September 2016

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The week before last I looked at Donald Trump’s likely “path to victory” and adjudged it as “a tightrope walk down an insanely narrow path to 270 electoral votes.” I’d now take out the adjective insanely and maybe even suggest it’s a walk along a balance beam rather than a tightrope. As the popular-vote margin separating Clinton and Trump gradually shrinks, putting together a map of states Trump might carry involves less conjecture about where he might make gains and more confidence that he might be able to consolidate gains he has already made.

Deciding who is leading nationally or in the battleground states is, of course, a matter of choosing whose measurement of public opinion you consult. I’d automatically assume, unless there is some compelling reason to do otherwise, that polling averages make the most sense. Nationally, the most straightforward of the polling averages, from RealClearPolitics, has Clinton up by two points in a four-way race. That is her smallest lead at RCP since late July. Averages at FiveThirtyEight and HuffPost Pollster factor in trends and poll accuracy data; they give Clinton a slightly larger lead (3.1 percent at FiveThirtyEight, 4.2 percent at HuffPost). It is worth noting that only one national poll has been published with data from September 11, when the unverified conventional wisdom would have it that Hillary Clinton’s standing might have taken a fall. It also appears that Trump is getting, despite contrary expectations earlier, the traditional pro-Republican “bump” when pollsters switch from samples of registered voters to those of likely voters. That could tilt polling averages a bit more in his direction very soon.

So observers are no longer asking (at least not right now) if and when Hillary Clinton’s lead is going to blossom into the double digits, as it has occasionally done in certain polls at different points in the general-election contest. It is, by most accounts, a close race still favoring Clinton.
Something similar has happened in state polling, with a subtle but important difference: What looked a couple of weeks ago like a long wall of states in which Trump needed to overcome a long-standing Clinton lead has gotten shorter. This is most dramatically shown in the state-by-state projections from Daily Kos (a pro-Democratic but, if anything, rather impressively pessimistic outlet), which now gives Trump an advantage not only in the previously red but blue-trending states of Arizona and Georgia, but also in Florida, Iowa, Nevada, North Carolina, and Ohio. Add all that up with the states everyone expects Trump to carry and he’s at 259 electoral votes.

Other state-by-state projections (the Upshot has a nice table of them) have Clinton ahead in Florida, Iowa, Nevada, North Carolina, and Ohio (though a new Bloomberg poll of Ohio showing Trump up by five points among likely voters could change estimates of that state’s trajectory), but none by such margins that a tilt by a couple of points nationally would not topple all or most of them into Trump’s column. Then comes the point when it starts getting harder for Trump to get across the line to 270. But it is clear that if he can move Pennsylvania — a “blue” state that has been trending “red” and where the demographics offer him some strategic avenues — into the hypercompetitive category, then all things are possible for him.

It is possible, in fact, that Trump is opening up multiple paths to victory. Recent polling in both New Hampshire and Colorado — two states generally conceded earlier to be in Clinton’s pocket — is showing a decided tightening of the race. There’s also fresh evidence Trump could win in the second congressional district of Maine, which independently awards a single electoral vote. There is one scenario where even if Trump loses Pennsylvania he could get to 270 votes via New Hampshire and that 1 vote from Maine.

Clinton’s strategic advantage, however, includes not just multiple paths to 270 EVs, but an advantage in battleground-state ad and field resources. And that’s where it gets really tough for a GOP nominee who cannot afford to lose his best states.

A very granular look at Pennsylvania by Sasha Issenberg and Steven Yaccino at Bloomberg, using proprietary data, suggests that if Clinton successfully turns out her base and her less reliable voters using her GOTV advantage, she will be very tough to beat. Trump would have to “run a perfect ground game, miraculously turn out all his Republican targets, win every expected persuadable vote cast—projected to be around 187,000—and [could] still lose.” According to this analysis, he isn’t likely to win Pennsylvania unless he can dig even further into the remaining Democratic vote in the southwest part of the state.

So it’s possible Trump will hit a wall in Pennsylvania even if he does win all of those other states where white working-class voters offset millennials or minorities. Still, it could be a near thing. In another analysis, Harry Enten concludes Clinton has been outperforming what demographics and voting history would expect her to have in the Keystone State. If, as he suggests, her “natural” lead is only 3 percent, that’s a small cushion.

