Monthly Archives: May 2016

Isolationism vs. Internationalism: False Choices

George Friedman has a thoughtful piece on US international relations this week, specifically the views of people in the US who are considered to be isolationists , via John Mauldin:

One side is committed to maintaining the institutions created to fight the Cold War. This includes NATO, various bilateral agreements, and economic structures such as the International Monetary Fund. The supporting argument is that these were successful in the Cold War, and they remain a useful platform for broad US engagement in the Eastern Hemisphere.

The counterargument is that the Cold War was a contest with a peer power, the Soviet Union. As such, it required the US to create a vast alliance web based on the United States’ guarantees. Today, no peer power threatens American interests. Therefore, the Cold War structures are irrelevant and too expensive. More important, they are no longer designed to deal with anything that is essential to the US.

World War II and the Cold War required maximum global effort from the US. That effort is no longer needed. What is needed is to clearly identify American interests and relationships, and forces tailored to those needs. Everything cannot be an American duty, since American resources are limited. Involvement in affairs not central to American interests strain the treasury, and cause wars that can neither be won nor abandoned.

I am not arguing which is the more persuasive view. There is, perhaps, even a third option. But to label as isolationist a view that argues for a shift in prior US policy is in error. The isolationists in the past may have been wrong, but they weren’t really isolationists.

The whole commentary is worth a read.

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Stiglitz on crony capitalism

Nobel prize winner Joseph Stiglitz, May 11, 2016, via Project Syndicate.  The article is about competing economic models and how they explain today’s inequality problems.  He also gets into crony capitalism and how it relates to these issues as well:

In today’s economy, many sectors – telecoms, cable TV, digital branches from social media to Internet search, health insurance, pharmaceuticals, agro-business, and many more – cannot be understood through the lens of competition. In these sectors, what competition exists is oligopolistic, not the “pure” competition depicted in textbooks. A few sectors can be defined as “price taking”; firms are so small that they have no effect on market price. Agriculture is the clearest example, but government intervention in the sector is massive, and prices are not set primarily by market forces.

US President Barack Obama’s Council of Economic Advisers, led by Jason Furman, has attempted to tally the extent of the increase in market concentration and some of its implications. In most industries, according to the CEA, standard metrics show large – and in some cases, dramatic – increases in market concentration. The top ten banks’ share of the deposit market, for example, increased from about 20% to 50% in just 30 years, from 1980 to 2010.

Some of the increase in market power is the result of changes in technology and economic structure: consider network economies and the growth of locally provided service-sector industries. Some is because firms – Microsoft and drug companies are good examples – have learned better how to erect and maintain entry barriers, often assisted by conservative political forces that justify lax anti-trust enforcement and the failure to limit market power on the grounds that markets are “naturally” competitive. And some of it reflects the naked abuse and leveraging of market power through the political process: Large banks, for example, lobbied the US Congress to amend or repeal legislation separating commercial banking from other areas of finance.

The only word I disagree with in the above is “conservative.”  I would just remove it because, for instance, the legislation referenced in the last sentence was pushed through by Bill Clinton, and Obamacare has created huge entrenched interests in both the pharmaceutical and insurance industries.  The political forces are strong for this on both sides of the aisle.

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Happy research

My favorite happiness guru, Eric Barker, has a new post along the same old lines.  But this one has a couple of really fascinating tidbits:

We all want others to support us. And people are more likely to be optimistic about your success when you’re optimistic about it, too.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

People were five times more likely to be optimistic about another person’s goals if they thought the person was optimistic himself or herself. Less significant factors included the person’s personal experiences and the overall likelihood of the outcome. (Werneck De Almeida 1999)


Spending too much time on the information superhighway kills happiness as much as being stuck in traffic on a not-so-super highway.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Recurring long periods of personal Internet use were associated with 28 percent lower life satisfaction. (Green et al. 2005)

Here’s a somewhat condensed version of the whole thing, which is worth a read:

What do you need to do to be happy? What attitude should you take toward life? How can you reduce stress and be gritty? What makes for a loving relationship?

1) Sappy Means Happy

A lot of the advice on being happier is sappy. But science says that sappy stuff works. It may produce eye-rolling, but it actually does produce smiles as well.

“Take the time to appreciate something beautiful” sounds like the slogan you’d see on a mug you’d quickly shove to the back of the cupboard. But it also produces a 12% boost in life satisfaction.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Those who said they regularly took notice of something beautiful were 12 percent more likely to say they were satisfied with their lives. (Isaacowitz, Vaillant, and Seligman 2003).

