Category Archives: Stupid Cartesians

The Beginning of the End of the Euro Crisis?

Baruch has been a student of the wondrously dysfunctional Greek
political system long before it became fashionable, and is surprised at the
sudden relevance of what he had always thought to be rather interesting, but
not particularly useful. No longer – Greek politics is currently at the centre
of the world. What is upsetting, however, is that most everyone inside and outside Greece seems to disagree with him about what happened last week. Far from being a calamity exposing the weaknesses of the latest bailout package, Baruch thinks the ramifications of the call by Papandreou for a referendum are deeply positive. Merkel and Sarkozy, and the rest of us, should actually be grateful to him for heading off in Greece what is frankly the
biggest risk Europe and the global economy faces – political risk; specifically
“austerity ennui” on the part of the population, and pandering politicians
eager to exploit it.

Baruch is also unamused by the people who are watching what appears
a train wreck with barely disguised glee, rubbing their hands in anticipation
of the Euro’s supposedly imminent demise, starting of course with the ejection
of Greece. Your celebrated correspondent has no particular love for the common
currency, not least the silly name (“Euro-“ is a prefix, he has always thought),
but once in, the likely costs of leaving are so awful as to make it imperative
to stay in. In the case of Greece, were it to drop out of the Euro, we would be
talking about the instant impoverishment of a modern democracy, whose citizens’  life savings would be wiped out (apart from the  very rich who are able to have accounts abroad, take that, Gini co-efficient!) and the bankruptcy of every exporting enterprise. There would be mass unemployment. Imports such as energy and medicines would skyrocket in price, creating shortages; basic services would likely break down. People would die. It would be less like Argentina, more like post WW1 Germany, or maybe Eastern Europe after the collapse of communism.

Within the living memory of politically active people Greece has fought a bloody civil war, and flirted with fascism. European leaders should probably pause before inflicting this sort of stress on one of the most politically dysfunctional and divided states in Europe, a relatively big fish in the Balkan backwater, itself no stranger to conflict.

Seriously, I wouldn’t want this Pandora’s box opened even
if I was short the Euro, which I am not and which I happen to think may be a
quite bad idea if you want to make money in the near future. Yet never mind the
Eurosceptics who are actually looking forward to it, everyone else seems to be
fairly resigned to it as well. Even clever people. Felix, for instance, sees a “chaotic collapse” of Greece as “inevitable”. Josh Brown cheers him on.

I think the very awfulness of what will happen if Greece is ejected from the Euro in a messy way (and until the treaty is changed there isn’t really another way it can happen) actually makes it more likely that it doesn’t happen. No matter how nasty a generation of austerity may be, it is a walk in the park in comparison with the likely alternative.

And that realisation may just have dawned in Greece last week. Continue reading

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

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.

Quantitative Queasing

So we have been having Quantitative Easing already, and Baruch doesn’t  like it.  The stockmarket is up (or was), the data seems to be improving; QE has done its work and for all we know it will continue. But there is a special unhealthy quality to it all. It feels like a “wrong” rally, like the cat from Pet Sematary was clearly a wrong kind of cat.

The problem as I see it is this: QE lowers overall interest rates and makes all the stocks go up when they wouldn’t have normally. It raises their valuations, which you can also express by saying it makes for higher PEs. This makes people feel richer. They will go and buy more stuff like LCD TVs, making the companies who make the stuff they buy richer too. They will invest more, and buy more stuff from companies who make stuff not for people, but for other companies. Eventually all the companies grow into their higher stock valuations, and we are all fine.

The key word here however, is “eventually”. What happens in the bit between the 2 points:  after all the stocks have gone up, and before the fundamentals improve to justify their new valuations? Because I think that’s where we are if stocks have stopped going up, or where we will soon be.

Now, my tech stocks aren’t exactly expensive. Lots of them are to be had for PE multiples in the low teens, which really isn’t bad. But there has been no fundamental improvement in their businesses since the summer, as far as Baruch can tell, and yet their stocks have absolutely zoomed to levels I frankly have difficulties buying them at, at least on the charts. Baruch was astonished last week to see that the NASDAQ 100 was basically back to its pre-crisis high!! You get that? That index is telling you that things are as good as they were before the Great Unwind.

I can’t short them either, at least not on past form. That’s been a mug’s game; the subtext of QE is “kill all the shorts” — another way of making sure stocks go up. Returns on short books have been pretty brutal, and most long short guys in the past couple of months have learned to be mostly long, or if they have to stay balanced, then long stocks, short indices.

So, now what? If stocks are now disassociated from their fundamental realities, however short a time that disassociation is supposed to last, non-fundamental realities are going to rule, and I have no idea what that means. Will we get stasis, a crunch in volatility and volumes? Will we have vast nauseating unexplainable swings in stocks, huge moves in the VIX? Will we crash? Will we carry on straight up? Will we pause and rally? Who can say? We’re in a period where anything is possible, as I’ve said before, a world of unintended consequences coming down the pipe. Some may be good, and some may be bad.

