Agency Problem: Examples, Risks and Lessons

Here is an example of what we've been referring to as the agency problem or the conflict of interests that may result from different incentives guiding diverse economic actors or as defined by wikipedia.org "treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent, such as the problem that the two may not have the same interests, while the principal is, presumably, hiring the agent to pursue the interests of the former".



Gretchen Morgenson and Louise Story of the New York Times brings to spot a possible case, (bold emphasis mine),

``Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

``How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

``While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say."

Read the entire article here.

Meanwhile Professor Arnold Kling of econolib.org makes a good explanation (bold emphasis mine),

``One difference is that financial innovation often serves the purpose of regulatory arbitrage--devising an instrument to comply with the letter of regulation while evading its spirit. Another difference is that financial innovation often is used by clever Wall Street bankers to separate less sophisticated investors from their money. In that sense, it is sort of like innovation in stealing credit card information. In the case of bankers outsmarting their clients, you can blame the victims for failing to be wary or to protect themselves."

The obvious lesson is that people's actions are impelled by divergent incentives whether it be motivated by regulatory arbitrage, profits, innovation, reputation and etc...

The second lesson is that divergence could mean conflict of interests; the cost -benefits and risk-reward tradeoffs, aside from information or knowledge can be asymmetric and opposite to the interests of the other party.

Third, while the article's innuendo is one of 'market failure' via misrepresentation, the fact is that regulators themselves have different incentives from the private or non-public economic actors which could lead to myriad forms of conflicts of interest. In other words, trying to forcibly align incentives by means of added regulations will likely lead to more distortions and/or unintended consequences.

The fact that regulatory arbitrage exists, which could be construed as a cat-mouse dynamic, is a manifestation of how private economic actors work to always circumvent current regulations.

Also, the fact that regulatory capture is stereotyped mostly in industries that are heavily regulated implies that many economic actors collude with regulators (or politicians) to "game" the system (example, monopolies, special licensing, private-public partnership and etc...).

Fourth, it is also true that with the growing sophistication of markets, diversified security instruments may be used for hedging, than simply a one-direction trade, often seen in underdeveloped markets. Hence, unless governments opts to bring society, as represented by the markets, back to the medieval ages, the question of conflicts of interest could be contentious and signify as controversial gray area.

Lastly, the ultimate lesson is nailed by Professor Kling, "you can blame the victims for failing to be wary or to protect themselves."

This means that without understanding the incentives driving the source of your information or those whom you do business with, you can increase your risks.

``Risk comes from not knowing what you're doing” warns Mr. Warren Buffett, we'd further improve "risk comes from not knowing the incentives with those whom you are dealing with"

Happy Holidays: Live Life. Love Life. Love Liberty!

I'd like to greet everyone a Merry Christmas and A Healthy and Prosperous New Year!

In ecumenical context: Happy Holidays!!!

My message, to paraphrase the Hallmark Channel: LIVE LIFE. LOVE LIFE. LOVE LIBERTY.

That's because, to quote Greek author and historian Thucydides (460-404 B.C.) ``The secret of happiness is freedom. The secret of freedom is courage.”

Creative Destruction: Composition Of The Top 25 Global Companies Over The Decade

This should be a sequel to our March post A Tectonic Shift In The Global Banking Industry!

But this time, our BEFORE (1999) and TODAY chart, covers the 25 largest global companies in terms of market capitalization.

From Wall Street Journal

Some highlights shown above:

-technology companies dominated the top 25 in 1999

-only 8 of the top 25 during the 1999 remains on the list (the chart enumerates the companies removed from the roster)

-total market cap of the group shrank by 20% in the decade

-China has four of the top 25, in 1999 China has none.

-Iconic CEOs of 1999: Bill Gates of Microsoft, Jack Welch of General Electric, and Carla Fiorina of Hewlett Packard

-Iconic CEOs of 2009: Eric Schmidt of Google, Ratan Tata of the Tata Group (India) and Steve Jobs of Apple

How a shift of this magnitude impact markets?

Economist William Easterly writes, (bold highlights mine)

``One reaction is that free markets are very scary if you were an employee or shareholder of one of the 1999 companies that crashed. OK this kind of destruction scares ALL of us.

``Another reaction is that creative destruction is one of the triumphs of the market. The consumer is king: in 2009, the consumer wants iPhones in their Xmas stocking and not whatever Worldcom had been pretending to be producing. The radical uncertainty of how to please consumers is an argument FOR free markets:

``It is because every individual knows so little and… because we rarely know which of us knows best that we trust the independent and competitive efforts of many to induce the emergence of what we shall want when we see it. (Friedrich Hayek)

Organizational Capital: Business Model Innovation

One of the reasons we believe that traditional fundamental metrics will hardly apply today is due to the fact that the world economy has been transitioning from the industrial age to the information age-where Alvin Toffler calls this the Third Wave.

This means that the current underlying trend which deepens the integration of global markets (globalization), intensifies comparative advantages and the international division of labor plus competition driven technology innovations has been paving way for a reconfiguration of global economic structures.

This also means that capital in a traditional sense has also been evolving to incorporate organizational capital-or a procedure implemented by businesses to complete work (wikipedia.org).

