Friday, March 2, 2018


Verschlimmbesserung ("fair-shleam-besser-oonk") is German for "a supposed improvement that actually makes things worse". In English, we do not have any phrase which is nearly so concise or elegant, but I think Milton Friedman put it best:

One of the great mistakes is to judge policies and programs by their intentions rather than their results.

People ask me: why should I trust the free markets? In annoyingly Socratic fashion, I usually flip the question around and pose: why should I trust policymakers to appropriately manage the economy instead? If knowledge in a society is diffuse and decentralized (which is especially inherent to today's fast-paced constantly-online interconnected society) and thus needs to be aggregated to discover optimal solutions, what is the best system to do that? For politics, we can probably agree that that optimal solution is open democratic free elections with maximized voter participation. For economics, aren't free markets similar to free elections, except instead of the stakes being political decisions (legislation), we are faced with economic decisions (resource allocation) where "votes" are instead weighted by dollar instead of capita? Both are knowledge-aggregation machines, just with different intended purposes (legislation vs. resource allocation) and vote-weighting schema (dollars vs. capita). Just as how networks are valued by the number of nodes and connections (in fact, it may scale quadratically or even exponentially), the effectiveness of a knowledge-aggregation system depends the number of participants: Wikipedia (millions of mostly non-experts) proved far more successful than Encyclopedia Britannica (thousands of experts) despite the greater average expertise of the latter's contributors.

To be clear, I am not arguing that policymakers make sub-optimal decisions because they are malicious or because they are idiots (although we seem to be seeing a lot of both recently). The issue has nothing to do with whether policymakers are inherently good or evil, or even whether they are competent or not. Even if they were enlightened philosopher-kings advised only by top Harvard PhDs, the fact remains that a managed economy only aggregates the knowledge of a small subset of people and thus is are following the Encyclopedia Brittanica model rather than the Wikipedia model.

Furthermore, the type of knowledge they gain is frequently flawed. Policymakers by nature try to target certain indicators tmeasure the degree of success of their policies. However, when a measure becomes a target, it ceases to be a good measure. This is known as Campbell's Law or Goodhart's Law. One of my favorite examples is the use of test scores as a way to measure educational attainment:

achievement tests may well be valuable indicators of general school achievement under conditions of normal teaching aimed at general competence. But when test scores become the goal of the teaching process, they both lose their value as indicators of educational status and distort the educational process in undesirable ways.

Interestingly, the test itself isn't the problem. This problem arises no matter what type of test as long as the stakes are high enough (funding or admission is dependent on high scores), because the system adapts (teachers change their methods to "teach to the test" and students change their learning methods in order to maximize test scores). The system as a whole is no longer in the same state (aggregate behavior has changed) that it was before the measure became a target. The result? Test scores lose explanatory power and become worse measures of basically everything, even as they go up. If you improve your IQ score through intensive study, have you actually become more intelligent?  The map is not the territory.

Why does this happen? Due to emergence, complex systems are more than the sum of their parts. In fact, any effort by policymakers to measure macro-variables in a complex system tends to get Heisenbergian. This is even more true in social sciences where the state of the system is determined by the aggregate behavior of many individuals, each of whom can and will change their behavior in reaction to policymakers' public actions.

This is also why every economic crisis looks different from the last one (e.g. subprime mortgage lending caused the last recession while a tech bubble caused the one before that). This is because after every recession, policymakers try their very best to analyze what went wrong and usually discover that certain indicators would have been clear warning signals if only they had been measured. Thus armed with this knowledge, policymakers then try very hard to target the those exact indicators to prevent them from reaching those dangerous red flag levels. However, in the act of targeting those indicators, they have altered the deep parameters of the system (similar to the observer effect, where the act of observing a complex system can change the state of that system).

I hope it is clear why intervention in managed economies is generally sub-optimal. However, to be comprehensive, I believe that there are certain conditions in which it is in everyone's best interests that policymakers do intervene in the free markets (after all, I'm not an anarchist). These conditions can be grouped into: 1) externalities, 2) central banks setting monetary policy, and a bit further down in priority: 3) counter-cyclical fiscal policy as well as 4) wealth/income distributional issues (people born with different amount of dollars and thus "votes"). However, there are actually several ways to address these while respecting free-market mechanisms without resorting to creating a bloated bureaucracy with an alphabet soup of government agencies. If there's interest, I may do a follow-up post. Maybe even if there's no interest...


This post was inspired and prompted by "I, Pencil" as well as Friedrich Hayek's classic essay "The Use of Knowledge in Society".

Monday, March 20, 2017

Houses are terrible investments

To be fair, they're great to live in. However, if you are purchasing for the purpose of making money, there are far better and frankly easier ways to do so (namely, good ol' stocks and bonds). The historical record of house price appreciation is quite poor. Taken from the Wikipedia article on the Case-Shiller index, the best-known house price index (Shiller won the Nobel Prize in Economics for his "empirical analysis of asset prices", so he knows a thing or two about this stuff):
Robert Shiller draws some key insights from his analysis of long term home prices in his book Irrational Exuberance. Contrary to popular belief, there has been no continuous uptrend in home prices in the US and the home prices show a strong tendency to return to their 1890 level in real terms. Moreover, he illustrates how the pattern of changes in home prices bear no relation to changes in construction costs, interest rates or population.

