Posts filed under ‘Government’
Plumbers & Cops: Can the Debt Ceiling be Fixed?
The ceiling is leaking, but it’s unclear whether it will be repaired? Rather than fix the seeping fiscal problem, Democrats and Republicans have stared at the leaky ceiling and periodically applied debt ceiling patches every year or two by raising the limit. Nanosecond debt ceiling coverage has reached a nauseating level, but this issue has been escalating for many months. Last fall, politicians feared their long-term disregard of fiscally responsible policies could lead to a massive collapse in the financial ceiling protecting us, so the President called in the bipartisan plumbers of Alan Simpson & Erskine Bowles to fix the leak. The commission swiftly identified the problems and came up with a deep, thoughtful plan of action. Unfortunately, their recommendations were abruptly dismissed and Washington fell back into neglect mode, choosing instead to bicker like immature teenagers. The result: poisonous name calling and finger pointing that has placed Washington politicians one notch above Cuba’s Fidel Castro, Venezuela’s Hugo Chavez, and Iran’s Mahmoud Ahmadinejad on the list of the world’s most hated leaders. Strategist Ed Yardeni captured the disappointment of American voters when he mockingly states, “The clowns in Washington are making people cry rather than laugh.”
Although despair is in the air and the outlook is dour, our government can redeem itself with the simple passage of a debt ceiling increase, coupled with credible spending reduction legislation (and possibly “revenue enhancers” – you gotta love the tax euphimism).
The Elephant in the Room
Our country’s spending problems is nothing new, but the 2008-2009 financial crisis merely amplified and highlighted the severity of the problem. The evidence is indisputable – we are spending beyond our means:
Source: scottgrannis.blogspot.com
If the federal spending to GDP chart is not convincing enough, then review the following graph:
- Source: blog.yardeni.com – A graph a first grader could understand.
You don’t need to be a brain surgeon or rocket scientist to realize government expenditures are massively outpacing revenues (tax receipts). Expenditures need to be dramatically reduced, revenues increased, and/or a combination thereof. Applying for a new credit card with a limit to spend more isn’t going to work anymore – the lenders reviewing those upcoming credit applications will straightforwardly deny the applications or laugh at us as they gouge us with prohibitively high borrowing costs. The end result will be the evaporation of entitlement programs as we know them today (including Medicare and Social Security). For reference of exploding borrowing costs, please see Greek interest rate chart below. The mathematical equation for the Greek financial crisis (and potentially the U.S.) is amazingly straightforward…Loony Spending + Looney Politicians = Loony Interest Rates.
Source: Bloomberg.com via Wikipedia.com
To illustrate my point further, imagine the government owning a home with a mortgage payment tied to a 2.5% interest rate (a tremendously low, average borrowing cost for the U.S. today). Now visualize the U.S. going bankrupt, which would then force foreign and domestic lenders to double or triple the rates charged on the mortgage payment (in order to compensate the lenders for heightened U.S. default risk). Global investors, including the Chinese, are pointing a gun at our head, and if a political blind eye on spending continues, our foreign brethren who have provided us with extremely generous low priced loans will not be bashful about pulling the high borrowing cost trigger. The ballooning mortgage payments resulting from a default would then break an already unsustainably crippling budget, and the government would therefore be placed in a position of painfully slashing spending. Too extreme a shift towards austerity could spin a presently wobbling economy into chaos. That’s precisely the situation we face under a no-action Congressional default (i.e., no fix by August 2nd or shortly thereafter). To date, the Chinese have collected their payments from us with a nervous smile, but if the U.S. can’t make some fiscally responsible choices, our Asian Pacific pals will be back soon with a baseball bat to collect.
The Cops to the Rescue
Any parent knows disciplining teenagers doesn’t always work out as planned. With fiscally irresponsible spending habits and debt load piling up to the ceiling, politicians are stealing the prospects of a brighter future from upcoming generations. The good news is that if the politicians do not listen to the parental voter cries for fiscal sanity, the capital market cops will enforce justice for the criminal negligence and financial thievery going on in Washington. Ed Yardeni calls these capital market enforcers the “bond vigilantes.” If you want proof of lackadaisical and stubborn politicians responding expeditiously to capital market cops, please hearken back to September 2008 when Congress caved into the $700 billion TARP legislation, right after the Dow Jones Industrial average plummeted 777 points in a single day.
Who exactly are these cops? These cops come in the shape of hedge funds, sovereign wealth funds, pension funds, endowments, mutual funds, and other institutional investors that shift their dollars to the geographies where their money is treated best. If there is a perceived, heightened risk of the United States defaulting on promised debt payments, then global investors will simply take their dollar-denominated investments, sell them, and then convert them into currencies/investments of more conscientious countries like Australia or Switzerland.
Assisting the capital market cops in disciplining the unruly teenagers are the credit rating agencies. S&P (Standard and Poor’s) and Moody’s (MCO) have been watching the slow-motion train wreck develop and they are threatening to downgrade the U.S.’ AAA credit rating. Republicans and Democrats may not speak the same language, but the common word in both of their vocabularies is “reelection,” which at some point will effect a reaction due to voter and investor anxiety.
Nobody wants to see our nation’s pipes burst from excessive debt and spending, and if the political plumbers can repair the very obvious and fixable fiscal problems, we can move on to more important challenges. It’s best we fix our problems by ourselves…before the cops arrive and arrest the culprits for gross negligence.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Performance data from Morningstar.com. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MCO, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Curing Our Ills with Innovation
Fareed Zakaria thoughts have blanketed both traditional and internet media outlets, spanning everything from Newsweek to Time, and the New York Times to CNN. With an undergraduate diploma from Yale and his PhD from Harvard, Dr. Zakaria has built up quite a following, especially when it comes to foreign affairs.
In his latest Time magazine article, Can America Keep Pace?, Zakaria addresses the role of innovation in the U.S., “Innovation is as American as apple pie.” The innovation lead the U.S. maintains over the rest of the world will not evaporate over night because this cultural instinct is bred into our DNA – innovation is not something you one can learn directly from a textbook, Wikipedia, or Google (GOOG). With that said, the innovation gap is narrowing between developed and developing countries. New York Times columnist Tom Friedman captured this sentiment when he stated the following:
“French voters are trying to preserve a 35-hour work week in a world where Indian engineers are ready to work a 35-hour day.”
