Wednesday, November 12, 2003

I'll take Inaction for $1000, Alex

My mom always has good questions. Yesterday, she asked 'is politics getting crazier or is it just me?' I'm sure you'll join me in reassuring her that she's not going crazy. I feel that our elected decision makers are losing sight of their mandate. They are supposed to act for the good of their constituents, not waste my tax dollars bickering for their own political gain. I mean, who the f*ck would root for the US to fail in Iraq. We each have the right to our own opinion on whether or not we should be there, but to take satisfaction in the death or suffering of another human (US soldier, Baghdad shopkeeper, or Ba'athist, it makes no difference) is evil in that black-and-white biblical Marvel Comics sense of the word that George Bush understands so well.

Then she asked 'so what happens in a society where the politicians run amok like this?' Open your world history book to just about any page and you'll find the same story. It goes a little something like this:

    Step 1 -->
People begin to feel out of touch with their politicians, and by extension, with their issues, debates, speeches, decisions, laws . . .
        Step 2 ----> People look for something different that they can believe in. There's a long road and a short road history can take from here. Either they go directly to step 3, or some demagogue surfaces promising to save the world, only to lead them to ruin in pursuit of his/her own personal gain . . . and then they move on to step 3.
           Step 3 ------> People lose trust in their politicians, and in the government those pols run.
**Disenfranchised and with a sense of impotence, people grow indifferent to the frick and frack of the
government (why worry about that which you cannot control?). They stop voting.
**They begin to feel that 'as long as the politicians don't do anything that invades on my little
day-to-day world, they can do whatever the heck they want.' They don't really care who's in office.
**They increasingly resent the tax money these pols waste on things which don't help them.
**With no faith in the pols, people fear any decisions, actions, or movement of any kind. In fact, they
get so nervous when they feel that the government might actually DO something that they support
anyone who acts as a foil
            Step 4 --------> This is the way the world ends.
This is the way the world ends.
This is the way the world ends. Not with a bang
but with a whimper. (Thanks, Al)
                Step 5 --------------> Eventually, some folks in a nearby not-so-disenfranchised land decide to take the place over and the clock rolls back a ways.

Is there a way out? Not sure. When in doubt, follow the advice on my bumper: "What Would Reagan Do?"

*Stock Market Experts*

"Scheisters and Idiots"

Which one are you?

The behavior of any market is just the result of some extremely complex equation with a zillion and one variables, each one changing with every passing second, each one influenced by numerous other, constantly changing variables. If we were bright enough, we could just plug the numbers in and, voila! Brokers go the way of the dodo. Back here in the real world, however, the closest that Wall Street PhDs and B-school gurus have gotten is statistics. Numbers. Math. Probabilities. Data series and trend lines, means and medians, standard deviations and confidence intervals. First thing I learned in stats class is that the past doesn't predict the future, so this isn't exactly the holy grail either, but it can at least tell you where the market has been and then quantify the probability of it going where you want it to go ceterus paribus. If you believe that tomorrow will bring no earth-shatteringly fundamental change over yesterday, you can put the various probabilities into Excel and let it tell you the allocation which has the highest probability of giving you the highest return. Log onto eTrade and execute for 10 bucks.

Something's wrong here. Too good to be true. If it's so simple, why doesn't everybody do this? Because, in the long-term, it will give you only the AVERAGE market return -- and who wants to settle for average? No, no, we need to "beat the market" if we're going to have the condo in the Keys before we're 40.

People use all sorts of methods to figure out how to beat the market. Some read the paper for company names in the headlines. Some watch the ticker under the mistaken premise that you can predict the future by looking at the past. Some use arcane and nebulous economic theories (and I mean that in the not-applicable-in-the-real-world sense of the word) to pick which sector, product, CEO, or time of the month they want to throw their money at. Some have a 'trusted friend' advisor or mutual fund manager (aka broker aka scheister) who somehow just knows . Then there are the endlessly droning talking heads on **insert name of banal news-entertainment channel here**. Certainly they must be experts or else they wouldn't be on said banal channel. Others pay $19.95 for a book of 'secrets' by the likes of reverend Tony Robbins. The slightly smarter ones give up and throw darts.

