Category Archives: Global Economics

Life is going to turn very nasty if we can’t solve the growth puzzle

My Comments: I’ve written before about income inequality and the effect it will have on society if we do not find a solution.

The ever long crisis in the Middle East arises from vast segments of the population having very little compared to a small ruling class who have a lot. Using religion as a way to remedy their poverty is all they have left in a society where democracy is essentially a sham.

The US built it’s global leadership in the 20th Century on the backs of the middle class who had a realistic expectation of rising up the economic ladder toward prosperity. That is now disappearing. Think college students borrowing money to gain an education and being saddled by crippling debt until they reach middle age.

Prosperity permeated society. The upper class paid taxes to help the lower classes because it gave them more money with which to buy stuff. Our military was second to none across the planet. Today the middle class in the United States is shrinking. The number of working poor is rising. Birth rates are declining. The 1% are favored by our leaders with tax cuts. Add the effects of a con man in the White House and things are going to get nasty.

This is a long article, written for Britain specifically, but for any of you concerned about the world your children and grandchildren will inherit, you need to pay attention and vote accordingly. Assuming there are candidates who also understand this looming problem and are willing to fight to solve it.

by Andrew Rawnsley \ November 25, 2017

One of the earliest examples of the personal computer was the LGP-30. Created in 1956, it had a tiny fraction of the processing power contained in the slim phone that I carry in my pocket. This artefact from the Jurassic era of computing was also excruciatingly expensive. Its retail cost was $47,000. That’s more than $400,000 in today’s money.

This is one way of illustrating why productivity matters so much. It is by improving the efficiency of making things that more people can have better stuff at cheaper prices. Getting more from each hour worked allows wages to rise, lifts living standards and boosts the tax take to finance additional government spending on desirable services. It is this which ultimately underwrites political promises and makes us feel we are getting better off. Absent improvements in productivity, everything else goes to pieces. Including politics. Especially politics.

Which is why it wasn’t any of the big sounding numbers in the budget that counted. The figure that really mattered was a tiny one. That number was 1.2%, which is the revised amount by which the Office for Budget Responsibility thinks productivity will grow per year. From that alarmingly small number, it projects other frighteningly small numbers. The economy will grow by less than 2% in each of the next five years. That means protracted wage stagnation. This forecast, grim as it sounds, is based on one rosy assumption, which is that Brexit has a relatively benign effect on the economy. A bad Brexit would make things considerably worse.
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These small numbers have large consequences. The period since the Great Crash of 2008 is turning into the most stagnant era for living standards since records began. If Britain is now stuck in a low-growth rut, this will be massive. It will fundamentally reshape political argument and very likely blast apart existing parties. It already is. We will be taken in directions that will be highly challenging and to places that could be extremely unpleasant. For all of the life of every adult living in Britain, there have been economic ups and downs and governments have come and gone with the booms and busts. Yet the overall picture has seemed steady. It was the shared assumption of both politicians and voters that the economy would expand at a reasonable clip over time. It was the essential foundation of the expectation that most people would be better off than their parents. The parties argued about how to divide the cake, but they shared a belief that the size of the cake would carry on growing at a respectable rate. That made the dividing business a lot easier. If the cake ceases to grow – or increases at such a glacial pace that it feels like a stop to many folk – that is going to have vast implications.

Let’s start with the least important consequence, which is what this might mean for our current rulers. It has been a rough-and-ready rule that governments improve their chances of re-election if most people feel they are becoming better off. “You’ve never had it so good”, as Harold Macmillan didn’t quite say on his way to an election victory in 1959 as an incumbent presiding over a buoyant economy. Governments struggle to retain support if voters think living standards are stalling or falling.

This rule doesn’t explain everything about election results, but it is a significant component of most. Take our two most recent contests. In 2015, David Cameron was lucky that the timing of the election coincided with a brief period when real disposable incomes were rising. It helped him to justify the pain of austerity on the grounds that a pay-off was beginning to show up in people’s pockets. The Tories improved on their performance of five years earlier and won a narrow majority. Two years on, Theresa May chanced her arm with the electorate when real disposable incomes were once again being squeezed. She tried to change the subject by making the June election about other things, notably Brexit, but that didn’t really work. The stagnation of living standards gave traction to Jeremy Corbyn’s argument that the rules of the economy are rigged in favour of the rich. The Tories lost their narrow majority.

