Tag Archives: finance

When Stocks Only Go Up?

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Spoiler alert to the Wall Street Journal post, What Happens When Stocks Only Go Up – they don’t. But far more interesting than the impossibility of predicting a major correction, whether this time it’s really different, or some other alternative, is the exploration into the psychology of the investor (or trader):

In February 2020, before the pandemic had fully hit home, these investors estimated the odds of such a bear market at an average of only 4%. By April, just after the S&P 500 had fallen by one third, their expectations that the market would plunge again in the coming year nearly doubled to 8%.

Those fears swiftly faded. By last December, investors in the Vanguard survey estimated the probability of another crash in the ensuing 12 months at only 5%. That was slightly lower than their average estimate during the three years before the pandemic.

But one group was different:

…those who went into early 2020 with the highest expectations for stock returns in the upcoming year. They ended up reducing their exposure to stocks much more sharply during the crash of February and March 2020 than those who had been expecting lower returns.

Again, not necessarily by way of prediction but a historical account of the madness of the crowds that should at least give pause, “in the 1920s, a “new era” of technological disruption made caution look absurd—until stocks crashed by 89%.”

Optimism everywhere – as well as the expectation of inflationary pressures

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A post in the Wall Street Journal last week reported pre-pandemic levels of consumer confidence and for good reason(s), “as more people received vaccinations, stimulus payments reached households and businesses more fully reopened.” Employment, stimulus, an opening economy, vaccinations – all very compelling and obvious drivers to an overall feel of things, as well as the continued disucssion of inflation and how this will shape policy choices in the mid to long-term.

The University of Michigan Surveys of Consumers shows a consistent trend (with the next update in two weeks):

The survey adds the following commentary on inflation the finds support for either direction with:

Each side in the current policy debate finds support in the consumer data. The recovery is far from complete as less than half of the fall in consumer sentiment has so far been recovered, and the current and prospective stimulus and infrastructure spending has the potential to spark a renewed inflationary psychology, although that will not occur immediately…

Inflationary psychology preceded actual inflation by about two years in the last bout in the 1970s. The key balance is not to underestimate the ultimate impact of those policies on jobs and inflation, and not to overestimate the ability of policies to bring any excesses to a painless soft-landing.

Similarly, in the May 1 Berkshire annual meeting Buffett noted on the one hand the last 20 plus years, “was not a highly inflationary period as a whole,” but what they are seeing is:

…very substantial inflation. It’s very interesting. We’re raising prices. People are raising prices to us, and it’s being accepted. Take home building. We’ve got nine home builders in addition to our manufactured housing operation, which is the largest in the country. So we really do a lot of housing. The costs are just up, up, up. Steel costs, just every day they’re they’re going up. And there hasn’t yet been because the wage stuff follows. The UAW writes a three-year contract, we got a three-year contract, but if you’re buying steel at General motors or someplace, you’re paying more every day. So it’s an economy really, it’s red hot. And we weren’t expecting it.

When asked in the Q & A his thoughts on the worry of “more inflation or that we will have a pretty dramatic fiscal monetary collision,” Buffett diplomatically answered, “we don’t know.”

What a difference a year makes

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While the Fed continues its stimulus through low rates and bond buying, optimistic news continues as reflected in the following (and practically everywhere) which raises questions about the path forward:

Kelly, D. (2021, April 19). Economic Update. J.P. Morgan Asset Management. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/market-updates/economic-update/ 
Khan, K. (2021, April 23). Goldman Sachs says U.S. economic growth is peaking. SeekingAlpha. https://seekingalpha.com/news/3685126-goldman-sachs-says-us-economic-growth-is-peaking
Cox, J. (2021, April 23). The Fed is unlikely to hint at policy changes next week, even with a stronger economy. CNBC. https://www.cnbc.com/2021/04/23/the-fed-is-unlikely-to-hint-at-policy-change-despite-stronger-economy.html
Tepper, T., & Curry, B. (2021, April 16). 2021 April FOMC Meeting Preview: The Fed Remains On Guard. Forbes Advisor. https://www.forbes.com/advisor/investing/fomc-meeting-federal-reserve/

Of course those articles that were suggesting no action yesterday were right per the concensus. But the question remains for economists and investors: how much good news (and at what rate of recovery) is too much? As quoted in Reuters, “we do feel that a higher inflation reading this year and in 2022 will prove to be not transitory, that the Fed will hit that 2% threshold and above, if not even higher, on a more sustained basis. So that’s where I think we would be on the side of disagreeing with Chairman Powell, that we think inflation is going to gain a toehold.”