Shiller notes that there is a strong perception across the globe that home prices are continuously increasing, and that this kind of sentiment and paradigm may be fueling bubbles in real estate markets. He points to some psychological heuristics that may be responsible for creating this perception. He says that since homes are relatively infrequent purchases, people tend to remember the purchase price of a home from long ago and are surprised at the difference between then and now. However, most of the difference in the prices can be explained by inflation. He also discusses how people consistently overestimate the appreciation in the value of their homes. The US Census, since 1940, has asked home owners to estimate the value of their homes. The home-owners' estimates reflect an appreciation of 2% per year in real terms, which is significantly more than the 0.7% actual increase over the same interval as reflected in Case–Shiller index.
0.7% real return is absolutely terrible. However, if you think Shiller's analysis is flawed due to its 120 year time horizon (perhaps you don't believe the 1800s or early 1900s is relevant to today's investment environment), take a look at the data over a more recent period. Over the last 30 years (1987-2017), the Case-Shiller US national house price index has appreciated 3.6% per year. Considering that headline CPI inflation has averaged 2.6% over the same period, this means that the average home has delivered 3.6-2.6=1.0% real return. Wow, that's not that much better!

In comparison, the S&P 500 has returned 7.3% per year, which is a 7.3-2.6=4.7% real return. That is almost 5x as much return as the average home! You would need to borrow 80% against your house value to realize that return, which is in fact, what many people do (i.e. get a mortgage with 20% down). However, stocks can deliver that return with NO leverage (a fancy word for debt), which is an incredibly valuable thing (after all, who wants to be indebted?).

High fees. The average round-trip broker fee in the US is commonly quoted as 6%, and for the lack of better data, I will use this number**. With 1.0% real return, it takes you six years to break even on your house investment! In comparison, the bid-ask spread on the iShares S&P 500 ETF (IVV) is about 1 cent, which is about 0.004%. The annual expense ratio is 0.04%. Thus, a six year investment in stocks costs about 0.244%, which looks a lot nicer than the exorbitant 6% on houses.

A standard refrain to this argument is the assertion that although stocks return more, they are way more risky than houses. It is true that in investing, we don't look at return by itself, we generally consider return per unit of risk. Well, going back to the data...

Looking at the max drawdown* (the difference from peak to trough), it is about -53% for stocks, which occurred during the '07-'09 financial crisis. Thus, in the worst case scenario, you can expect to lose about half the value of your stock holdings. How about houses? Their max drawdown was 26% of their value, so you can expect to lose about a quarter of your house's value.

Thus, stocks have 2x the risk while delivering 5x the return as an un-levered house investment. Not a bad trade-off in favor of stocks! Even with leverage, this analysis doesn't change - in fact, leverage creates even more issues. If you borrowed 80% against your home, and your house goes down -20% in value, that essentially wipes out your homeowner's equity. Any more than 20% and you actually have negative equity. In that case, it makes sense for you to walk away from your debts and just not pay, since there is no recoverable value for you to realize. This is NOT a hypothetical scenario - this is exactly what led to the '07-'09 financial crisis in the first place.

Illiquidity. Houses tie up your capital. Liquidity is defined as how quickly you can transform an investment back into cash. If you have a sudden need for cash, you can sell your stock holdings this very second. On the other hand, houses typically take months and even years to sell at a fair market price (which, unlike stocks, is not known to you). Thus, you can easily turn a liquidity problem into a solvency problem.

Lack of timely, accurate information and transparency. There is no surefire way of ascertaining the value of your home. You can't go on Bloomberg / Yahoo / Google and look up the price of your specific home. While there are certain online tools (Trulia, Zillow) those are merely estimates; there is no guarantee that you can get that price when you sell. The only way to know for sure is go through the cat-and-mouse game of listing, appraisal, negotiating with brokers (who have their own disparate incentives), weighing serious offers, etc. With such a large asset (and corresponding liability if you have a mortgage) on your balance sheet, this introduces significant uncertainty to your net worth calculations. If you don't have an accurate idea of your wealth, how can you make wise financial decisions, such as allocation to consumption and savings?

No power of diversification. Finally, unless you have access to significant amounts of capital or leverage, there is no easy way to diversify your housing investments (although with the advent of home price futures, this may change). Even if you do, you still have the pitfalls listed above of very low real returns, high fees, illiquidity, informational uncertainty as well as the standard problems of leverage.

Now, whether it makes sense to purchase a house to live in is a totally separate consideration requiring a very different type of analysis (consideration of the rental market, etc.). If you know you are going to live in the same house in the same location for 20, 30 or more years, many of these issues simply don't matter. Anything shorter than that time horizon, however, requires a long, hard look at the considerations listed above.

*Why not look at volatility (standard deviation of returns) as a measure of risk? Since there is no good way to do high-frequency, mark-to-market pricing of house prices due to illiquidity (how often is a given house bought and sold? not that often!), I would argue that volatility as a risk measure doesn't really work for houses. Thus, I prefer to use max drawdown.

**Some people argue that since only the buyer pays (or the converse argument, only the seller pays) the correct number is half, or 3%. This leads to an incorrect analysis, since any evaluation of investment return net of fees needs to consider the round-trip transaction (purchase and sale). Otherwise, you're not talking about realized returns.

