Archive for June, 2009
In this video, I explain that we have to outsource. Increases in the American standard of living priced us out of the manufacturing market. We can’t afford to make thing in the United States.
I want to point out a specific point I made about American arrogance around 3 minutes and 20 seconds through the video. We have to watch out for feeling “entitled” to our success.
There is a famous joke that Woody Allen tells at the end of Annie Hall, which seems so pertinent with regard to investing:
A guy tells his buddy, “My brother thinks he’s a chicken.”
And the buddy responds, “ You should have him committed to an asylum.”
The guy retorts, “Well we would, but we need the eggs…”
I love the fact that the guy makes no qualms about his brother’s sanity. He knows his brother is nuts but believes that staying insane is in the family’s best interest. They need the eggs…just like so many of us now need returns on our investments.
In order to retire, most Americans need their savings to grow. Growth rate assumptions vary but the common understanding is that equities return 8% per year on average. Eight percent! This is the assumption that the brokers use when they calculate the “future expected value.”
How much money do we need for Junior’s college? The broker or advisor enters in some factors, and Voila! the computer spits out an entire analysis, retirement assets, income expected et al. The analysis is based on the assumption that your stocks will all go up 8%.
The 8% growth was a real number. 8% was the average return on equity over the past 100 years. However the last 100 years were not “typical,” and assuming that the type of growth and innovation we experienced on planet earth over the past century will continue on unabated at the same or even higher pace is overly optimistic.
The world became industrialized over the past 100 years. We had a revolution in science and technology that changed earth from an agrarian planet to an industrial planet. Tools and machines that made people infinitely more productive helped to drive the standard of living higher and higher. Profits were unleashed in all areas of our existence. Everything changed in dramatic fashion. Electricity, air-conditioning, rockets, planes, penicillin, computers; the amount of change in the 20th century was unprecedented.
In order to produce all of these goods, huge amounts of credit were needed. Someone had to put up the money. The financiers and investors were rewarded handsomely. Their investments paid big returns. They took risks, backed entrepreneurs and visionaries. Built rail roads and roads and cities.
However, things are different now. We’ve built all of the roads. We’ve strung the wire and installed the plumbing. We’re computerized, and digitized. The corporations are faced with more and more competition as 2nd and 3rd rats join the race.
The returns on equity are not the same for maintaining a new society as they would be for creating a new society. It stands to reason that the returns we saw over the past 100 years were high because the development was so incredible. It also stands to reason, that unless we remake our society in an equally dramatic and amazing way, our returns on our assets would be lower going forward.
Millions upon millions of people rely on the 8% assumption. The 8% assumption is embedded in their retirement calculations, in their college savings plans, and in their insurance company future benefits. People should make sure that they are not basing their retirement on 8%. If I am wrong, we can all throw a big omelette party.
Just trying to help.
J.O.Y. to the world,
Convexity or Gamma in the financial world makes people think of high school geometry class, and their eyes glaze over. Yet convexity is a major source of our global credit market pain. All around the world, investors have been burned by toxic mortgage products. The toxicity of these mortgages is a result of the “short gamma” or negative convexity embedded in these products.
The easiest way to think of convexity, CURVATURE.
Convexity, or gamma, means that your instrument of choice, whether it be a bond, or an option does not move in a consistent manner, but rather its performance accelerates, or decelerates as compared to its benchmark or underlying assets.
This changing correlation means that to hedge the instrument, the trader must continually rebalance the amount of securities in his portfolio.
The curvature in mortgages comes from prepayment. The borrower has an option to pack back early. The choice to immediately terminate the loan, or not, gives borrowers great power. Consequently it gives the lender a tremendous burden. Hedging can be quite difficult.
In a simple example:
Peter borrows $1 million from Mortgage Mavens to buy a house. Mortgage Mavens charges Peter 5% on a 15 year loan. MM is at risk.
If interest rates rise, then they get burned on the cost of their money. That is easy to hedge, they just borrow the money and lock in the lower rate.
