January 2013


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I’ve been having a bit of a discussion with a fellow financial blogger on the topic of sentiment. She doesn’t have any particular axe to grind on this…but I do. Sentiment is less than useless when engaging with the financial markets.

Hussman Funds – John P. Hussman, Ph.D.: Capitulation Everywhere

The bears are gone, extinct, vanished. Among the ones remaining, many are people whom even I would consider to be either permabears or nut-cases. And yet, the historical evidence for major defensiveness has rarely been stronger. The newest iteration of the bullish case is the idea of a “great rotation” from bonds and cash to stocks, as if the outstanding quantity of each is not held by someone at every point in time. The head of a “too big to fail” investment firm argued last week that stocks are “underowned” – as if every share of stock presently in existence is not actually owned by someone. To assert that stocks can be “underowned” seems to reflect either a misunderstanding of how markets work, or a desire to distribute overvalued institutional holdings onto the unwashed muppets. Likewise, the idea of a “rotation” out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade. Similarly, to “move cash into the market” requires a seller of stock who becomes the new holder of said cash.

I dealt with the ‘great rotation’ yesterday.

Comment

Yesterday we noted that The New York Times, USA Today and The Wall Street Journal all had lead stories about the stock market, every one of which was very bullish.

Regarding Hussman’s claim that bears are gone, see the first chart below. It shows the tightest range of bearish newsletter writers in the last 50 years! We have argued this shows a core of newsletter writers (about 20% to 25%) who will never change their opinion from the dark side.

So, when the market rallies or declines, the other 75% of writers (second chart below) vacillate between bullishness and looking for a correction. Prior to a year ago it was the correction camp (blue line, second chart) that never moved and the bulls and bears moved as mirror images of each other. Now the bears are in an unusually narrow range while the vast majority of newsletter writers are bullish or bullish but looking for a correction first.

We believe this is the result of the belief that the Federal Reserve will not allow bear markets. Print enough money and Wall Street gets it. Prices are not allowed to go down.

So it appears the only bears for the time being are the permabears that will never change their opinion. This has been the case for almost a year. You can thank the Federal Reserve for this situation.

Barry and I are in agreement here. It is the Federal Reserve. Of course this is nothing new. Yesterday I posted this chart:

1st-QE

The bounce out of the lows continued until the Federal Reserve ended the QE program…then this happened.

fredgraph

The ‘smart’ bulls will remain bullish while Bernanke has their back. When Bernanke folds, so do the smart bulls.

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Great analysis begins with choosing the right data. Everyone has heard the expression “Garbage in, garbage out.” This is where it starts.

Great analysis starts with choosing the correct methodology. You can choose the empirical, or the a priori. Which you choose depends upon the problem that you seek analyse: is it a social problem or is a natural science [physics] problem?

If it is a social problem then the empirical methodology is illegitimate as a choice. Therefore the entire article is simply incorrect as it proceeds from a faulty premise as its foundation.

As a point of illustration:

There are other elements, including the more active role of the Fed, but you get the drift. If you were interested in predicting volume, you probably would not use data that was more than a few years old. Too much has changed.

Even when it comes to more general market analysis I am not interested in what happened in the Taft Administration, the FDR era, or even the Ike years. I do not care much about the Nixon years, or even Jimmy Carter. We at least need to get to the modern era of an active Fed, active stock trading with low commissions, and broader access to data through financial television and computers.

It would seem that “Dash” is uninterested in history. It holds no value for him. This in light of his example is rather unfortunate as the Fed from is instigation in 1913, has played the major and dominant role in the US financial markets ever since and anyone who thinks otherwise is sadly lacking in their historical knowledge.

1st-QE

As can be seen, the Federal Reserve in the Great Depression of the 1930’s engaged in ‘QE’, there is nothing new under the sun as they say.

The point being however that the historical data is critically important if you want to truly understand the role of the Federal Reserve. Equally important is the methodology employed.

For the purposes of this post I want to use a very innocent example from two of my favorite sources – both valuable contributors to our understanding of markets and current issues.

