Posts Tagged ‘Financial Disaster’
Tuesday, May 15th, 2012
by James Montier, GMO
This paper is based on a speech delivered at the 65th Annual CFA Institute Conference in Chicago on May 6, 2012.
As a child, watching my parents write postcards whilst we were all on holiday was an instructive experience. My mother would meticulously write out the card, scattering a few interesting holiday tidbits within the text. My father, whose sum total of postcards sent was invariably just one (to his office), opted for a considerably more efficient approach. His method is shown at the left in Exhibit 1.
I think we can construct a similar diagram to explain the Global Financial Crisis (GFC), represented at the right in Exhibit 1. In essence, the GFC seems to have sprung from the interaction of the following four “bads”: bad models, bad behaviour, bad policies (which is really just bad behaviour on the part of central banks and regulators), and bad incentives.
In an effort to rethink finance, I want to examine each of these factors in turn, beginning with bad models. Bad Models, or, Why We Need a Hippocratic Oath in Finance
The National Rifle Association is well-known for its slogan “Guns don’t kill people; people kill people.” This sentiment has a long history and echoes the words of Seneca the Younger that “A sword never kills anybody; it is a tool in the killer’s hand.” I have often heard fans of financial modelling use a similar line of defence.
However, one of my favourite comedians, Eddie Izzard, has a rebuttal that I find most compelling. He points out that “Guns don’t kill people; people kill people, but so do monkeys if you give them guns.” This is akin to my view of financial models. Give a monkey a value at risk (VaR) model or the capital asset pricing model (CAPM) and you’ve got a potential financial disaster on your hands.
The intelligent supporters of models are always quick to point out that financial models are, of course, an abstraction from reality. Just as physicists can study worlds without frictions, financial modelers should not be attacked for trying to reduce the complexity of the “real world” into tractable forms.
Finance is often said to suffer from Physics Envy. This is generally held to mean that we in finance would love to write out complex equations and models as do those working in the field of Physics. There are certainly a large number of market participants who would love this outcome.
I believe, though, that there is much we could learn from Physics. For instance, you don’t find physicists betting that a feather and a brick will hit the ground at the same time in the real world. In other words, they are acutely aware of the limitations imposed by their assumptions. In contrast, all too often people seem ready to bet the ranch on the flimsiest of financial models.
Read the whole letter in the slidedeck below (Fullscreen for the easier read, or download)
Tags: Asset Pricing, Bad Behaviour, Bads, Capital Asset Pricing Model, Capital Asset Pricing Model Capm, Central Banks, Cfa Institute, Eddie Izzard, Financial Disaster, Financial Modelling, Financial Models, Global Financial Crisis, Hippocratic Oath, James Montier, Line Of Defence, National Rifle Association, Rebuttal, Sum Total, Value At Risk, Value At Risk Var
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Tuesday, April 3rd, 2012
from David Rosenberg, Gluskin Sheff
What a quarter! The Dow up 8% and enjoying a record quarter in terms of points — 994 of them to be exact and in percent terms, now just 7% off attaining a new all-time high. The S&P 500 surged 12% (and 3.1% for March; 28% from the October 2011 lows), which was the best performance since 1998. It seems so strange to draw comparisons to 1998, which was the infancy of the Internet revolution; a period of fiscal stability, 5% risk-free rates, sustained 4% real growth in the economy, strong housing markets, political stability, sub-5% unemployment, a stable and predictable central bank.
And look at the composition of the rally. Apple soared 48% and accounted for nearly 20% of the appreciation in the S&P 500 (it now makes up 3% of the 200 largest hedge fund portfolios — three times as much as any other name; 4% of the S&P 500 market cap; and 11% of the Nasdaq). Not since Microsoft in 1999 was one stock this dominant, though the valuations are not comparable (MSFT then was trading with a 70x P/E multiple).
But outside of Apple, what led the rally were the low-quality names that got so beat up last year, such as Bank of America bouncing 72% (it was the Dow’s worst performer in 2011; financials in aggregate rose 22%). Sears Holdings have skyrocketed 108% this year even though the company doesn’t expect to make money this year or next.
What does that tell you? What it says is that this bull run was really more about pricing out a possible financial disaster coming out of Europe than anything that could really be described as positive on the global macroeconomic front. Low- quality stocks in the S&P 500 outperformed high-quality stocks in Q1 by 500 basis points and high-beta stocks within the Russell 1000 outperformed low- beta by 900bps. On a global scale, what has been a poorer place to put capital to work than Japan? And yet the Nikkei posted a ripping 19% advance in Q1, the best start to any year since the pre-bubble-burst times of 1988. Emerging markets are up 13% year-to-date. Greece rallied 7% in Q1 — that also tells you something about this rally. It’s called a dead-cat bounce. Meanwhile, the stodgy sectors that worked so well last year are biding their time — utilities so far in 2012 are down 3%, telecom is flat, and staples are up a mere 5%.