…Watching cat and puppy videos online gets a lot of flack. But animals do make us happier. And people with a pet they love are 22% more satisfied with their lives.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Interaction with animals supplies us with both immediate joy and long-term positive feelings, and contributes strongly to our happiness. Those with a loved pet are 22 percent more likely to feel satisfied with their lives. (Barofsky and Rowan 1998)


2) Optimism

If you don’t have a very good reason to focus on the negative, think positive. You’ll be almost 30% more likely to feel happy.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

People with a tendency to see things optimistically were 29 percent more likely to feel a sense of well-being. (Lounsbury et al. 2003)

…We all want others to support us. And people are more likely to be optimistic about your success when you’re optimistic about it, too.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

People were five times more likely to be optimistic about another person’s goals if they thought the person was optimistic himself or herself. Less significant factors included the person’s personal experiences and the overall likelihood of the outcome. (Werneck De Almeida 1999)

3) Control

How does “66% more likely to be happy” sound to you? Okay, then you want a feeling of control over your life.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

People with a sense of control in their lives, in both career and relationship, were 66 percent more likely to report feeling happy and satisfied. (Chou and Chi 2001)

Feeling in control is the antidote to stress. And the good news is, you don’t have to be in control, you just have to feel in control.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Researchers gave participants a skill test and exposed them to a loud, distracting sound. Those who were told the sound would go away if they succeeded on the test showed significantly fewer ill effects of the stressful situation than those who were told the sound would continue regardless of what they did. Researchers concluded that a sense of control calmed the first group, even though neither group really had any control over the process. (Pennsylvania State University 2002b)

4) Communicate

Sharing your innermost thoughts with a partner is associated with a 62% greater likelihood of a happy marriage.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

In studies of marriages of various lengths, couples with a high degree of intimacy between the spouses— that is, couples who shared their innermost thoughts— were 62 percent more likely to describe their marriage as happy. (Pallen 2001)

Unspoken expectations of your partner leads to screaming matches.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Research on marriages with high levels of conflict finds that more than half of the couples in these marriages have disputes involving the failure of one or both partners to conform to unspoken expectations. (Philpot 2001)

…And what’s holding you back from earth-shattering joy right now? Oh, that one’s easy…

You’re on the internet. Spending too much time on the information superhighway kills happiness as much as being stuck in traffic on a not-so-super highway.

From The Simple Secrets for Becoming Healthy, Wealthy, and Wise:

Recurring long periods of personal Internet use were associated with 28 percent lower life satisfaction. (Green et al. 2005)

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Jarred Dillian published a piece on economic freedom at Mauldin Economics.

There have been some startling developments in the past few months. Like, did you hear the talk about getting rid of $100 bills?

It’s not just C-notes. 500EUR notes in Europe, 1,000CHF notes in Switzerland—everywhere people are talking about getting rid of large-denomination bills, because… some people use them to evade taxes or to commit crimes. You don’t pay your drug dealer with a credit card. So the thought is, get rid of the large-denomination bills and crime goes away.

This is scary. Part of economic freedom is the ability to transact anonymously. Take the extreme example where cash is eliminated altogether. Everything goes on a credit or debit card. Your whole purchasing history is stored on the Internet. Well, if you’re not doing anything wrong, you have nothing to hide, right?

Part of freedom (including economic freedom) is the ability to do bad things. Do you want to eliminate the option for people to do bad things, or do you want to give people the choice to do the right thing? All morality is meaningless if people are given no choice of whether to behave or misbehave. This is a deep philosophical issue.

Again, some people think a perfect world is a world without crime, but that’s not true. A perfect world is where people have the ability to commit crimes, but don’t.

But this talk about large-denomination bills is really gaining momentum, and honestly, I think it is at least half responsible for the run up in gold prices over the last couple of months.

There is quite a bit more to it, as well.  The whole article is thought provoking.

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Health Care Directives

This post is based on the work of Dr. Ferdinando Mirarchi with the Institute on Health Care Directives.  He gave a presentation on 5/11/16 at the Jefferson Education Society in Erie, PA.

There is value in the idea that there should exist a statement of a person’s medical treatment wishes in case the person is unable to provide instruction.  This is currently done via 2 documents, the living will and the POLST.  The living will is something you keep at home, and the POLST is a document that doctors or hospitals may keep as part of your medical record.

