Election Day is coming and everyone is telling us how to vote. I have a more basic question: should you vote at all?
Don’t do it. Voting in the presidential election could kill you. We know this because economists say so.
I know that sounds weird. Let me explain.
Economics is all about how we allocate scarce resources… such as your vote. Like most other decisions, we make it using cost-benefit analysis: What does x cost and what benefit will it give me? If benefit outweighs cost, then x is a rational choice.
So, what is the cost of voting for our next president? It’s not much. Just find your way to the polling place, check a few boxes, and then go home to await the results.
Voting’s benefit also seems clear: Your vote helps your chosen candidate win.
It’s a little more complicated than that
You see, whoever wins the presidential election will almost certainly win whether you vote for that person or not.
Your vote probably won’t decide the election—though it could. Here’s what would have to happen.
First, the other 49 states would have to line up such that no candidate has an Electoral College majority.
Next, your own state (or your congressional district if you’re in Maine or Nebraska) would have to deadlock with no one candidate earning a plurality of the popular vote. Then, your vote—yes, yours—is the one that tips the scale.
This scenario is possible. We can even calculate the odds it will occur.
It turns out the chance your vote will be decisive is considerably less than the chance you will be hit by a truck and killed on your way to the polling place.
Risk is a cost
Taking it is irrational unless you receive compensation.
We should note that the math changes for state or local elections. Your vote carries more weight in smaller populations.
But the math is also clear that voting for president is more likely to kill you than result in your candidate winning.
Statistically, voting for president because you think your candidate needs your vote is like watching a football game on TV and yelling at the coach to run a different play.
Will your yelling help your team win? Possibly.
Maybe your neighbor will hear you and happen to know the coach’s phone number.
Maybe he will call the coach to share your idea during the next commercial break.
Maybe the coach will call the play you suggest, and maybe it will win the game.
All that could happen, but it probably won’t
The cost-benefit analysis is clear, then. Voting for president is a hazardous act we should all avoid. Yet many of us vote anyway. Why?
This is a big problem for researchers. It’s called the Downs Paradox, named after the political scientist who identified it back in the 1950s.
Quantitative decision models presume people are benefit-maximizing, cost-minimizing variables who always make rational choices. Yet next week, millions of us will do something clearly irrational. We’re breaking economics, and we don’t even feel guilty about it.
Humans are irrational
Humans are far more complex than any equation can capture. But economists keep trying. Including the economists who work at the Federal Reserve.
The Fed’s hundreds of PhD-holding economic experts know exactly how to manage the economy if everyone is rational. Since we’re obviously not rational, we are also unmanageable.
It’s not just that we are irrational. We are all irrational in different ways, depending on our circumstances. We change all the time, too. For any model to reflect this dynamic diversity is all but impossible.
The Fed’s models assume a world that doesn’t exist. Is it any wonder they give us such crazy, ineffective interest rate and monetary policies?
To be fair, Janet Yellen knows the models are flawed. She has been asking the Fed staff to find better ones. They’re working on it.
Meanwhile, Election Day is coming.
Should you vote or not?
Yes, you should.
Voting is about more than electing our preferred candidate. By voting, we show the politicians they work for us. We set an example for our children. We remind ourselves that, for all our differences, we are one nation that shares an important responsibility.
Yes, a truck might hit me on the way to vote. But it could also hit me if I go to the mall.
Staying home won’t shield me from lightning strikes. Danger is everywhere, not just around polling places.
I know my vote won’t change the election’s outcome. I also know with 100% certainty that my vote will change me.
None of us likes admitting mistakes. So, we defend whoever we voted for even when we shouldn’t. We give them a blank check—which is an excellent reason to take the choice seriously.
If I don’t vote at all, I’m essentially withdrawing from society. I’m saying to everyone else, “You’re on your own. Don’t blame me.”
That attitude is understandable if you don’t like any of the choices, but it’s not natural or healthy.
None of us lives in an economy of one. The “course of human events” that Thomas Jefferson described in the Declaration of Independence includes every human.
Election Day is when we show our commitment to each other by making the best choice we can. That, I submit, has benefits far greater than its risks.
So live dangerously: Vote, and watch out for trucks.
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The frightful performance of the health care sector could find imminent relief at a key chart juncture – if temporarily.
If there is one sector chart scary enough to merit a Halloween post, it would have to be health care. As we have been warning for some time, the performance of health care stocks in recent months has been a nightmare for investors. Whether it’s biotechs, pharmaceutical stocks, etc., the entire sector has been a bloody mess. However, at some point, things can become so bad that they can’t get any worse. And based upon a potentially key chart level, health care stocks may be reaching such a point, at least in the near-term.
While many important longer-term trendlines have already been broken across the health care space, there is one key line being tested right now that has yet to fail. Looking at a linear chart of the Dow Jones U.S. Health Care Index, its Up trendline since the 2011 lows has been especially prominent. With touches in October and November 2011, June, November and December 2012 and February of this year, the trendline has been more than validated. The fact that the index is presently testing the trendline, near 715, may give health care investors some hope that the bleeding might stop here.