Tuesday, January 26, 2016

notes from conferences

Took these notes about a year ago but forgot to publish them at the time. Here they are, mainly for my reference:



1.       Global growth remains at the 30y avg, although both DM and EM growth have slowed

a.       This is called Simpson's paradox, if you have both low-growth A and high-growth B growing at slower pace, but B is a bigger component, then A+B can grow at the same pace

b.      Structurally faster-growing EM is a bigger component now

2.       ECB has the biggest QE in terms of bond purchases divided by bond net issuance

3.       Oil prices will be lower for longer

a.       We are no longer in the 1974-1986 monopoly pricing regime where OPEC set arbitrary prices and adjusted supply accordingly

b.      We are now in a competitive pricing regime

c.       Supply

                                                               i.      Saudis are not going to give up mkt share

                                                             ii.      Middle East can't get much worse, tons of supply

                                                            iii.      Lots of storage is waiting for prices to come back, PE firms are buying energy corp distressed debt

                                                           iv.      No consolidation yet, but will happen if oil stays near $50

d.      Demand

                                                               i.      Demand intensity is going down, driven by China

                                                             ii.      China is now a price-setter not price-taker anymore, e.g. recent natural gas deal with Putin at 40% below mkt price, paid in CNY not USD

4.       Cheapest and most attractive major mkt is Japan

a.       Macro and FX are no longer the drivers

b.      Corps are using JPY depreciation to improve profitability rather than cutting prices

c.       Profit margin expansion is only half done

d.      18% of companies need more outside directors and to improve governance

e.      Institutional investors are placing more emphasis on ROE

5.       Asia - more easing to come

a.       Disinflation provides room for easing

b.      CBs are already behind the curve

c.       REER is actually up - USD appreciation was more than offset by EUR and JPY depreciation

d.      Asia is not as strongly affected by Fed or US growth as the rest of EM

e.      Relative growth is more favorable than the rest of EM

6.       China now is most similar to Taiwan in the 90s

a.       Taiwanese stocks grew 12x in 3y in the late 1980s

b.      Loss of competitiveness by 1990 due to rising labor costs led to slower growth

c.       Infrastructure investment led to credit growing by 100% of GDP

d.      Monetary policy was eased to maintain growth starting in 1995

e.      Rather than depreciate, the currency remained strong

f.        Current account surplus, protected financial system, fully domestically funded and strong external BS

g.       Reforms led to a smaller public sector and larger private sector

7.       China

a.       Next 5y, Asian African landmass will be hooked up with Chinese infrastructure

b.      Ricardian growth from infrastructure linkup for years to come

c.       Like Marshall plan, China is lending RMB abroad

d.      RMB internationalization: 30% global trade settlement is in RMB, up from 5% in 2012

e.      IMF may add CNY to SDR in November - China wants to maintain RMB bond stability

f.        Freer mkt - there have been 3 defaults including SOEs

g.       Mkt is mainly retail investors: all momentum-driven

h.      Govt has either cut rates or expanded stock connect program every time the mkt went down 5%






1.       US - attitude is more unilateralist

a.       Tech has allowed this: with drones and cyber, we can conduct war without allies

b.      Transatlantic relationship between US & Europe is the weakest since USSR collapsed - no chance of turning around in near future

c.       UK - no more special relationship

                                                               i.      UK is more nationalist, partisan and populist

                                                             ii.      No interest in leadership in the EU - in fact, it may leave the EU

d.      France - Hollande is a weak leader

                                                               i.      Largest, restless Muslim population in W. Europe

e.      Germany - de facto leader in EU

                                                               i.      More commercial and industrial focused than the US

2.       China - only country that has a "global strategy"

a.       No interest in fixing the Middle East

b.      No interest in military intervention

c.       Strategy is completely economic/mercantilist

d.      New Silk Road and Asia Infrastructure Investment Bank (AIIB) - Chinese version of the Marshall Plan

                                                               i.      $1 trillion in invest in infrastructure

                                                             ii.      This will align regional economies more closely with China and away from the US

                                                            iii.      IMF gives money only when you reform to look like the US - AIIB doesn't have such conditions

                                                           iv.      China is creating strategic relationships for their SOEs

                                                             v.      Even UK, Germany, and Korea are joining AIIB - they are hedging their US relationships

3.       Middle East - is going to a bad place

a.       US is not going to fix it

b.      China is not going to fix it

c.       Saudi was on a reform path - now it is more focused with military and regional problems

                                                               i.      Trying to consolidate the GCC

d.      Low oil is going to make things more dangerous

e.      Lebanon, Jordan and Egypt still need foreign aid which they are no longer going to receive

f.        ISIS and al Qaeda are becoming more attractive to young Muslims

g.       Sunni vs. Shiite sectarian tensions are center stage - rather than anti-US, Asia and Latam sentiment

h.      EU and Russia have disenfranchised Muslims

4.       Asia has real leadership, in particular: India

a.       Modi is the real deal, FM Arun Jaitley is very competent, industrial corridor states are fully aligned with BJP party






Q. Given Q1 GDP, where do you see economic growth for the rest of the year?

A. Q1 in general was disappointing. Most have attributed the weakness to transitory factors. While there is no question that weather, port strikes and residual seasonality have contributed, these 3 combined do not account for the majority of slowdown. Looking at the weak data pts since Q1, it can't just be seasonality.


Contrast this weak Q1 with last year's. Just as last year, Q1 weakness was largely unexpected. However, by May 2014, rest-of-year Q2-Q4 2014  growth was revised up. That is not happening this year and in fact, rest-of-year Q2-Q4 2015 growth has been downgraded. This year is not a repeat of last year, due to disappointing consumption numbers, an energy capex decline that was more than expected. We have lost some momentum in underlying performance, perhaps due to strong USD. Yes, there has been some bright spots such as autos and housing. Furthermore, there may be a lag of low gasoline price being passed through to consumers. Our data-dependent orientation is particularly important at this point, since there are more questions at this point in 2015 than in 2014.