So, the two examples:

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The second image is put forward as the superior example as it perfectly captures the ‘bottom’ of the 2009 bear market and presumably, puts the investor back into stocks at the low.

The first chart is dismissed as incorrect due to the poor data selection. However if we look at another chart:

chart-of-the-day-the-msci-world-equities-index-reacting-to-monetary-policy-announcements-by-the-fed-and-ecb-from-2008-to-present-day-september-2012

Here we see the expansion of the Federal Reserve within the crisis, and cognizant of history, we know that the ‘bottom’ in common stocks is close, in real time, not in some ‘regressed’ chart that is of no use to you after the fact.

In summary, the empirical method is illegitimate for economics as economics is a social science not measurable through the methodology employed for the physical sciences. The financial markets are a sub-set of economics and are simply not measurable by tools employed by the physical sciences.

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Ray Dalio articulated the meme from an interview in Davos. Since then it seems to have caught on pretty much everywhere.

It is both right and wrong.

The reason is Bernanke. Bernanke will continue to purchase bonds across all yields, maturities and asset classes. Bernanke can create money at will, therefore however much private bond money flows out into equity, Bernanke can and will replace it.

Equities will benefit from the great rotation and it will push the market higher because it will not be accompanied by rising bond yields.

The monetary inflation will create higher nominal equity prices. It will also create commodity prices to rise both nominally and real. The question is just how steep will the real rise become?

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A typical day of mine consists of 3-4 hours of sleep and lots and lots and lots of reading, watching and listening. For years, I’ve been reading anything and everything that I can get my hands on. I’ve studied the profound and the inane. For over a decade, I’ve isolated the bulk of my reading to the classics, novels, biographies, poetry and essays.

For someone who claims to have read so much, flippe-floppe is surprisingly ignorant in so many areas.

Over the past 6 months, I’ve put the books down in exchange for cinema.

Hmmm.

I found, while in conversations with the average pedestrian, cinema is a topic of great universal appeal. Most people don’t have the capacity to read 5,000 pages of art per month, so they chew on popped corn and watch movies. I’ve always enjoyed going to the movies; but I had very little knowledge of the old classics, which is why I embarked on an obsessive mission to see them all, literally.

5000 pages of art per month. While I’m sure it’s possible, there is no way flippe-floppe has ever done this. The evidence lies in his lack of displayed knowledge.

On average, I’ve been watching about 1 movie per night, sometimes more. I do that in the late night, past midnight, when the bats are hanging upside down in your garages.

Odd, I thought bats flew at night, slept in the day.

During the day, I listen to conference calls, bloomberg radio, CNBC and read an inordinate amount of research. Since I am able to read at a pace no less than 800 words per minute, I skim through everything in minutes.

Research. Pah.

I’ve concluded that it is my life’s work, a CHARITABLE FUNCTION OF THE KINDEST ORDER, to read the tea leaves, develop tools inside The PPT,

There it is. The plug for the PPT. Nothing wrong with a plug. Nothing at all, assuming that point in fact you did actually develop the thing…which as far as flippe-floppe is concerned is simply not the case.

flippe-floppe tried to reverse engineer Barry Ritholtz’ and Fusion Analytics alogorithm. Barry caught on and shut down their access.

Try following flippe-floppe’s trades for a while. That is an exercise in frustration.

And yet…my main man is at +7% at last count for the year so far.

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With interest rates low, close to all time lows, the mortgage default levels are near all-time highs? You just know something is hideously wrong with the economy.

What is it?

Residential Mortgage Delinquencies measure delinquency percentages for residential real estate loans secured by one- to four-family properties. It includes home-equity lines of credit.

Delinquent loans represent those loans that are past due 30 days or more and are still accruing interest, as well as loans in non-accrual status.

Why is it important?

We believe a higher than average mortgage delinquency rate is a key factor in the continuing housing crisis and also as it relates to the broader economy.

How do we interpret it?

