The storyline matters too…

It’s been a while since I have posted, something that reflects the fact that while the market has moved around recently I feel it’s been of the “full of sound and fury, signifying nothing” variety as market participants prepared for and are now digesting the Fed’s QE announcement.  However, just because the market's movement over the last couple of months may determine little over the medium-term, it doesn’t mean they should be ignored or that one shouldn’t seek to profit from them.  Unfortunately, that’s not something that Our Man has succeeded in during recent months.

When we think about investing we spend a lot of time thinking about the end or the final scenario; for example, will we see deflation or massive inflation?  Is China a bubble?  What’s the target price for Stock X?  However, much like reading a book, while the end is important…the story-line matters too.  It’s the twists in the plot that make markets (and books) interesting.  For an investor, this means that one should think about the twists in the plot that one might encounter on the way to reaching end; there’s little point having a portfolio today that’s perfectly set up for the end, if you can’t continue to hold it through all the twists in the plot to get there!  This is far from easy since it means thinking and weighting information (and your beliefs) about different time horizons and then using this information to help structure a position and the portfolio in general.

Why mention this?  Well, it’s not something that Our Man has done well, especially recently.  As you know Our Man doesn’t trade (i.e. do anything in the 30-day time horizon window) but that should not stop me from taking advantage of short-term factors to exit investments (with the opportunity to reinvest later) or change the composition of the portfolio.

The biggest example of this has come in the last few months, with regards to the Treasury holdings.  While they have been strong contributors for the year, they have hurt in recent months and Our Man missed an opportunity to take advantage of some short-term factors to exit the position even though the long-term view is unchanged.

The graph above (courtesy of Mish Global Economic Trend Analysis) shows the movement in Treasury yields.  As we can see, leading into Bernanke’s Jackson Hole speech there was a tightening of Treasury yields (including at the long-end, where Our Man is invested) as investors began to fear a double dip in the economy.  These yields remained largely steady, though off their lows, following the speech in which Bernanke hinted at the possibility of QE2 as investors “bought the rumour”.  However, following the Fed announcement of QE2 these spreads have widened as investors “sold the news”.  For Our Man this has meant that much of the Treasury gains from the summer have been given up but it need not have been this way.  While my long-term view hasn’t changed, I should have taken both my short-term understanding of the “buy the rumour, sell the news” phenomenon and the fact that the returns had become more front-end loaded (as a result of the tightening around/before the Jackson Hole speech) as a sign to at least reduce the position.

Hopefully, this is something that Our Man will learn in the coming months and years.  While it's great to have conviction, especially in long-term ideas, Our Man's got to a better job of taking into account some of the short-term factors.  Remember, it's not just the ending...the storyline matters too!

Late for Halloween: The Horror.....a post on a pointless topic!

There are many things that Our Man tries to avoid talking about in this blog, mainly because they’re terribly dull.  However, some of these he does his best to avoid talking about at all (even with friends, down the pub).  These include topics as tedious as why don’t Arsenal have a good ‘keeper and why are the Mets terrible, but there’s one topic that Our Man avoids more than any other; politics!!  It’s not that Our Man doesn’t like politics (he does), it’s just that talking about it isn’t all that interesting; it’s largely ideological (on both sides), and who cares about the facts!

So why force you to read a post on politics?  Well, as a politician would say, “It’s their fault” (cue: Our Man pointing in the direction of various friends who’ve attempted to get him to discuss politics over the last 2 weeks.  You know who you are).  I can’t blame you for turning away now, but if you can stomach it, here are Our Man’s thoughts on some political topics:

Does a Republican House suit President Obama?
Firstly, I’d note that the biggest impact on Obama’s presidency (2011-2012 edition) probably won’t be the election results tonight!  It was likely Peter Rouse replacing Rahm, on at least an interim basis, as Chief of Staff.

While most, especially the market, are assuming that a Republican House means gridlock and that’s a good thing, I’d instead ask if a Republican House suits the President?  Doesn’t it allow him to do what he does well – sit above the fray, and broker consensus building agreements between the Senate and the House?  And given Republicans control the House, doesn’t it make it harder to characterize the President as a Socialist when you’re writing the bills and sending them to him?  And if you’re in power, and control the House (which writes the legislation) it’s probably somewhat harder to be the party of “No”…without taking a hit from the public for it.

The most important post-election story for the markets
Won’t be an extension of the Bush Tax Cuts (more on that below), but will be the chairmanship of a sub-committee of the US House of Representatives Financial Services Committee.   Yes, you read that right.  Why?  As among the roles of the Domestic Monetary Policy & Technology sub-committee are the Oversight of Emergency Authority and the Audit of the Federal Reserve.   Oh, and the ranking minority member (and thus presumably favourite to become Chairman of the sub-committee) is a certain Ron Paul.  Yes, the Ron Paul who published a book in the last 18months called “End the Fed”.

Bush Tax Cuts and Wealth
While there is much debate as to whether the Bush Tax Cuts will be extended, and for whom, the debate is likely moot.  In all reality, the current Congress will let them expire and the new Congress will pass something with even the President willing to extend them for those making up to $500K/$1million.  Given that, according to the IRS, less than 2% of US households make even $250/year the debate about whether the tax cuts should be extended for those over $500K or $1mn will have little impact on the majority of society.  Thus Our Man's view of how far up the tax-cuts are extended is, in Snoopy-style, to go Bleah!

Before I venture off further into contentious ground, let me end this blog post with a Rawls-ian thought experiment.  Imagine splitting the US into wealth quintiles (or fifths, as I personally like to call them) from the wealthiest (top 20%) to the least wealthy (bottom 20%), and ask yourself: i). To estimate how much wealth do each of these quintiles currently represent as a % of the total? (i.e. Top 20% currently represent A%, Second 20% represent B%, etc) and ii). To construct a distribution of wealth, that in an ideal world, you think would be fair (i.e. Top 20% should have X% of the wealth, Second 20% should have Y%, etc)

Thankfully, I’m not crowdsourcing, but a recent paper by Michael Norton (Harvard Business School) and Dan Ariely (Duke University) actually asked these kind of questions in a nationally representative sample and their results are below.  You’ll note the irony that people’s estimates were almost (identical irrespective of sub-group) and their ideals were also broadly similar, but neither was a good reflection of reality.