Clouds on the Horizon

On March 10, 2017, 720Global introduced the Trump Range Chart. Developed to see several different markets on one page, this unique chart provides a composite perspective of many instruments at once.  Given the large post-election market gyrations across many asset classes, our concern was, and still remains, that those moves are transitory, reflective of extreme and possibly unwarranted optimism regarding the ability of the new administration to pass bold economic initiatives. For a broad discussion of the harsh economic landscape Trump faces, our cause for doubt, please read The Lowest Common Denominator: Debt.

Unbridled Enthusiasm

On May 17, 2017, the S&P 500 fell 1.82% on rumors that President Trump had tried to persuade former FBI Director James Comey to influence the FBI investigation into potential Russian interactions with the Trump campaign. This resulted in the largest equity market decline since March 21st, when healthcare legislation was being challenged and produced a surge in volatility as well. Outside of these two days, optimism has run rampant as witnessed by the daily gains and recurring all-time highs in many major equity indexes. As a result, equity volatility as discussed in Volatility: A Misleading Measure of Risk, has reached lows only seen on four other days since 1990.

Two important points: First, valuations are reaching levels akin with those preceding memorable market crashes and are concurrent with still weaker economic growth and a Federal Reserve (Fed) that is hiking interest rates. Secondly, at current valuations, prudence demands a defensive posture but watching the markets move higher when hunkered down in a conservative position is both frustrating and humbling. This counter-intuitive dynamic is always present in markets at points of extremes. Most move comfortably with the herd while only a few have the fortitude to break away from the misguided pack.

Clouds on the Horizon

It is growing more obvious by the day that the administration lacks the ability to enact much of the economic legislation that generated the surge of optimism reflected in post-election stock indexes.

As market participants who like to support assertions with data, we also prefer to talk about events in terms of their probabilities. We think about the current situation this way: since the election, the S&P 500 has gained 13% at its highs on May 16. Corporate earnings have improved, but economic growth has proven weaker than expected and the Fed has been more aggressive in raising rates than most thought last November. Therefore, we believe a large majority of the gain stems from non-domestic forms of liquidity emanating from Europe and Japan and a belief that Trump will be able to pass much of his economic agenda. Given the hostile political climate in Washington, the probability of Trump executing his plans is certainly lower than the market suggests. On what logical basis should the probabilities of passing aggressive, pro-growth legislation remain unchanged?

Markets/Range Chart

Despite these important considerations, the stock market exhibits little fear. The performance of other asset classes contradict the stock market. The graph below charts the percentage moves since the election of the S&P 500, Gold, U.S. Dollar and the 2year/30year Treasury yield curve. Despite widening significantly in the days following Trump’s victory, note that the yield curve is now flatter today than where it was on election-day. This is not a vote of confidence in the higher growth/reflation outlook that has bolstered stocks. The U.S. Dollar has also reversed the entirety of its post-Trump gains and gold is nearing breakeven over this period. While most investors pay close attention to stock prices and possibly bond yields, this analysis highlights other asset market signals that warrant attention.

Clouds on the Horizon range chart 5.23.17

Data Courtesy: Bloomberg

The chart above uses 4 pm closing prices for each day. The Range Chart, below, uses intraday prices including the extremely volatile night of the election.  Below the summary is a user guide for the Range Chart.

range

Data Courtesy: Bloomberg

Summary

Many mistakenly compare Trump’s proposals to those of Ronald Reagan. They correctly identify  similarities but few mention the stark differences between the economic landscapes of the two periods.

With the probability of successful and full implementation of Trump’s economic agenda declining, investors should question whether equity prices will be able to meet the lofty expectations currently set forth by current valuations.  

How to read the range chart

The data in the Trump range chart above is shown in a format that is quite different from what is commonly used to illustrate market changes. This format provides an easy way to view relative performance across a broad number of indexes and securities. It is intended to be a meaningful supplement and not a replacement to the traditional charts most investors review on a routine basis.

The base time frame captured by the graph reflects the market move for each index or security since Election Day, November 8, 2016. This change is represented by the 0% to 100% on the left hand axis. The 0% level reflects the intra-day low of the security since November 8 and the 100% level the intra-day high. For more clarity on the prices associated with the range, see the table below the chart for each respective index.

The (red/blue) bar reflects the price range of the past month relative to the base time frame.  The black “dash” within the 1-month bar reflects the previous week’s closing level (PWC) and the red dot highlights the closing level on the “as-of” date in the top left corner.

The diagram below isolates the chart and data for the Russell 2000 to further illustrate these concepts.

how to read

720Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

The Unseen”, is our subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email mplebow@720global.com 

 

©720Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

 

 

 

 

 

 

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The Animated Virtuous Cycle

The Animated Virtuous Cycle

A short video illustrating economics in plain English

Our name, 720Global, is meant to evoke an image of two overlapping individual circles (2 x 360°) in the reader’s mind. The two circles represent what we believe to be the two primary pillars of successful investing – investment valuation and macro-economic analysis. Understanding value, pricing and risk/reward tradeoff within the context of the business and credit cycles provides a durable platform from which results-oriented, sound investment can happen. As Ben Graham said, “Price is what you pay. Value is what you get.

During periods of extreme bullish sentiment, investors tend to get overly enamored by price trends and investing fads while neglecting fundamental analysis and the primary driver of asset prices, the macroeconomic landscape. Accordingly, to level the playing field, many of the articles we have published have been devoted to exposing fallacious economic thinking. We believe our discussion on the matter is imperative as most Ph.D. economists, including those at the Federal Reserve, have convinced investors, policy-makers and U.S. citizens that durable economic growth stems from debt-fueled consumer spending. This is not only a patently false claim, but it has immense implications for investors as we have explained and depicted on many occasions. In particular, we wrote, The Death of the Virtuous Cycle, to provide readers with a clear understanding of why the United States and many other developed economies have seen productivity, wages, and economic growth stagnate.

