Investing for Sustainable Gains

1) Reward criminals and incompetents, rather than punishing them, but only when lots of money is involved.

1) Pass legislation exempting some sectors of the economy (e.g. medical industry) from antitrust laws, and prohibit trade that would allow local prices to equilibrate with the global market. Make Americans pay 2x to 10x as much as anyone else for the same products and services!

1) Allow arbitrary “ChargeMaster” bills to be charged to customers who cannot even see the prices beforehand! Most healthcare expenses could be paid out of pocket if the bills actually reflected necessary costs rather than bloat.

1) Pass legislation that requires people to pay for services they do not need, or else pay taxes for being healthy instead. Thus forcing everyone to feed the insane insurance industry, creating insane incentives and tying up millions of people in paperwork jobs that add no economic value.

1) Pass legislation that no one even has time to read, let alone understand. Then fail to address legitimate issues arising from the unpalatable special-interest garbage that was in the bill.

1) Don’t pass a budget each year. Just let everything run on autopilot until something egregiously bad happens.

1) Each election cycle, reelect the same people who created the current problem. Keep them lying to us while failing to address crucial national issues, yet endlessly feathering their cronies’ nests at our expense.

1) Fail to protest when the government exceeds its constitutional authority.

We get the government we deserve. The Constitution will only live if those who believe in it stand up to defend it!

P.S. Yes, all ten of these are ranked #1. I couldn’t decide which of them made me feel most ashamed to be an American.

P.P.S. Yes, there are only 8 items on the list of “ten”. If you feel like protesting that, you might also consider protesting your local politicians, who routinely promise far more than they deliver, and whose decisions have a much greater impact on your life and your future than this blog comment!

When those with expert knowledge detect that a potentially calamitous event threatens, but they aren’t sure, human nature runs in two directions. We are torn between wanting to issue a warning so that folks can take precautions, versus wanting to keep everyone calm to prevent the damage that could be caused by mass panic.

Meanwhile, those being warned are faced with their own difficult choice. Do they ignore the warning, accept the risks, and go about business as usual? Do they drop everything and take shelter or flee for safety? What level of precaution is appropriate?

Consider first the case of actual tornados. According to Wikipedia, early forecasters were banned from making actual tornado warnings, because of the fear of public panic.

According to NOAA data, tornado warnings have been about 70% accurate since the mid-1990s. Now, we need to be careful when measuring “accuracy”, because even when a tornado warning correctly predicts a tornado touchdown, the tornado doesn’t touch everyone in the warning area. And even if a tornado doesn’t touch down, the severe thunderstorm can still do damage with high winds, hail, and heavy rain leading to flash floods.

But despite not being a perfect warning system, we know that the warnings (a) provide people with valuable time to take shelter, (b) do not disrupt activities excessively, and (c) save lives when tornadoes do touch down and wipe out buildings and vehicles. The issue with mass panic has been addressed through decades of careful public education in tornado-prone areas, training people to react appropriately.  People have come to accept and value the warning system, most recently in Oklahoma City where 16 minutes’ advance notice saved thousands of lives as the mile-wide EF5 tornado (an extremely bad one!) wiped out thousands of buildings. The warning didn’t prevent the tornado, but the community will recover much more quickly because they reacted well.

But now consider a warning that might, by itself, trigger human reactions which bring about the calamitous event that it is warning about! What if, whenever it is issued, it causes a certain part of the business community serious damage, while saving others from grave harm? And of course it is going to cause anxiety among those who are warned, and people don’t like that unless it’s really justified.  This is the situation one faces when considering a “Tornado Warning” system for the stock market.

There is a stock market “measurement” (technical indicator) which has a 30-year record of making predictions which have a 77% accuracy in anticipating a market decline of 5% or more. Let’s call any 5% decline a “market tornado”. The measurement does not predict every “market tornado”, but it has triggered before all the really bad tornadoes (with drops in the DOW of 20% or more) and nearly all of the “medium size” ones (10% or more).

Note that in a “market tornado”, as with a real tornado, the damage is far greater in some places than in others. Thanks to inflation and growth, the market as a whole recovers eventually, just as communities repair their damage after real tornadoes. But in a 5% “market tornado” decline, some stocks will fall much farther than the average, just as some homes suffer more damage than others in a real tornado. And if the market tornado is bad enough, some stocks get destroyed (bankruptcy) if the company isn’t in good financial condition, just as weaker houses get destroyed by very bad real tornadoes.

However, unlike in a tornado, a “stock market tornado warning” induces more people to try to sell, which tends to push prices down, and that might exacerbate the market decline that the warning is all about. Businesses involved in the market will be damaged by loss of customers, decline in revenue from remaining customers, and potentially losses on their own trading positions.  We must expect the psychology of market participants to be deeply resistant to warnings which cause them immediate harm, even if the warning provides a prudent opportunity to prevent the harm from being far worse! (For some reason I’m reminded of the scene in Jaws where the shark is spotted and the warning is issued, but the folks running the beaches refuse to spread the word because they don’t want to scare people having fun… and lose profits…)

On the other hand, perhaps when a market has run up too far, a “Market Tornado Warning” might actually mitigate the subsequent inevitable correction?  Perhaps with proper public education, market participants could simply take precautions, rather than panicking?  A warning gives those caught “offsides”, overextended on leverage, a chance to pull in their positions, helping the market to be less overextended and less at risk of a deep crash. Those looking to buy in might hold back a bit, expecting a dip in prices ahead. By slowing the rally and creating a pool of folks willing and able to “buy the dip”, the market tornado might be far smaller than it would otherwise have been. This would stabilize the market, by preventing so many from buying too soon and then becoming sellers at the worst time for all.

