Investors must recognize what ‘this time it’s different’ really means

http://www.washingtonpost.com/business/barry-ritholtz-investors-must-recognize-what-this-time-its-different-really-means/2014/05/15/c2d7d072-dc74-11e3-bda1-9b46b2066796_story.html

by petethomas • 12 years ago

54 43 12 years ago

washingtonpost.com

lotsofmangos• 12 years ago

Rates are at a 300 year low apparently so I'd guess they are going to rise. Now, I have nothing to do with trading and don't own any property, so presumably I'm the shoeshine boy.

Lost_BiomedE3• 12 years ago

If you see the USD under 70, be prepared for this time is different, for real.

Banks have huge reserves right now, about 6x historical norm, and are making money in the market due to the low rate they get. When rates rise, that avenue is not as lucrative. They will lend. Each dollar lent has a 10x multiplier on it. They could introduce up to 120% GDP into the money supply.

Just one thing to watch these days.

amykyta3• 12 years ago

I am not sure what you're talking about.

What is the level of 70 for USD?

Also, through what mechanism do you think rate will rise (real or nominal)? It'll have to be with a nudge from the FOMC which implements the monetary policy by buying/selling treasuries from/to the banks. As rates rise, some of those reserves banks have now will get absorbed by the FOMC. Additionally, just because banks have money to lend doesn't mean they're going to throw caution and credit concerns to the wind and start lending again.

dredmorbius9• 12 years ago

If you're looking at the economy and financial returns, there are a number of factors other than strictly cyclical characteristics of stock market and financial vehicle returns to consider. Pardon the self-link spam, but this is a topic of some interest to me:

There's the Shift Index by Deloitte's Center for the Edge, which shows a long-term secular decline in return on invested capital (ROIC) from 1965 to 2009 by 75%. It's fallen from 6.2% to 1.3%, and is on track to negative returns in a little over a decade. http://redd.it/1y3z3n

There's the relationship of GDP growth to the price of oil (WTI), as portrayed in this FRED graphic from 1945 - 2012: http://i.imgur.com/hfBRw9f.png

Prior to 1974, WTI tracked a very predictable 2.5% price trend. This was the period during which the TRC, Texas Railroad Commission, effectively set the price for oil through extraction (production) quotas. In March of 1971, the TRC lifted those quotas, effectively removing any limits on extraction rates. US oil extraction had peaked. 1971 is the watershed. Oil prices never resume their previous level of stability, and GDP cycles become more random and volatile. Afterward, oil prices are often higher (much of the 1970s and 2000s), sometimes lower (1984 - 1999), but always volatile. The regularity of GDP cyclical trends is lost. http://redd.it/1tz6y2

Though there have been financial panics before, the period from 1929 - 2007 is exceptionally notable for its lack of any widespread panics. There were a few edgy times -- going off Bretton-Woods in 1971, the 1987 stock market crash, the Asian currency crises of the 1990s, but central banks held the show together until 2008 and the fall of Lehman Brothers. Observers such as Michael Lewis, particularly in The Big Short, have commented on the financial restructuring that's sustained paper profits while real wealth growth is questionable. The YC and HN crowd might want to look at where all that magic money making Rails coders so much more valuable than janitors comes from, and how long the music will play.

amykyta3• 12 years ago

I think you mean Michael Lewis.

As for the price of oil and GDP cycles. I am not sure I understand your point. Can you please elaborate?

First world economies are more based around services than industrial production at this point, so while oil is still a hugely important commodity, there have clearly been structural changes in what comprises world GDP.

dredmorbius9• 12 years ago

Yes, thanks, corrected.

There's a set of heterodox economic schools which hold that it's principally energy which is responsible for economic growth, and specifically the abundance, const, and convenience of that energy. Hydrocarbons, especially liquid hydrocarbons, are a spectacularly convenient form and store of energy. Electricity is a useful form of energy, though it's not particularly storeable. This has been suggested and explored by numerous economists and others since the early Industrial Revolution, notably: William Stanley Jevons (The Coal Question (1865)), US Navy Rear Admiral Hyman G. Rickover, Kenneth Boulding, Nicholas Georgescu-Roegen, Charles Odum, Charles A.F. Hall, and others. Generally, "thermoeconomics", "biophysical economics", or "ecological economics".