We make every effort to craft articles in a clear format using common sense analysis and straight-forward logic. Financial jargon, complex formulas, and abstract theories are tools for those who prefer to sound smart or simply wish to advance an agenda by confusing readers and obstructing basic truths. That said, despite our efforts to be laconic and make the complex simple, we struggle at times. To combat this, we have often written sequels or follow-up articles to present a topic in a different light or to add emphasis and enhance the reader’s understanding.

Due to the significance of the message contained in The Death of the Virtuous Cycle and our desire to effectively reach as many people as possible, we take a new approach and present the concepts using an animated short video.

 

Link to The Animated Virtuous Cycle

 

 

 

 

720Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

The Unseen”, is our subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email mplebow@720global.com 

 

©720Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

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The Deck is Stacked

 

The Deck is Stacked

Putting Risk and Reward into Perspective

The individual investor should act consistently as an investor and not as a speculator.” – Ben Graham.

We are frequently told that valuation analysis is irrelevant because fundamentals do not signal turning points in markets. Scoffers of valuation analysis are correct, as there is no fundamental statistic or for that matter, technical or sentiment indicator that can provide certainty as to when a market trend will change direction.

Despite being humbled by recent market gains and the difficulties associated with timing the market to call a precise top, we remain resolute about the merits of a conservative investment posture at this time. At some point, current equity market valuations will succumb to financial gravity and the upward trend of the last eight years will reverse. When that day arrives, it will not be because a valuation ratio hit a certain level or because the market formed a well-known technical pattern. It will simply be the day that selling pressure overcomes demand.

In prior articles, we compared the current economic landscape to the early 1980’s.  Let’s revisit that contrast to further quantify the risk and reward associated with the U.S. stock market during both time periods.

As Graham so eloquently stated, speculating and investing are two vastly different endeavors, and we prefer the practice of investing.

Risk-Return Tradeoff

Investors contemplating a new investment or evaluating an existing holding are typically faced with two basic but essential questions:

  • How much of my wealth am I willing to risk?
  • What returns do I expect in exchange for that risk?

When Ronald Reagan took office in 1981, investors needed to evaluate whether his fresh economic policies could spur sustainable economic growth. In the decade preceding his election, the economy was hampered by significant inflation, double-digit interest rates, and a steadily rising unemployment rate.  The Dow Jones Industrial Average (DJIA), essentially flat over the prior decade, was resting at levels similar to those seen 17 years earlier in 1964. Valuations over this period were equally stagnant, with the Cyclically Adjusted Price to Earnings (CAPE) ratio, as an example, ranging between 7 and 9.  Despite the bargain basement equity prices, few investors believed that market trends would reverse.  Equity valuations had been low and falling for so many years to that point, the trend became a permanent state in many investors’ minds by way of linear extrapolation.

Contrast that with today. As in early 1981, there is a new president in office with a non-typical background presenting non-conventional economic ideas to aid a struggling economy. Unlike Reagan, however, public support for Donald Trump is marginal. Trump was not elected by a majority, he lacks Reagan’s humility, optimism, good humor and diplomacy and his approval rating historically ranks among the worst of incoming presidents. Additionally, while Reagan’s and Trump’s economic policies may have similarities, there are stark differences between the economic landscapes that prevailed in the early 1980s and today. (Please read The Lowest Common Denominator for a full write up on what the current administration is up against.)

Equity investors betting on Reagan in 1981 were investing in an environment where the probabilities of success were asymmetrically high. With Cyclically Adjusted Price-to-Earnings (CAPE) ratios below 10, investors could buy in to a stock market whose valuation on this basis had only been cheaper 8% of the time going back to 1885. Given the likelihood of success as inferred from valuations, investors did not need much help from Reagan’s policies. Current equity market valuations require investors to believe beyond all doubt that Trump’s policies can produce strong economic growth and overcome hefty economic and demographic headwinds. More bluntly, the risk-return profile of 1981 is the polar opposite to that of today.  To highlight this stark difference, the following graph compares five-year average total returns and the maximum drawdowns that have occurred over the last 60 years at associated CAPE readings.

risk return

Data Courtesy: Robert Shiller -http://www.econ.yale.edu/~shiller/data.htm

Based on the graph above, investors in the first years of Reagan’s presidency should have expected annual returns, including dividends, of nearly 20%, while simultaneously risking a maximum drawdown of less than 5%. Today, investors should expect returns over the next five years, including dividends, to be near zero. Worse, during the next five years the S&P 500 is likely to experience a drop of nearly 30%. That is quite a risk investors are shouldering for a return they can easily attain with a risk-free 5-year U.S. Treasury note.

Fire Sale

Beyond the obvious, there are a couple of problems with the current risk-return profile. In a best case scenario, it is likely an equity investor will earn a return that could be attained by putting cash under one’s mattress. Although it occurred an eternal nine years ago, the financial crisis of 2008, is still a faint memory for investors. If the market does indeed drop by 30%, will investors keep their cool and not sell? If they do sell, they will lock in a permanent loss.  One of the demographic headwinds we have discussed in prior articles is the growing number of retirees that are heavily reliant on their retirement accounts to meet their living expenses. Will they be able to keep their collective heads under the duress of a major correction? What if prices do not rebound as quickly as they did in the post-financial crisis years?

The hard truth of this scenario is that humans always panic when faced with severe market drawdowns. The back-testing of “what-if” scenarios for buy-and-hold analysis are irrelevant because investors do not HOLD – they sell, and usually at the worst time after abandoning all hope for a durable bounce. The anxiety that retirees will face in such a scenario, many of whom can barely maintain their standard of living on an optimistic outlook, will be paralyzing.