The Boston Global Consulting Group presents a recent paper "Business Model Innovation" highlighting on these:

According to BCG, (bold highlight mine)

``This combination of product innovation and business model innovation (BMI) put Apple at the center of the market approximately 30 times larger than its original market. It also helped expand the company's share of the traditional computer market, as new customers become so attached to their iPods that they took another look at the Apple's computers.

``The greater frequency of disruption and dislocation in many industries is shortening business model lifecycles. New global competitors are emerging. Assets and activities are migrating to low cost countries. Systemic risk is growing as global business becomes increasingly interconnected. Social and ecological constraints on corporate action are emerging. All these factors require businesses to bolster and accelerate innovation. The discipline of BMI offers a fresh way to think about renewing competitive advantage and reigniting growth in this challenging environment.

``Business model innovation means more than a brilliant insight coming at the right place and the right time. To confer a reliable advantage, BMI must systematically cultivated, sufficiently supported, and explicitly managed.

Here is a diagram of the conventional model.

The BCG says that BMI is helpful during times of crisis or instability in the sense that

-it provides companies a way to break out of competition via process or product innovation.
-it help address disruptions or technological shifts-to cope with new business demands
-it addresses specific opportunities, by enabling companies to concentrate on either lower prices or reduce risks and cost of ownership for customers-usually by means of reengineering or reinventing themselves.
-companies often find it easier to gain consensus around the bold moves required to reconfigure an existing business

To add, BMI delivers superior and sustainable returns according to BCG, aside from offering "a premium over the average total shareholder return" on their industries or businesses See exhibit 2

And BMI can take several forms (see above).

Read the entire BCG paper here

And it is probably a reason why workers may have been more productive even during today's crisis. To quote Garrett Jones (Source Tyler Cowen: Marginal Revolution), ``Workers mostly build organizational capital, not final output. This explains high productivity per 'worker' during recessions."

Doug Kass' Prediction For 2010: Strong US Dollar, Weak Gold And Equities

This is another post to highlight on the different predictions by various "experts" for 2010.

Here, we quote Barron's Randall Forsyth's entire article on Doug Kass' fearless forecast for 2010 with my comments.

According to Mr. Forsyth, (black highlights original, blue highlights mine) [parenthesis my comments]

``Seabreeze Partners’ Doug Kass today is expanding on his outlook articulated in a recent Barron’s interview (”Skeptical Growth Will Take Root,” Dec. 14), notably about rising populist fervor in the land. One outcome he sees is Goldman Sachs‘ (GS) deciding it no longer wants to be a public punching bag and will revert to private status.

``And why, you may ask, should anybody pay attention to Kass’ prognostications. For one thing, he saw a “generational low” in stocks in early March, just days before the market’s bottom. In any case, here are Dougie’s Top 20 Surprises for 2010:

1. There is a glaring upside to first-quarter 2010 corporate profits (up 100% year over year) and first-quarter 2010 GDP (up 4.5%). It grows clear that, owing to continued draconian cost cuts, coupled with a series of positive economic releases and a long list of company profit guidance increases in mid to late January and early February, there is a very large upside to first-quarter GDP (up 4.5%) and, even more important, to S&P profit growth (which doubles!). The upside on both counts is in sharp contrast to more muted growth expectations. While corporate managers, economists and strategists raise earnings per share, full-year growth and S&P target estimates, surprisingly, the U.S. equity market fails to respond positively to the much better growth dynamic, and the S&P 500 remains tightly range-bound (between 1,050 and 1,150) into spring 2010.

2. Housing and jobs fail to revive. An outsized first-quarter 2010 GDP (up 4.5.%) print is achieved despite a still moribund housing market and without any meaningful improvement in the labor market (excluding the increase in census workers) as corporations continue to cut costs and show little commitment to adding permanent employees.

3. The U.S. dollar explodes higher. After dropping by over 40% from 2001 to 2008, the U.S. dollar continued to spiral lower in the last nine months of 2009. Our currency’s recent strength will persist, however, surprising most market participants by continuing to rally into first quarter 2010. In fact, the U.S. dollar will be the strongest major world currency during the first three or four months of the new year.

[Mr. Kass forgets Bernanke's policy imperative to devalue the US dollar as one major options to save its highly levered banking system and the economy]

4. The price of gold topples. Gold’s price plummets to $900 an ounce by the beginning of second quarter 2010. Unhedged, publicly held gold companies report large losses, and the gold sector lies at the bottom of all major sector performers. Hedge fund manager John Paulson abandons his plan to bring a new dedicated gold hedge fund to market.

[Mr. Kass thinks gold as only benefiting from speculative actions. He joins the camp of populist Nouriel Roubini. My bet would be with Mr. Paulson than with Mr. Kass]

5. Central banks tighten earlier than expected. China, facing reported inflation approaching 5%, tightens monetary and fiscal policy in March, a month ahead of a Fed tightening of 50 basis points, which, with the benefit of hindsight, is a policy mistake.