Most investors can dig back to 2000 if they really try. It was not uncommon for typically risk-averse investors such as retirees to be insistent that at least half of their portfolios consisted of Microsoft, Intel, Cisco and Dell. Each of these stocks had gone parabolic and none of them paid dividends, which was a good thing because that left them with all those earnings to plow back into the business. If you needed to buy groceries, you could just sell a few shares for cash flow.
My how things have changed. Today, “dividend paying stocks” are all the focus of attention — not to mention fund flows. Indeed, what is still so fascinating is how the private client sector simply refuses to drink from the Fed liquidity spiked punch bowl, having been burnt by two central bank-induced bubbles separated less than a decade apart. Investors continue to use stock price appreciation as an opportunity to rebalance and diversify rather than chase performance — pulling $15.6 billion from U.S. equity mutual funds so far this year while taxable bond funds have seen net inflows amounting to $59 billion.
The lack of any real significant back-up in bond yields suggests that the asset allocators have been idle as well.
It would then seem as though this is a market being driven by traders. Then again, it has been a very tradable rally, just as the post-QE1 and post-QE2 jumps were. Ditto for the current post-LTRO rally. But liquidity is not an antidote for fundamentals. And a market that lacks breadth, participation and volume is not generally one you can rely on for sustained strength, notwithstanding the terrific first quarter that risky assets delivered. We lived through this exactly a year ago.
Meanwhile, we have real estate deflation rearing its ugly head in China, a spreading European recession (for all the talk of German resilience, retail sales volumes sank 1.1% in February and have contracted now in four of the past five months), acute debt problems in Portugal and Spain (there is already talk in Greece about the need for a third bailout), and the U.S. data have been coming out rather mixed (it should have enjoyed a much bigger bounce than it did in recent months from the extremely warm weather — it was the fourth warmest winter since 1896; 15% warmer than usual.
In Chicago, it was the warmest March ever and second balmiest March on record in New York City. For the latter, it was 9 degrees above normal and would have lined up in the top 10 for any April!). That the employment, housing and spending data weren’t even stronger than what they showed — likely little better than a 2% pace for Q1 real GDP — is the real story beneath the story. The fact that the 10-year note yield stopped at 2.4% and has since rallied 20 basis points instead of making the expected technical challenge of 2.65% suggests that the bond market crowd may be figuring out what this means for the Q2 landscape as the weather skew to the data subsides.
U.S. DATA ON SHAKY GROUND
Yes, yes, U.S. personal spending jumped an above-expected 0.8% in February, above the 0.6% increase that was generally expected and the largest monthly gain since August 2009 when the shoots were green. But if truth be told, this as we would say in market parlance, was a “low multiple” increase. The reason? Personal incomes were soft and that is what counts most — income fundamentals remain dismal. Not only did income come in soft at +0.2% (half what was expected) but not even enough to cover the cost of living, but January and February were both revised lower. Real disposable income also declined 0.1% — the third decrease in the past four months and on a per capita basis is down 0.4% YoY, a far cry from the +2% trend of a year ago. The economy is building momentum. Right.
Let’s just say that had the savings rate stayed the same in February, nominal consumer spending growth would have come in at a puny +0.2% and guess what? Real PCE would have been -0.1%. Thanks for coming out. As we said, a “low quality” spending performance, absent the income fundamentals, there is no sustainability.
Then we got yet another spotty regional manufacturing index in the form of the Chicago PMI (the national figure comes out today). It came in below expectations at 62.2 for March (consensus was 63.0) — a 1.8 point drop from the previous month, and the third decline in the past four months. New orders slid from 69.2 to 63.3 — the largest one month drop since last May and the lowest level since October (this is now the fifth manufacturing survey to show a drop in new orders). If not for the inventories, which jumped from 49.6 to 57.4 — the sharpest run-up since December 2010 and the highest levels since last September — the headline decline would have been much worse. And in a signpost of how corporate executives (or the Human Resource departments in any event) are responding to negative productivity growth, the employment index dropped from 64.2 to 56.3— largest drop since April 2008 and it has fallen in two of the past three months.
Then we got the University of Michigan consumer sentiment index which was revised higher for March to 76.2 from 74.3 in the preliminary reading — this the highest level since February 2011. What was interesting were the details beneath the surface, such as auto buying plans being revised down from 123 to 122 — first decline in three months; and buying conditions for large household items being revised lower from 127 to 125— a four-month low.
Finally, the best Canada could muster up was a 0.1% gain in real GDP for January. At least it was positive — but barely. It reveals an economy that right now is uneven and sputtering. It’s a good thing there was a solid handoff from the tail-end of Q4, as that is what is keeping Q1 GDP estimates close to a 2% annual rate. If there is a piece of information that Canadian dollar bulls can put in their back pocket it is that manufacturing output, even with the loonie at par, managed to post a solid 0.7% advance — factory output up now for five months running. Now that is impressive.
