Month: November 2014

From Elliott Management’s Q3 letter, by Paul Singer

A Brief Note On Capitalism

From time to time we find ourselves compelled to write a few words in defense of capitalism. Capitalism is a system according to which capital is owned by private citizens, who in turn determine its price and flow by interacting with one another. Capitalism implies that private citizens get to keep most of the fruits of their labor or the profitability of their capital. Capitalism is neither a “state of nature” nor a primitive scrum. It can work (i.e., create value for owners and for society while being acceptable to the citizenry, including those without capital) only with appropriate rules of fairness and honesty, and workable standards of disclosure. To these factors must be added the ability for people, in a meritocratic way, to have a chance to participate in capitalism. The proper combination leads society to buy into the concept that the individual freedom to own property leads to the most efficient allocation of resources, which in turn results in the highest economic growth and prosperity. Capitalism is never perfect, but the closer society adheres to its general principles, the better it is for the population at large.

If you take away these elements and put the bulk of power in a society in the hands of a central authority, bureaucracy and/or central banker, then all of the natural imperfections of human decision-making – including the problem of unintended consequences, the inability of central planners ever to have enough information to make wise decisions about the allocation of resources across an entire society, corruption, arrogance, and the fallibility of human nature – are exacerbated and concentrated. It is no surprise that governments do almost everything worse than the private sector, and that private philanthropy has created so much more societal value per unit of human effort and wealth than governments have in terms of efficiently and creatively addressing problems.

When the governmental impulse is to make all major decisions for people and control almost every aspect of their lives, the “cost” is inefficiency, ineffectiveness, unfairness and tyranny (see the old Soviet Union for details). Having the government choose winners and losers does not lead to better or fairer results than allowing merit and private effort to dictate those outcomes. When it is time to take an action related to life, health, work and career, there is no reason to prefer a government decision over a private decision. The distortions imposed by governments’ exercising control over things that do not need to be controlled by governments are almost without end. Shortages and inflation are traditional consequences of controlling prices. Poor growth, emigration and job losses are the repercussions of making the economic environment unattractive for employers and employees by taxation, regulation, corruption, disdain for the rule of law, and rigid employment policies. It is no accident that the more government does, and the more control government has or is given over people’s lives, the greater the level of corruption and cronyism – even (or especially) in those countries that have populism as their (phony) rallying cry.

The question that governments should always be asking is: How can we make the economy work better, grow faster, provide the best full-time job opportunities, allocate capital more efficiently, help the largest number of people get rich or pursue their destinies, and provide the fairest and most open platform for people to live their lives without interference and to experience the worthiness of achievement or career or parenthood and family? Sadly, we cannot think of many leaders in the developed world who are pursuing policies with that combination of goals in mind.

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Stocks have risen so often in the last five years that many investors may take further gains for granted even after the latest slump, according to Wells Frago’s Jim Paulsen. As Bloomberg reports, Paulsen’s ‘US stock market consistency indicator’ (which tracks the ratio of monthly gains and losses for the preceding five years), reached 3 for the first time since April 1999 – less than a year before the end of a bull market driven by Internet stocks – a level not seen since the late 1920s. Of course, it’s different this time, but as we noted earlier, the consensus bull case is unbreakable and as Paulsen notes “Consistency breeds complacency,” or a sense of comfort among investors that’s at odds with potential losses.

 

 

As Bloomberg explains,

“Consistency breeds complacency,” or a sense of contentment among investors that’s at odds with potential losses, Paulsen wrote.

 

“While the stock market did decline aggressively earlier this month, its quick and nearly full recovery, if anything, has probably boosted complacency.”

 

Complacency earlier this year reached levels seen in the 1990s, the 1950s and the 1920s, according to Paulsen, based in Minneapolis. His conclusion was derived from an indicator that combined the consistency gauge with a stock-volatility index, also tied to Shiller’s data.

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Authored by The Ron Paul Institute's Daniel McAdams via Contra Corner blog,

The US government loves to “promote democracy” overseas, often at the barrel of a gun. Strangely enough, however, it often “deplores” actual elections being held in such places. Take Ukraine, for example. An election held last week by a group that forcibly seized power from a legitimately-elected government was hailed by the US administration as a great democratic achievement.

Said John Kerry about last week’s parliamentary election held by the post-coup government in Kiev:

We applaud Ukraine’s commitment to an inclusive and transparent political process that strengthens national unity. … The people of Ukraine have spoken, and they have again chosen to chart the course of democracy, reform, and European integration.

In this US-approved vote, the parties disapproved by the US were harassed and even essentially banned. But that’s OK.