[This would probably the last thing central banks would do. Central Bankers will likely lean towards erring on the side of inflation, in the mistaken belief that inflation can be domesticated than suffer from a repeat bout of deflation that risks menacing their banking system (am speaking of developed economies). Yet, in the event that markets respond negatively to policy measures, central bankers will hastily regress to zero bound policies]

6. A Middle East peace is upended due to an attack by Israel on Iran. Israel attacks Iran’s nuclear facilities before midyear. An already comatose U.S. consumer falls back on its heels, retail spending plummets, and the personal savings rate approaches 10%. The first-quarter spike in domestic growth is short-lived as GDP abruptly stalls.

[Mr. Kass appears to be reading from the current direction of US policymakers to impose economic sanctions or embargo on Iran by early 2010, of which Cong. Ron Paul rightly argues that this could be a precursor to a war.]

7. Stocks drop by 10% in the first half of next year. In the face of renewed geopolitical tensions and reduced worldwide growth expectations, stocks drop as the threat of an economic double-dip grows. Surprisingly, though, the drop in the major indices is contained, and the U.S. stock market retreats by less than 10% from year-end 2009 levels.

[Again Mr. Kass ignores two factors: policies directed to pump different markets to save the banking system and too much distortions from government intervention which muddies market signals. Nevertheless, a correction like that of gold's present actions could occur on the truism that markets don't move in a straight line-a midsized probability]

8. Goldman Sachs goes private. Goldman Sachs stock drops back to $125 to $130 a share, within $15 of the warrant exercise price that Warren Buffett received in Berkshire Hathaway’s (BRKA) late 2008 investment in Goldman Sachs. Sick of the unrelenting compensation outcry, government jawboning and associated populist pressures, Warren Buffett teams up with Goldman Sachs to take the investment firm private. The deal is completed by year-end.

9. Second-half 2010 GDP growth turns flat. The Goldman Sachs transaction stabilizes the markets, which are stunned by an extended Mideast conflict that continues throughout the summer and into the early fall. While a diplomatic initiative led by the U.S. serves to calm Mideast tensions, flat second-half U.S. GDP growth and a still high 9.5% to 10.0% unemployment rate caps the U.S. stock market’s upside and leads to a very dull second half, during which share prices have virtually flatlined (with surprisingly limited rallies and corrections throughout the entire six-month period). For the full year, the S&P 500 exhibits a 10% decline vs. the general consensus of leading strategists for about a 10% rise in the major indices.

10. Rate-sensitive stocks outperform; metals underperform. Utilities are the best performing sector in the U.S. stock market in 2010; gold stocks are the worst performing group, with consumer discretionary coming in as a close second.

[Mr. Kass evidently is in the deflation camp. Yet he sees rate sensitive issues outperform, i.e. aside from utilities which I also interpret to mean banks, insurance companies, REIT, etc... Nonetheless this would be quite inconsistent with the "deflation" outlook]

11. Treasury yields fall. The yield of the 10-year U.S. note drops from 4% at the end of the first quarter to under 3% by the summer and ends the year at approximately the same level (3%). Despite the current consensus that higher inflation and interest rates will weigh on the fixed-income markets, bonds surprisingly outperform stocks in 2010. A plethora of specialized domestic and non-U.S. fixed-income exchange-traded funds are introduced throughout the year, setting the stage for a vast speculative top in bond prices, but that is a late 2011 issue. [More evidence of Mr. Kass' deflation bias]

12. Warren Buffett steps down. Warren Buffett announces that he is handing over the investment reins to a Berkshire outsider and that he plans to also announce his in-house successor as chief operating officer by Berkshire Hathaway annual meeting in 2011.

[This is a high probability event considering that Mr. Buffett is 79 years old and is already grooming several candidates for his replacement. Stephen Burke's inclusion to the Berkshire board makes it all in the family according to this Bloomberg news]

13. Insider trading charges expand. The SEC alleges, in a broad-ranging sting, the existence of extensive exchange of information that goes well beyond Galleon’s Silicon Valley executive connections. Several well-known long-only mutual funds are implicated in the sting, which reveals that they have consistently received privileged information from some of the largest public companies over the past decade.

14. The SEC launches an assault on mutual fund expenses. The SEC restricts 12b-1 mutual fund fees. In response to the proposal, asset management stocks crater.

15. The SEC restricts short-selling. The SEC announces major short-selling bans after stocks sag in the second quarter.

[Obviously Mr. Kass looks at an environment where more regulation would be implemented (13-15) yet is ironically bullish over interest rate sensitive issues]

16. More hedge fund tumult emerges. Two of the most successful hedge fund managers extant announce their retirement and fund closures. One exits based on performance problems, the other based on legal problems.

[more hedge funds will implode only when markets are extremely volatile-mostly to the downside]

17. Pandit is out and Cohen is in at Citigroup (C). Citigroup’s Vikram Pandit is replaced by former Shearson Lehman Brothers Chairman Peter Cohen. Cohen replaces a number of senior Citigroup executives with Ramius Partners colleagues. Sandy Weill rejoins Citigroup as a senior consultant.