This is why 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.

I’m not saying we’re in an undead homicidal zombie market, though we may be. But here’s an example of what the Pet Sematary market is capable of in terms of unintended consequences: QE inflates all asset prices, including commodities. This pressures the Chinese consumer, who we are relying on to pull us all out of this mess, who can suddenly not afford his new LCD TV because his Moo Shu pork is costing 20% more than it used to. Changes in commodity prices have a much greater impact on his consumption than Joe Schmoe in Idaho, with his low cost high fructose corn syrup and processed trans fat diet. The BoC has to raise rates to offset the inflation this is causing, hurting Chinese growth even more, and global GDP growth drops 50bp. Bravo the Bernank. With your Quantitative Easing you just killed off the only good thing in this market which was working naturally without outside interference.

OK, Baruch may be exaggerating, but a big part of today’s selloff is driven by fears of commodity prices in China and a collapsing Shanghai stockmarket. It’ll probably turn out to be nothing, a damp squib. But if it doesn’t, you heard it here first. I feel sure there is a wider point here to make about the bad things that happen when you mess with the signalling mechanism of the stockmarket. After all, the stockmarket does not exist solely to make us richer, does it? But that’s probably for another post.

Get me some of that subprime action!

One part of Baruch’s latest post concerned what after today may now properly be called “Mortgage Crisis II — The Evil Spawn”. I’m not referring to the foreclosure issue, that’s totally separate. I mean the bit where the banks knew that they were selling on dodgy mortgages — where they had done the due diligence and forgot to tell anyone they were selling them crap. We got the first case today. Pimco, the NY Fed, and others are suing BofA, and want them to take back $47bn of dodgy mortages they sold on. At par! It’s called a “Putback”, apparently.

Anyway, as you may remember from the post, Baruch made a joke! He wrote, concerning, as it may come to be known, Putbackgate (actually, Felixgate would be much better):

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.

Baruch also wrote, and then deleted “I got to get me some of that sub prime paper” — on the ground that it wasn’t that funny. Honestly, I really did.

Incredibly, doing precisely that is the new real life trade on Wall Street! This crappy old mortgage paper trading at 40c on the dollar has suddenly found a new lease of life. Once you own 25% of a securitised issue you can, apparently, get to look at the books and find out just what it was the securitising banks didn’t tell you. You can get your own Clayton to look at the loans. And if you find a discrepancy, you hit the jackpot! Double your money. I dont think these loans are going to stay at 40c for long.

Pimco, according to the WSJ, had 63% of its main bond fund in government paper in July this year. Now it’s just 33%. They’ve been buying, among other things, mortgages, now 28% of the fund. Clever Baruch, with his little joke. But much cleverer is Pimco, methinks, for taking its sense of humour seriously, and thinking of a way of making money from it.

 

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.

Google’s long goodbye

Baruch: Today, another round of derivative punditry: There is much reading of tea leaves re Google’s reading of tea leaves re what Chinese authorities really think of Google’s continued web presence in mainland China.

What we know:

Chinese authorities do not look kindly upon the automatic redirecting of a locally-hosted, licensed website with the .cn suffix (google.cn in this case) to a non-.cn website (google.com.hk). China-based sites that have or want a government-issued Internet Content Provider (ICP) license need to be used for their stated purpose. Redirecting is not a valid activity for such a site.

This is not an arbitrary Google-only rule. I was made aware of it last year when my own China-based web project was about to go live — the ICP license was still pending as launch day approached, so we mooted a plan B where the URL would redirect to content on a non-Chinese server. The idea was nixed after we were told by government officials this would be a bad idea. (Fortunately, our ICP license was granted just in time.)

Now that Google’s ICP license is up for renewal, the strategy Google came up with in January March to serve uncensored search results to mainland Chinese netizens is found lacking. This automatic redirecting business has got to go.

What Google is replacing this with is the next best thing (from its perspective): An image that looks just like its search page, but which transports you to the Hong Kong version as soon as you so much as breathe on it. The page looks like it has a search entry field, but it is fake. Click on it and you go to a real search entry field on google.com.hk.

This kind of fakery allows Google to argue that Chinese law has now been followed to the letter, even if the spirit has been taken out the back and shot. The argument better work: If Google’s application for the renewal of its license is declined, it might as well close down all web activity in China. Google needs this new ICP license by July 1. The application based on this new “manual” redirect method was made on June 28.

What we think:

I doubt Google’s trick will fly with the relevant authorities, who will see it for what it is — a politely stated fuck you. A manual redirect is still a redirect, with the site doing nothing else at all. What it does allow Google to do, however, is force China’s hand. Google won’t abandon its users by pulling out of China — it will insist on being pushed.