Q: Thoughts on wages?


The rather strong sustained job creation has not resulted in wage increases above current modest levels. While surveys have said for 2y that wages would increase, every uptick has disappointed and come back down. Other measures of labor force slack may guide us here. If you look at the LT unemployed, they are very gradually coming back into employment. The natural rate is lower than we thought.


Q: What do you need to see to make your rethink what you've done?


A market event like the October 15 phenomenon (recall that there was an intraday peak-to-trough swing of 40 bps in the 10y yield). This was due to a multiplicity of factors. There has been a lot of changes in micro-market structure. 1) Expansion of bond funds, 2) reduction of dealer balance sheet capacity, 3) acceleration of HFT entry into the FI markets, 4) very low IR for 7y now. Anecdotally, we are hearing that it is harder to move large positions.


However, what's the correct point of comparison? I would argue that while markets in 2006 were very liquid, it was illusory liquidity. You could make the case that the superabundance of liquidity could also be negative for market structure health, because the pricing didn't correctly include illiquidity premium or incorporate sharp changes in creditworthiness. The eternal problem is that when daggers are falling, very few people are willing to catch. This doesn't change no matter how much liquidity there is. People fundamentally and behaviorally do not want to catch daggers.


Draghi said "get used to vol". Risk needs to  be pushed out to the end users.


We've been through this market change before. In the late 70s, money center banks were facing the rapid growth of capital markets, which was competition to them. Growth of MMFs gave people more savings options. This was a business model challenge. Another comparison: 12-14y ago, the funding mechanism for securitization faced similar challenges. The growth of capital markets will always continue and disrupt the existing paradigm.


Q: The international regulatory patchwork is confusing and creates challenges. There is fragmentation of international regulatory jurisdictions. How can the Fed help manage harmonization of standards?


Need to realize that Basel sets minimum standards. National regulations should exist on top in order to supplement them. We don't create ceilings, we create floors.






There are two predominant explanations for today's low demand:


1) the Reinhart/Rogoff story - there is significant debt overhang in both public and private sector and growth will suffer until the deleveraging process is done. I think this has some truth to it, but it's not obvious in places such as the US where banks and households have better balance sheets and private firms are swimming in cash.

2) the Larry Summers "secular stagnation" story - the future is not that exciting in terms of growth for structural reasons. I put more weight in this story. There is a slowdown in productivity growth. While this is bad news for the future, it also affects decisions today. Firms look forwards to the future and see low demand and choose not to invest today and consumers choose not to consume. This is a supply side phenomenon, but it explains low demand today.


The correct policy for our economy depends on which story you believe in. In the former, you need to restructure debt. In the second, you need to foster total factor productivity growth.


Q. Why has growth slowed in EM?

There are two reasons. You need to identify places where previous growth was "fake" (above potential GDP and not improving potential GDP) and where growth was for real, the economy was growing at potential. In the former, places such as Latin America were clearly growing above potential, and they did not do anything to improve their potential. Now they are merely giving back their above-potential gains. In the latter, in places such as China and sub-Saharan Africa, a slowdown is mainly due to a naturally falling potential.


Q. Should we concerned about rising levels of inequality?

There has been some effect on growth but that is not the main reason to worry about inequality. The problem is that there is a tech-based skills crisis. There is a large mismatch between those are willing to work and the type of people that firms are looking to hire. Krugman once said that all lawyers will be eventually replaced, I think that he's right. In solving this, institutions matter enormously. For example, CEO/avg wage differs hugely among countries. US has a much larger divergence in CEO/avg pay and I don't believe there is THAT much of a difference between US and French CEOs.


Q. Thoughts on globalization and international capital flows?

The idea that trade is a global growth machine is, to a first order, wrong. When you buy from someone else, your domestic industries suffer. The idea that a slowdown in global trade hurts global growth is something that I don't buy. Stan Fischer said, who needs ST capital flows. I agree, less financial flows is better.


Q: How has financial regulation over last 5y affect credit and growth?

More regulation leads to institutions to take less risk, this decreases first and second moments.  Do we want to live in a high reward high risk world or a low risk low reward world? After the crisis, we voted for the latter.


Q. Do you have any advice for the Fed? The IMF seems to like to give it. Should the Fed wait until 2016?

I was not involved in article 4, the IMF piece on Fed policy that is currently in the news. By the way, this commentary is something that we do all the time. This is part of our job. We talk about correct fiscal and monetary policies for all our member countries. The US should not be an exception.


Q. Is liftoff priced in? Is talk overdone?

This is one of the most anticipated Fed moves of all time. This is a data dependent decision. Will there be problems as the Fed raises rates? Perhaps. The plumbing may clink for a while. However, I doubt that this will create any global macro problems. This won't derail growth anywhere, US or otherwise.


Q. Was QE effective?

Yes, it showed that even when the policy rate is zero, you can still do a lot, although there are some side effects. CBs can get rates negative, but it shouldn't be too negative.  This can help on the margin. Rogoff wanted to make cash illegal and force everyone into an electronic monetary system, then there would be no ZLB (zero lower bound). In the absence of such a system, having a bit more inflation will decrease the probability of hitting ZLB. For this reason, I have advocated for a higher inflation target, something like 3-4%.


