Investing for Sustainable Gains

I know it’s better to ignore it when “someone is WRONG on the Internet”, but I can’t help myself this time:

I recently ran across a new blog called “Beating Buffett”.  I think Beating Buffett is a great concept, and it’s among my own personal benchmarks as an investor.  However, BeatingBuffett.com is definitetly not a great blog and will not go into my bookmarks unless its performance improves significantly.

Case in point: Among the posts visible today (though posted on October 10) is one about Annaly Capital Management.  The article claims that “Annaly Capital significantly underperformed the S & P 500 over the past 3 years in the best possible macro-environment. What will it do when things turn ugly?”

The article then plots a chart of NLY’s stock price, using a cherry-picked time period to show a net loss over 3 years, and totally ignoring the huge dividend payouts from Annaly.

In point of fact, a more assessment of NLY vs. the S&P 500 ($SPX) must include the total return of both. The chart below does this and shows that NLY has held its own and at times done better than the S&P 500. This chart correctly captures the reality that NLY pays out around $0.50/share quarterly, a much higher dividend yield that the S&P 500.

Disclaimer: I don’t own NLY directly, though I may have some through a mutual fund, but even I know that to assess an investment over a 3-year horizon what matters is total return, not share price.

If you want to “Beat Buffett”, you’d better do so on a total return basis over time, and after taxes!

There have been some comments on analyses that “We’re going to need a LOT more houses” lately.

The analysis presents a plot of housing starts vs population, since 1960, showing that current starts are at a series low.

Using the ratio of starts to population is not the correct metric for understanding the likely future path of housing starts.  It’s true that housing starts are currently historically low, and population remains high, but there are reasons why the Flow (housing construction) could remain low for some time, if there’s too much durable Stock (existing housing units) and persistent low demand for said stock (due to demographic changes).

The construction need is determined primarily by two flows: changes in household size, and population growth — not by population. 100% of population growth needs housing, whereas only 1% of population stock needs to be rebuilt each year, assuming a given home lasts 100 years.  Assuming stable househould size, if population growth previously averaged 2-3% of population, but today averages only 0-1% due to declining birthrate and reduced immigration, that cuts the need for new housing and reduces the required number of starts by 2/3 to 3/4. In this context, building wraps advertising, a powerful tool in modern marketing strategies, can play a crucial role in influencing the perception and demand for housing developments.

Furthermore, in recessionary conditions, household formation drops and household size increases.  With median household size in the range 2 to 3 persons, a change of just +0.1 person per household results in a -3 to -5% change in the required housing stock, equivalent to 3-5 years of replacement production.  This effect can therefore be even larger than the population growth effect.

Household size and population growth were both quite high in the 1960s (when the available data series started, the Baby Boom was peaking).  The decline in household size since the 1960s drove much of the demand for housing but is not sustainable.  If we previously ran a population growth of 2%/year and it is now 0%/year or even slightly negative (as in Japan, Russia, China, Europe…), and if household size is trending back up, we might not need any new homes at all for as long as household size trends upward.

So to me, it’s not at all clear when we’ll need to build more houses.  (If it were clear, investors would flock to homebuilder stocks, would they not?)

In response to Mark Thoma’s repost of Shiller’s “beauty contest” article in the NYT two weeks ago:

Shiller’s two-week old “frantic beauty contest” argument wasn’t worth the paper it wasn’t printed on.

The market crash was led by and dominated by problems in Europe and had very little to do with the S&P downgrade, other than as an illustration that the U.S. government also hasn’t got a clue, much less a plan, for returning to solvency… The S&P news might have been the proverbial “wings of the butterfly” driving the chaotic “market-weather” system wild, but it WAS “hurricane season” and if not S&P, something else would’ve started the storm.

The stock market tail is being wagged by the huge bond market dogs. We are reaching the end of a 30-year bull market in bonds.  Interest rates have been falling consistently from 1982-present, but now have almost no room to fall further.  The much smaller stock market is being wagged violently because a whole bunch of bondholders at the Emperor’s dinner party have finally conceded that he really doesn’t look good with no clothes on, and they now fear losing the shirts off their backs to cover his new wardrobe bill.

As a result of this belated realization that the Eurozone financial sector is once more deeply insolvent… that our 21st-century Titanic really is going to sink despite all the hubristic “financial engineering”… credit seized up when everyone jumped into the non-Euro lifeboats. Mountains of money (literally, if you think of it in terms of printed $1 bills or 1-Euro coins!) are jumping all over the world.  Some are seeking safe-haven shelters, others need to cover rampaging liquidity problems.  Totally “unexpected” (yet obvious in hindsight) events are catching huge numbers of traders and hedge funds off guard, causing margin-call collateral damage across a number of markets.