The fungibility of labor has pressured industries by transferring jobs abroad to much lower-cost regions like China and India, and that trend is only expanding further into countries with even lower labor cost advantages. Zakaria agrees:
“America’s future growth will have to come from new industries that create new products and processes. Older industries are under tremendous pressure.”
The good news is the United States maintains a significant lead in certain industries. For instance, we Yankees have a tremendous lead in fields such as biotechnology, entertainment, internet technologies, and consumer electronics.
The poster child for innovation is Apple Inc. (AAPL), which arose from the ashes of death ten years ago with its then ground-breaking new product, the iPod. Since then, Apple has introduced many innovative products and upgrades as a result of its research and development efforts, including the recently launched iPad.
The Education Engine
Where we are falling short is in education, which is the foundation to innovation. In a country with a high school system that Microsoft Corp.’s (MSFT) founder Bill Gates calls “obsolete,” society is left with one-third of the students not graduating and nearly half of the remaining graduates unprepared for college. In this instant gratification society we live in, the long-term critical education issue has been pushed to the backburner. Other emerging countries like China and India are churning out more college graduates by the millions, and also dominating us in the key strategic count of engineering degrees.
Government’s Role
With the massive debt and deficits our country currently faces, an ongoing debate about the size and role of government persists. Zakaria makes the case that government must place a significant role when it comes to innovation. Unfortunately, the U.S. wastes billions on pork-barrel projects and suboptimal subsidies while dilly-dallying in political gridlock over critical investments in education, infrastructure spending, basic research, and energy policies. In the meantime, our fellow competing countries are catching up to us, and in certain cases passing us (e.g., alternative energy investments – see Electric Profits).
Zakaria makes this point on the subject:
“The fastest-growing economies are all busy using government policy to establish commanding leads in one industry after another. Google’s Eric Schmidt points out that ‘the fact of the matter is, other countries are putting a lot more money into nurturing new industries than we are, and we are not going to win unless we do something like what they’re doing.’”
As a matter of fact, an ITIF (Information Technology & Innovation Foundation) study measuring innovation improvement from 1999 to 2009, as it related to government funding for basic research, education and corporate-tax policies, ranked the U.S. dead last out of 40 countries.
Not All is Lost – Pie Slice Maintained
Source: Carpe Diem
Although the outlook may sounds bleak, not all is lost. In a recent Wall Street Journal interview with Bob Doll Chief Equity Strategist at the world’s largest money management company (BlackRock has $3.6 trillion in assets under management), he makes the case that the U.S. remains the leading source of technological innovation and home to the greatest universities and the most creative businesses in the world. He sees this trend persisting in part because of our country’s relative demographic advantages:
“Over the next 20 years, the U.S. work force is going to grow by 11%, Europe’s going to fall by five, and Japan’s going to fall by 17. This alone tells me the U.S. has a huge advantage over Europe and a bigger one over Japan for growth.”
So while emerging markets, like those in Asia, continue to gain a larger slice of the global GDP pie, Mark Perry at Carpe Diem shows how the U.S has maintained its proportional slice of a growing global economic pie, over the last four decades.
Growth is driven by innovation, and innovation is driven by education. If America wants to maintain its greatness, the focus needs to be placed on innovation-led growth. The world is moving at warp speed, and our neighbors are moving swiftly, whether we come along for the ride or not. The current, sour conversations regarding deficits, debt ceilings, entitlements, wars, and unemployment are all essential discussions, but more importantly, if these debates can be refocused on accelerating innovation, the country will be well on its way to curing its ills.
See also Our Nation’s Keys to Success
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, GOOG, and AAPL, but at the time of publishing SCM had no direct position in MSFT, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Inflation and the Debt Default Paradox
With the federal government anchored down with over $14 trillion in debt and trillion dollar deficits as far as the eye can see, somehow people are shocked that Standard & Poor’s downgraded its outlook on U.S. government debt to “Negative” from “Stable.” This is about as surprising as learning that Fat Albert is overweight or that Charlie Sheen has a substance abuse problem.
Let’s use an example. Suppose I received a pay demotion and then I went on an irresponsible around-the-world spending rampage while racking up over $1,000,000.00 in credit card debt. Should I be surprised if my 850 FICO score would be reviewed for a possible downgrade, or if credit card lenders became slightly concerned about the possibility of collecting my debt? I guess I wouldn’t be flabbergasted by their anxiety.
Debt Default Paradox?
With the recent S&P rating adjustment, pundits over the airwaves (see CNBC video) make the case that the U.S. cannot default on its debt, because the U.S. is a sovereign nation that can indefinitely issue bonds in its own currency (i.e., print money likes it’s going out of style). There is some basis to this argument if you consider the last major developed country to default was the U.S. government in 1933 when it went off the gold standard.
On the other hand, non-sovereign nations issuing foreign currencies do not have the luxury of whipping out the printing presses to save the day. The Latin America debt defaults in the 1980s and Asian Financial crisis in the late 1990s are examples of foreign countries over-extending themselves with U.S. dollar-denominated debt, which subsequently led to collapsing currencies. The irresponsible fiscal policies eventually destroyed the debtors’ ability to issue bonds and ultimately repay their obligations (i.e., default).
Regardless of a country’s strength of currency or central bank, if reckless fiscal policies are instituted, governments will eventually be left to pick their own poison…default or hyperinflation. One can think of these options as a favorite dental procedure – a root canal or wisdom teeth pulled. Whether debtors get paid 50 cents on the dollar in the event of a default, or debtors receive 100 cents in hyper-inflated dollars (worth 50% less), the resulting pain feels the same – purchasing power has been dramatically reduced in either case (default or hyperinflation).