However in eastern Ukraine, which refused to recognize February’s US-backed coup in the western part of the country, parliamentary and presidential elections scheduled for tomorrow are scorned and even “deplored” by the US administration.

The White House condemned tomorrow’s elections in eastern Ukraine in no uncertain terms:

We deplore the intent of separatists in parts of eastern Ukraine to hold illegitimate so-called local ‘elections’ on Sunday, November 2. If held, these ‘elections’ would contravene Ukraine’s constitution and laws and the September 5 Minsk Protocol.

So much does the US administration hate the idea of unapproved people voting, that it even refused to call them elections, placing the very term in “scare quotes.”

Shortly after the February coup in Kiev, referenda were held in Crimea and in parts of eastern Ukraine to determine whether to remain tied to Kiev or declare independence from the new regime. Those elections were also condemned by the US.

“We reject the ‘referendum’ that took place today in the Crimean region of Ukraine.  This referendum is contrary to Ukraine’s constitution,” said the White House immediately after the March vote in that region. The February coup was also contrary to Ukraine’s constitution but that did apparently not bother Washington.

Similarly, when referenda were held in eastern Ukraine this spring to determine that region’s future course, the White House spokesman condemned them as “illegal under Ukrainian law and a transparent attempt to create further division and disorder.”

When the wrong people hold votes, it seems, “division and disorder” are the result.

Those who overthrow democracy by force are legitimized – you might even say laundered – by an election they had no legal right to hold in the first place, while those who stood by previously-elected leaders and scheduled elections as a way out of the crisis caused by US interference are condemned, ignored, and not even recognized by the US government.

So here is the real message from the US government: elections overseas are only legitimate if we have pre-approved the parties allowed to stand and if we have pre-approved the outcome. The election must result in exactly the kind of “pro-West” government that we desire or we will begin destabilization and regime change, if completely ignoring the results does not do the trick.

Is that what John Kerry meant when he said, “you just don’t in the 21st century behave in 19th century fashion”?

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Nine short months ago, the clever people running the show in Europe suggested a number of measures including "unpaid work for the young and unemployed up to 24 years old, so that companies would have a strong motive to hire young employees". 'Unpaid' work sounded a lot like slavery to us then but it seems the arrogance is contagious as Canada – that bastion of freedom – suggests that the employment situation is so bad that young people should consider working for free. As The Globe & Mail reports, Bank of Canada Governor Stephen Poloz said 'Adult children stuck in their parents’ basements because they can’t find adequate employment should take unpaid work to bolster résumés as they wait for the recovery to take hold'.

 

Here is Europe in January, the Centre of planning and Economic Research in Greece has proposed a controversial measure in order to deal with the problem of increasing unemployment in the country.

The measure includes unpaid work for the young and unemployed up to 24 years old, so that companies would have a strong motive to hire young employees. Practically, what is proposed is the abolition of the basic salary for a year. At the same time the “export” of young unemployed persons was also proposed to other countries abroad, as Greek businesses do not appear able to hire new personnel.

And here is Canada today (via The Globe and Mail),

How bad are things in Canada’s job market? Bank of Canada Governor Stephen Poloz says bad enough for young people to consider working for free.

 

Adult children stuck in their parents’ basements because they can’t find adequate employment should take unpaid work to bolster résumés as they wait for the recovery to take hold, Poloz said Monday in Toronto.

 

The Bank of Canada estimates about 200,000 young people want to work or work more, and Poloz said they may be scarred by prolonged unemployment that prevents them from moving out on their own. He said he’s been asked for advice on how young people can find work.

 

“Having something unpaid on your CV is very worth it, because that’s the one thing you can do to counteract this scarring effect,” Poloz told reporters was his advice to discouraged youth.

And now Canada shifts to the US "slack" model…

Job market indicators suggest there’s significant slack in the economy even with an unemployment rate that has fallen to the lowest in six years, Poloz said.

 

“The unemployment rate as it is today overstates the amount of improvement we’ve actually had because in the background there are discouraged worker effects,” Poloz told reporters after the speech.

 

…

 

“Unlike workers with experience who lost jobs during the recession, youth who couldn’t find work during the recession face a much greater challenge,” she said in an e-mail Tuesday. “With little to no experience and major gaps in their resume, they must compete every year for entry-level positions against a new cohort of starry-eyed bushy-tailed recent grads.”

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As we concluded previously, whether it’s Europe in the 1930’s or the US during the same period (conflicts between strikers, the National Guard and armed militias), unemployment can create a powerful cocktail of unrest.