That was not the only difference between those two elections, but it was one of the important ones. If the Tories can stretch this parliament to its full length, they will next face the voters in 2022. You wouldn’t fancy their chances if most people are feeling no better off than they do now and some feel worse off than they were at the time of the Great Crash. Put another way, if Labour were not to win the next election in those circumstances, Labour would only have itself to blame. A low-growth future will be nightmarish for governments of any complexion. It will be much harder to fulfil their promises. Every budget will be difficult. To raise the funds to meet pressure for spending on public services, taxes will have to go up – and it won’t be just “the rich” and companies paying more. Or there will have to be a moderation in expectations of what the state can deliver.

The challenges of a low-growth era will be just as sharp for Labour as for the Tories. It may be more acute for Labour with its historical impulse to promise a New Jerusalem. John McDonnell can use the growth forecasts to attack the current management, but he’d best hope that they are not accurate if he ever ends up in the Treasury with responsibility for trying to find the money to make good on all of Labour’s spending promises. The solution won’t be found on an adviser’s iPad.

In a low-growth future, there might be more of an audience for the view that we over-emphasise economic goods. If there’s not much growth to be had anyway, the Greens and those of a similar inclination could win a wider hearing for the contention that there are more important things in life. My hunch is that it will take a long time to acclimatise most citizens to the idea that growth is no longer a given.

One likely effect on political argument is that it will become more ferociously polarised, an amplification of a trend that is already evident. Desperate times breed more extreme remedies. It is no coincidence, as the old Marxists liked to say, that Brexit, Trump and other populist eruptions have occurred during the long squeeze on living standards that has followed the financial crisis. Brave politicians may try to start an adult conversation with the electorate about the hard choices that follow from low growth. The cowardly, the desperadoes and the unscrupulous will take the national conversation in darker directions. If they can no longer plausibly promise to make people better off, some pursuers of power will seek to create dividing lines around identity and nationality. That ugly trend is already manifest at home and abroad.

A more beneficial use of political energy would be to find out why growth has become so anaemic and do something about it. Politicians have been slow to come to a subject that has been troubling economists for some time. All the advanced economies are struggling with “the productivity puzzle”. The syndrome does seem especially chronic in Britain, but it is not unique to us. This is unfortunate. If other countries had cracked the problem, economists would no longer call it a “puzzle” and we could copy the solutions.

The left contends that low wages, inequality and corporate hoarding are the principal villains. The right prefers to find the fault in regulation and tax. There is merit in various arguments, even if they always seem to suit the pre-existing prejudices of those advancing them. There are some obvious things that government can try to do, such as addressing skills shortages and deficient infrastructure. There are some obvious things that government ought not to do, such as disrupting the relationship with our most important trading partners. But the fact that the “puzzle” is afflicting a wide variety of countries with different political histories suggests that there is not one simple, catch-all cause or solution.

A politically neutral explanation for low productivity growth is that humanity is simply not coming up with enough breakthrough ideas. Ever since the first clever woman lit the first fire, human progress has been powered by discovery, from seasonal crop rotation, to the steam engine, to the computer chip. Ingenious members of our species are still coming up with smart innovations, but it is argued that none of them is significant enough to trigger a new wave of growth.

Are there any sources of optimism? Some. I’ve a hunch that “driverless cars” are not the miracle solution, and my scepticism is reinforced because so many politicians are trying to get into them, but humanity hasn’t lost its talent for invention. Another hope is that economists are wrong, which they often are. One reason they could be wrong about growth prospects is because it has got harder to accurately measure productivity. They may be too pessimistic about it.

If the future is low growth, our politics will change in ways which could be very nasty. Let’s hope that the economists are wrong. Or that someone out there has a very clever idea.



Maybe We Should Take Socialism Seriously

My Comments: To me, it’s both pathetic and amusing to hear political candidates rail against the idea of ‘socialism’ and declare it’s mankind’s greatest threat.

Like so many of the ‘…isms” applied to economic models of all stripes, socialism is no more a threat to the health and welfare of any society than is capitalism or communism. Well, maybe communism, but certainly not capitalism.

Unfettered capitalism, as some would have it today, is not far from the feudalism of long ago in that the masses would be under the thumb of a wealthy elite whose only motivation is the preservation of their power. Does any of that sound familiar to you?

by Noah Smith \ October 26, 2018

When President Donald Trump’s Council of Economic Advisers released a 55-page report called “The Opportunity Costs of Socialism,” many economists scoffed. But the report is important, because it shows that big, systemic economic issues are again being considered. And it provides an interesting jumping-off point for those important discussions.

