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From Greenspan-Put to Perma-Put?

admin — Wed, 16 May 2012 20:27:08 +0000

Déjà vu all over again?

Haven’t I seen this movie before?

The storm?

The gathering storm in Europe?

Haven’t I seen headlines before like those today – May 17^th, 2012?

“Spanish borrowing costs soar”1
“Rajoy says Madrid faces being shut out.”2
“Greek euro exit looms closer as banks crumble.”3
“Flight of Euros From Greece Accelerates With Coming Vote.”4
“Drachmageddon.”5
“Euro starts to crack as investors look to the exits.”6
“Euro’s last turn before the Grexit.”7US Federal Reserve Balance Sheet 1994-2012

The worry?

Haven’t I seen the grim faces of the UK Prime Minister and Bank of England Governor as they look across the Channel and wring their hands over euro-can-kicking-itis – as they did yesterday?

“…[M]ake-up or… break-up.”8 (James Cameron)
“[The eurozone is] tearing itself apart without any obvious solution.”9 (Sir Mervyn King)

The no? The yes?

Haven’t I seen the Germans saying “Nein!” one minute and “Ja!” the next the way Jens Weidmann, Bundesbank President said last week:

“Greece will not receive any more financial aid if it does not stick to the agreed bailout deal.”10

While this week Angela Merkel was described in a headline this way:

“Merkel Says She is Open to Stimulus for Greece… German Leader Softens Stance and Advocates Keeping Athens in Euro Zone.”11

The ambivalence?

Haven’t I seen the Greeks always wanting to stay in the euro and always threatening to leave? The way I saw it yesterday even with the leftist and supposed extremist, Alexis Tsipras of the Syriza party? Who said in one breath in an interview with Christiane Amanpour of CNN:

“…With this [austerity] policy we are going directly to the hell…”

But in the next breath…

‘We don’t want Europe to be in a catastrophe way… we want to save Europe.”12

The pose?

Haven’t I seen the ECB (European Central Bank) talking tough on the surface but being soft under the surface? The way it did yesterday when they refused to fund four Greek banks? But, of course, let those banks be funded by the Greek Central Bank? Which then funds itself from the ECB? And all of this followed by the friendly headline:

“ECB Urges Athens To Remain In The Bloc.”13

The cries?

Haven’t I heard cries of hopelessness?

“Europe Is Missing a Contingency Plan…”14

Haven’t I heard the old IMF deus-ex-machina cry?

“Only the IMF can break the euro debt crisis logjam.”15

The markets?

Haven’t I seen the European markets go down as the storm gathers?

The Euro Stoxx index has declined -18% 16 since March 15.

Haven’t I seen Europe drag down the US as people figure the storm may cross the Atlantic?

The Dow Jones has declined -5% 17 since May 1.

The Fed?

Haven’t I seen people – even within the US Fed – say that low interest rates are fueling an excessive taste for risk, as the minutes of the Fed revealed yesterday? When…

“…some members of the Federal Reserve’s rate-setting committee saw ‘signs that very low interest rates might be inducing some investors to take on imprudent risks.’”18

The risks?

Yet haven’t I seen the Fed wanting to do just that – get people to take risk?

As JP Morgan did with its famous CDX.NA.IG.9 trade that is now costing at least $3 billion? 19
As those who are giving $15 billion to Facebook’s selling-IPO shareholders are doing? 20

The past?

Didn’t I see the same movie last year – late Spring to early Fall?

Haven’t I seen it since 2008?

The savior?

Isn’t the outcome always – that Central Banks Ride To The Rescue – with programs called QE2 and Operation Twist over here? Or SMP or LTRO over there in the land of the ECB? 21

Or Governments Ride To The Rescue – with stimulus plans or austerity plans followed by stimulus plans?

Won’t there be QE3 as bond guru Bill Gross predicts?22 Or LTRO 3? Or other variations on the theme?

The put?

Hasn’t the Greenspan-Put of 1987-200623 – the confidence that Greenspan would always step in with massive temporary liquidity in a market crisis – morphed into the massive Perma-Put?

Doesn’t the chart of the Fed’s balance sheet on Page One show that? 24

Isn’t it the reason for the confidence that the Fed, ECB, JCB and other central banks will always step in with gargantuan and permanent buying up of assets?

The believers?

Can there be cause for real concern if, in the end, a Big Daddy will make things better?

Just as a team from Bank of America believes that if the Greeks exit the euro…

“Central banks around the world would act in concert as in 2008-2009; the EU would take a big stride towards “fiscal union” (real fiscal union, not phony German Fiskalunion); a system of pan-European deposit guarantees (i.e., a euro version of America’s FDIC); and capital injections to stop contagion in the banking system… The ECB would cut rates, launch quantitative easing, blitz euroland with liquidity, and drive down Club Med yields with mass bond purchases.”25

The give-up.

Is there any reason to be managing risk if risk always gets taken care of?

Or…

Is this time different?

Or…

Are these the right questions?

Or…

Does the fact that these questions arise at all indicate a basic change to our financial environment?

One Answer.

I think the answer to the last question is “yes.” There is a change.

As to the rest of the questions?

I offer them for your ruminations.