So a reminder for Canada's elites, turning your nation's young into slaves does not seem like a good solution to us…

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We can't help but see the irony that one hand we have the US president demanding raising minimum wage (i.e riasing the cost of labor for those on the margin of employment) as Canada's leadership see unpaid work (i.e. cutting the cost of labor) as a way to grow employment…

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Excerpted from Elliott Management’s Paul Singer letter to investors,

The consensus (bull) case:

The power of psychology is overwhelming, and investor sentiment indicates that the Fed can be trusted, that asset prices are being driven higher by QE and ZIRP, and that we should not worry too much about the unintended consequences, because the Fed will be able to follow a path to normalization and a soft landing. America, in any event, is the safe haven and always will be.

 

Moreover, goes the case, we may be at the sweet spot of the economic cycle. It has taken a long time to get here, but finally we are getting sustainable growth, and we can expect more of the same.

 

Interest rates are completely under control – in fact, long-term rates are in a secular decline, which is not nearly at its bottom.

 

Inflation is virtually impossible, and we really ought to be worrying about deflation instead. We need to focus on getting inflation higher, and growth will follow.

 

The currency is also under control. In fact, what could the dollar fall against? The competition is in much worse shape.

 

Banks are in far better financial condition than in 2008 and will gradually bleed off any remaining toxic assets that they own.

 

If anything starts to go wrong, the government will step in to fix it.

 

Pushing investors out on the risk curve in search of yield is a good idea and a clever way to encourage them to do what they should be doing on their own (i.e., taking risks to help the economy grow). We should not worry, because things will be okay.

 

We can even trust the representative branches of government, because elected officials will not have to do much that is unpalatable or challenging – the central bankers have it all covered.  

 

Above all, trust the Fed.

The opposite case is basically a refutation of every element above and compels us to look to history for clues about the next market, financial and economic environment.

Six years of stability after the financial crisis, with policies that we believe to be unsound and solutions that have not really solved anything, are concerning to those who want better policies and are afraid of when the next shoe will drop… However, sometimes unsound trends go far past where you think they should go, in both time and price.

 

Consequently, we at Elliott are always hedged.

 

So does it matter whether we are right or wrong about the risks? Yes, because when stocks started falling apart in 2000 and 2008, we knew it could be for real. People who had no comprehension of what a crash could do, or the possible boundaries of price movement, had their careers and/or capital destroyed by one or both of those episodes.

An understanding of history, context, the incentives of policymakers and the fundamentals of the economy is very useful, even essential, for survival, in order to develop a sense of humility and an appreciation for how broad the range of outcomes can be. To start with, we believe that any period of real deflation (however unlikely to occur in the first place) cannot continue for long, because of the alertness of policymakers to such an event and their oft-repeated determination to throw monetary policies at any hint of declining prices. Conversely, regardless of whether serious inflation is possible or on the horizon, a bond market collapse is always possible in a system that is not sound.

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We cannot possibly make the following statement any more clearly or strongly:

Policymakers and pundits, with rare and courageous exceptions, are marching (and looking) in precisely the wrong direction.

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Submitted by Nicholas Colas of Convergex

1,001 Nights Of Stock Market Stories

There is an old Wall Street chestnut that goes, “It’s not a stock market; it’s a market of stocks.”  Fair enough, but we’ll take a different approach today to complete this aphorism: “It is a market of stories.”  Yes, it is stories that vie for our attention, define our realities, and spur us to action.  Recent academic work on the subject reveals that the right narrative – ideally one with a strong human element – physically changes how we process information and make us more likely to empathize with and ultimately believe the stories we hear.  Too fluffy a concept for you?  The research we cite was partially funded by the U.S. Department of Defense’s Advanced Research Projects Agency (DARPA), and when they have an interest in something, rest assured it has a very serious purpose.  As for applications in the world of investing, recognizing powerful stories earlier than the pack is pretty much the job description for analysts and portfolio managers alike.  Just be aware that it is all too easy to fall for one as well. 

As a child, my parents would tell me stories out of the “1,001 Nights”, a collection of Middle Eastern tales that (in Western form, anyway) include Aladdin’s Lamp, Ali Baba and the Forty Thieves, and Sinbad the Sailor. Only in adulthood did I read the actual translations, which makes HBO’s Game of Thrones look like a 1950s “Archie” comic book. Even the framing of the stories is pretty nasty.  At the beginning of the first book we read about a king who, betrayed by his first wife, now chooses a young woman from his kingdom to wed every night.  And then early the next morning he has them killed. “It’s not you, it’s me, but follow the man with the ax anyway”…

This goes on until the Vizier’s own daughter, Scheherazade, decides to put an end to the serial killing of the country’s maidens.  She marries the king, but on their wedding night asks that her sister might visit for a few hours before the executioner comes at daybreak.  The sister asks for a story, and Scheherazade obliges.  The climax of the tale comes just as the sun rises, and by this point the King is so involved in the story that he grants Scheherazade a second day of life just to hear its conclusion. The next night she starts a new story, and the same thing happens at daybreak.  Fast forward 1,001 nights of stories (2 ¾ years) and the King has fallen love with Scheherazade and they live happily ever after. 