Sometimes you can get lulled into complacency by win-probability projections that sound immutable but really aren’t. Citigroup put out a warning about that today:

A new note from Citigroup Inc. says that while the firm still puts the probability of Hillary Clinton securing the U.S. presidential election at 65 percent, investors are not taking the remaining chance of a win by Donald Trump very seriously.
“A 35 percent probability for a Trump victory is more meaningful than investors may be appreciating,” the team, led by Chief Global Political Analyst Tina Fordham, writes in a note published on Tuesday. “Political probabilities are not like blackjack — there is only one roll of the dice, and 35 percent probability events happen frequently in real life.”
The Upshot, which rates Clinton at an even higher 79 percent win probability, offers this sobering analogy: “Mrs. Clinton’s chance of losing is about the same as the probability that an N.F.L. kicker misses a 45-yard field goal.”

So, in the fourth quarter of a very close game, when that placekicker trots out onto the field with everything on the line, how confident are you that he will nail that “high-probability” field goal? Are you a tad nervous?

Those who have laughed off Donald Trump’s chances while believing his election would represent a turn for the worse in their own lives should be nervous right now.

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“Every time I see it, that number blows my mind.”

Erik Hurst, an economist at the University of Chicago, was delivering a speech at the Booth School of Business this June about the rise in leisure among young men who didn’t go to college. He told students that one “staggering” statistic stood above the rest. “In 2015, 22 percent of lower-skilled men [those without a college degree] aged 21 to 30 had not worked at all during the prior twelve months,” he said.

“Think about that for a second,” he went on. Twentysomething male high-school grads used to be the most dependable working cohort in America. Today one in five are now essentially idle. The employment rate of this group has fallen 10 percentage points just this century, and it has triggered a cultural, economic, and social decline. “These younger, lower-skilled men are now less likely to work, less likely to marry, and more likely to live with parents or close relatives,” he said.

So, what are are these young, non-working men doing with their time? Three quarters of their additional leisure time is spent with video games, Hurst’s research has shown. And these young men are happy—or, at least, they self-report higher satisfaction than this age group used to, even when its employment rate was 10 percentage points higher.

It is a relief to know that one can be poor, young, and unemployed, and yet fairly content with life; indeed, one of the hallmarks of a decent society is that it can make even poverty bearable. But the long-term prospects of these men may be even bleaker than their present. As Hurst and others have emphasized, these young men have disconnected from both the labor market and the dating pool. They are on track to grow up without spouses, families, or a work history. They may grow up to be rudderless middle-aged men, hovering around the poverty line, trapped in the narcotic undertow of cheap entertainment while the labor market fails to present them with adequate working opportunities.

Here is the conundrum: Writers and economists from half a century ago and longer anticipated that the future would buy more leisure time for wealthy workers in America. Instead, it just bought them more work. Meanwhile, overall leisure has increased, but it’s the less-skilled poor who are soaking up all the free time, even though they would have the most to gain from working. Why?

Here are three theories.

1. The availability of attractive work for poor men (especially black men) is falling, as the availability of cheap entertainment is rising.

The most impressive technological developments since 1970 have been “channeled into a narrow sphere of human activity having to do with entertainment, communications, and the collection and processing of information,” the economist Robert Gordon wrote in his book The Rise and Fall of American Growth. As with any industry visited by the productivity gods, entertainment and its sub-kingdoms of music, TV, movies, games, and text (including news, books, and articles) have become cheap and plentiful.

Meanwhile, the labor force has erected several barriers for young non-college men, both overt—like the Great Recession and the decades-long demise of manufacturing jobs—and insidious. As the sociologist William Julius Wilson and the economist Larry Katz have both told me, the labor market’s fastest growing jobs are not historically masculine or particularly brawny. Rather they prize softer skills, as in retail, education, or patient-intensive health care, like nursing. In the 20th century, these jobs were filled by women, and they are still seen as feminine by many men who would simply rather not do them. Black men also face resistance among retail employers, who assume that potential customers will regard them as threatening.

And so, at the very moment that the labor market obliterated manufacturing jobs and shifted toward more soft-skill service jobs, diversion became a vastly discounted experience that could provide a moment’s joy at home. As a result, entertainment has become an inferior good, where the young and poor work less and play more.

2. Social forces cultivate a conspicuous industriousness (even workaholism) among affluent college graduates.

The first theory doesn’t do anything to explain why rich American men work so much harder than they used to, even though they are richer. That’s odd, since the point of earning money is ostensibly to afford things that make you happy, like free time.

But perhaps that’s just it: Rich, ambitious Americans are already spending more time on what makes them fulfilled, but that thing turned out to be work. Work, in this construction, is a compound noun, composed of the job itself, the psychic benefits of accumulating money, the pursuit of status, and the ability to afford the many expensive enrichments of an upper-class lifestyle.

In a widely shared essay in the Wall Street Journal last week, Hilary Potkewitz hailed 4 a.m. as “the most productive hour.” She quoted entrepreneurs, lawyers, career coaches, and cofounders praising the spiritual sanctity of the pre-dawn hours. As one psychiatrist told her, “when you have peace and quiet and you’re not concerned with people trying to get your attention, you’re dramatically more effective.”