So yes, Google knows the game is up, which is why its Chinese users are being weaned off google.cn and onto google.com.hk. In China, Google users are among the sophisticated half of web users, and they know how to change a home page, default search location, or shortcut. All they need is a bit of a push to get them to change these defaults, and then they’ll be on their way. When google.cn goes dark, they’ll be fine.

The one thing that would really put a spanner in the works for Google would be if the Chinese government decides to block all non-Chinese google properties, out of spite. But that would just be vindictive, and it would anger far too many web-savvy Chinese users who tolerate their state’s web paranoia as long as ready circumvention options are available.

The thin veneer

Baruch is staring-eyed and stressed. This sovereign debt crisis is beginning to wear him down. He’s beginning to worry. He wouldn’t mind if he was just dealing with risk; he can quantify and hedge that. No, he feels deeply uncertain. Here’s why:

The general hopelessness of european policymakers is just too evident. We don’t have a fiscal head, a SecTreas, to make reassuring noises. We have a cacophony of differing national agendas, and a bunch of governments up for re-election. Arguably reasonable when they do stuff separately, when they act together everything they do has an air of compromise, half measure, and to the uncharitable, incompetence. The ECB, as the heir of the Bundesbank, should have a certain astringency when it comes to dealing with crisis — which in Europe hasn’t come about very often — that the Fed has long since abandoned. If the Fed, especially under Greenspan, was always the loving Mommy, the Bundesbank was the harsh Prussian Vater, prepared to let its kids die if they thought it was good for them. We think that’s what the ECB is supposed to be like, but we just don’t know. It might also tend more to the Banque de France part of its inheritance, which was if possibly even more of a pushover than the Fed is. It’s essentially untested. That’s not risk; that’s uncertainty.

This general European hopelessness in the face of this particular crisis is actually surprising considering how much is at stake. That’s because it is not just about trivial economic issues: what is at stake are key national interests and core principles of post war foreign policy, harking back to a period where tanks roamed the continent blowing things up. It’s also about domestic policy, the fabric of the settlements between right and left in Europe, insofar as what seems to be happening is that the world has decided to stop funding Europe’s social model.*

Baruch was taught to understand the Euro, and the whole European project, in the context of a historic compromise between France and Germany to prevent war from ever breaking out on the continent again. Germany was permitted to become a normal state again, and to thrive, so long as it was separated into BDR and GDR, and vitally, integrated into a number of key institutions, in which the French would be the senior partner (and French the main language — they like that sort of thing). They started with the European Coal and Steel Community, and moved on to the EEC, the Single Market, and later, the EU, gathering more and more members on the way as it was clearly proving to be A Good Thing.

The USSR falling to bits put paid to this cosy arrangement; suddenly half the bargain was going to be broken as the Germans clearly wanted their Eastern relatives back. That this was a real problem at the time is easily forgotten; the Blessed Margaret famously fretted whether Reunification should actually be “permitted” at all. EMU and the Euro was the agreed-on price. Unified Germany would be even more tightly integrated to the rest of Europe, with the added bonus that, at a stroke, the more feckless European economies would be given the envied central banking credibility of the Bundesbank, the model for the ECB. For countries like Italy and Greece, where the smallest notes in circulation had lots of zeros on them, this was also seen as A Good Thing.

This is up in the air now. The Euro is at more risk than it has ever been. And for the new generation of politicians in France and Germany the compromises of  the 1990s may not mean so much. We don’t know how much they are prepared to risk to defend the status quo. They don’t have direct memories of firebombed cities, of fathers not returning home, of mothers and sisters raped by the Red Army. I don’t think we’d have the same worry if Kohl and Mitterand were still around. We would trust them more not to fuck about. Again, like the ECB, Merkel and Sarko are untried; their being in charge implies less risk, more uncertainty. And the French disengagement on this whole issue worries me.

I think that what I learned in 2008 about debt markets and leverage (they seem to go together) is that there’s nothing there without confidence; take it away, and trillions can become worthless in the blink of an eye. And all you get is a stupid coupon. Say what you will about equities (yes, Felix, I like the videos), there tend to be tangible realities behind them, stuff you actually own. Even if it is the nebulous brand value of a TV sock puppet selling online petfood, it is more than zero. This, Baruch thinks, is why bonds are not an asset class for serious people.

Subprime blowing up and its ramifications were, with hindsight, pretty obvious for some time before the crap really hit the fan. When confidence there evaporated the implications for valuing other asset classes were only indirect. The debt of developed western governments may be another matter. Aren’t they the anchor for the whole risk spectrum? All my company DCF models use respective 10 year government yields for the basis of the rate I discount their earnings at. Banks around the world have worked to derisk and delever their balance sheets in the past 2 years; you don’t get safer than AAA/AA government bonds. They must be stuffed to the gills with it. Mrs Baruch turned to me the other day and whispered, you know dear, after all this, corporates are going to be viewed as less risky than governments. She’s almost always right when she talks like this. I don’t know the ramifications of that. I have no idea. The limited bits of CAPM I remember don’t include that contingency. Again, uncertainty, not risk.