Of course, we did mention that many other longer-term trendlines have already given way, including the post-2008 Up trendline in the NYSE Biotech Index (BTK) and the post-2009 Up trendline in the NYSE Pharmaceutical Index (DRG), both on log scales. Therefore, there has been enough technical damage done across the health care space that this one trendline may not be able to hold up the sector permanently. Not to mention, the DJ Health Care Index has put in a clear lower high on its chart.
However, health care stocks have been so badly beaten down that they are at least primed for a bounce. Therefore, this trendline may, at a minimum, serve as a tourniquet for the bleeding in the immediate-term. That said, the health care “patient” is so sick, technically, that any bounce may merely be a selling opportunity.
The commentary included in this blog is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
People still think of me as an “ETF guy,” even though it’s been years since I’ve made markets in ETFs.
I was in the ETF business during the Jurassic period, when ETFs were mainly trading vehicles, not something you really invested in.
But I’ve seen the entire arc of the industry, from inception (those crazy days of the QQQ on the AMEX) all the way to the present, disrupting the mutual fund industry and gathering trillions in assets.
I have some thoughts about the journey.
Trade and speculate vs. buy and hold
In a sense, I agree with Vanguard CEO Jack Bogle. As the story goes, he resisted Vanguard’s push into ETFs, thinking that people would be encouraged to trade and speculate instead of buy and hold.
There is also something attractive about the open-end fund structure. You can only buy or sell at the close—it discourages rapid trading.
I think, with the benefit of a little hindsight, that most investors are happy to let shares of an ETF sit unmolested in a brokerage account. But there is a small minority of investors who like to trade actively, and the ETF issuers have come up with products that are best suited to trading.
Along those lines, I continue to be shocked at the sort of products the SEC approves—a leveraged volatility ETF like TVIX is just as mathematically complex as options on variance swaps—maybe even more so. I think a number of products out there (including all leveraged ETFs) are best suited for hedge funds, but have retail appeal.
Confusion happens when retail investors mistake these trading products for investing products, like holding 3x leveraged ETFs for a year or more. This sort of thing has, on occasion, given ETFs a bad name. It is too bad.
Passive investing can lead to really big distortions
The mechanics and legal structure of an ETF are obviously a terrific innovation, but ETFs have benefited from the passive/indexing revolution more than anything.
Just recently, I saw a big piece in the Wall Street Journal on how passive investing is destroying the actively managed mutual fund business, with assets fleeing active funds and piling into passive funds.
I’ve written about this in the past, and while there is a place for passive investing, when it starts taking up a large percentage of the market, really big distortions can happen.
As a thought experiment, what if the entire stock market were held by index funds? My guess is this is closer to a fad than a structural shift than people think.
The ETF blowup isn’t happening
People have taken their shots at the ETF industry over the years, most notably the Kauffman report in 2010, which called ETFs “derivatives” and called attention to ETFs that were heavily sold short. These theories were all debunked.
People are still waiting for that ETF “blowup.” Six years after the Kauffman report, it hasn’t happened. It will never happen, absent counterparty risk with swaps in leveraged ETFs or ETNs, or human error in managing the funds. The legal and operational structure is sound.
Here’s why there are so many ETF listings
As an ETF trader, I used to get bent out of shape at what I would call “throwing-spaghetti-at-the-wall” ETF listings. It is cheap to list an ETF (relatively speaking) versus the probability that it might gather a lot of assets.
For this reason, issuers are incentivized to list as many as possible (within reason) in the hopes that one or more of them catch on. It’s a similar business model to venture capital. (For an example of this, see WSKY.)
I’ve concluded that, aside from the ticker clutter, there really isn’t any harm in issuing a bunch of funds, even if you know that most of them will eventually close. Investors aren’t harmed; they get their cash back at the NAV. It’s simply a business decision for the ETF issuer.
ETFs and active management
Ten years ago, there was a lot of excitement that the ETF fund structure could be used for actively managed products. A lot of that enthusiasm has waned over the years, for good reason. The ETF structure doesn’t lend itself well to active management because the ETF market-maker is never really sure what is in the basket. So the promise of tracking error reduces liquidity in the fund, which increases trading costs.
Open-end funds are much better for active management. I think people have finally started to figure this out.
Closed-end funds
I think what is lost in the whole discussion about ETFs versus open-end funds is the closed-end fund structure. Closed-end funds are actually pretty handy, especially when you are dealing with illiquid asset classes like leveraged loans or emerging market debt.
I am always surprised that closed-end funds haven’t gathered more assets over the years. They are still basically an afterthought in the asset management industry.
For sure, they have some weaknesses (including one big one, the fund discount/premium, and the fact that it is hard for a fund to grow). But in a world where both mutual funds and ETFs have liquidity constraints (most recently imposed by the SEC), maybe this isn’t such a bad thing.
ETFs… too much of a good thing?
I have been accused of being a “pro-ETF” guy, which I guess is sort of true, but there can definitely be too much of a good thing. We are starting to see those distortions from too much indexing.
But there can also be too little of a good thing. Face it: the exchange-traded fund has to be one of the top five financial innovations in the last 100 years. Hands down. People who have bet against it have been made to look very foolish.