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So the Clinton campaign, out to conceal the candidates’s illness, forced the Secret Service to break protocol and avoid the emergency room after her near-collapse Sunday.

This is one determined bunch of liars.

First, her team says nothing as it sneaks her from the 9/11 ceremony — after she nearly collapses. It later claims she was “overheated” and parades her outside her daughter’s place, where she claims she feels “much better.”

And has the candidate — a possibly infectious pneumonia case — hug a child to make the lie seem cute.

It adds up to hours of effort to deceive — even enlisting federal officers in the effort. That’s the bottom line of The Post’s scoop, thanks to sources who revealed that she was headed to the ER, as Secret Service protocols demand — until her staff insisted otherwise, for fear hospital staff might leak word of her illness.

It seems Team Hillary saw the risk of disclosure as worse than the risk to her health.

Only when their lies didn’t stop the questions did the Clinton camp announce that she’d been diagnosed with pneumonia — last Friday.

Heck, sending her to the 9/11 ceremonies in the first place — rather than admitting she had a common-enough ailment — was a bid to deceive. Her doctor had ordered rest.

So what if Clinton now promises “additional medical information” in the coming days? At this point, it’s impossible to believe she’ll ever provide a full and honest picture of her health.

If not for the video of her near-fall Sunday, her folks would’ve kept lying. Even then, it took them hours to tell the truth.

Or part of it. Clinton’s odd stiffness in the video, among other things, suggests more than pneumonia may be at play. The concussion and cranial blood clot she suffered in late 2012 sidelined her for six months. Are those issues truly resolved?

Dishonesty is her first instinct. After all, she answered federal orders to preserve her records by having her e-mails wiped clean with BleachBit and her hard drives smashed with a hammer.

And much of the press helped her hide her health woes after her recent coughing fits: CNN called those asking questions “the new birthers” and claimed to “debunk” the “conspiracy” theories. The Washington Post’s Chris Cillizza raged at the “conspiracy theorists.” Jimmy Kimmel and Stephen Colbert mocked concerns.

Funny: Those asking questions, from Donald Trump to Matt Drudge to our own Michael Goodwin, turned out to be right.

Like Trump, we wish Clinton a speedy recovery from this illness. Too bad she’ll never get over her Pinocchio syndrome.

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A quick update on near-term market action. Last week’s market retreat was a very minor example of the “unpleasant skew” I’ve discussed in recent months. Under present market conditions, the single most probable outcome in a given week remains a small advance, but with a smaller probability of a steep loss that can wipe out weeks or months of gains in one fell swoop. So the mode is positive, but the mean return is quite negative (see Impermanence and Full Cycle Thinking for a chart of what this distribution looks like). Again, last week was a very minor example. Prospective 10-12 year returns increased by only a few basis points.

In recent months, the compression of volatility has encouraged speculative put option writing by pension funds (see here for example), coupled with increased market exposure by volatility-targeting strategies that buy as volatility falls and sell as volatility rises. Last week, JP Morgan’s quantitative derivatives analyst Marko Kolanovic observed “Given the low levels of volatility, leverage in systematic strategies such as Volatility Targeting and Risk Parity is now near all-time highs. The same is true for CTA funds who run near-record levels of equity exposure.” This setup is reminiscent of the “portfolio insurance” schemes that were popular before the 1987 crash, and rely on the same mechanism of risk-control – the necessity of executing sales as prices fall – that contributed to that collapse.

I continue to expect market risk to become decidedly more hostile in the event that various widely-followed moving-average thresholds are violated, as those breakdowns are likely to provoke concerted efforts by trend-following market participants to exit, at price levelsnowhere near the levels where value-conscious investors would be interested in buying. For reference, the 100-day average of the S&P 500 is about 2120. The 200-day average is about 2057. For now, keep “unpleasant skew” in mind, to avoid becoming too complacent in the event of further marginal advances. I see the most preferable safety nets as those that don’t rely on the execution of stop-loss orders.

Looking out on a longer-term horizon, the following chart shows the ratio of nonfinancial market capitalization to nominal GDP, where we can reasonably proxy pre-war data back to the mid-1920’s. Our preferred measure is actually corporate gross-value added, including estimated foreign revenues (see The New Era is an Old Story), but the longer historical perspective we get from nominal GDP is also valuable. The chart shows this ratio on a log scale. To understand why, see the mathematical note at the end of this comment. The recent speculative episode has brought this ratio beyond every extreme in history with the exception of the 1929 and 2000 market peaks.

