Category Archives: Finance

Hedge funds love Hillary

From yesterday’s Wall Street Journal:

Owners and employees of hedge funds have made $122.7 million in campaign contributions this election cycle, according to the nonpartisan Center for Responsive Politics—more than twice what they gave in the entire 2012 cycle and nearly 14% of total money donated from all sources so far.

The lines around what constitutes a hedge fund aren’t always clear in the data, or in the financial industry. But the numbers are stark. The top five contributors to pro-Clinton groups are employees or owners of private investment funds, according to federal data released last week and compiled by OpenSecrets.org, the center’s website. The data show seven financial firms alone have generated nearly $48.5 million for groups working on Mrs. Clinton’s behalf.

The total for Donald Trump: About $19,000.

The Fed’s new ‘regime-based’ concept

From a new paper by St. Louis Fed President James Bullard:

The Federal Reserve Bank of St. Louis is changing its characterization of the U.S. macroeconomic and monetary policy outlook. An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

…

It is a good time to consider a regime-based conception of medium- and longer-term macroeconomic outcomes. Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor. We therefore think of the current values for real output growth, the unemployment rate, and inflation as being close to the mean outcome of the “current regime.”

Of course, the situation can and will change in the future, but exactly how is difficult to predict. Therefore, the best that we can do today is to forecast that the current regime will persist and set policy appropriately for this regime. If there is a switch to a new regime in the future, then that will likely affect all variables—including the policy rate—but such a switch is not forecastable.

Seems reasonable.

Larry White on lowering long-term risk

I’m taking Larry White’s Monetary Theory and Policy class this fall at George Mason University. Here’s a selection from his book, The Theory of Monetary Institutions on one interesting utilitarian argument for adhering to a gold standard.

A more reliable unit of account lowers the risk of long-term nominal contracts, as we have just noted with respect to bonds. Lower risk on long-term bonds encourages more long-horizon investment. When savers are more willing (do not demand so large a purchasing-power risk premium) to buy long-term bonds, a firm with a long-payback project, like a railroad company, can more cheaply sell bonds long enough to match the duration of its expected payoff stream from the real assets being financed. Such duration-matching eliminates the significant refinancing risk involved in relying on short-term debt, which is the risk that interest rates will be higher when the firm goes to roll over its debt. High-payoff long-horizon investment projects are therefore not shelved simply because of inflation risk, which undoubtedly aids economic growth, though the size of the effect would be hard to estimate.

A gold standard, then, has the effect of boosting confidence in money’s purchasing power in the long-term, thereby increasing general confidence in long-term investment and long-term bonds. Just a paragraph before, White explains that some railroad companies in the nineteenth century found willing buyers for 50- and 100-year bonds! Today, corporate bonds of 25 or more years are uncommon.

I recommend the book. Great so far.

Brief musings on the market

  1. The DJIA lost 3.57 percent today. Last Friday it lost 3.12 percent. This is nowhere near even the 20th worst day in the DJIA’s history—a 6.98 percent loss on September 29, 2008. But the past two trading days do represent the DJIA’s 19th and 20th worst daily point losses ever.
  2. Most economists think Greenspan’s Fed left interest rates too low for too long when rates hovered between one and two percent for 32 months between December 2001 and May 2004. But that’s nothing compared to today, which marks roughly 80 months of near-zero rates.
  3. Even if the U.S. stock market recovers somewhat in the next few weeks, problems in China have proven to be very fundamental and very serious. I take this as another good reason to believe my 8-month old prediction—that the Fed will not raise rates in 2015. China is in full-on stimulus mode, and sharp divergence between central banks’ policies makes conducting monetary policy in the U.S. difficult. If the Fed continues to flirt with the idea of a rate hike, it will be while China, Japan, and the Eurozone still meddle with stimulus. At the very least, this risks boosting the dollar’s value even further and weakening U.S. exports in the process. Larry Summers made this point in the Financial Times today. I explained it last fall.