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The death of US Treasury bonds has been anticipated for at least 2
years. Ever since the Federal Reverse stated that they would stop
pressing the accelerator pedal all the way to the floor, someone has
come out to talk about how the 20 year bull market in Bonds has come to
an end. And every time they have been wrong. Now it is widely
anticipated that the FOMC will raise interest rates, not tomorrow, but
in December. Will this be the catalyst to finally knock Bonds off of
their highs?
The chart below suggests that we may need to wait
quite some time to find out. A top is never known at the point of
inflection. It can be guessed at but until it is confirmed you can
never be sure. Look at July 2015 for example. After Bond prices
started to fall in April 2015 they found a bottom 3 months later and
rallied to new highs. The top in July 2016 may prove to be the turning
point. But at this point Bonds have not even made a lower low yet. No
confirmation.
And when will that confirmation
come? A move below the June 2015 low would be a start. But even then
Bond prices would only be in the middle of a 20 year rising channel. It
would take a move under the channel, roughly parallel to the 100 month
moving average for a break down. And then a break below the December
2013 low for confirm it. That is 25% lower than today’s values. Many
will already have taken credit for calling the top by then. But then
many have already taken the credit for the tops that have not happened
over the last 2 years as well. Watch prices for proof, not nice suits
and smart sounding words.
Gilead Sciences, Inc. (GILD) Healthcare - Biotechnology | Reports November 1, After Market Closes.
Key Takeaway
The Estimize consensus is calling for earnings per share of $2.88 on $7.47 billion in revenue, 7 cents higher than Wall Street on the bottom and almost $100 million on the top
GIlead has faced setbacks in recent quarters due to weaker sales from its key Hepatitis C franchise
Gilead’s robust pipeline bodes well moving forward but don’t expect them to turn the corner this quarter
Gilead Sciences has turned a fruitful 2015 into a troublesome 2016 after a string of weaker than expected earnings reports. Shares are down 27% year to date as investors jump ship to better performing companies. A large portion of this draw-down has been driven by weaker sales of its flagship Hep C products; Harvoni, Sovaldi and the recently launched Epculsa. Its widely expected that this trend will take its tolls on third quarter results. In fact, analysts are taking down estimates feverishly leading into the report.
Analysts surveyed by Estimize are calling for earnings per share of $2.88, 9% lower than the same period last year. That estimate has been revised down nearly 10% since Gilead’s most recent report at the end of July. Revenue for the period is forecasted to fall 9% as well, to $7.47 billion, marking a second consecutive quarter of negative growth. Historically this was a name that consistently topped expectations but those days are behind the drugmaker with all signs pointing to a miss tomorrow. Gilead’s rise and now fall have come at the hands of its hepatitis C franchise, which includes Harvoni, Sovaldi and the recently launched Epclusa. The treatments were primarily credited with its double digit gains in 2014-15 and are now being blamed for negative growth in fiscal 2016. In the second quarter, the group of drugs recorded a 18.5% decline primarily due to lower sales of Harvoni. Harvoni sales were down a resounding 29% as new competition, mainly from Merck, seize its market share. Weak performance from the Hep C franchise was not only disappointing in the U.S. but Europe as well.
This sharp downturn caused management to cuts its outlook for the year in the range of $29.5 to $30.5 billion from $30-31 billion. Nevertheless some of these losses should be somewhat offset by its growing HIV business which includes a handful of already established treatments. Also, a robust pipeline positions Gilead for an easy bounceback in the near future. Setbacks from HCV will nonetheless be the primary talking point from this quarterly report. Do you think GILD can beat estimates? There is still time to get your estimate in here!
With concerns related to next week’s election and the strong possibility of a December rate hike, the stock market’s intermediate-term profile has shown some significant deterioration in recent weeks. From MarketWatch:
U.S. stocks ended a volatile session with modest losses on Friday, pressured by the surprise announcement that the Federal Bureau of Investigation was restarting a probe into Hillary Clinton’s emails, adding a new dose of political uncertainty into the market.Major indexes had traded higher earlier in the session, supported by a strong GDP reading, but the news prompted a turnaround and extended the week-to-date declines of the S&P 500 and Nasdaq. However, indexes also ended well off their lows of the session as investors digested the news and its potential implications for the coming election.
In the S&P 500 chart below, the 50-day moving average (blue) helps us monitor the health of the intermediate-term trend; the 200-day moving average (red) assists with the market’s long-term trend. The 50-day recently rolled over, which is indicative of waning intermediate-term momentum. Currently, the slope of the 200-day looks quite a bit better than it did before the 2016 New Year’s plunge, telling us the present day long-term outlook is quite a bit better than it was on January 1, 2016.
Possible Buying Opportunity
Given current valuations and the relatively disappointing state of global growth, it is easy to understand the long-term bearish case. Is there any long-term evidence that can help us keep an open mind about better than expected long-term outcomes? The answer can be found in this week’s video.
After you click play, use the button in the lower-right corner of the video player to view in
full-screen mode. Hit Esc to exit full-screen mode.