18. A weakened Republican party is in disarray. Sarah Palin announces that she has separated from her husband, leaving the Republican party firmly in the hands of former Massachusetts Governor Mitt Romney. An improving economy in early 2010 elevates President Obama’s popularity back to pre-inauguration levels, and, despite the market’s second-quarter decline, the country comes together after the Middle East conflict, producing a tidal wave of populism that moves ever more dramatically in legislation and spirit. With the Democratic tsunami (part deux) revived, the party wins November midterm elections by a landslide.

19. Tiger Woods makes a comeback. Tiger Woods and his wife reconcile in early 2010, and he returns earlier than expected to the PGA Tour. After announcing that his wife is pregnant with their third child, both the PGA Tour’s and Tiger Woods’ popularity rise to record levels, and the golfer signs a series of new commercial contracts that insure him a record $150 million of endorsement income in 2011.

[This is much ado out of trivialities; if showbiz personalities can be accepted by media as living a more licentious life, then why can't sports champions]

20. The New York Yankees are sold to a Jack Welch-led investor group. The Steinbrenner family decides, for estate purposes, to sell the New York Yankees to a group headed by former General Electric (GE) Chairman Jack Welch.

Donald Coxe: Underweight US Markets, Overweight Commodities, Canada And Emerging Markets

Donald Coxe in his December issue of Basic Points has some interesting recommendations (hat tip: Prieur Du Plessis)

From Mr. Coxe: (bold and italics highlights mine)

1. Remain underweighted in US equities - as a percentage of equities within global portfolios, and as a percentage of assets in US balanced portfolios. Underweight US bonds in global portfolios.

The long-term financial projections for the US are scary, even if one accepts the Obama assumptions: ten years of large deficits, no recessions, strong, sustained economic growth, and a mere 1% increase in Treasury yields. Those numbers make no allowance for the costs of health care, which will be huge. Debilitating tax increases are inevitable, even if the global warming “cap and tax” legislation does not pass.

2. Within US equity portfolios, underweight US economy-related stocks and overweight stocks tied to foreign economies.

US stocks outperformed after Obama’s election, but that created what could be called erogenous risk for investors. As long as the KRE [Regional Bank Index] continues to underperform both the BKX [Philadelphia Bank Index] and S&P, risks of a double-dip economy remain.

3. Overweight Emerged Markets (such as China, Hong Kong, Brazil, India and Korea) within global and international equity portfolios.

These markets should no longer be discounted heavily because of assumed gaps between their accounting and American practices. The credibility gap has been narrowed significantly. The FASB’s capitulation to Congressional pressure on big banks’ balance sheets is a sign that Volcker-style virtue is outdated.

4. Remain overweight commodity stocks within balanced accounts and equity-only accounts.

Strong commodity-oriented companies are tied to global growth trends, led by the Asian powerhouses, which means they have less endogenous risk than companies tied to the US and Europe.

5. Emphasize gold stocks in commodity stock accounts.

Gold and other precious metals appear to have entered a period of above-average volatility, but the unprecedented creation of paper money and national debts means ownership of the metals and producers will tend to reduce endogenous risk in most portfolios. The stocks will tend to outperform bullion on the upside; the bullion will outperform on the downside.

6. Continue to overweight the agriculture stocks.

The best-performing commodity group in the past three months has been the agricultural stocks, led by the machinery and fertilizer stocks. Street analysts turned negative on these groups during the summer, when it looked as if US crop production would reach painful levels. Then the weather intervened. We remain of the view that the best of the agriculture stocks are among the best-quality core positions among all equities.

7. Maintain exposure to the energy stocks, but continue to emphasize oil producers and to de-emphasize natural gas producers.

Oil and natural gas are both in oversupply at the moment. The difference is that crude oil prices remain strong despite oversupply, as oil companies and speculators hoard oil in anticipation of stronger demand next year - and in fear of a new Mideast war. Shale gas may be too readily available to be good short-term news for either the profits or stock prices of oil and gas producers - but Exxon’s move on XTO Energy shows what having huge shale reserves can do for takeover values in politically-secure terrain.

8. Base metal stock prices are somewhat riskier than those of other commodity groups, but are worth holding.

The producers are dependent on China’s willingness to continue to buy more metal than it needs for current consumption.

9. Within balanced portfolios, emphasize long-duration, high-quality bonds at the expense of Cash. Canadian bonds should be used by foreign investors, where possible, as alternatives to Treasurys and US corporates.

Cash isn’t a true risk reducer, because it delivers no yield and cannot rise if there’s a new panic. If you must own something that pays you nothing, buy gold. In contrast, long-duration bonds are the best hedge against a renewed economic downturn.

10. Canada offers better government, better governance, a better currency, and a better stock market than the USA. Buy Canadian.

The flip side to this is a wise balance sheet policy for Canadian companies. Borrowing in American dollars makes sense for Canadian exporters and resource companies - and for some other Canadian industries. Take advantage of (1) Bernanke’s heroin injections into US debt markets, and (2) Canada’s new financial prestige to reduce your endogenous currency risk by bulking up your borrowing in greenbacks.

Read the rest of Mr. Donald Coxe's report here.

