If markets can go up a lot, they can go down a lot. And when an asset class gets more volatile, it gets riskier. Your risk appetite hasn’t changed over the past couple of months, so your appetite for stocks should really have gone down.
If you borrow a lot of money from a friend, or lend a lot of money to a friend, then ultimately your friendship is likely to suffer. The same dynamic is now at work in the EU.
Can the SEC just release, daily, the names of all the companies to whom it has sent Wells notices? Moody’s stock has plunged today after it disclosed late on Friday that it received a Wells Notice on March 18. Mish says that the receipt of the notice “is a significant event that Moody’s failed to report to shareholders”, but Reuters is talking about “relatively short six-week lag in disclosing that it got a Wells Notice”.
I don’t understand what purpose is served by letting companies make their own decisions as to whether or not receipt of a Wells notice is a material event. But this one certainly does, since it raises the possibility that Moody’s will cease to be officially recognized as a ratings agency:
On March 18, 2010, MIS received a “Wells Notice” from the Staff of the SEC stating that the Staff is considering recommending that the Commission institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization…
The Staff has informed Moody’s that the recommendation it is considering is based on the theory that MIS’s description of its procedures and principles were rendered false and misleading as of the time the application was filed with the SEC in light of the Company’s finding that a rating committee policy had been violated.
The finding in question relates to the scandal uncovered by the FT two years ago; the wheels of the SEC grind slowly, but once it reaches the point of issuing a Wells notice, it’s pretty clear that it’s taking things very seriously. What’s more, it’s clear that even a large market reaction to news is often insufficient, and that it’s never too late to sell. On May 20 2008, Moody’s stock closed at $42.69; after the FT broke its story on the 21st, it plunged to $35.89. Today, it’s at $21.88. And if it turns out to be at serious risk of losing its NRSRO status, it will surely fall further still.
Update: Henry Blodget reports that Moody’s CEO Raymond McDaniel dumped 100,000 shares of stock at $29 a share the day the Wells Notice arrived. Looks bad: as Blodget says, even if it was an automatic sale, shouldn’t he have canceled it once he received material non-public information?
Ylan Mui reports on the “Hill Blitz” orchestrated last week by payday lenders, aggrieved that they might at last face federal regulation:
According to a study by the Federal Deposit Insurance Corp. released in December, about a quarter of American households have little or no access to banks or other traditional financial services; many rely instead on payday lenders and check cashers.
But in back-to-back meetings with dozens of members of Congress last week, industry executives argued that their sector is already regulated by a complex web of legislation in the states, including some that ban payday lending. A federal regulator would create another layer of work that would increase their costs and potentially put some providers out of business, they said. In addition, they are often the only alternative for consumers who cannot qualify for — and sometimes do not want — a bank account or credit card.
It’s completely insane that a system which protects the relatively well-off customers of banks might include a carve-out specifically excluding the unbanked from any federal consumer protection. They are, after all, the people who need such protection most. And I’m particularly tickled that the payday lenders seem to think that the fact that they’re banned in some states is a good reason for a federal consumer protection agency not to regulate them at all.
The worrying thing about all this, however, is that the less-government-is-better-government crowd is likely to lap it up. And it seems that the consumer-protection rules were drafted far too sensibly, which means that as the payday lenders achieve success in their lobbying efforts, they’ll weaken the final agency far too much.
The right thing to do, it seems, would have been to take a leaf out of Blanche Lincoln’s book. After she proposed that investment banks be forced to spin off their swaps desks entirely, she put the banking lobby on the back foot: all of the lobby’s efforts are now being put towards weakening or repealing that one rule, and the rest of her derivatives legislation seems much more likely to sail through the Senate. Maybe Chris Dodd should have proposed banning payday lenders. Then they would be lobbying for mere regulation, rather than agitating against it.
The best price-to-rent ratios yet — Dept of Numbers
Things Lady Gaga Wants — Twitpic
Adventures in anonymous sourcing: do you believe “art experts who have heard details of the transaction”, or do you believe “most of the players with a keen need to know the prices”? — Art Market Monitor
My op-ed on Hollywood box-office futures — NYT
A fantastic anti-Facebook rant from Ryan Singel — Wired
Is the massive EU bailout a case of “too much, too late”? At $1 trillion, give or take (depending on the highly-uncertain value of the euro), it’s certainly enormous: Mohamed El-Erian calls it “a completely new level and dimension” in terms of European policy response. But the late-night negotiations of European finance ministers might yet fail to pass muster with national governments. After all, as Kevin Drum notes, the $700 billion TARP bill was initially voted down by the House of Representatives, and this deal has to be ratified by not one but many different legislatures.