– John Allison

1 The Telegraph, “Spanish borrowing costs soar as FTSE losing streak continues”. May 17, 2012. Front-page headline.

2 Watkins, Mary et al. “Spain warns on borrowing cost risk.” Financial Times. May 17, 2012.

3 The Telegraph, “Greek euro exit looms closer as banks crumble.” May 17, 2012. Finance-page headline.

4 Alderman, Liz et al. Flight of Euros From Greece Accelerates With Coming Vote.” The New York Times. May 17, 2012.

5 Mackintosh, James. “The Short View.” Financial Times. May 17, 2012.

6 Ross, Alice. Euro starts to crack as investors look to the exits.” Financial Times. May 17, 2012.

7 Editorial. “Euro’s last turn before the Grexit.” Financial Times. May 17, 2012

8 Associated Press. “UK’s Cameron urges Eurozone to “make up or break up.” The Washington Post. May17, 2012.

9 Grierson, Jamie. “David Cameron and Sir Mervyn King urge eurozone action.” The Independent. May 16, 2012.

10 Kuehnen, Eva. “No more aid for Greece without reforms: ECB’s Weidmann.” Reuters. May 11, 2012. Content taken from an interview by Jens Weidmann, head of the Bundesbank in Sueddeutsche Zeitung.

11 Kulish, Nicholas et al. “Merkel Leader Softens Stance and Advocates Keeping Athens in Euro Zone.” The New York Times. May 17, 2012.

12 Gold, Lucky. “Going directly to the hell.” CNN. May 16, 2012. Report on Alexis Tsipras, leader of Greece’s second largest, leftist political party, Syriza, and his interview on the Amanpour news show.

13 Blackstone, Brian et al. “ECB Urges Athens to Remain in the Bloc.” The Wall Street Journal. May 17, 2012.

14 Nixon, Simon. “Europe Is Missing a Contingency Plan Amid Greek Exit Fears.” The Wall Street Journal. May 17, 2012.

15 Goodhart, Charles. “Only the IMF can break the euro debt crisis logjam.” Financial Times. May 17, 2012.

16 Decline of Euro Stoxx Index from March 15, 2012 through May 16, 2012: 2608.42 to 2138.49: -18%.

17 Decline of Dow Jones Industrial Average from May 1, 2012 through May 16, 2012: 13,279.32 to 12,598.55: -5.1%.

18 The Overheard Column of “Heard On The Street” in The Wall Street Journal. May 17, 2012.

19 Alloway, Tracy et al. “How a storm in a teapot became a tidal wave.” Financial Times. May 17, 2012 and Schwartz, Nelson D. et al. “JP Morgan’s Trading Loss is Said to Rise at Least 50%.” The New York Times, May 17, 2012.

20 Winkler, Rolfe. “Three Fears for Facebook as IPO Approaches.” The Wall Street Journal. May 17, 2012.

21 “QE” = “Quantitative Easing”; “SMP” = “Securities Market Program”; “LTRO” = “Long-term Refinancing Operations.”

22 Gross, Daniel. “PIMCO’s Bill Gross: QE3, Inflation, Muted Growth on the Way.” The Daily Ticker. May 16, 2012.

23 Alan Greenspan’s tenure as Chairman of the Federal Reserve lasted from June 2, 1987 to January 31, 2006.

24 I could only find a chart showing the years from 1994 onward rather than 1987 onward.

25 Evans-Pritchard, Ambrose. “Market rally on Greek exit?” The Telegraph. May 17, 2012. The quote Evans-Pritchard’s summary of what a Bank of America research trio from France, Germany and Greece is forecasting as an outcome of a Greek exist from the euro.

The information contained in this communication is proprietary to UNIO Holdings, LLC. Reproduction or retransmission of this information, in whole or in part, is prohibited without the prior written consent of UNIO Holdings, LLC. This information does not constitute investment advice.

Today vs. 300 Years of Interest Rates and Debt

admin — Wed, 09 May 2012 18:28:42 +0000

Unprecedented? Yes.

This time is different. If you look at the chart below – 300+ years of short-term Bank of England interest rates – you see in what unusual times we live. From 1700 rates were about 5% for 130 years. Then for about 130 years they fluctuated between 2½% to 10% — averaging somewhat below 5%. In the next 40 years – they fluctuated between 2½% and 17%. Finally, in the past couple of years they have dropped close to zero – to territory where no man or central banker has gone before.

Chart sourced from Martin Wolf’s excellent “After the bonfire of the verities,” Financial Times, May 1, 2012.

Source: Bank of England Quarterly Bulletin, 2010 Q4: “The UK recession in context – what do three centuries of data tell us?” By Sally Hills, Ryland Thomas and Nicolas Dimsdale

Unprecedented? No.

On the other hand, this time is not different. If you look at the second chart – 300 years of long-term rates and national debt to GDP – you see relative normalcy. The red line – long-term rates – are about average at 4+%.

Long-term rates have had a few jumps to the 6% level from about the time of the American Revolution to the Napoleonic Wars (1775 to 1812) and a super-jump in the 1960-75 period to 14½%. But where they are now is about where they have mostly been during England’s modern period.

National debt to GDP is even more strikingly not at unusual levels. The ratio is about 0.6. That is, national debt is about 60% of GDP. Contrast that with the period from 1700 to 1825 when it rose from about 20% of GDP to over 200% of GDP. Or with the period from 1914 to 1950 when it rose from 40% of GDP to 280% of GDP.

The whole story.

These charts are not intended to tell a complete story – whether for England or for the world.

In England’s case (as in Spain’s) private debt levels – particularly bad private debt like residential real estate – are the problem.

The purpose of sharing these charts is to make a simple point.

To the degree England’s rates reflect Europe’s and the US’ (and I believe they mostly do) the really unusual event is the amount of central-bank largesse we are witnessing. It is this largesse – fire-hose monetary policy – that has driven down short-term interest rates to multi-century lows.

