Arnold Kling reports that free markets are more popular in China than in the U.S.
That reminds me that I should give more thought to investing in China-related companies.
Investing
Arnold Kling writes some interesting comments about the uses of oil futures markets.
I recall reading that the President of Exxon was forecasting oil prices much lower than the futures markets and thinking that if he believes his own forecast, then he should put his company up for sale.
I think there’s a genuine inconsistency between Exxon’s talk and its actions, but selling the company isn’t the optimum response. We don’t know that Exxon’s stock price currently reflects the prices forecast by the futures market (I decided 6 months ago that energy-related companies were underpriced relative to the futures market and sold my last 2009 futures contract while keeping a large position in energy-related companies) or that the market for large oil companies is liquid enough for Exxon to be sold at a good price. It makes more sense for Exxon to hedge larger fractions of its production by selling more futures contracts.
Maybe the long-date futures markets are illiquid enough that prices would approach what Exxon’s president thinks they should be, in which case Exxon would make slightly more money than under its current policies (assuming the resulting prices are right, which Exxon ought to assume is the best available guess). Or maybe the markets have enough liquidity that Exxon would hedge a large fraction of its production at prices near $60/barrel, which would help Exxon dramatically if Exxon’s president is right, and forgo big profits if he’s wrong. It’s fairly clear the market doesn’t have the liquidity to keep long-dated futures prices over $60/barrel if Exxon tries to make big hedges overnight, but if Exxon were fairly patient about building up the hedge positions, I don’t think we can know what would happen without performing the experiment. There are lots of people out there who think that betting against Exxon would be a good deal. Their confidence in their beliefs remains untested.
The government has all sorts of subsidies for alternative energy. However, the most efficient subsidy would be to buy oil futures contracts. If we must have an energy policy, it should consist solely of strategic futures market purchases.
Buying oil futures contracts would be the least wasteful way to subsidize the solar energy market, where there are many designs that are close to providing competitive mass-produced products. But financial markets are pouring enough money into that market that there’s little reason to think government subsidies are valuable.
Buying oil futures won’t provide the kind of subsidy that, say, fusion advocates would want. If markets are inadequately funding fusion research and government is benevolent enough to do better (a suspicious pair of assumptions, but without assumptions of that nature the popular demand for a government energy policy is a mistake), then oil futures markets won’t solve the problem because the problem is something like markets having inadequate information to target the right research or patents not providing inventors with the optimum fraction of the social benefits of their inventions.
Last week in a ski lift line I overheard a college-aged guy bragging about how he was making money in the Florida housing market before going to college.
This kind of anecdotal evidence is not as reliable as I would like, but market bubbles rarely have conclusive evidence, so I feel a need to make use of all evidence. If housing market peaks are much like stock market peaks, this is definitely evidence that we are near at least a short-term peak in the housing market.
Book Review: Unconventional Success : A Fundamental Approach to Personal Investment by David F. Swensen
This book provides some good advice on how an amateur investor can avoid sub-par results with a modest amount of work. It starts by describing why good asset allocation rules should be the primary concern of the typical person.
I found this quote especially wise: “While hot stocks and brilliant timing make wonderful cocktail party chatter, the conversation-stopping policy portfolio proves far more important to investment success.” Fortunately for those of us who make a living exploiting the mispricing of fad-chasing investors, the most valuable points of this book aren’t in the kind of sound bite that will make them popular at cocktail parties.
But even if you choose investment ideas for cocktail party conversation rather than for building wealth, you should be able to find some value in his explanations of how to avoid being ripped off by fund salesmen and why ETFs are better than most mutual funds.
His attacks on the mutual fund industry are filled with redundant vitriol that may cause some readers to quit in the middle. If you do so, don’t miss table 11.3, which gives an excellent list of ETFs that most investors should use. I was surprised at how much I learned about the differences between good and bad ETFs from this book.
His arguments against investing in foreign bond funds are weak. I suspect he overestimates the degree to which foreign equities diversify exposure to currency risks.
He advises investing more in U.S. equities than in equities of the rest of the world combined, even though his reasoning implies more diversification would be better. But I’ve been slow enough to diversify my own investments this way that I guess I can’t fault him too severely.
He has a plausible claim that not-for-profit organizations that provide investment vehicles on average treat customers more fairly than for-profit funds do, he goes overboard when he claims not-for-profits have no conflict of interest. The desires for job security and large salaries create incentives that would cause many investors to be fleeced if they switched to not-for-profits without becoming more vigilant than they have been.
His faith in the U.S. government is even more naive. He says “U.S. Treasury Inflation-Protected Securities, which provide ironclad assurance against inflation-induced asset erosion”, “Treasury … bondholders face no risk of default”, and “The interests of Treasury bond investors and the U.S. government prove to be better aligned than the interests of corporate bond investors and corporate issuers. The government sees little reason to disfavor bondholders.” But a close look at the CPI shows that indexing to it provides very imperfect inflation protection (e.g. its focus on rents hides the effects of rising home prices), and the current reckless spending policies combined with large foreign holdings of U.S. bonds can hardly avoid creating a motive for future politicians to inflate wildly or default.