Confidence in bond markets is a veneer. We saw what was underneath in 2008 when the veneer thinned. I feel it thinning now, and am really worried that if subprime blowing up meant that commercial lending disappeared, and factories in Shanghai closed their doors for a month and global economic activity froze, the blowup of Eurozone sovereign debt can easily have the same impact.

As I write, eurozone finance ministers are meeting and, we are told, Have a Plan. I hope it is fittingly thermonuclear.

* this is not my original line, it came from an obscure Korean fund manager quoted in a Bloomberg article I read last week. I can’t find it any more. 유감스러운.

UPDATE: Wow, Angela Merkel must read my blog! Wait — hang on — did I just save the Eurozone . . . ?

No Stock Recommendations here; move along

Baruch recently found himself commenting on Wall Street Cheat Sheet, on a post by Damien Hoffman, who seems to really dislike Jim Cramer. The post was about some investigation of TheStreet.com by the SEC, which Damien thought highly amusing, perhaps because he also runs a competing subscription-based financial edutainment site. Now, Baruch doesn’t pay attention to Jim Cramer on TV, but in fact quite likes him in print. He reads his posts on theStreet.com, and respects his track record as a hedge fund manager and pioneer econo-blogger.  So Baruch felt a brief moment of annoyance about seeing someone he liked being unecessarily trashed, but soon his heart was filled with forgiveness and understanding again. We must not be too harsh; snark is Damien’s job, what he gets paid for. He is a financial blogger-journalist, and being cheeky about mainstream media figures is part of that David and Goliath thing blogging used to be all about.

Anyway, this post is only a bit about Jim Cramer and Damien Hoffman. The exchange got Baruch thinking about the differences between journalists/bloggers (or whatever you want to call them) and investors, and what it means to communicate about investments with the public. Baruch finds this terribly interesting, because of course as an amateur econo-blogger and a professional investor, he has a foot in both camps.

Some of Baruch’s best friends are, or have been, financial journalists and commentators, on blogs and print. Being a financial journalist is a good, interesting job, and very important to the proper functioning of a marketplace. Journalists can do things, find things out, and explain things the public and investors need to know in ways investment professionals can’t, at least without risking jail.

But in the end journalists are explainers, commentators. They are dependent on market participants to provide them with things to write about. They review what others do. They work with the huge advantage of hindsight. And when it comes to giving advice about what what should be done, most media commentators are no better than the rest of us. Probably worse; they don’t get as much practice at it.

The major problem that commentators have is that rewards are based on reputation. Praise from peers and increased readership is the only way they have of knowing how good at their jobs they are. This is dependent on how smart the writer sounds, rather than how good he or she is at giving actual foresight. It’s a difficult thing, having to appear smart all the time. A well publicised prediction gone wrong can be pretty devastating to a reputation and undo lots of less well-publicised predictions which went right. Many writers solve this problem by not making many predictions at all. This is why most analysis pieces in newspapers and mainstream blogs end up in prevarication and fence sitting. Most journalists these days are smart enough not to end their articles with the words “only time will tell” — but they may as well.

The need to constantly appear smart also incentivises some to find a shortcut. A good and quick way of appearing relatively smarter is to find some fellow commentator who has broken the cardinal rule of journalistic punditry and actually had a stab at predicting something in a clear, falsifiable way — and got it wrong. Pointing out someone’s errors is a good way to come up with copy when you can’t think of anything constructive to say.

Ironically, consumers of financial media are actually crying out for someone to tell them what to do, rather than the prevarication they are confronted with everywhere. So pundits who do state clear positions tend to get eyeballs pretty quick. This unsettles their peers, who are universally relieved when these outliers inevitably cock it up, and they can now write gleeful articles about how it was obvious their colleague didn’t really know what he was talking about in the first place. Realising this, even sites which purport to give readers actionable intelligence, such as Lex, don’t actually tell them what to do, which would be too risky. A conclusion is always hinted at, but never made as plain as ” we think you should sell”. Instead you get some coded priggishness, like the chairman of company X “should enjoy the view from the top while he can”. Which gives the Lex writer enough wiggle-room to appear clever whatever the outcome for shareholders. This is, after all, the point of his writing, which he would freely admit to you as well if you bought him a pint.

Compare financial journalists now to actual market participants. While every now and then hedge funds get in a feeding frenzy and will short your longs and go long your shorts if they think you are in distress, the rest of the time professional managers are remarkably civil about each other in print, in person, and in front of clients. They don’t have cat fights very often. Continue reading