Some will fall into the worst trap: the more expensive the advice, the better it must be. To heck with eTrade; you've got to spend money to make money, right? As every Wall Street ad says, the key to retiring a millionaire at 40 is to build a long term relationship with a pricey broker. Don't worry, it's not the thousands in fees he bleeds out of your account each month which motivate him. It's that love he feels for you, evidenced by the 3-martini lunch he treats you to once a month. He spares no expense in building that relationship so you will buy the fairy tales of financial gems he offers only to you, his best friend. Unfortunately, every minute he spends valuing you as a person is a minute he's not spending studying the markets. Think about it: 160 hours in your average work-month. 200 clients in your average broker's black book. Not much time left to uncover all those gems-to-be?

And that's OK, because however much time he spends, and whatever (legal) method he uses, math will eventually catch up with him. Anyone who consistently beats the market (long or short term), is a statistical outlier, and by definition we can't all be outliers. You can shoot for the Buffetian 25% long-term rate, but without a lotta luck and a little inside info, you won't likely be remembered as the sage of anything. And don't think that your Rolexed broker or those mutual fund managers who have recently stumbled into the limelight are immune to the laws of stats either. Not that they care -- since their commission is earned upfront, they win either way. When one of their portfolios goes south, they just sell it and mask the loss by folding the money into a better-performing portfolio. By definition, this means selling low and buying high. It also means buying into something which is statistically due for a drop (in order to return to long-term market average). In the mean time, your 401k is worth half what you put into it, and he's earned enough commissions to ski Vail next Christmas. If he messes up enough times, he may be pressured into early retirement, but he certainly isn't asked to refund the millions he's earned in commissions.

Give up the quest, stop paying for his BMWs and just buy the index. Memorize these letters: S P Y. The market grows at a long-term average rate of 11%. Inflation runs at a long-term average rate of 4%. So if, as I said earlier, you're willing to assume that tomorrow will be more or less like yesterday and the trend line will continue, you can settle in and earn your 7% long-term real rate of return, which is just going to have to be good enough.

Like everyone else who reads this, you probably are convinced that you (and your broker) are among the bold, the few, the statistical outliers. Reminds me of the old saying "the lotto is a tax on stupid people."

Tuesday, October 28, 2003


Folks, colorblindness is only cure for racism.

Thursday, October 16, 2003

You've heard of the Illuminati, right?

That secret club of grey-haired European guys who sit around and drink Cognac, give each other secret handshakes, and anonymously control the World.

Controlling the World may be a bit rich, but limit it to the World economy and the notion is not as far fetched as most Yankees think. Look no further than the boards of the largest insurance companies.
--> Allianz (German) (and the biggest)
--> Aegon (US - I mean Bermuda - I mean . . . not even the IRS can figure it out)
--> Not to be confused with Aon (US - I mean Bermuda - I mean - whatever)
--> AXA (French)
--> Metlife (US)
--> Nippon Life (Japan)
--> Prudential (US)
--> Royal and Sunalliance (Brit)
--> Winterthur (Swiss)
--> Zurich (Swiss)
--> although not as big, we'll throw in Berkshire Hathaway (US)
--> finally, for kicks, we'll include the retards (literally) Baiduri Berhad (Brunei)
By harnessing a bulletproof income stream of premium payments, they accumulate assets up the wazoo. They then live up to the credo they invented 'save for a rainy day' by squirreling cash away in every imaginable asset class in every imaginable country at every imaginable risk level. My whole (brief) professional career has been spent in Finance and one thing I've learned: if you have an asset to sell, they're buying. If you need an asset, they have it.

Of course its not quite so explicit as all that. By going through holding company after holding company after broker after broker they make it virtually impossible to quantify the scope of their involvement in any given market. Suffice it to say that they own enough of everything to take control of the market for anything they choose. And where they don't have 51%, you will find them using the most quaint of all European contributions to business: cross-shareholdings and board-of-director swaps. Though only showing the info that's neutered enough to print, their annual reports and org charts show a complex and chummy mess worse than the Bostonian Interstate Highway system.