Of course, Ben Bernanke and the Federal Reserve Bank would like investors to believe a Goldilocks scenario is possible, which is the creation of enough liquidity to stimulate the economy while maintaining low interest rates and low inflation. At the end of the day, the inflation picture boils down to simple supply and demand for money. Fervent critics of the Fed and Bernanke would have you believe the money supply is exploding, and hyperinflation is just around the corner. It’s difficult to quarrel with the printing press arguments, given the size and scale of QE1 & QE2 (Quantitative Easing), but the fact of the matter is that money supply growth has not exploded because all the liquidity created and supplied into the banking system has been sitting idle in bank vaults - financial institutions simply are not lending. Eventually this phenomenon will change as the economy continues to recover; banks adequately build their capital ratios; the housing market sustainably recovers; and confidence regarding borrower creditworthiness improves.
Scott Grannis at the California Beach Pundit makes the point that money supply as measured by M2 has shown a steady 6% increase since 1995, with no serious side-effects from QE1/QE2 yet:
- Source: Calafia Beach Pundit
In fact, Grannis states that money supply growth (+6%) has actually grown less than nominal GDP over the period (+6.7%). Money supply growth relative to GDP growth (money demand) in the end is what really matters. Take for instance an economy producing 10 widgets for $10 dollars, would have a CPI (Consumer Price Index) of $1 per widget and a money supply of $10. If the widget GDP increased by 10% to 11 widgets (10 widgets X 1.1) and the Federal Reserve increased money supply by 10% to $11, then the CPI index would remain constant at $1 per widget ($11/11 widgets). This is obviously grossly oversimplified, but it makes my point.
Gold Bugs Banking on Inflation or Collapse
Gold prices have been on a tear over the last 10 years and current fiscal and monetary policies have ”gold bugs” frothing at the mouth. These irresponsible policies will no doubt have an impact on gold demand and gold prices, but many gold investors fail to acknowledge a gold supply response. Take for example Freeport-McMoRan Copper & Gold Inc. (FCX), which just reported stellar quarterly sales and earnings growth today (up 31% and 57%, respectively). FCX more than doubled their capital expenditures to more than $500 million in the quarter, and they are planning to double their exploration spending in fiscal 2011. Is Freeport alone in their supply expansion plans? No, and like any commodity with exploding prices, eventually higher prices get greedy capitalists to create enough supply to put a lid on price appreciation. For prior bubbles you can reference the recent housing collapse or older burstings such as the Tulip Mania of the 1600s. One of the richest billionaires on the planet, Warren Buffett, also has a few thoughts on the prospects of gold.
The recent Standard & Poor’s outlook downgrade on U.S. government debt has caught a lot of press headlines. Fears about a technical default may be overblown, but if fiscal constraint cannot be agreed upon in Congress, the alternative path to hyperinflation will feel just as painful.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in FCX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Rebuilding after the Political & Economic Tsunami
Excerpt from Free April Sidoxia Monthly Newsletter (Subscribe on right-side of page)
The Start of the Arab Uprising
The Arab uprising grew its roots from an isolated and disgraced Tunisian fruit vendor (26- year-old Mohammed Bouazizi) who burned himself to death in protest of the persistent, deep-seeded corruption prevalent throughout the government (view excellent 60 Minutes story on Tunisia uprising). The horrific death ultimately led to the swift removal of Egypt’s 30-year President Hosni Mubarak, whose ejection was spurred by massive Facebook-organized protests. Technology has flattened the world and accelerated the sharing of powerful ideas, which has awoken Arab citizens to see the greener grass across other global democratic nations. Facebook, Twitter, and LinkedIn can be incredible black-holes of productivity destroyers (I know firsthand), but as recent events have proven, these social networking services, which handle about 1 billion users globally, can also serve valuable purposes.
As the flames of unrest have been fanned across the Middle East and Northern Africa, autocratic dictators haven’t had the luxury of idly sitting on their hands. Instead, these leaders have been pushed to relent to the citizens’ wishes by addressing previously taboo issues, such as human rights, corruption, and economic opportunity. These fresh events feel like new-found changes, but these major social tectonic shifts have been occurring throughout history, including our lifetimes (e.g., Tiananmen Square massacre and the fall of the Berlin Wall).
Good News or Bad News?
Recent headlines have created angst among the masses, and the uncertainty has investors asking a lot of questions. Besides radioactive concerns in both Japan and the Middle East (one actual, one figurative), the “worry list” of items continues to stack higher. Oil prices, inflation, the collapsing dollar, exploding deficits, a China bubble, foreclosures, unemployment, quantitative easing (QE2), mountainous debt, 2012 elections, and the end of the world among others, are worries crowding people’s brains. Incredibly, somehow the market still manages to grind higher. More specifically, the Dow Jones Industrial Average has climbed a very respectable +6.4% for 2011.
With the endless number of worries, how on earth could the major market indexes still advance, especially after a doubling in value from 24 months ago? For one, these political and economic shocks are nothing new. History has shown us that democratic, capitalistic markets ultimately move higher in the face of wars, assassinations, banking crises, currency crises, and various other stock market frauds and scandals. I’m willing to go out on a limb and say these worrisome events will continue this year, next year, and even over the next decade.
Most baby boomers living in the early 1980s remember when 30-year mortgage rates on homes reached 18.5%, inflation hit 14.8%, and the Federal Funds interest rate peaked near 20%. Boomers also survived Vietnam, Watergate, the Middle East oil embargo, Iranian hostage crisis, 1987 Black Monday, collapse of the S&L banks, the rise and fall of the Cold War, Gulf War I/II, yada, yada, yada. Despite all these cataclysmic events, from the last birth of the Baby Boomers (1964), the Dow Jones Industrial catapulted from about 890 to 12,320. This is no April Fool’s joke! The market has increased a whopping 14-fold (without dividends) in the face of all this gruesome news. You won’t find that story on the front-page of The Wall Street Journal.