Decoupling of energy (and resources generally) from GDP growth has been argued by numerous authors, though I find their case unconvincing. It's been argued against by others.

Global GDP vs. primary energy consumption shows a pretty strong correlation, and I find the causality argument plausible: http://i.imgur.com/42I4Jmf.png (from Wolfram+Alpha).

Yes, efficiency has improved, but so has overall consumption: http://i.imgur.com/Hu0NWsI.png

As for oil and GDP cycles: my point is that while the price and supply of oil were highly stable, GDP variation was very regular. As oil price and supply began to vary, GDP stability went all to heck.

clamprecht• 12 years ago

Given what you have said, where should a US-based person put their savings in order to (1) keep up with inflation, and (2) make a reasonable return (somewhere in the 6-10% range)?

saryant2• 12 years ago

Just buy everything.

Retail investors are unlikely to beat the market as a whole, so just buy the entire market, hold it forever and keep costs low. For instance, Vanguard's Total Stock Market fund holds almost every publicly traded stock in America (~3700) and is dirt cheap.

dredmorbius9• 12 years ago

The combination of insurance protection and high return is not something you're going to find. The general argument is to invest in a broad market index (or even a spread of several stocks and/or bonds (6-12 gives a pretty high level of diversification, though a broad index based on the top 100, 500, or 1000 securities is of course even broader).

That will give you protection from volatility in any one security. You won't be protected against general market (or financial system) risk.

There are several bond issues which are specifically inflation-indexed, e.g., TIPS for the US:

https://en.wikipedia.org/wiki/Treasury_security#TIPS

https://en.wikipedia.org/wiki/Inflation-indexed_bond

You're not going to find a 6-10% return on these though, generally.

stygiansonic2• 12 years ago

For the average investor, who doesn't have copious amounts of time to do research, a low-cost index-tracking ETF would be one of the best investment vehicles.

You would want to tailor your asset allocation to match your risk profile. Furthermore, your timeline (i.e. when you will need access to the funds) will affect your asset choices. If you have a short amount of time (less than five years) it's usually too risky to have a high or even moderate exposure to equities. In fact, if I knew that I would need to spend the money within five years, I would keep a large percentage in safe (i.e. guaranteed) investments.

amykyta3• 12 years ago

People don't seem to be reading the actual story posted so let me TLDR it: Barry Ritholtz has been around and has seen a cycle or two. The economic drivers change but fear and greed still drives the 'melt-ups' and 'melt-downs'. Analyze the market (and what the proper valuation is) in the context of where the economy is now and where it's coming from. Don't dogmatically avoid tech stocks because their valuation multiples are higher than you've been targeting for the last 30 years. Don't buy things just because everyone else is doing it and is making quick paper profits from it.

The old saying of "Bulls make money, bears make money, pigs get slaughtered." is relevant.

jqm3• 12 years ago

Predicting the economy is like predicting the weather. Sure, you can get the short term right very often, but longer term the number of factors and the relationships between them becomes very complex. I would guess "this time it really is different" with supporting reasons has been sung plenty of times before. I'm not convinced. War, plague, drought, social unrest... these things come along and their effects are far reaching. To say nothing of financial disasters (maybe those who control the levers have the machine figured out... then again, maybe not. I don't know).

In the long long term yes... I would guess technology is going to be important and there will be profits. Shorter- long term.... it does seem a bit frothy right now. Short-Short term? Ride the trend until it ends.

Pullbacks happen. Sometimes they are bigger, sometimes smaller. They serve an important function. To separate what is important and deserving of capital from that which isn't. Just don't believe they won't happen because yes... they will. That is never different.

dredmorbius9• 12 years ago

I'd actually argue almost entirely the opposite.

Near-term economic forecasting is difficult (though there may be some accuracy in the very near term).

Long-term, you can accurately forecast economic trends based on overall resource availability. See the Limits to Growth baseline model.

jqm3• 12 years ago

Resource availability is a very important component to economic growth.