Summary

If someone were to offer you a unique investment opportunity forecast to pay 0% annual returns over the next five years, would you sign up? What if they added that, at some point over that period, the value of your investment may drop by 30%? High volatility, low return investments do not get serious attention among even the most foolish of investors, so we would venture to guess there would be very few takers.

Interestingly, based upon the CAPE analysis above, the U.S. stock market is currently offering that very same probability of return and risk and buyers cannot seem to get enough. Given these dynamics, not only is investor behavior perplexing, it seems to us altogether incoherent which in our view provides further evidence bubble behavior is upon us. For the sake of illustration, the graph below provides three random scenarios showing how such an expected return and drawdown could play out over the next five years.  None of these, nor the infinite myriad of other possible paths, appeal to us.

scenarios

In a sinister rhyme to that of the early 1980’s, equity market valuations have been rising so steadily for so many years now that the trend has become a permanent state in many investors’ minds.  The “investors” identified in Ben Graham’s quote do not acquiesce to the crowd or bet on whims. Instead, they carefully assess an investment’s potential risk and expected return to make calculated decisions. The virtue of this time-honored practice of cost-benefit analysis does not reveal itself every day but avoiding the pitfalls, even if it means foregoing additional speculative gains, has a long and proven track-record of compounding wealth over time.

 

 

720Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

Coming soon 720Global will offer “The Unseen”, a subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email info@720global.com 

 

©720Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720Global, LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720Global, LLC. 

 

 

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Volatility: A Misleading Measure of Risk

Volatility: A Misleading Measure of Risk

 

History has not dealt kindly with the aftermath of protracted periods of low risk premiums” – Alan Greenspan

 

The ability to see beyond the observable and the probable is the most important and underappreciated characteristic of successful investors. For example, visualize a single domino standing upright. With this limited perspective, one can establish what the domino is doing in the present and form expectations around what might happen if the domino falls. However, by expanding one’s viewpoint, you may discover the domino is just one in a long line of dominoes standing equidistance from each other. The potential chain of events caused by the first domino falling now offers a vastly different outcome. Many investors myopically focus on the trends of the day and fail to notice the line of dominoes, or what is technically known as multiple-order effects.

Since the Great Financial Crisis of 2008, maintaining animal spirits has been a primary goal of the world’s central banks. The crisis proved a brutal reminder that, in this new era of significant leverage, a loss of investor confidence can result in violent reactions that ripple throughout the financial markets and the global economy. By employing extraordinary policies and optimistic narratives, the central banks have persuaded the public to believe that all is well. They have successfully focused the investor on one domino.

As investors, we are negligent if we follow the Fed’s lead into this complacent stupor. By prodding economic growth with unproductive debt and reigniting asset bubbles, the central banks have simply done more of what created the spasms of 2008 in the first place.  Despite the markets calm façade and historically low perception of risk, the vast chasm that lies between perceived risk and reality is troublesome.

Implied Volatility

Implied volatility is a well-followed measure of expected price change. The metric, derived from the prices of put and call options, can be thought of as the amount of risk that investors expect to occur between today and a specified expiration date. Bullish periods are most frequently categorized by low implied volatility, while bearish periods tend to have elevated levels of implied volatility.

Chris Cole of Artemis Capital has a broader definition of volatility – “(volatility) is the difference in the world as we imagine it to be and the world that actually exists.” Think about his quote carefully before reading on.

In the investment sphere, Cole’s statement can be boiled down to the contrast between the consensus mindset investors hold to explain the current state of economic activity, fundamentals, market valuations and implied risks versus the reality encapsulated by those metrics. While no one can quantify “the reality”, the wider one perceives the difference between implied volatility and reality, the greater the opportunity present in the market.

Since the 2008 crisis, and especially over the last three years, implied volatility has been abnormally low more often than not. In other words, investors believe the risks of a significant downdraft in stock prices is relatively minimal. This by no mean indicates that the actual risks investors face have decreased per se, just that the financial gauges constructed on investor positioning claim that to be the case.

The graph below plots implied volatility (VIX) for the S&P 500 since 1990.

VIX

Data Courtesy: Bloomberg

Currently implied volatility is at a level that has only been experienced 0.22% of the time since 1990 and is almost half of its longer term average.

Some of the primary reasons for this abnormally low level of implied volatility are:

Monetary Policy and the Federal Reserve (FED): The FED’s recent monetary policies, including a near zero percent Federal Funds rate, have resulted in increased financial leverage and increased demand for securities. This occurred as the Fed removed $3.5 billion of U.S. Treasury securities from the market through Quantitative Easing (QE), further affecting supply-demand curves. As a consequence, the prices of many fixed income securities have risen sharply and yields and yield spreads hover near all-time lows.

It is worth mentioning that, at times when the stock market has dipped, the Fed has been vocal about their ability to take more aggressive action. As a result, investors believe the Fed will “not allow” the equity market to decline by much. The “buy the dip” strategy reflects this mindset.

Share Buybacks: Since 2012, 94% of S&P 500 companies participated in buybacks while all U.S. corporations spent over $2 trillion in precious cash over that time period. Meanwhile, total U.S. corporate profits over the same time frame rose only $14 billion.  Reinforcing the “buy-the-dip” mentality, corporations tend to increase their pace of repurchases during periods when the market pulls back. An additional benefit of share repurchases is the purely optical effect on valuation measures like price-to-earnings. Although nothing material about a company’s long-term growth prospects change (indeed, prospects are arguably hurt by imprudent use of cash), buybacks afford the cosmetic appearance of improved operating performance which triggers additional demand or eases investor concerns.