Rising delinquency rates are an after-the-fact reflection of challenging economic climates.

Since mortgage payments are less discretionary than general consumer expenditures, increases in this indicator are more likely to occur during times of economic difficulty.

Typical historical range

As of December 2011, 90% of observations for the mortgage delinquency rates

fall between 1.47% to 10.30%.

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>Needless to say if the world sees a major currency collapse, which up to this point I think most people would consider to be an absurd idea, it’s going to spark a panic for protection. Despite stocks entering the euphoria stage of this bull market, stocks are not going to protect one from a currency crisis. Only hard assets will do that, and the two hard assets that are best at protecting one’s wealth are gold and silver.

Wouldn’t it be fitting that at a time when gold and silver are about to be most cherished, they are now completely loathed by the market?

The Gazza is being a little over-dramatic here. Food funnily enough maintains a demand. To grow enough food as one example for fast approaching 7 billion people, machinery, fertilizer, etc are required. These are assets.

Stocks are of course [largely] productive businesses. As such they are assets that protect purchasing power. During the Weimar collapse of the Reichmark, common stocks protected wealth.

The point is, common stocks are a viable wealth protecting asset class against a fiat money collapse should that in point of fact eventuate.

Further, I would hardly classify gold at circa $1700oz ‘unloved’. If it was still say $250oz, that would be unloved. So while the post is interesting from a technical snapshot of the Yen, it rather goes OTT with its consequences.

That being said…I do agree that fiat money, if Central Banks continue their reckless expansion could and will, at some point trigger a hyper-inflationary crisis that could see a major currency collapse. I also agree that the Yen is as good a candidate as any out there.

World Currency 2012 Performance

1.
Polish Zloty

+11.37%

2.

Mexican Peso

+8.42%

3.

South Korean Won

+8.27%

4.

New Zealand Dollar

+6.64%

5.

Singapore Dollar

+6.12%

6.

Russian Ruble

+5.28%

7.

British Pound

+4.58%

8.

Taiwanese Dollar

+4.29%

9.

Canadian Dollar

+2.94%

10.

Swiss Franc

+2.48%

11.

Australian Dollar

+1.82%

12.

Chinese Renminbi

+1.03%

13.

Hong Kong Dollar

+0.22%

14.

Macau Pataca

+0.20%

15.

Euro Currency

+0.02%

(Figure 1.5)

16.

U.S. Dollar

-0.01%

(Figure 1.6)

17.

Indian Rupee

-3.51%

18.

Iranian Rial

-8.98%

19.

Brazilian Real

-9.00%

20.

Japanese Yen

-11.34%

Then take a look at the common stock index of the associated currency. The weaker the currency, the better [generally] the common stocks perform in nominal pricing.

An example being the US dollar and the SPY and another being the Russian pair.

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I’ve touched briefly before on how behavioural economics makes the central libertarian mantra of being ‘free to choose’ completely incoherent. Libertarians tend to have a difficult time grasping this, responding with things like ‘so people aren’t rational; they’re still the best judges of their own decisions’. My point here is not necessarily that people are not the best judges of their own decisions, but that the idea of freedom of choice – as interpreted by libertarians – is nonsensical once you start from a behavioural standpoint.

Well you may have touched briefly previously, but there is no argument presented here that substantiates your claim. Libertarians maintain that choice is ordinal and not cardinal. There is no conflict between ‘Behavioural economics’ [BE] and choice under an ordinal system. An ordinal system makes no value judgements on whether a choice is rational or irrational. The choice made under an ordinal system is a value choice, which, can be either rational or irrational. Your argument is without merit.

The problem is that neoclassical economics, by modelling people as rational utility maximisers, lends itself to a certain way of thinking about government intervention. For if you propose intervention on the grounds that they are not rational utility maximisers, you are told that you are treating people as if they are stupid. Of course, this isn’t the case – designing policy as if people are rational utility maximisers is no different ethically to designing it as if they rely on various heuristics and suffer cognitive biases.

