Buttonwood's notebook
Financial markets
The euro zone crisis
Growth problem
Dec 17th 2012, 17:32 by Buttonwood
EUROPE's politicians are often berated for an excessive focus on austerity. And it seems likely that there is a huge problem with several countries pursuing austerity simultaneously. One cannot switch the economy from domestic consumption to exports, if all your neighbours are trying to do the same. Canada's success in the 1990s occurred during the great boom of its biggest trading partner, the US.
Investing
Distinguishing skill from luck
Dec 14th 2012, 15:21 by Buttonwood
THERE is much to enjoy in Michael Mauboussin's latest book, The Success Equation: Untangling Skill and Luck in Business, Sports and Investing, but here are a few highlights.
How do you distinguish skill from luck? He writes that
There's a quick and easy way to test whether an activity involves skill; ask whether you can lose on purpose. In games of skill, it's clear that you can lose intentionally but when playing roulette or the lottery you can't lose on purpose
The problem of sample size. Tell people that the US counties with the lowest rates for kidney cancer have small rural populations and they will come up with a number of explanations: healthy lifestyle, lack of pollution etc.
Longevity
Where did the ancient Britons go?
Dec 12th 2012, 18:35 by Buttonwood
MUCH media coverage of the 2011 British census has focused on the fast-rising population, the effect of immigration and the decline in religious observance. But the Actuary magazine (what do you mean, you don't subscribe?)* has spotted an intriguing detail—the shortfall of 90-year-olds.
Forecasting the number of 90-year-olds sounds easy; take the number of 80-year-olds from the last census, apply the mortality tables and bob's your great-uncle. But the 2011 census is 30,000 nonagenarians short, a 15% decline relative to expectations. The biggest shortfall is in the male cohort but female centenarians are more than 10% down on forecasts.
The financial system
Market failure
Dec 12th 2012, 11:03 by Buttonwood
ONE of the most mysterious market phenomena is momentum - the tendency for fast-rising stocks to keep going up. How come such an obvious market anomaly is not arbitraged away?
I have referred in previous columns to the work of Paul Woolley and Dimitri Vayanos of the London School of Economics on this issue, and they have a new piece in the latest issue of Central Banking Journal. Their idea is that the anomaly is the result of investors using agents (professional fund managers) to manage their money. They choose those managers on the basis of past performance. That past performance will inevitably result from good/lucky stock selection.
Bond markets
Blessed are the governments
Dec 11th 2012, 16:48 by Buttonwood
WHEN Treasury bond yields fall to historically low levels, other markets are bound to follow. According to Stuart Culverhouse at Exotix, a broker, the yield on emerging market government dollar debt has dropped to 4.4% which is a low for the decade and very probably an all-time low.
Investors are very keen on extra income, just as they were in 2006 and 2007, and will flock to any asset class that provides it. Does that mean emerging market debt is a bubble? Not necessarily.
The pensions squeeze
Finding the right rate
Dec 11th 2012, 10:10 by Buttonwood
BURIED in last week's autumn statement was a promise by the British government to consult on a method of lowering pension fund liabilities, to ease the pressure on struggling companies. Pensions are a debt-like liability so bond yields are the appropriate measure for discounting future claims. But the result is that lower bond yields mean higher liabilities.
The effect of quantitative easing - the £375 billion programme of the Bank of England to buy gilts - has been to drive down yields, although the depressed state of the economy, and safe haven flows from Europe, have played their parts as well. Liabilities have risen 40 to 50% since the crisis began.
Equity and bond markets
Burying the "Fed model"
Nov 29th 2012, 15:59 by Buttonwood
IF YOU invested in equities in the 1990s, you were bound to hear, sooner or later, about the "Fed model". This, I should hasten to add, was not the official position of the Federal Reserve but the name given to a relationship found by three economists between Treasury bond yields and stockmarket valuations. Lower bond yields lead to higher price-earnings ratios or, if you invert the latter, lower earnings yields. Those who thought that equities were ridiculously overvalued in the late 1990s were told that they "just didn't get it".
The idea was fairly simple. The present value of a stock was its future cashflows, discounted at some rate that was derived from the bond market.
Asset allocation
Earning a bob or two with Dylan
Nov 23rd 2012, 14:31 by Buttonwood
SORRY to see that Dylan Grice is deserting his strategist post at Societe Generale, where the team never fails to keep readers entertained. He is off to join an investment management firm as did his predecessor, James Montier, who is now at GMO.
