Tuesday, May 31, 2011
For quotes related to Grant’s comments on Bernanke, see the excerpt from David Iben’s letter.
A: I've been all wrong on this. I thought that this massive monetary stuff would generate the conventional kind of inflation that would be expressed in much higher CPI readings. Not so far. But all things are cyclical and the seemingly impossible is just around the corner. On September 30, 1981, the 30-year US Treasury bond traded at 14 7/8 percent and I remember some crank, some visionary, was talking about how interest rates were going to zero, you watch. Oh, yeah right. And so it came to pass.
A: Sometimes they can't control things. We had 6 percent inflation before. Washington is full of well-intentioned people. Ben Bernanke keeps saying that what we really need is a little inflation. He says we'll get 2 percent or a little bit more. You shouldn't even think that, let alone say it out loud. That's such bad luck to tempt fate by saying that you can calibrate things like that. You can't do that.
A: The trouble with the present is that nothing is actually cheap. My big thought is that our crises are becoming ever closer in time. The recovery time from the Great Depression was 25 years. The stock market peaked in 1929. It got back there in 1954. We had a peak in 2000, crash, levitation, then the biggest debt crisis in anybody's memory. The cycles are becoming compressed. The temptation to become invested at peaks of these shorter cycles is ever greater.
Perhaps one way to proceed is to hold cash at the opportunity cost of not much in Treasury bills. You make nothing, but you want to have this money when things are absolutely, not just relatively, cheap. This time of full or overvaluation shall pass. On recent form, it'll pass in a thunderclap and there will be a panic and it'll seem as if the world's ending. And that's when somebody who is nimble can get fully invested in a comfortable way.
In “Fooled by Randomness” Nassim Taleb said the news makes idiots of us because it gives us confidence, not insight. Like a PhD in macroeconomic theory. So a couple of months ago I decided to experiment. I took Taleb's advice and restricted myself to just The Economist each week and the occasional blog, avoiding everything else.
And I came to the conclusion that Taleb is right: surprisingly, I didn't actually feel less informed; it made no difference to the performance of the pitifully small Grice retirement fund (which was unfortunate, some 'performance' would have been nice!); it made no difference to conversations I had with friends or family; to my overall sense of well being. I found that if anything was important it would find me. And reaction is easier than prediction.
But I also realised that I missed the news for its pure entertainment aspect. Finding out how sub-stories end after the fact without the suspense before was a bit like seeing only the football results on a Monday morning.
Related previous post: Avoid News: Towards a Healthy News Diet - By Rolf Dobelli
Found via Simoleon Sense.
We are at a cusp point in medical generations. The doctors of former generations lament what medicine has become. If they could start over, the surveys tell us, they wouldn’t choose the profession today. They recall a simpler past without insurance-company hassles, government regulations, malpractice litigation, not to mention nurses and doctors bearing tattoos and talking of wanting “balance” in their lives. These are not the cause of their unease, however. They are symptoms of a deeper condition—which is the reality that medicine’s complexity has exceeded our individual capabilities as doctors.
On that note, regardless of how one looks at present market conditions from a cyclical perspective, it is clear that stocks are not in a secular bull market (in the 1950-1965, or 1982-2000 sense). Secular bull markets comprise a whole series of cyclical bull-bear combinations, where each bull market achieves a successively higher level of valuation. Historically, they have started at Shiller-type P/E multiples of about 7 (about 40% below we saw at the 2009 low), and have ultimately ended about 18 years later at multiples above 24, which is, well, about where we are now. That said, I should note that the 2000 peak - at over 40 - was a huge outlier in that regard, with predictably unfortunate consequences for subsequent market returns for a very extended period of time.
The algebra of returns in secular bulls is easy to grasp. Given that S&P 500 earnings have grown at a very consistent peak-to-peak rate of about 6% annually across economic cycles (as have normalized earnings), an 18-year period where the PE moves from 7 to 24 produces overall capital gains of about (1.06)*(24/7)^(1/18)-1 = 13.5% annually. At a Shiller multiple of 7, the dividend yield on the S&P 500 has typically been around 6% or more, while a multiple of 24 puts the yield below 3%, so the average dividend yield over the course of a secular bull has been something over 4%, putting the average total return for the S&P 500 at close to 18% annually over a period of nearly two decades. Since earnings expansion and valuation expansion move in the same direction in a secular bull market, the cyclical bull markets tend to be longer than average, with extended periods of modest, largely sideways returns taking the place of deeper declines, and outright bear markets running somewhat shorter than average.
The algebra of returns in secular bears, in contrast, is predictably hostile. As long as one allows for valuation levels to vary over the long-term, as they have historically, it is very difficult to escape very extended bouts of poor overall returns for stocks once valuations become as elevated as they are today. The canonical 18-year secular bear, again assuming long-term earnings growth is unaffected, produces overall annual capital gains of about (1.06)*(7/24)^(1/18)-1 = roughly zero. In general, dividend income (again, somewhere in the range of 4% over the full course of time) is the primary source of return for passive investors in a secular bear market period. Since the long contraction of valuations offsets the benefits of long-term earnings growth during secular bear periods, the cyclical bull markets tend to be shorter than average, and cyclical bear markets tend to be extended and often brutal.
Despite the "lost decade" since the extreme valuations of 2000, valuations are now presently at about the same level from which prior secular bear markets have just started. There is no basis to expect a secular bull until we observe the valuations from which they have invariably started. Meanwhile, the recent cyclical bull market from the 2009 low has already run the same duration and slightly further than the typical cyclical bull in a secular bear.
Monday, May 30, 2011
Just as the boys were inspired by the movie Frankenstein, one cannot help but imagine a younger Bernanke, back in 1985, watching Weird Science and hatching a plan to use a few computer models, some creative nomenclature, some green pieces of paper and maybe a little lightening, to create beauty and wealth. Maybe using “molecular manipulation” he could turn paper into gold!
Creatively, he decided that calling this experiment “Quantitative Easing (QE)” made it somehow more palatable than using a more forthright—“Dollar Debasement.” There is even a stated goal for debasement—2% every year. They call this “Inflation Targeting.” Keynes, the author of many theories that have been embraced by inflation apologists to defend spurious government policy, had a more honest appraisal of inflationary policy. Quoting Vladimir Lenin of all people, Keynes stated, “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.” He added, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they cannot only confiscate but they confiscate arbitrarily.” Even the father of the communist Soviet Union understood some economic principles that Bernanke does not seem to. The following quotes suggest that he isn’t especially prescient.
“At this juncture… the impact on the broader economy and financial markets of the problems in the sub-prime markets seems likely to be contained,”
- Ben Bernanke, March 2008
“Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.”
- Ben Bernanke, February 2006
“The Federal Reserve is not currently forecasting a recession.”
- Ben Bernanke, January 2008
“The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”
- Ben Bernanke, June 2008
“I expect there will be some failures [referring to smaller regional banks]. Among the largest banks, the capital ratios remain good and I don’t anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system.”
- Ben Bernanke, February 2008
(As to how and why inflation results in a highly regressive “tax” on the poorer segments of society, it is too lengthy a discussion to include here, but is explained well in the readings highlighted earlier.)
Uttering perhaps the most scary quote ever made by a Fed Chairman, in a December interview on 60 Minutes, Mr. Bernanke claimed that he was “100% certain” that he could contain inflation.