BMO Capital Markets Basic Points Dec 2009

Financial Populism Means Confirming Mainstream’s Biases

``Who do you listen to? Who are you trying to please? Which customers, relatives, bloggers, pundits, bosses, peers and passers by have influence over your choices? Should the Pulitzer judges decide what gets written, or the angry boss at the end of the hall so influence the products you pitch? Should the buyer at Walmart be the person you spend all your time trying to please? Your nosy neighbor? The angry trolls that write to the newspaper? The customer you never hear from? Just for a second, think about the influence, buying power, network and track record of the people you listen to the most. Have they earned the right?” Seth Godin The people you should listen to

Some experts will virtually say anything just to get to the limelight or promote ideology. Unfortunately, the public hardly understands the motives behind such actions.

For instance when mainstream experts obstinately hammer on a “remittance driven Peso”, even if they have hardly been directly correlated in terms of remittance growth trends relative to the Peso-US dollar value [see How The Surging Philippine Peso Reflects On Global Inflationism], would be analogous to religion, arguing against populism would appear like blasphemy.

This goes to show that it is never about evidences or direct proofs (ipse dixitism) or logical reasoning but about indoctrination- from what academic or institutional experts, as repeatedly quoted by media, thinks they should be.

It’s Isn’t About Adherents, It’s About Profitability

At the start of the year high profile local experts had been in near unison predicting that the Philippine Peso will fall in excess of the Php 50 to a US dollar level.

Yet, in spite of the repeated forays by the local central bank (Bangko Sentral ng Pilipinas) to keep the Peso from firming, the Philippine Peso has virtually been up (by about 1.8% as of Friday’s close on a year to date basis) blatantly defying the collective projections of these mainstream experts.

Media never elaborates on the motivations of the actuations of mainstream experts or their predisposition for more interventionist government via inflationism in an attempt to uphold the plight of OFWs.

Since OFWs have been glorified as economic heroes, populism dictates that socio-political policies have to be directed at alleviating the conditions of the 12% of the economy at the expense of the rest.

However, these experts, who pretend to know how resources ought to be allocated, have failed to see the unintended effects of the 40 years of devaluation, and importantly botched at predicting the Peso level for 2009.

Yet if they can’t predict the whereabouts of the financial markets how the heck should we expect them to know how to deal with an even more complex real economy?

Still, in order to devalue the Peso, the BSP will have to massively intervene by printing money and/or have government spend more in the economy.

Yet, hardly any of these experts dealt with the repercussions of such interventionists actions through flagrant distortions in the production structure of the domestic economy and the resultant higher consumer prices.

Nor have they expounded on the crowding out effect of private investments that would lead to higher unemployment and to greater incidences of corruption from an enlarged bureaucracy, aside from greater inefficiency in the system as a consequence of government’s politicization of the economy.

Also yet none appears to have ever discussed on how the Peso’s over 40 years of devaluation from Php 2 to a US dollar in 1960s to Php 55 in 2005 have NOT lead to a goods and service export economy but to an unintended consequence-labor or manpower exports.

So while we have been correct in predicting for a stronger Peso for 2009 and a meaningful recovery in the Phisix, it’s primarily because we focused on what we thought mattered most-the impact of global political inflationism to asset and consumer prices and its diversified impact to the idiosyncratic structures of national economies.

And maybe lady luck mattered too.

In other words, we didn’t mince words to go against the crowd and worked on the basis of facts operating on free market based economic theory.

So it really doesn’t matter if we don’t gain “adherents”, what we have purported to do is to offer an alternative “contrarian” point of view in spite of the risks of social ostracism. Most importantly, we aim to impart market profitability and not just entertainment value.

In adhering to Warren Buffett’s investment advice, ``Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success.''

Populism And Forecasting Accuracy

Does populism imply forecasting accuracy?

Perhaps for some, especially for those with a longer term horizon such as Warren Buffett, Dr. Marc Faber or Jim Rogers, but certainly not for all.

Especially NOT for celebrity gurus.

If it is not saying something radical, populism is always about declaring something outlier that connects with the mainstream ideology or short term views.

Tyler Durden of Zerohedge recently unmasked RealMoney columnist James Cramer “Citigroup” recommendation that prompted for a 14% drop in 3 days. The mercurial TV personality James Cramer appears to have a poor track record in calling the market right (Wall Street Cheat Street).

Another celebrity guru, Nouriel Roubini followed up on his debate with Jim Rogers [see Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble] and has repeatedly but incoherently been thrashing gold (projectsyndicate.org).

Mr. Roubini introduced the US dollar carry trade as a major risk “mother of all carry bubbles” last November, even when we had brought out this possibility last August [see The US Dollar Index’s Seasonality As Barometer For Stocks]- this means we have already reckoned the US dollar carry trade even prior to Mr. Roubini’s admonition.

Mr. Roubini’s derring-do concept has reflexively been embraced by the mainstream institutions like the IMF (Bloomberg), the World Bank (World Bank Blog) and other financial institutions.

