Posts Tagged ‘Innovators’

Robert Arnott: Reversion To Which Mean?

Monday, July 6th, 2009


Rob Arnott, founder of Research Affiliates, innovators of FTSE RAFI Fundamental Equity Indexes discusses the concept of ‘reversion to the mean’, but asks, ‘ which mean?‘

Here are highlights:

Mean reversion is one of the most powerful and reliable drivers of long-term capital markets returns. It’s like a pendulum. When valuation levels get high (or low) by historical standards, they’ll usually swing back to past norms, often overshooting as a pendulum might. To be sure, mean reversion works its magic slowly, so one can often wait a long time for values to revert.

One challenge with relying on mean reversion is that we don’t know what the “right” mean is. Stocks today look cheap relative to the “mean” of the last 20 years, but expensive relative to the “mean” of the last 100 years. So, which is right?

About stocks:

Spreads between growth and value stocks widened to near record levels in March. Even now, deep value stocks are priced for a bleak outcome. If these prices are right, then the growth stocks are ridiculously expensive. If the growth stocks, which are priced to reflect an economic recovery in the next 6-12 months, are right, then deep value stocks are cheap.

About corporate bonds:

Investment grade corporate bonds also yield 2 per cent to 4 per cent more than the stocks of the companies that issued the bonds, so the bonds can beat the stocks if earnings and dividends grow slower than 2 per cent to 4 per cent. Over the past 50-100 years, earnings and dividends have grown about 4 per cent to 5 per cent a year, of which 3 per cent was inflation. This means stocks should edge past their own corporate bonds, unless the growth rate has changed.

Treasury inflation- protected securities represent a useful hedge against renewed inflation. And, they’re priced at a yield about 2 per cent lower than notional Treasury bond yield of the same maturity.

Government intervention is changing the landscape, and altering the market norms of last twenty years:

The market is trying to figure out what equity and bond ownership means in an order that chooses direct intervention over Adam Smith’s “invisible hand”.

Will this move towards centralised control deliver unintended consequences? Of course. The most obvious is that if secured bondholders are no longer assured of being “first payee” in bankruptcy, then bondholders will demand more reward to compensate for an unexpected new layer of risk. If stockholders are subject to expropriation, then stock prices will reflect a new layer of risk.

The most important consequence is whether centralised management of the economy will lead to improved economic growth. History suggests the contrary. So, the “mean” moves. But by how much? Ben Graham drew a distinction between price-based losses and a permanent loss of capital. The former represents a buying opportunity; the latter does not. We’re seeing more of the latter imposed on the capital markets – by government fiat – than we’ve seen in the past.

In other words, be careful and don’t rely strictly on what you think you know about the market, nor your assumptions as to what you think the mean might be to guide you here. (Read the June 28, 2009 article here.)

Back in late April, we published the note, Bonds: Reversion Cuts Both Ways, in which Rob Arnott asserts that investors should take care to not make broad assumptions about which asset group will outperform over the long term. Arnott, who is the founder of FTSE RAFI Fundamental Indexes, willingly explains why he’s been favouring bonds.

Suggestion: Get to know as much about the bond market, interest rates, and currency relationships as you can.

Here is some suggested reading (and viewing) from items we have covered that you may have missed:

Hugh Hendry: 10-year Treasury Signals Deflation

August 6, 2008 - Hendry points out that 10-year treasurys are up 15% YTD, and are signalling deflation - in the same segment, he also skewers Lloyd’s Nick Hodson.

Hendry: Not Yet Time to Invest in Inflationary Assets

March 17, 2009 - Though Hendry appears to be wrong about investing in inflationary assets in the short term back in March, when the recovery rally started, his arguments are compelling, and he gets into an impassioned debate/argument with Liam Halligan over which side of the trade one should be on. Its enlightening and educational, because it highlights the debate between inflationists and deflationists.

Peter Thiel: Letter to Clarium Capital Partners

April 21, 2009 - Clarium’s Managing Director, Patrick Wolff does an excellent and interesting job of explaining the credit market, Quantitative Easing, and among other things how it is and is not inflationary, given the consensus over the whirring of government printing presses. Believe it or not - the amount of money being printed may not be sufficient - yet.

Make Sure You Get This One Right

July 3, 2009 - Niels Jensen discusses the inflation/deflation debate and about what side of the trade investors should consider.

These are good start for now.

Source: FT.com, Robert Arnott, June 28, 2009

by-nc-sa

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | No Comments »

Memo to All My Valued Employees

Monday, December 29th, 2008


Listening to AM640 here in Toronto today, I heard an excellent discussion about the letter from “The Boss,” a truth-be-told debate about the value of tax-cuts, stimulus and taxation. In the current climate of government intervention, and neo-socialism, the letter is a breath of fresh air for those of us who have made the greatest productive contribution. Thanks to Charles Adler for posting the letter at his blog.

To go one step further, it is reminiscent of the world of Ayn Rand’s “Atlas Shrugged,” in which the story’s heroes, the entrepreneurs, the innovators, the captains of industry, the prime-movers, decide the best remedy is to withdraw, to go on strike, as the world is looted by bureaucrats, socialists, pseudo-intellectuals, and mystics.

Memo to All My Valued Employees

Author: The Boss

There have been rumblings around the office about the future of this company and, more specifically, your job. As you know, the economy has changed for the worse and presents many challenges. The good news, however, is this: The economy doesn’t pose a threat to your job. What does threaten your job, however, is the changing political landscape in this country.

