The S&P 500 sank 3.6% in the third quarter, yet the index was up 11.7% this year to date. The Dow was down 2.6% while the NASDAQ was down 4.12% for the quarter.
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Global short-term interest rates rose while expectations for the pace of rate hikes to slow and eventually stop during 2023. The impact of the abrupt departure from the ultra-low rates era may weigh on financial conditions in the quarters to come. Pressure is building as people consider taking fixed income with yields that have not been seen in a long time. This temptation to take guaranteed returns can be very disruption to a quality long-term strategy.
The Federal Reserve has now lifted interest rates twelve times since March 2022. The US economy has adjusted from a long period of ultra cheap money reasonably well. The September 30, 2023 issue of Barron’s featured a cover story entitled, “This Time Really Is Different for the Economy. Just Look at the Job Market’s Confounding Strength. Unemployment remains near historic lows even after the Fed’s aggressive rate hikes. What’s behind the job market’s resilience—and why it could last.”
The commentary notes:
“There is no single satisfactory explanation for what has gone right so far. Instead, a delicate combination of factors appears to have bolstered the labor market, including generous fiscal stimulus, unexpectedly strong labor-force participation, a rebound in immigration, a boom in small-business creation, and continued growth in in-person services sectors…”
It is unfortunate that the ultra-low interest rates could not have been raised in a more gradual process, yet here we are at levels considered more “normal”. The cheap money was funneling to all sorts of speculation and creating significant distortion throughout the global economy. The 2008 policy response of near free money created a disconnect in how the Dollar can be valued. Inflation was a distinct risk and the pandemic exacerbated rising prices in dramatic fashion.
This inflation threat is daunting to the financial system as it can spiral and feed on itself. It seems that the Federal Reserve has employed a strategy that is extreme, yet the economy has tolerated it exceedingly well.
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Economics is a social science that studies production, distribution, and consumption of goods and services. The “Dismal Science” attempts to investigate the choices that individuals, businesses, and governments make to allocate resources.
The “choices” component of Economics introduces psychology and behavioral elements. Economics was based on rational human economic decision making for much of its modern development. Adam Smith’s “Invisible Hand” functioned in a world populated by entities that were assumed to behave coherently or in some measure of self-interest.
The formal recognition that there was significant irrationality in financial behavior and decision making began to emerge in the 1970s. Kahneman and Tversky wrote in 1973, “In making predictions and judgments under uncertainty, people do not appear to follow the calculus of chance or the statistical theory of prediction, they rely on a limited number of heuristics which sometimes yield reasonable judgments and sometimes lead to severe and systematic errors”.
This convergence of psychology and behavioral science with economics produced information that led to a paradigm shift. The revelation that economic theory needed a significant behavioral component led to Daniel Kahneman being awarded the Nobel Prize in 2002.
The thinking component of our financial, investment and monetary decisions has been shown to be biased and impatient. The spectrum of mistakes the human mind is vulnerable to when combining mathematics, discipline and long-term planning is very broad.
The vast insights of economists in behavioral economics are now available to those seeking perspective on their potential blind spots and thinking deficiencies. Indications may point to little improvement as the ways in which we fool ourselves are inherent in the complexity and randomness of reality. Sadly, the availability of this information does not seem to be creating higher quality decision making across the population.
Foremost in this societal challenge is that the mind wants to conserve energy. The brain seeks “rules of thumb, shortcuts, and avoidance of deep assessment partly due to the vast amount of energy required to power the mind. So much of societal behavior seeks a solution by trial and error or by rules that are only loosely defined.
University of Utah management professor Bryan Bonner notes “proxies of expertise:” …our brain’s natural inclination to take shortcuts by focusing on the loudest – or even tallest – person in the room, as opposed to the actual expert on the matter at hand.
We tend to be selective in our biases, favoring our own beliefs while applying more scrutiny to novel and external ideas. A 2015 study indicated: “Reasoning research suggests that people use more stringent criteria when they evaluate others’ arguments than when they produce arguments themselves.”
Acknowledgment of cognitive bias is the first step towards dedicating ourselves to our investments and in our daily lives to work towards higher quality decision making. This challenge is likely to broaden and grow as the torrent of information that modern humans face is exponentially growing.
