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Friday, April 27, 2012
Monday, February 27, 2012
The Elusive Concept "RISK"
Lets define Risk. Don't take my word for it...below are three striking similar comments from three investors, with multi decade track records, about risk.
"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non fluctuating asset can be laden with risk.” – Warren Buffet, 2/2012
“Remember too that for those great opportunities to avoid pain or make money – the only investment opportunities that really matter – the numbers are almost shockingly obvious: compared to a long term average of 15 times earnings, the 1929 market peaked at 21 times, but the 2000 SP 500 tech bubble peaked at 35 times! Conversely the low in 1982 was under 8 times. This is not about complicated math.” – Jeremy Grantham, 2/2012
“Rather than volatility, I think people decline to make investments primarily because they’re worried about a loss of capital or an unacceptably low return. The me, “I need more upside potential because I’m afraid I could loose money” makes an lot more sense than “I need more upside potential because I’m afraid the price may fluctuate.” No, I’m sure “risk” is – first and foremost the likelihood of losing money.” - Howard Marks, 2/2006
Monday, January 9, 2012
Land of Fat Tails
Unpredictability and Uncertainty...compounded by higher probability of extreme events.
We think usually of bell shaped distribution where average outcomes are clustered around the average, with an extremely low probability of extreme events. We are moving towards a bi-modal distribution that has implications for how to invest (not what you invest in).
Europe - Europe can no longer kick the can. They go one of two ways...fragmentation, deflation, etc...or strengthen the Euro zone and change its construct.
This applies to risk and opportunity.
Underlying characteristics are changing - consider that interest rate risk is changing into credit risk.
The FED's tools are not sufficient to stimulate growth or improve employment. Now, the Fed is using communication to push investors to take more risk. The problem is the disagreement amongst FED members and second their are real costs associated with the strategy of encouraging risk. The FED alone cannot solve this - the FED is at best acting as a bridge (with the bridge not functioning properly either).
The FED cannot produce the desired outcomes - with signficant risk that the FED can produce un-desired outcomes.
Key Euro Issues:
1. "Re-Founding" Eurozone by Germany and France
2. Counter fragility of banks
3. Mix debt containment with growth
4. Burden sharing of insolvent debtor sovereigns
Key US Issues
1. Can the US withstand economic weakness in Europe and European financial pressure. There is a very low probability that the US totally withstands Euro weakness
Big macro themes tend to be indiscriminate - they affect things universally - so macro uncertainty leads to paralysis - which creates opportunity to be offensive.
We think usually of bell shaped distribution where average outcomes are clustered around the average, with an extremely low probability of extreme events. We are moving towards a bi-modal distribution that has implications for how to invest (not what you invest in).
Europe - Europe can no longer kick the can. They go one of two ways...fragmentation, deflation, etc...or strengthen the Euro zone and change its construct.
This applies to risk and opportunity.
Underlying characteristics are changing - consider that interest rate risk is changing into credit risk.
The FED's tools are not sufficient to stimulate growth or improve employment. Now, the Fed is using communication to push investors to take more risk. The problem is the disagreement amongst FED members and second their are real costs associated with the strategy of encouraging risk. The FED alone cannot solve this - the FED is at best acting as a bridge (with the bridge not functioning properly either).
The FED cannot produce the desired outcomes - with signficant risk that the FED can produce un-desired outcomes.
Key Euro Issues:
1. "Re-Founding" Eurozone by Germany and France
2. Counter fragility of banks
3. Mix debt containment with growth
4. Burden sharing of insolvent debtor sovereigns
Key US Issues
1. Can the US withstand economic weakness in Europe and European financial pressure. There is a very low probability that the US totally withstands Euro weakness
Big macro themes tend to be indiscriminate - they affect things universally - so macro uncertainty leads to paralysis - which creates opportunity to be offensive.
Tuesday, August 2, 2011
"Panic Now! And Beat the Rush" and Other Investmentisms....2
By now, we know that the latest Greek bailout has changed nothing. We can assume that the "plan" is for the politicians to slowly and gradually steer European peripheral public and private institutions through rounds of debt restructurings, recapitalizations, liquidity provisions, austerity, and wealth transfers, while maintaining political solidarity and economic stability.
Admittedly, the announced bailout was more dramatic than the markets expected, but 180bn buyout doesn't buy you much of a rally these days.
