BIS Pushes ABCT Draws Fire

ABCT investing offers financial advise derived from the Austrian business-cycle theory, so to be confident in that advise investors need to be confident in the theory. The most visible institution promoting the theory today is the Bank for International Settlements (BIS). The BIS is the central bank for central banks based in Basel, Switzerland. Just as the Fed in the US coordinates the exchange of funds for commercial banks, the BIS acts as a clearinghouse that coordinates the international transfer of funds between the central banks of nations. 

Claudio Borio and William White of the BIS have used the ABCT for years to analyze events and create policy. Recently, the bank created a minor storm in the world of economics and central bank policy with the release of its 84th annual report. The report asserts that the loose monetary policies of the world's central banks as well as fiscal policies of governments have failed and continuation of those policies will prove harmful. Mainstream economists trashed the report. Martin Wolf of the Financial Times descended to juvenile language. Gavyn Davies, also of the FT,  wrote of the report,

The Bank for International Settlements (BIS) caused a splash last weekend with an annual report that spelled out in detail why it disagrees with central elements of the strategy currently being adopted by its members, the major national central banks. On Wednesday, Fed Chair Janet Yellen mounted a strident defence of that strategy in her speech on “Monetary Policy and Financial Stability”. She could have been speaking for any of the major four central banks, all of which are adopting basically the same approach.

Dow 17000!

The Dow Jones Industrial Average crossed the 17,000 mark for the first time this year. What does it mean?

The market is somewhere in the Excitement stage of the Overstone cycle of trade.  Overstone described business cycles in the mid-19^th century. Starting at the six o’clock position in the graphic, the cycle begins with Stagnation, the depths of the depression with high unemployment. Stage two is Improvement, followed by Confidence, then Prosperity, Excitement, and last, Convulsion.

If you enlarge the graphic you’ll notice Overstone’s sense of humor. In the Excitement phase, crowds fight to get into the building with the sign “South Pole Warming Company” while a machine lifted by four hot air balloons flies over the building. In the Convulsion stage the Royal Bubble Bank explodes and sends people flying.

George Soros describes the Excitement stage as one in which the stock market becomes disconnected from the real economy, but Soros is thinking like a mainstream economist and assumes that the market has an intrinsic value somewhere close to the net present value. In reality, investors are merely adjusting their risk tolerance for the prevailing interest rates and opportunity costs. With ridiculously low interest rates, investors are showing greater tolerance for risk and a thirst for yield. One of the main drivers of stock prices is the changing discount rate of investors. 

What that means is that PE ratios may continue to rise and there is no way of knowing how far. But investors will have to come back to ground when profits start to fail. We are entering the profit reporting season for the third quarter and it may give us market direction.

At this stage in the cycle investors need patience most of all, but that's what they lack according to this quote from the Wall Street Journal newsletter Wealth Adviser: 

The market’s rarest commodity: patience. Benjamin Roth’s diary of the Great Depression is highly relevant today, as is his notion of why the wealthy investors’ club is an exclusive one. In a Motley Fool column, Morgan Housel cites some excerpts, including this one: “Most people do not have the patience to wait for the bad break. The average speculator is tied up in the market to the hilt when the break comes and has no liquid cash for the bargains that prevail.”

So when the market crashes as it did in 2000 or 2008, their wealth gets caught in the whirlpool and gets flushed.

Not only do investors need patience, but we need to be willing to be wrong as Spitznagel wrote in The Dao of Investing. Investors who followed his MS Index might have exited the market last year and missed the latest run ups to record highs. Friends and family would be mocking them and they might suffer from regret. But if they stick with the index they will earn more in dollars over time by avoiding the major collapse that is coming, even if it is another year away. As Spitznagel wrote, it's counterintuitive, like many of the teachings of the Dao.

Many advisers can find good value stocks when the market is high, but keep in mind what Benjamin Graham wrote about buying unloved stocks when the market is high. Investors won't love those stocks more when the market collapses. They will drop with the crowd.

Financial Bull Riding in paperback

Laissez Faire Books has published a paperback version of Financial Bull Riding in addition to the ebook and audio book. But the paperback is available only through Amazon here right now. Reviews of the book by anyone who has read it would be nice.

Forecasting Failure

The latest revision of GDP for the first quarter of this year caught most economists by surprise. A decline of 2.9% is the worst since the latest recession. Surprising most economists shouldn’t surprise anyone. The Laissez Faire newsletter alerted me to studies by the IMF economists Hites Ahir and Prakash Loungani on the abilities of private and public sector economists to forecast recessions. In short, their records are almost perfect, failure that is.

The photo of the Queen with the comment “Why did no one see this coming?” comes from a presentation at George Washington University on forecasting by the two economists. In a second photo, a London School of Economics representative responds, “Ma’am, to see this one coming would have ruined our perfect record of failure to see it coming.”