Lost Decade Goes on Sale
The gains over the last four and half decades have been substantial, but much more is said about the recent “Lost Decade.” Although it has generally been a lousy decade for most investors in the stock market, eventually the stock market follows the direction of profits. What the popular press negates to mention is that S&P 500 operating earnings have more than doubled from about $47 in 1999 to an estimated $97 in 2011. Over the same period, the price of the market has been chopped by more than half (i.e., the Price – Earnings multiple has been cut from 29x to 13.5x). With stocks selling at greater than -50% off from 1999, no wonder smart investors like Warren Buffett are buying America – Buffett just spent $9 billion in cash on buying Lubrizol Corp (LZ). Retail investors absolutely loved stocks in 2000 at the peak, believing there was virtually no risk. Now the tables have been turned and while stock prices are trading at a -50% discount, retail investors are intensely skeptical and nervous about the prospects for stocks. Shoppers don’t usually wait for prices to go up 30% and then say, “Oh goody, prices are much higher now, so I think I will buy!” but that is what they are saying now.
I don’t want to oversell my enthusiasm, because the deals were dramatically better in March of 2009. Hindsight is 20-20, but at the nadir of the stock market, stock prices traded at bargain basement levels of 7x times 2011 earnings. We may not see opportunities like that again in our lifetime, so sitting in cash may not be the most advisable positioning.
Although I would argue every investor should have some exposure to equities, an investor’s time horizon, objectives, constraints and risk tolerance should be the key determinants of whether your investment portfolio should have 5% equity exposure or 95% exposure.
So while the economic and political dominoes may appear to be tumbling based on the news du jour, don’t let the headlines and the so-called media pundits scare you into paralysis. Bad news and tragedy will continue, but fortunately when it comes to prosperity, history is on our side. As you attempt to organize and pickup the financial pieces of the last few years, make sure you have a disciplined, long-term investment plan that adapts to changing market and personal conditions.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in LZ, Facebook, Twitter, LinkedIn, BRKA/B, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Nuclear Knee-Jerk Reaction
It’s amazing how quickly the long-term secular growth winds can reverse themselves. Just a week ago, nuclear energy was thought of as a safe, clean, green technology that would assist the gasoline pump pain in our wallets and purses. Now, given the events occurring in Japan, “nuclear” has become a dirty word equated to a life-threatening game of Russian roulette.
Despite the spotty information filtering in from the Dai-Ichi plant in Japan, we are already absorbing knee-jerk responses out of industrial heavyweight countries like Germany and China. Germany has temporarily closed seven nuclear power centers generating about a quarter of its nuclear capacity, and China has instituted a moratorium on all new facilities being built. How big a deal is this? Well, China is one country, and it alone currently accounts for 44% of the 62 global nuclear reactor projects presently under construction (see chart below).
Source: World Nuclear Association (URRE Presentation)
As a result of the damaged Fukushima reactors, coupled with various governmental announcements around the globe, Uranium prices have dropped a whopping -30% within a month – plunging from about $70 per pound to around $50 per pound today.
Where does U.S. Nuclear Go from Here?
As you can see from the chart below, the U.S. is the largest producer of nuclear energy in the world, but since our small population is such power hogs, this relatively large nuclear capability only accounts for roughly 20% of our country’s total electricity needs. France, on the other hand, manages about half the reactors as we do, but the French derive a whopping 75% of their total electricity needs from nuclear power. According to the Nuclear Energy Institute, Japanese reliance on nuclear power falls somewhere in between – 29% of their electricity demand is filled by nuclear energy. Like Japan, the U.S. imports most of its energy needs, so if nuclear development slows, guess what, other resources will need to make up the difference. OPEC and various other oil-rich, dictators in the Middle East are licking their chops over the future prospects for oil prices, if a cost-effective alternative like nuclear ends up getting kicked to the curb.
Source: The Economist
As I alluded to above, there is, however, a silver lining. As long as oil prices remain elevated, any void created by a knee-jerk nuclear backlash will only create heightened demand for alternative energy sources, including natural gas, solar, wind, biomass, clean coal, and other creative substitutes. While we Americans may be addicted to oil, we also are inventive, greedy capitalists that will continually look for more cost-efficient alternatives to solve our energy problems (see also Electrifying Profits). Unlike other countries around the world, it looks like the private sector will have to do the heavy lifting to solve these resources on their own dime. Limited subsidies have been introduced, but overall our government has lacked a cohesive energy plan to kick-start some of these innovative energy alternatives.
Déjà Vu All Over Again
We saw what happened on our soil in March 1979 when the Three Mile Island nuclear accident in Pennsylvania consumed the hearts and minds of the country. Pure unadulterated panic set in and new nuclear production ground to a virtual halt. When the subsequent Chernobyl incident happened in April 1986 insult was added to injury. As you can see from the chart below, nuclear reactor capacity has plateaued for some twenty years now.
Source: Wikipedia
The driving force behind the plateauing nuclear facilities is the NIMBY (Not In My Back Yard) phenomenon. The Three Mile Island incident is still fresh in people’s minds, which explains why only one nuclear plant is currently under construction in our country, on top of a base of 104 U.S. reactors in 31 states. I point this out as an ambivalent NIMBY-er since I work 30 miles away from one of the riskiest, 30-year-old nuclear plants in the country (San Onofre).
Unintended Consequences
The Sendai disaster is home to the worst Japanese earthquake in 140 years, by some estimates, but history will prove once again what unintended consequences can occur when impulsive knee-jerk decisions are made. Just consider what has happened to oil prices since the moratorium on offshore drilling (post-BP disaster) was instituted. Sure we have witnessed a dictator or two topple in the Middle East, and there currently is adequate supply to meet demand, but I would make the case that we should be increasing domestic oil supplies (along with alternative energy sources), not decreasing supplies because it is politically safe.
