In these pages we have often defended equities against their naysayers in the great bonds vs stocks debate that seems to be currently raging. But defence is only half the job. It is time to go on the attack! Note well, dear reader, that I know very little about bonds, and I don’t want to know any more in case I have to change my views. However knowing very little about an asset class doesn’t stop bloggers from talking about it with authoriteh, especially if it is bond apologists harping on about equities. So I, Baruch, am going to give them a dose of their own medicine.
OK, so some of the stuff below is a bit tongue in cheek. But tell me if any of it is actually untrue: Continue reading →
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.
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.
Priceless post by Jean-Louis Gassée on an imaginary conversation at Nokia between the amusingly named CEO Olli Pekka Kallasovo and his head of mobile devices Anssi Vankoji. The key point is where Fake Oily says to Fake Anssi:
This leaves us with one choice: Android. I have made the decision and I want you to implement it.
Go read it. It’s very funny.
More seriously, dear readers, I actually think it’s going to happen. I don’t share Jean Louis’ pessimism on this. These Finns are totally fucked. Symbian 3, Symbian 4, Maemo, Meego, no-one knows what to write code for, and everyone is just tired of listening, of attending another bullshit launch of another car crash handset. In his discussions with analysts, salespeople and other investors, Baruch feels a tipping point has been reached. Nokia have lost all credibility with investors and developers and will very rapidly fade into irrelevance unless they go Android, and do it while they can still make a difference in deciding the outcome of the war between Android and iPhone.
Needless to say, OPK and the current set of Finns will have to go.
Just think of the consternation at Motorola and HTC. Much gnashing of teeth. It’s a delicious prospect. Android is going to suffer a severe setback later this year when Verizon, the major refuge of the Androids, goes iPhone. Google getting Nokia on board, still the leading handset player in the world with a lock on the higher end in developing countries, would pretty much cancel that out and equalise the playing field. Needless to say, Nokia would immediately become Google’s préféré, the recipient of the latest updates to the OS.
Ultimately, Finns are nothing but pragmatic. I think this is going to happen and I think it will be sooner rather than later.
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 . . . ?
Much is being made of this video among the various Apple groupie blogs.
Readers will of course recall the fascinating one-two punch on the iPad delivered by myself, Baruch, and my dear colleague in blogging, Bento. His contention was the the real audience for the iPad will be older people. It is, he wrote, “a complex computer, simplified”, perfect for those intimidated by all the fiddly things you have to do to make them work:
It does one thing at a time. Your finger is the cursor. There is no need to tap things twice before stuff happens. You are allowed to turn it off with the power button.
No, Baruch contended, or rather, yes, but it is also or primarily a simplified computer for busy, empowered women: who as a group are perfectly capable of doing all those fiddly things but who don’t see why they should have to.
So one might think, “bravo Bento, you finally got one over on that loudmouth Baruch; look at Virginia, the 99 year old lady in the video using the iPad as her first computer. Proof of your thesis.”
Ha! Not so fast! Because of course Virginia is also a woman.
Just devoured the Michael Lewis book: flipping marvellous it was, too.
Baruch has 3 major takeaways.
Takeaway One: I wrote not so long ago that “investing should be a solitary activity” — in a (-nother overlong) post which was nicely taken up and expanded upon by Tadas at Abnormal Returns. What I meant was that you shouldn’t be dependent on Baruch and others for your investing results. The Big Short is a reminder of something else: that the independence of mind working alone creates is a huge asset. All the guys in the book were “out of the flow”; Mike Burry because of his Asperger’s, Cornwall Capital because it was just too small for anyone to want to service it, and Steve Eisman, well, because he was on a mission to punish evil-doers. And being out of the flow allowed them to see the unclothed nature of the Emperor. Baruch has lived through bubbles; he knows the attractions of being well-connected, getting “first call” on the hottest new trend or IPO. But its mostly bullshit; an invitation to join the current groupthink.
Takeaway Two: out of the three investors in the book, Baruch identifies most with the Cornwall Capital guys. He largely shares their epistemology, as described by Lewis. They and Baruch are Talebian investors, people who know the opportunity is that they live in Extremistan, but many things are priced like it’s Mediocristan instead. Betting on mispriced, assymetric outcomes is what Baruch tries to do too, and tech investing is great place to find opportunities like that. It’s odd though that Taleb isn’t mentioned by Lewis in the sections relating to Cornwall, as he is sort of the intellectual father (OK, maybe uncle) of investment strategies such as Cornwall’s — but never mind.
Shorting subprime debt via buying credit default swaps, which weirdly amounted to, as Lewis makes clear, something akin to writing subprime CDOs, was the classic Talebian strategy: a small outlay for an outsized payoff in the case of an outcome wrongly judged by the crowd to be highly improbable. Situations like that can be excessively profitable for the smart punter on the right side of the trade, yet the other side is correspondingly highly dangerous. In the case of subprime, the other side was the financial system. If we ever do somehow “fix” everything, remove the leverage, create redundancy and robustness in the system, it struck Baruch, might we not also partially remove from the system the ability to make big bucks? I hope not. After all, that’s how I put food on my children, as George Bush used to say.
Takeaway 3. I’m not sure how to feel about Lewis’ conclusion about overall financial system. He thinks that when the big old Wall Street partnerships went public it removed all restraint and socialized all the risks; the managers of partnerships with unlimited liability, Lewis thinks, tend to be more careful with the money, which after all belongs to them, than when the capital belongs to faceless shareholders. This is a good insight, and should not be controversial.
However, could the old partnership structure sustain the massive expansion of financial services in the past 30 years? Many would say that is exactly the point, that our current financial system is far too dynamic, too big. But really, can we be sure there aren’t positive aspects to this as well? The past 30 years also happen to be the period where, despite the odd systemic crisis, more people around the world have been brought out of hopeless poverty into the global economy than ever before, and while we have created some undeserving super rich, I suspect that when you consider the relative change in real incomes in BRIC markets, wealth inequality on a global basis might have actually fallen. It may only be a coincidence that the two phenomena occured at the same time. Then again, it may not. If an economy gets bigger and more complex, might it not need an increase in the size and complexity of its circulatory system?
Anyway, let’s see. Roll on the next crisis if it means another book as good as this one.
