Replies to Notes & Comments

Photo Credit: Andrew Steele || 42 (with apologies to the late Douglas Adams)

My last post generated its share of comments. Let me respond to a few of them, and add a little more.

1. Yes, I live outside Baltimore. I have lived more of my life in or near Baltimore than anyplace else. Am I a critic of Baltimore? Of course, everyone near/in Baltimore is a critic of Baltimore. But Baltimore is more complex than most outsiders can understand. It is a “city of neighborhoods.” Positively, it means that if you are in a good area, you can rely on that. Negatively, it means that if you are in a bad area, you can rely on that. It is not a consistently good or bad city, and that was true when I went to Hopkins as well. I lived one year in a relatively bad area of Baltimore, and during that time worked in a different bad area of Baltimore. They are still bad, almost 40 years later, and Baltimore is no better off on the whole. What Baltimore needs is not more money, but a consistent set of directions for the police, such that they can act to the extent desired by the communities that they serve. That said, the amount of Baltimore that is unsafe is maybe 10% of the city, and everyone who lives there understands that.
2. Maryland has some of the best medical assets in the country, including Johns Hopkins (my alma mater), University of Maryland, and NIH. As a result, we have a large portion of the state devoted to healthcare and biotechnology. Other outstanding industries of Maryland include software, defense/intelligence, REITs, and hotel management. These are the overweighted industries of Maryland. Do I have friends in these businesses? Of course, but I have little knowledge of what they do, and I am not a defender of these industries per se.
3. Telling your children not to “Blame the Ump” is indeed correct. Children and adults need to respect the governing authorities, even when they are wrong in minor ways. One reason our society is weak is that we don’t have respect for authority. We respect the office, even if the person holding it is a jerk. FIghting over small matters is not a virtue. With respect to the Presidential election, I say what I always say — if there is genuine evidence, it will be undeniable. Conspiracies rarely happen. THere is too much profit to be made from disclosing a conspiracy for it to happen. Also, when there are many parties looking over the details it is hard for a conspiracy to exist.
4. The same logic applies to those who deny the spread of the C19 virus is not real. I have too many friends of friends who have become very sick or who have died from it for it not to be true.
5. On #6, my bond management strategy is twofold. One, I try to keep costs low, and because I am small, that means using ETFs and closed-end funds. Two, I focus on mispriced risks and prevailing trends. I hold a variety of short bond funds for liquidity, which is around 50% at present. I earn less than 1% on those assets. I have 25% of the assets in TSI which yields around 6%. Then there are the two ETFs invested in short foreign government bonds and emerging market sovereigns denominated in dollars. The first pays off because of US dollar deterioration. The second does well because of their relatively high yields.
6. The 10-year estimate for equity returns on the S&P 500 is now 1.88%/year not adjusted for inflation. We are now in the 97th percentile. Should you be concerned? Yes, particularly if you are invested in growth stocks, particularly the hot FANGMAN stocks.
7. Much as the US is a free market place, there is a dislike in the government for companies that become too powerful. I remember as a youth reading articles about how the US should break up GM (pitiful company that it ended up being). Often those sentiments come at or after the apex of the company — the government may not really need to act, as the “Alexander effect” may kick in — they have conquered all that they can, and there are “no more worlds left to conquer.” That may sound aggressive with respect to Apple, Amazon or Google, but that legislators or government executives are musing about breaking them up should give everyone pause — not because they will be broken up a la AT&T, but that the interest of the government is often an indicator that their market cap has outgrown their relevance.
8. Regarding #13, I agree with the comments of Publius left at the blog. Monetary stimulus should not affect relative prices much, but with assets, lowering financing rates will allow marginal businesses to survive so long as easy conditions continue. That makes it harder for the Fed or other central banks to easy hyper-easy policies, even though they should bite the bullet, and just let weak firms die. Creative destruction has to do its work, or we will have a slow growing economy where capital is not deployed to achieve the best returns.
9. On the inequality part of the comments on #13, I don’t mean to be a controversialist. I mean to tell the truth in a way that most aren’t willing to face. My long forgotten piece called Rethinking Comparable Worth is still correct. Think of the spread of income across the world as a whole. Yes, for some activities, there is more capital investment in some places than others, requiring higher educated workers than in other places, with those workers earning higher wages for now. But as technology improves, those same benefits come to those with lesser skills. That brings a slow but persistent equalization of wage rates as the technology “de-skills” skilled workers. Who benefits? Lesser skilled workers, and the creators of technology. As wage levels equalize for occupations over the world, the world becomes more equal, but for the lower skilled in the developed world, it leads to losses for them. That leads to the nationalism that is rampant in Europe and the US — why are our relative incomes suffering?! They suffer because what they are doing is in excess supply, and they should retrain for something better rather than carping to the government. No one owes you a living. Plan ahead, and look for something better rather than imagining that the government has your back. It doesn’t.
10. Though I agree with Lacy Hunt and Gary Shilling regarding deflation, where I am a little different is what might change matters. QE loses potency with repeated use. There is only so much that you can lower rates, and the effect on stimulating GDP declines. Eventually the government will reach for something with more firepower, like forcing the Fed to buy new issues of government debt. Remember that central bank independence is a myth during stressful times. They are a creation of the government, and not independent from them. When things are calm, we can indulge fantasies of central bank independence as we enjoy s’mores around the campfire and let ourselves get scared as we tell each other ghost stories.
11. If I had to phrase it in a different way, pretend national and local governments don’t exist. That is the way the global economy is heading regardless of government policies. Positively, one thing that it has changed (temporarily reversed by C19) is that the worst poverty in the world is being reversed by the triumph of capitalism. There are genuinely fewer people in such grinding poverty. Fewer people with hunger problems, aside from those that self-cause their problems.
12. Immigration to the US mostly does not absorb existing jobs, but performs jobs that most Americans don’t want to take on, like picking produce. They take on the hard work but low pay positions. Do any of you want that? Maybe the children of immigrants will compete with the children of “natives” but in general most immigrants don’t compete with existing Americans for their jobs. Yes there are some technologically skilled that get hired in the US, but that is because we don’t produce enough technologically skilled young people from the “natives.”
13. Not all of my children listened to me. The ones that listened to me are doing well, and ones that didn’t are not. (A few of them are in-between.) I say the same to all those who read me. Pursue skills that are differentiated, and are not easily obsoleted. Anything that can be replaced by technology or offshored is not a safe place to be.
14. One last comment, which I posted in response to a LinkedIn post by Christof Leisinger, who I have some respect for. Here is the response:

It is a future risk when the ECB and Fed intervene in the repo funding markets, that the markets would become dependent on the Central Banks. It would be difficult to wean the repo markets off their assistance, but in one sense it makes sense for the Central Banks to do it permanently if you are going to have repo markets.

Repo markets are inherently unstable because you are financing long-term assets with short-term liabilities, and accounting for them as a short-term loan. It works fine until you have a crisis in the long asset, with prices falling hard, and the scam is exposed.

Now, the bad thing about the Central Banks taking over the repo markets is that it removes one more price out of the free markets, and will allow repo markets to balloon as they become riskless to outsiders. This is the same as people not paying much attention to bank deposits because of the existence of the FDIC.

I realize we are in the “brave new world” where Central Banks are imagined to be omnipotent, but if there is a significant financial crisis that the ECB or Fed feels that it has to bail out amid rising consumer price inflation, the creation of additional credit at that time will prove toxic.

LinkedIn Post

To my readers: I ask that you interact with my posts civilly and pertinently. I keep comments open on my blog, and I have done so for 13 years, amid a general closing down of comments across the web. Don’t abuse the freedom I offer here by going off-topic, or being abusive in your speech.

WIth that, let me say that appreciate my readers and commenters. Thanks for your efforts, and let’s keep things constructive.

Full Disclosure: Long TSI for my clients and me