baruch’s immediate target among the evil-thinkers, for his (last week’s top read on Abnormal Returns) The Top 10 Stock Market Myths that Just Won’t Die. And that Felix Salmon is also guilty as sin in this, for many offences against shares committed over the past few years.

Myth 1: stocks don’t generally go up

Wronngggg! Try shorting for a living and see how long you last. I’ve tried it. It is *really* fricking hard. Actually this year my shorts have made me more money than my longs, but I am an investing genius, and you are probably not. To those bond apologists who claim that this “stocks for the long haul” stuff is bullshit, I urge you to actually count the number of 10 year periods since 1950 where stocks have not made you a net percentage gain. I can only see 1963-64 and 1999-2001 as periods with evident losses (check out the S&P log chart from 1950). So around 90% of the time in the past 50 years, stocks have made you money on a 10-year investment horizon.

It’s not like you lost lots of money when they did go down, either. At worst, if you had been unfortunate (or dumb) enough to invest in January 2000, by 2010 you had lost about 20%. You would have faced the same, a 20% loss,  in 1964 to 1974. Your upside risk, however, has been pretty assymetric, and in most 10 year periods you would at least have doubled your money, with triples, quintuples and zilliontuples common in the 10 year periods after 1980. That’s from a 60-year sample, which admittedly doesn’t include much in the way of catastrophe, revolution and property confiscation that has occurred in the stock market histories of other countries.  But still, equities look pretty good to me off this very basic analysis.

Clearly, just because in 90% of cases equities made you a positive 10 year return in the past is no guarantee it will continue in future periods. But I bet there were moaning minnies telling us stocks were dead at every point in this history. The onus has to be fairly put on the current stock-deniers to explain why they are right this time.

Myth 2: stocks and the economy are no longer linked

Brett Arends uses the Japanese example to illustrate this point: “since 1989 their economy has grown by more than a quarter, but the stock market is down more than three quarters”. He was probably well aware that this is a thoroughly exceptional example. This was number 4 in his top 10 list of “myths”, and I think he was already beginning to panic that he had 6 more to come up with still.

To be fair, the linkage between stocks and economies, while direct, is complicated. Companies’ share of GDP can increase or decrease while economies are booming or stagnating. Valuation is an extremely important filter. Extremes in the entry and exit point of when you actually invest can determines most of the result of the investment; Brett here chooses the very peak of the stockmarket and real estate bubble in Japan as his entry point for his trade. Not, I think you’ll agree, an exercise immune from sample size error.

The rest of the time, filters aside, stock prices are based on company earnings. When a company announces a better than expected quarter (nota bene,  better than investors expected, not the sell side consensus), the stock tends to go up. In their massive, millionaire-creating stock ramps, Apple and Google and Microsoft all went up because we realised they were going to earn much more in period n+1 than we thought at period n.

Fact is, economies tend to grow, and in a country with stable population it is productivity gains, doing more with the same or less, which is responsible. In other words, innovation equals growth. The repository of innovation, the sharing of ideas and the investment to put them into practice is the private sector, in the vast R&D departments of major enterprises and fast moving startups. May I refer you to the cod Hayekian but still excellent work of fellow Collegiant Matt Ridley for a longer exposition of this. That’s what you buy when you buy equities, that’s what you incentivise when you ask for shares in an IPO. You are driving and partipating in economic growth. Economies grow, company earnings tend to go up, and shares tend to rise. Simple really. Don’t lose sight of the forest for the trees.

Myth 3. The Machines are in charge. The Humans should give up.

Algo-bots sort of rule. Machines dominate lots of daily flow, and make it weird. But they don’t determine the forward PE ratio of e.g. Cisco. We do, and by its own lights the reasoning behind stocks being where they are is sound — if we double-dip, CSCO and everyone else will see their earnings fall, and so stocks trade at lower PEs than their long-term growth track record implies they should. Consensus estimates, the denominator of the PE, do not include the possibility of another recession. The punters, who are not paid to be bullish, don’t trust the numbers and are partially pricing it in.