From a fundamental perspective, a recent MarketWatch headline, “Residential Building Can’t Keep Pace With Seattle’s Surging Job Market”, seems incongruent with the end of the world is around the corner theory. From the article:
Seattle’s growth isn’t a new story, but defining its size and impact is often difficult. Companies are often tight-lipped about hiring numbers. Based on multiple reports, though, just four local companies are planning on hiring an additional 10,000 employees in the coming year. There’s phenomenal job growth throughout the region across dozens of large organizations, but by simply focusing on Amazon, Google, Facebook, and Microsoft, the region needs to build an additional 10,000 housing units within a reasonable commute distance to keep our housing situation from becoming more constricted.
A Four-Month Comparison
In the chart below, notice how the S&P 500’s 200-day moving average had been falling for four months prior to the ugly stock market plunge in January 2016 (see slope of thick red line). Compare and contrast the last four months of 2015 to the last four months in 2016 (slope of red thick line vs. slope of green thick line). The market’s risk profile, from a long-term perspective, looks better today relative to late 2015/early 2016.
The present day look of the 200-day does not eliminate concerns related to waning intermediate-term momentum (looking out several weeks). Sharp declines can occur within the context of a rising long-term trend.
Summary
Until some observable improvement occurs, the market is susceptible to further downside in the coming weeks. If the S&P 500 can recapture and hold above its 50-day moving average (2,155), it would help reduce some of the short-term pressure.
If the market’s long-term trend remains intact, any short-term pullback may represent a buying opportunity, which means it is prudent to maintain a high degree of flexibility. Two anecdotal examples of a “buying opportunity” pullback are August 2015 and the recent Brexit sell-off in June of this year; both periods required a high degree of bull/bear flexibility.
If the market’s long-term trend starts to deteriorate, which is possible, the buying opportunity component would be negated from a probability perspective. As shown in the chart above, the S&P 500 has a band of possible support between 2,134 (2015 high) and 2,100 (area of prior resistance). Time will tell.
I recall writing (back in the 1990s and early 2000s) that one of the great things about the US was our economic mobility. By that, I mean the ability of people to shift on the economic spectrum—to move from being a low-income family to being a high-income family, for example.
It means the America I grew up in is changing. And that cuts right into my emotional comfort zone. I guess this should not surprise me because (a) the US is always changing, and (b) the evidence clearly shows the cultural shifts and economic woes of the younger generation.
My old friend Frank Buckley is a professor at the Scalia Law School at George Mason University. He sent me this piece, and his words will make many of you uncomfortable.
Buckley says that the political devolution we’re now seeing in the US (and that came to a head in the form of Trump and Sanders) is actually a confirmation of Marxist theory (though Buckley himself is hardly a Marxist). What we see is essentially class warfare, at least in the political realm. He thinks a large portion of the populace has become disenfranchised and radicalized.
Buckley then moves right to the research and shows that the United Sates is behind most of the developed world in terms of economic mobility. The irony is that much of the reason for this problem is our “progressive” policies. Our conservative policies are also making the situation worse compared to other countries, though.
Buckley’s prescription? I’ll let him develop his argument for you, rather than spill the beans.
Restoring America’s Economic Mobility
By Frank Buckley
The following is adapted from a speech delivered on July 11, 2016 at Hillsdale College’s Allan P. Kirby, Jr. Center for Constitutional Studies and Citizenship in Washington, D.C., as part of the AWC Family Foundation Lecture Series.
In the Communist Manifesto, Marx and Engels wrote that “the history of all hitherto existing societies is the history of class struggles.” Today, the story of American politics is the story of class struggles. It wasn’t supposed to be that way. We didn’t think we were divided into different classes. Neither did Marx.
America was an exception to Marx’s theory of social progress. By that theory, societies were supposed to move from feudalism to capitalism to communism. But the America of the 1850s, the most capitalist society around, was not turning communist. Marx had an explanation for that. “True enough, the classes already exist,” he wrote of the United States, but they “are in constant flux and reflux, constantly changing their elements and yielding them up to one another.” In other words, when you have economic and social mobility, you don’t go communist.
That is the country in which some imagine we still live, Horatio Alger’s America—a country defined by the promise that whoever you are, you have the same chance as anyone else to rise, with pluck, industry, and talent. But they imagine wrong. The US today lags behind many of its First World rivals in terms of mobility. A class society has inserted itself within the folds of what was once a classless country, and a dominant New Class—as social critic Christopher Lasch called it—has pulled up the ladder of social advancement behind it.
One can measure these things empirically by comparing the correlation between the earnings of fathers and sons. Pew’s Economic Mobility Project ranks Britain at 0.5, which means that if a father earns £100,000 more than the median, his son will earn £50,000 more than the average member of his cohort. That’s pretty aristocratic. On the other end of the scale, the most economically mobile society is Denmark, with a correlation of 0.15. The US is at 0.47, almost as immobile as Britain.
A complacent Republican establishment denies this change has occurred. If they don’t get it, however, American voters do. For the first time, Americans don’t believe their children will be as well off as they have been. They see an economy that’s stalled, one in which jobs are moving offshore. In the first decade of this century, US multinationals shed 2.9 million US jobs while increasing employment overseas by 2.4 million. General Electric provides a striking example. Jeffrey Immelt became the company’s CEO in 2001, with a mission to advance stock price. He did this in part by reducing GE’s US workforce by 34,000 jobs. During the same period, the company added 25,000 jobs overseas. Ironically, President Obama chose Immelt to head his Jobs Council.