Fed Chair Transcript: No Changes for Now

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As somewhat expected, the transcript from the Fed Chair today indicated no expected change to rates or bond buying activity in the immediate future. This prompts questions from economists regarding how long this can last given the good news that continues to emerge. For instance:

Economists think a decision to taper is months away although a minority think the Fed might start discussing the issue in June. Fed officials have said they want to see “substantial further progress” in meeting their goals of full employment and 2% inflation before tapering.

The post goes one to cite the recurring themes of optimism, inflation and pandemic risks as potential drivers for a change in policy.

Chair Powell reiterated that, “the FOMC and I kept interest rates near zero and maintained our sizable asset purchases. These measures, along with our strong guidance on interest rates and on our balance sheet, will ensure that monetary policy will continue to deliver powerful support to the economy until the recovery is complete.” Again, no surprise, but he continues, “while the recovery has progressed more quickly than generally expected, it remains uneven and far from complete.” 

But one brief comment also describes some of the most felt implications of Federal and local policy decisions (and recovery):

The economic downturn has not fallen equally on all Americans, and those least able to shoulder the burden have been the hardest hit. In particular, the high level of joblessness has been especially severe for lower-wage workers in the service sector.

In conclusion, the Fed will:

Continue to increase our holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum-employment and price-stability goals.

Which will in turn extend the trend of low interest rates, housing prices and asset inflation of all kinds.

Apps for Economics

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I found this excellent site in the Journal of Economic Education as I was researching another topic. In that article, the following overview describes the useful content cataloged on the site:

As the digitization of teaching resources becomes increasingly available, instructors can adapt by making course pedagogy more mobile through incorporating “bring your own device” into the course design. The number of available apps can be overwhelming. We identify many of the best apps with user rankings on a 5-point qualitative scale from Awful (1) to Excellent (5).

Why should we use apps in economics? Strategic selection of an app engages students. This selection offers understanding throughout a range of cognitive domains while providing connections to learning styles that link to individual strengths. Apps provide a hands-on study of economics that can intrigue and satisfy. When students have fun engaging economic apps, their learning and retention increases. Our Web site arranges the apps into seven categories: Study Aids, Calculators, Data, Events, Feedback, Quizzes, and Simulations. Study Aids provide resources for better understanding principles of economics. Calculators identify spreadsheets as well as financial, mortgage, and currency calculators. Data apps profile domestic and international macroeconomic data sources. Events allow class members to keep abreast of current events. Feedback offers instructors a variety of mechanisms to gather classroom responses. Quizzes afford students tools for selftesting of economic concepts. Simulations generate a virtual world to put economics into practice. (Cochran, Velikova, Childs & Simmons, 2015).

 The site is authored by an excellent team of innovators, researchers and educators who have a “passion for technology.” This site is an excellent resource and I hope it continues to be updated.

 

Reference:

Cochran, H. H., Velikova, M. V., Childs, B. D., & Simmons, L. L. (2015). Apps for Economics. Journal Of Economic Education, 46(2), 231. doi:10.1080/00220485.2015.1006745

Fed Chairwoman: Trying to Build Consensus Among Disparate Views on Policy

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Even with all the discussion of the implications of China’s Move to Devalue the Yuan, it has been widely accepted that a policy of firming easy money would probably still move forward. But this could prove more challenging for the Fed given the variegated opinions among policy makers:

Officials have signaled for months they intend to start raising short-term rates from near-zero interest before year-end. But they have provided no clear sign of having settled on whether to move at their next policy meeting Sept. 16-17. Minutes of their July 28-29 meeting, released Wednesday, underscored why the decision remains a close call.

“Most [officials] judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point,” the minutes said.

That passage might be read as a hint that officials saw a September rate increase in the cards, but the minutes showed officials had wide-ranging views about taking that step and several notable sources of trepidation.

The Fed has said it won’t move rates until it is more confident inflation will rise toward its 2% target after running below it for more than three years. “Some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2 percent over the medium term,” the minutes said.