As I’ve often emphasized, one of the most important questions to ask about any indicator is:how strongly is this measure related to actual subsequent market returns? Investors could save themselves a great deal of confusion by asking that question. Hardly a week goes by that we don’t receive a note asking, for example, that “so-and-so says that earnings are going to strengthen in the second half – doesn’t that make stocks a buy?” Well, it might, if year-over-year earnings growth had any correlation at all with year-over-year market returns (it doesn’t), or if there was evidence that earnings tend to strengthen in an environment where unit labor costs are rising faster than the GDP deflator (they don’t). That’s not to say that we can be certain that earnings or stock prices won’t bounce, but we can already conclude that so-and-so hasn’t convincingly made their case. When investors ignore the correlation between indicators and outcomes, they make themselves the victims of anyone with an opinion.

The chart below shows the same data as above – the ratio of nonfinancial market capitalization to nominal GDP – but uses an inverted log scale. The red line is the actual subsequent total return of the S&P 500 over the following 12-year horizon. We use that horizon because that’s the point where the autocorrelation profile of valuations hits zero (seeValuations Not Only Mean-Revert, They Mean-Invert). The chart offers some sense of why Warren Buffett, in a 2001 Fortune interview, called this ratio “probably the best single measure of where valuations stand at any given moment.” Again, we prefer corporate gross value-added, but at that point, we’re quibbling over a 91% correlation and a 93% correlation with subsequent 12-year market returns. Buffett hasn’t mentioned this measure in quite some time, but that’s certainly not because it has been any less valuable in recent market cycles. As I’ve frequently observed, it’s fine to assert that stocks are “fairly valued” relative to interest rates here, but only provided that “fair” is defined as an expected nominal total return for the S&P 500 averaging about 1.5% annually over the coming 12-year period.

It’s not a theory, it’s just arithmetic

Understand that valuation levels similar to the present have never been observed without the stock market losing half of its value, or more, over the completion of the market cycle. We’ve periodically heard analysts talking about stocks being in a “secular” bull market that presumably has years and years to go. These analysts evidently have no sense of what drives such secular market phases.

The period from 1949 to about 1965 represented a secular bull market, comprising a series of complete bull-bear market cycles, characterized by progressively richer valuations at the peak of each cyclical bull market. Likewise, the period from 1982 to 2000 represented another long secular bull market, again characterized by progressively richer valuations at each cyclical bull market peak.

By contrast, the periods from 1929 to 1949, and again from 1965 to 1982 both represented secular bear markets, comprising a series of complete bull-bear market cycles, but with a somewhat less progressive profile. Still, each period was characterized by a move from extremely rich valuations at the beginning of the secular bear market to extremely depressed valuations (and extremely high expected future returns) nearly two decades later. I’m not at all convinced that these secular phases have reliable periods like 18 years, but suffice it to say that secular movements between durable extremes of overvaluation and undervaluation can span a whole series of cyclical bull-bear cycles.

From the chart above, it should be clear that the defining feature of a secular bear market low (and the beginning of a long secular bull market) is deep undervaluation. Indeed, the 1949 and 1982 market troughs each brought the ratio of market capitalization to nominal GDP below 0.33. By contrast, the defining feature of a secular bull market peak (and the beginning of a long secular bear market) is extreme overvaluation. Indeed, the 1929 and 2000 market peaks each brought the ratio of market capitalization to nominal GDP to levels similar to what we observe today (the 2015 peak slightly exceeded 1.30).

Let’s do some quick arithmetic. Suppose that real GDP growth accelerates to 2% and inflation picks up to 2%, producing 4% annual nominal GDP growth for the next 25 years. Now allow for the possibility that the stock market hits a secular bear market low similar to 1949 and 1982, not two or three years from now, but fully 25 years from now. On those assumptions, what would happen to the S&P 500 Index over the coming 25 years?

The answer is simple. The ratio of the future S&P 500 Index to the current S&P 500 Index would be:

(1.04)^25 * (0.33/1.30) = 0.677. Put differently, the S&P 500 Index would be 32.3% lower, 25 years from today, than it is at present. Even including the income from a growing stream of dividends, we estimate that in the event of a secular low 25 years from today, the average annual total return of the S&P 500 between now and then would come to less than 3% annually. It’s not a theory, it’s just arithmetic.

Am I suggesting that investors should avoid stocks until the next secular low? Certainly not. Current valuations are more consistent with the start of a secular bear than with a secular bull, and my impression is that we’ll eventually look back and see that the 2000 bubble peak was the beginning of what is currently still a secular bear with quite a long time ahead of it. But regardless of where valuations head in the long-term, we expect to observe regular and substantial investment opportunities in stocks over coming market cycles, with the most favorable opportunities emerging at points where a material retreat in valuations is joined by an early improvement in market action.