Problem- what if rates drop, and MM already locked up the rates? No problem because they lent at 5%, and have locked up the rate… except now Peter pays back the loan, because he was offered a 4% mortgage by FU and Co. There is no safety for the mortgage lender.
The problem never goes away, until the mortgage is paid off. However, the less volatile the interest rate market, the easier it will be to hedge the products. It will also be less expensive in a calm market, as fewer trades will be required.
Unfortunately, our Federal Reserve is in the middle of the biggest financial experiment in the history of the world, at the same time that our government has created the biggest deficit in the history of the world. This makes divining future interest rate changes almost impossible. We are in unchartered waters. Interest rates are extremely volatile, and will remain volatile for a long time.
The housing market was fueled by cheap finance- without cheap finance, the prices of homes, and the frequency by which they were bought and sold will be significantly lower. The US economy was powered by ridiculous lending standards, and will not recover any time soon.
This nice woman asked me, “Do you think we’re at the bottom now?” and I felt like a cad telling her that we aren’t. But why would the recession end now? In this video, I explain further.
The problem with health care isn’t the doctors, lawyers or insurance companies. It’s that medicine is rapidly improving beyond our ability to pay for it. In this video I explain further that Britain and Canada’s models aren’t the answer either. Their systems don’t meet the quality expectations of the US citizen.
The Federal Reserve has doubled our monetary base over the past year. Prior to this massive expansion in our money, the biggest one-year expansion was 16%. Following is a chart graphically demonstrating this alarming growth:
In an effort to combat the economic implosion, the Fed has used all of the tools at its disposal, very very aggressively. While it is some comfort to know they are on the job, I can’t help being a bit skeptical.
In sailing, when someone goes “overboard” you don’t jump in after them, but throw them a line. One person remains safe. Did we just jump in after our banks?
In medicine, the Hippocratic Oath assures that doctors’ first order is “DO NO HARM” – maybe it should also be the Fed’s first, too.
The short answer: no.
There are two camps interpreting. One group believes recessions last 18 months, and then we magically see improvement. The other group is of the mind that this time is different. I am in the latter group.
The fed is on hold- September and December are cheap. The recession is going to last and last and last…
Ahmadinejad won? The fact that the holocaust denouncing s.o.b. won a “democratic” election sends a fear across the globe. The best thing to buy is probably 2-year notes. The Fed is not close to changing policy, and two years are cheap from a policy standpoint as well…
It doesn’t matter how awesome your idea is.
Commander Kirk of the Starship Enterprise had a “communicator” for all extra-vehicular exploits. Today, I hold in my hand a mobile phone that is superior to Kirk’s Communicator. In fact with the “apps” available on my iPhone, I have 100 times more computing power than was available to all of the Apollo Missions.
The companies that invented these amazing devices must have wealth beyond our imaginations, as certainly the products they have created for everyday people are beyond anything the great Gene Roddenberry could have imagined.
But, lo, this is not the case at all. Spying profit, firms across the world all have rushed into the mobile phone market. From Japan to Sweden, the global demand has been filled and sated, saturating the planet with hundreds of millions of mobile phones. And the ideas keep coming.
Remember when the “ Motorola RAZR” was all the rage? My then 9-year-old pleaded for a RAZR for her 10th birthday.
By the time she was 10, it was a “Chocolate.” By 11, it was a Blackberry; by 12, an iPhone. Along the way, each manufacturer has provided an amazing product, only to be outdone by a new and more advanced product.
The products keep getting better and better, all the while getting less and less expensive. Where is the money in that?
By now, phone manufacturers are literally giving away these masterful inventions for free (if you sign up for a two-year service contract).
As an investor, the mobile phone business is dreadful. Profits are quickly devoured by R&D and competitors. One company after another has tried to capture as much of the global market as possible. Each one has cut prices and added to the global market supply.
They have certainly put a mobile phone in every hand, but they drove the profits to zero, and investors were crushed. It’s a fantastic time to be a consumer, but a lousy time for ROI.
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