Meanwhile, Peter Boone and Simon Johnson have some very scary numbers about Greece in particular: it will have to cut spending by a whopping 11% of GDP; its debt-to-GDP ratio will rise to at least 149% of GDP in a best-case scenario; and realistically Greek GDP could fall by 12% between now and 2011. Now that’s a recession.
Meanwhile, Lee Buchheit and Mitu Gulati have a paper out showing just how easy it would be for Greece to default. Buchheit is the godfather of sovereign debt restructuring, and he notes that uniquely among countries in that position, most of Greece’s indebtedness is governed by its own domestic law:
No other debtor country in modern history has been in a position significantly to affect the outcome of a sovereign debt restructuring by changing some feature of the law by which the vast majority of the instruments are governed.
In this context it’s worth noting that Simon Johnson, who used to be the IMF’s chief economist, says that the Fund “floated in some fashion an alternative scenario with a debt restructuring, but this was rejected by both the European Union and the Greek authorities”. What that means is that the idea is being seriously talked about at the highest levels — and that even if the Greek government isn’t going to crack right now, it has a clear “in case of emergency, break glass” Plan B temptingly sitting there for whenever the pain of recession becomes unbearable. With Lazard on board as sovereign advisors, a clear plan of action from Buchheit and the IMF comfortable in principle with a default, the path of least resistance is quite clear.
The obstacles to default would be the Greek banks, which would become insolvent overnight, the Greek pension funds and of course, the EU more generally, which is clearly putting up all these billions today in order to avoid any euro zone default. As Anna Gelpern says, “Greece’s political leverage to restructure may be limited, even if its legal leverage is considerable” — but only insofar as it considers EU and euro zone membership a blessing rather than a curse.
So while the EU’s trillion dollars is surely sufficient to prevent any country from having to default in the next few years, I fear that its enormity will only exacerbate tensions between the euro zone countries over the long term. They’re not all partners together anymore: now they’re bifurcating into the rich lenders, on the one hand, and the formerly-profligate debtors, on the other. The mind-boggling sums involved are only going to increase resentments both of the south in the north and of the north in the south.
The Euro is at more risk than it has ever been. And for the new generation of politicians in France and Germany the compromises of the 1990s may not mean so much. We don’t know how much they are prepared to risk to defend the status quo. They don’t have direct memories of firebombed cities, of fathers not returning home, of mothers and sisters raped by the Red Army. I don’t think we’d have the same worry if Kohl and Mitterand were still around. We would trust them more not to f— about. Again, like the ECB, Merkel and Sarko are untried; their being in charge implies less risk, more uncertainty. And the French disengagement on this whole issue worries me.
To recast my matrimonial analogy, the parents have promised to bail their wayward children out of jail. And they think that the children will respond overnight with gratitude and with a fundamental change of behavior. Does that ever actually happen?
Many thanks to the guys at HuffPo, who splashed my video from Friday all over their front page this weekend: the resulting post has now received well over 2,500 comments, and there’s even now a “Felix Salmon Investment Advice” tag over at HuffPo, which is scary.
Naturally, the video being less than 80 seconds long, there wasn’t room for a lot of background and exegesis. But the message I was trying to send is not that I think stocks are going to fall. Rather, it’s that volatility has risen, and that it makes sense to sell stocks in periods of high volatility.
I had a very interesting conversation with Barry Nalebuff today, co-author of Lifecycle Investing: he’s the guy with the idea that young people should lever up their stock-market investments, and that pretty much everybody under the age of 40 should have 100% of their retirement funds invested in stocks. I wrote about his idea a couple of years ago, and I found it intriguing; my main issue with it is that it’s very hard to implement in practice, and that someone trying to do so might well fail miserably. Basically, it’s far too complicated for a typical young investor to even try to follow.
Barry made one thing very clear to me today: if you don’t believe in the existence of the equity premium — if you don’t believe that stocks are going to outperform bonds over the long term — then you shouldn’t invest in stocks at all. Even if you’re completely agnostic on the issue — if you have no idea whether the equity premium exists — you should still have no money in stocks.