Time will tell if the Japanese earthquake/tsunami-induced nuclear disaster will create additional unintended consequences, but I am hopeful the recent events will at a minimum create a serious dialogue about a comprehensive energy policy. If the comfortable, knee-jerk reaction of significantly diminishing nuclear production is broadly adopted around the world, then an urgent alternative supply response needs to occur. Otherwise, you may just need to enjoy that bike ride to work in the morning, along with that nice, romantic candle-lit dinner at night.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and alternative energy securities, but at the time of publishing SCM had no direct position in BP, URRE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Foreign Frights & Debt Doubts
Excerpts from Sidoxia monthly newsletter (Subscribe on right side of page)
Over the last few years the globalized nature of the financial crisis has forced a diverse set of world leaders to deal with obscure international flare-ups in countries ranging from Iceland to Dubai, and Greece to Tunisia. The crisis du jour is the popular revolt in Egypt against 30-year president Hosni Mubarak and his autocratic, authoritarian government. The situation for the U.S. becomes a little sticky because Egypt, although creating a GDP (Gross Domestic Product) of less than the state of Illinois, is still the largest Arab country by population (approximately 82 million – even larger than Iran); a staunch ally with the U.S. in keeping peace with Israel; has contributed important intelligence to our country’s war on terror; and has been a responsible partner in controlling commerce through the all-important Suez Canal. The problem with Egypt and Mubarak’s regime is that the Egyptian economy is in relative shambles (they do not have oil reserves like their neighbors), unemployment is through the roof, and the government has been slow to push democratic advancements forward for the Egyptian people.
As emerging market “haves” increasingly join the ranks of the middle class, the people representing the “have-nots” of Yemen, Jordan, Algeria, Tunisia, Egypt, and others are thirsting for a cocktail of democracy and a higher standard of living, like some of their wealthier neighbors. These autocratic, authoritarian regimes can do their best to slow or delay the democratizations of their countries, but they cannot put the genie back in the bottle. Information is flowing faster than ever, and societies previously kept in the dark are now seeing the light of democracy.
Like any volatile government situation, there are threats and opportunities, depending on whether Mubarak stays in power, and if not, the nature of the new leadership. If an extremist government fills the leadership void, the U.S. may wish to rewind the clock and put the slow-moving reformist, Mubarak, back in power.
The short-term impact of the popular revolt may create additional volatility in the markets, but in the long-run, if the turmoil introduces more open, transparent, less corrupt, and democratic ideals to the new agenda, then the world will become a better place.
Bitter Debt Pill Tough to Swallow
There is never a shortage of issues to worry about, and from an economic standpoint, the suffocating amount of debt our country is dealing with is at the top of the concern list. The 2008-2009 financial crisis hole that we are still climbing our way out of is a friendly reminder of what happens to countries adopting irresponsible fiscal policies. The choking amount of debt the U.S. is swallowing remains a central issue for the current administration and will be a core topic to be debated through the 2012 Presidential election cycle.
How serious is the issue? The problem is serious enough the Congressional Budget Office (CBO) just raised its budget deficit forecast for fiscal 2011 to hit a record $1.5 trillion (9.8% of GDP), a level higher than $1.3 trillion in fiscal 2010. The blame for the new record can be largely attributed to the recent extension of the $858 billion in Bush tax-cuts and other benefits/breaks. Kicking the can down the road recently led Moody’s Investors Services of threatening the U.S. with a downgrade of its triple-A rated debt.
Source: The Peterson Institute
The President addressed some of our fiscal problems in his State of the Union Address recently (e.g., proposing a freeze on discretionary spending), but the rubber really hits the road when he comes out with his budget proposal later this month. How serious is he about reducing our hemorrhaging deficits? We’ll soon find out when the individual budget line-items are distributed for everyone to see. Shortly thereafter, around the end of March, the debt ceiling impasse will become a game of political “chicken.” Each side, Democrats and Republicans, will attempt to withdraw concessions from the other party, in exchange for a vote that will prevent a disastrous default of our government’s debt payments. Basically, our government is effectively looking to expand its credit card credit line, because our government credit limit is maxed out.
The situation isn’t hopeless if our politicians can show leadership by making difficult, unpopular fiscal decisions, but if America ignores our painful debt problems and does not take its bitter medicine, then prepare for an economy on the verge of keeling over.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Shrewd Research or Bilking the System?
Information is power and some hedge funds, mutual funds, and investment managers will go to great lengths to obtain the lowdown.
Integrity of the financial markets is key and recently several hedge funds (Level Global Investors LP, Diamondback Capital Management LLC and Loch Capital Management LLC) have been raided by the Federal Bureau of Investigation (FBI). Other large investment players, including SAC Capital Advisors, Janus Capital Group Inc. (JNS) and Wellington Management Co. have also received inquiries as part of what some journalists are calling rampant industry insider trading activity. Even investment bank Goldman Sachs (GS) is allegedly being examined for potential unlawful leakage of merger information. Little is known about the allegations, so it is difficult to decipher whether this is the tip of the iceberg or standard investigative work?
Regardless of the scope of the investigation, there is a fine line between what scoop is considered fair versus illegal. The distinction becomes even more difficult to pinpoint with the evolution of faster and more voluminous trading (i.e., high frequency trading). The internet has accelerated the speed of information transfer faster than a politician’s promise to cut spending. Data is chewed up and spit out so quickly, meaning tradable information has a very short shelf life before it is profitably exploited by someone. In the old days of snail mail and private back-office meetings, security prices would require time for information to be completely reflected.
Expert Networks Questioned
Another ingredient introduced over the last decade is the advent of the “expert network,” which are firms that connect fund managers to industry specialists, in many cases as part of a “channel check” to gauge the health of a particular industry. About 10 years ago Regulation FD (Fair Disclosure) was introduced to prevent selective disclosure of “material non-public” information (tips that will likely cause security prices to go significantly up or down) by senior company officials and investor relation professionals to investor types. Greedy (and/or ingenious) institutional investors are Darwinian and as a result figured out a loophole around the system. Hedge funds and other investment managers figured out if the senior executives won’t cough up the good info, then why not target the junior executives and squeeze the inside story from them like informants? Expert networks (read thorough description here) serve as an informational channel to service this demand. Although I’m sure there have been a minority of cases where mid-level managers or junior executives have leaked material information (intentionally or unintentionally), I’m very confident that it is the exception more than the rule. In many instances when the beans were spilled, Regulation FD protects both the person disseminating the information and the investor receiving the information.
Rigged Game for Individuals?
OK sure…hedge funds and institutional managers may occasionally have privileged access to executive teams and can afford access to industry experts. I should know, since I managed a multi-billion fund and consistently had access to the upper rank of corporate executives. Hearing directly from the horse’s mouth and trying to interpret body language can provide insights and instill confidence in a trade, but these executives are not stupid enough to risk prison time by selectively disclosing material non-public information. This dynamic of privileged access will never change as long as CEOs and CFOs are allowed to communicate with investors. Corporate executives will naturally prioritize their limited investor communications towards the larger players.
So with the big-wig managers gaining access to the big-wig executives, has the game become rigged for the individual investors? The short answer is “no.” Over the last decade individual investors have experienced a tremendous leveling of the playing field versus institutional investors. While institutions have privileged access and have pushed to exploit HFT and expert networks, individual investors have gained access to institutional quality research (e.g., SEC filings, real-time conference calls, Wall Street reports, etc.) for free or affordable prices. With the ubiquity of technology and the internet, I only see that gap narrowing more over time.
There will always be cheaters who stretch themselves beyond legal boundaries and should be prosecuted to the full extent of the law. However, for the vast majority of institutional investors, they are using technology and other tools (i.e., expert networks) as shrewd resources to compete in a difficult game. I will reserve full judgment on the names pasted all over the press until the FBI and SEC reveal all their cards. So far there appears to be more noise than smoke coming from the barrel tip of the insider trading gun.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, SAC Capital Advisors, Janus Capital Group Inc. (JNS), Wellington Management Co., or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Impoverished Global Babysitter
I don’t mind being a babysitter for the world, as long as I get paid for it. Unfortunately, not only are we paying to be the nation’s global defense babysitter, but we are also paying for the protection responsibility with unsustainable borrowings.
I don’t want to be a cold-hearted neighbor to our friends and allies, but it is all a matter of degree. Collecting a vacationing neighbor’s newspaper and mail, and watching for any potential suspicious activity is all part of being a conscientious, dependable neighbor, but where do you draw the line? As a good neighbor, should I also be responsible for paying for and installing a security system on their premises? Or how about getting my 16 year old nephew to spend the night at my neighbor’s because of some scary noises heard during the previous night?
For politicians to say we need to cut spending but defense spending is off the table is hypocritical. Bruce Bartlett, columnist at The Fiscal Time, had this to say on the subject:
“No one is saying the defense budget is the sole source of the deficit, but the fact is that it has risen from 3 percent of the gross domestic product in fiscal year 2001 to 4.7 percent this year. That additional 1.7 percent of GDP amounts to $250 billion in spending — almost 20 percent of this year’s budget deficit. And according to a recent Congressional Research Service report, the cost of wars in Iraq and Afghanistan alone accounted for 23 percent of the combined budget deficits between fiscal years 2003 and 2010.”
Even the government should have learned one of the prime lessons from the 2008-2009 financial crisis: tough times require the necessity to do more with less. Whether you are talking about a large corporation like $173 billion valued General Electric (GE), a small mom-and-pop coffee shop, or a middle-class family of four, the moral of the story is bad things eventually happen to individuals, corporations, and governments that live beyond their means. The crisis was exacerbated by excessive borrowing to achieve the higher standard of living and operations.
New Heightened Sensibility?
The initial deficit reduction proposals crafted by the bipartisan commission headed by Erskine Bowles and Alan Simpson should be lauded, regardless of how much Congress decides to dilute the $4 trillion in budget cuts over the next 10 years. The plan may not garner votes for politicians, but these types of necessary cuts will place our country on firmer ground and provide a more sustainable path to prosperity. More specifically, the plan would bring the federal budget deficit down to 2.2% of GDP (Gross Domestic Product) by 2015 and reduce the country’s debt to 60% of GDP by 2024.
Building Flying Rolls Royces
Bowles and Simpson appear to get it, but our bloated government doesn’t seem to understand. If I were running an unprofitable company with a lot of debt, would it be a good idea to develop a new flying Rolls Royce car fleet (with questionable utility) for my employees? Common fiscal sense would dictate the answer to be “NO.”
Regrettably our government has answered “yes” by building a ridiculously costly flying Rolls Royce fleet of its own under the name of Joint Strike Fighter (the F-35 program from Lockheed Martin Corp. [LMT]). This absurdly priced program – the costliest in our country’s history – is projected to cost up to $382 billion for 2,443 aircraft over the next two decades (Reuters). This translates into a whopping $156 million per aircraft. Cost overruns have already come in 40-90% higher than expected over the last nine years, and the price tag continues to rise. The state of the art jet program is touted as a Swiss army knife (flexibility to be used by all three branches of the military), but may actually turn out to be a butter knife due to the program’s questioned utility (see great PBS video here).
So like any company, individual, or government, there is something called prioritization. By cutting fat in less critical areas, a portion of those savings can be redeployed to INCREASE spending in the areas that matter. I won’t wade into the relative merits (or lack thereof) related to Afghanistan and Iraq expenditures or appropriate troop levels, but suffice it to say, I’m certain spending can be cut in many areas to make room for our country’s primary defense priorities.
I’m no defense expert but when faced to deal with a murky, inconspicuous issue of terrorism (cave dwelling insurgents and bomb-making sleeper cells), intelligence collection and international coordination make more sense than building $150 million flying Rolls Royces, which are better suited for fighting an obsolete cold war than finding terrorist needles in a global haystack.
Crotch Costs
Layer on the new TSA passenger flight costs associated with crotch fondling pat downs and the costs related to buying miniaturized shampoo and gel containers, one wonders if tax-payer money can be more efficiently spent. For what it’s worth, the FDA has approved the latest body scanning machines with no health concerns, so if an airport worker gets his/her jollies by ogling an overweight out of shape passenger like me, then so be it. The fact of the matter is that estimates show 99% of passengers choose the innocuous body scan, which displays a white, ghost-like naked computer image to the agent. For those worried about self image issues or privacy concerns, perhaps the airports can set up a meet-and-greet room option for passengers to become better acquainted with the agent before passing through the scanner.