Am I suggesting that the long-term tradeoff between expected return and risk is unfavorable at current valuations, and that near-term and intermediate-term market outcomes could become steeply negative in response to a moderate further deterioration in market action? Absolutely – a century of market evidence offers little to support any other expectation.

Elaborate fallacies

The danger of the current iteration of “this time it’s different,” I think, is in how elaborate and far-reaching the underlying fallacies have become. By equating the delay of consequences with the absence of consequences, investors have now set up the most extreme episode of equity market speculation in U.S. history next to the 1929 and 2000 market peaks, and the broadest episode of general financial market speculation outside of the 11-month period from November 1928 to September 1929 (as measured by the estimated prospective 12-year total return on a conventional portfolio mix of 60% stocks, 30% bonds and 10% Treasury bills).

It’s not just that investors have oversimplified a complex interaction, which they are certainly doing here in assuming that “easy money makes risky assets go up.” This simplification fails to explain, for example, how the U.S. stock market could lose more than half of its value on two separate occasions since 2000, during periods when the Federal Reserve was persistently and aggressively easing. It also overlooks that the Japanese stock market shed more than 60% of its value on two separate occasions since 2000, despite short-term interest rates that were regularly pegged at zero and never breached even 1%.

The historically supported, but more complex statement recognizes that the relationship between monetary policy and the financial markets is not reliably mechanical but wholly psychological. Easy money operates by creating safe but low-interest liquidity that someonein the economy must hold at every moment in time until it is retired. Investors often treat that liquidity as an inferior and uncomfortable “hot potato,” but only if they don’t see safety as desirable. So the accurate statement is that “easy money can encourage speculation, but only does so reliably when investors are already inclined to speculate.” As I’ve often noted, we infer the preference of investors toward speculation or risk-aversion by the uniformity or divergence of market internals across a broad range of individual securities, industries, sectors, and security-types.

The fallacies underlying today’s “this time is different” mantra go even further, assuming not only that central bank behavior has permanently changed, but that we can also abandon everything we’ve learned from centuries of economic dynamics, human behavior, and even basic arithmetic.

Having repeatedly borrowed enough short-lived bursts of consumption from the future to keep U.S. real GDP growth barely above 1% over the past year (and indeed, over the pastdecade), monetary authorities have convinced investors of a cause-effect relationship between activist monetary policy and economic outcomes that is entirely absent in actual data (see Failed Transmission – Evidence on the Futility of Activist Fed Policy). Worse, central bankers have convinced investors that the progressive overpricing of financial securities can substitute for actual growth. Unfortunately, with every increase in price, what was “prospective future return” a moment earlier is suddenly converted into “realized past return,” leaving nothing but lower expected returns and greater risk on the table for investors who continue to hold those securities. The essence of a Ponzi scheme is to reward investors who leave early, out of the capital of investors who arrive later, thereby ensuring losses for anyone who stays. What else is current central bank policy but a massive greater-fool Ponzi scheme?

The recent speculative episode has even convinced investors that human nature itself has changed. Centuries of financial market behavior can easily verify that periodic cycles of greed and fear are an inherent part of market dynamics. Instead, investors have abandoned that lesson, believing that central banks have discovered the ability to do “whatever it takes” to keep markets higher (without realizing that the effectiveness of easy money is entirely dependent on the absence of risk-aversion among investors).

The thing that allows this is imagination. In every market cycle, imagination is what gives greed and fear their impetus. In a financial or economic crisis, imagination is what leads investors to question whether the economic system itself can survive. In a bubble, imagination is what leads investors to invent endless reasons why the carnival can continue indefinitely. For example, despite the fact that Japan’s real GDP has grown at just one-half of 1% annually over the past two decades, while the Nikkei stock index has taken an extraordinarily volatile trip to nowhere over that period, imagination leads investors to ask why the Federal Reserve won’t suddenly begin buying stocks, as the Bank of Japan and the Swiss National Bank have done. Well, one answer is that Sections 14 and 15 of the Federal Reserve Act prohibit it. Another is that even if the Fed could emulate the Bank of Japan, the Nikkei Index is still below where it was in 2000, 2007 and 2014 (not to mention 1986), so it’s not at all clear that such purchases exert any sustained effect on stock prices. In addition, one needs to examine the situation of each government to understand why certain central banks, and not others, have purchased equities in the first place.