In both cases, the documents were made by lawyers and/or legislators.  This means that both medical workers and those who are filling out the documents frequently do not understand or agree on the meanings of the words used, or when these documents should be applied.  This results in people being treated, or not, in ways that they did not want.

The biggest source of confusion is that there is not just one scenario.  Do you want to be kept alive using all available methods?  Under what circumstances?  If you are otherwise healthy and have an unexpected heart attack, do you want the first responders to use a defibrillator to restart your heart?  What about if you have a terminal illness and you are in hospice?  Living wills do not make any distinction here, although they are intended to apply to a person incapacitated by a long term or chronic illness.  If an EMT finds you unresponsive, and they find a living will that says you do not want extraordinary measures, it is 50/50 whether or not they will shock your heart or try any other life saving measures.

A complicating factor is that insurers are trying to get people to fill out these forms as a cost savings tool.

Dr. Mirarchi has made a checklist for medical personnel that can be used in emergency situations:

The Resuscitation Pause
ABCDE’s of the Living Will, DNR, or POLST

A:  Ask the patient or surrogate to be clear about their intentions in their advance directive (Living Will, DNR order, or POLST form).
B:  Be clear about whether this is a terminal condition despite sound medical treatment, PVS (persistent vegetative state) vs. treatable critical illness.
C:  Communicate clearly whether you believe the condition is reversible and treatable, and whether with a good or a poor prognostic outcome.
D:  Design a plan and discuss next steps. For example, “Your mom is critically ill. We can give her a trial of instituting life-sustaining care for 48 to 72 hours, and if there is no benefit, we can withdraw the life-sustaining treatment and provide comfort.”
E:  Explain that it is okay to withhold or withdraw life-sustaining treatment and provide comfort so long as it is in keeping with the perceived wishes of the patient. Also, take a moment to explain the benefits of palliative care and hospice.

The Institute for Health Care Directives has also come out with an ID card that EMTs can use with instructions that are in medical terms they will understand, and that are much clearer to medical personnel than anything in a living will.

Additionally, medical workers need training on this topic.  Even a little training goes a long way!

If this were added to required training for doctors and nurses, and something like the ID card were broadly adopted, for instance by insurers, it would go a long way toward improving treatment of people without unnecessary errors.  Right now the way it’s headed is that insurers want more people to fill out the confusing forms.  This will help them, because if half the time treatment is withheld in an emergency situation based on a living will, it saves them money.  They are also the ones writing the laws about this stuff.  There really are no advocates for the patients with money to influence the lawmakers.

The website above has a resources and media page with a lot more information.

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More Respectful Disagreement with Hussman

This time from Jeff Miller, via Advisor Perspectives:

My Own Concerns about the Conclusions

Many have asked me why I have not followed this approach in my own investment management. I do not write about it very much because of the work required. Dr. Hussman has a great research budget and team. I have a small staff who are already fully-employed on stock picking and managing our programs. Going back to replicate one of the old charts would be a fair amount of work. I will share my concerns here, but only in abbreviated form.

  • We never seem to reach the point of evaluation. How did these approaches work in the past?
  • The methodology seems to include many of the classic overfitting problems. I am certainly not the first to note this. Philosophical Economics in late 2013 wrote Valuation and Stock Market Returns: Adventures in Curve Fitting.
  • There are adjustments that are not well explained. The earnings are adjusted for expected changes in profit margins, for example. What if this assumption is not accurate? Profit margins are an intense (and separate) debate.
  • The method for adjustment keeps changing – different approaches, coefficients, etc.
  • Over the years, the time frame for the forecast keeps moving, from seven, to ten, and to 12. If you go back to the original Shiller papers, he was using five years. His disciples keep experimenting with different choices.
  • The independent variables change with each new iteration. The overall model always seems to fit. Past discrepancies disappear.
  • The attribution of “bad patches” in results to market overvaluation or undervaluation. This seems backwards. Why is the market wrong and the model right?

I am especially bothered by what I see as exaggeration and distortion. What does it add to this discussion to call valuations “obscene?” I find especially distasteful the statement, “The CAPE Ratio id doing exactly what it has always done, which is to help investors anticipate the investment returns they should expect over the next decade. Those returns will very likely be in the low, single digits”.