If you think this is just old-time storytelling with no place in a modern “Rational” society, consider that the U.S. Department of Defense funds research on how humans process stories through its Defense Advanced Research Projects Agency (DARPA).  These are the same folks that brought you highly advanced drone technology, cutting edge night vision systems, micro-sized GPS for people and munitions, and, well, the Internet (original name: ARPANET).  Their interest in storytelling is entirely pragmatic, as you can see from this 2011 posting on FedBizOpps (www.fbo.gov):

“DARPA is soliciting innovative research proposals in the areas of (1) quantitative analysis of narratives, (2) understanding the effects narratives have on human psychology and its affiliated neurobiology, and (3) modeling, simulating, and sensing-especially in stand-off modalities-these narrative influences. Proposers to this effort will be expected to revolutionize the study of narratives and narrative influence by advancing narrative analysis and neuroscience so as to create new narrative influence sensors, doubling status quo capacity to forecast narrative influence.”  (Translation: Help us understand what stories will cause people to act – especially those stories that we can transmit from a distance – that’s what “Stand-off modalities” means.)

One of the researchers involved in this work is Paul Zak, a Claremont Graduate University professor, researcher, and popular TED conference speaker.  In a Harvard Business Review blog posting last week, Dr. Zak outlined his recent research.  Here is a quick synopsis with link to the whole post below:

• One important driver of human empathy is a neurochemical called oxytocin, which “Is produced when we are trusted or shown a kindness, and it motivates cooperation with others.”
• With DARPA’s funding, Zak’s team “Developed ways to measure oxytocin release noninvasively at up to one thousand times per second”. 
• Through various studies, Professor Zak and his researchers isolated two drivers of oxytocin release in the human brain.  The first is attention – people have to shut out all the extraneous noise around them and focus on the story at hand.  The second was to have character-driven narratives, namely actual human beings that are relatable to the listeners/viewers.  Put those two things together – as Zak does in a 2013 article published by UC-Berkeley about research that focused the story of a young boy dying of cancer – and you get genuine empathy. 
• What does empathy get you?  Well, crassly put, money is one outcome.  In the Berkeley study, subjects volunteered a portion of their honorariums to charity after generating outsized amounts of oxytocin from a heart-wrenching video of a father and dying son.  Moreover, in another experiment where some subjects received synthetic oxytocin through the nose, that group contributed 57% more to charity after watching numerous public service ads than the control (no external oxytocin group).

Storytelling clearly matters a lot more than just being entertained or enlightened.  An attention-grabbing story about relatable people triggers an actual biological response which, in turn, drives us to action.  In thinking through what this means for investors, I arrived at the following list:

• We need people in the mix in order to feel empathy.  Wonder why the Federal Reserve does those quarterly press Chairperson press conferences?  Communication and information, yes…  Without them, however, it is far less likely that anyone will really connect with the story the Fed is trying to tell about the U.S. economy and its policies.  Now, if you just don’t like the U.S. central bank, this isn’t going to work on you.  Unless to get a hit of that synthetic oxytocin, perhaps.  But if you are on the fence, associating a real person with an abstract policy may help.  In short, you are more likely to “Buy in” to the policy and story. 
• Some investment communities and industry sectors are more prone to “People stories” than others.  Every decade or so the venture capital world goes through a meltdown, and part of that failure stems from an overreliance on a particular story.  Think “Eyeballs” in 2000.  More recently there was a good example of this published on TechCrunch yesterday, outlining the concept of “Fundraising Acceleration”.  Apparently venture capitalists are marking up any hyper-growth startup with outsized valuations simply because there are relatively few of them.  The idea is that these will be the big winners, so price is less of an issue than access to the equity of such companies.  The story here: valuation doesn’t matter – people and narratives do.  After all, valuation chatter doesn’t make for much empathy.  But a successful serial entrepreneur and a hot new idea sure do. Until, of course, they don’t. 
• Use this all to your advantage, and be aware of when you are being gamed.  If you are presenting information, realize that the relatable, people focused narrative is your friend if used judiciously.  And if you are watching a presentation, remember that you might be the focus of a purposeful manipulation meant to spark the creation of oxytocin and, by biochemical extension, empathy.

Sources:

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