As a fairly insular economy, Japan’s encouragement of overlapping and often centrally-planned relationships between government, business and the banking system has been the dominant economic model for decades, which has allowed more tolerance for the actions of the Bank of Japan. That said, buying corporate securities is actually quite a hostile act toward the public, compared with buying government debt. The reason is that when government bonds are issued for the purpose of public expenditure, or ideally, productive investment, central bank purchases of those bonds are a form of public finance. By contrast, when a central bank purchases corporate securities, and if they subsequently lose value, the creation of base money acts as a public subsidy to private investors who would otherwise have borne that loss. Since central bank purchases of stock are the last resort of a central bank that has already pushed other forms of speculation to the limit, the likelihood of loss is quite high. Those losses will involve a large opportunity cost to the public, as well as a transfer of public wealth to private individuals. From a contrarian perspective, I suspect that the worst time for a central bank to buy stocks is when the public itself is too bullish to oppose it.

Meanwhile in Switzerland, the desire to peg the Swiss franc to the value of the euro can only be achieved by following Mario Draghi down the primrose path of asset purchases, and the already bloated balance sheet of the Swiss National Bank leaves stocks among the few assets available to buy. My expectation is that this too, will turn out in hindsight to have imposed a huge opportunity cost on the Swiss public.

With regard to the basics of yield arithmetic, investors have equated raw yield with total return, in a way that leaves them with no meaningful prospect for investment returns over the coming 10-12 years, and the likelihood of deep interim losses over the completion of the current market cycle. Understand that the “current yield” of a stock or a bond (the annual dividend or interest payment divided by the current price) is quite a misleading indicator of likely total return. Consider, for example, a 30-year bond with a coupon yield (annual interest payment/face value) of 3%. By the time the price advances enough to bring the current yield (annual interest payment/current price) down to 1.58%, the yield-to-maturity on that bond has already hit zero; investors in that bond will then earn nothing for 30 years. Moreover, an increase in the yield-to-maturity from zero to just 1% will generate a -20% capital loss. Indeed, German 30-year bonds, which hit a record low yield-to-maturity of 0.34% at the end of July (think about that), have already lost about -8% as yields have increased by just a few tenths of 1%.

Investors seem to forget that the lower the yield and the longer the maturity of a financial asset, the greater its vulnerability to capital losses in response to even minor changes in yields or risk premiums. This is particularly true for equities. The language of a market top is “well, even if it goes down, it will eventually come back up.” To some extent, that’s true. Over the 16 years since the 2000 market peak, the S&P 500 has posted an average total return of 4% annually, though it’s taken the third most extreme equity market bubble in U.S. history to do it. Unfortunately, a century of market history suggests that all of that return is likely to be wiped away over the completion of the current market cycle; an outcome that would only be run-of-the-mill given current valuations. By that point, investors may be quite right that they didn’t lose anything by purchasing stocks at the 2000 highs. I doubt that it will be much solace.

The belief in “TINA” – the notion that “there is no alternative” but to own stocks – ignores that stocks are already so overvalued that the S&P 500 is likely to underperform even the 1.6% yield on Treasury bonds over the coming decade. Frankly, we expect even the average return on Treasury bills to be higher over that horizon. So, yes, I very much believe that safe, low-interest cash is a presently a better investment option, both in terms of prospective return and potential risk, than equities, corporate bonds, junk debt, or even long-term Treasury bonds.

My view is that investors should presently make room in their portfolios for safe, low-duration assets, hedged equities, and alternative strategies that have a modest or even negative correlation with conventional securities. I expect that there will be substantial opportunities to alter that mix over the completion of the current market cycle. The time to focus on higher beta and longer duration assets is when those assets are priced at levels that offer potential compensation for their prospective risk. Currently, investors in conventional assets face a combination of weak expected returns and spectacular downside potential. I expect that this will soon enough be as obvious as it was in 2002 and 2009, when investors looked back on their insistence that “This time is different” and replaced that thought with “What the hell were we thinking?”

In the interim, as value investor Howard Marks observed in The Most Important Thing, “Since many of the best investors stick most strongly to their approach – and since no approach will work all the time – the best investors can have some of the greatest periods of underperformance. Specifically, in crazy times, disciplined investors willingly accept the risk of not taking enough risk to keep up… Investment risk comes primarily from too-high prices, and too-high prices often come from excessive optimism and inadequate skepticism and risk aversion.”

A mathematical note on valuations and subsequent market returns

I’ve introduced a lot of analytical methods and indicators over the years, and various graphics demonstrating the relationship between reliable valuation measures and subsequent market returns have come to be known as the “Hussman valuation chart.” Since we continually do research and learn from those efforts, we’ve identified increasingly accurate measures over time. For example, while Shiller’s cyclically adjusted P/E (CAPE) is preferable to say, price/forward earnings, the CAPE becomes much more reliable when one corrects for variations in the embedded profit margin (see Two Point Three Sigmas Above the Norm). Some observers seem keen to characterize learning from research as some sort of nefarious “evolution,” or to dismiss a century of evidence on valuations as “data mining” or “curve fitting,” so it’s important to understand how strongly the relationships between valuations, growth rates, and investment returns are rooted in identities and basic arithmetic.