Nevertheless we have argued against this [see Jim Rogers Versus Nouriel Roubini On Gold, Commodities And Emerging Market Bubble and Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble] noting of:

-the confusion between the incentives of private purchases against government purchases of commodities and select financial securities,

-the ultimate tasks of (developed economies) governments appear to be securing the stability of its banking system via the manipulation of several key markets including the mortgage, treasury and equity markets coupled with the tacit aim to devalue their currencies (US dollar, UK pound, Japanese Yen),

-the variability of the impact from the recent recession on industries and nations,

-the inability by the old financial system to regenerate systemic leverage,

-expectations of money’s neutrality,

-comparing today’s economic model with that of the Great Depression and

-the tendency of experts, like Mr. Roubini, to anchor on the recent past events or from the success of recent ‘carry’ models.

Mother Of All Carry Trade Bubble, Where?

Yet the proof of the pudding is in the eating.

Figure 3: Stockcharts.com: What US Dollar Carry?

With the US dollar has been up 4.8% from its recent bottom over the last 2 weeks, surprise (!), we are hardly seeing any generalized financial market tumult similar to that of 2008 see figure 3)

Except for the recent weakness in China’s Shanghai index (not shown above), Asian ($DJP1), European ($STOX 50) and Emerging markets (EEM) equities appears to be generally resilient amidst a rising US dollar.

In addition, the infirmity of the gold market, which has reflected on its inverse correlation with that of the US dollar, has yet to spillover to other commodities.

Instead of weakening, it would appear that other commodities have been firming up such as the Dow Agricultural Index ($DJAAG), the Copper markets ($COPPER) and most importantly, rallying oil prices ($WTIC) again, in the face of the recent strength by the US dollar.

So unless we see further deterioration across global financial markets (amidst the Dubai debt Crisis and the recent credit rating downgrade of Greece), there hardly seem any traces of the unwinding of “mother of all carry bubbles”.

So, where o’ where is the US dollar carry?

Seasonal Oil Strength And Celebrity Guru Track Records

Figure 4: US Global Investors: Oil’s Seasonal Price Patterns

Moreover if we should see oil’s seasonal strength play out, as it had during the previous 15 years, similar to gold and US dollar index (which has proven to be quite effective see Gold and the September Stock Market Seasonality Syndrome and The US Dollar Index’s Seasonality As Barometer For Stocks), then we can probably expect oil prices to further rise from current levels (see figure 4) and possibly break above its recent high at $82 per barrel in the face of a rising US dollar.

As a caveat, the rising US dollar appears to be a technical bounce and is likely a short term event more than fundamentally driven inflection or reversal.

Perhaps the US dollar bounce could also be interpreted by markets as anticipating the end of the US QE program, while major trading partners as the UK and Japan proceed with their own versions. In addition, the downgrade of Greece which risks of a contagion may spur more policy easing from the ECB to contain the ripples of the shockwaves.

Nevertheless with 7 banks closed by US regulators this week (marketwatch.com), and with next wave of ALT-A and Prime mortgages (aside from Commercial Real Estate) threatening the US banking system anew [see 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects], we shouldn’t expect any policy tightening or reversals of the QE program even if they expire in March. In fact, if things turns for the worst we should expect QE policies to intensify.

Yet celebrity guru Mr. Roubini has had a poor track record, according to Wall Street Cheat Street, with only 1 out of 7 predictions being accurate over the last few years.

Mr. Roubini had earlier failed to see this year’s rally and vehemently denied of its persistence, and also predicted that oil will trade at the $40 for the rest of 2009 [see Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons].

Realizing his obvious mistake, Mr. Roubini has switched sides during the midyear and declared oil to rise “closer to $100” (CNBC), which apparently hasn’t likewise been valid unless oil explodes during the coming sessions.

With wrong predictions after wrong predictions, it’s a wonder how mainstream institutions and experts have been hasty to freely embrace such flimsy and specious macro theories based on archaic models without addressing the impact from the policy directives by global governments on the economy and markets aside from oversimplistically interpreting economics like some school laboratory experiment.

Perhaps the common denominator for publicity seeking gurus is the ideological likemindedness, where according to Richard Ebeling, ``a whole host of economists who crave popular approval and political influence have been propounding a whole series of quack medicines to "heal" the economy, with the promise of curing the recession through interventionist and monetary "elixirs." (bold highlights mine)

If it were a choice between 15 minutes of fame from quackery and profitability from accurately predicting markets, the latter would be my choice hands down.

Everyone Is A Genius In An Inflation Driven Bull Market!

``Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”-Warren Buffett

Recently I’ve been drawn into some discussions about how being “right” might lead to more audience following and how being “right” may come in the face of being unpopular.

As a student of the markets, we understand that incentives drive everybody’s actions.

Conventionalism As Camouflage

Here are some examples of the divergent underlying incentives that impel for some of the actions by market participants:

-For traditional sellside analysts-generate literatures that would prompt clients to trade short term or ‘churn’ accounts.

-For conventional bankers- sell ‘one size fits all’ financial products to a diversified consumer base.

-For many subscription newsletter editors-write wild and audacious forecasts that would elicit attention and/or peddle short term snake oil ‘technical’ outlooks.

