Wednesday, March 20, 2013

A Macro View - Part 2, Decay

To recap the last post, the economy is lack-luster, and it doesn't have a lot of upside potential.  There is too much debt and most innovation is just "bling", full of flash and dazzle and signifying nothing.

So the economy languishes, but the markets are on fire.  Interest rates are held low using both traditional and non-traditional means.  The Australian economist Steve Keen holds that the stock market is a debt-fueled bubble and he illustrates this by comparing the relationship between margin levels and stock market levels.  Highly correlated and both highly high.

It appears as though the stimulus money has gone into the market, rather than the economy.

Bernacke is going to hold tight to QE.  I don't blame him, it is his job to try and fend off disaster and make the economy grow, but I think he is fighting against the tide.

QE may have unintended consequences - the depreciation or potential devaluation of the US dollar, perhaps a currency war and the damage this will cause to international trade.  Throw the EU/Cyprus thing into the mix (the tax levy on savings balances) and confidence is further undermined.

I think this desperate desire to make things grow is at the root cause.  In nature, pruning and sometimes even controlled burns are helpful to the cycle.  But the point is, it is a cycle, of growth and decay, growth and decay. 

In my opinion, we want to transcend this natural process and just grow, grow, grow.  Did you know that never happens?  From a microscopic to a universal scale, we ride a sine wave that oscillates us, up and down, forever and ever, amen.

I don't know why this needs to be a problem.  Embrace it, we can't change it anyway.  Look for opportunity in the decay phase.

That will be the topic of the next post.

Wednesday, March 13, 2013

A Macro-View, Part 1 - Growth

A couple of weeks ago I went to cash by selling all of my equity positions (I didn't have anything else).  It was partially reactionary - there was a lot of bullish sentiment and it was partially based on the research that I had done in order to produce those three infographics. 

Once out of the market, I could be more objective and think about what was going on and what was likely to happen.  Every morning for the past two or three weeks, I've been mocking up different macro-economic scenarios, looking at interest rates, money supply, inflation, exchange rates etc.  Frequently, I just get over-whelmed.  There are so many moving parts, so many possibilities.  I think, maybe I should just sit this one out.  But it's too interesting.

Of particular interest to me is quantitative easing.  Let me go over some of the questions that arise from this subject:
  • Why didn't low interest rates stimulate the economy (making some governments turn to QE)?
  • What are the effects, intended and not, of QE?

The first question is the focus of this blog.  My theory, based on the infographic work, is that low interest rates didn't work because, at least for the time being, our economies have grown all they are capable of growing.  Innovation is the main driver of growth because innovation can make us more productive.  More productivity, more growth.

There are some remarkable technological developments happening without a doubt, and they'll continue to happen, but they aren't going to move the needle on productivity the way, say, indoor plumbing did, or the electric light, or the car.  Let me illustrate graphically:

The invention of the telephone made huge productivity gains.  The cellphone made gains, but not as much as the telephone did.  And smartphones add comparatively little.  This is the law of diminishing returns in action, applied to technological development.

<As an aside, in my opinion, I think it is possible to get negative gains from technology in certain cases, smartphones being a good example.  The reason stems from distraction, the illusion of multi-tasking usefulness, and blurred boundaries between work and recreation.>

So perhaps we've hit a bit of a plateau for a while in our ability to grow our economy.  There are other reasons why this might be the case SUCH AS AN AWFUL LOT OF DEBT, and for more information I direct you to Robert J. Gordon's work on the subject.

However, we've been growing consistently for a number of generations, we've come to expect it.  I think governments are not prepared to face a non-growth environment and will attempt to grow by any means possible.  One of those means is what we have now - quantitative easing.

My next posting will discuss the impacts of this policy.

Sunday, March 3, 2013

The Final Infographic of the Series - Graphing and Understanding Growth of the S&P500


Over the month of February, I was hard at work producing a series of three financial infographics, inspired by the work of Dr. Albert Bartlett on compound growth.  I think his message is important and I recommend watching videos of his lectures.  It would be an investment of only an hour and 15 minutes of your time.

Although the first infographics came together quite quickly, I really struggled with the third.  I didn't know what to do.  I wasn't interested in the old saw of compound growth and how it grows your investments.  Who hasn't heard that?  I wanted these infographics to be useful and I didn't think recycling old information was useful.

Long story short, I started mucking around with S&P500 data.  There were a few dead ends, but eventually I calculated the average growth rate of the S&P and the doubling time that corresponded with that rate.  I graphed it and then graphed the actual value of the S&P at each of the doubling times.

The two lines moved in sync for the first 50 years (1950 to 2000), but after 2000, the S&P500 couldn't sustain parabolic growth.  Wow, unlimited growth not sustainable.    In hindsight it seems so obvious, as that is what the esteemed Dr. Bartlett says, but I was very excited to see it.

Next step, more research.  Cutting another lengthy tale short, I came across the work of Dr. Robert J. Gordon from Northwestern University.  He published a working paper called, "The End of Growth?  Faltering Innovation Confronts the Six Headwinds".  A worth-while read.

I used Dr. Gordon's work to help explain the results of the doubling time graph.

I hope you enjoy the infographic.  Please send me a message with any comments or questions you have.  I'd love to hear from you.

In closing, the whole process got me thinking like stink about where the focus of my next investment analysis should be.  It's going to be a macro-view leveraging our financial analysis software and it'll be the topic of my next blog.