Investors must recognize what ‘this time it’s different’ really means
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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.
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.
http://www.newyorker.com/online/blogs/johncassidy/2013/04/th...
Yes.
So the book may be worth reading in spite of the bad research they've been attached to since.
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.
http://en.wikipedia.org/wiki/File:Productivity_and_Real_Medi...
So any congresscritter who claims they are working for the benefit of the masses has my immediate suspicion. If their track record shows they're telling the truth, that's a different story, and frankly that's what matters anyway, rather than their election-year talking points.
A link to the site, with data sets the book covers freely downloadable: http://irrationalexuberance.com/
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.
The old saying of "Bulls make money, bears make money, pigs get slaughtered." is relevant.
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.
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.
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.
Is that the jevons / Rickover etc argument?
Real value (as opposed to financial value) is created by re-structuring your environment to provide more useful services.
A huge problem with existing economic theory is the failure to account for stock depletion in natural resources (there are other problems, but that's a biggie). So while you can convert stuff in the ground to cash in hand, what you haven't done is to increase your total wealth. You've exchanged your physical stock for financial purchasing power.
You can use those stocks to create more value, but in the case of energy tend to consume it in the process (materials can often be recycled).
You can look at the economic value created by a quantity of energy -- I've done some exploration of this in terms of $billion GDP/quad (quadrillion BTU energy) or $/barrel: http://redd.it/1vlksg
One way of considering a barrel of oil is in how much economic benefit you get from it. In various countries:
US: $1022
China: $528
Japan: $1678
Syria: $498
Egypt: $441
India: $493
Germany: $1465
UK: $1586
Switzerland: $2792
Mali: $4425
Note that industrialized nations tend to get $1000+ per barrel, nonindistrialized ones (Mali excepted) $400-500 or so. Oil's been running around $100 - $120/bbl the past couple of years.
That means the US sees about $9 in returns for each dollar spent on oil, Switzerland nearly $27. Mali sees a large nominal return, but both its GDP and oil consumption are minuscule.
Egypt's in much worse shape: $3.41 in returns per oil dollar spent. India's slightly better ($3.93), China a bit above that ($4.82). But all are running on pretty thin margins. Increased oil prices will push a lot of marginal uses out of reach, and likely shrink their economies markedly. Note that Egypt and Syria in particular are two nations undergoing pronounced unrest -- and which have also recently gone from net exporters to importers of oil. This is a transition described by the Export-land model (https://en.wikipedia.org/wiki/Export_Land_Model).
Yes, increasing your efficiency of energy use is one way to increase wealth, but accessing more (or cheaper) energy is another route. You don't have to be more efficient.
So I would say that turning coal into kinetic energy in a train is an increase in wealth / value for humans. The externalities do need to be accounted for and minimised (climate ch age etc) but otherwise we cannot measure value increase in this seemingly useful way
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.
John Bogle, founder of Vanguard, recommends "your age in bonds". So if you're 20, make bonds 20% of your portfolio. Some adjust this up or down depending on their appetite for risk (I think age minus 10 is the common advice from Vanguard now).
A straightforward bond/stock split has been recommended, and it's probably the simplest but even then there are questions of which bond fund/ETF and which index/equity fund/ETF to choose.
Creating a plan requires understanding what your tolerance for risk is. It doesn't have to take a lot of time [1] and some basic reading and math will enable you to pick what's right for you. Basically, are you willing to tolerate more volatility (i.e. variability in year-to-year returns) in exchange for higher returns in the long-term?
1. http://www.finiki.org/wiki/Portfolio_design_and_construction
>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
The comment you are responding too is asking what to do assuming the top-level comment is correct, and the total return on invested capital is, in fact, declining.
Buying a low load index fund is advice that few people are going to argue with, but it doesn't answer the question.
Both financial vehicles and cash presume that the economic system will sustain itself. There's always the possibility it won't.
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.
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.
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.
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.
US Dollar index: http://www.fxstreet.com/rates-charts/usdollar-index/
- 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.
Yes, the Fed will ultimately raise rates, just as Bullard has signaled:
"...he repeated his own expectation that rates will likely need to rise by the end of the first quarter of next year, as inflation recovers to its desired target. That is several months ahead of the summer rate rise many investors now expect." http://www.reuters.com/article/2014/05/16/us-usa-fed-bullard...
- 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.
Watch them throw caution and credit concerns to the wind. You will have plenty of time to see that they are doing this before taking an action. I do not have any doubts based on how they have behaved in the past, are behaving now, and how they are encouraged to do so.
Banks are under very close scrutiny right now and will be for many years to come. I doubt very much that the next bubble will get inflated exactly where the last one popped.
The question is how you get businesses to invest when there is no one who can buy more stuff. This is going to be a slow economy for a very long time.
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.
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.
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?
Among factors you might want to consider:
Britain is built on coal. It was washing up on the beaches (the early name for it was "seacoal").
Coal, oil, and gas were known to the ancients. What they lacked was a decent means to haul it any distance. Easier to grow your own hydrocarbons locally than dig them out of some smelly pit a few hundred, or thousand, miles away. So unless you happened to sit right next to a coal pit, tar seep, oil well, or gas jet, you burned wood.
England turned to coal as it was burning through its forests.
We've been prospecting for other resources. We've got a pretty good idea of what there is, and an even better idea of what there isn't.
Joseph Tainter writes on collapse and complexity. Among his points: societies don't adopt complexity unless there's a compelling need (and benefit). It's better to survive at a simple level, much of the time. You'll even see this today in IT.
And by your own statement: we've fewer resources now than humanity had in the 1700s, by virtue of burning our way through them.
And yet here we are... happily driving our SUV's 50 miles each way to sit at a computer. (Presumably the Easter Islander that cut down the last tree didn't stop and think "gee, maybe I should have a tiny fire tonight" either.)
So from the point of view of our current way of doing things I do have to say... the long term economic outlook doesn't appear so great. But there are things the "could" happen to change this. A breakthrough in energy (unlikely). A sudden loss of 2-3 billion people from the planet (sadly, more likely). A war resulting in an entirely new social order which is more efficient (or less efficient). Just a lot of factors make it hard to say what will happen.
Exponential consumption rate exhaustion based on GP's Annual Review 2013 is 2048-2049. Which suggests that flow rates (which sustain modern civilization) will start falling precipitously well before then.