Q. Wouldn't a higher inflation target create a credibility issue?

Well, think about all the changes in policy targets in past years. The markets always adapt. Moving inflation target from 2->4% would not lead to hyperinflation.


Q. What's the difference between financial regulation and macroprudential policy?

Financial regulation: high capital requirement ratios but don't move it around

Macroprudential: low capital requirement ratios but have the flexibility to move it up and down in accordance to the macro scenario. This is essential for policymakers.


Q. Will there be spillovers into the emerging markets from the actions of the Fed/ECB/BoJ? RBI's Raghuram Rajan said that we need to rethink rules of game.


How bad is the equilibrium when every CB focuses on itself? It's not so bad. The Fed should focus on its impact in the US, not the impact outside the US. Yes, EM should consider various capital flow management tools: capital controls and FX interventions should be de-stigmatized and utilized more frequently. EM should be allowed to interfere with market mechanisms when they are bad. This is because some capital flows are bad, namely ST flows.


Q. Real capital accumulation is going down, is this due to uncertainty?

In school, you learn about the accelerator theory of investment. This says that investment decisions depend only on 1) current sales and 2) expected sales. I have found this to be mainly true; you don't need additional theories about uncertainty, other factors, etc. Combine this with low potential growth and you have a good explanation of today's current low investment.


Q. Thoughts on Greece?

There has been too much incorrect info. Institutions (i.e. IMF) have drawn a proposal that we presented to the Greek authorities, which included a very substantial easing of the pace of fiscal adjustment and pace of structural reform. VERY SUBSTANTIAL. It is completely feasible if accepted. This would require more financing from Europeans and some debt relief.







The average US growth for the decade has been 2.2%. We survey 1000 households per month: still a majority of people think the economy is on the wrong track.


Housing is improving slower than Fed would like. This is not a demographic issue. Alleged behavioral differences of millennials is a myth. Surveys show that millenials want homes, just like previous generations. A large number are renting single family homes, which means that they will eventually buy. Gen X is small proportion of population, they are step up buyers as baby boomers leave. Millennials are more conservative; they are merely awaiting real income growth. This will eventually come and provide housing demand.



Generally I don't take GDP data seriously. It is so heavily revised and there are problems with measurement... But let's take it seriously for the moment. If you take out residual seasonality, Q1 was 1.25%, which is a still a deceleration considering that the trend is 3% and potential growth is around 1.5-2%. Clearly there were transitory factors such as oil. However, I think it will be hard for Q2 to be lower than 3.5%.


The large fall in net exports (NX) in Q1 must be noise. Anyway, USD appreciation is not big enough and the US economy is not open enough for NX to really hurt. NX has contributed negatively to growth 19 out of last 25 years. A 10% REER appreciation leads to GDP levels falling by 0.3% in first year, 1.5% in second year.



Private growth (Total GDP minus Govt, or C+I+NX) remains close to 3%. Wage inflation pass-through is limited and takes time.


Q. Where is productivity growth? Isn't it a bit of a paradox that we're having all this tech innovation but there's no productivity?

Marcello. Yes, it's been dismal since 2004. Now the Bureau of Economic Analysis (BEA) has changed its GDP methodology to capture tech by including semiconductors. However, statistics cannot pick up managerial organizational improvements in logistical processes. The debate of real value-add of tech is ongoing. It could be that tech has huge value-add and we're not measuring it. Or it could be that there simply isn't that any value. Think about conf calls. Now we can see each other's faces on iPhones. Does that actually improve anything?


Kathy. More optimistic about extraordinarily low productivity growth. There are areas or pockets where productivity is stronger than measured. There will be huge advances in areas such as in healthcare and biotech, which will experience incredible change with new tech such as drugs and big data. This is not captured very well in data.


Q. While real disposable income is up 3.5% YoY. However, despite the sharp decline of gasoline prices, most of this has been saved than spent. Is this permanent shift towards saving more, or is consumption just lagging?


Doug. Surveys show conservative behavior.


Marcello. Scars still there. Oil tax cut will be here for 2y. Quite optimistic about C going fwds. Ignore Q1 data. Strong C in q4.


Kathy. Disposable income is growing faster than consumption. We will see more C. More sanguine abt consumers spending gasoline windfall.


Q. Reinhart Rogoff. Debt run up and crisis leads to 7-8y of slow GDP growth. Michael Bordeaux said same abt housing crisis.


Doug. US demographic profile is one of the best in the world. Construction is 1.6mm annually. Our forecast is 1.15mm, way below normal, some ways to go. Directional path is right. Growth will accelerate.


Kathy. Look at Nordic countries. Took a decade to come back to reasonable growth. Finland saved by Nokia, need positive tech dynamic to help economy recapture prior growth capacity. Yes we go back to trend but at slower level. Going fwds other issue is that divergence of MP has implications. We see Fed lift rates this yr maybe Sept, ECB and BoJ continue QE, we will see development of MP clusters. Latam Canada can't fight the Fed. EU can't fight ECB. Asia is complicated, deal with BoJ and PBoC.  Regional trade blocs instead of previous global trade dynamics.


Q. Last time Fed hiked rates, no iphone. When hike rates and what impact on US eco.

Doug. September is our forecast for 2y.

Marcello. I think Sept. Look at NFP and UE today. Fed focuses on labor.  Most telegraphed hike on the face of earth. There will be no surprise.


Look at all Fed hikes in last 30y. USD goes down as often as it goes up. Stocks are sideways or up. Crazy things can happen.


