What we are reading on 7/31/2017

Here’s what we are reading today. We do not necessarily agree with the opinions expressed therein and we disavow any actual or implied investment advice therein. In no particular order:
Why sleep patterns change as we age
Here come the bugs
Sweets affect men’s mental health differently than women’s
What Sets College Thrivers and Divers Apart? A Contrast in Study Habits, Attitudes, and Mental Health
Chicago’s (and Illinois’) downward spiral…
The college bubble may be coming to an end
New results on assortative mating by education
Robots on the trading desk
Investing in the Misunderstood
Hot Potatoes and Dutch Tulips
How to find stocks on the move using exponential regression
Building an Unconstrained Sleeve
How Round Number Bias and Psychological Pricing Affect Your Gains and Spending

Inflation monitor as of 7/28/2017

Inflation has been trending downwards for decades.  We think the following factors have created this long-term trend:

  • an aging population that buys less
  • wage competition from third-world countries, due to globalization.

With talk of border taxes and rolling back globalization (at least partially), can we assume that the downward inflation trend will continue from here?  We don’t know, but we intend to track the numbers.  This post reviews a wide range of market-based and statistically derived measures of inflation.

Recent indicators suggest some softening of inflation.

Our takeaway:  the annual rate of inflation is probably 1.5%-2.5%.

Backward-Looking Measures

Consumer Price Index (CPI) – changes

The CPI is calculated by the government.  More than a few investors view the index with a degree of skepticism.

CPI:  +1.62%

Median CPI:  +2.14%

Core CPI:  +1.68%

Sticky CPI:  +2.12%

Trimmed Mean PCE:  +1.48%

Producer Price Index (PPI) – changes

The PPI is calculated by the government.  Some investors regard it with suspicion:

Finished Goods:  +2.07%


Wages are very important because they account for such a large portion of the cost of goods and services.

Average hourly earnings:  +2.46%

An increase in average hourly earnings does not translate into an equal amount of inflation.  Increases in productivity can offset (entirely or partially) the inflationary effect of higher wages.

Billion Prices Project

The billion prices project estimates the annual rate of inflation by using prices posted by online merchants.

As of the last publicly available data point, BPP estimates the U.S. inflation rate at annualized rate of about +1%.

Purchasing Manager’s Index

The Institute for Supply Management publishes the results of a monthly survey of their members, including a price diffusion index.  A diffusion index doesn’t tell us the rate of inflation, but rather what percentage of the survey respondents are seeing prices go up or down.

The survey results suggest no significant inflationary pressures.

Manufacturing Prices:  55.0

Services Prices:  52.1

Forward-Looking Measures

Treasury Inflation Protected Securities

In addition to ordinary bonds, the U.S. Treasury issues inflation-protected securities (TIPS).  By comparing the yields, one can infer the inflation forecast of the capital markets.

Ordinarily one should assign high credibility to this type of information. However, caution may be appropriate given extensive central bank manipulation of the credit markets.

Five Year Forecast:  +1.68% per annum (5Y Treasury Yield5Y TIPS Yield)

Ten Year Forecast:  +1.83% per annum (10Y Treasury Yield10Y TIPS Yield)

5-Year, 5-Year Forward Inflation Expectation Rate

Inflation expected from 5 years from now to 10 years from now:  +1.98%

Michigan Consumer Sentiment

1-Year Expected Rate of Inflation:  +2.6

5-Year Expected Rate of Inflation:  +2.6

ECRI U.S. Future Inflation Gauge

ECRI +0.3

Trend-based indicators

Crude Oil:  Downtrend = deflationary pressure

Copper:  Uptrend = inflationary pressure

U.S. Dollar:  Downtrend = inflationary pressure

A challenging workout

I try to exercise regularly and found the following workout (which I designed) to be one of the most challenging I have ever attempted.  It’s not complicated and it doesn’t seem like too much, but it is surprisingly difficult both physically and mentally.

If you want to try it for yourself, please be smart about doing so:  Get advice from your doctor before trying it.  I don’t want anyone having a heart attack (or worse) from this idea!