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“The amount of energy needed to refute bullshit is an order of magnitude bigger than to produce it”. This is known as The Bullshit Asymmetry Principle. To expand this powerful concept, let us note the following:
The ease of spreading false and/or unsubstantiated ideas that align with underlying fears or beliefs that flow from confirmation bias.
Amplification of silo-based communities spreading misinformation now broadcast at scale for near zero cost on various digital media mechanisms.
Moving the burden of proof away from the claim and towards those who wish to seek facts, by recklessly suggesting that something is “possible”.
Leveraging familiarity, where repeating something, even a lie, helps to foster it into our understanding and beliefs.
As investors we need to be aware of the ocean of questionable material that we will be confronted with. There are some basic mindset strategies that can buffer the nonsense.
Protections/Actionable Paths to rational perspective:
Occam’s Razor: The explanation with the fewest assumptions, rather than the convoluted web of causal factors is more likely.
Hitchen’s Razor: This principle states, “what can be asserted without evidence can also be dismissed without evidence.”
Scientific Method: Developing an informed hypothesis, then actively testing, and trying to falsify that hypothesis in order to develop a theory of how things function.
CRAAP: Currency, Relevance, Authority, Accuracy, Purpose
The CRAAP test provides a methodology to evaluate sources, including news. Considering the various criteria of the CRAAP test can help you to determine whether content should be deemed legitimate, cited, or shared.
Currency: When was the information published? Has the information been updated or revised?
Relevance: Who is the intended audience? Can the information be related to a topic in a clear understandable way?
Authority: Who’s the author, creator, or publisher? What are their credentials? Does the author’s educational background, experience, or organizational affiliation relate to the information in a meaningful way?
Accuracy: Is the information supported by evidence? Has the information been reviewed by professionals in its affiliated field?
Purpose: Does the information aim to inform or persuade? Is there any evidence of bias? Is the information based on fact or opinion?
There are many more ways to be wrong than to be right. Being correct, rational and reasonable is often not revealed until significant time has passed. External events (war, pandemic, political disruption) can make quality decision feel flawed or stupid. The process of investing is laden with hours of historical reference, logical reasoning, and examination of all manners of data. It is easy to fall into a trap of Manichean thought: seeing all manner of things as binary or good vs bad when nuance can often dictate no conclusive determination can be made.
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Labor unrest and strikes are a complex issue that we can attempt to parse through. Through review of multiple sources and historical reference, we can then begin to have some perspective. It seems that there is a reaping of consequences of the pervasive grievance mongering that has emerged from our political system. This labor unrest has also been impacted by the pandemic disruption and the reckless immigration clampdown during season one of the apprentice presidency.
The recent UAW strike has potential to crimp the domestic vehicle manufacturing landscape. The workers seem to be working from a playbook that was written generations ago. It is sad to consider that auto worker unions had been granted unsustainable levels of compensation in the era prior to the globalization of the vehicle marketplace. The era of General Motors as one of the most powerful corporations in the world has long since passed.
The most likely scenario is that the migration of heavy manufacturing will be pushed further to nonunion regions of the United States and outside the country. Only 7.2 million or 6% of the U.S. private workforce is unionized, down from nearly 17% four decades ago. The Big Three Detroit auto makers are suffering $15 million a day in lost income. That is ultimately a cost that all industry participants will bear.
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A changing of the guard atop the Fox media empire began on September 23 as Rupert Murdoch gave up the chairmanship at Fox Corporation. His statement encapsulates the ethos of this incredibly influential media organization:
Elites have open contempt for those who are not members of their rarefied class,” wrote Murdoch, a billionaire Oxford University alum, without any ironic regard to the fact that he is an iconic member of said group.
“Most of the media is in cahoots with those elites, peddling political narratives rather than pursuing truth.”
This is a parting message from the 92-year-old billionaire who has had global media influence at unheard of scale for decades. You might imagine that with all the incredible success of the Fox empire someone might make comments that are considered endearing or at least classy. Sadly, the narrative that there are groups, “in cahoots,” is standard rabble. “The Media” is an arm of the advertising business (period). The notion that Fox is a fighter for truth is difficult to reconcile with the actual product. Witness the recent $787m settlement with Dominion. “If it bleeds it leads”, has been cleverly replaced with provocation and the sad notion of relentless partisanship as entertainment.