Freeloaders Cutting Spend
Source: The Financial Times
Domestic defense spending cuts become especially touchy when discussed in concert with European spending reductions. Take for example German plans to slash $10.7 billion in defense spending by 2014 and British spending cuts of 10% to 20% (around $6 – $12 billion). Europeans are labeled by Americans as socialists because of their lengthy paid vacations, maternity leaves, and generous healthcare benefits. More power to them and I desire all those things for myself and my family too, but I just don’t want my taxes to pay for others’ benefits when our country cannot afford those same wonderful benefits for ourselves.
While our Defense Secretary, Robert Gates, has been talking a good game with respect to a $100 billion in savings cuts, these cuts should be put in the context of a $567 billion budget for 2011 and a $700 billion estimated 2015 budget. As it turns out, these $100 billion in cuts are not cuts at all – Gates is also talking out of the other side of his mouth by saying he wants to continue increasing overall defense spending.
Is the size of spending appropriate? According to SIPRI, an independent international research institute, the U.S. defense budget accounts for 54% of the world’s total military spending, when our population only represents less than 5% of the world’s total. If that is not a disproportionate subsidy to the rest of the world, then I do not know what one is? The real longer term threat is not Iran or North Korea, but rather China. I’ll go out on a limb and say we can probably hold our own for a while, considering China is still only spending about 15% of what we spend on defense.
As I stated earlier, it is more important than ever to do more with less. Corporations are clearly doing that now by cutting spending, while still able to create record profits. The government has to get on board with trimming fat in all areas of our government…including defense. Coordinating intelligence and combining resources across the globe is crucial if we want to get more bang for our buck, while still devoting adequate resources to fend off the real and immediate evil threats of terrorism. Babysitting is an important duty and responsibility, but as impoverished Americans we are not capable of providing that service to the whole world free of charge.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GE, LMT, Rolls Royce, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Ration or Tax: Eating Cake Not an Option
We live in an instant gratification society that would like everything for free ( like my pal Bill Maher), which explains why we want to have our healthcare cake and eat it too. I think George Will said it best when discussing universal healthcare coverage, “If you think health care is expensive now, just wait until it is free.” Look, I love free stuff too, like the rest of us, whether it’s free sausage sample at Costco (COST) or a breath mint at the Olive Garden (DRI). But regrettably, exploding deficits come at a price.
With midterm elections coming up, the issue of healthcare is once again front and center. The majority party feels like a checkbook is a solution to healthcare prosperity. Can you really look me in the eyes and say covering additional 32 million uninsured Americans is going to save us money. The government hasn’t exactly built a ton of credibility with the disastrous train-wreck we call Medicare, which is already carrying 45 million covered passengers.
The minority party hasn’t done a lot better with the layering of the 2006 unsustainable Medicare Part D drug plan. Conservatives are campaigning on “repeal and replace” and that is great, but where are the cuts?
There are only two solutions to our current healthcare problem: ration or tax (read Plucking Feathers of Taxpaying Geese). Is healthcare a right or privilege? I don’t know, but if we want to cover current obligations, or add 32 – 50 million more uninsured, then we will be required to cut expenses (ration) to pay for increased benefits and/or increase taxes to cover additional benefits. I would love to cover all Americans, along with the starving children in Africa too, but unfortunately we are limited by our resources. Writing checks with borrowed money will only last for so long.
How severe are the exploding healthcare costs, which are covering the graying of the 76 million baby boomers? Here’s how Forbes describes the unsustainable Medicare obligations:
The Medicare Trustees tell us that Medicare’s expected future obligations exceeded premiums and dedicated taxes by $89 trillion (measured in current dollars). No, that’s not a misprint. To put that number in perspective, Medicare’s liability is about 5 1/2 times the size of Social Security’s ($18 trillion) and about six times the size of the entire U.S. economy.
Not a pretty picture. These estimates look pretty far in the future, but even more bare bone figures arrive at a still frightening $33 trillion. Take a look at healthcare spending forecasts as a percentage of GDP – even the lowest estimates are depressing:
Source: National Center for Policy Analysis via Forbes
In our increasingly flat globalized world, competition between countries is becoming even more intense. We are in a marathon race for improved standards of living, and all these debts and deficits are dragging us down like an anchor tied to our legs. Even without considering other massive entitlements like Social Security, healthcare alone has the potential of grinding our economy to a halt. Politicians are great at promising more benefits and tax cuts in exchange for your votes, but true leadership requires delivering the sour medicine necessary for future prosperity. Before we eat the healthcare cake, let’s raise the money to buy the cake first.
Read more about the Medicare Explosion on Forbes
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in COST, DRI, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Crisis Delivers Black-Eye to Classic Economists
Markets are efficient. Individuals behave rationally. All information is reflected in prices. Huh…are you kidding me? These are the beliefs held by traditional free market economists (“rationalists”) like Eugene Fama (Economist at the University of Chicago and a.k.a. the “Father of the Efficient Market Hypothesis”). Striking blows to the rationalists are being thrown by “behavioralists” like Richard Thaler (Professor of Behavioral Science and Economics at the University of Chicago), who believes emotions often lead to suboptimal decisions and also thinks efficient market economics is a bunch of hogwash.
Individual investors, pensions, endowments, institutional investors, governments, are still sifting through the rubble in the aftermath of the 2008-2009 financial crisis. Experts and non-experts are still attempting to figure out how this mass destruction occurred and how it can be prevented in the future. Economists, as always, are happy to throw in their two cents. Right now traditional free market economists like Fama have received a black eye and are on the defensive – forced to explain to the behavioral finance economists (Thaler et. al.) how efficient markets could lead to such a disastrous outcome.
Religion and Economics
Like religious debates, economic rhetoric can get heated too. Religion can be divided up in into various categories (e.g., Christianity, Islam, Judaism, Hinduism, Buddhism, and other), or more simply religion can be divided into those who believe in a god (theism) and those who do not (atheism). There are multiple economic categorizations or schools as well (e.g., Keynsians, monetarism, libertarian, behavioral finance, etc.). Debates and disagreements across the rainbow of religions and economic schools have been going on for centuries, and the completion of the 2008-09 financial crisis has further ignited the battle between the “behavioralists” (behavioral finance economists) and the “rationalists” (traditional free market economists).
