Posts tagged ‘Paul Volcker’

Back to the Future: Mag Covers (Part I)

 Magazine Covers Part II  – – – Magazine Covers Part III

I’m not referring to the movie, Back to the Future, about a plutonium-powered DeLorean time machine that finds Marty McFly (played by Michael J. Fox) traveling back in time. Rather, I am shining the light on the uncanny ability of media outlets (specifically magazines) to mark key turning points in financial markets – both market bottoms and market tops. This will be the first in a three part series, providing a few examples of how magazines have captured critical periods of maximum fear (buying opportunities) and greed (selling signals).

People tend to have short memories, especially when it comes to the emotional rollercoaster ride we call the stock market. Thanks to globalization, the internet, and the 24/7 news cycle, we are bombarded with some fear factor to worry about every day. Although I might forget what I had for breakfast, I have been a student of financial market history and have experienced enough cycles to realize as Mark Twain famously stated, “History never repeats itself, but it often rhymes” (read previous market history article). In that vein, let us take a look at a few covers from the 1970s:

Big Bad Bear 9-9-74

Newsweek’s “The Big Bad Bear” issue came out on September 9, 1974 when the collapse of the so-called “Nifty Fifty” (the concentrated set of glamour stocks or “Blue Chips”) was in full swing. This group of stocks, like Avon, McDonalds, Polaroid, Xerox, IBM and Disney, were considered “one-decision” stocks investors could buy and hold forever. Unfortunately, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the1973-74 period.

Why the glum sentiment? Here are a few reasons:

  • Exiting Vietnam War
  • Undergoing a Recession
  • 9% Unemployment
  • Arab Oil Embargo
  • Watergate: Presidential Resignation
  • Franklin National Failure
Crash Through China

A cartoon from the same bearish 1974 cover article.

Not a rosy backdrop, but was this scary and horrific phase the ideal time to sell, as the magazine cover may imply? No, actually this was a shockingly excellent time to purchase equities. The Dow Jones Industrial Average, priced at 627 when the magazine was released, is now trading around 10,247…not too shabby a return considering the situation looked pretty darn bleak at the time.

 Reports of the Market’s Death Greatly Exaggerated

Death to Equities 8-13-79

Sticking with the Mark Twain theme, the reports of the market’s demise was greatly exaggerated too – much the same way we experienced the overstated reaction to the financial crisis early in 2009. BusinessWeek’s August 13, 1979 magazine captured the essence of the bearish mood in the article titled, “The Death of Equities.” This article came out, of course, about 18 months before a multi-decade upward explosion in prices that ended in the “Dot-com” crash of 2000. In the late 1970s, inflation reached double digit levels; gold and oil had more than doubled in price; Paul Volcker became the Federal Reserve Chairman and put on the economic brakes via a tough, anti-inflationary interest rate program; and President Jimmy Carter was dealing with an Iranian Revolution that led to the capture of 63 U.S. hostages. Like other bear market crashes in our history, this period also served as a tremendous time to buy stocks. As you can see from the chart above, the Dow was at 833 at the time of the magazine printing – in the year 2000, the  Dow peaked at over 14,000.

This walk down memory lane is not complete. Conveniently, the Back to the Future story was designed as a trilogy (just like my three-part magazine review). You can relive Parts II & III here:   Magazine Covers Part II  – – – Magazine Covers Part III

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

 

DISCLOSURE: Sidoxia Capital Management (SCM) has a short position in MCD at the time this article was originally posted. SCM owns certain exchange traded funds, IBM, and DIS, but currently has no direct position in Avon (AVP), Polaroid, Xerox (XRX). 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.

September 7, 2014 at 11:31 am 1 comment

Financial Engineering: Butter Knife or Cleaver?

Recently, former Federal Reserve Board Chairman Paul Volcker blasted the banking industry for innefectual derivative producs (i.e., credit default swaps [CDS] and collateralized debt obligations [CDOs]) and a lack of true innovation outside of the ATM machine, which was introduced some 40 years ago. In my opinion, the opposing views pitting the cowboy Wall Street bankers versus conservative policy hawks parallels the relative utility question of a butter knife versus a cleaver. Like knives, derivatives come in all shapes and sizes. Most Americans responsibly butter their toast and cut their steaks, nonetheless if put in the wrong hands, knives can lead to minor cuts, lost fingers, or even severed arteries.

That reckless behavior was clearly evident in the unregulated CDS market, which AIG alone, through its Financial Products unit in the U.K., grew its exposure to a mind boggling level of $2.7 trillion in notional value, according to Andrew Ross Sorkin’s book Too Big to Fail. The subprime market was a big driver for irresponsible CDO creation too. In The Greatest Trade Ever, Gregory Zuckerman highlights the ballooning nature of the $1.2 trillion subprime loan market (about 10% of the overall 2006 mortgage market) , which exploded to $5 trillion in value thanks to the help of CDOs.

Derivatives History

However, many derivative products like options, futures, and swaps have served a usefull purpose for decades, if not centuries. As I chronicled in the Investing Caffeine David Einhorn piece, derivative trading goes as far back as Greek and Roman times when derivative-like contracts were used for crop insurance and shipping purposes. In the U.S., options derivatives became legitimized under the Investment Act of 1934 before subsequently being introduced on the Chicago Board Options Exchange in 1973. Since then, the investment banks and other financial players have created other standardized derivative products like futures, and interest rate swaps.