Volatility Trading: Through VIX futures contracts and a multitude of long and short volatility ETF’s, the popularity of volatility as an asset class has increased dramatically in recent years. VIX traders are emboldened that volatility has risen for short periods of time but regresses toward or below its mean. This predictable behavior has made shorting volatility an attractive trade, especially during market drawdowns when VIX spikes higher. Again, such action strengthens the buy the dip reflex. Contributing to lower than average VIX levels is the upward sloping term structure of forward VIX futures contracts (known as contango). Trades which take advantage of this upward slope have made shorting volatility profitable even when the VIX is not elevated.  An important dynamic in VIX trading is that as volatility falls, profit-seeking traders must increase the size of their positions to generate the same income as they did when the VIX was at a higher level. Doing so, however, clearly raises the potential risk of loss for these positions.

Passive Mentality: Historically-low fixed income yields have tempted investors to take on more risk. In part, this so-called “chase for yield” has led to a herding mentality. Investors have been flocking to securities, industries and indices that exhibit strong momentum, not necessarily commensurate fundamentals. Also growing is the popularity of passive investment styles. As we discussed in Passive Negligence and Passive Negligence II, the overwhelming demand for passive index funds has led many investors to eschew appropriate security evaluation. As a result, investors have bid up prices of some stocks to valuations that are well above historical norms.

Noted value investor Seth Klarman described it this way in his recent letter to clients: “One of the perverse effects of increased indexing and ETF activity is that it tends to ‘lock in’ today’s relative valuations between securities. Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricing’s.

The factors listed above, coupled with cheerleading from the media, Wall Street and the Fed, have led to a behavioral state best labeled as “animal spirits.” The term, introduced by John Maynard Keynes, is a way to say that human emotions have resulted in greed. When animal spirits run rampant, confidence trumps fundamentals, historical valuations, and poor risk/reward profiles.  Janet Yellen’s husband, George Akerlof, literally wrote the book on animal spirits. Along with fellow author Robert Shiller, he wrote Animal Spirits to document how important human psychology is in driving desired market and economic results. In Fed Up, by Danielle DiMartino Booth, the Dallas Fed insider stated the following: “and yet here was the Fed, with Yellen as its biggest cheerleader, once again trying to build an economic recovery on the back of frenetic animal spirits.” Our review of Danielle’s book can be found here (LINK).

CNBC

The four broad factors discussed above coupled with low but stable economic growth have temporarily sated investors’ desire for economic stability and, in turn, market confidence. While this may appear well and good, we must consider what lies underneath the cloak of stability.

The Unseen Dominoes

While low levels of implied volatility may comfort investors for the moment, it seems prudent to contemplate current factors that run counter to low levels of implied volatility:

Debt Outstanding: The total amount of U.S. debt outstanding, including Federal, personal and corporate debt, is greater than $60 trillion and over three times U.S. GDP. More concerning, much of this debt is unproductive as it has not been employed towards productive investments which generate economic growth to service and retire the debt. Debt used solely for consumption, as has largely been the case, allows for the purchase of more goods and services today that otherwise would have been consumed in the future. This leaves a consumption void tomorrow, as demand is satisfied and marginal consumption is restricted by debt payments.

“To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about.” Friedrich Hayek – Monetary Theory and the Trade Cycle

Interest Rates: Interest rates have been on a 35-year path lower. This is partially the result of decades of demand-focused monetary policy designed to incentivize debt-fueled consumption. With interest rates at unprecedented low levels and a limited ability for many to continue borrowing, the marginal benefit of lower interest rates is minimal. Additionally, investors are being forced to take outsized risks due to paltry returns offered by most fixed income securities.

Productivity: Productivity growth in the U.S. and most developed economies has slowed sharply from prior decades and in many cases has begun to decline. Without productivity growth, economic growth can only occur with increased debt and/or favorable demographics. Given poor demographics and record debt levels, relying on either is a highly questionable strategy.

New York Times author and economist Paul Krugman said: “productivity isn’t everything, but in the long run, it’s almost everything.”

Economic Trends:  GDP growth in the U.S. has been in secular decline for over forty years. The rate of real economic growth is projected to be below 2% for the years ahead. This assumes the productivity, demographic, and debt landscape referenced above. Secular GDP per capita, a better measure of true output, is growing well below 1% annually and could decline in the years ahead.

Trump, Brexit, and Nationalism: Donald Trump, BREXIT and a growing worldwide nationalist movement raises concerns that global trade may become compromised. The Great Depression was, in part, due to a reduction in global trade as a result of protectionist actions. See Hoover’s Folly for more information.

China: The significant growth of China has played an outsized role in supporting global growth over the past fifteen years. The combination of cheap labor and a surge in debt is rapidly losing its effectiveness in China. Massive debt loads, rapidly declining productivity growth and competition is resulting in financial instability.

Rising Social Instability: Donald Trump, Bernie Sanders, BREXIT and other recent events serve as clear signals that voters are demanding change. The financial effects of consumerism are finally forcing people to bear an unacceptable weight. Social instability is on the rise as can be attested to by the recent riots at Berkley, the post inauguration women’s march on Washington, and racially oriented riots in Baltimore and St. Louis. While these events have different themes, causes and flag bearers, they are indicative of inequality.

VIX

The prolonged monetary exertions of the Federal Reserve and global central banks have put investors into a complacent trance. Implied volatility appears tame but a regime shift, when it arrives, will test even the most seasoned managers.

Volatility has not been mastered. The powerful forces that have suppressed it will turn, and the dormant but still present fundamental forces that few seem to consider will not fade away. The recognition of reality may occur slowly and provide watchful investors ample warning. However, the vast chasm that lies between reality and implied risk could make such a turn explosive and will certainly catch the unprepared off-guard.

