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.

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:

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. 

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.

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.

RX for Healthcare.gov

I posted in November in A Monkey with two bananas about the left's contempt for management being the cause of the failure of the Obamacare web site, Healthcare.gov. Recently, Foreign Affairs magazine detailed the management failures of those in charge of the web site in The Key to Successful Tech Management. The authors wrote,

Assuming basic technical competence, the essential management challenge for all large technology projects is the same: how best to balance features, quality, and deadline. When a project cannot meet all three goals simultaneously -- a situation HealthCare.gov was in by the beginning of 2013, as the administration’s internal memos show -- something has to give, and management’s job is to decide what.

In other words, everyone wants their projects finished fast, cheap, and good, but in reality we can only have two of the three. Good managers understand that and let the client set priorities. The Center for Medicaid and Medicare Services (CMS) settled for fast and cheap so quality suffered. But as the authors point out, Healthcare.gov wasn't the government's worst disaster:  

That honor probably goes to the Federal Aviation Administration’s Advanced Automation System, an attempt at modernizing air traffic control in the 1980s and early 1990s that has been characterized by one participant as “the greatest failure in the history of organized work.”...

In the end, the FAA determined that $1.5 billion of the total $2.6 billion spent on hardware and software for the system had simply been wasted -- more than twice the total cost of HealthCare.gov.

And that's without adjusting for inflation! Then there was the FBI’s Virtual Case File, an upgrade of its Automated Case Support system begun in 2000. The project failed outright by 2005 and the entire $170 million project had to be written off. The authors summarize the government's problem:

These are only two of many such examples one could choose from, all stemming from problems in at least one of three distinct arenas of government tech administration: hiring and procurement, planning, and management.

The government spends $80 billion per year on tech projects, many of which will fail like those mentioned because few people in government have any respect for the field of management. 

Unfortunately, decades of nine- and ten-figure failures have not sufficed to teach the federal government and its contractors such basic lessons....

So the real question is not how to fix a website, even a big, complicated one. It is whether Washington will ever allow good management to become part of its standard operating procedures, rather than something that it turns to only when its regular routines fail badly enough to produce a crisis.

That will happen when socialists admit that CEO's deserve their pay. Good managers are as rare as good NFL coaches. Coaches do little but stride up and down the sidelines and yell during a game, while the players on the field do all of the work. And so it appears to the media and public that CEO's do little but take credit for the work of others.

But the NFL coach's job, and that of a good CEO, is to orchestrate the efforts of the many different players to achieve the team's goals. The coach needs to know something about every position, though he may not be an expert at each. No one function should dominate the effort; each contributes its portion to the goal. One can learn the basic principles of management by reading a few books. But like coaching football, becoming good at it takes years of practice.

The government will continue to fail at everything from IT projects to hurricane clean ups until it learns respect for the role of management. Unfortunately, bureaucrats who fail miserably tend to get promoted while in the private sector they get fired. CEO's have failed, but none as spectacularly as bureaucrats do on a regular basis.

Presidential Returns

In honor of President's Day this week I decided to take a look at a popular cyclical candidate running to help you time the stock market - the presidential election cycle. Jeffrey Hirsch, chief market strategist at the Magnet Æ Fund and author of The Little Book of Stock Market Cycles wrote about the technique in "Using Seasonal and Cyclical Stock Market Patterns" in the June issue of AAII's Journal. Hirsch's Stock Trader's Almanac has followed this cycle for fifty years and found it profitable.

Here is his graph of the average returns for the Dow Jones Industrial Average in each year of the four-year cycle from 1833-2012:

 

Hirsch explains that, "In an effort to gain reelection, presidents tend to take care of most of their more painful initiatives in the first half of their term and 'prime the pump' in the second half so the electorate is most prosperous when they enter the voting booths. The 'making of presidents' is accompanied by an unsubtle manipulation of the economy...By Election Day, he will have danced his way into the wallets and hearts of the electorate and, it is hoped, will have choreographed four more years in the White House for his party."

After the election, reality asserts control: