Last Post

In the second half of last year I started thinking about potentially leaving my current employer and starting my own investment firm.  There were many reasons for this, not the least of which is complete disillusionment with company management.  For a number of months now I have been exploring this possibility, researching regulatory requirements, interviewing financial service providers, developing a business plan, etc.

I started this blog as part of this research.  The concept was to incorporate it into a more traditional business web site and use it as a way of effectively communicating updates to clients and prospective clients.

The blog has turned out to the the easy part.  Creating one and filling it with content has been simple compared to the other tasks.  And, after a very detailed examination of the alternatives, I have decided to shelve the idea of launching own firm for now.  The rate of change and amount of uncertainty in the financial services industry is at extreme levels, and I may end up elsewhere, but for now it will not be of my own volition.

So, this is the last entry for the Durable Investor.  I will turn my efforts back to concentrating solely on success in my current role.  Yes, management at my company remains questionable, and perhaps has even been borderline criminal in the past, but I have the ability to work independently to a very large extent and protect my clients from my own company as well as the overall markets.

To close, here’s a final thought: while the future does not look appealing right now, it does not look as bad as many think.  We may be in a “Great Recession”, but it remains highly unlikely that we are in Great Depression II.

Look at this entry from Calculated Risk.  CR was one of the very early voices warning about the bubble economy.  Behavioral investing is all about being aware of crowd dynamics and irrational actors.  We are currently in a pessimism bubble; try to keep things in perspective.

“Financial Equivalent of Snake Oil”

Today’s Financial Times has a second great column to go with Martin Wolf’s, mentioned in the prior post.  This column is from Robert Shiller, again talking about Keynes, his concepts of capitalism, the need to balance it with government, and the chaos of human emotion or “animal spirits” that adds a wild card to what classically trained economists wish would be a rational and easily modeled social science.

The column is an excellent read.  The best sound bite is calling modern investment products the “financial equivalent of snake oil”.

“Errors of Undue Pessimism”

In at least parts of the investor class there is certainly a brewing crisis of confidence with Obama’s economic policies.  I believe it’s too soon to pass judgment, but the cries of alarm are on the right (“socialism!”) and left (“nationalize the banks now!”).

Getting back to my favorite topic of behavioral economics / investing, here’s a relevant post via Economist’s View.  An excerpt:

However, Keynes can be our savior only to a very partial extent, and there is a need to look beyond him in understanding the present crisis. One economist whose current relevance has been far less recognized is Keynes’s rival Arthur Cecil Pigou… Pigou was much more concerned than Keynes with economic psychology and the ways it could influence business cycles and sharpen and harden an economic recession that could take us toward a depression (as indeed we are seeing now). Pigou attributed economic fluctuations partly to “psychological causes”…

It is hard to ignore the fact that today, in addition to the Keynesian effects of mutually reinforced decline, we are strongly in the presence of “errors of…undue pessimism.” Pigou focused particularly on the need to unfreeze the credit market when the economy is in the grip of excessive pessimism… One of the problems that the Obama administration has to deal with is that the real crisis … has become many times magnified by a psychological collapse. …

The Real Problem?

Let me preface this by stating that I am an unabashed capitalist.  I believe in the free markets and the entrepreneurial spirit that makes our economy the most robust in the world.  I am confident that these forces will lead us to recovery in due time.

But let’s be clear about the root cause of the current crisis. We are in the current economic crisis because the banks are publicly traded.  Before you burn me at the stake, listen to my argument.

Keynes Was Right

The markets can remain irrational longer than you can remain solvent.  Today’s market action was just bizarre.  Obama’s speech last night had nothing in it that should have triggered the drop we saw, unless the markets were hoping that he was just going to roll over and abandon his prior stated positions altogether.

One of the “legs of the stool” that Obama outlined was a stimulus package that passed today in the Senate.  The contents of the Senate’s version of the this bill has been pretty well known for days, so any new negative reaction to it today is odd.

Another leg in the stool is getting credit flowing.  Geithner’s speech laying out the broad outlines of his plan certainly did lack specifics, as he has said all along would be the case.  So, if the markets were hoping for strong assurances that current investors in the financial sector would be made whole going forward, there was reason for disappointment.  But, that seems like an unreasonable expectation to me.

So, I have to chalk this one up to pure human emotion, underlining once again the difficult position that believers in efficient markets have been placed.  Behavorial investing seems to offer a more plausible explanation for current investor behavior.