Summary

Fixing the world’s economic and financial problems will be arduous and steps taken to date have done nothing to abrogate those issues.  Durable solutions require time, discipline, sacrifice and a return to sound fiscal and monetary policy. Throughout the last 30 years, mounting economic problems have been consistently ignored. The overriding goal of economic policy makers has been to keep near-term economic growth on par with the seemingly arbitrary goals of the day. Economic policy has focused on immediate gratification and avoidance of pain at the expense of long-term economic health. This adolescent logic stimulates short-term growth as desired, but more importantly, it fosters boom-bust cycles and long term instability.

Successful investors understand that optimism, momentum and hope, the first order movements, the emotions that currently fill the media and Twitter-sphere, are most responsible for driving prices on a day-to-day basis. There is no doubt that such animal spirits could easily send the market even higher. That said, investors would be well-advised to devote significant time toward considering the multiple order effects. It is those effects, the emblematic line of forgotten dominoes, which will ultimately drive prices.  When the entirety of the current situation begins to more fully reveal itself, investors are likely to find that the difference between esoteric measures of implied volatility and their very tangible perception of reality could not be more different.

 

 

 

 

 

 

720 Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

Coming soon 720 Global will offer “The Unseen”, a subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720 Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email info@720global.com 

 

©720 Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global, LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

 

 

 

 

 

 

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Play the Game to Win

Play the Game to Win

What Rick Barry and the Atlanta Falcons can teach us about risk management

 

Something about the crowd transforms the way you think” – Malcolm Gladwell – Revisionist History

 

With 4:45 remaining in Super Bowl LI, Matt Ryan, the Atlanta Falcons quarterback, threw a pass to Julio Jones who made an amazing catch. The play did not stand out because of the way the ball was thrown or the  agility that  Jones employed to make the catch, but due to the fact that the catch easily put the Falcons in field goal range very late in the game. That reception should have been the play of the game, but it was not. Instead, Tom Brady walked off the field with the MVP trophy and the Patriots celebrated yet another Super Bowl victory.

NBA basketball hall of famer Rick Barry shot close to 90% from the free throw line. What made him memorable was not just his free throw percentage or his hard fought play, but the way he shot the ball underhanded, “granny-style”, when taking free throws. Every basketball player, coach and fan clearly understands that the goal of a basketball game is to score the most points and win. Rick Barry, however, was one of the very few that understood it does not matter how you win but most importantly if you win.

The Atlanta Falcons crucial mistake and Rick Barry’s “granny” shooting style offer stark illustrations about how human beings guard their egos and at times do imprudent things in order to be viewed favorably by their peers and the public. It is this protective behavioral trait, rooted in the fear of being different, that frequently weighs on our ability to make decisions that are in our best interests. As equity markets climb to levels that have previously been associated with historic financial bubbles, and portend massive drawdowns, this article is another way of reminding investors that the ability to suppress the ego is needed if one is to mitigate the potential consequences of the current market bubble. As previously discussed in Limiting Losses, controlling drawdowns is paramount to compounding and long-term wealth accumulation.

Dan Quinn

The story of Super Bowl LI will go down as a miraculous comeback and one of the greatest games ever. It could have easily been a relatively boring blow-out, with the commercials and halftime attraction garnering the fans memories. When Julio Jones completed his astounding catch to give the Falcons a first down on the Patriots 23 yard line, Falcons coach Dan Quinn had a decision to make. It was not really a football decision but a basic judgement of risk and reward. He could conform to the conventional path and keep the drive alive in an effort to score a touchdown or he could have had quarterback Matt Ryan take a knee for three straight plays, force the Patriots to use their timeouts, and kick a field goal. With either decision, a score would have, in all likelihood, sealed a victory.

Quinn elected to go for the touchdown. Unfortunately, a quarterback sack and a holding penalty in the series pushed the Falcons backwards to midfield and turned an easy field goal attempt into a punt. The Patriots got the ball back and proceeded to tie the game, sending it to overtime where they ultimately stunned the Falcons.

Rick Barry

Malcolm Gladwell, in his podcast series Revisionist History – The Big Man Can’t Shoot, highlights how ego, pride and the opinion of the masses can prevent us from doing the right thing. The focal point of the narrative is NBA Hall of Famer Rick Barry who had a storied professional basketball career that included being named rookie of the year, 12 all-star game appearances, and an NBA championship. In 1980, at the time of his retirement, his 90% career free throw percentage was the highest in NBA history. Despite all of his accomplishments, Barry is best known by most people as the guy who shot free throws underhanded.

In 1962, Wilt Chamberlin scored 100 points in a single game, which to this day stands as a record. Less well known is that, in that same game, he made 28 free throws which is also a single game record. Chamberlin, a career 51% free thrower shooter, shot 88% from the free throw line on that record-breaking night. It was not a fluke. That was the only game of his career that he shot free throws underhanded. Despite his historic achievement that night, he never shot underhanded again. In his words “I felt silly, like a sissy shooting underhanded. I know I was wrong. I know some of the best foul shooters in history shot that way. Even now the best one in the NBA, Rick Barry, shoots underhanded, I just couldn’t do it.”

Like Wilt, NBA legend Shaquille O’Neal (“Shaq”) was a terrible free throw shooter. Shaq shot free throws at a paltry 52% while the remainder of league averaged approximately 75% from the “charity stripe”. His shooting percentage was such a liability that, in close games, opposing teams adopted a strategy called “Hack-a-Shaq.” This strategy forced Shaq to the free throw line allowing the opposing team to take advantage of his pathetic free throw shooting. One would think that, given this glaring fault, he would welcome tips for improvement. Rick Barry once approached Shaq about trying his underhand style. Shaq’s reply was “I’d rather shoot zero.”

In Gladwell’s podcast, Barry explains why shooting underhanded is not only more natural but produces a softer shot which increases the probability of it going through the hoop. Despite the rewarding mechanics behind the shot and the proven success of Rick Barry as well as others before him, Shaq, Wilt and virtually every other professional and collegiate basketball player refuse to shoot underhanded.