In addition, with a reasonable warning system, businesses catering to market participants would have a chance to issue polite warnings that actually help their clients. They would have to accept that some short-term damage to portfolios is very likely, but they would have a critical window of opportunity to work constructively to minimize that damage. And that could also minimize the risk of deep damage to the business.

Perhaps, when the market is due for a correction, the warning actually allows the correction to take place in a less-damaging manner?  That is a tantalizing thought, because the horrific economic damage created by deep market declines affects millions or billions of people…

Oh, and the name of that “Market Tornado Warning” technical indicator?  It’s usually referred to as the Hindenburg Omen.  I believe that’s a poor choice of name, since the name alone induces more panic than it should.  And the indicator itself isn’t perfect and could probably be made better. But more about the Hindenburg later…

The Monthly payrolls data from the BLS shows, over the past year:
* About 1.9 million more jobs, but only a 1.3% increase in jobs
* Job growth is about the same as working-age population growth (not getting ahead)
* Also, 0.4 million (20%) of the new jobs are only part-time. Part-time jobs are increasing at a faster rate than full-time jobs. (Definitely not getting ahead).
* For those working, average weekly earnings are only up 1.6%, only about the same as official inflation. (Most definitely not getting ahead.)

In most previous years this report would have been abysmal, but I guess this month we’re just glad the sky isn’t falling again… yet…

Stimulated by this post at A Dash of Insight by Jeff Miller.

Yesterday’s Twitter-induced “flash crash” and last week’s “gold smash” illustrate why using stop loss orders and trailing buy orders can be a really bad way to play in the markets.

Folks with a “shopping list” and trailing buy orders in the S&P yesterday might have gotten a bonus by getting their orders executed during the dip, but it’s a risky way to trade. Consider those folks with trailing buy orders for gold last week – they were hammered by getting their orders filled at prices which soon proved to be well above the market price! That sudden dip isn’t always buyable…

But there’s a broader conclusion to both the gold-smash bear raid and the flash crashes: any time you send a stop-loss order to your broker, you’re giving Mr. Market a free option to liquidate your shares at a loss to you (and thus a profit for Mr. Market). In the old days a “flash crash” was called a “Bear Raid” or “running stops”, and it was one of the ways the marketeers fleeced the muppets so that the brokers could have their yachts…

Conversely, any time you leave a trailing buy order out there, you’re giving Mr. Market an option to dump his shares on you, at a price which might have been fair when you entered the order, but it very likely won’t be fair when you get your execution!

All options have at least some value. Why give value away for free? Folks shouldn’t be giving those stop-loss and limit-order options away to the market, unless they’re getting good value in return. Maybe the peace of mind is worth it, but it seems like Mr. Market is collecting a lot of rent from those unwilling to hold their positions with conviction. And maybe sometimes those sudden dips prove profitable, but it sure looks a lot like collecting pennies in front of a steamroller.

From a discussion at Economist’s View, I submit the following on the topic of “more exploration of non-wage paths to rising incomes and living standards.”

Another possibility to improve living standards would be to minimize the rentier / interest-earning fraction of the population (who are effectively a tax on the working, indebted population) and help those individuals find more productive (or at least, less-extractive) roles. This issue has both generational-conflict and class-conflict dimensions, but there are non-conflict alternative solutions that no one talks about. A shift in cultural values could lead the seniors to think less in terms of a pure-leisure “retirement” and more in terms of “aging gracefully” while still contributing as much as possible to family and to society. A second shift could lead the “rentier class” to be stigmatized for engaging in consumer lending (a tax on the borrowers) while socially rewarding those who actually engage in investment behavior (formation of true sustainable capital, rather than consumption).

Lowering prices, or at least the rate of increase of prices, would improve living standards (at least in a ceteris paribus world). The inflation goal could be 0%, not 2%, and in fact “stable” is the statutory goal in the Federal Reserve Act. The debt-funded sectors (housing, healthcare and education) all need to become less expensive in order for living standards to rise. Here are the tips on traveling on a college budget, which allow them to explore the world without sacrificing their future prospects.

A third way of increasing living standards would be to encourage job growth in sectors that actually improve living standards, while minimizing jobs (and other costs) in sectors that don’t really contribute. I mentioned the broken healthcare sector above. If we could find a new “peace dividend” (improved international diplomacy resulting in a reduction in military and homeland security staff), that would allow perhaps another million potentially-productive members of society to actually produce goods and services (that would improve living standards), rather than defending against harm (which consumes resources that perhaps could be better used elsewhere).

The options exist. We just need to get people thinking about them, instead of wasting their time on divisive non-solutions.

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!