Q. NAIRU is still important? What chg in labor mkt that makes it so low?

Marcello. 0.3 decline in NAIRU. More old ppl


Q. Low rates? Curve flatter?

Doug. Yes the fed will be low for long.

Marcello. Way too flat. Fed has to hike faster than signaling. Potential for upward surprise. Close to PGDP, not much room to grow fast. 2.5 in 2017 instead of below 2.


Q. Pent up demand for housing is huge. Deficit is significant. Housing starts to go up?

Doug. Hhld formation is half of LT avg. long run is driven by demographics. 25-34 cohort there are 6m more than when boomers were that age. There's been some pick up in formation. Largest share of young adults living at home. Survey parents if they love them and how long, love them for 2-5y. 70% were happy but exp them to move out. 

Thursday, December 31, 2015

Year in Review

More for my reference than anything else, here's a list of what I think are the most significant events of 2015, in no particular order, on the global scale as well as in my own personal life. I like lists.
    • FX and monetary policy
      • currency regime shifts: Switzerland unpegged its Swiss franc (CHF) from the euro (EUR) and China loosens its Chinese yuan (CNY) peg to the USD - free floating currencies are crucial adjustment mechanisms for economies, especially those with diverging prospects and thus divergent policies. Unless the peg is removed (or relaxed), a strong dollar and weak euro means a strong CNY and weak CHF, which isn't always desirable. Global divergences are wreaking havoc on currency markets and central banks are being forced to react.
      • Fed raises rates for the first time in nine years: this is important as it affects the price of virtually everything. We will see 4 rate increases next year if all goes according to plan, which of course it won't.
    • oil collapse continues: from $53 to $37 per barrel and no one's sure if we've even found a bottom yet. In the medium term (1-3 years from now) oil prices will probably be higher than they are today, but in the meantime, we will see a massive transfer in influence, power and wealth from producers to consumers. This throws another dimension of complexity into the geopolitical uncertainties (below), especially for countries like US, Saudi Arabia (de facto leader of OPEC), Iran and Russia as they wrangle in the Middle East.
    • debt crises in Greece (bailout), Puerto Rico (no bailout), Ukraine (restructuring) - these three events actually have very little in common and their individual significance is quite small. However, they may be the forerunners of bigger fish to come (perhaps Brazil?) as global growth mediocrity persists.
    • civil wars in Syria, Yemen, Ukraine continue: proxy wars for US/EU/Saudi Arabia vs. Russia/Iran. Part of the picture is ethno-religious, but the bigger part is energy security. Much of the current issues are about securing a direct and convenient geographic link between consumers (EU) and producers (Russia and the Middle East). A Russia-Iran alliance could effectively create a gas cartel; however, Syria/Turkey/Ukraine are (in)conveniently geographically positioned between Russia/Iran and their clients in the EU (and thus the rest of the West). Furthermore, Saudi refusal to cut OPEC production has directly hurt Russia/Iran who are dependent on high oil prices. Resource-dependent countries stake their livelihood on economic access to their trade partners and guaranteeing this access sometimes means crossing sovereign borders, with tanks (or drones) if necessary.
    • international terrorism: Al Qaeda's Charlie Hebdo attacks in Paris; ISIS attacks in Beirut and Paris. Now that it is clear that their reach is global rather than merely regional, perhaps we will see a more forceful and coordinated response in the Middle East.
    • domestic terrorism and unrest: Tyrone, Ferguson unrest, Charleston church shooting, Freddie Gray protests in Baltimore, Colorado Springs Planned Parenthood, San Bernardino. Public opinion on racial and gun issues is reaching a breaking point; however, there is probably very little that policy can do. Gun laws that mainly target new guns/owners aren't exactly useful if there are already millions of unregistered untracked guns. Extreme pessimism here is probably warranted.
    • US foreign policy: thawing of relations with Cuba and Iran alongside a cooling of relations with China and Russia. I'm not sure what the strategy is here.
    • formation of trade blocs as a form of regional protectionism: this year we saw the creation of three disparate regional trade alliances: 1) US/Japan's Trans-Pacific Partnership (TPP) vs. 2) China's Asian Infrastructure Investment Bank (AIIB) vs. 3) Russia's Eurasian Economic Union (EEU). Trade and protectionism are increasingly being used for political aims rather than purely economic ones.
    • refugee humanitarian crises: compare responses to Syrian migrants from EU/Germany/Turkey/Saudi Arabia/Canada/US. The tensions between expanding welfare states alongside the opening of borders expose modern liberal hypocrisy. This will be a huge source of friction as lack of coordination pushes costs onto other countries (classic case of externalities). 
    • EU rise of radical populist over mainstream centrist parties: Greece (far-left Syriza), Portugal (anti-austerity Socialists), Spain (rise of far-left Podemos and Catalan separatist parties), UK (Cameron renegotiating EU membership terms), France (far-right Le Pen polling first place for 2017 elections). Increasing skepticism about the viability of the Eurozone and to a lesser extent, the European Union, will persist if these populist nationalist parties continue to be elected. It is hard to convince people to buckle down and work hard towards a common good if your neighbors have a different language/culture and your leaders are constantly emphasizing that fact. Even more importantly, it is fundamentally impossible to have a monetary union without a fiscal union.
    • US rise of radical populist over mainstream centrist candidates: rise of Donald Trump (and to a lesser extent, Bernie Sanders), resignation of John Boehner. It's not just Europe; it turns out that we're having our own brand of ridiculousness on both sides of the aisle.
    • unusual weather: January nor'easter, California drought, Nepalese and Hindu Kush earthquakes, Texas-Oklahoma-Utah floods and tornadoes, strongest hurricane (Patricia) in the Western Hemisphere on record, El Ni?o - climate change is real. Pretty soon we'll be surfing instead of snowboarding in the Northeast and getting our wine from England instead of France. 
    • science: there's water on Mars. NASA astronaut candidate applications are open - submit yours now. We are almost definitely currently in the midst of an ongoing Holocene mass extinction event - go see the polar bears and pandas at your local zoo asap.
    • signed my first apartment lease: previously, I had only informally sublet from friends
    • went to a lot of breweries, wineries, cideries, meaderies
      • breweries: Threes, Captain Lawrence, Other Half, Long Trail, Drop-In, Otter Creek, Fiddlehead, Magic Hat, Queen City, Zero Gravity, Prohibition Pig, Trapp Family, Napa Smith, Bronx, Allagash, Sly Fox, River Horse, Gun Hill, Vault
      • wineries: Paumanok (eastern LI), Quintessa, Artesa, Saintsbury
      • cideries: Nine Pin, Woodchuck, Woodside (eastern LI)
      • meaderies: Maine Mead Works, Urban Farm Fermentory
    • my first major injury: grade 3 complete tear of my MCL, luckily made a full recovery without surgery thanks to PT. I learned that healthcare advice (like all advice) can differ drastically from practitioner to practitioner. In that sense, they're more like economists than scientists.
    • fitness firsts: sprint triathlon in Staten Island (1/4mi swim, 12mi bike, 5km run in 1:13), NYC century (100mi bike in 12hrs), cyclocross bike race at Sly Fox Brewing, marathon in Honolulu (26.2mi run in 4:32)
    • sports: missed out on indoor soccer, but did kickball (we won our league!), outdoor soccer (scored 2 goals!), participated in the East Coast Spikeball tournament (didn't pass qualifiers, but hopefully will next year)
    • bikecamped to Poughkeepsie (roughly 100mi), camped in Clarence Fahnestock State Park
    • traveling: India (Mumbai, Aurangabad); Amsterdam (albeit only 24hrs); Russia (Moscow, St Petersburg); LA (kayaking/camping in the Channel Islands, my first national park); wedding and wine in Napa; sailing in Baltimore; eating and drinking in Portland (Maine, not Oregon); hiking, roadtrip, surfing, running, paddleboard and scuba in Hawai'i (and hiked Haleakala, my second national park)
One of the most eventful years that I can remember. I can't imagine 2016 (due to reversion to the mean) being more eventful but you never know. Life can surprise you in that way.