-For mainstream economists or financial experts-the need to be seen communicating on the conventional vernacular, as conventionalism secures their career reputations in terms of advancement or job shifts. As the illustrious and chief adversary of the Austrian school John Maynard Keynes once said, ``It is better for reputation to fail conventionally than to succeed unconventionally."

By seeking the comfort of the crowds, there is always the pretext behind what John Maynard Keynes says as being ``better to be vaguely right than exactly wrong.”

In other words, conventionalism is frequently used as camouflage against efficacy.

And for most of the above, divergent risks have apparently been sidelined for profit motives.

Yet, one must realize that for different market actors there are different perspectives from dissimilar incentives and these are the dynamics behind analyzes (reports or studies), communiqués or even quotes from news accounts.

As our favorite iconoclast Nassim Nicolas Taleb warned in Fooled By Randomnes of relying on mainstream media as main source for information, ``Most journalists do not take things too seriously: After all, this business of journalism is about pure entertainment, not a search for truth, particularly when it comes to radio and television”

In A Bull Market, Everyone Is A Genius

There is an old Wall Street cliché that goes “Everyone Is A Genius In A Bull Market.”

That’s exactly what we’ve been saying for the longest time.

NO matter what mainstream experts write about under present conditions; be it pertinent to the technical charting picture, micro fundamentals stories- industry, corporate (prospective merger & acquisitions or earnings) based or even from the macro dimensions, the coincident rise of the market security prices simultaneously with their Panglossian sentiments makes it appear they can’t do anything wrong. Genius has been at work.

Fundamentally these mind frames can be identified as cognitive biases; particularly,

-the fundamental self attribution bias- or the tendency to attribute positive outcomes on skills while negative outcomes on misfortune or as Nicolas Nassim Taleb describes in The Black Swan ``We attribute our success to our skills, and our failures to external events outside our control, namely to randomness. We feel responsible for the good stuff, but not for the bad. This causes us to think that we are better than others at whatever we do for a living.” We previously discussed this in Situational Attribution Is All About Policy Induced Inflation.

-and the survivorship bias or the winner’s bias-to quote Stephen Dubner of Freakonomics, ``The behaviors of winners are remembered and dissected far more thoroughly than those of losers, and given greater weight, even if the outcome was decided by a tiny margin.”

Put differently, people tend to selectively tunnel into so called “winners” at the expense of the overall picture.

Again from Nassim Nicolas Taleb, ``The mistake of ignoring the survivorship bias is chronic, even (or perhaps especially) among professionals. How? Because we are trained to take advantage of the information that is lying in front of our eyes, ignoring the information that we do not see.” (emphasis added)

In short, everyone, including experts, punters, scalpers or investors, can be right for the wrong reasons!!

Machlup-Livermore Model Applied To The Phisix and Berkshire Hathaway

This can be exemplified by looking at the Philippine Phisix from the big picture figure 1.

Figure 1: Phisix: Rising Tide Lifts All Boats

While the Commercial Industrial index (blue gray) have outperformed alongside with the mining index (green), generally ALL major sectoral indices have been on an uptrend (Phi-all violent, Property-Blue, Holding-red, Banking-black candle, Service-orange, and Phisix-gray) since bottoming out in late 2008.

As caveat we seem to be seeing some of the major indices as rolling over (possibly heralding for a temporary corrective pause)-specifically the holding, the property and service indices.

Nevertheless, any security specific underperformance relative to the general trend represents as the exception more than the rule. And it would be apt to quote a reminder from Edwin Lefèvre or a.k.a the legendary Jessie Livermore…

``I NEVER hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they all go up...I speak in a general sense. But the average man doesn’t wish to be told that it is a bull market or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing.”

In essence, Mr. Lefèvre’s empirical observation goes hand in hand with Austrian economist Fritz Machlup’s conclusion that stock markets have increasingly been driven by inflation [as previously discussed in Are Stock Market Prices Driven By Earnings or Inflation?], where inflationary policies propel investors sentiment and ultimately gets reflected on the market as seen in the rising and ebbing tide phenomenon or our Machlup-Livermore model.

Yet, even Mr. Warren Buffett’s flagship the Berkshire Hathaway which has consistently outperformed the S & P 500 for over two decades could be used as paramount yardstick (see figure 2)

Figure 2: Bigcharts.com: Berkshire Hathaway Also Reflects On Rising Tide

As you would notice, Mr. Buffett’s Berkshire has basically outperformed the S & P when the monetary landscape has been accommodative, from which has likewise been reflected on sprightly markets.

Yet, when liquidity had been drained from the system as a result of the recessionary forces (from overinvestments in technology and communications in 2000) or during the banking crisis of 2008, Berkshire has fallen almost more than the losses of the S & P 500 (both during the dot.com bust of 2000 and the Lehman meltdown in 2008).

So even the world’s most venerated investing guru has been subject to ebbs and flows of INFLATION!!!

The point is: anyone can mesmerize themselves with the delusions of market prices exhibiting conventional metrics while ignoring the fact that the impact of inflation to the prices of diverse financial markets including the currency market has been intensifying. In short, misdiagnosis leads to wrong therapy or errant investing actions.

