Lessons from Capital Market History

teeter-totterThis article from the CFA (Chartered Financial Analyst) Institute by Harry S. Marmer, CFA is chock full of graphs that quickly dispel some widely held views. One is that market “cycles” are really not cycles at all but are, rather random fits and starts that are characterized in the article as “episodic”. “Predicting the duration of the business cycle was aptly summarized by noted business-cycle analyst Victor Zanorowitz, who said, ‘Few business cycle peaks are successfully predicted, indeed, most are publicly recognized only with lengthy delays.'” So much for analyst humor.

The graph of 155 years of US business cycle history shows a “typical” average length of 4.7 years but with a standard deviation of 2.2 years. “In other words, the underlying length of the business cycle has broadly ranged anywhere from 2.5 years to 6.9 years 68% of the time.” The bar chart in the article looks like a silhouette of a major downtown city skyline. Because of this unpredictability in business cycles, investors “should avoid investment and policy decisions (based upon predicting market cycle turns).”

The shape of stock return distributions from the last 89 years resembles a fat rocket ship on a plain. The sharpness of the graph is called its “kurtosis”. “The kurtosis from this distribution is 9.7; a normal distribution has a kurtosis of 3”, that is like the “bell curve” we all heard about in high school.  The plain of the rocket ship is there to report a -30% on the one side and a 42% on the other side. The shape of the curve is due to “the fact that stock returns are characterized by jumps. More specifically, financial prices tend to “jump, skip, and leap” up and down rather than change in a continuous fashion.” How many of us have heard colleagues talk about “trends”, “price supports”, and “floors and ceilings”? These are empirically fictitious. Who among us could say with any accuracy what the Mean, Median, or Standard Deviation is of the monthly returns of the S&P 500? Here you have it. The Mean is .94%, the Median is 1.21% and, GET THIS: the Standard Deviation is a whopping 5.46%. That means that 68% of the time, the range is between 6.4% and -4.2%. The high is 42.98% and the low is -29.61. The probability of seeing the extremes of the distribution are about .1% judging by the graph.

“Why do markets behave in this fashion?” These are most likely caused by “traits in the world outside the markets or ‘exogenous’ effects”, says noted mathematician Benoit Mandelbrot. The lemming effect or “investor behavioral biases” is also cited as “a primary driver of the heavy or fat tails in asset class return distributions. That is a very high summit to scale. On the one hand we have “real world” events, both physical and financial to have to contend with and, on the other hand, irrational investors if we are to be successful in market timing. Indeed, as the article goes on to say, “Nobel prize winning economist Paul Samuelson described the challenges in market timing best: ‘Scores of documented statistical studies attest that not one in ten ‘timers’ ends up getting back into the market at bargain prices lower than what they sold at earlier.'” So much for market timing.

Indeed, the “Opportunity Costs of Missing Market Performance: $1,000 Invested” bar graph in the article shows that investors who bought and held their portfolios for the 10 year period ending July, 2016 in the S&P 500 gained an annual average of 7.4% or cumulatively $1,046 while those who missed just 10 of the best days saw a .3% or $33 cumulative gain. It gets worse as the hapless investor, trying to escape downturns buys and sells in and out of the market until the worst in the chart, 40 best days missing loses 10.3% on average annually or $664 cumulatively.

Marmer finishes the article by advocating “implementing a disciplined rebalancing policy back to the long-term policy mix (over market timing).” That is the investment strategy of Jim Hannley LLC because I exercise discipline and I look for rebalancing opportunities in my portfolios daily.

 

Infrastructure plan or…..scam?

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Hernando de Soto Bridge, Memphis

Paul Krugman, columnist for the New York Times questions the plan to use tax credits to incentivize corporations to build or repair US infrastructure. Krugman states that the plan is to allow the corporations to use up to 82% tax credits on the equity created and then to allow these corporations to charge the public for the use of these projects to recover the other 18%. Krugman rightly observes that with transportation projects the new corporate owners can apply toll charges to recoup the remainder of their investment but what of such needs as sewer replacements? He does not answer this question entirely but, imagine if your city allows a corporation to upgrade its sewer system. Under this proposed plan, that corporation could apply sewer fees above the city’s cost of normal maintenance. What about municipal water systems? Will Americans soon anticipate their water system to be privately owned? Krugman points out the very limited utility of this arrangement as being “back door” borrowing but with the catch that the public ownership would be lost.

Do elections really matter to financial markets? Pt 2

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To continue. So Hillary Clinton will arrive at the White House with her two shipping containers of baggage. She will (unless this election outcome is the best possible and that is with Democrat majorities in both halls of Congress) have to fight hard to implement her platform.

However, Obama’s sweeping overtime rules reform is a powerful force for economic growth as I asserted above. This will help her right out of the box. Then there is her minimum wage increase initiative. That initiative, if implemented sooner rather than later will bring with it profound economic growth. Economists agree that demand side economics is an undeniable force for growth. The minimum wage increase brings with it a change in the distribution of value added in services and manufacturing. Instead of an inordinate proportion of income, both personal and corporate flowing to a tiny minority, less will flow to them and more will remain with employees who will spend it quickly, so great is pent up consumer demand.

Workers with their new disposable income will empty stores enthusiastically causing a supply shortfall that will drive manufacturing expansion. They will dine out more often filling tables at local restaurants; take vacations and travel more often; etc., etc. as a more dynamic economy takes hold.