According to establishment Republicans, none of this can be helped. We are losing middle-class jobs because of the move to a high-tech world that creates jobs for a cognitive elite and destroys them for everyone else. But that doesn’t describe what’s happening. We are losing middle-class jobs, but lower-class jobs are expanding. Automation is changing the way we make cars, but the rich still need their maids and gardeners. Middle-class jobs are also lost as a result of regulatory and environmental barriers, especially in the energy sector. And the skills-based technological change argument is entirely implausible: countries that beat us hands down on mobility are just as technologically advanced. Folks in Denmark aren’t exactly living in the Stone Age.
This is why voters across the spectrum began to demand radical change. What did the Republican elite offer in response? At a time of maximal crisis, they have been content with minimal goals, like Mitt Romney’s 59-point plan in 2012. How many Americans remember even one of those points? What we remember instead is Romney’s remark about 47 percent of Americans being takers. That was Romney’s way of recognizing the class divide—and in the election, Americans took notice and paid him back with interest.
Since 2012, establishment Republicans have continued to be less than concerned for the plight of ordinary Americans. Sure, they want economic growth, but it doesn’t seem to matter into whose pockets the money flows. There are even the “conservative” pundits who offer the pious hope that drug-addicted Trump supporters will hurry up and die. That’s one way to ameliorate the class struggle, but it doesn’t exactly endear anyone to the establishment.
The southern writer Flannery O’Connor once attended a dinner party in New York given for her and liberal intellectual Mary McCarthy. At one point, the issue of Catholicism came up and McCarthy offered the opinion that the Eucharist is “just a symbol,” albeit “a pretty one.” O’Connor, a pious Catholic, bristled: “Well, if it’s just a symbol, to Hell with it.” Likewise, the principles held up as sacrosanct by establishment Republicans might be logically unassailable, derived like theorems from a set of axioms based on a pure theory of natural rights. But if I don’t see them making people better off, I say to Hell with them. And so do the voters this year. What the establishment Republicans should ask themselves is Anton Chigurh’s question in No Country for Old Men: If you followed your principles, and your principles brought you to this, what good are your principles?
Had Marx been asked what would happen to America if it ever became economically immobile, we know what his answer would be: Bernie Sanders and Hillary Clinton. And also Donald Trump. The anger expressed by the voters in 2016—their support for candidates from far outside the traditional political class—has little parallel in American history. We are accustomed to protest movements on the Left, but the wholesale repudiation of the establishment on the Right is something new. All that was solid has melted into air, and what has taken its place is a kind of right-wing Marxism, scornful of Washington power brokers and sneering pundits and repelled by America’s immobile, class-ridden society.
Establishment Republicans came up with the “right-wing Marxist” label when House Speaker John Boehner was deposed, and labels stick when they have the ring of truth. So it is with the right-wing Marxist. He is right-wing because he seeks to return to an America of economic mobility. He has seen how broken education and immigration systems, the decline of the rule of law, and the rise of a supercharged regulatory state serve as barriers to economic improvement. And he is a Marxist to the extent that he sees our current politics as the politics of class struggle, with an insurgent middle class that seeks to surmount the barriers to mobility erected by an aristocratic New Class. In his passion, he is also a revolutionary. He has little time for a Republican elite that smirks at his heroes—heroes who communicate through their brashness and rudeness the fact that our country is in a crisis. To his more polite critics, the right-wing Marxist says: We are not so nice as you!
The right-wing Marxist notes that establishment Republicans who decry crony capitalism are often surrounded by lobbyists and funded by the Chamber of Commerce. He is unpersuaded when they argue that government subsidies are needed for their friends. He does not believe that the federal bailouts of the 2008–2012 TARP program and the Federal Reserve’s zero-interest and quantitative easing policies were justified. He sees that they doubled the size of public debt over an eight-year period, and that our experiment in consumer protection for billionaires took the oxygen out of the economy and produced a jobless Wall Street recovery.
The right-wing Marxist’s vision of the good society is not so very different from that of the JFK-era liberal; it is a vision of a society where all have the opportunity to rise, where people are judged by the content of their character, and where class distinctions are a thing of the past. But for the right wing Marxist, the best way to reach the goal of a good society is through free markets, open competition, and the removal of wasteful government barriers.
Readers of Umberto Eco’s The Name of the Rose will have encountered the word palimpsest, used to describe a manuscript in which one text has been written over another, and in which traces of the original remain. So it is with Canada, a country that beats the US hands down on economic mobility. Canada has the reputation of being more liberal than the US, but in reality, it is more conservative because its liberal policies are written over a page of deep conservatism.
Whereas the US comes in at a highly immobile 0.47 on the Pew mobility scale, Canada is at 0.19, very close to Denmark’s 0.15. What is further remarkable about Canada is that the difference is mostly at the top and bottom of the distribution. Between the tenth and 90th deciles, there isn’t much difference between the two countries. The difference is in the bottom and top ten percent, where the poorest parents raise the poorest kids and the richest parents raise the richest kids.
For parents in the top US decile, 46 percent of their kids will end up in the top two deciles and only 2 percent in the bottom decile. The members of the top decile comprise a New Class of lawyers, academics, trust-fund babies, and media types—a group that wields undue influence in both political parties and dominates our culture. These are the people who said yes, there is an immigration crisis—but it’s caused by our failure to give illegals a pathway to citizenship!