Two decades ago, it seemed as if capitalism had decisively won the battle of ideas. The collapse of the Soviet Union and the grinding poverty of Mao’s China and communist Vietnam and North Korea clearly demonstrated that the most extreme versions of socialism were disastrous. But even in non-communist countries, attempts at regulation, nationalization and redistribution suffered big setbacks. The License Raj, a system of heavy-handed business regulations in India, was repealed, and the country’s growth leapt ahead. Privatizations and other market-oriented reforms in the U.K. helped the British economy make up ground it had lost. Sweden made its fiscal system much less progressive, and North European countries deeply reformed their labor market regulations.

But as inequality of income and wealth steadily rise in countries like the U.S., and as populism and political discontent roil nations across the globe, some are beginning to question the consensus that emerged at the end of the Cold War. Polls show an increasing number of young Americans responding favorably to the word “socialism”:
Openly socialist candidates are starting to win a few elections in the U.S., and calls to end capitalism are starting to appear in the mainstream news media with increasing frequency.

The CEA’s new report should be seen in this light. It’s an indication that both socialism’s proponents and its opponents have begun to take the idea seriously again. With the world troubled not just by inequality but also by productivity stagnation and the threat of climate change, it’s time to ask whether there are big systemic improvements that could be made.

The CEA report shows just how long it has been since such a discussion was held. A key explanation of socialism is taken from “Free to Choose,” a 1980 book by Milton and Rose Friedman. The economics profession has shifted decidedly to the left since those days, but most economists now concern themselves with highly specific topics rather than the grand sweep of political-economic systems. The people spending their time thinking about socialism, capitalism and other really big ideas are now more likely to be the writers of Teen Vogue or activists on Twitter. Let’s hope the CEA report will prod more economists, who tend to have more empirical knowledge and theoretical depth, to think bigger.

But although it’s an important conversation starter, the report doesn’t do a good job of comprehensively debunking socialism in all its forms. Some of the examples it invokes are particularly inapplicable to the modern day, and it overlooks much of the evidence in favor of an expanded role for government.

For instance, the report highlights collectivized agriculture as a prominent example of a socialist failure. Collectivized farming is indeed a disastrous policy, failing essentially everywhere it has been tried, and leading to widespread famine and death. But modern-day socialists in Western countries are — wisely — not calling for this. Instead, the industries they want to nationalize are health care and (possibly) finance.

Socialized health insurance exists in many countries — for example, France, Canada, and Japan. The costs and benefits of government health insurance systems don’t have to be assumed — they can be observed. The U.S., with its unique hybrid of public and private insurance, pays much more than other rich countries for the exact same medical services — and achieves similar health outcomes. Meanwhile, the U.S. biggest government health insurance system, Medicare, holds down prices much more effectively than its private counterparts:

Higher Tariffs Won’t Work Now Because They Never Did

My Comments: At the national level, if we want more money to spend, both on ourselves as citizens and at the Federal level on things that require money to finance, please tell me why this administration insists on doing things that will result in less money.

Yes, I know, the old and wealthy white cadre somehow feel threatened by those with brown and black skin, but come on!

We’ve pulled out of the Trans Pacific Partnership, effectively ceding global economic supremacy to China, we’ve enacted tax rules that will effectively bankrupt the middle class, what’s left of it, over the next two decades and beyond, and as these comments about tariffs show, will result in slower economic growth in this country.

How does any of this Make America Great Again ?????

By Al Root \ Oct. 26, 2018

Smoot-Hawley is a dirty word in economics. That law, named for its congressional sponsors, raised tariff rates significantly as the global economy was weakening. It was passed in January 1930, just weeks after the stock market crashed on Oct. 24, 1929—Black Thursday. That’s the ultimate in pro-cyclical policy making—kicking the economy when it’s down. We still are taught about the Great Depression in American schools, but the impact of the Smoot-Hawley tariffs may be forgotten by the general public.

After all, the current generation of investors only knows a world with declining trade barriers. The General Agreement on Trade and Tariffs (GATT) was signed after World War II in 1948. That was the precursor to the World Trade Organization (WTO), which was formed in 1995. China joined the WTO in 2001 which helped usher in the boom in fixed-asset investment witnessed there in the early 2000s.

Don’t forget the European Union was also formed in 1993. That improved personal mobility on the continent and then the euro was adopted in 1999. Closer to home, the North American Free Trade Agreement (Nafta) was finalized in 1992.

The story of trade liberalization over the last 130 years can be seen by looking at U.S. customs receipts versus the size of the American economy. This is a proxy on tariff rates and, importantly, it pre-dates the global institutions that most of us have grown up with.