Rather than producing costly and difficult investigative journalism that that is unlikely to result in profitable audience engagement, low-cost business models have been developed and refined without regard to societal impact. “Cable News” has degenerated into panels and roundtables of pundits and partisans. The concept of “Cable” has become obsolete as the shift to a fragmented streaming media array emerges.
The driver is profitability in media as in all forms of commerce. The infotainment complex that includes partisan media such as MSNBC and Fox are no different than endless sequels or fast food. The important takeaway is to remember that investors must seek understanding, not incidental impressions that shape beliefs in ineffective ways.
As is pointed out here every quarter, digital media is a pervasive force upon the public psyche. Pew research contends that “A little under half (48%) of U.S. adults say they get news from social media “often” or “sometimes” The foaming river of modern digital information is driving volumes of unfiltered, unedited material deep into the human psyche. The dramatic items that garner attention often fade with little impact or meaning yet it is impossible to filter out the distractions from important signals.
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Mar 2, 2018: “When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win,” Trump tweeted. “When we are down $100 billion with a certain country and they get cute, don’t trade anymore – we win big. It’s easy!”
The preceding statement is mind-boggling to consider in the context of generations of effort by the United States to bring the world into a rules-based trading system. The alternatives to globalization are likely to reveal higher costs, reduced innovation and declining international relations. In exchange we can at least rest assured that no countries will be “getting cute” whatever that could mean.
The WSJ ran a story on 9-9-23 titled, “Trade Slump Reshuffles World’s Economic Cards in Favor of U.S.” The following subheading stated, “Large, export-dependent economies from China to Germany are main losers from the new trend”.
The surge in demand for services after the pandemic is a more likely explanation. In fact, Peter Navarro, a principal architect of the recent trade “war” policies was just convicted of contempt of Congress. Mr. Navarro is a fascinating figure as he has been in politics since he ran for office in California five times, as a democrat, all unsuccessful. He spoke in support of the Clinton-Gore ticket in 1996 during the Democratic convention of that year. He was at times an independent, a republican and ultimately a vehement anti-China trade warrior.
Simon Johnson, an MIT economist wrote regarding Navarro’s ideas in 2016, “…its projections are based on assumptions so unrealistic that they seem to have come from a different planet.” According to estimates from Peterson Institute economists, for every steel-worker job saved by those tariffs—at a cost of $650,000 per job—more than eight were lost in the related industries that use steel and aluminum. The numbers are equally troubling in agriculture. The Peterson Institute for International Economics noted “Chinese buyers are diversifying toward other suppliers, while the US agricultural sector remains highly dependent on the Chinese market for its exports.”
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As we observe the current struggles of the federal government to fund operations, it is illuminating to look back at the tax cut era that began in the early 1980s. The Economic Recovery Tax Act was enacted on August 13th, 1981. President Reagan fostered a reduction in federal revenue by 2.9% of gross domestic product. This was a paradigm shift for tax revenue being paid to the federal treasury. Massive deficits immediately began a process of modification of the tax cut to reduce the impact on federal revenue.
When Reagan was elected, the top marginal income tax rate for individuals was 70%. This does not mean that high income earners actually paid the 70% rate as there were huge incentives for compensation not deemed to be wages, but instead corporate earnings and dividends. There was seemingly a lot of room to cut the top individual tax rates. The Reagan “tax cut” era emerged as the GOP became champions of the wealthy and reduction of the tax burden, particularly at the top.
Since the 1980s, the Republican Party’s approach to federal government sustainability changed. Instead of limiting deficits and debt, their top priority became cutting taxes – regardless of the consequences. Former Vice President Dick Cheney famously remarked, “deficits don’t matter” – meaning that there were no immediate political consequences of running a budget deficit and pushing up the national debt.
The Democratic Party approach is currently unmoored by economic reality. Filled with grandiose ambition and the notion that the Federal debt will somehow never matter. We are living in an era that will be forced to come to terms with generations of tax cuts and politicians who advocated them without the courage to also cut government programs. The drift of our binary system to a competition of political marketing ideas of little substance has left us without healthy debate and argument about the real challenges the country must address.
The point here is that our investments are subject to an infinite set of past events and actions combined with reaction to news, anxious narratives and the vast randomness that is human reality. The genius of the American system has also proven extremely resilient in the face of incredible challenge going back to the Nixon resignation, the disputed election of 2000, and of course the reality television recklessness of 2016.
