Wednesday, June 22, 2016

Sector rotation confirms ABCT

Mark Skousen in his excellent economics text, The Structure of Production, shows that professions on the front line such as accountants and investing experts, follow the Austrian business-cycle theory (ABCT) often without know it. Schwab confirmed that in March of this year with a chart titled “The Business Cycle: How Does Each Sector Perform.

The chart divides the business cycle into four segments – early expansion, maturing expansion, late expansion and recession – and shows which sectors perform the best in each segment of the cycle. I do something similar in Financial Bull Riding but use segments of the cycle described by Lord Overton in the mid-1800s.

Wednesday, June 15, 2016

How not to predict the stock market

Investing expert Bert Dohmen said that “Looking at earnings, dividends and P/E ratios in order to predict future stock prices are all a waste of time” in a recent Forecasts & Strategies email issued by the economist Mark Skousen. The email continued:
Dohmen explained, “If a P/E were meaningful for predicting future price performance, why is a stock like Facebook selling at a lofty P/E of around 90, and Amazon with a P/E of 300, both still highly recommended and rising, while other stocks, like Apple, with a low P/E of around 10, [are] declining and down 35%?”

He added, “Analysts tell us that ‘earnings’ are the most important thing affecting stock prices. Really?! Well, corporate earnings in 2015-2016 have had the largest decline since the crisis in 2009, but the DJI and the S&P 500 are within about 1% of making new record highs.”

Then Dohmen asked the all-important question, “So what is the major determinant of stock market trends?”

Of course, the answer is “future earnings.” Stock prices are always based on the forward-looking views of investors. That’s why high-priced stocks such as Facebook are selling for 90 times earnings. It also explains why Amazon is selling for 300 times earnings and Tesla is selling for $230 a share even though it has no earnings! Investors are upbeat about their future. Meanwhile, Apple is selling for only 10 times earnings because it’s not viewed as a growth stock anymore.

Tuesday, June 7, 2016

How D-Day teaches economics

June 6, 1945, Allied forces invaded the Nazi fortress of Europe. Not everyone cheered. General Douglass MacArthur said of the invasion that he would court martial the SOB who had planned it. Of course, he knew well the planner. He had worked as MacArthur’s aid for several years: General Dwight Eisenhower. The mass slaughter of Allied troops in the invasion horrified MacArthur. His philosophy had been to land where the enemy wasn’t and then attack. In dozens of amphibious landings MacArthur lost fewer men than the Allies lost at Anzio alone. Churchill had lobbied for the main landing in the south of France where the German presence was much thinner. Instead, Eisenhower and the Allied command chose to jump right into the the teeth of German troops in Western Europe.

The D-Day invasion succeeded in spite of being a very poor military strategy. But why? The Germans held a significant advantage and were very confident. The answer lies mostly in the field of organizational behavior, specifically, the issue of centralized versus decentralized decision making. In organizational theory, the larger and more complex the situation, the more decentralized decision making must become. Centralized decision making works best with routine and simple operations.

Thursday, June 2, 2016

Fundamentalist investing scores big gains

Last week I wrote about fundamentalism and I want to carry on with that theme this week. I’m late to the party. Research Affiliates launched their fundamental indexes over ten years ago, but I only recently read The Fundamental Index: A Better Way to Invest by Robert Arnott, Jason Hsu and John West.

The authors promote index investing because of the evidence of the failure of most active managers to match the percentage returns of indexes such as the S&P 500. For most part time investors, indexes are the best choice. Even Warren Buffet enlisted an index fund to sustain his wife’s wealth after he moves on.

Thursday, May 26, 2016

Golf, economics and fundamentalist investing

Scottish people will always have trouble getting into heaven because they have tempted humanity with two infamous inventions: golf and economics. They’re trying to make up for it with their whiskey, and doing a pretty good job, but the final judgment is up to someone else.

Golf offers a few lessons that would help economists as investors if they would pay attention. The chief lesson is get back to the fundamentals. Fundamentalism has become a curse word lately, but in Christianity it originally meant one who held to the doctrines of the virgin birth, deity, death and resurrection of Jesus Christ, that is, the fundamentals of the faith. Fundamentalists were distinguishing their concept of Christianity from the modernists who denied all of the fundamentals but for some strange reason, or out of pure dishonesty, continued to call themselves Christians. Twenty years ago a few journalists intent on advertising their ignorance began misusing the word and today a fundamentalist is the vilest murderer on the planet.

We should rescue the term from ignorant journalists. (Other words need rescuing as well, such as liberal and justice.)Those who practice the fundamentals of any discipline are fundamentalists and the fundamentals are important in most areas of life. In football the fundamentals are blocking and tackling. With investing, fundamental analysis is extremely important. In golf they’re grip and swing, according to the golf masterpiece, Harvey Penick’s Little Red Book. Penick recommends revisiting the fundamentals when you’re golf scores suffer from inflation. Are there any fundamentals in economics that could rescue the field from the macro confusion that threatens it today? Yes. The fundamentals of economics are in micro.

Two schools of macroeconomics exist – Austrian and mainstream. But the mainstream world is split between paleo-Keynes, neo-Keynes, monetary and neoclassical. In spite of their common origins, they imitate their socialist counterparts in other fields by fracturing and fighting over insignificant details. All of them pretend that micro doesn’t exist and try to build their systems through correlations of aggregates, such as aggregate demand, aggregate supply, savings, investment, exports, money supply and GDP.

On the other hand, Austrian economics builds up its macro on the certain fundamentals of micro. There are no schools in micro. Micro is just micro because the principles of micro are the most certain in all of economics. No good economist disputes the laws of supply and demand, or diminishing marginal returns, though mainstream macro pretends they don’t exist.

The focus of Austrian economists on the fundamentals has enabled them to craft the best business-cycle model in the field. Mainstream economists are still stuck, after eighty years, with “crap happens!” They call it “shocks,” but it’s the same thing.

So if you find you investing landing in the rough, try getting back to the fundamentals: the market follows profits and profits follow the business cycle, the Austrian business-cycle.

Monday, May 23, 2016

Party like it's 1999

 The lyrics to one of the late Prince’s songs, “Party like it’s 1999,” seem more appropriate today as writers applaud new tech companies. In the late 90s, all an entrepreneur had to do to raise money for an idea was attach the suffix “dot com” to his company name and hot money would rain on him. That enthusiasm for tech stocks drove the NASDAQ to the stratosphere where the lack of oxygen makes people hallucinate. The crash that followed in 2000 punished the dreamers severely.

A similar euphoria is gelling around the fintech, or financial technology, that intends to transform finance. One fintech company is SoFi, a San Francisco based company whose founder claims it will do to banking what Uber has done to taxis. You may have seen its Super Bowl 50 ad, “Great loans for great people.” 

Friday, April 29, 2016

The first Austrian economist - Washington Irving

Washington Irving is best known for his short stories "The Legend of Sleepy Hollow" and "Rip Van Winkle," but he also wrote many essays. Before he lived by the pen he was a business man and one essay proves that he was a good economist as well. He wrote about the Mississippi Bubble in France of the 1720’s which he published as part of the “Crayon Papers” essays.

At the time Irving wrote this essay, in the 1820’s, there were no good business cycle theories. The most common ideas blamed a shortage of money (gold or silver) or a general overproduction. Say, the French economist, distilled his famous law as part of an effort to debunk the overproduction theory. The Manchester school in England didn’t attempt its explanation until the middle of the nineteenth century and of course Mises didn’t put it all together until early in the twentieth century. Somehow, Washington Irving figured out the essence of the Austrian business cycle theory long before.