There’s a top ten percent in Canada, of course, but its children are far more likely to descend into the middle or lower classes. There’s also a bottom ten percent, but its children are far more likely to rise to the top. The country of opportunity, the country we’ve imagined ourselves to be, isn’t dead—it moved to Canada, a country that ranks higher than the US on measures of economic freedom. Yes, Canada has its much-vaunted Medicare system, but cross-border differences in health care don’t explain the mobility levels. And when you add it all up, America has a more generous welfare system than Canada or just about anywhere else. To explain Canada’s higher mobility levels, one has to turn to differences in education systems, immigration laws, regulatory burdens, the rule of law, and corruption—on all of which counts, Canada is a more conservative country.
America’s K-12 public schools perform poorly, relative to the rest of the First World. Its universities are great fun for the kids, but many students emerge on graduation no better educated than when they arrived. What should be an elevator to the upper class is stalled on the ground floor. One study has concluded that if American public school students were magically raised to Canadian levels, the economic gain would amount to a 20 percent annual pay increase for the average American worker.
The US has a two-tiered educational system: a superb set of schools and colleges for the upper classes and a mediocre set for everyone else. The best of our colleges are the best anywhere, but the average Canadian school is better than the average American one. At both the K-12 and college levels, Canadian schools have adhered more closely to a traditional, conservative set of offerings. For K-12, a principal reason for the difference is the greater competition offered in Canada, with its publicly-supported church-affiliated schools. With barriers like America’s Blaine Amendments—state laws preventing public funding of religious schools—lower-class students in the US must enjoy the dubious blessing of a public school education.
What about immigration? Canada doesn’t have a problem with illegal aliens—it deports them. As for the legal intake, Canadian policies have a strong bias towards admitting immigrants who will confer a benefit on Canadian citizens. Even in absolute numbers, Canada admits more immigrants under economic categories than the US, where most legal immigrants qualify instead under family preference categories. As a result, on average, immigrants to the US are less educated than US natives, and unlike in Canada, second- and third-generation US immigrants earn less than their native-born counterparts. In short, the US immigration system imports inequality and immobility. If immigration isn’t an issue in Canada, that’s because it’s a system Trump voters would love.
For those at the bottom of the social and economic ladder who seek to rise, nothing is more important than the rule of law, property rights, and the sanctity of contract provided by a mature and efficient legal system. The alternative—in place today in America—is a network of elites whose personal bonds supply the trust that is needed before deals can be done and promises relied on. With its more traditional legal system, Canada better respects the sanctity of contract and is less likely to weaken property rights with an American-style civil justice system which at times resembles a slot machine of judicially-sanctioned theft. Americans are great at talking about the rule of law, but in reality, we don’t have much standing to do so.
Then there’s corruption. As ranked by Transparency International’s Corruption Perceptions Index, America is considerably more corrupt than most of the rest of the First World. With our K Street lobbyists and our donor class, we’ve spawned the greatest concentration of money and influence ever. And corruption costs. In a regression model, the average family’s earnings would increase from $55,000 to $60,000 were we to ascend to Canada’s level of non-corruption, and to $68,000 if we moved to Denmark’s level.
In a corrupt country, trust is a rare commodity. That’s America today. Only 19 percent of Americans say they trust the government most of the time, down from 73 percent in 1958 according to the Pew Research Center. Sadly, that is a rational response to the way things are. America is a different country today, and a much nastier one. For politically engaged Republicans, the figure is six percent. That in a nutshell explains the Trump phenomenon and the disintegration of the Republican establishment. If the people don’t trust the government, tinkering with entitlement reform is like rearranging deck chairs on the Titanic.
American legal institutions are consistently more liberal than those in Canada, and they are biased towards a privileged class of insiders who are better educated and wealthier than the average American. That’s why America has become an aristocracy. By contrast, Canadian legal institutions aren’t slanted to an aristocracy.
The paradox is that Canadians employ conservative, free market means to achieve the liberal end of economic mobility. And that points to America’s way back: acknowledge that the promise of America has diminished, then emulate Canada.
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Global stocks fell almost 2% in October, measured by the MSCI AC World Index. However, a reliable historical indicator suggests October may have been more soothing than scary for long-term investors. The yield spread—the difference between long and short-term interest rates—rose for many countries in October, a key indicator that the risk of global recession and accompanying bear market in the coming year diminished during the month.
Yield spreads rose in October
Source: Charles Schwab, Bloomberg data as of 10/30/2016.
Reliable indicator of recession
Historically, the difference between short and long-term interest rates has acted as a reliable indication of a recession in the coming year for economies around the world. Usually, as the gap between short-term and long-term interest rates narrows, the higher the probability of entering a recession within the next year, as illustrated in the table below.
Yield spread suggests diminished odds of a recession in the next 12 months
All yield spreads calculated as 10 year less 3 month yield except Mexico (5 year less 3 month). Historical time period begins: U.S. 1967, Eurozone 1970, Germany 1970, UK 1970, Sweden 1970, Mexico 2000. Source: Charles Schwab, Macrobond data as of 10/30/2016.
