Thinking Macro

October 8, 2009

Since launching the Global Macro strategy earlier this year, everyone in our office has thought much more about things in macro terms-not just how things affect us immediately, but how changes affect the entire system.

David Malpass has a very interesting editorial in the Wall Street Journal today where he discusses what happens to an economy with a weak currency. He argues that there is a flaw in the weak dollar argument: ”Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create.”

From a macro perspective, Mr. Malpass points out what has happened to American shareholders:

Equity gains provide cold comfort when currencies crash. From the euro perspective, the S&P peaked at 1700 in 2000, finally reattained 1100 in the 2007 bubble, fell below 600 in March and now stands at 700 (see nearby chart). With most of the market capitalization of U.S. stocks held by Americans, the dollar devaluation has caused a massive decline in the U.S. share of global wealth.

U.S.-based investors, for the most part, are not really aware of these changes. They just want “the market” to come back. But the market is no longer just a domestic one. Thinking more broadly and flexibly will be essential to investment survival.

Click here for disclosures from Dorsey Wright Money Management.

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Posted by Mike Moody

Peer Pressure Redux

October 8, 2009

Some time ago, I wrote about some peer pressure studies by Solomon Asch. It’s been one of our most-read posts ever. Now Michael Maubaussin of Legg Mason has taken up this thread and in this video discusses new research from Emory University. Researchers at Emory used an MRI to see which areas of the brain were activated during cognition. It turns out that when people are conforming in the Asch study model, they are not remaining independent, but then making a conscious choice to conform. The pressure to conform actually changes their perception. (And you have to watch the video to see what happens to the subjects that do remain independent and go against the crowd.)

In other words, you might never see the bubble coming because it will no longer look like a bubble to you.

This is a powerful reason to use some kind of systematic model. If you plan to rely on your judgement, it might not be there when you need it. It’s also a very good explanation of why trends and bubbles will continue to recur. Once a trend gets going, everyone agrees on what is happening and the peer pressure tends to make it self-reinforcing. From an investor behavior perspective, it’s perhaps not all that surprising that trend following works.

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Posted by Mike Moody

Walking Albert Pujols

October 8, 2009

During last night’s Dodgers/Cardinals playoff game, the subject of walking Albert Pujols was discussed by one of the announcers, Bob Brenly. For those of you who are not familiar with the Great Albert Pujols, he is one of (if not the) best hitters in the game today. He is also one of the best hitters of all time, and by the time he is done with baseball he will no doubt have made his presence felt all over the record books. The Dodgers are well aware of this and chose to intentionally walk Pujols several times. They are so fearful of Pujols’s bat they are willing to give him a free base to avoid something worse happening.

Bob Brenly was in agreement with the Dodgers’ decision to walk Pujols. He also said just about every other manager would do the same thing. Brenly used to be a major league manager so he has some insight into the decision-making process that goes on. But one of the reasons Brenly gave for walking Pujols simply floored me. Brenly said most managers wouldn’t want to pitch to Pujols because they don’t want to deal with the media if it turns out Pujols winds up beating you. They’re scared to answer the media’s questions? Nice… If that’s how you manage, I hope you have your resume up to date!

The sad thing is that I don’t think Brenly is off-base with his comments. You can find this sort of behavior all over. Portfolio management is a great example. How many “closet indexers” exist today? We have written about the concept of Active Share before, and it is clear from the research that the number of truly actively managed portfolios has been dwindling over time. The reason is simple: managers are afraid to deviate too much from their benchmark. They’re afraid to take the risks they need to take in order to outperform their benchmark. A manager who is truly active will go through stretches of poor relative performance. That’s just part of the deal. But research shows those managers are really the only ones who can provide alpha over time. The “closet indexers” wind up underperforming by the amount of the fee over time. Portfolio managers fall into the same trap as baseball managers. They don’t want to deal with the short-term consequences of deviating from the crowd, even if it is the best thing to do over the long-term.

So is walking Pujols the right decision over time? If you just look at his numbers versus Matt Holliday’s (the next batter) then you would probably say, “yes.” This is what the announcers were discussing last night. But I believe that is not the right question to be asking! Pujols is a better hitter than Holliday, no question. But is Pujols better than Holliday with Pujols on first base? I’m not so sure the expected run differential is as great as people think. But that is a question for the real stat-geeks! The series is still far from being over so it will be interesting to see how this matchup plays out.

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Posted by John Lewis

Skin in the Game

October 8, 2009

Most organizations or societies function appropriately when everyone has skin in the game. Mutual dependence is what makes the world go around. In tribal societies, the rule is very simple: pitch in and help or we will ban you and you can go hunt on your own. NFL quarterbacks don’t usually trash their offensive linemen in the media no matter how many times they got sacked on Sunday. Mutual dependence: one of those scorned linemen might miss a block accidentally on purpose in a later game. Prior to 1970, investment banks were required to be private partnerships. Capital was handled carefully because the capital belonged to the partners. When it is OPM (other people’s money) far less care may be exercised. Anyone remember 2008? Even in investment management, Morningstar wants to know how much portfolio managers have invested in their own funds. Hedge fund managers are often required by prospective investors to have significant investments in their own funds. The whole point is to discourage abusive behavior on the part of a few members of the organization or society.

The United States is perhaps close to a tipping point in this regard. According to the latest tax data, 47% of Americans pay no federal income tax. Those of us who do are effectively subsidizing most of the nation’s spending. If you have no stake in the system, it’s much easier to feel good about taking advantage of it. Wouldn’t everyone be in favor of massive federal bailouts that benefited them if they weren’t paying for any of it? Doesn’t it make sense to make everyone have some kind of stake in the system, no matter how small? After all, as Margaret Thacher famously quipped, “The problem with socialism is that eventually you run out of other people’s money.”

Leave a Comment » | Non-partisan op-ed | Permalink
Posted by Mike Moody