His final piece, in typical style, invokes the cockroach, that consummate survivor, which follows the rule that a gust of wind indicates a potential predator and accordingly scurries off in a different direction. The cockroach has survived several mass extinctions, including the one that wiped out the dinosaurs.
Economic outlook
Groping for growth
Nov 20th 2012, 16:43 by Buttonwood
WHAT distinguishes modern man from his ancestors is the expectation of steady economic and population growth. Since the start of the 19th century, both have taken off in a way that was not seen in ancient times or the middle ages. As we look forward to the next 20-30 years, we can be pretty sure that population growth is going to slow, and in some countries, there will be a fall. Does the same apply to the economic growth rate?
Two fund management groups have just completed fairly gloomy notes on this subject. At Research Affiliates, Christopher Brightman suggests that US growth will only be 1% a year while Jeremy Grantham of GMO plumps for 1.4%.
Monetary policy
Opposing voices
Nov 14th 2012, 11:17 by Buttonwood
ONE of the interesting sessions in our recent Buttonwood gathering featured David Einhorn, the hedge fund manager and scourge of many a chief executive. But this time he was not talking about corporate accounting standards, but about easy monetary policy, and arguing that it has been overdone (see the full interview above). A similar argument was made in the July-September issue of the journal World Economics, written by John Michaelson and Sebastien Walker. Michaelson runs Imperium Partners, an investment management firm.
Monetary policy
Reshuffling the deck
Nov 9th 2012, 13:37 by Buttonwood
UNCONVENTIONAL monetary policy has some unconventional consequences, as this exchange of letters between the British chancellor and governor of the Bank of England reveals. To summarise, the Bank of England has been buying gilts through its quantitative easing (QE) programme). It holds these gilts (some £375 billion worth) in an off-balance sheet vehicle called the Asset Purchase Facility. But what happens to the interest on the gilts? Even at low interest rates, it is quite a tidy sum.
Election aftermath
A small triumph for markets and maths
Nov 7th 2012, 12:34 by Buttonwood
THE European equity markets are modestly higher this morning in the wake of the US election. The most likely reason is a sense of relief that we are not headed for a repeat of 2000, when Florida and its hanging chads kept us on tenterhooks for weeks. But after several billion dollars of campaign expenditure, and almost a year since the first caucus, we have ended up with a Democratic President and Senate, and a Republican House, just as we did before. (In Britain, total campaign spending in 2010 was just over £30m ($45m) and it took three weeks; just a suggestion).
Bond yields have fallen in the wake of the polls. There is some convoluted reasoning behind this.
Equity markets
Back to the Shiller p/e
Nov 5th 2012, 10:13 by Buttonwood
ONE key reason why I have been pessimistic about the outlook for the US stockmarket is based on the use of the Shiller price-earnings ratio. Ben Graham, the doyen of securities analysis, devised a version of this measure, but it has become associated with Robert Shiller, the Yale professor who can claim credit for calling both the dotcom and housing bubbles in his book Irrational Exuberance. He maintains the data on his own website.
The Shiller version tries to eliminate the effect of the economic cycle on valuations; without it, stock markets look expensive when earnings collapse in recessions and look cheap when earnings are high in booms.
New York conference
Buttonwood gathering
Nov 2nd 2012, 15:39 by Buttonwood
THE looming American fiscal cliff was one of the main subjects of discussion as delegates gathered in a (literally) antediluvian New York for the Buttonwood Gathering on October 24 and 25 at the Museum of the American Indian. But the conversation also roamed far and wide, with Larry Summers debating the euro zone crisis, Mohamed El-Erian giving the Bagehot lecture on the bond markets, Sam Palmisano of IBM on corporate governance and Vincent Reinhart on deleveraging. Click on the various links to see the panel discussions, interviews and speeches. Further links, including David Einhorn on the downside of QE and Hugh Hendry on the definition of insanity, will follow.
Monetary policy
Inflation, QE and forcing the banks to lend
Nov 1st 2012, 17:11 by Buttonwood
NO sooner has one Morgan Stanley economist suggested raising the inflation target (see yesterday's post) than another rejects it. Charles Goodhart, an eminent economist (he invented Goodhart's law) and a consultant to MS, suggests a couple of problems.
With nominal interest rates at the lower bound, it is not clear exactly which policies will achieve this higher future inflation. In the absence of such policies, the higher inflation target may not be credible.
The argument that inflation be consciously raised for macroeconomic purposes, e.g, to reduce inherited debt is inherently dangerous.
Continue reading "Inflation, QE and forcing the banks to lend" »
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
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