I'm applying to MBA school as we speak, so for practice let's do a case study. Michel Pebereau, Chairman of the board of directors of BNP-Paribas, the largest French bank is on the Supervisory board of AXA, which in turn owns controlling interest in the bank, which in turn shares its client base with a joint-venture set up with AXA selling rebranded AXA products. Like yin and yang Claude Bébéar, chairman of the Supervisory board of AXA is on the board of directors of BNP-Paribas. By the way, Pebereau is also on the board of Dresdner Bank, which his bank and AXA both have cross-shareholdings in. Dresdner has similar arrangements with Deutsche Bank, which has similar arrangements with Allianz, which completes the circle by owning part of AXA. Incidentally, everyone owns a piece of Vivendi, which of course has a reciprocal director swaps with BNP-Paribas and AXA and which now owns a piece of General Electric (itself quite a financial institution) after selling Universal's US assets to them. Barry Diller, remaining on as a member of Vivendi's board, is also on the board of Coca-Cola alongside Warren Buffet of Berkshire Hathaway (also on my list above).

When a big company starts looking like its going under, I guar-on-tee these guys find some smokey room in which to swill their cognac and decide its fate.

Unfortunately, that's about as sophisticated as some of their decision making gets. They only rely on risk math when it agrees with their preconceived notions and personal preferences. The sheer magnitude of their assets (and liabilities?) allows them to mask, ignore, and walk away from huge screw-ups. Certainly a 'Black Monday' or two might cause some of them to crash and burn, but the more likely risk is that someone will realize the Emperor really isn't wearing anything. This will lead to inquest and meltdown. In the end, some politician will have the bright idea of creating an FIIC (Federal Insurance Insurance Corporation) to ensure that "no American ever has to fear not getting his insurance payout."

Fear these guys, not because they're big and powerful -- or because they're old, white, and male -- but because they are careless with YOUR money and if they fall, they fall hard.

Tuesday, September 23, 2003

Chinese Growth - Who's afraid of the big bad wolf?

China has grown at 8.6% for over 20 years. Great for them, but I agree with James Kynge of the FT: hardly 'the most striking economic transformation in human history.' You might be concerned that they consistently grow output twice as fast as the US and 8 times as fast as Europe.

We all know that growth allows you to live as though you have more than you have. It makes otherwise unprofitable investments profitable and it makes otherwise unbearable expenditures bearable. Were it not for the historic clip of US growth, one can only imagine which projects wouldn't have been able to show a good enough IRR on paper to be carried through to a finished product: TV, cellphones, PCs, commercial websites, artificial hearts, Grisham novels, Spielberg films, Red Bull . . . often times, products upon which we have or will build even more advanced and productivity/growth enhancing products. A virtuous cycle for the economy.

Back when Economics was just a quaint European social science, the US was growing at a much more heady clip. To do this, we (gladly) paid the price in social and environmental terms as we inefficiently ravaged natural resources and exploited human resources like locust. China is at a similar point in their economic progression, and they are doing exactly the same thing.

But as their economies became richer, their middle classes larger, their governments more sophisticated, they began to attribute ever higher costs to these environmental and social exploitations. Eventually, they had to find other, more sustainable ways of growing. The real genius in the US is that we have been able to move to the highest standard of sustainable methods and yet maintain 4% growth. What makes the US different from other European or Asian economies?

Investment savvy.