Gladwell gives his two cents about refusing to shoot underhanded by stating: This is doing something dumb even though you’re aware you are doing something dumb.Those prescient words are worth contemplating.

Connecting Field Goals and Free Throws to Investing

There are times in life when human beings are so enamored with appearances, driven by our egos and not wanting to appear different, that we do not properly consider the consequences of our actions. Some might consider “settling” for a field goal to be cowardly.  Yet, had the Atlanta Falcons coaches been able to suppress their “fears”, it is very likely they would be Super Bowl LI champions.  Taking the risk of playing for the extra four points, offered by a touchdown, cost them dearly.

Had Wilt Chamberlain been less sensitive to what other people thought and been willing to shoot under handed, he would have raised his per game scoring average by three points and would have the highest career scoring average in the NBA (assuming shooting underhanded allowed him to raise his career free throw percentage from 51% to the league average 75%).  As it stands, he is number two behind Michael Jordan by 0.05 points per game. Similarly, had Shaquille O’Neal been able to put winning above his ego, he certainly would have lead his teams to more victories and possibly additional championships.  Assuming Shaq shot underhanded and made 75% of his free throws instead of 52%, he would have raised his career scoring average by two points per game which would have vaulted him from #21 on the all-time scoring list into the top 10!

Let us consider how Quinn, Barry, Chamberlain and O’Neal reflect the consensus investment perspective. The equity market stands at valuations rarely seen before and ones that have historically been accompanied by tremendous drawdowns. Investors, failing to consider the risks, appear eager to run up the score even further. While “greed is good” as Gordon Gekko said, reaching for nickels in front of a steam roller can be hazardous to your health (and wealth). If investors are staying fully invested because they believe that valuations can stay elevated and Trump’s pro-growth policies can overcome enormous economic and political headwinds that is a highly speculative and very risky posture. However, there are likely a majority who do not understand the magnitude of risk in the markets and instead are following the herd.

If equity market valuations were to normalize, there is compelling precedence for a decline of 50% or more. One could waste precious years riding the market lower and then waiting even longer for the market to recover. One could also take some chips off the table and have those funds available in the future when the market presents a more equitable risk-return tradeoff. Investing is a long-term proposition.  Wealth is most effectively compounded when one limits their losses even at the expense of foregoing some gains.

The graph below shows that as percentage losses grow, the percentage gain required to compensate for the respective loss is increasingly larger than the loss. For example, an investor facing a 50% loss, would need to have a 100% gain to break even. Importantly, the graph does not account for the time and opportunity cost that such a process entails to say nothing of the anxiety.

loss gain graph

Summary

I made my money by selling too soon” – Bernard Baruch

There is no doubt that the market can grind higher to more dizzying valuations. However, there is also strong historical evidence that this market will normalize to average valuations. In the wisdom of Bernard Baruch, there are times when you “make your money” by not losing it. Perhaps more importantly, you preserve the ability to buy when better opportunities present themselves.

Investors can kick the field goal, shoot underhanded, decrease their exposure to stocks and sit on unrewarding cash balances. Conversely, they can hope that the market continues to do as it has over the past eight years. Given the lesson of the last Super Bowl, is the opportunity cost of forgoing the additional gains worth the price of losing potentially much more? The media, your broker and maybe your friends will tell you to let it ride. Like Shaq, you may decide it is not worth the ridicule to be prudent. Or, like Rick Barry, you may elect to ignore popular opinion knowing excellence and results are what matter most.  Our recommendation is to weigh the benefits and consequences, do your best to ignore peer pressure and play the game to win.

 

 

720 Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

Coming soon 720 Global will offer “The Unseen”, a subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720 Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email info@720global.com 

 

©720 Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global, LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

 

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Passive Negligence II

 

Almost a year ago, we stumbled upon a topic that is currently generating much discussion in the financial media. In Mm Mm Good, published August 2016, we highlighted the Campbell Soup Company (CPB) and the utility sector to show how yield-starved investors were chasing dividend stocks to dangerously high valuations. The following quote from the article highlights the risk inherent in CPB’s valuation: “This concept of a no-growth company with soaring valuations is alarming. The price of CPB would have to drop 30% to return to its post-recession average P/E. If that were to occur, it would take 16 years’ worth of dividend payments to recoup the price loss, assuming dividends remain stable”.

When writing that article, we assumed that a hunger for yield was the primary driver of excessive valuations in those relatively safer sectors. We did acknowledge, however, that there were other factors. Unbeknownst to us at the time, the shift from active to passive investing was one such factor playing a growing role in creating valuation divergences.

We followed up the article in November of 2016 with Passive Negligence. This sequel, of sorts, discussed valuation divergences and economic inefficiencies occurring as a result of the growing popularity in passive investing and the related decline in value/active management strategies. The following quote summed up a concern we had then and one that is even more troubling today: Typically, market index changes are the result of the movement in underlying constituents. Today, market index changes are the driver of the underlying constituents”.

Valuation Regulator

Passive index funds can play an important role in portfolio management. However, when such passive styles of investing grow in popularity to the point that they are overly influential in setting prices, problems tend to arise. In fact, the ongoing massive shift of capital toward passive strategies argues that the healthy process of price discovery is being destroyed.

Value/active managers are vital for efficient asset pricing in the long run. By simply buying what they believe to be cheap and selling what they think is expensive, they help keep valuations and fundamentals in sync over the long run. When their role is diminished, as is frequently seen in bubble manias like today, these investors lose their ability provide the market with necessary checks and balances. For example, in the late 1990’s value/active investors were eschewed in favor of those chasing technology stocks to record-breaking valuation peaks. This type of passive management created absurd pricing distortions that eventually resolved themselves when investors broadly re-awakened to the reality of fundamentals. As the bubble burst in the year 2000, the popularity of value/active investors spiked and valuations normalized.