Volcker Expands on Financial Engineering Innovation

In his comments, former Chairman Volcker specifically targets CDSs and CDOs. Volcker does not mince words when it comes to sharing his feelings about derivatives innovation:

“I hear about these wonderful innovations in the financial markets, and they sure as hell need a lot of innovation. I can tell you of two—credit-default swaps and collateralized debt obligations—which took us right to the brink of disaster…I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.”

 

When Volcker was challenged about his skeptical position on banking innovation, he retorted:

“All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without credit-default swaps and without securitization and without CDOs.”

 

Cutting through Financial Engineering

The witch-hunt is on for a financial crisis scapegoat, and financial engineering is at the center of the pursuit. Certainly regulation, standardized derivative contracts, trading exchanges, and increased capital requirements should all be factors integrated into new regulation. Curbs can even be put in place to minimize leveraged speculation. But the baby should not be thrown out with the bathwater. CDSs, CDOs, securitization and other derivative products serve a healthy and useful purpose towards the aim of creating more efficient financial markets – especially when it comes to hedging. For the majority of our daily requirements, I advocate putting away the dangerous cleaver, and sticking with the dependable butter knife. On special occasions, like birthday steak dinners, I’ll make sure to invite someone responsible, like Paul Volcker, to cut my meat with a steak knife.

Read Full WSJ Article with Paul Volcker Q&A

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 time of publishing had no direct position in any company mentioned in this article, including AIG. 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.

January 8, 2010 at 12:08 am 4 comments

Back to the Future: Mag Covers (Part I)

 Magazine Covers Part II  – – – Magazine Covers Part III

I’m not referring to the movie, Back to the Future, about a plutonium-powered DeLorean time machine that finds Marty McFly (played by Michael J. Fox) traveling back in time. Rather, I am shining the light on the uncanny ability of media outlets (specifically magazines) to mark key turning points in financial markets – both market bottoms and market tops. This will be the first in a three part series, providing a few examples of how magazines have captured critical periods of maximum fear (buying opportunities) and greed (selling signals).

People tend to have short memories, especially when it comes to the emotional rollercoaster ride we call the stock market. Thanks to globalization, the internet, and the 24/7 news cycle, we are bombarded with some fear factor to worry about every day. Although I might forget what I had for breakfast, I have been a student of financial market history and have experienced enough cycles to realize as Mark Twain famously stated, “History never repeats itself, but it often rhymes” (read previous market history article). In that vein, let us take a look at a few covers from the 1970s:

Big Bad Bear 9-9-74

Newsweek’s “The Big Bad Bear” issue came out on September 9, 1974 when the collapse of the so-called “Nifty Fifty” (the concentrated set of glamour stocks or “Blue Chips”) was in full swing. This group of stocks, like Avon, McDonalds, Polaroid, Xerox, IBM and Disney, were considered “one-decision” stocks investors could buy and hold forever. Unfortunately, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the1973-74 period.

Why the glum sentiment? Here are a few reasons:

  • Exiting Vietnam War
  • Undergoing a Recession
  • 9% Unemployment
  • Arab Oil Embargo
  • Watergate: Presidential Resignation
  • Franklin National Failure
Crash Through China

A cartoon from the same bearish 1974 cover article.

Not a rosy backdrop, but was this scary and horrific phase the ideal time to sell, as the magazine cover may imply? No, actually this was a shockingly excellent time to purchase equities. The Dow Jones Industrial Average, priced at 627 when the magazine was released, is now trading around 10,247…not too shabby a return considering the situation looked pretty darn bleak at the time.

 Reports of the Market’s Death Greatly Exaggerated

Death to Equities 8-13-79

Sticking with the Mark Twain theme, the reports of the market’s demise was greatly exaggerated too – much the same way we experienced the overstated reaction to the financial crisis early in 2009. BusinessWeek’s August 13, 1979 magazine captured the essence of the bearish mood in the article titled, “The Death of Equities.” This article came out, of course, about 18 months before a multi-decade upward explosion in prices that ended in the “Dot-com” crash of 2000. In the late 1970s, inflation reached double digit levels; gold and oil had more than doubled in price; Paul Volcker became the Federal Reserve Chairman and put on the economic brakes via a tough, anti-inflationary interest rate program; and President Jimmy Carter was dealing with an Iranian Revolution that led to the capture of 63 U.S. hostages. Like other bear market crashes in our history, this period also served as a tremendous time to buy stocks. As you can see from the chart above, the Dow was at 833 at the time of the magazine printing – in the year 2000, the Dow peaked at over 14,000.

The walk down memory lane is not over yet. Conveniently, the Back to the Future story was designed as a trilogy (just like my three-part magazine review), so stay tuned for “Part II” – coming soon to your future.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

 

DISCLOSURE: Sidoxia Capital Management (SCM) has a short position in MCD at the time this article was originally posted. SCM owns certain exchange traded funds, but currently has no direct position in Avon (AVP), Polaroid, Xerox (XRX), IBM or Disney (DIS). 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.

November 11, 2009 at 2:00 am 8 comments


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