The advice in Barry’s book is entirely for people who are invested in the stock market, and who will invest even more in the stock market. They are likely to put in far too much money towards the end of their lives, when they’re at the peak of their earning power, and far too little at the beginning; Barry’s idea is to even things out a bit so that they’re less likely to get wiped out by a freak stock-market fall just before they retire. If you can follow his strategy — and that’s a very big if — then it’s actually safer than most retirement-fund strategies.
So let’s say that you’re a long-term investor, and you believe in the equity premium, and so you want to invest a chunk of your money in stocks. What percentage of your money should that be? Ayers and Nalebuff helpfully provide a downloadable “Samuelson Share Calculator” to come up with a number for that.
The Samuelson Share is named after Paul Samuelson, and basically says that the percentage of your retirement funds that you should have in stocks is found by a pretty simple formula:
Samuelson Share = Return / (Risk^2 x RRA)
Here, Return is the expected equity premium: the degree to which stocks will outperform bonds, on an annualized basis. Risk is the VIX, and RRA is your own Relative Risk Aversion.
On the downloadable spreadsheet, you can fill in whatever numbers you like for the different variables. Ayres and Nalebuff plug in a pretty high equity premium of 5.04%: that doesn’t mean that they expect stocks to rise by 5.04% a year, remember, that means that they think stocks will outperform Treasuries by 5.04% a year. I find that very optimistic, but fine, let’s leave it there. They also assume an RRA of 2, which means your risk appetite is greater than that of about 76% of the population. Given the expected audience for their book, maybe that’s reasonable. And finally, they plug in a value of 18% for the VIX. With all those inputs, the Samuelson Share output is 78%: you should have 78% of your investments in stocks, on average, over the course of your investing life.
But now what happens if you change the 18% value for the VIX to its actual closing level on Friday, which is 40.95%? Suddenly, the Samuelson Share plunges to just 15%.
And if you go from a portfolio with 78% stocks to a portfolio with 15% stocks, then that means you have to sell more than 80% of your stocks, pretty much overnight.
Meanwhile, if you think that the equity premium is just 1% rather than 5%, your Samuelson Share falls even further, to just 3%. And if your risk aversion is a pretty typical 4, rather than a relatively aggressive 2, then your Samuelson Share becomes a barely-visible 1.5%. At that point, you basically have to sell all your stocks.
And remember, none of these calculations are based on the expectation that stocks will fall — in fact, they’re all based on the expectation that stocks will rise!
The point here is that volatility alone is reason enough to exit the stock market. If you want your lifetime investments to have an average 78% exposure to the stock market, then it makes sense to have 100% or even 200% exposure when you’re young. But that’s no longer the case if the VIX is somewhere over 40. (And remember, it hit 80 at the height of the market chaos at the end of 2008.)
I feel I ought to have some money in the stock market. But if I take the spreadsheet and plug in an equity premium of 2.5%, a VIX of 30%, and an RRA of 2, then my Samuelson Share comes out at a decidedly modest 14%. And that’s being very generous, in my view, when it comes to the equity premium.
You don’t need to have a very long memory to remember how loss-averse people turn out to be when the stock market plunges. They hate it when that happens — even if their stock-market investments are long-term savings which they have no need to liquidate. That kind of risk aversion is — or should be, in any case — an incredibly important driver of asset-allocation decisions. And in a time of great uncertainty and stock-market volatility, the lesson to be drawn is that most of us will be able to sleep much better at night if we’re not invested in the stock market.
Just ask Barry Nalebuff. His net worth isn’t in stocks: it’s tied up in a company he co-founded, Honest Tea. Which has surely provided a much better return than any index fund, no matter how leveraged: ten years after he founded it, Coca-Cola bought a 40% stake for $43 million.
Thanks to Johannes Bruder of Hamburg University for sending me this intriguing chart:
I suspect that the pattern would continue were you to include non-European countries as well; what’s interesting to me is the way in which there’s much more variation among eurozone countries than there is at the bottom of the scale, between Germany and countries like the UK and Switzerland which set their own interest rates.
As for trades, I wonder whether the chart might be pointing to a long-Ireland, short-Italy relative-value trade here. That trade has a positive carry, and if the two countries even so much as converge, you end up making a nice profit. Ireland has already shown that it’s politically grown-up enough to be able to implement tough fiscal austerity. I don’t think anybody really believes that of Italy.
Jake Dobkin interviews Swoon — Gothamist
Kanellos the Greek protest dog — Guardian
Carlos Slim’s rep denies NY Post report; says billionaire didn’t visit Newsweek, isn’t upping NYT stake — Forbes
Raj Rajaratnam’s defense docs — Raj Defense