According to Bloomberg, Vanguard, primarily a passive fund manager, saw net inflows of $2 billion a day in the first quarter of 2017. In the same quarter they raised $121 billion of new cash, beating the prior quarterly record by almost 50%. Vanguard is just one of many passive managers exhibiting massive growth. This growth is coming largely at the expense of value/active managers, the regulators of valuation.

Toilet Paper

The implications of this dynamic may be illustrated through a simple example:

Imagine walking down the paper goods aisle in your local grocery store in search of toilet paper. Instead of picking out your preferred choice you just blindly take the first one you see. This act on its own would not be meaningful, but imagine if most shoppers chose toilet paper in a similar manner. Manufacturers that produced higher quality product could lose the advantage of differentiation and their additional cost of providing a higher quality product would be wasted. In fact, the quality of the product would be irrelevant to the shopper as compared to the ease in which the product can be grabbed from shelf. Without consumers making thoughtful trade-offs between price and value, the price of all brands of toilet paper would converge, rising and falling depending only on how easy it is to grab off the shelf!

As we began the process of writing a sequel to Passive Negligence we watched a video that masterfully explains the effects of the soaring popularity of passive investing. Therefore, we decided that instead of reinventing the wheel, our readers would be best served by providing them links for the video and chart book from Steven Bregman’s presentation at Grant’s Fall 2016 Conference.

Video

Chart Book

The video is courtesy Steven Bregman and Horizon Kinetics. The chart book is courtesy Steven Bregman and Horizon Kinetics as well as Grants Financial Publishing.

Summary

This topic is important if one is to understand why valuations continue to rise despite a fundamental backdrop that has historically been poor for stocks. Watching money flows to and from passive managers may very well help provide valuable insight into how much higher valuations can rise and may offer hints as to when they might begin to normalize.

Based upon the prevailing money flows, it appears few investors realize the benefit that value/active investing provides.  When their role is diminished by indiscriminate buying based only on the market cap or float of a security, as is the case in passive investing, value/active investors have less influence over the price discovery process and asset valuations become broadly exaggerated.

The outperformance of passive investing strategies over active ones is a major reason for the shift in interest and money flows, but there are other reasons as well. By comparison, fees on passive strategy funds are lower than those of active strategy funds and anticipation of the Department of Justice’s Fiduciary Rule is also having an impact on retirement accounts and those who manage them. That said, active managers tend to earn their fees when it matters most to investors – by protecting wealth when it is jeopardized by collapsing markets. Passive investing has no such conscience and will offer no sympathy when the day of reckoning arrives.

Finally, Jesse Felder of The Felder Report clarified the “logic” of such decision-making in simple terms:  “Embracing passive investing is exactly this sort of ‘cover your eyes and buy’ sort of attitude. Would you embrace the very same price‐insensitive approach in buying a car? A house? Your groceries? Your clothes? Of course not. We are all very price‐sensitive when it comes to these things. So why should investing be any different?

 

 

720 Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

Coming soon 720 Global will offer “The Unseen”, a subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720 Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email info@720global.com 

 

©720 Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global, LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

 

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The Forgotten Path to Prosperity

This article, and those that will follow in this series, describes in simple but compelling form several objective truths about the dynamics of scarcity and prosperity and the role they play in human decision-making within the context of an economy. The simple elegance of the economic system we describe seems to have been long forgotten, buried under an accumulation of overly sophisticated explanations, theories and complex models.

 

The Forgotten Path to Prosperity

 

“The record of history is absolutely crystal clear. There is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.”  – Milton Friedman

Whether one thinks of a market as barter, a grocery store, internet commerce or the New York Stock Exchange, the concepts behind each of them are identical.  In all of these marketplaces, people have resources which they are willing to give up in order to gain something else they deem as more valuable.

If I own a coop full of chickens that produces two dozen eggs every week, then I am not likely to pay for eggs in the grocery store.  More likely, a grocer may be willing to buy my eggs for re-sale to his customers.  If my portfolio is over-weighted with technology stocks, then I am less likely to seek new technology stocks to own.  If I need money to pay for my daughter’s college tuition, then I may need to work harder and/or sell some of my assets in order to meet the obligation. This simple set of examples is intended to reflect the decision-making human beings face when considering resource allocation. In the 720 Global philosophy statement we put it this way:

  • Human beings have desires and those desires drive decision-making. Given the desire and the means or ability to fulfill those desires, they will do so. This results in demand.

 

  • At the same time, in order to fulfill one’s desires, human beings will undertake activities that give them the means to fulfill their desires. This results in supply.

 

  • When human beings interact in a manner that allows their desires and their means to intersect, markets are created.

To emphasize the important linkage between resource allocation, economic success and the role of markets, a basic review of the terms scarcity and prosperity is important:

Scarcity is defined as a deficiency in quantity or number compared with demand. It is a universal, natural condition whereby resources such as time, labor and material wealth are limited. In a world where desires are, by nature, unlimited, people are required to make prudent decisions about the use of limited resources.

Prosperity is defined as the condition of being successful or thriving; economic well-being. It is a manufactured condition whereby the economic well-being of a person, community or nation is determined by the millions of choices citizens and government leaders make every day.  Prudent decisions regarding the use of our limited resources produce prosperity.

In the opening quote, the free enterprise system to which Milton Friedman refers is the system whereby people are free to engage in a vocation of their choice as a means of fulfilling their desires by producing something others need or want. Economic value, the basis for free market exchange, is subjective.  What has great value to one person may be of little value to another. Because anything a person could desire is to one degree or another scarce, each of us must prioritize our values by our individual preferences and means.  This not only applies to purchases and consumption but, just as important, how much we produce and how we spend our time.