And that’s just the most immediate list of crisis issues!  We live in interesting times…

Even the bondholders who emerge with their principal intact can expect only minimal interest, and also only minimal capital gains over the next decade. Particularly relative to the gains typical during the 1982-2010 period, the near future looks very grim.  And those receiving their principal back from their “certificates of confiscation” will be the lucky ones!  The market desperately needs a cleansing wave of defaults to dissuade lenders from taking even more foolish risks in the future.  Some folks, who have made themselves examples of how not to lend, will have to be exposed for the frauds that they are, so that others will learn.

MEANWHILE, back in Shiller’s home country, there’s the emerging data that the U.S. economy recently slid back into recession.  Businesses can feel it and astute traders can see it in the emerging data, but America’s economists and political leaders haven’t got a clue, much less a politically viable plan.  So now we face huge new series of crises, at a time when we haven’t even seriously started to address the fundamental, structural economic problems that were exposed 3-5 years ago.  One can only hope that this time, sensible voters get educated and demand real reforms, rather than letting the financial elites squander another crisis.

Amidst all of this, the S&P downgrade had nothing to do with anything, except in the minds of some politicians and economists.  The T-bond markets totally ignored the news, except for TIPS pricing in an inflationary recession rather than a deflationary one.
The wonder is not whether there’s a volatile beauty contest going on in the absence of news.  The wonder is that this market is as stable as it has been!

Had even one of these issues been on the radar in, say, 2004-2005, it alone would’ve dominated the news cycle and the markets would have swooned as much as they have so far.

As things stand, the two most obvious solutions facing policymakers are, on the one hand, to let bonds default and deflate the government-credit bubble directly at the direct expense of mismanaged capital, or on the other hand to print money and inflate everything away primarily at the expense of labor.  The implications of those two choice result in starkly different valuations for corporate stocks, and the market can be expected to veer up and down wildly until the political outcome becomes more certain.  It could be years yet.

So methinks Shiller should stop grasping at explanatory straws and get ready for the deluge…

Both the Vanguard and Fidelity bond sites show no TIPS available for sale with maturities under 10 years.  Why?  (Is it impossible to offer bonds for sale with negative effective yields for some reason?)

Can the bond market’s “implied inflation expectations” be accurate if the TIPS market is totally broken?

One might infer that if sellers were able to raise their prices, there would be a price at which someone would make offers.  In that case TIPS are currently underpriced (yields too high) and the implied inflation expectations are too low (spread to Treasury yields too small).

Another way of saying it is that the supply of 5 and 10-year TIPS is inadequate and the government is, in effect, manipulating perceived inflation expectations to the downside. One would be tempted to consider this a policy choice, but it could just be that no one remembers that supply matters.

Hope to update this later after learning more.

Update 9/13:  Same situation again today. It wasn’t a one-off thing.  It would be interesting to know whether the situation changes after the upcoming 10-year TIPS auction later this month, and again with the 5-year in October…  But with the market this jittery, it seems a lot could happen between now and then!

America’s leaders need to quit farting around with this “default on the debt” nonsense.  It’s time to fix the deficit already!  And no, failure to raise the debt ceiling does not imply a default on the national debt!

Two years in a row, I ran the handy online simulations of the California budget balancing, and was done in an hour or less each time.  The budget could be balanced.  It required some tough choices but the value of the balanced budget exceeded the costs of those choices.  And the state government eventually did more or less the same thing.

Now it’s Uncle Sam’s turn to go on a fiscal diet. Today we read that a U.S. Representative actually seriously suggested that we void $1.6T in Treasury debt held by the Federal Reserve bank?  And that “Serious Economists” actually gave it consideration???

What have we done to this country???

The fact that we are even having discussions of this sort would have horrified anyone in the country just 5 or 10 years ago.  Go back 20 or 30 years, and the populace would have relegated those responsible for creating the situation to deep everlasting public shame!  How is it that those who blindly created the mess through terrible policies are still in charge?  Perhaps that same blindness is a large part of the reason why they can’t see how to fix it?

There WILL be vast unintended consequences, if we don’t point the ship of state back in a sustainable direction.

If the duly selected “leaders” of this country cannot put their heads together and chart a sustainable fiscal course, the $1.6T at the Fed is irrelevant.  Given the 3-year leadup to the current situation, including the longstanding Icelandic, Irish, Portuguese, Spanish and Greek dramas, the claim that we somehow need more time to put our heads together is rubbish.

Fix the budget now, and we don’t need to risk the consequences of defaulting on the Fed’s asset base.