The workout is a one mile run with five burpees at the beginning of each minute.  If you don’t know what a “burpee” is then watch this video.

So, at the beginning of the run, you do five burpees.  After completing the burpees you run for the remainder of the first minute.  At the end of the first minute, you stop running and do five more burpees; and then resume running for the remainder of the second minute.  You keep doing this for as long as it takes to run one mile, stopping to do five burpees at the beginning of each new minute.

On average, it took me about 20 seconds to do the five burpees, leaving 40 seconds for running.  I think that is a good balance between the two.  If you are very fit, you could try six (or maybe seven) burpees; if not, maybe fewer.

This workout creates two challenges:  physical and mental.

The physical challenge occurs in multiple ways:

  • the burpees leave less time for running, which makes the relatively modest one mile run more difficult.
  • the burpees interrupt the momentum and cadence of running.
  • the burpees require a large expenditure of energy and increase the heart rate, which leaves one feeling depleted while attempting to run. Normally I run at a pace that feels sustainable – I work hard but I don’t feel like I am going to explode.  This workout took me into the I-feel-like-I-am-going-to-explode zone.

Sustaining the effort is a great mental challenge:

  • If you go fast on the burpees, you will have more time to run but your racing pulse will make it harder to run fast.  So you will have to summon all of your will to push yourself forward.
  • On the other hand, if you conserve energy by going slow on the burpees, you have less time to run meaning more rounds of burpees.  Either way, you have to push yourself hard to complete the workout.

Full disclosure:  I have tried this once and had to stop at 0.5 miles.  I am going to try to build up to a mile over the next few months.


Do bull markets die of old age?

At more than eight years of age, the current bull market is not young.  But do its whiskers doom the bull market to a certain death?  In this regard, we look at bull markets as being somewhat like people:  People don’t die of old age itself, but the older a person the more likely that at least one of the life-sustaining systems in the body will fail to do its job.

We think a bull market of any age may continue under the following circumstances:

  • valuations are not too high;
  • investors remain cautious;
  • economic performance is reasonable – neither too strong nor too weak;
  • monetary policy is not hostile.

An aging bull market may indicate deterioration in the conditions that tend to cause a bull market in the first place.

For example, year after year of double digit stock price returns are likely to push valuations ever upward.  The longer the bull market, the greater the likelihood that stock prices have risen well above intrinsic value. We believe stocks will face headwinds as they become increasingly overpriced.

Bull markets tend to overcome cautious investors.  While there are some investors who become more cautious as stock prices rise, the historical record shows that investors on average tend to become progressively less cautious the more stock prices rise.  This means bull markets tend to draw in ever more investors over time, until there are not enough investors left to buy and to push up the prices of stocks.

A long-lived bull market may carry implications about economic performance.  Years of solid economic performance can result in rising consumer confidence.  Consumers borrow too much, which puts economic growth at risk.

Alternatively, the kind of sustained economic growth that accompanies long bull markets may encourage business leaders to become more aggressive in their hiring and investment plans.  Increased business aggressiveness can cause the economy to overheat and spark rising inflation.  Rising inflation may alarm the central bank.  An alarmed central may switch from a policy of accommodation to restriction in an attempt to prevent inflation from getting out of hand.

Thus, we don’t think bull markets die of old age.  But they may die from the complications of old age.

What we are reading on 7/25/2017

Here’s what we are reading today. We do not necessarily agree with the opinions expressed therein and we disavow any actual or implied investment advice therein. In no particular order:
Steps To Jump Starting A Stalled Job Search
The Real Value Of A Finacial Advisor
Is the Crypto Coin Market a Ticking Time Bomb?
The New Supply Side Economics Fueling Asset Bubbles
On Simple Markets
Is Managed Futures Now Mainstream?
The state of investing in Europe
Global Green Shoots
Getting Help
When Should We Eat?
Many People Can’t Tell When Photos Are Fake Can You
Why Aren’t Students Showing Up For College
The Myth Of Drug Expiration Dates
This Is Why Its So Hard To Be A Contrarian Investor
Overvaluation is NOT Due to Passive Investing
Separating Positions from Allocations
Trick Question: How is the Momentum Factor Performing YTD?
Academic Research Insight: When Does International Investing Make Sense?
Coin Flip Investing
Could The US Default Due To A Complexity Catastrophe?
Sometimes the crowd is right?
Checklist Investing: This is How You Get an Edge over the Market
4 Invaluable Investing Insights from Guy Spier
Want To Live Longer? Be Neurotic
Salient features of bull market peaks
Low-cost demands spurring managed futures evolution
The Problem with Being a Top Performer

Are stock repurchases a substitute for dividends?