Too much debt

From this great Blackstone piece:

The whole world is suffering from too much debt.  As a result, growth almost everywhere is going to be slow.  I know you believe the problem is insufficient demand, but the major industrialized countries already have considerable debt and do not want to add any more to it to stimulate the consumer.  Japan is an exception.  They already have the highest debt to Gross Domestic Product (GDP) of any major country and they are willing to add more.  China is an exception on the other side.  They are in a position to take on more debt because their debt to GDP ratio is low.  Without more fiscal stimulus, demand will be tepid and growth will be disappointing.  This is the state of the world now, and it is likely to endure for some time.  In the near term, I don’t see a calamity, just sluggish economies and many equity markets not doing much. 

A new piece, and a great interview

Here’s my new piece at EnhancingCapital.com on interest-sensitive investments — a handy little read, I hope, for anyone concerned about how an interest rate hike might affect their portfolio. Then again, I still stand by my prediction from last December: The Fed won’t raise interest rates in 2015. Inflation is just too low. In fact, I don’t think raising rates in 2015 was ever a serious possibility when rate-hike-talk began last fall.

Switching gears…

Here’s a great interview with some great thoughts on immigration (and other things) from someone who could very well be the next President of the U.S. At the least, it’s encouraging to know that someone running for president actually believes his message is robust enough to convince millions of people (i.e. Republicans) that they are wrong on a big issue (immigration).

Tech-bubble-talk on repeat

I haven’t posted in a while. I’ve been busy. I started a new job two weeks ago and I still have class three evenings per week. The job is great, though. I’m a research associate at a pretty cool market research firm here in the D.C. area. My coworkers and assignment are quite engaging.

I did find time to write a piece for Enhancing Capital last week. It’s on the “tech bubble” (or lack thereof, in my opinion). Mostly, talk about the tech bubble has been based on impulsive reactions to sky-high valuations of tech startups. The old guard just can’t seem to bring themselves to believe these companies actually add amazing value to users of their products. Airbnb and Uber come to mind.

On one hand, this incredulity is understandable. These companies often have just a few dozen employees. Their products are little games and buttons that live on a little 5.1″ handheld display. Isn’t a $1 billion valuation a little high?

But on the other hand, apps these days are becoming quite sophisticated, yet simultaneously easier to use for the average person. And they’re not just fun and games. Apps like Airbnb and Uber bring the physical and digital worlds together in ways that make life easier for everyone. They solve problems we didn’t know we had in ways that add real, dollars-and-cents value to our wallets.

On a somewhat related note, I guarantee you kids in twenty years won’t believe we used to hail cabs by walking down to the sidewalk and flailing our arms around hoping a driver would see us.

My new piece, and a pet peeve

I have a new piece out at Enhancing Capital. Topic is booming stock markets and how to explain record-highs.

On a related note, one thing that’s frustrated me lately is people’s willingness to ignore good news when it comes from the “wrong” source. Booming financial markets, for example, are happening. Perhaps you think the recovery is all “phony” or whatever, but that doesn’t change the fact that stocks have performed remarkably well over the past five years. Those who insist this is all a facade and refuse to buy in are only hurting themselves.

“But the country just can’t be doing well as long as Obama is in office, right? I mean, he’s got all the wrong ideas! He’s “fundamentally changing” (or whatever) the United States!”

Again, even if that is true, it doesn’t mean we haven’t had six years of strong recovery, or that major economic indicators aren’t looking better and better with each passing quarter. Good things can happen even with the “wrong” people in power.

Don’t let your politics get in the way of your financial success. You can still criticize Obama and the actions of economic/monetary policymakers while taking advantage of the booming stock market. And yes, you can even believe things are worse than they would be if policymakers had taken another path while still believing that markets are strong.

Same goes for your personal life. Don’t ignore good ideas coming from people you don’t like, or from people who’ve had only bad ideas in the past. And don’t let the source of your information determine how you are going to use it. Weigh everything on its own merits and look out for your own interests. Don’t waste your energies spiting others or refusing to grant legitimacy to an idea you had rejected in the past. Rise above all that. You’ll be better off for it.

Me on net neutrality

If you’re like most people, you’re hearing a lot about net neutrality but know almost nothing about it. It has something to do with the internet. President Obama likes it. Republicans don’t seem to get it, but they don’t like that Obama likes it.

