Nov 11, 2016

Weekend Links - Election Week

QUOTE OF THE DAY

After all, civility doesn’t require consensus or the suspension of criticism. It is simply the ability to disagree productively with others while respecting their sincerity and decency. That can be hard to do when emotions run so high. But if we understand better the psychological causes of our current animosity, we can all take some simple steps to turn it down, free ourselves from hatred and make the next four years better for ourselves and the country.   - Jonathan Haidt and  Ravi Iyer in the WSJ


CHART OF THE DAY


RETIREMENT FINANCE AND PLANNING

How to Navigate and Prep for a Surprise Early Retirement, WSJ.  Understanding where you are financially will give you a sense of control amid a retirement that may be out of your control, financial advisers say. 

A Portfolio Approach to Retirement Income Security, Steve Vernon.  With the decline of traditional pensions, many older workers and retirees urgently need to decide how to make their retirement generate income that lasts for the rest of their lives. With retirements that can last 20 to 30 years or more, this is indeed a daunting challenge for those fortunate enough to have significant savings by the time they retire. 

Before Retiring, Take This Simple Test, WSJ. Many choose to retire too early, much to their regret financially  

Retirement health care estimates vs. reality, financial-planning.com.  Health care costs are one of the largest—and potentially most variable—expenses in retirement. Unfortunately, many clients either ignore these expenses when they make a retirement income plan or make woefully inadequate estimates. A study of almost 2,000 adults by Fidelity Investments found that 48% of respondents estimated they would spend $50,000 per person for health care in retirement. That's a low number according to most published research. Most data illustrates a starkly different scenario, suggesting substantially higher costs.  

The Downside of Retirement, Darrow Kirkpatrick.  Yes, retiring is great fun for most people, at first. 

The Retiree Nest Egg--Navigating the Risks, Mark Shemtob, Member American Academy of Actuaries.   




MARKETS AND INVESTING  

Inflation is back, Josh Brown.  health care costs are shooting up and contributing a lot to what we’re seeing in the inflation numbers these days. Along with gasoline prices, the fluctuation in health care costs are a big driver of the monthly CPI print. 

This Bull Market Has Room to Run, Barry Rithotz.  These things are always terribly clear in hindsight; in real time, they are more challenging to discern. It is easy to say 1982 to 2000 was a secular bull market, but read the commentary at the time. It was hardly definitive while it was happening. 

Risk Matters: An Ounce of Prevention Is Worth a Pound ofCure, Milliman FRM. One clear takeaway from these charts is that mitigating the most severe negative returns has a bigger absolute effect than failing to capture the highest positive returns. 

The Nine-Day Losing Streak In S&P 500 Is A RandomPattern, PriceActionLab.  The current nine-day losing streak is a 3.07% drop, less than 1% more than the average of 2.17%. The standard deviation is 2.11% and three standard deviations away from the average are at -8.55%. Therefore, the current streak is a random event with no significance. We could even get 12 or 15 down days in S&P 500 with no causal connection to future direction, up or down.  

Are Index Funds the Best Wayto Own Preferred Stocks? CFA Institute.  Large amounts of capital haphazardly chasing a narrow asset class should alarm any value-conscious investor. Moreover, the diversification investors expect from owning an index fund is muted by the high industry and issuer concentration found in preferred stock indices. As of the end of October, roughly 73% of the constituents in the S&P US Preferred Stock Index were classified as financials, and the same large US bank issued three of the top 10 constituents.  

Dumb Alpha, CFA Institute.  Assume an equity portfolio with a 10% annual return and volatility of 15%. The probability of a positive return over any given year is 93%. As a result, an investor who evaluates the portfolio once a year will experience a loss once every 10 years or so. If the same portfolio is evaluated quarterly, a loss will occur about once every four quarters, or once a year. And if that portfolio is evaluated daily, roughly 120 days a year will register losses. It takes superhuman discipline not to change a portfolio when you are confronted with losses 120 times a year. But the best returns in the long run are achieved by adhering to a well-diversified investment strategy that lets you reap the benefits of the different risk premia available to long-term investors. To stay calm and measured, you need to turn off your Bloomberg screen, close your Excel spreadsheets, look at your performance only sporadically, and avoid the temptation to tinker too often with your portfolio. 