As a side note, I also use logarithms quite a bit. If you’re serious about investing, learning how to work with logs is time well-spent, because returns tend to be linear in log valuations (see, for example, The Coming Fed-Induced Pension Bust).

Let’s review this arithmetic (see Rarefied Air: Valuations and Subsequent Market Returns for details and data). Below, P is price, F is some reasonably reliable fundamental, V is the valuation ratio P/F, and g is the nominal growth rate of that fundamental over the following T years. We can then write the future capital gain in the form of an arithmetic identity:

P_future / P_today = (F_future/F_today) * (V_future / V_today)

P_future / P_today = (1+g)^T x (V_future / V_today)

Or in log terms:

log(P_future/P_today) = T x log(1+g) + log(V_future) – log(V_today)

All this says is that your future investment return is driven by: the holding period T, the growth rate of fundamentals g over that horizon, and the change in valuations over the holding period. Because departures of valuations and nominal growth from their historical norms tend to mean-revert over time, one can obtain reliable estimates of prospective 10-12 year market returns by using historical norms for g and V_future.

But we can actually go further. The estimates turn out to be accurate even in periods where g and V_future depart from their historical norms. The reason is that variations in g over a 10-year period tend to systematically offset variations in terminal valuations log(V_future), largely because of how investors respond to inflation. Put simply, market valuations tend to be negatively correlated with the growth rate of nominal GDP over the preceding decade. It’s a systematic relationship. Meanwhile, average dividend income over a given holding period has a high inverse correlation with starting valuations.

The consequence is that annual nominal total returns in the S&P 500 over a 10-12 year horizon have a robust and inverse correlation with the log of starting valuations, particularly as measured by market capitalization/GDP or market capitalization/corporate gross value-added. That’s not data mining or curve-fitting. It’s not a theory, it’s just arithmetic.

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I just read a ‘research essay’ purported to be a criticism of the NZ Court of Appeal decision in Jackson Mews.

So when I read, ‘criticism’ I expect to see original reasoning pertaining to the decision. Add in words like ‘misinterpretation’, ‘blurred reasoning’ and I am very interested.


Because for a student to have the gumption and balls in a ‘to be published’ critique of the Court of Appeal, well that’s worth reading.

Only it wasn’t. Put aside the spelling errors, grammatical errors and really strange sentence structures and assess the actual substantive work…and there is none.

This was not a critique. This was a summary of everyone else’s critiques. In addition, the ‘click bait’ of, ‘misinterpretation’ and ‘blurred reasoning’ was so hedged and watered down, that those words should never have appeared in the title of the essay in the first place.

Was this a total waste of time? No, as I am now aware of an issue that prior to reading, I was not aware of. So I have gained.

So how did I come by this essay from another student?

It was emailed to everyone by the lecturer. Presumably, this lecturer thought, or felt, that this piece of work was worthy of our reading.

The author, despite any criticisms of her work…is a babe.screen-shot-2016-09-13-at-5-20-00-am

Screen Shot 2015-11-18 at 4.55.47 PM

Forget about the headphone jack for a second.

Sure, it’s pretty annoying that Apple’s newest iPhones — the 7 and 7 Plus, which were unveiled in San Francisco on Wednesday and will start shipping to customers on Sept. 16 — will not include a port for plugging in standard earbuds. But you’ll get used to it.

The absence of a jack is far from the worst shortcoming in Apple’s latest product launch. Instead, it’s a symptom of a deeper issue with the new iPhones, part of a problem that afflicts much of the company’s product lineup: Apple’s aesthetics have grown stale.

Apple has squandered its once-commanding lead in hardware and software design. Though the new iPhones include several new features, including water resistance and upgraded cameras, they look pretty much the same as the old ones. The new Apple Watch does too. And as competitors have borrowed and even begun to surpass Apple’s best designs, what was iconic about the company’s phones, computers, tablets and other products has come to seem generic.

This is a subjective assessment, and it’s one that Apple rebuts. The company says it does not change its designs just for the sake of change; the current iPhone design, which debuted in 2014, has sold hundreds of millions of units, so why mess with success? In a video accompanying the iPhone 7 unveiling on Wednesday, Jonathan Ive, Apple’s design chief, called the device the “most deliberate evolution” of its design vision for the smartphone.