The conundrum is self obviating: move too fast, and you are going to tank this forward moving, but tepid recovery. Do nothing, and you might have fueled yet another bubble. And there are voices calling for action citing the need for credibility, confidence and timing, others, for caution:

Other developments are giving Fed officials new reason for caution. At the July meeting they noted China’s stock-market declines; since then Chinese officials have allowed their currency to depreciate, a new source of concern about the growth outlook in the world’s second largest economy.

U.S. crude oil prices hit a six-year low Wednesday and U.S. stocks tumbled, boosting demand for ultrasafe U.S. government debt. The yield on the benchmark 10-year Treasury note fell to 2.129% from 2.196% on Tuesday and marks the yield’s lowest closing level since May 29. A gauge of 10-year inflation expectations in the bond market fell to the lowest level since January.

So back to the conundrum. Wait and by implication, call into question the health of the U.S. economy, or move forward and see if the economy “would be able to absorb higher interest rates and that inflation was moving toward the committee’s objective.” That’s life in the big chair.

Fed Capital Requirements: Bearing the Cost that Failure Would Impose on Others

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Too big to fail is a narrowing option. And running with riskier assets is going to be costly for larger banking institutions, according to new rules by Federal Reserve as noted in the Wall Street Journal:

The Fed completed one rule stating that the eight largest banks in the country should maintain an additional layer of capital to protect against losses, its plainest effort yet to encourage them to shrink. At the same time, it offered a reprieve to General Electric Co.’s finance unit from more-intensive regulation, after the company promised to cut its assets by more than half.

…Regulators have pushed big banks to expand their capital buffers to better absorb losses, reduce their reliance on volatile forms of funding, improve their risk management and cut back on risky assets. So-called stress tests measure banks’ resilience each year and can restrict shareholder payouts at firms that don’t pass.

For Wall Street banks and their investors, the emerging regime presents a series of choices: specifically whether to pay the cost of new regulation, which will fall to the bottom line, or change their business models by shedding businesses or withdrawing from certain markets, such as owning commodities.

In a quote that I think is one of the best commentaries on the subject,

Fed Chairwoman Janet Yellen, before voting to approve the new measure, said financial firms must “bear the costs that their failure would impose on others.” She offered banks the choice of maintaining more capital to reduce the chance they would fail, or get smaller and reduce the harm their failure would have on the financial system.

The big banks of course object to the action stating that it will remove billions from the economy. Below is a graph of the big 8 that will be hit with he most significant requirements (click for larger image):

Bigger Buffer

But it is not size along that determines how each bank will be assessed, “the size of each bank’s additional capital requirement is tailored to the firm’s relative riskiness, as measured by the Fed’s formula, which considers factors such as size, entanglements with other firms and internal complexity. As those factors shrink or grow, so will a bank’s surcharge.”

The Lesson of ‘Good Enough’

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Comparing and contrasting the birds-eye view with the worms-eye view

The higher a person ascends the ranks of financial operations, the more imperative it becomes to discern between certain levels of detail, and the need to push work products forward to completion. This is especially true in the budgeting aspects of financial operations versus compliance issues in accounting and auditing which can become exceedingly nitpick at times. Closely related to this is the need to learn to communicate financial information to other business professionals who are not financial specialists. This can proved to be exceedingly difficult for a highly competent analyst who frankly, loves “getting their hands dirty.” In other words, this is not meant in any way to trivialize the value of a highly detail oriented analyst. But it is meant to serve as a cautionary note to those who wish to exercise leadership that is built upon their years of financial expertise. Two quick thoughts may serve to illustrate this: the worm’s eye view and the bird’s eye view, each with its strengths and limitations.

The worm’s eye view will assist with a great deal of detail, but sometimes distorts reality due to its limitations of vision. This is not to in any way demean or devalue the benefits or the work of highly detail oriented people. It is simply to say, sometimes in order to complete certain types of work in a timely manner, decisions of priority must take precedence over the desire to continue with hedgehog-like determination and the quest for perfection that is sometimes not practical.

The bird’s eye view on the other hand, enables a panoramic vision of the whole while simply limiting detail. Both have their function in analytical work. But here is the takeaway. Leaders communicating financial information need to be able to deliver highly summarized, accurate information. Then in an instant, zoom into detail in response to a question, request for clarification, etc. Then zoom back out to high level – smoothly and reassuringly. Listen to a few quarterly earnings conference calls for effective and ineffective examples. For the executive leader, a careful distinction between the two approaches and the timing of the each is essential.