But I might point out... they had more resources than we do now in the 1700's. So there are other components. Technology being one of them. Can anyone predict what we will be able to do in 50 or 100 or 200 years? Or what else might happen between now and then?

zhte415• 12 years ago

For anyone that hasn't read it, I highly recommend 'Irrational Exuberance' by Robert Schiller, a professor at Yale which covers the theme 'This time its different' in depth, in a long term context covering around 200 years of economic data, in particular regarding herding of investors and thought (as sheep herd, then scatter, then herd). One of the interesting observations of the book is that there has been a recession every 10 years for as far back as the data covers (100+ years) +-2 years of the end of each decade.

A link to the site, with data sets the book covers freely downloadable: http://irrationalexuberance.com/

vishnugupta• 12 years ago

And as an addendum, I highly recommend "Thinking, Fast and Slow" by Daniel Kahneman. A huge take away for me from that book was that humans are very bad at predicting far into the future, especially when it comes to phenomenon that involve multiple feedback loops.

Finance is a prime example of such a phenomenon where changes in policy, regulation, productivity and a host of other factors that influence financial markets, have their impact only several years down the road. Human mind is such that it impulsively reacts only to recent memory and uses it to extrapolate it to future.

It is a fascinating read, one that got me hooked into the subject matter of human psychology and behavioral economics.

BrandonMarc2• 12 years ago

I wish this book were required reading for politicians:

This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff

http://www.reinhartandrogoff.com/

They take a MASSIVE dataset - 8 centuries of data across hundreds of governments - and find the same patterns repeating. Policy makers of different stripes make the same mistakes leading to the same crises, and - when the emergency comes - they try the same failed solutions their forebears tried, often with the indignant claim that "this time it's different!"

Often, the solutions the policy makers are so apt to try just happen to be short-term band-aids, or kick-the-can-down-the-road ways to postpone the hard stuff, or ways to save face and let the next guy be caught holding the bag.

potatosareok• 12 years ago

So I was thinking of picking up this book on your recommendation. However, the names seemed vaguely familiar to me already, which reminded me of the scandal where some grad student reran numbers from one of their papers, and found that Reinhart and Rogoff had made basic coding errors in Excel (I think Excel?) running the data (as well as cherrypicking data to some extent). When the data was processed correctly, it actually showed the opposite of what Reinhart and Rogoff had argued for.

Since I obviously don't have time to fact check all the numbers in their book, and they have a demonstrated history of biased results, I think in the end I'll pass on the book. Just my 2 cents.

NoPiece• 12 years ago

It is not true that the revised data showed the opposite of what Reinhard and Rogoff argues for. It just showed it to a much lesser degree. The New Yorker wrote a fair but critical analysis:

http://www.newyorker.com/online/blogs/johncassidy/2013/04/th...

BSousa• 12 years ago

Was this the same data that was used by IMF and the rest to justify the push the austerity measures on the troubled economies in Europe? I remember there was a big backlash at the time when the numbers came to light but nothing changed anyway (maybe the save face issue above)

rquantz• 12 years ago

My understanding of it is that Rogoff is a great economic historian, but not a great economist. Or something like that. Paul Krugman, for instance, often points out that it's sad R&R are so consistently wrong about how to handle the current crises, because this book was so good.

So the book may be worth reading in spite of the bad research they've been attached to since.

danieltillett2• 12 years ago

Often, the solutions the policy makers are so apt to try just happen to be short-term band-aids, or kick-the-can-down-the-road ways to postpone the hard stuff, or ways to save face and let the next guy be caught holding the bag.

Actually it is worse than this. The policy makers all know what needs to be done, but it is against the interests of the powerful. So instead of doing what is right for the bottom 99.9% they do what is right for the top 0.1%.

The policy makers have actually learned a great deal on how to siphon off the proceeds of improved production towards the top 0.1% and have now got it down to an art form. They have even managed to convince us that they don't know what they are doing - rather than listening to what they say, follow the money.

Djehngo• 12 years ago

Is this part of the premise of the book or personal opinion?

Investors must recognize what ‘this time it’s different’ really means

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