With the stock market offering a paltry dividend yield, some market commentators have tried to make the case that the “yield” is much higher.  One must not ignore the effect of stock repurchases.  We don’t agree with this argument.

Managements have two means of returning cash to shareholders:

  • pay the cash out in the form of dividends.  In this case, all shareholders receive the same amount of income per share.
  • use the cash to buyout shareholders who would like to sell.  In this case, only the selling shareholders receive a flow of cash from the buyout.  The company retires the shares of the selling owners.  The remaining shareholders benefit in that they each own a greater percentage of the total remaining shares outstanding.

Some people argue that stock repurchases should be considered the same as dividends for the purpose of valuing stocks.  For example, if a company has a $10 billion market capitalization and pays out just $100 million in dividends, the dividend yield is an unimpressive 1%.  But if one were to include $500 million worth of stock repurchases as part of the “yield” then the “yield” might be five percentage points higher at 6%.

While we support the idea of a company buying in its stock at a price below its intrinsic value, we don’t like the idea of conflating stock repurchases and dividends for valuation purposes.

Management teams don’t declare dividends lightly.  Stock market investors react very badly to reductions in dividends, so management teams tend to increase a payout if they have a great deal of confidence that they will be able to sustain the dividend over the long term.

In contrast, stock repurchases give management much more flexibility.  A company can announce the intention to repurchase stock while leaving the timing of the repurchases uncertain.  If corporate cash flows are insufficient due to company-specific or general economic conditions, the company can quietly delay or abandon its repurchase plan.

People who invest for income expect to be paid.  Dividends represent a far greater commitment to producing income than a stock repurchase plan.


Commitment bias

People do not like being regarded by others as inconsistent.  When a person commits publicly to a particular point of view, commitment bias likely will exert a powerful influence on subsequent beliefs and behavior.

Commitment bias reflects the tendency of people to have their current and future beliefs remain consistent with their past beliefs.  To be inconsistent now with one’s past implies that earlier beliefs were wrong either in part or in total.  Being wrong is a threat to one’s sense of self-worth.

There are many examples of inconsistency creating problems for people. The more someone changes their point of view, the less trustworthy they seem.  For example, politicians have lost elections for having inconsistent views over time.

The greater the commitment, the more urgent the desire to remain consistent.  A privately held belief does not trigger commitment bias as strongly as a belief boldly proclaimed to the public.  A weakly held belief does not influence the mind as much as a strongly held belief.

It is easy to see how commitment bias could cause trouble for investors. Investing involves making high-stakes decisions under uncertain conditions.  Putting money to work in an investment creates an immediate commitment to the thought processes that led to the investment decision. The commitment will make it more difficult to determine the best time to sell and move on to another opportunity.

A possible cure to commitment bias is to remember the words widely attributed to John Maynard Keynes.  Supposedly, someone once confronted Mr. Keynes that he had changed his mind regarding some matter, to which Mr. Keynes allegedly replied, “When the facts change, I change my mind.  What do you do, sir?”

In short, recognize that new information may warrant new beliefs and give yourself permission to adjust accordingly.

Anchoring heuristic

The anchoring heuristic defines a mental shortcut in which people overweight the importance of the first information received when making a decision.  This heuristic is very difficult for most people to avoid.

For example, let’s imagine an experiment to be administered to many thousands of people.  Everyone is asked to guess the age of an adult.  A third of the participants in the experiment are told that the 21.1 years old is not the correct answer.  Another third of the participants are told that 90.7 years old is not the correct answer.  The remaining third are not told anything.