Tariffs were higher in the past, but don’t forget the federal government used to fund itself with customs duties. The U.S. didn’t have federal income tax until 1913. The first tax bracket was a levy of 1%. Talk about a different era.

That chart also shows that tariff rates were persistently high in the 1930s. The U.S. government was, apparently, slow to change its thinking on trade. The Barron’s forecast, shown with the blue bars, tries to imagine a worst-case scenario where all Chinese product imported to America is taxed at 25%. The level of trade-taxation looks significant, but predicting how long this era of trade readjustment will last is more important for understanding the long-term impacts.

Barron’s spoke with Gian Maria Milesi-Ferretti, deputy director of the research department at the International Monetary Fund, to talk about tariff distortions. The IMF is still using its influence to promote open markets – “no (trade) agreement is perfect, things can be tweaked, but we believe strongly in multilateral cooperation.”

Milesi-Ferretti talked in detail about the impacts of tariffs, some of which are harder to characterize than others, and added “global supply chains are highly integrated,” a fact that is different today versus other prior eras.

Clearly, the world is worried about trade tensions. The doctrine of trade liberalization appears to be under siege and companies are talking about higher procurement costs impacting 2019 profits. Presently, the short-term impact of higher costs may be well understood, but the bigger question remains. What impact will trade conflict have in 2020 and beyond?

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‘Rolling Bear Market’ Will Paralyze Stocks for Years: Morgan Stanley

My Comments: It became accepted wisdom that a properly diversified stock portfolio can indefinitely absorb an annual 4% withdrawal rate to satisfy a need for retirement income.

That assumption is now disappearing. There is growing sentiment that over the next decade, if not longer, a 4% withdrawal rate will lead to the exhaustion of your reserves, leaving you with no money with which to pay your bills.

This story talks to this and suggests what we’ve recently seen as a solid return on investments is changing.

By Shoshanna Delventhal | September 14, 2018

U.S. stock investors should brace for a market that will be paralyzed for several years in a narrow trading range, according to one team of analysts on the Street, and as reported by CNBC. Investors are already in the midst of a “rolling bear market” that will push the S&P 500 down as much as 17% and no higher than 4% from today’s levels, Morgan Stanley’s chief equity strategist, Michael Wilson, told clients in a recent note.

“We think this ‘rolling bear market’ has already begun with peak valuations in December and peak sentiment in January,” stated Wilson.

What A Rolling Bear Market Looks Like

High: 3000, up 4%
Low: 2,400, down 17%

Earnings Deceleration Caused by Higher Input Prices

Unlike a typical bear market, where stocks fall simultaneously, Morgan Stanley says the “rolling bear market” will rotate from sector to sector and even from stock to stock, as the weakest are hit first and the hardest. As a result, the investment firm indicates that assets like bitcoin, the world’s largest cryptocurrency by market capitalization, as well as emerging market debt equities, base metals and homebuilders could prove particularly risky.

He expects the rolling bear market to accelerate as the investors send shares down on weaker than expected earnings, driven by higher supply-side inputs like energy, transports, labor, funding, tariffs and material costs.

“We view the rate of change in earnings growth as one of the most important drivers of equity prices broadly; so our belief that earnings growth is likely to slow more in 2019 than the market anticipates is important for our less optimistic view on equities,” wrote Wilson, who is the most bearish strategist tracked in CNBC’s regular survey. His June 2019 S&P 500 target of 2,750 implies a 5.2% downside from current levels. At 2,901 as of Thursday morning, the S&P 500 reflects an 8.5% return year-to-date (YTD).

These Rolling Bear Market Sectors Are at Risk:
Emerging Market Debt
Emerging Market Equities
Base Metals

Information Technology Looks Risky

Wilson reiterated a pessimistic outlook for high-flying information technology stocks. “It makes sense to lower broad exposure in the near term as elevated valuations, lack of material earnings upside against expectations, extended positioning, technicals, and trade-related risks all add up to a poor risk reward for the sector in the near term,” he wrote.

In May, Morgan Stanley first forecasted the rolling bear market, which it says is now upon us, and recommended stocks that would thrive in this kind of environment. In the report titled, “30 for 2021: Quality stocks for a 3-year holding period,” analysts highlighted players such as video game maker Activision Blizzard Inc. (ATVI), financial firms The Charles Schwab Corp. (SCHW), JPMorgan Chase & Co. (JPM) and BNY Mellon (BK), consumer brands leader Constellation Brands Inc. (STZ), and search giant Alphabet Inc. (GOOGL) as safe bets in the rolling bear market.