Investment decisions always boil down to a risk-vs-return equation. However, imperfect information creates a margin of error in this equation which can easily be larger than the expected return. In other words, we might estimate that a project has a cost of $10 and an estimated return of $12-$15. Guaranteed return of 20 to 50 percent. Riskless, right? If your calculations are accurate enough and your estimates are realistic enough its is. The US continues to develop and refine powerfully accurate calculations whose variables are populated using tomes of stochastic data. The rest of the world has not spent an equivalent amount of scientific effort on investment strategy and thus uses simplified equations with variables populated using guesswork. Worse, their equations are often not economically rational because they include favoritism, prejudice (for example, they prefer invest in local projects even if they aren't as profitable as alternatives). As a result, the US investor can be highly confident in his conclusion He thus is supremely successful at rapidly throwing big dollars at certain investments and reaping the big rewards. The rest of the world's investors find that their calculations are 50% as accurate at predicting returns. Even though both groups of investors came up with the same $12-$15 range, the non-US group's margin of error means that (whether they recognize it or not) their real range expands to $6-22.5. Suddenly, the same investment becomes riskier for the non-US group. Time and again, the inaccuracies of their calculations lead them to make poorer investment decisions, and reap lower profits. As they recognize this, they lose the appetite for risk and their investment strategies drift toward safer, lower-yielding investments -- look at the percentage of Japan's money which sits in bank deposit accounts earning less than a percent a year -- whereas US investors' consistent success fuels their appetite for ever more (calculated) risk and are willing to put money into ever more germinal projects with longer delays before payouts. US investors are willing to make bigger R&D investments which often spawn other, more sophisicated and more profitable projects along the way. Thus, the returns compound into a virtuous cycle. On the other hand, non-US economies require immediate payouts, not just for the investors but for the laborers as well. Unsurprisingly, non-US economies end up with consistently lower growth figures than the US.

If China can do the same, they will increasingly be an economic force to fear. If not, they will be just another Japan.

The illusion of geopolitical borders

We can once again thank the quaint Europeans for this legacy! As they played Imperialist Edition Monopoly with planet Earth, they felt it only appropriate that no square foot go un-claimed. When they chickened out on colonialism, the borders of their global jigsaw puzzle largely became seamless national borders. They handed over responsibility and ownership to the fledgling national governments, bought themselves a round of beer, and called it a day.

These new national governments also inherited another gift from their previous bosses: a European-structured government, conceptually based on the rule of law and the supremacy of the state. Sometimes democracy, colonial robber-baronist economics, a military command structure, and/or human rights were thrown in as well, but I digress.

And for many many years the world has obligingly acted like these new countries are legitimate.

But let's face it: many of these malfunctioning governments have no more control over their own territory than your average American parents have over their brat kids. And they like it that way. They make 'national' laws which are to be enforced by a 'national' military/police/judiary complex. In fact, most often, that complex stretches no further than the capital city and is applied sparingly even then. The fun is in writing up the rules -- too much trouble and too little money to actually finish the job. Plus, think of all the Birthday presents you get when your citizens know every law is up for negotiation. Accidentally shoot your neighbor in the head? Well, that's nothing a few well-placed yaks and a bottle of Russkaya can't wash away.

Despite the fact that Sudan has laws calling for a national tax, post, police, army, and legal system, no one living in the desolate Northwestern Quarter gets a tax bill. When they do not pay, they are not visited by the tax man, the cops, or even those annoying collection agencies. On the flip side of the coin, why should they pay? Their homes and camels are not made safe from robbers and vandals by this reputed national police. Their mail is not collected and delivered by any national post office. The ownership of their intellectual property is not guaranteed by any legal system. If they decide to create a Sudanese branch of Bin Laden U, they are not stopped by any national army. Their national health system consists of crappy Medecins Sans Frontiers tents.

And yet G7 leaders "call on" these national governments to enact and enforce laws. They negotiate with them about trade and security as if the people they are talking to have any power to follow through. No, these 3rd world clowns are in the game for one reason: to look out for number one. To trade empty promises for dirty aid money (plus a free ride to Harvard for their kids, of course).

We should recognize that there are empty spaces between countries. Maybe not between Switzerland and Germany, but how about Ecuador and Peru? Even THEY can't agree on where to draw the line. This begs the question: if both slash neither country claims the contested territory, whose laws are the inhabitants subject to? The answer, of course, is neither. It's no-man's-land just like the Wild West of my great-great-grandparents. The only security you can count on is the Winchester above the fireplace. Jeez, maybe we should send the Freemen!