Lets revert to the beginnings of this crisis: weak growth. It appears that most market participants are desperately hanging onto the view that the credit crisis has not meaningfully impacted growth in the developed and emerging markets. As of today, the evidence is in. The only way the developed world (and emergininvest) policymakers have been able to deliver barely acceptable growth has been through unsustainable policies which put short term gains first but which also create huge long term risks to sovereign credit quality and which leave a deeply negative scar in the memories of the private sector which is attempting to delver and knows they are facing the mother of all tax liabilities going forward. The reality is, assuming a private sector debt binge and assuming we are coming to the end of the line with respect to policy, then trend growth in the developed world in the next five years is likely be be somewhere around 1-2%. Once the market sees through the policy and "excuses" (soft patches), then it is inevitable that we see a re-pricing income, earnings expectations, consumption and asset prices.
Admittedly, the announced bailout was more dramatic than the markets expected, but 180bn buyout doesn't buy you much of a rally these days.
Lets revert to the beginnings of this crisis: weak growth. It appears that most market participants are desperately hanging onto the view that the credit crisis has not meaningfully impacted growth in the developed and emerging markets. As of today, the evidence is in. The only way the developed world (and emergininvest) policymakers have been able to deliver barely acceptable growth has been through unsustainable policies which put short term gains first but which also create huge long term risks to sovereign credit quality and which leave a deeply negative scar in the memories of the private sector which is attempting to delver and knows they are facing the mother of all tax liabilities going forward. The reality is, assuming a private sector debt binge and assuming we are coming to the end of the line with respect to policy, then trend growth in the developed world in the next five years is likely be be somewhere around 1-2%. Once the market sees through the policy and "excuses" (soft patches), then it is inevitable that we see a re-pricing income, earnings expectations, consumption and asset prices.
"Panic Now! And Beat the Rush" and Other Investmentisms...1
The end of QE2 removed a powerful support for asset prices in general (Equities, Houses, Commods) while bonds rallied. Wrapping up QE2 also coincided with a cyclical weak period driven by numerous factors (the weather, Japan, Europe's fiscal issues).
Perhaps the most important take away from QE2 ending is that the problem in the U.S., like the problem in peripheral Europe, is structural. The current cycle of debt growth and debt restructuring is driven by central bank management of interest rates and asset prices. Households and Financials are in the (still) early stages of de-leveraging, after 30 years of debt accumulation. But, the effect of household/financial de-leveraging is offset by central bank "re-leveraging": since 2008 household debt is down by $600bn, financial sector debt is down by $3tr, and the balance sheet of the Federal Reserve has increased by $2tr.
No wonder that the end of QE2 marks the end of cyclical economic and asset strength. The Fed will eventually have to de-lever, at which point the next phase of this economic cycle will emerge: the re-privatization of risk. This will occur in an environment of positive real interest rates and little support of asset prices. We expect that the eventual (necessary and certain) restructuring of household debt in the U.S., and European peripherals, Brazilians, and local Chinese municipalities and State owned enterprises will occur with significant pain.
Perhaps the most important take away from QE2 ending is that the problem in the U.S., like the problem in peripheral Europe, is structural. The current cycle of debt growth and debt restructuring is driven by central bank management of interest rates and asset prices. Households and Financials are in the (still) early stages of de-leveraging, after 30 years of debt accumulation. But, the effect of household/financial de-leveraging is offset by central bank "re-leveraging": since 2008 household debt is down by $600bn, financial sector debt is down by $3tr, and the balance sheet of the Federal Reserve has increased by $2tr.
No wonder that the end of QE2 marks the end of cyclical economic and asset strength. The Fed will eventually have to de-lever, at which point the next phase of this economic cycle will emerge: the re-privatization of risk. This will occur in an environment of positive real interest rates and little support of asset prices. We expect that the eventual (necessary and certain) restructuring of household debt in the U.S., and European peripherals, Brazilians, and local Chinese municipalities and State owned enterprises will occur with significant pain.
Wednesday, May 18, 2011
Future Shock
This post draws significantly on Michael Farrell.
Alvin Toffler captured the zeigeist of his era with is publication of Future Shock in 1970. He described the psychological effect on individuals and societies with the premature arrival of the future and the effect of "too much change in too short a period of time." He argued that "change was going to accelerate and that the speed of change could induce disorientation...with future shock, you stay in one place but your own culture changes so rapidly that it has the same disorienting effect as going to another culture.