That was me a few weeks ago. Then I read up on net neutrality, and now I’ve written a piece at Enhancing Capital that (I hope) familiarizes people with net neutrality and helps put the issue in some context. I also offer some advice for investors who might have positions in some stocks whose performance could be affected—namely, that both ISPs (like Comcast and Verizon) and large web content owners (like Netflix and Google) could see some volatility in the coming weeks and months, as net neutrality is approved by the FCC (which is quite likely), is fought by Republicans in Congress (also likely), and reveals its true nature (whether it will be a game-changer for the internet as we know it).

I’m not a big fan of net neutrality. I understand its proponents’ arguments and their fear that big, powerful ISPs “colluding” with big, powerful content owners could stifle competition. But I don’t like government meddling in markets, and frankly it only makes sense to me that barriers to entry become higher as an industry gets older. Trying to prevent this from happening will, I think, have some unfortunate consequences.

Draghi makes his case

Mario Draghi making the case for more stimulus to combat disinflation in Europe:

The risk cannot be ruled out completely, but it is limited. The important thing is what inflation rate people expect over the medium term. Since June, we have seen that these expectations have declined. If inflation remains low for a long time, people might expect prices to fall even further and postpone their spending. We are not there yet. But we need to tackle this risk.

…

History shows that falling prices can be as damaging to the prosperity and stability of our countries as high inflation. That is why our mandate is symmetric. And that is why we are now ensuring that the risk of deflation you just asked me about does not materialise. You, as a journalist, also have a duty to explain. Public opinion in Germany is very important for us.

Note that this interview was given to a German financial newspaper. German officials are perhaps Draghi’s biggest opponent in the fight for more stimulus.

Some perspective on oil

Vaclav Smil at AEI shedding needed light on the oil price drama:

Falling oil prices have been called shocking, unprecedented, and (most incredibly) a highly regrettable development that will end the rise of American stock market and create unrest and uncertainty around the world. However, what we are experiencing is the eighth oil price decline of more than 30 percent during the past 30 years.

For more reading, here’s my brief analysis at Enhancing Capital of the not-so-great implications of oil’s price collapse. Read mine in light of Smil’s, though—while I do note potential downsides of low oil prices, this doesn’t mean the episode will precipitate an end to “the rise of the American stock market” or usher in some new, oil-less economic era.

The lowdown on negative interest rates

Here’s my humble attempt to explain the logic of “negative interest rates” over at Enhancing Capital. I’ve found some good stuff written on this topic already, but nothing that I thought was accessible to the average person. Hopefully this report helps to fill that gap.

One highlight I’d like to point out is that negative interest rates on reserves at the central bank aren’t necessarily a “game changer.” They do reverse the logic of interest on reserves (commercial banks pay interest to the central bank instead of the central bank paying interest to commercial banks), but they don’t mean that banks are all of a sudden going to try to get rid of all their reserves. This hasn’t been the experience of banks in the Eurozone, where negative rates already exist on some deposits at the ECB. It won’t be the experience of banks in the U.S. if the Federal Reserve takes similar measures. Finance is all about trade-offs—paying a small fee to hold reserves at the central bank could still be a more attractive option to commercial banks than making more loans to keep their negative interest-bearing reserve balances from growing. What matters is whether commercial banks can identify enough credit-worthy borrowers whose risk of default is low enough to promise a higher return than the negative interest rate charged by the central bank. If not, then banks might very well be content to pay interest to the central bank rather than make more loans.

Finally, I realize this report might seem mistimed. If anything, talk on the town regards when the Fed is going to tighten monetary policy, not loosen it. My explanation is three-fold:

  1. I’m not convinced tightening is as imminent as many analysts are making it out to be, for reasons I’ve explained before.
  2. It’s important for investors to understand the logic of negative interest rates before they happen, not after (no harm in being over-prepared!).
  3. The ECB has already imposed negative interest rates, and the Bank of Japan has toyed with the idea. The policies at these banks, of course, have ramifications worldwide, and investors everywhere ought to understand what negative interest rates are.