Retiring Soon? Plan for Market Downturns

My Comments: Are you nervous yet? If you have 20 years or so until you retire, you may not need to be nervous. But if retirement is just around the corner, then you need to start being defensive, if you’re not already.

There are a number of pressures building in the markets. This gives you a few steps to offset them. Personally, I think the average annual returns over the next decade are going to be significantly less that what they’ve been since 2009.

The author’s syntax is a little confusing but you’ll get the message.

By Anne Tergesen | Sept. 21, 2018

For every year by which a bull market persists, staff change into likelier to retire. However those that depart the workforce now—the ninth yr of the longest U.S. bull market—are probably setting themselves up for a tricky stretch that might check their portfolio’s long-term resilience.

Why? When the inventory market turns into traditionally costly, as some metrics recommend it’s at present, analysis reveals it’s typically a harbinger of below-average future returns. This may be particularly painful for retirees with lengthy life expectations as a result of withdrawals mixed with poor returns will depart much less in an account to compound over many years.

Take, as an illustration, a 65-year-old who retires when his or her portfolio is price $1 million. If the retiree withdraws 4%, or $40,000 within the first yr, and the portfolio loses 40% of its worth quickly after, she or he can have simply $576,000 left to fund a retirement that might final 30 or extra years. Any subsequent withdrawals will make it even tougher for the portfolio to get better.

Returns in “the primary 5 to 10 years of retirement matter most,” says Wade Pfau, a professor of retirement revenue on the American Faculty of Monetary Companies in Bryn Mawr, Pa. Early declines can “lock a portfolio right into a downward spiral.”

That doesn’t imply that individuals on the cusp of retiring ought to cancel their plans. For one factor, it’s notoriously tough to foretell the arrival, length and severity of bear markets. And if you’re prepared to go away your job, sticking round might undermine your well being and happiness.

The excellent news: There are steps you possibly can take to restrict withdrawals from shares when they’re down and partly shield your portfolio. Simply make sure to perceive the trade-offs.

1. Construct a money cushion

This technique sometimes includes setting apart one to 5 years of dwelling bills in money so that you received’t must promote shares at depressed costs.

Retirees with money buffers typically react extra calmly to market declines, decreasing the percentages that they are going to panic and bail out of the market fully, says Ross Levin, a monetary adviser in Edina, Minn.

The issue, Mr. Levin says, is that the low returns on money typically cut back a portfolio’s long-term returns. “If in case you have 80% in shares and 20% in bonds with a three-year money place, that’s a worse technique from a returns standpoint than having 70% in shares and 30% in bonds,” and nothing in money, he says. A money buffer “lets you handle a shopper’s psychology throughout dangerous instances, however it’s not an optimum technique.”

To unravel that drawback, some advisers as a substitute use bonds as a buffer. A $1 million portfolio with 60% in shares and 40% in bonds successfully holds eight years of dwelling bills in bonds, Mr. Pfau says.

But when shares sink and a retiree must liquidate bonds to cowl dwelling bills, the buffer is more likely to shrink.

To stop purchasers from promoting shares at depressed costs to replenish their bonds, many advisers advocate ready till the shares get better their losses to take action. However an investor who used such a method in 2008—when the monetary disaster slammed U.S. shares—would have had to attract down his or her bond buffer for about 5 years earlier than beginning to construct it again up, a nerve-racking expertise for all however the least risk-averse, Mr. Pfau says.

2. Rebalance

A greater technique, many say, is to spend money on a diversified portfolio—resembling 60% in shares and 40% in bonds—and rebalance it after main market strikes.

Retirees who accomplish that will use their winners to cowl at the very least a few of their bills. For instance, in 2008, when the S&P 500 misplaced about 37%, investment-grade bonds gained about 5.25%. Consequently, somebody who had 60%, or $600,000, in shares and 40%, or $400,000, in bonds earlier than the crash had 47%, or $378,000, in shares and 53%, or $421,000, in bonds afterward.

If a retiree with such a portfolio wanted $40,000, he would begin by withdrawing the $21,000 of bond income. As a result of bonds comprise considerably greater than 40% of the post-crash portfolio, the investor would whittle them additional, by withdrawing the extra $19,000 in spending cash he wants. To re-establish the specified 60% stock-40% bond allocation, he would then switch $77,400 extra to shares from bonds.

In distinction to holding a “money buffer,” this method “systematically ensures” that an investor sells holdings which have appreciated most whereas additionally shopping for issues which have declined and are comparatively low cost, says Michael Kitces, director of wealth administration at Pinnacle Advisory Group Inc. in Columbia, Md. By shifting cash into belongings which are crushed down, rebalancing helps a portfolio get better quicker when a turnaround lastly arrives, he provides.