A Stock Market Stress Indicator Starts to Look Ominous Aheadof Election, WSJ.  Correlations can bounce around, and relationships can dissipate just as quickly as they form. But if everything starts to look the same, it’s a sign fear is building. And that may extend beyond Tuesday vote. “People should see it as a little scary, and a signal that there’s underlying risk out there that might be beyond the election,” said Jim Strugger, a derivatives strategist at MKM Partners.    [comment: relax, the American economy is not going out of business…this year, anyway]

Bitcoin's at It Again, Christopher Langner.  Bitcoin tends to dance to its own tune, but when volatility rises, it's been in lockstep with gold…It's still a good reason not to use Bitcoin as a hedge against the expected market sell-off an electoral victory by Donald Trump would entail.  There are other reasons, too.For one, Bitcoin is quickly becoming a thing of the past. As Bloomberg View's Elaine Ou pointed out this week, some of the newest cryptocurrencies such as Zcash and Monero have gained popularity fast because unlike Bitcoin they offer the ability to keep transactions confidential.Then there's the threat of proper central bank-backed digital currencies, which are expected to come into existence soon and may take much of the sheen off Bitcoin.   [comment: I have a tiny position in Bitcoin and often wonder why]

Active vs. Passive Investing and the “Suckers at the PokerTable” Fallacy, CFA Institute.  investing is not a zero-sum game, dumb money is not the primary driver of returns for most strategies, and the “suckers at the poker table” is not a useful analogy for most long-term investors.  

Sharpening the Arithmetic of Active Management, Lasse Heje Pedersen.  Abstract: I challenge Sharpe’s (1991) famous equality that “the return on the average actively managed dollar will equal the return on the average passively managed dollar.” This equality does not hold in general. It is based on the implicit assumption that the market portfolio never changes, which does not hold in the real world because new shares are issued and others are repurchased. Hence, even “passive” investors must trade regularly in order to maintain their market-weighted portfolios. Since passive investors may trade at less favorable prices than active managers, Sharpe’s equality is broken. The changes of the market portfolio are large enough that active managers can add noticeable returns. Hence, active managers can be worth positive fees, which allow them to provide an important, beneficial, role in the economy — helping to allocate resources efficiently. Passive investing also plays a useful role, especially since the average active mutual fund manager has charged larger fees than their value added. 

The importance of statistical programming for investmentmanagers, sr-sv.com  [comment: I learned a little bit of R programming for the reasons listed in the post]


How Risk & Uncertainty Affect Returns, Larry Swedroe. According to the authors’ model, the premium on equity is made up of two separate terms. The first term compensates for standard market risk. The second term represents an additional premium for variance risk. 

Five Concerns with the Five-Factor Model, Blitz et a Robeco Asset Mgmt.  Although the 5-factor model exhibits significantly improved explanatory power, we identify five concerns with regard to the new model. First, it maintains the CAPM relation between market beta and return, despite mounting evidence that the empirical relation is flat, or even negative. Second, it continues to ignore the, by now, widely accepted momentum effect. Third, there are a number of robustness concerns with regard to the two new factors. Fourth, whereas risk-based explanations were key for justifying the factors in the 3-factor model, the economic rationale for the two new factors is much less clear. Fifth and finally, it does not seem likely that the 5-factor model is going to settle the main asset pricing debates or lead to consensus.  


ALTERNATIVE RISK

The Psychology of Trading Panic, TraderFeed.  Sometimes, however, our imagination runs wild and entertains the worst possible outcomes for our trades.  This is when the normal fear of loss can become panic.  When we panic, we respond to the threats--not the opportunities--generated by imagination. 

Why is it so hard to be inactive? catalystsminusheadwinds.com If I’ve already recognized that my system doesn’t work when there is no identifiable trend, and there is no identifiable trend (A.K.A the market is choppy), then I need to stop trading. 

If the 60/40 portfolio really is dead, here’s one way to respond, Citywire.  Alternative assets are another option for those who feel the returns offered by mainstream stocks and bonds to be too meager. It’s within that section of the market that JPMorgan made a rare upgrade to growth forecasts compared to last year’s estimates, predicting 3.75% annualised growth. 

Commodities for the Long Run, Ari Levine et al. AQR+NYU/NBER. This paper analyzes a novel data set of commodity futures prices over a long sample period starting in 1877, which allows us to shed new light on several important and controversial questions. We document that commodity futures returns: (1) have been positive on average;  (2) vary significantly across business cycles, inflation episodes, and periods of backwardation versus contango, (3) are driven mostly by variation of spot returns and therefore closely linked to the underlying commodity spot market;  (4) perform well during inflation cycles and provide more return in backwardated states; and  (5) display low correlation with stocks and bonds.  These long-run stylized facts imply that commodity futures can add value to a diversified portfolio from an asset allocation perspective.  