The CAPE ratio is not some wise old friend that has been around for centuries. It was invented only recently and has not worked very well. The claim of historical validation is also completely wrong. What if I told you that the Packers always won at home after a double-digit away loss in a dome? (I made this one up, but you get the idea). It is historically accurate, but does not have any value for predicting the future. Since Dr. Shiller and Dr. Hussman made a lot of specific choices about measuring earnings, past time frames, use of inflation information, and future time frames, their conclusions should be described as a model, not some definitive historical record. It is rather easy to create a view of history that provides a vastly different conclusion. (see The Single Greatest Predictor of Future Stock Market Returns). It includes this impressive chart.



[Jeff] Similar approach, vastly different result. This is not the only such example.

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Pre School

I have always felt that pre-K that consisted of my kids trying to sit still and learn something academic would have been a total waste for them.  My 2 very energetic boys absolutely did not need that.  This mother’s intuition is at least reflected by SOME academics.  From AEI:

Research on school-based pre-K overwhelmingly focuses just on early gains in rudimentary academic skills, like recognizing letters, holding a book right-side-up, and counting small numbers.

Most so-called positive results show that kindergartners who attended pre-K are a couple of months ahead of their peers in these basic skills; in other words, children who went to pre-K know letters in September that they wouldn’t have known until, say, November if they hadn’t. But while these kinds of short-term gains in basic skills are easy to measure and look good in headlines, they aren’t what’s important.

Instead, overwhelming evidence shows that the key to children’s long-term success is a range of cognitive and noncognitive capacities like language and executive function skills, reasoning, critical thinking, problem-solving, persistence and the ability to get along well with others. Pre-K advocates claim that small gains in basic kindergarten skills lead to large gains in these essential capacities which, in turn, lead to graduating from high school and staying out of prison. But we simply have no idea if that’s true. There’s almost no rigorous research on the long-term impact of school-based pre-K. And common sense suggests that changing outcomes for at-risk children — and knowing if they’ve successfully been changed — is going to require more than raising and measuring kindergarten test scores.

So does pre-K work? We don’t know — and it’s the wrong question to be asking in the first place. Instead, the critical question is: what are the most effective early interventions for improving disadvantaged children’s lives?

I would change the question to:  what are the most effective early teaching strategies for improving children’s lives?  These strategies then need to be applied to preschools for all kids.  Disadvantaged kids probably have special needs, as well, and those should be studied, too, but we should start at the beginning:  What and how can we teach toddlers and young children to help them become happy, peaceful, productive adults?

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Leading Economic Indicator

Doug Short published this article 4/22/16.  Not sure exactly how to use this information, but it seems to be something worth thinking about.

The Conference Board’s Leading Economic Index (LEI), which we report on monthly here, is a composite of ten indicators that stretches back to 1959. Over that multi-decade time frame, the US population has increased by about 84 percent. What would the LEI tell us about our economy if we adjusted the data for population growth?

Here is a chart of the LEI series with documented recessions as identified by the NBER. We’ve also overlaid the same series with a population-adjusted version based on the Census Bureau’s mid-month estimates and an extrapolation for the latest month. The LEI is 1.4% off its high. The population-adjusted LEI is 9.1% off its high. The peaks for both series occurred a decade ago in March of 2006. The unadjusted version is close to setting a new high, although it has trended sideways of late. The population-adjusted version is significantly less encouraging.

Conference Board's LEI

For a sharper comparison of the relationship between the LEI and recessions, the next chart illustrates the percentage off the previous peak for the index across its entire history.

LEI from Peak

The population-adjusted version of the second overlay shows a sideways trend over the past year at a level well below its pre-recession peak. The implication is that the US economy is somewhere in the vicinity of two-thirds of the growth needed to recover fully from the last recession. By this metric, despite the distance in months since the end of the Great Recession in mid-2009, the economy remains at risk of a double dip recession.

The red line in the charts above offers a context for understanding the current state of politics in a presidential election year, which includes:

  • The appeal of Sanders to the younger citizens desperately seeking a path to financial stability, and
  • The strength of Trump among a broad base of financially challenged voters who haven’t fared well during the Fed-managed recovery.

Even without the population adjustment, this last recession has been particularly nasty, and the recovery is still incomplete.  Not that everyone didn’t know it, but it’s nice to see economic data that reflects the reality of so many people.

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ETF or Mutual Fund?