Yet there are signs that my critique of Apple’s designs are shared by others. Industrial designers and tech critics used to swoon over Apple’s latest hardware; nowadays you witness less swooning and more bemusement.

Last year, Apple put out a battery case that looked comically pregnant — “a design embarrassment,” said The Verge — and a rechargeable mouse with the charging port on the bottom, meaning you have to turn it over to charge it. And the remote control for Apple TV violated the first rule of TV remote design: Don’t make it symmetrical, so people can figure out which button is which in the dark. (One tip: Put a rubber band on the bottom, so you can quickly figure out which end is up.)

Then there’s software interface design. The Apple Watch, also released last year, looked fine (and some of its wristbands were truly stunning), but its user interface was so puzzling and took so long to learn that Apple was forced to go back to the drawing board. In a new update to be introduced soon, the watch’s interface has been substantially simplified.

IPhone 7 and Wireless Headphones: Analyzing Apple’s Announcements SEPT. 7, 2016

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It’s the same story for Apple Music. After the streaming service was widely panned for its confusing array of options, Apple had to completely redesign it this year.

It’s not just that a few new Apple products have been plagued with design flaws. The bigger problem is an absence of delight. I recently checked in with several tech-pundit friends for their assessment of Apple’s aesthetic choices. “What was the last Apple design that really dazzled you?” I asked.

There was a small chorus of support for the MacBook, the beautifully tiny (if functionally flawed) laptop that Apple released last year. But most respondents were split between the iPhone 4 and the iPhone 5 — two daring smartphone designs that were instantly recognized as surpassing anything else on the market.

The iPhone 5, in particular, was a jewel; to me, its flat sides, chamfered edges and remarkable build quality suggested something miraculous, as if Mr. Ive had been divinely inspired in his locked white room. But the iPhone 4 and iPhone 5 were released in 2010 and 2012. If you have to reach back to the last presidential election to find an Apple design that really caught your eye, there’s something amiss.

Apple’s design difficulties prompt two questions: How bad is this problem? And how can Apple solve it?

To the first: It’s not acute, but it is urgent. Despite a slowdown in growth, Apple is still by far the most profitable consumer electronics company in the world. Consumer satisfaction surveys show that customers love its products. And even if the tech cognoscenti no longer rave about Apple’s designs, there’s little sign that their griping has affected sales.

Despite criticism, Apple Music also signed up 17 million subscribers in about a year. Apple doesn’t release sales numbers for the watch, but many analysts believe that sales have been brisk, and customer-satisfaction surveys are through the roof. And the iPhone has proved remarkably durable; as I argued last year, the iPhone’s continuing dominance is the closest bet in tech to a sure thing.

The real danger is in Apple’s long-term reputation. Much of Apple’s brand is built on design and on a sense that everything it delivers is a gift from the vanguard.

Two years ago, the designer Khoi Vinh, a former design director for The New York Times who now works at Adobe, summed up Apple’s design prowess this way: “If there’s a single thread that runs through nearly every piece of Apple hardware, it’s conviction, the sense that its designers believed with every fiber of their being that the form factor they delivered was the result of countless correct choices that, in totality, add up to the best and only choice for giving shape to that particular product.”

But in assessing the iPhone 6, then new, Mr. Vinh felt Apple had gone astray. Whereas the iPhone 5 had sharp, sophisticated lines that set it apart from everything else, “the iPhone 6’s form seems uninspired, harkening back to the dated-looking forms of the original iPhone, and barely managing to distinguish itself from the countless other phones that have since aped that look,” he wrote.

That was in 2014. Now, two years later, we still have the same basic iPhone design. For years, Apple has released a redesigned iPhone every other year, but now we’re going to go three years without a new iPhone look.

And while Apple has slowed its design cadence, its rivals have sped up. Last year Samsung remade its lineup of Galaxy smartphones in a new glass-and-metal design that looked practically identical to the iPhone. Then it went further. Over the course of a few months, Samsung put out several design refinements, culminating in the Note 7, a big phone that has been universally praised by critics. With its curved sides and edge-to-edge display, the Note 7 pulls off a neat trick: Though it is physically smaller than Apple’s big phone, it actually has a larger screen. So thanks to clever design, you get more from a smaller thing — exactly the sort of advance we once looked to Apple for.

An important caveat: Samsung’s software is still bloated, and its reputation for overall build quality took a hit when it announced last week that it would recall and replace the Note 7 because of a battery defect that caused spontaneous explosions. To the extent that making a device that doesn’t explode suggests design expertise, Apple is still ahead of Samsung.

But the setbacks from Apple’s rivals aren’t likely to last. Apple can’t afford to rest on its past successes for long.


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