When people are freely allowed to come together and cooperate in pursuit of their own self-interests, everyone benefits. The fewer needless restrictions imposed on a society, the more the individuals in that society are incentivized to innovate and produce as a means of satisfying their desires. This is how human beings deal with scarcity. Given our infinite desires and the natural limitations of time, energy and capital, markets determine how we navigate these exchanges.

From Scarcity to Plenty

According to Adam Smith, “If men work together and cooperate, they can combine their land, labor and capital to greatly multiply their ability to produce even greater and more complex things.”

Although evident in many ways, the power of Adam Smith’s observation is highly apparent in the technology and innovation that drove the industrial revolution and mass production.  The impact of mass production is seen not only in the technology and specialization of tasks, but also in its effect on prices. When goods are mass produced, the increased quantity of goods and lower costs of production drive down prices, which in turn makes them affordable to even more people.  Increasing productive capacity and deflating the cost of production is one of the primary reasons that western civilization so successfully fought scarcity and experienced prosperity.

 

Law and Liberty

In contemplating how markets allow humans to meet their most basic needs and desires, it is important to discern the mechanisms that have allowed the United States and western civilization in general to be so prosperous. Some nations deprived of resources are prosperous, while others, rich in resources, suffer from acute scarcity. Therefore, one must look to the degree of freedom in markets to determine why scarcity is more problematic in some countries and societies than others.

 

Law and liberty set the context for how markets function.  The United States is a republic that operates under the rule of law.  The rights and laws as originally established by the Declaration of Independence and U.S. Constitution are the principles of right and wrong by which citizens and the government must abide.  Among these, and vital to the engine of wealth creation, is the right to private ownership of property. Through this, a citizen owns what he or she produces or what they are paid by an employer for their production. As originally constructed and put forth in the founding documents, Americans are protected against unwanted intrusions. Simply put, one cannot take what is rightfully owned by another. In all of the aforementioned documents it is established that the government’s primary purpose is the defense of those rights.  Those documents make it perfectly clear that the unalienable rights bestowed upon all citizens are primarily intended as protections against governmental abuse.

 

The rights and protections decreed are not just about right and wrong, as they thoughtfully serve as the bedrock for efficient markets and importantly engender the incentives that drive productive work in America.  The ability to fulfill desires in a vocation of one’s choosing inspires individuals to work, save, invest and consume. In a word, it is the path to contentment.  These incentives compel men and women to deliver goods and services as efficiently as possible.  An individual’s productive effort not only renders the resources by which one can meet their own needs and desires, but taken in aggregate, it propels the wealth of the entire populace.

 

Interestingly, despite simple logic, modern central bankers try to convince the world that deflation is evil. They preach that they must intervene to stoke inflation at all cost for the good of society. The truth of the matter is that deflation is a beneficial by-product of innovation and productivity gains. Said differently, the incentives that inspire work and creative ingenuity produce prosperity and work against scarcity.

 

Productive deflation, which reduces scarcity as described above, benefits a society.  It especially benefits those at the bottom of the economic ladder as the issue of scarcity is a more profound problem for those with less. So why does modern society give central bankers the benefit of the doubt when they undertake such measures as debauching the currency in efforts to incite inflation?

 

Summary

The prosperity of a nation and its people comes about through the availability of goods and services to more people. Free markets, upheld by the rule of law, incentivize people to be productive through work and acquire the means to fulfill their desires. It is in this elegant yet simple virtuous cycle that productivity growth, prosperity and contentment flourishes and scarcity diminishes. The benefits do not solely accrue to those most motivated, the wealthy or those politically well-connected, but to everyone in society.

 

Most local grocers and butchers have been replaced by the likes of Costco and Amazon. The days of trading shares of individual companies has morphed into trading esoteric derivatives, ETFs, and a host of complex products. These intricacies are signs of innovation within maturing markets. The issue with which we must concern ourselves is the friction introduced to markets, not the market’s degree of complexity. When unnecessarily intrusive policies, laws, and regulations restrict our ability to be productive, incentives are diminished. Without proper incentives, productivity falters and the wealth and prosperity of a nation suffers.

 

As Milton Friedman said, “the record of history is absolutely crystal clear”.  A free market, capitalist system, despite all its imperfections, when properly protected by government as required by the founding documents, produces prosperity that benefits all of society.

 

 

 

 

720 Global is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  Our objective is to provide professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and marketing. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics.

 

Coming soon 720 Global will offer “The Unseen”, a subscription-based publication similar to what has been offered at no cost over the past year and a half.  In fact, what the subscription offers is precisely what we have delivered in the past, a substance in style and form that provides unique analysis and meaningful value to discerning investors. Those that have read our work understand the comparative advantage they have gained over the vast majority of investors that solely focus on the obvious. Our readers are prepared for what few see.

 

720 Global research is available for re-branding and customization for distribution to your clients.

 

For more information about our services, please visit us at www.720global.com or contact us at 301.466.1204 or email info@720global.com 

 

©720 Global 2017 All Rights Reserved

 

NOTICE AND DISCLAIMER: This material has been prepared by 720 Global, LLC. Opinions expressed herein are subject to change without notification. Any prices or quotations contained herein are indicative screen prices and are for reference only. They do not constitute an offer to buy or sell any securities at any given price. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness, reliability or appropriateness of the information, methodology and any derived price contained within this material. The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

Neither 720 Global, LLC nor its directors accept any liability for any loss or damage arising out of the use of all or any part of these materials.

All rights reserved. This material is strictly for specified recipients only and may not be reproduced, distributed or forwarded in any manner without the permission of 720 Global, LLC. 

 

 

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