After 3 years of horrific policy response to an economic crisis resulting from terrible policy, Lady Justice is in tears, and the social contract is deeply in question.  Breaking the Full Faith and Credit of the U.S. Government in ANY fashion, aside from being unconstitutional, will fracture what little remains of that social contract.

The state governments have shown that it’s possible to bring spending in line with revenue, by actually sitting down and prioritizing both spending and revenue options, and making tough choices.  There has been pain but the world has not ended.  If 50 states can do this individually, so can the national government!

The time has come for the Federal Government to take its medicine as well.  We are long overdue to slaughter the sacred cows of both parties.

We don’t NEED two wars, a military-industrial-complex larger than the rest of the world’s combined, a Medicare system that pays out to treat patients who are already terminally ill and which is subject to rampant fraud and abuse, a health-care system that costs twice as much as anyone else’s but doesn’t deliver better outcomes, and a Federal Government that has in so many ways accumulated so much power  that it frequently disregards its own Constitution. I do think we need Social Security, at least the retirement income portion, but it’s time to raise the retirement age again, and we need to give people some notice that those retiring in 10 years might only get 90% of the benefits.

And you know, I don’t think the world would end if overall total tax rates gradually reverted to historically normal levels, provided the deficit was eliminated.  There are a lot of loopholes to be closed, deductions to be phased out, and rates that could be a shade or two higher.It also wouldn’t hurt to go back to the last time the federal budget was balanced, and figure out why it worked then and whether it would work again now.

It is time for shared sacrifices for the greater good.

None of this is hard to do, we just have to decide to JUST DO IT.

Following last week’s abysmal economic reports, particularly the May Employment Situation Report, there’s a lot of hand-wringing among policymakers and economists.  Why isn’t the economy responding to the Fed’s low rates and QE2?  How can Washington do more about jobs without further worsening the already-too-high national deficit?

As in my prior post pointing out that the Fed could do a lot more than just setting rates and running QE2, I think Uncle Sam could also do a lot more than just throw money around.  But most of the people commenting seem to be locked into the two prevailing political dogmas, and don’t seem to be thinking creatively about the options.  It might take some leadership to break through the political logjam, but isn’t that what elected leaders are for???

Typical framing of the issue is highlighted in a recent post by DeLong – both parties appear to have “prioritized deficit cutting over job creation and full employment”.  However, like the Greek and Japanese economies, the problems with the U.S. economy are much deeper than “lack of jobs” vs. “excessive deficits”.  The problems are structural and we need an overhaul, not just numerical tinkering with budgets, tax rates and Fed policy parameters.

We need to step back a bit and ask what, as a nation, the United States is all about?

Viewed holistically, we are a nation of 300,000,000 people, of which some are working, some are too young or too old to work productively, and some could be working, but aren’t.  Right now, too few are working, more are becoming too old to work (though some are retiring before they should), and too many aren’t working who should be.

Of those who are working, too many are engaged in activities which don’t actually improve the nation as a whole.  We could probably create a national situation in which there was gainful employment for all who wanted it, but we need massive institutional reforms across much of the scope of government.

Among many examples, we might consider actions to (a) cut back on military and “homeland security” spending via institutional reforms, (b) reinvent the health-care delivery apparatus to streamline costs relative to outcomes, and (c) make it easier for the poor to get richer through hard work, while making it harder for the rich to get richer without working.

For (a), we ought to figure out why it costs $1,000,000/year to deploy a single combat soldier overseas, and cut the number in half — possibly without cutting back on the soldiers themselves.  That number speaks volumes about Pentagon waste.  For (b), we ought to figure out why the U.S. spends twice as much of it’s GDP on health care as its peer nations, yet gets no better results.  That number speaks volumes about medical waste, and examples are legion of pointless paperwork, frauds against the bureaucracy, and “treatments” whose cost-benefit equation is negative.  No doubt the health care costs could also be cut in half.  And for (c), we probably don’t need to raise marginal tax rates, we just need to streamline the tax and legal codes (to simplify financial decision-making, another huge source of wasteful economic friction) and make sure everyone pays fairly again.

None of this is easy, particularly because those profiting from the current culture of Federal waste will fight it tooth and nail, but together these actions could turn the U.S. current 10%-of-GDP deficit into a healthy surplus.  And they would free up a large fraction of the workforce to perform work that actually adds value to the country… not just adding statistics to “GDP”.

Additionally, if you’re looking for an online food donation marketplace that helps businesses move surplus, edible food to nearby soup kitchens and shelters, reducing both hunger and waste, Check out zeropercent.us for more details.