Tuesday, April 15, 2014

The View from Vienna on Interest Rates and the Stock Market

Interest rates have some impact on the stock market because if investors can earn a better return in bonds than in the stock market and with less volatility they will sell stocks and invest in bonds. A large part of the recent record highs in the stock market reflect the Fed’s squashing of interest rates. The Fed wants to punish savers and reward debtors.

Interest rates have been falling since the early 1980’s to near zero today. According to the Financial Times columnist, Gavyn Davies, my main source for what central bankers are thinking, the International Monetary Fund identified three main reasons for the decline depending on the period:

  1. In the 1980’s and 1990’s Fed inflationary policies caused the drop.
  2. Since 2008, businesses have quit investing.
  3. 2002 – 2007, the savings glut from emerging markets kept rates low.
  4. Since 2000, portfolio shifted to bonds because of two stock market crashes.

Wednesday, April 9, 2014

Escape from Mass Opinion

L. Albert Hahn, a great economist in the decades after WWII wrote Common Sense Economics because he thought that most mainstream economics had drifted into fantasy land as a result of the rise of Keynesian economics. I like the cover picture that shows a piggy bank sinking under water, which is what conventional investment wisdom will cause.

In section five on the stock market, Hahn wrote this:
 “As every experienced market operator knows, success on the stock market depends decisively on the ability to go against the prevailing tendency, i.e., against mass opinion, at the very moment when its correctness is least in doubt. The ability to go against the prevailing tendency, however, presupposes in the first instance that the individual remains conscious of the persuasive influence of mass opinion on his own opinion. This, in turn, presupposes a correct assessment of its force. Everyday observation shows the strength of mass opinion to be very great indeed. It engulfs not only those who easily succumb to foreign influences but even those with normally detached views and sober judgment. An almost superhuman effort is needed to evade the influence of mass opinion-particularly in the United States, where price movements and thus the opinions of others are continuously reported to the farthest corners of the country by the ticker. The ticker assembles, as it were, all the buyers and sellers in one room. The ticker influences speculation as the flag influences troops. As long as the flag is carried forward, every single man knows that the others still have the courage and strength to go on, and this knowledge sustains his own courage and strength. Once the flag retreats, every man concludes that the others' courage and strength is waning. As he knows that he cannot advance alone, he, too, retreats, even though he would not himself be forced to.
 “There is, of course, no general rule on how to counteract the influence of foreign opinion on one's own opinion. One of the most important aids for emancipation from mass opinion and its influence is to bear in mind that all prices are almost always necessarily wrong. It is further important to remember that mass suggestion wields its strongest influence when only one opinion is stated and discussion is prohibited. An experienced stock market operator will always listen with special attention to any arguments in opposition to the prevailing opinion.”

It’s old, but still good advice for investors. The time to follow the crowd is the period after the bull market starts until just before it ends. The crowd won't get out of the market until long after they have lost close to half their nest egg. Most individual investors don't get into the market until it has reached close to its top. The market is near its top today so successful investors will start rebalancing into cash or gold, but those who do will get a lot of criticism from most other investors. Being a good investor means learning to enjoy solitude. 
From Common Sense Economics by L. Albert Hahn, London: Abelard-Schumann Ltd., 1956, 213-214.

Thursday, April 3, 2014

Debt Alert

The S&P 500 set a new record high today, April 2, 2014, which should make investors nervous. Here's a chart from my book Financial Bull Riding showing the close relationship between margin debt on the New York stock exchange and the S&P 500 through 2011. The data are monthly averages.

Tuesday, March 25, 2014

QE to Infinity and Beyond and Cantillon

Mainstream economics denies that Cantillon Effects exist. Cantillon Effects are one of those insights that Austrian economics offers followers that help us avoid nasty surprises like the Great Recession. Recently, McKinsey and Company provided research that supports the Austrian view of Cantillon effects from QE. Here is one of their charts:

Tuesday, March 18, 2014

Markov Confirms ABCT

Greg Davies and Arnaud de Servigny offer a different take on diversification in their book Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory. Chapter 6, “Representing Asset Return Dynamics in an Uncertain Environment was the most interesting chapter to me, and the one that adds confirmation to using the ABCT as a guide to timing the market. 

Modern portfolio theory tells investors to diversify their portfolios at least between two asset classes, stocks and bonds. A simplistic summary of the method is to use the statistical measure called standard deviation to assess the risks of asset classes and diversify according to risk. But in reality, advisers have found that a fixed ratio, say 70% stocks and 30% bonds, often works better without requiring as much work. 

Tuesday, March 11, 2014

Financial Education Fails

 Many people share a strong pessimism about the future of Social Security while secure pensions from a lifetime of working for the same company have followed the path of buggy whips. So in spite of decades in which the nanny state tried to protect people from life, people feel  less secure than ever. 

As usual and when all else fails, the experts turned to education. Teaching people about the miracle of compound interest and providing GPS guides to navigate the forest of investment alternatives and complex securities would empower consumers to make wise investment decisions. But as usual it failed according to a paper by three academics who analyzed 168 papers covering 201 prior studies. The paper, “Financial Literacy, Financial Educationand Downstream Financial Behaviors” was made available online in January and will appear in a forthcoming journal, Management Science. The authors concluded that

These interventions cost billions of dollars in real spending and larger opportunity costs when these interventions supplant other valuable activities. Our meta-analysis revealed that financial education interventions studied explained only about 0.1% of the variance in the financial behaviors studied, with even weaker average effects of interventions directed at low-income rather than general population samples.

Tuesday, March 4, 2014

Buffet's Investing Advice

Fortune magazine recently published an excerpt from Warren Buffet's annual letter to investors in which Buffet offers advice for the average investor. He starts by telling two investing stories:

This tale begins in Nebraska. From 1973 to 1981, the Midwest experienced an explosion in farm prices, caused by a widespread belief that runaway inflation was coming and fueled by the lending policies of small rural banks. Then the bubble burst, bringing price declines of 50% or more that devastated both leveraged farmers and their lenders. Five times as many Iowa and Nebraska banks failed in that bubble's aftermath as in our recent Great Recession.