The rationalizations that I’m noticing from people who want to deny the existence of a housing bubble are becoming more obviously contrived.
Last spring, the strangest one I noticed was this Tyler Cowen post, which notes the unusual rent-buy ratios, then ignores that anomaly and devotes the rest of the post to questioning a weaker argument for the housing bubble theory.
This month I noticed someone on a private mailing list who had enough sense to realize that current housing prices probably depend on a continuation of unusually low and stable long-term interest rates expressed confidence that the “psychological consensus against inflation” would make that likely. If such a consensus existed, I would have expected to see people expressing concern that the Fed’s policy being too inflationary, when in fact I see people jumping at any excuse (e.g. a hurricane) to advocate a more inflationary policy. Plus I see politicians racing to expand the federal debt to levels that will give them massive incentives to inflate or default when the baby boomers retire.
Now Chris Hibbert comes up with some stranger rationalizations:
The worst historical cases that I know of were times when housing prices dropped 10 or 20 percent.
I thought he read Marginal Revolution regularly, but that comment suggests he is unaware of this description of Shiller’s apparently more accurate housing price history which includes what looks like a 50 percent drop in U.S. housing prices. But that deals with a national average, which gives you the kind of diversification you might get with a mutual fund. Chris’s real estate investments sound less diverse – is that safer?
Continue Reading
Brad Setser has a disturbing post about the risks that the hedge fund industry is taking, and which might cause a market crash. Puts are looking cheap these days, and I’m buying a modest amount of them just in case.
Book Review: Intangibles: Management, Measurement, and Reporting by Baruch Lev
It isn’t easy to make a book about accounting interesting and uplifting, but this book comes fairly close to accomplishing that. It provides a clear understanding of why it matters how well accounting rules treat intangible assets, and gives some good guidelines on how to improve them.
Some of the proposed improvements are fairly easy to evaluate, such as breaking down R&D into subcategories for basic research, improvements to recently released products, etc., but with some of the book’s suggestions (e.g. trademarks) I’m puzzled as to whether there’s little to be gained or whether he has a good idea that he hasn’t adequately explained.
Alas, accounting standards are a public good that few people have an incentive to create. The improvements suggested by the book could generally be adopted without first being approved by a standards committee because they mostly involve adding new information to reports. But the first company to adopt them gains little until investors can compare the information with that from other companies. And accounting standards committees tend to attract people whose main concern is preventing harm rather than creating new value. And that tendency is currently being reinforced by investors who want a scapegoat for their complacency at the peak of the recent stock market bubble.
Tyler Cowen claims that market prices say the “demand for raw materials will continue to outstrip the supply”. But I don’t see the market prices saying that. Tyler seems to be extrapolating from trends of the past few years.
He seems to be ignoring what futures contracts for delivery several years out are saying. Here’s what I see for commodities with futures contracts several years out:
| Commodity | Nearest future contract | Farthest future contract |
|---|---|---|
| Silver | $7.307 | $7.848 (Jul 2009) |
| Crude Oil | $51.15 | $42.41 (Dec 2011) |
| Natural Gas | $6.304 | $5.721 (Dec 2010) |
| Copper | $1.477 | $1.255 (Dec 2006) |
Gold and silver prices are expected (as usual) to maintain their purchasing power, while prices of other commodities that have had big run-ups recently are expected to fall.
I’ve been making some investments that are based on the belief that markets are underestimating Chinese/Indian demand over the next 5 years or so. But markets are clearly saying that the Hubbert Peak arguments are either wrong, or unimportant due to the likelihood of a switch to alternative fuels. And with metals, it sure looks like we are seeing merely a combination of asian demand and a weak dollar.
I returned home from a weeks vacation and discovered on Friday morning that one of my investments (Phazar Corp, symbol ANTP) had doubled since I had last looked at it. While there is a slight chance that this was due in part to buyers with inside information that it’s likely to sell equipment used in new tsunami warning systems, it looks like most or more likely all of the buying came from momentum players whose connection with reality is more tenuous than normal. So if I had been following the stock instead of snowboarding, I would almost certainly have sold before Friday at a lower price. As it happened, I had the patience to postpone my sale until Monday morning, getting what I expect will prove to be an unreasonably good price, and also delaying taxes on the profits. This is not the first time I’ve seen evidence that slightly slower reactions to price changes would be profitable, but it’s certainly the most dramatic.
The latest issue of my favorite investment advisory newsletter, The Whitebox Market Observer, has a good point about industrializing countries:
It is nonsense to think that China as a whole will become rich because the Chinese individually are poor. The ugly truth is that poor people don’t matter. They don’t matter as consumers because they don’t have any money; they don’t matter as producers because once they start producing they do not stay poor for long. Show me a persistently poor factory worker and I will show you a rotten factory, no threat to the U.S. or anyone else.
and goes on to note the similarities with Japan of the 1960s and Taiwan and South Korea of the 1970s, which started competing with U.S. companies using low wages to make up for their mediocre reputation for quality, and within about two decades switched to competing on quality.