To excerpt Agora Publishing’s Bill Bonner, “people seem to come to believe just what they need to believe – just when they need to believe it”, even if they are unsubstantiated by evidences or by facts.

And this is what distinguishes us from the mainstream.

Creative Destruction: Electronic Payments Over Cash And Checks

Creative destruction appears to be taking hold even in terms of the means to conduct payment.

In the United Kingdom, electronic payments appear to be getting the better of checks 'cheques', where the latter may be reckoned as passe.

According to Mint.com (bold highlights mine),

``This week, the British banks governing the UK Payments Council decided to phase out their check clearing system by October 2018. In effect, they set an expiration date for the use of paper checks (or “cheques” as they prefer). In a statement, the group’s chief, Paul Smee, noted: “There are many more efficient ways of making payments than by paper in the 21st century, and the time is ripe for the economy as a whole to reap the benefits of its replacement.”

``Like letters of credit, demands for payment and bills of exchange, bank drafts can trace their history to Roman times, when checks were known as “praescriptiones.” Paper drafts analogous to today’s checks were in use in the Islamic world in the 9th century and as early as the 12th century Templars honored pilgrims’ checks from one chapter house to the next. In England, clearing houses have had responsibility for settling checks since the early 1800s (before that they were often cashed in coffee houses).

``Bankers complain that many British retailers don’t accept checks anymore, that young people don’t even have checkbooks, and that it’s costing them as much as a pound (about $1.63 today) to process every check. But the decision certainly has its critics—especially advocates for the elderly and small business owners. On one hand, a generation uncomfortable with electronics will be forced to risk carrying and handling more cash. On the other, mom and pop stores have one more disadvantage against giant competitors (some of whom are starting to act as banks themselves). The move will also put the “unbanked”, who have to pay fees to cash checks but also lack access to accounts capable of electronic payments.

``The cost of cash keeps going up while the cost of using credit cards and electronic payments keeps going down. More retailers accept credit cards than checks these days. But while US banks also worry about the costs of handling cash and checks, they aren’t likely to echo the UK decision any time soon. Yes, paper checks are increasingly rare in high-tech countries—whether advanced Scandinavian nations or developing/modernizing regions such as Africa—but the US doesn’t rate as high-tech when it comes to personal finance (present company excepted of course). It has lagged dramatically in the modernization of its financial traditions, such as implementing electronic payments, even compared to Britain."

In other words, technology has been bringing about the intensifying diffusion of the electronic mode of payment as primary means to conduct transactions with reduced reliance on the traditional cash and checks.

The caveat here is that facilitating payments via electronics can translate to more debts and could function as faster conduit for the expansion of circulation or bank credit (inflation).

Nevertheless in a cash society as the Philippines, where 40% of the economy is considered informal and where the penetration level of mobile phones is far greater than people with bank accounts, the likely primary mode of electronic payment that could take shape would be that of mobile banking.

According to CGAP, ``To root the global market sizing in real world data, CGAP, GSMA and McKinsey analyzed, unbanked consumers in the Philippines, where two of the global leaders in m-banking operate (Smart, and Globe). One half (1.6 million) of active mobile banking users in the Philippines are unbanked. Furthermore, 26 percent of active users have incomes below $5 per day. On average, unbanked mobile money users spent $1.9 more per month than peers who do not. This is a considerable gain for mobile operators who saw average revenues per user (ARPU) as low as $4.04 in the 4th quarter of 2008, according to Wireless Intelligence...

``Mobile money reaches a base of financially active people. In the Philippines, more than half of the people interviewed for the study reported using at least one financial product. This mirrors findings in other countries showing the poor to be active money managers. Savings is the most common financial product in the Philippines, with low-income mobile money users and nonusers reporting that they save an average of $34. Informal mechanisms for saving dominate the market.

``Ninety-eight percent of unbanked Filipinos receive their income in cash, and overwhelmingly use informal saving instruments, such as keeping their money at home in a safe hiding place, giving money to a friend or family to hold, or joining a saving club. CGAP and GSMA estimate low-income Filipinos save an estimated $450 million in informal, actively managed with frequent deposits and withdrawals."

In other words, market in spite of government interventions has always been looking for the best interests of consumers. In this case by facilitating an easier mode of conducting transactions via electronics, be it through mobile banking, credit and debit cards or others.

And if markets are always looking for a way satisfy consumers, the recent onrush to gold has likewise brought about a new form of Automated Teller Machines (ATM)- gold ATMs in Germany.

According to the Financial Times (last June)

``Germans, long attracted to the safety of solid gold, will soon be able to sate their appetite for the yellow metal as easily as buying a chocolate bar after plans were announced yesterday to install gold vending machines in airports and railway stations across the country.

``The venture by TG-Gold-Super-Markt, a company based near Stuttgart, aims to build on soaring retail interest in gold since the financial crisis shook confidence in other investments.

``"German investors have always preferred to hold a lot of personal wealth in gold, for historical reasons," said Thomas Geissler, the owner of the company. "They have twice lost everything."

``He hopes to install "Gold to go" machines in 500 locations in German-speaking countries this year."

It's a curiosity how gold can be fused with today's rapid technology and market based innovation trends.