While I am certainly disappointed in the lack of specifics in the Geithner plan, he warned us of this so it is not surprising.  My outlook for the markets holds: trading in a tight range where we have seen the bottom, or something very close too it, but are unable to break through to new highs until significant new economic news emerges.

Animal Spirits

Robert Schiller, the famous Yale economics professor (see the Case-Shiller index mentioned above), has a great opinion piece in today’s WSJ, Animal Spirits Depend on Trust.  I have referred to “animal spirits” more than once, here is Schiller’s description:

The term “animal spirits,” popularized by John Maynard Keynes in his 1936 book “The General Theory of Employment, Interest and Money,” is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people.

The article goes on to say that recovery will not commence until trust is restored in the business and consumer sectors.  Given the conversations I have been having with my clients, I can say that trust is very low at this point.

Another entry in the classical vs. behavioral economics debate: we are not always the rational actors that classical theories rely upon.

Jeremy Grantham’s January Letter

Never one to pull a punch, Grantham’s latest quarterly letter is out and titled Obama and the Teflon Men, and Other Short Stories (Part 1).  (I’m not sure about who can register to get access to this.) This is going to be a long post, but one very much worth reading if you like to think about the big picture and investment trends.  If you want the quick bottom line: 2009 and even 2010 could easily see new lows in the stock markets but we will avert a new Great Depression.  The 7-year outlook for stocks looks good with traditional average annual returns over that time frame.

A Day Late…

An unexpectedly busy day at work yesterday dealing with a small crisis threw me off, so here’s a summary of what I meant to post:

1. David Brooks had a column on the emergence of behavorial economics and what he claims are the now obvious failings of classical economics and the notion of rational actors and efficient markets.  This is one of my favorite topics.  Interesting to see it come to the forefront among general interest columnists.
2. Another warning on the rise of protectionism and nationalism, this time from Paul Krugman.
3. If some banks are too big to fail, then let’s make them smaller – and quickly!  We are essentially nationalizing the biggest banks, so if we own them, let’s break them up and fire the managers who led us into this mess.  As taxpayers we should all be outraged by the deals that the “too big to fail banks” are getting.  No, they cannot be allowed to fail, but there’s no reason to allow them to continue on in their present form – a form that has proven to be disastorous.
   
4. The risk of ETNs vs ETFs is becoming quite clear as the banks that back ETNs, Barclay’s for example, come under increasing financial pressure.
5. If you want to get a taste of the sort of financial regulation that is coming, see this article in the latest The Economist.  A report from a group of economists and policy makers that includes many of the senior people in Obama’s circle.  It calls for some big changes, including separating much of the banking and investing functions that have been getting merged together of late.  “All that talk of the biggest overhaul of financial regulation since the 1930s just took a step towards reality.”  I hope this sort of thing gets implemented quickly.

End of Week Roundup and Thinking Things Through

Dismal employment and manufacturing reports coupled with a Congressional Budget Office prediction of prolonged economic contraction this year cap another week of grim economic news.  Job losses in 2008 were the worst since 1945 and the contraction is now widely expected to continue through the end of the year.  The WSJ notes that today’s report marks the worst job creation track record of any administration on record.

On top of that let’s add more scandals in the business (Satyam) and financial markets (muni bond price fixing) and throw in a dash of enhanced geopolitical risk (Gaza battles, Russia/EU natural gas deliveries).  Frankly, there has been little positive data or news in this very New Year.

But, rather than further commenting on why things are gloomy, it’s probably time to take a step back and attempt to assess the big picture.

3 Detailed Posts

If you like to read longer, detailed discussions from economic professors, there are 2 good posts in The Baseline Scenario today.  One provides much more commentary on a topic I posted on 2 days ago, the Fed’s new fear of deflation and actions they are contemplating to counter it.  The second discusses another of my themes, the human tendency to create bubbles and the structural issues in the financial system that need to be addressed.

A third post is a guest post, Obama Plan Is Bold, but Not Bold Enough, from The Baseline Secenario team in the WSJ’s Real Time Economics blog.  This is a lengthy post with commentary along the now common themes of the need for massive government spending to substitute for the lack of private sector and consumer spending, the need to recapitalize banks to restart lending, and the need for a pro-inflation policy to fight deflation.  The final point that they make that has not been discussed enough of late is the need to put a floor under the housing market.  It is abundantly clear that the recession in the housing market is far from over with housing prices continuing to fall.  This creates an insurmountable negative-wealth effect in the consumer sector, the single largest sector in our economy.  There can be no larger economic recovery if there is not also a recovery in the housing market.