Copyright © Gluskin Sheff
Tags: Bank Of America, Basis Points, Bull Run, Canadian, Canadian Market, China, David Rosenberg, Financial Disaster, Fiscal Stability, Fund Portfolios, Global Scale, Gluskin Sheff, Hedge Fund, Internet Revolution, Low Quality, Lows, Msft, Nasdaq, Political Stability, Quality Names, Quality Stocks, Record Quarter, Sears Holdings
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Friday, March 16th, 2012
It appears the answer is yes. After a few decades of the ‘financilization’ of all things in America – the past few years seems to have turned the tide (somewhat) away from a massive funnel of the best and brightest college grads deposited directly into the palms of Wall Street. I’d note this specifically for Harvard B-school which is cited in the story below - that is the epicenter of future Goldman, Morgan Stanley, and JPMorgan-ites. Anything that gets some of these brains into more of the ‘production’ (or even ‘service’) parts of the economy, rather than the ‘toll takers’ is a plus in my book. It seems quite a sea change might be happening, as more want to be the next Steve Jobs, Bill Gates, or Mark Zuckerberg rather than the next person “doing God’s work”.
- Wall Street, once a magnet for America’s best and brightest, is facing a recruiting problem. The industry’s loss of cachet, which started during the financial disaster, has been deepened by the lingering economic slowdown and a series of highly visible industry scandals that have drawn critical attention to the big banks. The most recent public relations crisis came from the resignation letter this week in The New York Times op-ed section written by Greg Smith, a former Goldman Sachs executive director.
- Conventional wisdom holds — and Goldman’s public relations team surely fears — that the people paying closest attention to the controversies are skittish clients and down-in-the-mouth employees. But Goldman and other financial firms should also worry about scaring off are college and business school students, some of whom are looking askance at once-prestigious jobs in finance.
- College students who were once attracted to prestigious banks like moths to bonfires are increasingly turning to other industries in search of success. Insiders say that pained testimonials of industry life can scare off would-be financiers from even applying for jobs at the most selective firms. “This is a significant problem for Goldman,” said Adam Zoia, the chief executive of the placement firm Glocap Search, whose clients include many aspiring big-bank employees and hedge fund workers. “Their perch of being the investment bank to go to is definitely at risk.”
- One former Goldman analyst recently decided to leave the firm after the rewards of a finance job no longer seemed to outweigh the costs. The former employee is now working at a small technology start-up for less money. “Perhaps Smith is a catalyst,” said the employee, who spoke on the condition of anonymity because many of his friends still worked at the bank. “There have always been unhappy people” in finance, he added, but “this is the year people are realizing things are structurally different.”
- The smaller paychecks are only making the decision easier for some students, who no longer view Wall Street as a fast-track to seven figure salaries. Last year, flagging profits at many Wall Street firms reduced some bankers’ compensation from stratospheric to merely generous. At Morgan Stanley, cash bonuses were capped at $125,000; some Goldman employees saw their annual cash payouts cut in half.
- Adding to the chorus of dissent, students now face criticism on their own campuses. Groups of protestors at Yale and Harvard stood outside bank recruiting sessions last fall, shouting slogans and holding signs with messages like “Take a chance, don’t go into finance.”
- “Everything from Occupy Wall Street to larger critical discourses of ‘fat cats,’ all of that has had some trickle-down effect” to young people, said Karen Ho, an associate professor of anthropology at the University of Minnesota who has studied the culture of Wall Street.
- The decline in the finance industry’s allure has been accelerated the explosion of the technology industry, which is making a play for some of the top-flight graduates who once walked nearly unquestioningly into Midtown Manhattan cubicles.
- A 2011 survey of 6,700 young professionals by the consulting firm Universum ranked Google, Apple and Facebook as the most-coveted workplaces; JPMorgan Chase, the highest-ranking bank on the survey, was ranked 41st.
- Chris Wiggins, an associate professor of applied math at Columbia University who sat on the panel, said he was seeing students shy away from Wall Street and veer toward industries where they could work and profit without bringing their morality under the microscope. “The claim of investment banking that it serves a social purpose by ‘lubricating capitalism’ has eroded,” Mr. Wiggins said. “It’s simply very difficult for young people to believe that they’re serving any social purpose now.”
- Even at top colleges and business schools, which once saw Wall Street as hallowed ground, the focus is shifting. In 2008, the last recruiting year before the financial crisis, 28 percent of the employed seniors in Harvard’s graduating class went into finance. Last year, that number fell to 17 percent.
- Ben Pruden, a second-year student at the McCombs School of Business at the University of Texas at Austin, said on Wednesday that he planned to go into technology, not onto Wall Street, after receiving his business degree. He has a job lined up at salesforce.com after graduation, and said that although he knows people working in finance, including his sister, the once-irresistible allure of Wall Street held little sway with him. “I have no interest in working at Goldman,” he said. “I want to build something. I don’t want to be working in an industry that effectively leeches off other industries.”
Tags: B School, Bill Gates, Bonfires, Business School Students, College Grads, Conventional Wisdom, Critical Attention, D Note, Economic Slowdown, Ed Section, Finance College, Financial Disaster, Goldman Sachs, Greg Smith, Morgan Stanley, New York Times Op Ed, Resignation Letter, Sea Change, Steve Jobs, Toll Takers
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