Organization Size, Slack, and Regulatory Uncertainty

"Better get under cover, Sylvester. There's a storm brewing...a whopper!"
--Professor Marvel (Wizard of Oz)

Not a huge gap compared to pre-tariff war period, but it does appear that shares of smaller companies have increased less than their larger share brethren over the past couple of years.

Micro-caps hit hardest since #TradeWar began@DataArbor pic.twitter.com/DbEFl0PiIw

— Liz Ann Sonders (@LizAnnSonders) December 10, 2019

Many factors could be involved outside of trade, of course. But to the extent that there is a significant relationship with policy uncertainty, then what is the underlying explanation?

One is that larger organizations carry more slack. Slack is a pool of excess resources that can be brought to bear during uncertain times to help weather the storm. Slack can be employed to either a) insulate the organization from external forces or threats (e.g., inventory, excess capacity, staff that can contract for better deals), or b) help the organization change in a way to better adapt to the turbulent environmental conditions (e.g., R&D processes, resources for lobbying for institutional change).

Because they possess less slack, smaller organizations are more subject to the vagaries of regulatory uncertainty. Perhaps investors have been pricing this in.

No Generation Gap

One day our generation
Is gonna rule the nation
--John Mayer

Included in this article discussing inter-generational investment preferences is recent data from Schwab showing top retirement account holdings for Millennials, Gen Xers, and Boomers.

The article emphasizes Millennials' unique faith in Bitcoin, which clocks in at number 5 at 1.84% of assets.

More striking to me, however, is what the generations have in common. Big FAANG exposure, Alibaba, Berkshire, Microsoft (MSFT). Few high dividend payers in the bunch.

These top positions suggest all three gens are betting their retirement futures on growth, not stability.

Suggests to me that there is little true generation gap when it comes to investing for retirement. Generally, all tend to throw caution to the wind--at least when it comes to their top positions.

no positions

Ideas Held Hostage

"Spread the word. Get on the wire to every squadron around the world. Tell them how to bring those sons of bitches down."--General William Gray

God made physical resources scarce. What isn't scarce is the creativity that springs forth from our minds. By combining those scarce resources with our abundant ideas we can alleviate some of that scarcity thru productivity improvement.

When we restrain ideas and our ability to use them in production, as we do thru 'intellectual property' laws, then we restrain prosperity.

When we hold ideas hostage, the world is a more barren place than it would be otherwise.

World of Debt

I am not the actor
This can't be the scene
But I am in the water
As far as I can see
--The Who

These page have noted the rising debt:GDP ratio in the US for some time. But this is not just a domestic phenomenon.

Global public debt has also reached its highest level in peacetime.

The $50 trillion + question is this: What is it that is drowning the world in debt?

Selling Strength

"He's right, you know, I had to sell. The key to the game is your capital reserves. If you don't have enough, you can't piss in the tall weeds with the big dogs."
--Gordon Gekko (Wall Street)

Stating the obvious, the best time to sell is when prices are high. But this is easier said than done. Account values are swelling. Plus, prices could go higher yet.

That said, I'm selling strength here as markets challenge all time highs after this morning's strong job report.

Need to have some extra liquidity for projects over the next year. To obtain it, I'm happy to 'feed the ducks' during rallies like this.

Concentrated Portfolios

Daniel LaRusso: What do you want me to do?
Miyagi: You stay focused.
--Karate Kid 3

Liz Sonders shares data indicating that active money managers are concentrating portfolio holdings more than in the past.

Growth of pas­sive in­vest­ing mo­ti­vating in­creas­ing # of ac­tive man­agers to shun di­ver­si­fi­ca­tion & fo­cus on fewer stocks to dif­fer­en­ti­ate them­selves from low cost, in­dex-track­ing ETFs that have done so well dur­ing 10-year bull mar­ket @WSJ @MorningstarInc pic.twitter.com/5vYX3fqJ9w

— Liz Ann Sonders (@LizAnnSonders) December 4, 2019

Funds holding 35 or less positions have been on the rise for years. Fund holding 20 positions or less have also been rising.

Since Markowitz's (1952) groundbreaking work on portfolio theory, diversification has been a widely accepted way for spreading risk and stabilizing returns. But risk and reward are directly related. Reducing risk also reduces potential returns. Fund managers competing against passively managed funds that spread risk across hundreds of positions have little chance of winning the diversification battle against index funds.