Libertarian economics is Austrian economics…not neoclassical economics. While the two theories may share some common ground, the inaccuracy of your argument invalidates any points that you make in relation to Austrian economics.

This ‘treating people as if they are stupid’ mentality highlights problem with neoclassical choice modelling: behaviour is generally considered either ‘rational’ or ‘irrational’. But this isn’t a particularly helpful way to think about human action – as Daniel Kuehn says, heuristics are not really ‘irrational’; they simply save time, and as this video emphasises, they often produce better results than homo economicus-esque calculation. So the line between rationality and irrationality becomes blurred.

Does ‘irrational’ mean stupid? I don’t think that it does. I think ‘irrational’ behaviour can simply mean acting in another way other than ‘rational’, say, emotionally. As an example: I earn $1 million a year and live in an area where the average earnings are $50 million, I will ‘feel’ poor. If however I earn the same $1M but live in an area where the average earnings are $100K, I feel rich by comparison. Would you classify me as ‘stupid’ or simply irrational?

For an example of how this flawed thinking pervades libertarian arguments, consider the case of excessive choice. It is well documented that people can be overwhelmed by too much choice, and will choose to put off the decision or just abandon trying altogether. So is somebody who is so inundated with choice that they don’t know what to do ‘free to choose’? Well, not really – their liberty to make their own decisions is hamstrung.

Again, the inaccuracy of the argument demonstrates the fallacy. Too much choice may confuse an individual, it may even paralyze the act of choosing…but it does not remove ‘liberty’ to make a choice.

Another example is the case of Nudge. The central point of this book is that people’s decisions are always pushed in a certain direction, either by advertising and packaging, by what the easiest or default choice is, by the way the choice is framed, or any number of other things. This completely destroys the idea of ‘free to choose’ – if people’s choices are rarely or never made neutrally, then one cannot be said to be ‘deciding for them’ any more than the choice was already ‘decided’ for them. The best conclusion is to push their choices in a ‘good’ direction (e.g. towards healthy food rather than junk). Nudging people isn’t a decision – they are almost always nudged. The question is the direction they are nudged in.

This is an important argument for the Socialist to win. It justifies then the State choosing for you, in everything. The logic of their argument is faulty.

First where is the evidence that proves the primary assertion, which is the highlighted area in the quote.

Does advertising and/or packaging, remove the ability of the individual to choose? How are choices made, does the evidence still stand?

I want coffee. Coffee is my highest valued demand. Will advertising for razor blades change my demand? Highly unlikely. What about a competitive good…tea for example, a tea advert in a magazine or on the internet…will it change my demand? In my case, no, I’m not a tea drinker. But if it was, it might. Does that suggest the accuracy of the original statement? No. It simply suggests that in competitive supply of goods and services that an influence of an unknown quatitative metric may sway consumers from Starbucks coffee to Nescafe coffee. Hardly the brainwashing that the author is trying to make the case for.

It must also be emphasised that choices do not come out of nowhere – they are generally presented with a flurry of bright colours and offers from profit seeking companies. These things do influence us, as much as we hate to admit it, so to work from the premise that the state is the only one that can exercise power and influence in this area is to miss the point.

So where do choices or demand come from? Some demand is obviously physiological…I need water, food, I have my preferences, but these may change due to circumstances. If I am without food for say 4 days, I will be a lot less fussy than if I last ate 3 hours ago. The whole advertising argument fails.

The fact is that the way both neoclassical economists and libertarians think about choice is fundamentally flawed – in the case of neoclassicism, it cannot be remedied with ‘utility maximisation plus a couple of constraints’; in the case of libertarianism it cannot be remedied by saying ‘so what if people are irrational? They should be allowed to be irrational.’ Both are superficial remedies for a fundamentally flawed epistemological starting point for human action.

Hardly. This article however is seriously flawed: [i] Austrian economics and neo-classical economics are very different theories [ii] choice is a value, that is subject to the law of diminishing marginal utility, which is an ordinal system. [iii] the case for advertising is weak and full of holes. In short this article is balderdash.

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