Why this largesse?

Not so much to deal with high public-debt levels but to counteract the bad economic effects of bad private debts – like sub-prime in the US – and the process of debt deleveraging that has unleashed.

Of course, public debts are rising as governments incur debt to keep the economy going creating a whole new problem.

At the same time, monetary largesse is fuelling asset price increases (like the stock market) and a return to “risk-on” thinking with all the wonderful new blow-ups that’s likely to bring.

As the Kurt Vonnegut character used to say… and so it goes¹.

– John Allison

¹ The character was Billy Pilgrim in Slaughterhouse-Five published in 1969.

Of Shale Gas, Asteroids & Health Care: The Present That Won’t Extrapolate.

admin — Wed, 02 May 2012 17:42:58 +0000

Expect the Unexpected.

Yogi Berra said it: The future ain’t what it used to be.

Marcel Proust said it: Toujours l’inattendu arrive (the unexpected always happens).

Nassim Nicholas Taleb, author of The Black Swan, said it: The inability to predict outliers implies the inability to predict the course of history.

All three said it: you can’t take an imaginary ruler, and extrapolate into the future because the future contains outcomes, good and bad, that have no pattern in the present to extrapolate from.

Three events – all positive as it turns out – reminded me of this important truth. One event occurred about 9 years ago. One was announced 9 days ago. One was reported on this past Sunday.

Source: Wired Science Magazine. April 23, 2012.

The unexpected: shale gas and its global implications.

Today everyone has heard of shale gas and “fracking”1 – the process of extracting gas or oil from shale rock.2

Before 2003 virtually no one, even among the highly educated general public, knew about it.

Nine years ago you would have been regarded as a fantasist if you had said: Shale gas can be extracted economically. It has the power to transform the US into a more energy-independent nation. It will provide US manufacturing with cheap energy and energy-feedstock. It will make manufacturing in the US much more competitive with manufacturing in emerging markets. It will increase US exports both of liquid natural gas (LNG) and manufactured goods. It will erode the economic position of gas-exporting countries like Russia. It will also marginally erode their geopolitical power.

It was only in the 2001-03 period that it became clear to its pioneers that it was possible to extract natural gas (or oil) economically from shale rock by fracturing the rock and drilling vertically and then horizontally to release it.

And from 1980-2001 only one individual – George Mitchell – son of a Greek immigrant had a true understanding of shale gas’ possibilities or the persistence to make good on his insight.

If the extraction of shale gas can be accomplished without negative environmental impacts and accidents, and the legal opposition they would produce – very important “ifs” – it has the potential to be the most transformative energy discovery of the past century. Not only because of its presence in the US and Canada. But because of its deposits in Europe and China. This is a pretty amazing, unexpected development for something only a handful of people had on their radar screens just a decade ago.

The unexpected: platinum from asteroids.

Before 9 days ago, I had known next to nothing about the possibility of mining rare metals on asteroids.

On April 24 a company called Planetary Resources Inc., funded by a group of wealthy business people including Google’s Eric Schmidt and Larry Page, announced that it would develop robotic mining of some of the 9,000 asteroids, 150 feet or more in diameter, that orbit near Earth.

As Wired Science3 writes:

Planetary Resources hopes to go [first] after the platinum-group metals — which include platinum, palladium, osmium, and iridium — highly valuable commodities used in medical devices, renewable energy products, catalytic converters, and potentially in automotive fuel cells…Platinum alone is worth around $23,000 a pound— nearly the same as gold. Mining the top few feet of a single modestly sized, half-mile-diameter asteroid could yield around 130 tons of platinum, worth roughly $6 billion.

Understandably people question whether the economics will work. It’s possible they won’t.

But it’s gone from impossible to possible that they will work.

And if the economics of asteroid mining do work, the implications are significant. Prices of commodities of all kinds, from wheat to gold to rare earths, depend on scarcity (relative to demand). The scarcer, the higher the price.

In addition, some commodities like rare earths which are critical to the manufacture of electronic devices are located in places like China which restrict their availability to the rest of the world.

The viability of asteroid mining would begin to change the long-term price and availability of high-value metals and, with it, undercut the assumption that the expansion of the less-developed world’s economies has to put unstoppable upward pressure on commodity prices. Hmm!

The unexpected: US health spending slowing down.

Last Sunday’s New York Times reported that health-care spending had slowed in 2009 and 2010 to less than 4% per year. This was the slowest growth rate in 50 years.

And health care as a per cent of GDP (17.9%) did not grow.4

As the Times points out, some part of these results is due to lost jobs and, with them, lost insurance.

But while the evidence is tentative, various health-care specialists cited in the article detect a change in the frequency with which health care is being purchased.

This may be due to the spread of higher deductibles – therefore more out-of-pocket health spending managed by individuals. It may be due to choices about tests and procedures, or to other factors.

While the Times’ article might be viewed as just a tentative straw in the wind, there are other supporting factoids. For example:

The average hospital stay is declining.5
There are fewer blockbuster pharmaceuticals (itself an interesting question as to why); therefore more dollars going off-patent than ever before, as was the case this past November 30, 2011 with the expiry of Pfizer’s US patent for Lipitor, once a $12 billion-a-year drug.6
There are increasingly complicated surgical procedures being done through so-called less-invasive techniques. Doing surgery through a pipe into the body rather than a cut is less expensive.
Finally, as one of my colleagues with very high-level health-care knowledge has shown me: there are continuous evolutions taking place in the practice and management of health care delivery and information that are producing better outcomes with fewer resources.