Instead, they are determining that they can compete for investment capital by positioning themselves as superior superior reward producers. The primary way to do this is to manage more focused portfolios. Potential for loss is greater but so is potential for reward.

It so happens that I've been moving toward a similar portfolio design. I like the idea of a 20-30 stock portfolio as a good balance between risk and reward.

Reference

Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7: 77-91.

Equity Market Tops

"Made it, Ma...top of the world!"
--Cody Jarrett (White Heat)

Interesting graphs showing tops in various equity markets. By definition, a top is a high point. Following tops in Japan, Europe, and emerging markets, major indexes in those geographies have essentially moved sideways--in some cases for decades.

US stock markets have not fallen in line with the pattern...as of yet.

Valuation Variety

Here by intervention
I want your attention
--Duran Duran

Liz Sonders writes that valuation methods are so subjective that at any time you can find some showing markets as undervalued while other metrics indicate overvaluation. Perhaps, but it is often the case that underlying assumptions cause metrics to diverge for predictable reasons.

The valuation metrics that Sonders presents help demonstrate. The first three metrics suggest that markets are cheap while the rest suggest that markets are expensive. What do the first three have in common? They all employ current interest rates as the discount rate for valuing stocks. As these pages have noted repeatedly, rates are at historic lows, driving discounting operations to render  'fair values' higher than they would be otherwise. Plugging in discount rates closer to long term average interest rates reduces fair values considerably, thereby reducing the 'undervalued' signal.

The other metrics on the list do not employ discount rates directly. Most of them reflect investor operations driven by low interest rate policies. One of these operation is known as TINA. In low interest rate regimes, investors buy stocks--particularly those with yield--because There Is No Alternative.

Low interest rates also encourage borrowing money to buy stocks, also known as the carry trade. Cheap sources of funds add to the amount of money in the market buying stocks, thereby bidding prices higher. Margin debt near all time highs provides a sense of the state of leveraged buying currently in effect. When that leverage comes off, prices will certainly feel downward pressure.

There is also, of course, the effect of non-economic buyers in the market, such as central banks and sovereign wealth funds, that are buying securities in part to complement low interest rate policies already in effect as a means to prop up markets and economic activity.

The message conveyed by different valuation methods may diverge in their message on the surface, but digging deeper suggests more convergence than meets the eye.

Impeachment Partisanship

Here comes the rain again
Falling on my head like a memory
Falling on my head like a new emotion
--Eurythmics

Alan Dershowitz discusses the Constitutional basis of impeachment and the debates of our founding ancestors about the issue. To be impeached, a president must commit a crime, and the commission of that crime must also constitute an abuse of office. Abuse of office by itself may be wrong, but it is not an impeachable offense.

The basis for impeachment was debated at the Constitutional Convention. When simply 'maladminstration' was proposed as grounds for impeachment, James Madison objected, arguing that the criterion was so vague and open-ended that the president would serve at the will of Congress and turn the federal government into a parliamentary democracy where the president could be removed with a vote of no confidence.

Instead, the framers adopted strict requirements for impeachment. Bribery, treason, or other high crimes and misdemeanors must be evident. A 2/3 super-majority vote in the Senate is required for removal.

In Federalist 65, Alexander Hamilton wrote of the dangers of a partisan approach to impeachment. Dershowitz suggests that the recent House impeachment circus demonstrates the partisan approach well. He suggests that impeachment partisanship further divides the nation and threatens to weaken the Constitution.

Perhaps, but the framers might also suggest that a partisan approach to impeachment is also likely to boomerang the party that goes on a unilateral witch hunt for all to see.

Wage Arbitrage

"So, arbitrage. Talk about adrenaline, huh? What do you think is the most important quality for a great arbitrager?"
--Tess McGill (Working Girl)

Larry Elder concludes what any reasoned person would conclude. If people were being paid less than their true market value, then employers would hire them.

"We’re going to end the absurdity of women making 80 cents on the dollar compared to men."
--@SenSanders 11/27/19

Women make 80cents on the dollar compared to men FOR DOING THE SAME WORK? REALLY? Then why don't employers fire men, hire women--and pocket the labor cost savings?

— Larry Elder (@larryelder) November 29, 2019

In free markets driven by the profit motive, employers can't afford to discriminate. They will arbitrage any wage discrimination away to acquire the extra productive capacity.