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?

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? Pt3

white-house Today is the first day after the election of Donald Trump. My earlier posts on this topic focused upon how a Hillary Clinton administration would affect the economy and the financial markets. I did not address how a Trump administration would affect them largely because I did not believe he had much chance of being elected. Now that he has been elected, I want to address this. Here is the editorial posted by the New York Times today: “Trump’s Revolt”.

Donald Trump opened his campaign with an attack on new immigrants to America; particularly Mexican immigrants. He claimed, without references that recent Mexican immigrants were “sent” by Mexico to this country and that Mexico was sending us “their worst”. Trump pledged that, as a remedy he would build a high wall the length of the US/Mexican border ostensibly to prevent more undocumented Mexicans and others from entering the USA without visas. This wall would be paid for by the Mexican government he said; threatening Mexico with adverse currency exchange rates if they did not. He stated that, if elected, he would mount an effort to identify and uproot the estimated 11 million undocumented immigrants and deport them to their country of origin. Trump has blamed these immigrants for displacing native and properly documented American workers. Donald Trump expressed alarm about the resettlement of war refugees; particularly those from war torn Syria and Iraq. Trump expressed much suspicion about Muslims living in this country.

On foreign policy, Trump claimed he knows more about the situation in Iraq and Syria than the US military commanders there. He stated he would “tear up” the multinational treaty to end the nuclear program in Iran. Regarding the war in Syria, he stated he would simply “bomb the s**t out of them”. During national security briefings he reportedly wanted to know why the USA did not use nuclear weapons more frequently. Trump depicted the current trade policy of the USA as being very unfavorable to the USA; citing the NAFTA for being “the worst trade deal in US history” and cited the US trade deficit as an example of government officials who “didn’t know what they were doing”. A regular theme of Trumps was to declare that Washington DC is a “swamp” of corruption and incompetence that he and he alone could fix.

Trump’s own business practices reveal a practice of lying and cheating his competitors, government regulators, his own employees, and those contracted to do work for him. His justification for these practices was that ethics really knows no place in business dealings; that the “art of the deal” is to win at any cost. He has displayed wanton disregard for the privacy and dignity of women and used his ownership of beauty pageants as a means to satisfy his sexual fantasies; bragging to other men about how he was free to intrude upon dressing rooms and even to take liberties with women without their consent; a practice many consider sexual assault. During the campaign more than 11 women came forward to assert he had sexually assaulted them; one of them a 13 year old at the time.

Trump is currently under investigation for fraud perpetrated upon thousands of students who enrolled in Trump University; saddling many of these students with massive debt with little to show for their money. There is evidence that he defrauded an insurance company of $17M claiming damages upon his Mar a Lago resort in Florida that was largely unscathed by a hurricane.  The US Dept. of Labor has issued three complaints against Trump for failure to bargain in good faith with a union representing workers at his Las Vegas casino.

President Elect Donald Trump will have Republican majorities in both the US House and Senate. Speaker Paul Ryan has already stated that his cohorts in the Senate are ready to scrap the Affordable Healthcare Act that has brought health insurance to more than 20 million uninsured Americans. They have no proposal to replace this program. This prospect suggests that those 20 million people will now have to return to waiting in emergency rooms when their ailments have reached extreme conditions. Hospitals; required to provide this care will now return to massive costs of uncompensated care. Here in Arizona, acceptance of the Medicaid portion of the Act brought an estimated $11B in insurance to hospitals and healthcare institutions saving many rural clinics from closing.

His suspicion of Muslim immigrants; particularly those war refugees led him to declare that he would no longer allow them to come to the USA.  I believe this suspicion could lead to a requirement that current residents from war torn countries in the Middle East would need to register with the Federal government and face an extended vetting process. The prospect of locating 11 million undocumented immigrants living in the USA would require massive investigations pitting community members against each other. Hillary Clinton depicted this process as likely to be “busloads and trainloads” of people forcibly removed from the country. I assert that it is likely that if Trump keeps this promise internment camps will have to be constructed as these people are processed for deportation.

Trump’s trade policy could cause the USA to attempt to renegotiate trade agreements decades old; causing constriction in trade between countries and possibly trade wars. The policies he has pledged to implement are likely to cause extreme uncertainty for investors in financial markets. I assert that the severe Market contraction of 2001 was more likely caused by investor uncertainty after the election of George W. Bush than it was from the so-called “tech bubble” or as some assert a “market bubble”. This contraction began a 10 year period in which the Dow produced no gain. The Trump policies are much more extreme than those of George W. Bush.

What vexes advisors in this extreme situation is that although we may believe there is a contraction coming due to this change in US leadership, there is no way to predict with accuracy when it will commence and there is especially no way to predict when the market hits the bottom. Systematically buying more shares of stock holdings as they decline in value will result in more shares ready to increase in value once the market turns up again. This “portfolio rebalancing” will produce better investment results over the long run but for those investors who are currently depending on their portfolios for income they face difficult times ahead. Election night saw S&P 500 futures slide 800 points until trading mechanisms closed the trading. Today’s 295 point Dow rally will be short lived, in my opinion.


Do elections really matter to financial markets? Pt 2


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.