First, while it’s easy to spew rhetoric that casts employers against employees, you have to understand that for every business owner there is a back story. This back story is often neglected and overshadowed by what you see and hear. Sure, you see me park my Mercedes outside. You’ve seen my big home at last year’s Christmas party. I’m sure all these flashy icons of luxury conjure up idealized thoughts about my life. But you don’t see the back story.

I started this company 12 years ago. At that time, I lived in a 300 square foot studio apartment for three years. My entire apartment was converted into an office so I could put forth 100% effort into building a company, which, by the way, would eventually employ you. My diet consisted of noodles because every dollar I spent went back into this company. I drove a rusty Toyota Corolla with a defective transmission. I didn’t have time to date. Often times, I stayed home on weekends, while my friends went out drinking and partying. In fact, I was married to my business — hard work, discipline, and sacrifice.

Meanwhile, my friends got jobs. They worked 40 hours a week and made a modest $50K a year and spent every dime they earned. They drove flashy cars and lived in expensive homes and wore fancy designer clothes. Instead of hitting Nordstrom for the latest fashion item, I trolled through the Goodwill store extracting any clothing item that didn’t look like it was birthed in the ’70s. My friends refinanced their mortgages and lived lives of luxury. I did not. I put my time, my money, and my life into a business with a vision that, some day, I too, would be able to afford the luxuries my friends had.

So, while you physically arrive at the office at 9 a.m., mentally check in at about noon, and then leave at 5 p..m., I don’t. There is no “off” button for me. When you leave the office, you are done and you have a weekend all to yourself. I, unfortunately, do not have that freedom. I eat and breathe this company every minute of the day. There is no rest. There is no weekend. There is no happy hour. Every day this business is attached to my hip like a one-year-old special-needs child. You, of course, only see the fruits of my labor — the nice house, the Mercedes, the vacations. You never realize the back story and the sacrifices I’ve made.

Now the economy is falling apart and the guy who made all the right decisions and saved his money have to bail out all the people who didn’t. The people who overspent their paychecks suddenly feel entitled to the same luxuries that I earned and sacrificed a decade of my life for. Yes, business ownership has its benefits, but the price I’ve paid is steep.

Unfortunately, the cost of running this business and employing you is starting to eclipse the marginal benefit. Let me tell you why:

I am being taxed to death and the government thinks I don’t pay enough. I have state taxes. Federal taxes. Property taxes. Sales and use taxes. Payroll taxes. Workers’ compensation taxes. Unemployment taxes. Taxes on taxes. I have to hire a tax man to manage all these taxes and then, guess what? I have to pay taxes for employing him.

Most of my time is now occupied with government mandates and regulations and all the accounting that goes with them. On October 15th, I wrote a check to the US Treasury for $288,000 for quarterly taxes. You know what my “stimulus” check was? Zero. Nada. Zilch.

The question I have is this: Who’s stimulating the economy? Me, the guy who has provided 14 people good-paying jobs and serves more than 2,200,000 people per year with a flourishing business? Or the single mother sitting at home pregnant with her fourth child waiting for her next welfare check? Obviously, government feels the latter is the economic stimulus of this country.

The fact is, if I deducted (read: stole) 50% of your paycheck, you’d quit and you wouldn’t work here. Why should you? That’s nuts. Who wants to get rewarded for only 50% of their hard work? Well, I agree, which is why your job is in jeopardy.

Here is what many of you don’t understand: to stimulate the economy you need to stimulate what runs the economy. Had suddenly government mandated to me that I didn’t need to pay taxes, guess what? Instead of depositing that $288,000 into the Government black-hole, I would have spent it, hired more employees, and generated substantial economic growth. My employees would have enjoyed the wealth of that tax cut in the form of promotions and better salaries. But you can forget it now.

When you have a comatose man on the verge of death, you don’t defibrillate by shocking his thumb to bring him back to life, do you? No. You defibrillate his heart. Business is at the heart of our economy and always has been. To restart it, you must stimulate it, not kill it. Suddenly, the power brokers believe the mud of economy is the essential driver of the economic engine. Nothing could be further from the truth.

So where am I going with all this? It’s quite simple. If any new taxes are levied on me, or my company, my reaction will be swift and simple. I’ll fire you. I’ll fire your co-workers. You can then plead with the government to pay for your mortgage, your SUV, and your child’s future. Frankly, it isn’t my problem anymore.

Then, I will close this company down, move to another country, and retire. You see, I’m done. I’m done with a country that penalizes the productive and gives to the unproductive. My motivation to work and to provide jobs will be destroyed and, with it, will be my citizenship.

While tax cuts to 95% of the people sounds great on paper, don’t forget the back story: If there is no job, there is no income to tax. A tax cut on zero dollars is zero. Who understands the economics of business ownership and who doesn’t? Whose policies will endanger your job?

Answer those questions and you should know who might be the one capable of saving your job. While the media wants to tell you “It’s the economy, stupid,” I’m telling you it isn’t. If you lose your job, it won’t be at the hands of the economy; it will be at the hands of a political hurricane that swept through this country, steamrolled the Constitution, and changed the landscape forever. If that happens, you can find me in South Caribbean sitting on a beach, retired, and with no employees to worry about.

Signed,

Your Boss

Who is John Galt?

 

by-nc-sa

Tags: , , , , , , , , , , , , , , , , , , , , ,
Posted in Economy, Markets | 5 Comments »