So we don’t need to blame the algos and high frequency traders for our long positions going wrong. Hedge fund dudes, market makers, and lots of people whose livelihood is exploiting the shorter term moves in the stock market, DO have potential grounds to complain. Their jobs have become harder because of the bots, whose job after all is to scalp the humans. But this is not a reason to give up on stock market mechanisms that still reward medium-term savvy investment decisions.

Listen: the markets are always hard. Its supposed to be like that. Oddly enough, rather than blaming themselves, people like to have someone else to pin it on when their investments go wrong. In the 1990s they used to blame daytraders for driving internet rubbish to great heights, then in the naughties the shadowy “Plunge Protection Team” was the scourge of the bears. These days the bots are the scapegoat. The bots will one day overreach — if they ever really “ran” the market they would very quickly stop making money; trying to scalp each other would not be a good idea. Relax, and learn to love the bots. Whatever bogeyman that replaces them may be much scarier.

Myth 4. Higher volatility = Sell your stocks. We are in a period of higher volatility

This is just SO VERY WRONG that Baruch has to bite his fist. Were it not the thesis behind Felix Salmon’s call to sell all stocks (backed up by some pointy-headed algebra) the midst of the sovereign debt bruhaha of not so very long ago, Baruch would merely have ignored it. To have Felix (Felix!) tell us this is like hearing someone you respect and admire tell you the moon landings were faked by the guy on the grassy knoll, that the US military invented AIDS and that people from Harvard Business School are capable of independent thought. You want to edge away, slowly.

Historically, higher volatility is actually the long investor’s friend. It is associated with stress, periods of fear and panic — in other words buying opportunities, not good points at which to sell. Similarly, low volatility is associated with periods of complacency and is often, but certainly not always, a good point to sell. It’s easy to act pro-cyclical. Buying “at the sound of cannons” is very hard when the cannons are actually going off. Selling is a much more natural reaction, and brings very quick relief. You can feel a very virtuous disgust at stocks, vow never to go near them again, and go and buy some 10 year T-bonds at a 2.4% yield.

Of course, this is a terrible mistake. All you have done is maximise your losses, and give up on the idea of ever making them back. No less an authority than Mrs Baruch, herself an accomplished investor, characterised selling at high volatilty and buying at low volatility a “catastrophic” idea when Baruch told her about it. In order to make money in equities you have to invoke the Costanza Doctrine, ie do The Opposite — the opposite of what you feel like doing, and the opposite of what everyone is telling you to do. The fact that very few people are actually clear-headed enough to do this is probably why equities as an asset class are increasingly unpopular.

Truth 1: everything else is screwed. If you need to invest, you will likely buy some stocks even if you don’t want to

The tragedy is, of course, that equities are the coming thing. No other asset class, at the moment, seems to have the same combination of great fundamentals and juicy valuation. Bonds while the 10-year yields you 3% in a period of heightened risk on sovereign solvency? Puh-leeze. Gold? Who the hell knows with the weirdos on either side of that trade. Commodities may be good, what do I know, but as an asset class they’re probably not suitable for more than 25% of your allocation. Real Estate? Maybe that’s not a bad idea either, but I refer to the answer I just gave on commodities. Also property tends to not be very liquid. Art? Wines? Antique cars? Be my guest. The dirty secret of alternative investments such as hedge funds and private equity is that most of them are disguised equity longs. Hedge funds generally feel much more comfortable being net owners of shares — Baruch has yet to see the multi-strat he works for go net short, for instance. Private equity needs healthy equity markets (and, if you ask me, naive ones) to make actual profits close to the otherwise fictional marks they carry on their books.

At the end of the day, however, it largely comes down to bonds versus stocks. You are going to be overweight stocks in the coming years. It might take some of you some time to actually bite the bullet, and you will do it at higher prices as a result, but you will do it. I look to no less an authority in this as the biggest, baddest bond investor in the world, PIMCO, who is getting into equities in a big way.

Right now, equity investors are being offered a win:don’t lose very much proposition. A double dip, the great fear of the equity markets, is at least partially priced in here, and the upside if we don’t double dip looks very good indeed. It’s a great moment for stocks.