In other words, what seemed, just yesterday, an inevitable tsunami of health care overspending due to a fatter and older population that would buy whatever the health care system would offer up, is possibly turning into a more disciplined, less costly marketplace – making the recently unthinkable, achievable.

***

These are three examples of the truth that there is much we don’t and cannot see until it pops into the future and changes our world.

The unseen may be bad – Taleb’s black swans.

The unseen may be good – Mitchell’s shale gas, metals from asteroids, controlled health spending.

The trick is: be ready for Proust’s the unexpected always happens.

When it does: react.

When you know where it’s headed: adapt.

– John Allison

1 The best place to get an introduction is Daniel Yergin’s, The Quest. He has a chapter on George Mitchell’s discovery and its global implication.

2 “Fracking” also spelled “fraccing” refers to “Hydraulic fracturing”, the process of injecting chemically-manufactured fluids under pressure into a rock formation to create fissures that release hydrocarbons such as gas or oil to a surface well through a pipe that often runs horizontally from the fractured formation and then vertically up to the well head on the surface.

3 Mann, Adam. “Tech Billionaires Plan Audacious Mission to Mine Asteroids.” Wired Science. April 23, 2012.

4 Lowrey, Anne. “In Hopeful Sign, Health Spending Is Flattening Out.” The New York Times. April 28, 2012. The data comes from the Centers for Medicaid and Medicare Services.

5 U.S. Department of Health and Human Services. “Health, United States, 2010.”

6 Barry, Patricia. “As Lipitor Goes Off Patent, What Will Happen to The Price of Your Prescription?” AARP Bulletin. November 30, 2011.

No. No. No. No. No. No.: Do We Know What European Voters Are Saying?

admin — Wed, 25 Apr 2012 13:30:19 +0000

What they said.

“No” said the Irish on February 25, 2011. They ejected Fianna Fail, the largest party in Ireland since 1927 and replaced it with Finn Gael.

“No” said the Italians on November 12, 2011. They sent away Silvio Berlusconi who served on and off for a cumulative 10 years from 1994 through 2011 and was Italy’s longest-serving Prime Minister ever.

“No” said the Spanish on November 20, 2011 to the Spanish Socialist Worker’s Party of Jose Luis Rodriguez Zapatero, two-term Prime Minister from 2004-2011, replacing him with the conservative People’s Party led by Mariano Rajoy.

“No” said Geert Wilders, Party for Freedom leader on April 21, 2012 to his coalition partner, Prime Minister Mark Rutte of the Liberal Party, sending Holland to a likely caretaker government and election on September 12.

Romans in the streets celebrating Silvio Berlusconi’s resignation.

Source: Reuters. November 12, 2011.

“No” said the French on April 22, 2012 in the first round of the French election to Nicolas Sarkozy, likely to be the first President since the beginning of the Fifth Republic in 1958, not to be a two-termer.

“No” say the Greek polls to the likelihood of a plurality of the votes in the May 6 election for the two leading parties combined (New Democracy polling at 22% and Pasok at 17%, for a combined total of the votes (not the seats in parliament) of 40% — the functional equivalent of Democrats and Republicans in the US getting 40% of the votes together.

No. No. No. No. No. No.

What’s up?

So what’s going on? Are these “kick the bums out” nos? Are they “we’re not better off than we were four years ago” nos? Are they anti-euro nos? Are they “we can’t stand our national identity being kicked around” nos? Are they “we want growth not austerity nos”? There are lots of pundits who will tell you lots of things. I will tell you two.

Knowing what you don’t know.

First, what the European people really think is remarkably not evident and hard to get at. The nos at election time are a reminder of how little we hear them speak and how little we know what they think. The only other time is when they band together in extremist parties. These are noisy and have press outlets so we can listen in. And extremist parties are growing. For example, Gerry Adams’ Sinn Fein is Ireland’s third largest party. Marine Le Pen’s National Front in France got 18% of last Sunday’s vote. Geert Wilder’s Dutch Party for Freedom has become Holland’s third largest. The Greek far left and far right are polling at 29% and 18% respectively. But most of the time the thinking of the European people remains opaque – more so than that of the American people who are culturally more voluble and typically more probed and analyzed. Why is it so hard to get at the ordinary Europeans’ mindset?

Best guess.

My working hypothesis is that reporting on and analysis of Europe is overwhelmingly about what the educated, professional European elites think about Europe. These elites have created an idea – Europe. They see it as a project on a one-way street toward the eventual and, in their eyes, historically inevitable United States of Europe. They see the euro as a piece of the roadway to that end. And they see the ordinary people and the parochial interests of individual European countries as flotsam and jetsam they have to navigate to get to the promised land. Like all those on a mission and with an agenda, the educated, professional elites of Europe are not really interested in people who might slow them down. And so they are typically the last to know of or report on troubles in the ranks. And we who read their newspapers or studies or BLOGs are the last to know as well unless we find other non-traditional ways to get behind the veil that shields the mind of the general population.

The numerate discount the immeasurable.

My second point is simpler and shorter: what the general population thinks and what it does is hard to measure, and since financial people love the measurable and hate the immeasurable, the general population’s intentions tend to be discounted or marginalized by those investing in Europe. If you want to know what the people might do – and what political risks might emerge from what they do – the last place to look is Wall Street, London and Frankfurt.

Listen.

Against the huge push for the European – and currently, the euro idea – by the educated, professional elites of Europe the patter of nos at election time seem like so many ineffectual raindrops splattering against a huge, concrete dike. Maybe so. But if the drops of rain tapping out no, no, no, no, no, no is all you’ve got as clues to a popular storm that one day might kick up, better to listen than not.