Among many of the world’s largest economies, the chance of a recession over the next 12 months is currently indicated to be around 20-40% by the yield curves. While that is above zero, it is important to keep in mind that the chances of a recession are never truly as low as zero, and the current probabilities are meaningfully below 50%.
As of the end of October, the widening of the gap between short and long-term interest rates to 1% suggests a lower risk of a global recession in the next year compared to the end of September. Although the historical probability of a recession is not materially different between the 0 to 1% range and the 1 to 2% range (with the exception of the UK), the rise puts yield spreads further from negative territory where the probability of a recession has been high.
Trick or treat
The jump in the yield spreads during October was partly the result of being treated to better economic data released during the month, but also may have been the result of central bankers having fewer tricks up their sleeves.
Although current interest rates in many economies are very low in absolute terms (and even negative in some), the yield spread has been a useful indicator of a forthcoming recession at all yield levels. Nevertheless, some investors may wonder if central bank manipulation is biasing the signal from this time tested indicator. Fortunately for investors, since negative interest rates have pulled down short-term rates in some countries to below zero and “QE” bond buying programs have pulled down long-term yields, these two policies together appear to at least somewhat offset each other in their impact on the yield spread. In our view, that means central bank policies have resulted in a roughly neutral net effect on the signal from the yield curve.
Central bank policymakers have acknowledged there are adverse impacts accompanying negative interest rate policy and have also noted that QE can’t go on forever. So, these distortions may begin to diminish, rather than increase, as we look to 2017.
Measuring the distortion
It is easy to see the amount that short-term rates are negative due to negative policy rates in the Eurozone (which includes Germany), Sweden, and several other countries. However, the amount that QE has been pulling down longer-term rates is not directly measurable. To try to assess this impact we observe that when the ECB adopted their QE program in March 2015 a gap emerged in what had been a tight relationship between the futures market expectations for the timing of a rate hike by the ECB and long-term bond yields in the Eurozone, as you can see in the chart below. The amount of this gap suggests that longer-term yields have been pulled down by about 0.5 to 1%, which is similar to the 0.75% short-term yields in the Eurozone and Sweden that are a result of negative interest rate policy.
Eurozone 10 year bond yields lower than implied by expectations for timing of first rate hike after ECB adopted QE
Source: Charles Schwab, Bloomberg data as of 10/30/2016.
Bear market unlikely
The yield curve is likely to remain a useful (though not perfect) indicator of recession even with the impact of central bank policies on short and long-term bond yields. We believe a global recession and accompanying prolonged bear market is unlikely over the coming 12 months. That is good news for investors spooked by fear of a bear market and suggests long-term investors should stick with their diversified asset allocation and rebalance as needed.
For just the 2nd time in 10 years, both stocks AND bonds are hitting 3-month lows.
This week, stocks began to exhibit some of the weakness of which our models suggested they were at risk. It hasn’t been manifested in the large-cap averages as much yet as they continue to hold within their recent months-long range. However, as we covered this week, small-caps and mid-caps have each exhibited potentially significant breakdowns. And another broad index that we can add to that list is the NYSE Composite. In early October, it broke its post-February Up trendline, softening up its rally support. And today, we see the index breaking below its September-October lows to set a 3 and a half-month low.
If we switch asset classes, we see an odd thing about this new low in stocks. Jumping to the bond market, we see that yields, specifically the 10-year Treasury yield, are hitting 5-month highs. Now, as bond prices move opposite yields, it strikes us as odd that bonds would also be hitting multi-month lows along with stocks. In recent years, bonds have been a reliable haven in the midst of stock weakness. To see both assets at new lows is certainly a change of character for the market.
So this development is different. But is it bad different? Well, certainly if one has a balanced portfolio of stocks and bonds, it is bad different at the moment. But is it a bad different signal going forward? And for which asset class?
Intuitively, it would strike us as a red flag for the bond market since stock market weakness in recent years has been a reliable buoy for bonds. Thus, this change of character would seem to reflect the bond market more so than stocks. And the fact that bonds have dropped in the face of stock market struggles would seem to bode poorly for the bond market.
But if you know us at all, you know that “intuitively” is not a sufficient investment strategy to us. We prefer a quantitative, measurable approach. Thus, let’s take a historical look at other times that saw stocks and bonds hitting 3-month lows at the same time. As it turns out, since 1965, there have been just 34 such prior unique occurrences, encompassing 118 days. This is just the 2nd occurrence in 11 years (June 24, 2013).
As yields were on an inexorable rise until 1981, it should be no surprise that 19 of the 34 unique occurrences, and 78 of the 118 days, occurred prior to 1982. The phenomenon has been much less frequent during the post-1981 secular bull market in bonds, particularly recently. Just 4 other occurrences, and 7 total days, occurred within the past 20 years. So this is indeed a rare development.
But what about the implications, if any? Looking at the prior occurrences, we do see a slight tendency for below-average performance in stocks and bonds in the short-term following such occurrences.
Median returns in the NYSE were negative over almost every period from 1 day through 3 months. The first few days were especially weak with stocks advancing just one third of the time. Bond yields tended to continue their rise up through a month later. After that, they tended to give back their gains.