Behavioral Finance on the Offensive
In the efficient market world of the “rationalists,” market prices reflect all available information and cannot be wrong at any moment in time. Effectively, individuals are considered human calculators that optimize everything from interest rates and costs to benefits and inflation expectations in every decision. What classic economics does not include is emotions or behavioral flaws.
Purporting that financial market decisions are not impacted by emotions becomes more difficult to defend if you consider the countless irrational anomalies considered throughout history. Consider the following:
- Tulip Mania: Bubbles are nothing new – they have persisted for hundreds of years. Let’s reflect on the tulip bulb mania of the 1600s. For starters, I’m not sure how classic economists can explain the irrational exchanging of homes or a thousand pounds of cheese for a tulip bulb? Or how peak prices of $60,000+ in inflation-adjusted dollars were paid for a bulb at the time (C-Cynical)? These are tough questions to answer for the rationalists.
- Flash Crash: Seeing multiple stocks (i.e., ACN and EXC) and Exchange Traded Funds (ETFs) temporarily trade down -99% in minutes is not exactly efficient. Stalwarts like Procter & Gamble also collapsed -37%, only to rebound minutes later near pre-collapse levels. All this volatility doesn’t exactly ooze with efficiency (see Making Millions in Minutes).
- Negative T-Bill Rates: For certain periods of 2008 and 2009, investors earned negative yields on Treasury Bills. In essence, investors were paying the government to hold their money. Hmmm?
- Technology and Real Estate Bubbles: Both of these asset classes were considered “can’t lose” investments in the late 1990s and mid-2000s, respectively. Many tech stocks were trading at unfathomable values (more than 100 x’s annual profits) and homebuyers were inflating real estate prices because little to no money was required for the purchases.
- ’87 Crash: October 19, 1987 became infamously known as “Black Monday” since the Dow Jones Industrial Average plunged over -22% in one day (-508 points), the largest one-day percentage decline ever.
The list has the potential of going on forever, and the recent 2008-09 financial crisis only makes rationalists’ jobs tougher in refuting all this irrational behavior. Maybe the rationalists can use the same efficient market framework to help explain to my wife why I ate a whole box of Twinkies in one sitting?
Rationalist Rebuttal
The rationalists may have gotten a black eye, but they are not going down without a fight. Here are some quotes from Fama and fellow Chicago rationalist pals:
On the Crash-Related Attacks from Behavioralists: Behavioralists say traditional economics has failed in explaining the irrational decisions and actions leading up to the 2008-09 crash. Fama states, “I don’t see this as a failure of economics, but we need a whipping boy, and economists have always, kind of, been whipping boys, so they’re used to it. It’s fine.”
Rationalist Explanation of Behavioral Finance: Fama doesn’t deny the existence of irrational behavior, but rather believes rational and irrational behaviors can coexist. “Efficient markets can exist side by side with irrational behavior, as long as you have enough rational people to keep prices in line,” notes Fama. John Cochrane treats behavioral finance as a pseudo-science by replying, “The observation that people feel emotions means nothing. And if you’re going to just say markets went up because there was a wave of emotion, you’ve got nothing. That doesn’t tell us what circumstances are likely to make markets go up or down. That would not be a scientific theory.”
Description of Panics: “Panic” is not a term included in the dictionary of traditional economists. Fama retorts, “You can give it the charged word ‘panic,’ if you’d like, but in my view it’s just a change in tastes.” Calling these anomalous historic collapses a “change in tastes” is like calling Simon Cowell, formerly a judge on American Idol, “diplomatic.” More likely what’s really happening is these severe panics are driving investors’ changes in preferences.
Throwing in White Towel Regarding Crash: Not all classic economists are completely digging in their heels like Fama and Cochrane. Gary Becker, a rationalist disciple, acknowledges “Economists as a whole didn’t see it coming. So that’s a black mark on economics, and it’s not a very good mark for markets.”
Settling Dispute with Lab Rats
The boxing match continues, and the way the behavioralists would like to settle the score is through laboratory tests. In the documentary Mind Over Money, numerous laboratory experiments are run using human subjects to tease out emotional behaviors. Here are a few examples used by behavioralists to bolster their arguments:
- The $20 Bill Auction: Zach Burns, a professor at the University of Chicago, conducted an auction among his students for a $20 bill. Under the rules of the game, as expected, the highest bidder wins the $20 bill, but as an added wrinkle, Burns added the stipulation that the second highest bidder receives nothing but must still pay the amount of the losing bid. Traditional economists would conclude nobody would bid higher than $20. See the not-so rational auction results here at minute 1:45.
- $100 Today or $102 Tomorrow? This was the question posed to a group of shoppers in Chicago, but under two different scenarios. Under the first scenario, the individuals were asked whether they would prefer receiving $100 in a year from now (day 366) or $102 in a year and one additional day (day 367)? Under the second scenario, the individuals were asked whether they would prefer receiving $100 today or $102 tomorrow? The rational response to both scenarios would be to select $102 under both scenarios. See how the participants responded to the questions here at minute 4:30.
Rationalist John Cochrane is not fully convinced. “These experiments are very interesting, and I find them interesting, too. The next question is, to what extent does what we find in the lab translate into how people…understanding how people behave in the real world…and then make that transition to, ‘Does this explain market-wide phenomenon?,’” he asks.
As alluded to earlier, religion, politics, and economics will never fall under one universal consensus view. The classic rationalist economists, like Eugene Fama, have in aggregate been on the defensive and taken a left-hook in the eye for failing to predict and cohesively explain the financial crash of 2008-09. On the other hand, Richard Thaler and his behavioral finance buds will continue on the offensive, consistently swinging at the classic economists over this key economic mind versus money dispute.
See Complete Mind Over Money Program
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in ACN, EXC, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