— John Allison

All the News That’s Fit to Tweet.

admin — Wed, 18 Apr 2012 17:10:05 +0000

Consider this.

Reuters now allows reporters to tweet first, file a story later. Reuters has editors to check facts before they’re tweeted. But it sees Twitter’s 140-million user base as a key complement to the newswire. 1
According to the Pew Research Center, while social media are only an incipient source of news – 9% of digital news versus 36% of digital news obtained by people going to web sites – they are growing; and interestingly, services like Twitter (27%), even more than Facebook (13%) are increasingly being used by professional news organizations. 2

In a survey of 1,400 college students and 1,400 young professionals under 30 done by Cisco in late 2011 – The Cisco World of Work Report – there is an overwhelming preference for flexible, mobile sources of social and business communication and a desire for one integrated business and personal approach to accessing information. 3

In another survey by the Association for Information and Image Management (AIIM) there is a clear, emerging trend toward enterprises using the business equivalent of social media – now called “social business systems” as the platform for employees’ communications with one another or with the outside world. 4

“And that’s the way it is…”

Source: People Magazine, July 19, 2009.

Now consider this…

I was invited to lunch by a reader of this BLOG at which Ted Koppel was the guest speaker. Koppel is very impressive.

I hope I am not doing him an injustice by saying his talk was a highly intelligent lamentation. It was about…

…the disappearance of great TV news like CBS Evening News anchored by Walter Cronkite from 1962-81.5

…the disappearance of central places where Americans would gather to find out what they needed to know.

…the disintegration of authorities to sift the news for what was important.

…the degeneration of TV news into TV entertainment (my words not his).

And Koppel was right. At one time most of America tuned into CBS, NBC, or ABC to find out what was happening “out there” or, in Cronkite’s famous nightly salutation, to hear the reassuring “And that’s the way it is…” from the man Gallup once polled as the most trusted man in America.

So what does this all mean?

I think it means two things:

1. There is no turning back social media. If you think of all the people and all the organizations connected to all the social media, you have the equivalent of a vast network of human “neurons” connected to other human “neurons.”

These neurons will never stop chattering. Some of the chatter is nonsense and inaccurate. Some of it is highly intelligent. Humans being humans though, once they have a vehicle through which to chatter, they will chatter.

2. As the volume of chatter rises there is, and will be, a deep need for an authoritative filtering system — someone or something to filter the true from the untrue, the real from the fictional, the important from the trivial.

Will those filtering intermediaries be the great news organizations – Reuters, the AP, the Financial Times, The Wall Street Journal and so on? New digital media that only operate online? Or other kinds of entities entirely – from human to robotic? Or combinations?

What’s changing. What’s not.

The important thing is the sourcing of what we call news – events that are happening or information that’s new – is radically shifting. As an investor, one of the two most important questions you need to know is “what’s changing?” The other is “what’s not?”

The shift to social media is definitely what’s changing.

The need for authoritative filtering is definitely what’s not.

And that’s the way it is.

– John Allison

1 Sternberg, Josh. Digiday. 4.17.12

2 Mitchell, Amy et al.”What Facebook and Twitter mean for News.” Pew Research Center. The State of the News Media 2012.

3 The Cisco World of Work Report, November 2011.

4 “Social Business Systems – Success Factors for Enterprise 2.0 Applications.” 10.4.11.From an AIIM (Association for Information and Image Management) survey and report.

5 See Wikipedia’s entry on the CBS Evening News.

Big Data. Big Bang. Big Deal.

admin — Wed, 11 Apr 2012 14:19:24 +0000

“It’s been said that 90 percent of the data that exists today was created in the last two years.”¹

Attention! Attention!

If you don’t know about Big Data you will. If you do know, you will as well.

Even if the opening quote is a wild, back-of-the-envelope guesstimate, as I suspect it is, the essence of what it says is pointing in the direction of the truth.

Data’s Big Bang.

Every day people are exchanging more words, sounds, pictures, and videos. All of these communications are bundles of data.

The data communicated is becoming denser. For instance, in dataland, a picture is no longer worth a 1,000 words. It is worth at least 100,000 words, since from a data perspective, a simple digital-camera photo represents about 1 million bytes of digital value versus 10 bytes for a word 10 characters long.²

Source: “Big Data and Big Content — Just Hype or a Real Opportunity? John Mancini. “Digital Landfill.” 3/15/12.

This denser data is being generated by more people communicating on more devices in more places and, because more devices are mobile and go where people go, for longer periods of the day. Cisco Systems estimates that the number of “things” (devices) connected to the Internet exceeded the world’s population of 7 billion in 2010. By 2020 it estimates 50 billion “things” will connect to the Internet.³

In terms of data we are going through the metaphoric equivalent of what the universe produced just after the Big Bang. The Big Bang occurred 13.75 billion years ago (plus or minus about 100 million years). Just after the expansion began (or 10^-37 seconds into the expansion) the universe accelerated into a short burst of so-called “inflation” where it grew enormously over a very short span of cosmic time and then settled back down to the “normal” rate of expansion we have been experiencing ever since.⁴

Data too has begun its Big Bang and now seems to be in its inflation phase.

Junk or jewels?

For some of you the data we’re generating may seem to be largely junk. All the talk, texting, photos are one huge generation of data waste which should be put into a data landfill and buried forever. If that’s your viewpoint, I understand where you’re coming from and you may even be right.

