Powell’s Trial by Fire and Other Friday Musings
Tying up some loose ends from a busy week.
Bloomberg, March 23, 2018
I am overdue for collecting all of my random thoughts on things large and small. Since the nor’easter has me sleep deprived – a one day round trip to Philly via the joy of Amtrak – today is as good as any to round up all of the random ideas, half-finished columns, and other effluvia circulating in my head.
No guarantees, but do not be surprised if some of these eventually become full blown actually researched and thought about columns.
On to the random quanta:
1. The new Fed chair’s baptism of fire: Paul Volcker had the threat of hyper-inflation, Alan Greenspan had the 1987 crash, Ben Bernanke the great financial crisis. It seems every new Fed chair gets tested somehow. 1 That raises the question of the recent volatility blowup: Was that Jerome Powell’s first trial as the new Fed chief, or is something uglier lurking out there?
2. Factor versus Smart Beta: Is smart beta really just factor investing marketed differently? That seems to be a legitimate criticism of this red hot investmentsegment. Two questions: Who really invented so-called fundamental indexing? (My best guess is Dimensional Fund Advisors). And is the Twitter battle between Cliff Asness of AQR and Rob Arnott of Research Affiliates really over?
3. Fiduciary standard: Despite the recent appellate court decision, the fiduciary standard seems to have gone global as countries from Australia to the U.K. have adopted a full-on no-exemption rule for all investors. The U.S. is a laggard, not a leader. Estimates show the cost of conflicted advice as $1 billion a year in Texas and New York, and almost $2 billion annually in California. While the Feds dither, the states are showing leadership: As Barron’s reported last year, Nevada and Connecticut passed legislation expanding fiduciary requirements for brokers. Other states — New York, New Jersey, Massachusetts and California — may soon follow.
4. XIV was built to fail: The storm from the spectacular volatility blowup in February seems to have passed. However, I am still awaiting a full explanation of what caused the trading debacle. I subscribe to the theory that these products were built to fail. Even the person who invented them said, “In my wildest imagination I don’t know why these products exist.”
5. Buybacks = financial engineering. Mention you don’t like buybacks, and the pushback is immediate and fierce. Yes, I know that as a group, they potentially generate alpha. And I also know they are more tax efficient than dividends. But that is because we wrote the tax laws that way. Nothing prevents us from making dividends as tax efficient as share buybacks, which are designed to goose the value of insiders’ stock options. I agree with my colleague Justin Fox that “buybacks encourage value extraction over value creation.”
6. Bull market threats: What could end the bull market that kicked off in 2013? Despite the headlines, I doubt it will be a trade war or a shooting war or even a nuclear war. The more likely threats are, in somewhat of a reversed causal order, weakening corporate profits, slowing economy, decreased consumer spending, (much) higher interest rates and inflation. And while the bears have been early (aka wrong) for the better part of nine years, someone has to make the counter-argument. Don’t be so quick to dismiss the analyses on the other side of your trade — next time you see one, hug a bear — you need them to make a two-sided market.
7. The Financial Industry Regulatory Authority should indemnify investors: Yeah, I said it: The brokerage industry’s self-regulator has been anything but a friend to investors. First came the kangaroo courts, also known as arbitrations. Now we find out that even when they beat the long odds in a crooked system, more than a third of investors who win their arbitrations get nothing to show for it. The brokers stiff them and FINRA does nothing about it.
This cries out for a simple solution: indemnification. When an investor wins an arbitration and the broker refuses to pay within 90 days, the investor should be able to collect from FINRA. Don’t worry, FINRA has more than $1 billion lying around being invested poorly.
8. Measurement issues: Missing Inflation? Check. Productivity gains? Nowhere to be found. What about workers missing from the labor pool? They are showing up slowly in the data. As we await the next economic report, we do not often enough question how modern and up-to-date the process that assembles the data is. Based on much of what we have seen, it looks like we have a measurement problem.
9. America’s gullibility problem: Yes, Facebook is a disaster and fake news is a very real issue, as are Russian bots and ideological bubbles and just about everything involving Fox News. But the bigger issue is a problem of intellect. Americans seem to have forgotten how to think clearly. There is little effort to be rational, data-driven or evidence-based. We consider neither our own cognitive biases nor the motivations of various sources. This is a societal failure; we should be teaching civics to schoolchildren. Rather than teaching them what to think, we should be teaching them how to think. The future depends on it.
Originally: Powell’s Trial by Fire and Other Friday Musings