His insights into the political culture were very telling. He noted that politicians seemed totally unaware of what was going on around them, and were content to continue to fund and managed antiquated systems that were the handiwork of the past.
This brings us to financial markets of 2011. Market practitioners of the mid 2000s will not recognize this drive to more parochial, less global, simplified financial system. Risk assessment, market forces and regulation are driving this change. At the same time, funding old systems has lead the U.S. government to a decision where the immediate needs of national debt crowd out private expenditure and investment.
Where does this leave us:
First - the state of markets is a chaotic mess. The simulataneous execution of radical monetary, fiscal, and regulatory reforms is introducing systemic risk into the market. Rather than change one variable in a complex system and test the outcome regulators and policymakers are changing virtually all of them at the same time. The lack of visibility into the inter relatedness of these changes increases unintended consequences.
Second - in times of chaos, those that survive are not necessarily the biggest or the bravest or the ones most capable of seizing opportunity. In times like these, survivors are nimble, smart, resourceful, and lucky.
Last - these are also times of great opportunity and progress. Such is the future.
Alvin Toffler captured the zeigeist of his era with is publication of Future Shock in 1970. He described the psychological effect on individuals and societies with the premature arrival of the future and the effect of "too much change in too short a period of time." He argued that "change was going to accelerate and that the speed of change could induce disorientation...with future shock, you stay in one place but your own culture changes so rapidly that it has the same disorienting effect as going to another culture.
His insights into the political culture were very telling. He noted that politicians seemed totally unaware of what was going on around them, and were content to continue to fund and managed antiquated systems that were the handiwork of the past.
This brings us to financial markets of 2011. Market practitioners of the mid 2000s will not recognize this drive to more parochial, less global, simplified financial system. Risk assessment, market forces and regulation are driving this change. At the same time, funding old systems has lead the U.S. government to a decision where the immediate needs of national debt crowd out private expenditure and investment.
Where does this leave us:
First - the state of markets is a chaotic mess. The simulataneous execution of radical monetary, fiscal, and regulatory reforms is introducing systemic risk into the market. Rather than change one variable in a complex system and test the outcome regulators and policymakers are changing virtually all of them at the same time. The lack of visibility into the inter relatedness of these changes increases unintended consequences.
Second - in times of chaos, those that survive are not necessarily the biggest or the bravest or the ones most capable of seizing opportunity. In times like these, survivors are nimble, smart, resourceful, and lucky.
Last - these are also times of great opportunity and progress. Such is the future.
Friday, April 22, 2011
The Political Challenge of the Moment
The great political challenge of the moment is how to update the 20th century entitlement state so that it is affordable. This challenge manifests itself in two main forms. The primary problem is the cost, or growth in cost, of health care in our country. The second problem is the current excess of spending over and above revenue in both discretionary and non discretionary spending.
Republican's like to say that "this country has a spending problem." In actuality, this country has a revenue and a spending problem, and addressing one without the other offers an overly simple and incomplete solution to this challenge.
In the recent past, both Mr. Ryan and President Obama have offered largely partisan proposals on how to solve this challenge. They are both drastically lacking in a comprehensive solution to this challenge. Mr Ryan health care proposals are incomplete and the rest of his budget is laughable in bad assumptions. Mr. Obama's health care proposal is enlarged government largesse, and the rest of his budget depends on politically favorable tax hikes which will result in sub optimum outcomes.
Mr. Ryan's health care proposal is to increase competition by giving "consumers" more control.
Republican's like to say that "this country has a spending problem." In actuality, this country has a revenue and a spending problem, and addressing one without the other offers an overly simple and incomplete solution to this challenge.
In the recent past, both Mr. Ryan and President Obama have offered largely partisan proposals on how to solve this challenge. They are both drastically lacking in a comprehensive solution to this challenge. Mr Ryan health care proposals are incomplete and the rest of his budget is laughable in bad assumptions. Mr. Obama's health care proposal is enlarged government largesse, and the rest of his budget depends on politically favorable tax hikes which will result in sub optimum outcomes.
Mr. Ryan's health care proposal is to increase competition by giving "consumers" more control.
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