The guidance provided to the first two groups tells us very little about the person’s age.  If an adult’s age range is from 18 to 95 (78 years in total) and our accuracy is to one decimal place, we have 780 possible guesses. The guidance eliminates just 0.12% of the possibilities.

If the participants are good at evaluating statistical information, they should move in the opposite direction provided by the guidance.  For example, if 21.1 is not the correct answer, than one should assume a slightly above average age because one knows that at least one of the below average ages is incorrect.

But the anchoring statistic predicts the opposite result:

  • for the group that was told 20 years was not the correct answer, the average guess might be 38.5 years;
  • for the group that was told nothing, the average guess might be 43.7 years, and
  • for the group that was told 90 years was not the correct answer, the average guess might be 53.2 years.

Used car dealers may take advantage of people’s susceptibility to the anchoring heuristic by posting ridiculously high prices on their inventory. A reduction in price is perceived as a good deal by the customer, even though the final sales price may still be too high – it only looks good compared to the original ridiculous price.

The anchoring heuristic could lead to a range of sub-optimal decisions for investors.  For example, let’s imagine that it is easy to find one- and three-year returns for mutual funds.  The easy-to-find results (the more recent returns) will tend to anchor perceptions of the skill (or lack of skill) of the investment manager.  Once that anchor has been set, subsequent information will not be accorded the same weight as recent returns.  Thus, the good recent returns will cause one to overlook a weak longer term track record, potential defects in the investment process and other potentially important considerations.

What we are reading on 7/18/2017

Here’s what we are reading today. We do not necessarily agree with the opinions expressed therein and we disavow any actual or implied investment advice therein. In no particular order:
Chipmunk speed podcasts
Science takes a look at getting a good night’s sleep
Is it time to change your diet?
What creates happiness? Experiences or stuff?
Coffee and your health
People regret choosing English as their college major
The Mexican Peso has recovered its losses from the election
Trend Following Research
Why Grim Reaper of Retail Hasn’t Claimed Best Buy
Academic Research Insights: Does the Scope of the Sell-Side Analyst Industry Matter?
What You Need to Succeed in Investing (Hint: It’s Not Genius Brain)
Should the real debate be about robots in education?
What’ll Happen to US Commercial Real Estate as Chinese Money Dries Up?
Even the Most Fiscally Fit States Have Pension Problems
Another Reason Men Don’t Work: Imaginary World More Enjoyable than the Real World
Institutional investors, real assets and inflation protection
The Wrecking Ball
Bank of England sounds the alarm
The Weight Of The Wait
The Self-Care Conundrum

Do economic expansions die of old age?

In our view, economic expansions do not die of old age.  We believe that economic expansions die because of imbalances that build up over time. The longer the length of the expansion, the more likely that some fatal imbalance has developed.  Thus old age itself does not cause economic expansions to die, but rather the problems (growing imbalances) associated with old age.

At some point, the imbalances become so great that something in the economic system “breaks,” at which point the economy rolls over into a recession.

In a classic economic cycle, an imbalance between (insufficient) supply and (excessive) demand can cause the rate of inflation to increase.  Rising inflation provokes an increase in the interest rate.  Higher borrowing costs discourage consumption and investment, causing the economic expansion to die.

Sometimes the inflation concentrates in the wages paid to labor rather than more generally throughout the economy.  We see an imbalance between wage inflation and inflation generally.  In this case, business cannot pass through rising labor costs in the form of higher selling prices. As business profits compress, businesses have begin to cut back on costs which then chokes off the economic expansion.

Sometimes the wages paid to labor do not increase, but businesses are able to raise prices nonetheless.  We see an imbalance between business selling prices and wages.  In this case, workers discover that their wages have less and less purchasing power over time.  As household budgets become stretched, consumers cut back on some purchases.  The economic expansion dies.

Excessive debt growth can be an imbalance.  An economic expansion can engender consumer and business confidence.  Confidence can lead to the willingness to take on debt.  Over the long term, it is difficult to see how debt growth in excess of income growth ends well.  At some point, the economy’s capacity to carry debt reaches a limit, at which point economic growth slows – perhaps enough to tip into a recession.