The problem is we don’t know what’s junk and what’s intelligence in this huge mound of data that’s being created every second. The reason we don’t is that most of the data being generated is unstructured.

We’re used to structured data. When someone asks for your name and social security number that’s structured data. It’s already predetermined where it goes, in which database. You accept its utility because the aim – to identify you to some organization – is already evident and pre-validated by you.

Unstructured data is your telephone conversation. Or your digital pictures. The Internet itself is unstructured to you. Very often you have no idea where the data lies; if it exists; how it is organized and what its utility might be. Google’s search engine is in effect a word- or picture-based flashlight for finding information in this unstructured jungle of data clumps called web pages which, while structured in relation to themselves, have no structure that you are aware of before you visit them and study them.

Data piles will not be ignored.

Whether we like or not, technology companies are going to try to extract value from all this data. They will find new ways to store it, manage it, access it, organize it. The so-called Cloud is just one of those efforts.

There are new companies that are working on data integrity – making sure the data you access is accurate and reliable.

There are others in earlier stages looking at capturing all the data you generate as if it were a stream of water from a garden hose with each drop of water tagged and identified for its various properties and for the time it came out of the nozzle.

There are legacy companies like Oracle and SAP which built huge database businesses on very expensive structured databases who are trying to figure out how to adapt.

There are relatively new companies like Google and Twitter – both originators of and organizers of data – trying to figure ways to be more relevant to their users.

Ironically scale may produce higher costs.

There is also the recently discovered economic fact that all this data being streamed over mobile devices is costly, as high-volume users of the new iPad are discovering on their monthly phone bills – producing the paradoxical situation that just as the free-of-charge Internet is attracting more and more users and use, the price of communicating all this data back to them is rising.⁵

***

The bottom line: Big Data is here.

It has had its Big Bang.

And that’s likely to be a Big Deal.

– John Allison

1 Solis, Nicole. “Structure Big Data.” Gigaom. 3.23.12. Reporting from Gigaom’s first annual Big Data conference in New York.

2 Chen, Brian X. “A Ballooning Megabyte Budget.” The New York Times. April 8, 2012.

3 Evans, Dave. “The Internet of Things.” Cisco BLOG. July 15, 2011. When Cisco talks about things it is counting any entity that connects to the Internet from a robot to an animal with a radio device to a human.

4 Wikipedia. “Timeline of the Big Bang.” I use “normal” advisedly. Is the universe expanding at a constant or accelerating rate? That is not a settled question.

5 See Brian Chen’s “A Ballooning Megabyte Budget.” The New York Times. April 8, 2012.

Uniquely Unusual US Profits. “Fascinating!”

admin — Wed, 04 Apr 2012 18:58:14 +0000

“Fascinating!”

US corporate profits, as a % of GDP, have recently been close to their highest levels in 62 years – 10% of GDP.

Only twice before in 62 years have they hit these peaks. Once in 1951-2. A second time just five years ago in 2007-8. That’s what the up-and-down green line of the chart below shows.

It also shows – the middle, solid mustard line – that US corporate profits as a % of GDP averaged 6% over 62 years in a range between 4 ¼% at the low end (the lower, dashed line) and 7 ¾% at the high end (the higher, dashed line).The clear message: profits at 10% of GDP are unusual. Or, as Mr. Spock, Chief Science Officer of the Starship Enterprise, said every time he encountered a phenomenon of unique interest: “fascinating!”

US corporate profits — at 10% of GDP — are at levels seen only 3 times in 62 years.
Source: Reuters

I have 3 takes on the chart – “unusual”, “most unusual” and “uniquely unusual.”

1. Unusual: any phenomenon that occurs once every 20 years is unusual. However, good investors are aware of it so this fact – as a fact – certainly isn’t news.

2. Most unusual: what I haven’t seen said is that there is a big difference between the profit peak of 1951-2 on the one hand, and the twin peaks in 2007-8 and 2010-11 on the other.

The peak in 1951-2 was the result of a one-time shift in the US economy. It shifted from an economy on a war footing up to 1945 to a consumer and export economy after 1945.

After 1945, pent-up war savings drove demand for consumer goods in the US. Added to that, rebuilding in Europe from the Marshall Plan (1948-52), and in Japan from the reconstruction period (1946-1951), drove demand for US exports to those regions and demand for US company production located in those regions.

By contrast the peak of 2007-8 was not at all a one-time event.

Qualitatively it was the culmination of another commodity boom, similar to the boom of 1970-1980 and other commodity booms of the past two centuries. It was bigger and steeper and broader than the boom in the 70s. No question. The huge growth of China and emerging markets made it so. But the peak in 2007-8 had all the markings of a scarcity boom in which profit margins go up because demand is rising for commodities – from iron ore to copper to gold – whose supply can’t keep up.

So while on the surface the three profit peaks of 1951-2, 2007-8 and 2010-11 look like the same thing, you have to leave out 1951-2 as anomalously related to a one-time world war and its aftermath.

Which then makes the 2007-8 peak ironically even more astonishing. It was not only the biggest commodity profit peak in 62 years. It was followed a few years later in 2010-11 by a twin peak. And the existence of a twin profit peak is…

3. Uniquely unusual: we have never seen anything like it in our lifetimes. Of course, the second peak had everything to do with the fire-hose of Federal Reserve and ECB money that these authorities unleashed. But that still begs the question: what did the monetary pumping-up, pump up? It’s impossible to know for sure. But my guess is that monetary authorities kept alive a commodity boom that was ready to go into its last chapters and that their largesse simply delayed that boom’s deflation. We’ll see.