In keeping with latest analysis, which checked out 140 mixtures of funding methods, withdrawal charges, and buffer-zone sizes over successive 30-year durations from 1926 to 2009, traders got here out forward with cash-buffer methods in solely three cases. In distinction, with rebalanced portfolios, they got here out forward in 70 simulations, stated co-author David Nanigian, affiliate professor of finance within the Mihaylo Faculty of Enterprise and Economics at California State College, Fullerton. Within the remaining 67 mixtures, the methods carried out the identical, he stated.

How typically must you rebalance? Some traders accomplish that quarterly or yearly. Cameron Brady, an adviser in Westlake, Ohio, says he acts when his purchasers’ portfolios drift by 5 proportion factors from goal allocations.

3. Use one other kind of buffer

What in case you like the concept of a money buffer, however don’t wish to tie up a portion of your portfolio in an asset that’s certain to earn low returns?

To supply purchasers with a supply of money within the occasion of a market meltdown, some advisers advocate utilizing home-equity traces of credit score or reverse mortgages, which permit folks ages 62 and older to transform their house fairness into money.

Each cost upfront charges. For instance, the upfront “mortgage insurance coverage premium” many debtors pay on reverse mortgages is now 2% of the house’s worth, capped at $13,593.

With a home-equity line of credit score, Mr. Pfau says, debtors should make month-to-month repayments. (Reverse mortgages should be repaid when the borrower dies, strikes, or fails to pay property taxes or house owner’s insurance coverage.) Each cost curiosity.

Mr. Pfau recommends that individuals with everlasting life insurance coverage, together with entire life and common life insurance policies, take into account tapping the money worth in these insurance policies throughout market crises. You may withdraw premiums tax-free and in addition borrow from the money worth to get extra tax-free revenue, he says.

“You’ll cut back the loss of life profit,” he provides, “however by serving to to protect the portfolio, you’re in all probability higher off.”

[ Wall Street Journal ]

We’re underestimating China’s economic power. Here’s why

My Comments: By first choosing to opt out of participating in the Trans Pacific Partnership (TPP) and then inviting a trade war with China, the US has effectively ceded global economic supremacy to China. The expressed logic behind these moves was in the guise of ‘Make America Great Again”. Hah!

In turn, China is attempting to match their new found economic supremacy with military supremacy. It’s only a matter of time before we find ourselves in a conflict or “Cold War” with echoes of what we lived with years ago and the Soviet Union.

September 27, 2018 Knowledge@Wharton

China’s economy is so large – and growing so rapidly – that it’s difficult to get a true read on the size of its influence on the world stage, according to this opinion piece by David Erickson, a senior fellow and lecturer in finance at Wharton. Before he taught at Wharton, Erickson was on Wall Street for more than 25 years, working with private and public companies to raise equity strategically.

Some of the rhetoric out of Washington recently has been suggesting that the U.S. is “winning” the trade war because the U.S. stock market is near all-time highs as China’s domestic equity markets have declined significantly. While the domestic Chinese equity markets have suffered since the trade tensions started earlier this year, I think that premise underestimates the economic power of the rapidly growing number-two economy in the world and really needs a bit of context.

The Chinese equity stock market — as represented by Shanghai stock market — actually peaked in 2015. This is not too dissimilar from the market cycles we have experienced in the U.S. in the last 20 years. This includes what we saw in the Dow Jones Industrial Average (DJIA), which reached 11,000 in May of 1999 but took more than seven years to reach 12,000. While the DJIA advanced from October 2006 to July 2007 from 12,000 to 14,000, it took almost six years, until May 7, 2013, before it advanced to the 15,000 milestone. For the NASDAQ market, the cycle was even more dramatic where it took 15 years to reach new highs in 2015. Markets do go through cycles.

But hasn’t the Shanghai stock market been quite volatile since the trade war started? Yes, it has. This is not surprising with much of the domestic Chinese equity market activity largely being from retail investors, especially with many having very limited experience in Chinese equity investing (which I will address shortly). With the uncertainty of the trade rhetoric over the last few months, there was likely to be some significant volatility. However, by way of comparison, the U.S. equity markets went through significant volatility earlier this year after a significant run since the 2016 U.S. election. If you go back a bit further, the U.S. equity markets, which are largely institutionally driven, had significant periods of volatility during the 2008 Financial Crisis, where the DJIA fell almost 800 points on September 29th; the technology “bubble” in 2000, where on April 14th the NASDAQ fell 9% and for the week 25% (and the NASDAQ 100 index lost 78% of its value in two years); and when the Dow Jones fell almost 23% in one day on “Black Monday” of 1987.