Read the full report at EnhancingCapital.com.

Dark clouds looming

A good piece from The Economist on “the dark clouds around the silver lining” of Fed monetary policy. A highlight:

…constraining the economy to so low a rate of average inflation is a good way to ensure that very low inflation or deflation becomes a serious threat whenever the next shock hits. That would be nasty in and of itself, given what we have learned about wage rigidity over the course of this business cycle. It is made all the worse by the very high probability that interest rates will quickly fall back to zero during the next downturn. That’s the third reason to pull one’s hair out over the Fed’s preferred approach: the lower the average inflation rate, the lower the nominal interest rate consistent with normal economic growth, and the higher the odds of hitting the zero lower bound whenever trouble strikes.

And the kicker:

…the Fed is the world’s monetary pacesetter, and it is rapidly moving toward tightening at a time when a disinflationary freeze is settling in around the rest of the globe. The Fed may tell itself that its responsibility is to take a very narrow, domestic view. Given the interconnectedness of the global financial system, taking a narrow, domestic view strikes me as a bad idea, even in terms of pure American self-interest.

I think this author is on to something important, but I don’t agree that the Fed is going to be as hawkish as he thinks. I don’t expect a rate hike in 2015 largely for those reasons this author cites. In short, I don’t think the Fed is “rapidly moving toward tightening” right now.

The Fed is frustrating (and won’t raise rates in 2015)

The Editors at BloombergView are spot on with this one:

Here’s the point, and it’s really quite simple: The Fed doesn’t know when it will start to raise interest rates, nor should it have to know, nor should it indulge analysts’ misconceived determination to find out. Interest-rate changes are not, and should not be, on a schedule. They depend entirely on what happens in the economy, and the Fed — like every last one of those analysts — doesn’t know what will happen. What it can and should do is draw attention to the economic indicators it is following — in particular, indications of inflation pressure in the labor market. The rest just sows confusion.

On a related note, I made a public prediction earlier this week that the Fed will not raise rates in 2015. Inflation, as measured by the Fed’s preferred PCEPI, is just too low. Fears of runaway inflation are totally unfounded in the data. Yes, stock values are soaring high enough to scare some investors, but Yellen has insisted that the presence of speculative bubbles is no reason to raise rates. That decision will come, she says, only once the two arms of the Fed’s dual mandate—unemployment and inflation—look good. And right now, inflation looks anything but. Yellen has always been a deflation hawk, anyways.

For more of my views on this topic, see my recent piece at Enhancing Capital. This is the startup I’ve mentioned on my blog before—an investments e-newsletter that “brings market analysis to life.” In this case, that’s more than just a cheesy slogan. They do some pretty cool stuff with data visualization that keeps things simple and straightforward without sacrificing depth of research. Most of my content there regards larger economic trends, but stock picks and sector analyses are their specialty. Check ’em out!

Bundesbank: No QE even with sub-zero inflation

Reuters is reporting that the Bundesbank head Jens Weidmann is skeptical of further QE in the Eurozone, even if the inflation rate drops below zero. In his own words:

Against the background of the rather moderate and uncertain impact as well as the risks and side effects and the not clearly given necessity at the current point in time, I am currently sceptical of a broad-based QE programme. … Substantial volumes would be needed to achieve a moderate and moreover uncertain impact.

This is especially interesting in light of a survey released yesterday showing that 90 percent of respondents in a Bloomberg survey predict the ECB will restart QE next year. This is up from 57 percent the previous month, before oil’s price collapse had become so drastic.

Draghi and Weidmann have sparred for quite some time over the need for more easing. Weidmann’s conservative stance arguably represents the popular opinion among Germans, whose economy has not suffered as deeply as smaller European economies. But Draghi seems to have won this bout—the possibility of a new round of easing has already lured investors into European equities, which would make squashing these expectations a nightmare for already-ailing European markets.

On a related note, here’s a post by Scott Sumner on the ECB. He asks whether the ECB is a hopeless case. He stops short of answering the question outright, but I think we can see where this is all headed.