I know people who disagree. They see this commodity boom as part of a supercycle that began in 1985 and has far to go.

But I see the 1985-95 profit period differently. Then, profit margins rose because companies underwent severe restructuring; the economy took on a whole new, high-profit-margin information technology industry based on the microprocessor and its enabling software; and this same industry’s technologies contributed to Corporate America’s and Corporate World’s own, large productivity gains as they became more and more expert at using the new technology.

There’s a lot to this simple chart. And I think Spock would agree. Fascinating!

– John Allison

“I Like My Entrepreneurs With Seasoning, Please.”

admin — Wed, 28 Mar 2012 18:35:01 +0000

What we think.

“Entrepreneur” means “young”. “Entrepreneur” means “energy.” “Entrepreneur” means “new.”

Right?

I was sent an article by The Economist1 that cites various studies showing that:

There are more successful entrepreneurs over 50 and 60 than commonly thought.
The ratio of older to younger successful entrepreneurs is about 2-to-1.
Flexibility of mind seems to be present at higher age-brackets than in the past.
Creativity, when it involves complex problems across disciplines, is emerging later.

Here is a key excerpt from the article which I have broken up for easier reading:

Research suggests that age may in fact be an advantage for entrepreneurs.

Vivek Wadhwa of Singularity University in California studied more than 500 American high-tech and engineering companies with more than $1m in sales. He discovered that the average age of the founders of successful American technology businesses (i.e., ones with real revenues) is 39. There were twice as many successful founders over 50 as under 25, and twice as many over 60 as under 20.

Dane Stangler of the Kauffman Foundation studied American firms founded in 1996-2007. He found the highest rate of entrepreneurial activity among people aged between 55 and 64—and the lowest rate among the Google generation of 20-to 34-year-olds. The Kauffman Foundation’s most recent study of start-ups discovered that people aged 55 to 64 accounted for nearly 23% of new entrepreneurs in 2010, compared with under 15% in 1996.

My take is that there are two intersecting factors at work here:

1. Outdated mental pictures.

People’s energy level and health are extending highly productive life far longer than mental pictures internalized in our youth have led us to expect.

2. Handling complexity benefits from experienced pattern-recognition.

Our world is dishing up more complex problems. They cut across more and different swaths of life – whether you’re in politics, business, investing, science, medicine etc. Having a brain with bigger pattern-recognition software as a result of experience can be a deciding resource in solving such problems – including problems where you have to know if their solution lies inside, or outside, the box.

- John Allison

1 “Enterprising Oldies.” The Economist. February 25, 2012.

When Central Banks Are Players Not Referees

admin — Thu, 22 Mar 2012 04:14:05 +0000

On the field.

“What would you do if the referee joined the game? Started playing for one side? It’d sure be a different game wouldn’t it? That’s what’s bothering us. When the referee becomes a player, the game changes. You either play or you leave. If you play, you’d better admit you’re playing a different game. For one thing, who would want to be the opposing team? If you know the referee’s on the other side, if you know you’re going to lose, why put up a fight? If you’re the opposing team, why not join the team with the referee on its side? Just score points – effortlessly. Sounds easy. But here’s what’s bothering us. The game’s not real. The points aren’t real. It’s phony. What happens when the referee leaves? You’d better watch him closely. Watch his eyes? Look for a signal that he’s staying or leaving. That’s what this new game does to you. You’re not even playing the game as such any more. You’re watching the referee.”

Everyman (and woman).

This monologue is a composite. It’s my best representation of conversations I’ve had over the past two weeks. With a currency hedge fund manager. With a distressed debt investor. With a former US Treasury official. With a financial journalist. With an economist. With a think-tank analyst. With a quantitative asset manager. With a high-net-worth individual. Sundry others. Plus, I’ve been sent, randomly, articles by a well-known fixed income analyst; by several large global investment banks; by a global macro analyst; by a former IMF official. All in the past 14 days.

It’s about the game, stupid!

Put aside any policy views you have. Forget whether you think the Fed, the ECB, the Bank of Japan and other central banks are the heroes of a generation or blowers of bubbles-future or anything in between. Focus on the fact that more and more intelligent participants in financial markets know – or at least intuitively feel – that THE GAME has changed. And they see facts that reinforce their view.

Facts.

Facts like the two charts above. On the left, the ECB’s balance sheet (green) and the Euro Stoxx 50 Index (yellow). On the right, the Fed’s balance sheet (blue) and the S&P 500 Index (orange). Both charts from 2007 through 2012. What these charts show is:

When central bank assets go up, stock markets go up.
When central bank assets go down (even slightly), stock markets go down.
When they go sideways, stock markets go sideways to down.
When risk is “on”, central bank balance sheets point up, when “off”, point down.

Other facts like:

Central bank balance sheets at 30% of global equity market capitalization vs. 10% in 2008;
Or between 20%-30% of their countries’ GDP;
Or the Fed buying 61% of US Treasury issuance in 2011 vs. almost zero in 2008;
Or Blackrock pointing out a fixed income game-change and advocating higher-yield securities;
Or central banks – e.g. Swiss and Israeli – investing reserves in equities for better returns.

“What do you think?”

In one of my conversations, I was asked: so what do you think the implications are?

I responded: in the short-run or the long-run?

My questioner: both.

My answer:

In the long-run…

…central-bank policies fill me with foreboding. Put another way, if things turn out badly in the long-run as a result of these policies, I won’t be surprised. I’m really trying to figure out the opposite: how they turn out well. So far I haven’t convinced myself.