Why do I go back to 1987 for context? Because in 1987, while a Wharton finance student could study “Black Monday” in the context of previous crashes in the U.S. stock market, the Chinese domestic equity market didn’t exist and wouldn’t until 1990. That’s right, a Chinese student studying finance on mainland China at the same time couldn’t learn about investing in the Chinese equity markets because it did not exist until a few years later. The Shanghai Stock Exchange was founded in 1990 (and Shenzhen around a similar time) creating a domestic equity market for both mainland Chinese companies to list and finance, and for Chinese institutions to invest. Today, it is estimated that the Shanghai Stock Exchange has over 200 million retail investors — total U.S. population is just 327 million — and for the full year 2017 was the number-two IPO market globally in terms of proceeds raised. So, while the Chinese equity market has suffered significant losses this year, given the “rapidity” of its evolution, these changes need to be put in context.

“Now, markets in Hong Kong, Shanghai and Shenzhen collectively represent the largest IPO market in the world….”

These are just a couple of the things we learned on our recent trip to Hong Kong, Shanghai and Shenzhen as part of Wharton’s MBA course called Strategically Investing in the Growth of China. A delegation of 58 Wharton Executive MBA students, along with three faculty members, met with prominent Chinese companies, leading Chinese public equity and private equity investors, as well as representatives of the Hong Kong and Shanghai Stock Exchanges, and explored how they strategically invest in the growth of China. While I had been to China many times during my previous investment banking career (though the last time was in 2013 before I retired), about 85% of our students had never been to Hong Kong or mainland China.

When we started our trip, given that many of our students had never been before, I wanted to give them a few numbers to provide some context as to the size and scope of the Chinese economic opportunity. Here are some of them — all approximations:
• a population of 1.4 billion people;
• 620 million mobile internet users as of 2015, according to China’s Mobile Economy: Opportunities in the Largest and Fastest Information Consumption Boom;
• 400 million in the middle class.

And to get some sense of the rapidity of the change:
• Exports have grown for the last 30 years at a 17% compound annual growth rate (CAGR), making China the world’s largest exporter at $2.3 trillion in 2015, according to The China Questions – Critical Insights into the Rising Power;
• In 1980 about 70% of Chinese labor force was in agriculture; by 2016 only 30% was in agriculture;
• In 1980 only 2% were university educated; by 2016, approximately 30%;
• In 1980 Shenzhen had a population of 30,000; by 2016, Shenzhen had a population of some 12 million.

What I realized as we progressed through our visits to these companies and investors was that these numbers were understated, and significantly under-estimate the economic power of China. Let me outline three of the specific attributes that we learned about and discussed as part of our trip:

In Defense Of Playing Defense (Part 3)

My Comments: On Wednesday I usually talk about Globla Economics. Today, however, I’m less concerned about emerging markets than I am the evolution of ideas that influence what is happening on Wall Street. Yes, it’s influenced by the hiccups we see in emerging markets globally but the political and economic forces at work in this country suggest the potential for something dramatic.

That’s a mouthful to absorb. What I hope you will get from these comments from Erik Conley is that being defensive right now with respect to your money is a good thing. I know I am with my money.

by Erik Conley, 9/18/2018

I lay out the case for playing smart defense in order to fill the hole that’s left open with the Buy & Hold approach.

When the stakes are high, it makes sense to have a contingency plan in place.

It is reasonable to expect that a solid Plan B could reduce the downside of these bear markets by at least 50%, which would have the effect of shortening the time it would take to reach one’s goals.

This idea was discussed in more depth with members of my private investing community, The ZenInvestor Top 7.

In part 1 of this series I posed the following question:
What would you do if you found out that your entire approach to investing was wrong? I said that this happens more often than you might think, and for a good reason. The investment advice industry, and the major financial media outlets, work hard to create the impression that the Buy & Hold method is far superior to any other approach that an investor can choose. But is this true?

In part 2 I closed with this thought:
The solution to managing risk with a B-H approach is to play smart defense. What’s that? My version is having a rules-based Plan B that is designed with one purpose in mind – shortening the amount of unproductive time that is wasted with a B-H approach.