The irrational neglect of optimal betting strategies, sr-sv.com. The straightforward notion of taking a constant and moderate amount of risk and letting the odds work in one’s favor just doesn’t seem obvious to most people   


SOCIETY AND CAPITAL

Food for Thought: Inspecting Public Pension Plans, Advisor Perspectives. What ERISA did not do, however, is apply these quality assurance standards to public pension plans - and this is an important distinction. Public pension plans, in contrast to private ones, generally provide much stronger guarantees. As a result, when private plans go bust retirees lose their benefits, but when public plans go bust they normally have to tap taxpayers to make up the difference. That makes the underfunded status of public plans an investment problem for everyone who lives in their jurisdictions. 

Declining Trends In The Real Interest Rate And Inflation:The Role Of Aging, Philly Fed. This paper explores a causal link between aging of the labor force and declining
trends in the real interest rate and inflation in Japan…The model suggests that aging of the labor force accounts for roughly 40% of the declines in the real interest rate observed
between the 1980s and 2000s in Japan.  

More Americans Leave Expensive Metro Areas for AffordableOnes, WSJ.  Americans are leaving the costliest metro areas for more affordable parts of the country at a faster rate than they are being replaced, according to an analysis of census data, reflecting the impact of housing costs on domestic migration patterns.    

The most Active Celebrity Investors, VisualCapitalist.com  Yet, you might be surprised to learn that celebrities have quietly been funding some of today’s fastest-growing startups. Today’s infographic from CB Insights ranks celebrity investors based on the number of private tech companies they’ve invested in over the last decade.  

Inflation Is a Valuable Tool. Too Bad We Can't Use It. Tyler Cowen, Bloomberg. My biggest worry is about the politics, not the economics. I am not sure that the American system of government, in its current state, could handle a vigorous debate about inflation, which has become a tough sell. 

Why Has the Unemployment Rate Fared Better than GDP Growth? Stanford.  Answer: Between 2007 and 2014, GDP growth was held back by shortfalls of  4.4 percent in productivity,  4.0 percent in capital input, 3.6 percent in labor-force participation, 2.2 percent in growth of the working-age population.  

Breaking the Rules: Moneyball Edition, Farnham Street.  An ideal situation for simple rules is something repetitive, giving you constant feedback so you can course correct as you go. But what if your rules stop working and you need to start over completely? 

Becoming an Expert: The Elements of Success, www.farnamstreetblog.com. Mere experience, if it is not matched by deep concentration, does not translate into excellence.   

Calculating Expected Social Security Benefits by Race,Education and Claiming Age, Boston College.  This paper found that: Non-Hispanic men, both black and white, who do not hold a college degree maximize their EPV of benefits by claiming before the full retirement age, especially using a 3-percent interest rate in the EPV calculation. On the other hand, white men with a college degree and white women with at least a high school degree maximize the EPV of their benefits when claiming after their FRAs. Within some groups, delayed claiming can result in a substantially higher EPV than early claiming, given today’s low interest rates. For white female college graduates, the maximum EPV occurs at age 70 and is 16 percent higher than the EPV at 62, assuming an interest rate of 1 percent. 

Discrimination, Social Risk, and Portfolio Choice, Bonaparte et al.  U Colorado and Univ of Miami.  Consistent with our conjecture, we find that minorities with high social risk participate less in the stock market and allocate a lower proportion of their wealth to risky assets. These results indicate that non-financial risks, such as social risk, influence financial risk-taking behavior of U.S. households. 

The Differences Between Selective and Nonselective in HigherEducation, Timothy Taylor.  Hoxby's analysis also suggests that if our social goal is to expand the number of students in college, it makes more sense to focus more heavily on improving K-12 education so that a greater number of students are college-ready, rather than just offering more loans or aid for college students. If improvements in K-12 education led to a substantially higher share of students being college-ready, then it would actually make sense from a social point of view to dramatically expand college spending per student--because students who are more college-ready would be positioned to take greater advantage of what college has to offer. In contrast, providing additinoal financing to send a greater share of students with low test scores to less-selective colleges may not have much social payoff.  

How to defeat dementia, Stanford Center on Longevity and Nature.  Dementia is the fifth-biggest cause of death in high-income countries, but it is the most expensive disease to manage because patients require constant, costly care for years. And yet, research funding for dementia pales in comparison with that for many other diseases.  Experts say that the coming wave can be calmed with the help of just three things: more money for research, better diagnostics and drugs, and a victory — however small — that would boost morale. 


Family Economics Writ Large, Greenwood et al.  St Louis Fed. [heavily quantitative] 

Congrats, You’re a Billionaire, Andy Kessler, WSJ. You can’t redistribute your way to progress. And the minutiae of studying mobility and income quartiles down to the percentage point and how much the 0.1% earns is pointless, especially when we are all billionaires compared with the very recent past. And the same pundits will pooh-pooh education reform when that’s exactly what’s needed to help churn out surgeon-class coders and the creative class to create this new world. 






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