In the short-run…

…gunning the money supply has always been bullish for stocks and bonds, especially when stocks are reasonably priced and bonds richly priced.

I agree with you that the game has changed. It’s been changing for several years. But now, instead of being a temporary change in the rules – it’s becoming a norm.

I like your referee-joining-the-game metaphor. While central banks have always been players to some extent, they are now fully in the game to a degree unique to the past 100 years.

But…

…and this is a big “but” – it’s clear that everyone sees it’s a new game.

Everyone watches the Fed like a hawk; watches the ECB like a hawk.

Those who watch are quick on the trigger. Sixty percent (60) of daily trading is algorithmic. The average trade lasts 11 seconds.

Also, rising stock markets are accompanied by lower volumes. (See the chart.) Conviction is low though I know they’re trying to suck in the high-conviction players on the sidelines.

S&P 500 ETF
Latest 12 months

Plus there’s something else…

…I love buying stocks. Statistically, there are lots of good equity values. Lots of very interesting companies.

The problem is it’s not so easy to tell how well the earnings of all these companies would do in a world without the monetary referee on the field. It’s hard to know how attractive equity valuations would be if the monetary referee stepped off and long-term interest rates started up for real.

Are equity prices attractive because the environment has been made artificially attractive by monetary authorities? Or are they attractive independently of that artificiality?

But one thing I know…

We are in a period of dislocation and structural change. That’s been my mantra for 5 years. It remains my mantra.

Part of the change represents deleveraging.

Part of the change represents a massive worldwide repositioning and overhauling of assets – from private-sector to public-sector assets.

I think I will recognize when we exit this period. In the meantime, we are faced with what Bismarck called “the imponderables.”

The game-change you – and so many others I’ve met in the past 14 days – describe and are intensely aware of, is one of them.

– John Allison

China and why it wants a convertible currency.

admin — Wed, 14 Mar 2012 20:13:58 +0000

There are two facts about China – and because they’re big facts let’s call them mega-facts. Both are reflected in or can be derived from the charts below.

MEGA-FACT #1 (the left chart).

Over the past 9 years, since 2003, China’s balance of trade has become more volatile; plus exports declining relative to imports are occurring more times and more severely. Look for example at the far right of the left chart to see the plunge in the trade balance to minus $31.4 billion.

These numbers show that it’s getting harder for China to grow through exports. We know why. Its main markets – Europe, the US, and Japan – are slowing or slow. Its labor costs – though still a small percentage of the value of exports – are rising. Its mix of exports are saturating their markets.

Chinese trade deficits.

It would not be surprising then, that over the next one to five years, China begins to run sustained trade deficits. China will require enormous imports for its growth plans. Imports – whether they supply the huge capital spending of the past 30 years or reflect a successful switch to more consumer spending – are imperatives politically and economically. For that reason, their trajectory will be hard to flatten.

But the trajectory of exports can change. Exports are outside China’s control. Exports prosper when the world prospers. Exports fade when the world’s economy fades. If there’s still a much greater likelihood of an anemic economic environment over the next 5-10 years than a robust one – and I believe there is – then Chinese exports over time are likely to be anemic relative to its fixed and growing need for imports. And if all that proves true, Chinese trade deficits are likely. They don’t have to be large. They just need to exist. If they do, China will earn less foreign currency from exports than they need for imports. Which leads to mega-fact #2.

MEGA-FACT #2 (the right chart).

China will need foreign currency funds to pay for imports that exceed exports. Where can it get those funds? It can get them by: A) letting the Chinese currency (the Yuan) rise in value so one Yuan can buy more imports; B) sucking in foreign funds to invest in China; C) making the Yuan convertible so that the Chinese can pay for imports with their own currency (like the US) and issue debt or equity in their own currency (as the US does); or D) make investments abroad (e.g. buying companies) to earn foreign currency.

The Yuan can buy more.

Seven years ago one Yuan bought 12 US cents. Today it buys 16 US cents. The Chinese have been working on point A – letting the currency rise.

Many think they’re doing this because of US pressure. Possibly in part. But the Chinese typically do what the Chinese think is best for them. We have a tendency to underestimate that fact. For example, for years there has been a narrative that the Chinese have been doing the US a favor by buying its Treasuries – or as the narrative says “lending to us”. In reality, the Chinese wanted dollars. They wanted dollars to have a war chest for buying imports in good and in emergency times. They wanted the strength and prestige that goes with having such a war chest.

Points B, C & D.

As to points B, C, and D the evidence is tentative now. But, if this whole thesis is right, one should expect to see the Chinese become much more receptive to foreign investment particularly by financial companies (point B); take steps to make the Yuan convertible (point C); and invest abroad (point D).

The Chinese have done little I can see to increase the amount of foreign investment they suck in (point B). So the jury’s out on that part of the thesis.

But they have begun allowing people to buy and sell Yuan for foreign currencies in Hong Kong for instance and just announced a program to lend Yuan to certain BRIC countries (point C).

And they have been acquiring abroad at an accelerating pace since 2009 with expectations of double-digit investments for the foreseeable future (point D).

From accumulator to seeker.

The point here is that a big change is possibly in the offing – from China as foreign-currency accumulator (via its export machine) to China as foreign-currency seeker (to feed its net-import machine).

On a month-to-month basis none of this may be visible. For example, next month exports may rise substantially and imports may fall; and the whole idea presented here may look off-base. But over time the shift to foreign-currency seeker is worth tracking even if you don’t believe it now because – if true – its implications are large.

– John Allison