That brings to mind another important Clinton economic expansion proposal: the ambitious 10 year $500B infrastructure renewal and jobs program. The beauty of this and many other Clinton economic initiatives is that it is largely funded by the richest 1% of Americans through increases income tax rates and even a 30% surcharge tax on incomes in excess of $5M. This is where fallow capital is to be found. It sits, mostly in US Treasury bonds; largely unproductive. This capital is to be given new velocity as it is appropriated through taxation and put to work building new bridges, laying high speed railroad track, installing high speed internet cable among other projects. This new and improved infrastructure will lower production and transportation costs increasing productivity that has been stagnant of late.

Another Clinton program is the promise of free college education for all Americans at community colleges and state universities. This is for students from households with income of $125,000 or less. This will create a post-secondary education boom growing jobs for educators, administrators and support staff. New student capacity will be needed causing growth in commercial construction.  The “value added” of a vastly improved educated workforce will be tremendous in the decade to follow this initiative as these colleges and universities graduate these new students. Instead of our society bringing on young college educated people with college loans averaging $27,000, these students will graduate debt free. Instead of these payments flowing to capital-bloated Wall St. banks, these new graduates will have much more disposable incomes with which to buy homes, furniture, cars, clothing and other tangible goods. The supply side will be greatly enriched with sales.

It must be obvious to the reader at this point that I am extremely optimistic about the new Clinton administration and the fiscal policy she brings. If she can implement a good deal of her platform, we will see an economic boom perhaps the likes none of us has ever seen since the 1950’s. This boom will be reflected in the financial markets as investors bet that great companies, both existing and to come will be ubiquitous and their stock offerings will find many excited investors.

Do elections really matter to financial markets? Pt 1

Image Stock Market Trading floorI was further amused just now to learn that this article from the Minneapolis Star Tribune was printed on Oct. 22nd and ran in the Arizona Daily Star yesterday. This article seeks to calm investor jitters over the looming election. Naturally, both Hillary Rodham Clinton (HRC) and Donald Trump (DT) are painted as being completely disastrous to the economy. First, I think that elections DO matter. I don’t know if it is a violation of my securities license to weigh in on an election or if it is not. I think this is ethical as long as I am controlling my emotions and being as objective as I can be. I have no financial stake in the Presidential race or either candidate.

I think that HRC comes to us with two large shipping containers. Both say “10 tons” but only one weighs 10 tons. The other container is empty. It is perceived to contain 10 tons but it does not. The first container contains all of the mistakes HRC has ever made in public life. She is not a perfect human being so she has made mistakes; some serious mistakes. When you operate with responsibilities of a magnitude that only perhaps one or two dozen people in the entire world operate with; your mistakes can be measured in as much as lives lost. Some people are willing to accept such staggering responsibilities but they are rare individuals. HRC is one of those.

I believe that for the mistakes she has made she has owned up for the most part. I could not support her, regardless of how correct her platform was if she did not have integrity. She is honest, public-serving, especially hard working and dedicated to the welfare of her country. She has endured great burdens throughout her public lifetime. Yet, she continues to want to serve. That is an admirable characteristic.

That brings me to the second container. I believe the awesome majesty of the media has been able to fill a 10 ton container with nothing but suspicion and innuendo. HRC has been singled out for special character assassination for at least 25 years. She was especially loathed by the most self-serving 1% when, upon her entering the White House with Bill, she set upon constructing nothing less than the complete overhaul of the so-called US healthcare system. She was brutally punished, pursued wherever she went to hold town-hall meetings, and vilified until she crept back into the WH kitchen where she “belonged”. The extent and magnitude of the false image that is borne by HRC and constructed by those who wish only to roll back progress or at the least to preserve the status quo is of historical proportions. The Whitewater Investigation; a Congressional investigation pursued both the Clintons for ten years and cost at least tens of millions of taxpayer dollars only to uncover coincidences and possibilities. Not a single indictment came from this foray. Whitewater is just one example of the numerous legal attacks that have been levied against the Clintons over more than a quarter of a century.

By now, any reader who is still with me has a good idea of whom I am going to vote for and I haven’t even begun to address Donald Trump. I am not going to do that but, instead examine the possibilities that a HRC administration could bring. These musings are not going to contain exact figures just recollections and approximations if you don’t mind. However, the practical effects of these policies can be examined without exact figures. First, lets take the effect of one labor policy that will begin to be implemented upon her arrival on Penn. Ave. That is the restructuring of the overtime rules. Obama, as Chief Executive is the commander of all US agencies. One of those is the Labor Dept. The Labor Dept. rules govern business employment. Employers have to observe these rules or face fines or even imprisonment. Long ago, a labor standard was agreed upon by Labor and Capital in the USA. That was indeed called the “Grand Bargain”. That agreement held that workers can be considered “full time” if they work no more than 8 hours per day, five days per week. They could not be compelled to work more in a day or more days in a week without their consent and the employer was sanctioned by being required to pay the hourly wage and a 50% bonus for the overtime.

Currently, the limit to consider employees “salaried” and therefore exempt from overtime rules is more than $54,000/year. That means, all those workers earning this much or less can be compelled to work overtime and they receive no bonus for this work. Obama, by Executive Order, had the Labor Dept change the exclusion allowance to less than $24,000. That means that many, many workers will either receive more time off, a higher wage, or time and a half for overtime. The macro-economic effect of this is to create a very large pool of jobs AND to create a huge pool of consumer demand. This will result in increase sales of consumer goods and all the ripple economic effects in the supply chain. (to be continued)