Returning to stocks, looking more closely, much of the weak tendency following these events can be traced to the earlier portion of the look-back period. For example, in the short-term, 18 of the 22 occurrences prior to 1984 saw negative 2-day returns. Bonds also saw losses 2 days later 17 out of 18 times prior to 1981. Looking further out, 13 of the 15 events prior to 1978 saw negative 3-month returns in the NYSE. That’s not a shock considering the mid-60′s to mid-70′s saw a handful of brutal bear markets in stocks (and bonds, for that matter).
More recently, returns have not been as consistently negative. In fact, the last 4 occurrences (in August 1999, May 2004, October 2005 and June 2013) all generally saw gains from 1 week to 1 year later. This recent trend certainly deserves to be weighed a bit more heavily than events occurring 50 years ago (though the market cycle may turn out to be not too dissimilar than that of the mid-60′s-early 70′s)
On balance, it is difficult to use this prior evidence to construct a reasonable bullish or bearish argument for either stocks or bonds following their coincident 3-month lows. The preponderance of events saw weakness afterward, but the most recent events did not. Thus, we have a hard time leaning either way based on this signal. But, as hard as we might try, we can’t seem to shake our intuitive feeling that this is more of a negative signal for bonds than anything else.
At a minimum, let’s just say that if this trend continues, all stock and bond investors are going to be pretty disappointed.
The commentary included in this blog is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
A weekly excerpt from the Macro Review analysis sent to subscribers on 10 markets and two timeframes.
Last week’s review of the macro market indicators
noted that heading into the weeks before the election equity markets
looked stable long term and mixed in the short run with the QQQ leading
and the SPY falling. Elsewhere looked for Gold ($GLD) to continue to
press higher short term while Crude Oil ($USO) continued to show its
strength. The US Dollar Index ($DXY) was also strong moving higher while
US Treasuries ($TLT) were bouncing short term in their downtrend.
The
Shanghai Composite ($ASHR) continued to drift higher while Emerging
Markets ($EEM) marked time in consolidation. Volatility ($VXX) looked to
remain subdued and falling, adding a tailwind to the equity index ETF’s
$SPY, $IWM and $QQQ. They were mixed short term though with the QQQ
moving higher, the IWM flat and the SPY at risk for more downside.
The
week played out with Gold slowly riding the 200 day SMA higher all week
while Crude Oil pulled back slightly. The US Dollar met some resistance
and pulled back Friday while Treasuries gapped lower and held. The
Shanghai Composite started the week with a bang to the upside then
slowly gave some back the rest of the week while Emerging Markets moved
lower in consolidation.
Volatility made bottom on Monday and
rolled higher all week, ending in the normal range. The Equity Index
ETF’s played out as they looked coming into the week Monday with the QQQ
moving higher, SPY sideways and IWM lower. By Tuesday tough they had
all turned lower and continued the rest of the week. What does this mean
for the coming week? Lets look at some charts.
SPY Daily, $SPY
The
SPY started the week with a move back over the 20 day SMA Monday. It
had not been there for two weeks and was a welcome sight. But it did not
last. It fell back Tuesday and Wednesday. Thursday saw it open again
over the 20 day SMA but sell off all day, finishing at the low. Friday
then continued lower.
It sounds horrible but looking at the daily
chart shows all of this happened in less than a 4 point range. It ended
at the support that has been in place since the gap down in September.
The RSI on the daily chart is falling too, and at the edge of a move
into the bearish zone, while the MACD is rather flat but curling for a
cross down.
The weekly chart shows a bearish engulfing candle. Not
what bulls want to see. There is also continuation of the bull flag.
The RSI on the longer timeframe is falling but at the mid line while the
MACD is falling but positive. There is support at 212.50, where it
sits, and 210.20 followed by 209 and 207.50. Resistance above may come
at 214 and 215 followed by 215.70 and 217. Consolidation with a Short
Term Bias Lower.
SPY Weekly, $SPY
Heading
into the last week full week before the election the equity markets
continue to look troubled on the short timeframe, with the weakness
starting to leak into the longer timeframe for the small caps. Elsewhere
look for Gold to drift higher while Crude Oil continues the short term
move lower. The US Dollar Index looks ready for consolidation or a
pullback short term while US Treasuries are biased lower.
The
Shanghai Composite looks to continue to drift higher as Emerging Markets
are biased to the downside in consolidation. Volatility looks to remain
in the normal range but creeping up so adding a headwind for the equity
index ETF’s SPY, IWM and QQQ. Their charts also show short term
weakness with the IWM the weakest as it falls and the SPY next but the
QQQ still holding near all-time highs. Use this information as you
prepare for the coming week and trad'em well.
Gilead’s rise and now fall have come at the hands of its hepatitis C franchise, which includes Harvoni, Sovaldi and the recently launched Epclusa. The treatments were primarily credited with its double digit gains in 2014-15 and are now being blamed for negative growth in fiscal 2016. In the second quarter, the group of drugs recorded a 18.5% decline primarily due to lower sales of Harvoni. Harvoni sales were down a resounding 29% as new competition, mainly from Merck, seize its market share. Weak performance from the Hep C franchise was not only disappointing in the U.S. but Europe as well.