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As Apple introduces the newest version of its pocket supercomputer it is hard to recall all the design and engineering that came before. The original iPhone was introduced on June 29th, 2007. During the presentation, Steve Jobs noted that the company dropped “computer” from its name and it was henceforth known as “Apple”. Apple stock was trading around $4.45 on that day. PC magazine and Macworld gave the iPhone mixed reviews. The Apple product was one of a crowded field of innovative devices that included Motorola, Blackberry and PALM. Rumblings of the “Financial Crisis” were around the corner. The market proceeded to convulse through early 2009.
The origin story of Apple illustrates how difficult it would be to accurately predict how incredibly successful the company has become. Hindsight bias would push our brain to incorrectly imagine that the success was foreseeable. The ups and downs of the company itself with the untimely loss of its founder, relentless competition globally would challenge any investor to hold the shares. To make the courageous decision in real time of investing in a technology hardware producer and hold throughout volatile ups and downs was extremely difficult.
The power of these devices transcends far beyond technological prowess. The simple observation of people will yield an endless number of fellow citizens literally glued to the small screen through which material flows persistently to the mind. More importantly, the communications of a pocket supercomputer have changed business communication and productivity profoundly.
The immense quantity of information has sadly resulted in an endlessly growing cloud of junk info. The low barriers to broadcast deceive the common citizen into a feeling of awareness. Like a grocery store filled to the rafters with items, this does not equate with gourmet meals.
Cooking is an art few can master. Synthesizing information is something akin to a master chef trying to craft a novel dish. Like a history professor attempting the composition of an impactful book how can we make sense of this information jungle?
It is crucial to recognize that most of the info stream is noise and will have a short shelf life and little meaningful value. Equally important is the task of remaining humble in our views as the sequence of events will not conform to prediction or theory.
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GameStop stock was a shiny object during the pandemic as the center of an implausible narrative that a defenseless company was being exploited by an organized band of short selling traders. The brief era of “meme,” or reddit based-stock traders began with a group of beaten down companies being hyped as viable investments. With a relentless narrative that the companies like BBY or AMC would be profitable and the redditors could band together buy the stocks that would be a gainful strategy.
Most investors that were drawn into the nonsense were unsophisticated and ultimately left with losses. The Meme trading was fraught with manipulation and most rational investors paid no attention. It was a classic pump and dump where messaging was broadcast relentlessly.
This created a wave of uninformed “traders” that were focused on social media messaging regarding stocks that were heavily shorted. This sudden buying hurt the short sellers initially and drove prices upward temporarily as the short positions were “squeezed”, forced to buy and GME rose massively.
This of course was all driven by excessive promotion over social media, as most of the companies involved were weak and not profitable. The heights of these stock prices were astounding and completely disconnected from any sustainable stock price. The gains have mostly reversed, and the stocks are back down near where they started or lost to bankruptcy. Those that entered late have been hit with dramatic losses.
The irony of this dramatic market event was that pointless attention was rendered to companies that were down and out. The marquee “meme” was a retailer of computer games. Computer games are built on graphics chips. For investors who invested in this graphics semiconductor sector the potential profits were significant. This is a sector that can possibly be held long term as a rational investment in the future of technology.
It turns out that graphics chips are showing promise in artificial intelligence. The notion that computers are making progress towards human abilities has become an exciting narrative of the next big breakthrough in technology. The AI mania has is filled with predictions of a world that will be changed in the manner of the printing press, the discovery of fire or the invention of the wheel.
The tech industry tends to overhype and over-promise, yet it may be that computing is on the precipice of a novel leap. Getting in on this emerging sector may or may not be profitable, but the economic prospects are immense. Incorporating this sector into a portfolio is a legitimate idea. Trading on social media images or internet gurus touting how to make a score is pointless. The recent mania has passed and left significant wreckage in its wake.
This recent event illustrates how events in the moment reflect noise that distracts and tells us little. Broad perspective is required for quality decisions to be made. Reading exciting narratives about beating the market and the key to riches is a trap.
Once again, we need to constantly reinforce and be mindful of the complexity and randomness of our human existence. Assuming that things can be figured out is a trap that ignores the patience and courage required to reach our full financial and human potential. The economy is functioning, and the political system is resilient beyond its current appearance. The next cycle cannot be predicted, but it will likely be very valuable to own.