Monday, October 5, 2015

some macro pitches

Long Mexico (EWW)

·          It's sold off hugely due to oil (it's an oil producer), but it's overdone since the government fully hedges its oil exposure (rumors are that the gov't sold futures near $100, basically locking in that price for its oil sales for the medium term). This should preserve gov't finances for this year at least.

·          In the long term, as Chinese labor gets richer and therefore costlier, more manufacturing should localize and move to Mexico to take advantage of its cheaper labor force (a MX auto worker cost 20% of his American equivalent) and its infrastructure and trade ties with the US and the rest of the world (Mexico has the most FTA free trade agreements in the world after Israel).

·          Thus it's levered to the strong US recovery, albeit with a lag.

·          Capital inflows and foreign investment are growing, with Mexico privatizing and selling off its oil assets for the first time in decades (auction results have been a bit disappointing however, need to watch this closely).

·          Auto manufacturers have announced plans to start plants in Mexico (including German car co's such as VW, BMW, Mercedes and Japanese car co's like Toyota, Honda, Nissan). This will also be supportive for the currency, which has been a victim of the indiscriminate Latam selloff since oil prices fell late last year.

·          MXN been used a liquidity proxy as one of the most liquid EM FX and has deviated too much from fundamentals. Lower cost of carry vs. other FX like BRL.


Short Brazil (BZF)

·          Perfect storm of several factors: stagflation (recession at the same time as high inflation of 9.5% vs. 4.5% target), too much debt/deficit yet they're at a bureaucratic impasse to pass budgetary austerity measures, no political support and significant political uncertainty, BCB is conflicted and already has very high rates (raising would mean deeper recession but less inflation and stronger currency), BoP deficit and choice of impossible trinity trade-offs means weakening FX, CB FX swap interventions are ineffectual

·          Classic case of Dutch Disease, in which a country's over-reliance on natural resources creates upward pressure on its domestic currency, reducing the attractiveness of the country's exports from other sectors, such as manufacturing. This creates a feedback loop in which non-resource sectors fail to attract investment or jobs, and the country becomes even more reliant on natural resource exports. For the past decade, however, the commodity price boom has hugely beneficial for those who have depended on its high prices for economic prosperity. However, like all good things, the commodity super-cycle has come to an end.

·          Many countries have dealt with Dutch Disease by nationalizing and saving its export revenues, usually through a sovereign wealth fund. This is not something that Latin America has done, however. Unfortunately, much of the wealth from these export surpluses were squandered through gov't handouts rather than investment and infrastructure.

·          The result is textbook reforms: this will be a painful adjustment to better fit reality: they need to be able to provide value-added goods and services and not rely on nat resources. 