$2 trillion was held in 1,411 ETFs in the US at the end of 2014, per ICI, now holding more assets than hedge funds.  This is dwarfed by the $16 trillion in mutual fund holdings, but ETF growth continues to outpace mutual fund growth.

The April 2016 DOL rule regarding the fiduciary duty of the financial advice industry may also drive some additional AUM to ETFs.

What are factors to consider when selecting between mutual funds and ETFs?  Start with costs.

  1. Taxes:  Because of the way that the funds are structured, ETFs often have lower tax costs than mutual funds.  This is an “all other things equal” kind of generalization.  All other things are often not equal, so be sure to verify recent tax impact of funds being considered.
  2. Trading Costs:  ETFs will incur several types of trading costs.  The one the investor sees is the trade commission.  In addition, there is the trading spread, which can be substantial, and is always present, and the premium or discount to NAV, which can actually work in the investor’s favor.  Mutual funds can have a sales load on the purchase or sale as well as transaction fees for each purchase and sale.  Mutual funds also have varying penalties if sold before specified holding times.
  3. Fees:  ETFs have a set fee, but check for a fee waiver that may expire.  Mutual funds have expense ratios, but can also have 12b-1 fees.

Next, consider what the funds are, especially in comparison to what they say they are.  Index funds should actually match (or be close to) the performance of the index, and not all of them manage to do that.  Conversely, actively managed funds should not match up closely to an index.  See for research on closet indexing.  The following metrics are useful for both ETFs and MFs, although not always easily found:

  1. Active share measures the percentage of a portfolio that is different from its benchmark.  This is normally only measured for actively managed mutual funds.  One source for this information is
  2. Tracking error measures the volatility of relative returns for a portfolio compared to the fund’s benchmark.
  3. And of course, the bottom line is the total return that the investor receives compared to the benchmark.  You can find information comparing the benchmark to the fund performance in the fund’s annual report.

These should be looked at for at least 1 and 3 year time periods, or as long as the current management team and process have been in place.  Note on active share:  Do not confuse active share with performance.  See Financial Analysts Journal, March/April 2016 (Frazzini, Friedman, Pomorski).

The December 2015 issue of this publication featured an article by Eric Robbins explaining NextShares, which is a way that ETFs can include active managment.   To find active ETFs that are similar to active MFs, start with the stated objective of the fund.  Check the style box, the sector breakdown, the number of securities held, and the turnover.  Obviously, performance should also be similar for the funds to be considered equivalent.

What about the “active index” or “smart beta” ETF products?  They are sort of in between active and passive products, and generally there are not both ETF and exact MF versions of these funds.  Like actively managed funds, compare the stated objective and measurable characteristics to determine if an ETF and MF are suitable substitutes.

When comparing actively managed funds to an index fund, the duty of a fiduciary is to know that any added cost of active management will result in a fund that is materially different from an index fund, and expect that the real net total return over the anticipated holding period is equal to or higher than that index fund.

Mutual funds have advantages in the following situations:

  • Client who is dollar cost averaging.  If you find a fund with no trading fees and similar expenses to the best ETF available, the monthly trade commission may make the ETF more expensive, especially for smaller amounts invested.  In addition, the client can always be fully invested in MFs, with no residual cash on hand.  Administration is also simpler from the advisor’s end.
  • Client investing in index funds in a tax advantaged account.  This eliminates the tax cost advantage of the ETF.  If you have access to institutional MF shares for the client, they can be cheaper than ETFs.
  • Investor has a strong preference for a specific active fund manager or fund family.  Be sure to look at the few active ETFs that are out there also.
  • You are investing in a market or asset class that doesn’t have an index for what you want to own.  Examples: China, with its large assortment of share types, markets, company ownership (SOEs, etc.), and even currency.  Bond markets (lots of people own AGG, but does anyone like it?).  Alternative investments, like futures or CTA-type funds.

ETFs may be the best choice in other cases:

  • Client who is investing in taxable account.   The exception to this would be if the amount invested is small compared to the total trading costs.
  • The client or advisor has a strong preference for passive investing, or factor investing (smart beta).  Although you should check for MFs, especially for the most common indexes, costs are usually lower for ETF index funds.
  • Rules based investing models (tactical asset allocation), where trades are made based on price levels.  Intra-day trading allows for technical trading of ETFs.

The choice between a mutual fund and an ETF is not always obvious.  As the ETF market expands, and fiduciary requirements increase, it is becoming more important to consider both alternatives for any given investment objective.


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