Today in part 3, I will lay out the case for playing smart defense in order to fill the hole that’s left open with the B-H approach. Note that I’m not calling for anyone to abandon their B-H approach, especially if it’s been working well for them. What I’m proposing is adding a defensive piece to the B-H approach. Here’s how.

When the threat of a new recession, or a new bear market, is sufficiently high – turn to your Plan B.

Fans of the comedy show It’s Always Sunny in Philadelphia have come to know how the gang operates. After sitting around their (empty) bar and tossing around ideas about how to get people to come in and spend money, they finally agree on a Plan.

Each week the plan that the gang dreams up is more outrageous than the last one, and the plans never seem to work. What’s missing is that they never have a Plan B in case Plan A blows up, as it inevitably does. Maybe if they took the time and effort to make a backup plan, they could someday fill the bar with paying customers.

Here’s another couple of examples. Football coaches always have a Plan B ready to go if their original game plan isn’t working. Soldiers on the battlefield would never think about venturing beyond the compound without having a Plan B and a Plan C in place.

You get the idea. When the stakes are high, it makes sense to have a contingency plan in place. So what would a Plan B look like for a B-H investor?

Plan B. A rules-based, systematic procedure that is clear and concise – leaving nothing to chance.

Here are some of the steps that a B-H investor can take to manage downside risk.
• Sell your worst-performing holdings, and allow your best-performing ones to run. Review this monthly or quarterly.
• Set up news alerts on your main holdings. At the first sign of a regulatory body asking questions about accounting irregularities, misbehavior in the C-Suite, or a bad miss on an earnings report, sell first and ask questions later.
• If one of your companies announces a dividend cut, sell first and ask questions later.
• If you catch wind that the company may not be able to meet a loan recall, or roll over a line of credit, head for the door.
• If the company brings in a new CEO who has no experience in the business involved, leave quietly.
• If the CFO gives evasive or confusing answers to analyst questions on a conference call, sneak out the back door.

Macro signals
As I said earlier, recessions and bear markets are killers, especially when looked at from the perspective of time lost. The B-H promoters claim that there has never been a 20-year period in the market when investors lost money. This is true. But is it relevant? I think not, and here’s why.

We invest to grow our purchasing power. It’s that simple. But we don’t have an unlimited amount of time to accomplish this. There have been 4 really bad bear markets in the last century, and each one of them brought pain and suffering to investors. None of them suffered more than the true believers in B-H.

The investment business will tell you that bear markets are just part of the game, and if you are patient, you will recoup your losses in due time. This is another example of the mythology of B-H. It’s partly true, but it’s irrelevant. This approach requires you to sit back and watch as your life savings spend 10, 15, 20 years or more “under water.” When you finally get back to even, there is no getting around the fact that you have just wasted a significant amount of time getting to your ultimate goal, which is financial independence and security.

“Time is the one resource that can never be renewed. Once it’s gone you can never get it back.”

Major bull & bear markets throughout history
The table below shows all of the major bull and bear markets since the Great Crash of 1929. It shows what was happening at the time to cause the bear markets, the losses suffered by investors, the loss of time, the macro environment that was present during each event, and the bull market recoveries that followed.

According to my analysis, a B-H investor would have earned an average annual return of about 9.7% throughout this entire period. That’s not bad at all. But it would have taken much longer to reach her investing goals if she simply rode out all of the ups and downs along the way.

It is reasonable to expect that a solid Plan B could reduce the downside of these bear markets by at least 50%, which would have the effect of shortening the time it would take to reach one’s goals.

For example, an investor who used a simple moving average crossover system as a way to reduce equity exposure would increase their returns from 9.7% to 11.6% per year, over the entire time frame.

An investor who systematically avoided the worst parts of economic recessions, and the bear markets that accompany them, would have achieved an annual return of 12.22%.
And an investor who used both the recession warning model and the bear market probability model would have achieved an annual return of 14.10%.

The reason for these better outcomes is based on the fact that markets go through long periods of over-valuation and under-valuation, and an astute investor will pay attention to which environment is in play at all times. Today the market is somewhat overvalued, so it makes sense to reduce exposure to the riskiest parts of the capital markets.

Likewise, in 2003 and 2009, the markets were very undervalued, and it made sense at that time to increase exposure to the risky end of the market. This is not rocket science. It’s just common sense.

Everybody is a Buy & Hold investor until their account value starts going down.

Where do we go from here?

In the next installment, I will present a few options for playing smart defense. Moving average crossovers are one. Mean Reversion is another. Sector rotation is a third. They are all defensive strategies that can be part of a solid Plan B.

See you next time.

Note from TK: Read Mr. Conley’s original article HERE.