·          Political realities are tough: President Dilma might get impeached, FM Levy can't pass a budget, 90% budget is non-discretionary


Long China/Asia (ASHR, GXC, GMF, AAXJ)

·          China is becoming more regionally active. Carrot and stick, China has a lot of carrots. Unlike the US, China is extremely pragmatic and morally agnostic, having no qualms with working with Muslim or authoritarian states if they have something that China wants. Willing to spend and invest huge sums, exceeding US foreign aid.

·          $100bn Asian Infrastructure Investment Bank (AIIB) is China's vision of a "new world order" led by Asia with China on top. This would supersede the post-Bretton Woods status quo of US-led IMF/World Bank/ADB/TPP international financial system. This could channel $20bn/yr of foreign investment into Asia, which would boost GDP, equities and currencies. Prominent proponents include Larry Summers and Hank Paulson have criticized the administration's stance towards AIIB, which many US allies have joined. Bernanke says it's because the US blocked a 2010 IMF agreement to shift 6% of quota/voting rights to EM.

·          CNY is now fairly valued. Bernanke emphasized that AIIB and CNY internationalization is mostly a symbolic and nationalist prestige issue rather than having any large practical economic implications.

·          For example, China-Pakistan Economic Corridor (CPEC): part of the Silk Road. It's a series of 50 projects totalling $46bn to connect Gwadar Port in Balochistan, Pakistan with Xinjiang, China. This creates a new, direct route for China to import oil from the Arabian Sea, bypasses the current much longer and less secure route which requires ships to pass through the Indian Ocean, the Strait of Malacca and the South China Sea, which are all geopolitical hotspots for China.

·          ASEAN-China Free Trade Area (ACFTA) - largest FTA in the world in terms of population (3rd largest in NGDP).

·          China has "FOMO MOMO" momentum driven by fear-of-missing-out sentiment, real estate bubble, difficult transition from I to C, healthy consumer, "middle income trap", costlier labor. On other hand, capital stock per capita is low.

·          Asset prices and specifically, stocks, have implicit support from PBoC. Governor Zhou Xiaochuan said: "most enterprises raising capital through the stock market are real-economy enterprises, and this helps the real economy to develop".

·          China has the 2nd largest stock market cap in the world and half of the 10 biggest companies in the world are now Chinese. This isn't reflected in major indices & benchmarks, so funds are underallocated.

·          Lots of tools: RRR and lending rates are still quite high and have room to fall, inflation is 2 p.p. below target, which gives PBoC further room to ease. $1 trillion (which is 10% of GDP) in fiscal infrastructure spending was accelerated in a fast-track approval process in January.

·          On the other hand, real indicators have been all declining, reflecting an slowdown in GDP growth. This is natural and inevitable. The question is if and how the administration will manage it. Furthermore, the stock market has little correlation with economic growth.


Long India EPI

·          Reformist-minded PM, who made a success story of his region when he was governor, is elected in an inefficient bureacratic developing economy with a huge labor force.

·          Highest growth prospects in the EM world, although GDP numbers are a bit strange.

·          Hawkish UChicago CB head who gives mkts relative confidence (for an EM CB head) about FX, esp since inflation is low.

·          There is lots of low hanging fruit such as land sale reform, GST (general sales tax). States are getting more power to run their own fiscal policies.

·          However, GDP numbers are not credible. Nobody knows how they get them. High 7-8% growth, up from 5% in the old methodology.


Long Eurozone equities (HEDJ)

Short EUR (EUO)

·          Don't fight the Fed -> Don't fight the ECB.

·          ECB QE - low agg new net supply due to low fiscal deficits, low liquidity, low public capital mkts participation (only 35-40% of core EZ debt is held by active managers) are actually a plus, this means that portfolio rebalancing effect will be huge and will force banks to sell bonds and lend to corps and households

·          However, low fiscal debt, deficits and structural reform, monetary union without fiscal union, Juncker Plan, which is the EFSI European Fund for Strategic Investments, has been identified as the ONLY initiative in the EZ where aggregate fiscal stance is concerned. It has largely failed due to national self-interest

·          It's all about the banks. They have stopped deleveraging, but they need to lend to the real private economy: i.e. households and corps. Households are borrowing, corps still are not.

·          Euro project means core gets a weaker currency, peripherals get a lower interest rate. Outcome? Core surplus and peripheral deficits without a regional rebalancing mechanism. This means deflation in periphery to improve competitiveness.

·          Core-peripheral divergence - as long as Germany refuses to run a current account deficit, the rebalancing mechanism will be extremely painful for peripherals. Germany already at potential, UE rate very low

·          Chances of a more open-ended QE is likely: in the last meeting, the bond purchase issuance limit was raised from 25 to 33%, and new language was introduced which says to conduct QE to Sept 2016 "or beyond if necessary". On the other hand, core CPI is solid near 1% and they seem happy with this.


Long Japan (DXJ)
Short JPY (YCS)

·          Three arrows is really just 1 arrow: monetary

·          Chances of further QE has increased - unlikely to hit inflation target, weak wage growth, Tankan inflation expectations declined

·          On the other hand, there's been strong household spending and "core core"(ex-food and ex-energy) inflation

·          BoJ has signaled that they may have to get more "creative" in achieving its inflation target. Interpreted this as more ETF and J-REIT purchases. Kuroda has stated that the scale of their ETF/J-REIT purchases is "extremely small". Since economic growth or inflation has not picked up significantly, the likelihood of this has increased.

·          Don't bet on significant fiscal or structural measures