Where You Stand Depends on Where You Sit…

I am talking about the rules that China does and doesn’t play by. China has developed an alternative to Western style democratic capitalism. Call it authoritarian capitalism if you will. China does not feel that it has to adapt and accept the standards from the West. It is developing its own viable, and it thinks, better model.

pedalling pg 1.jpg

Part of this model calls for the country to be world competitive if not dominating in ten high tech industries. This “Made in China 2025” is an admirable goal if it were not for the fact, as Mr. Trump and many critics argue, that China steals some of the technology involved here, forces companies who want to do business in China to disclose state-of-the-art technology and favors state led companies over foreign ones in procurement.

President Trump is calling China out on these moves. China has always been willing to make temporary changes to their buying and selling patterns to satisfy the U.S. but they have not been willing to make any systemic changes. Perhaps the only way to require them to do this is by brute force, restricting the sale of sensitive technology to Huawei for instance.

Knowing President Trump and his tweets, this all might be resolved amicably tomorrow, who knows, but the fact remains that China is a fast rising #2 with all the intention of being #1, and this power struggle with the U.S. will continue for a long time.

Ties pg 1.jpg

We risk today the danger of creating a two or three system model for the global economy, a system for China, a system for the U.S. and maybe a third system for Europe. This means perhaps different standards for 5G, different standards for PCs and smartphones and whole different platforms for social media. It will throw sand in the gears of global growth. The outcome is very much unclear, certainly above my pay grade right now. What will a Balkanization of the global economy look like? Will the world’s supply chain shift from China and if so to where? Back to higher cost U.S. or to Mexico, Vietnam, Malaysia, etc.? Will we see consumer nationalism develop, with the Chinese buying Huawei while we buy Apple? Lots of questions, few answers.

What Should We Be Doing Now?…

There is a general level of unease in the stock market today. Investors are not panicking but everyone is wondering, how long can this stock market rally continue? As the chart at the bottom shows, this current Bull Market is the longest in history. A big shoe has got to be about to fall or so goes one line of thinking.

quote pg 2.jpg

The quote from Warren Buffett to the right is spot on. You can teach investors all you want but when they get scared, they get scared. Peter L. Bernstein who died in 2009 reminded us about our ‘memory banks,’ those collective experiences we have lived through and which control our thinking about the future. We remember the Crash of 2008-2009 and the next one has to be equally painful or so says the human behavior side of our brain.

So how do we handicap the timing and severity of the next decline? Well we can turn to experts. We feel comfortable with experts, they speak authoritatively. But relying on experts may be the worst thing to do. Atlantic magazine in its June issue examined the record of experts. The National Research Council Committee on American-Soviet Relations has been running a test of expert forecasting about foreign affairs for thirty years. They have accumulated over 82,000 prognostications about the future.

They found that experts were horrific forecasters whether they were doing this over a short-term period or long-term. Experts get blinded by the narrowness of their knowledge and the inability to see the bigger picture. Better to practice ‘beginner’s mind;’ be open to many ideas and avoid the preconceptions of experts. Don’t underestimate the ability of laymen to make sense of this world. As Bob Dylan wrote, “you don’t need a weatherman to know which way the wind blows”.

If we can’t turn to experts then how about turning to what the market is saying? Here also there are problems. The Harris Reputation poll measures how people rate companies, highly rated or lowly rated. You would think that highly regarded companies would outperform more lowly regarded ones. Actually the reverse is true. The lowly regarded companies outperform. The reason is that highly regarded ones already sell at a high price reflecting their reputation. Low reputation stocks have very little expectation built into their price.

We are Value investors and believe in the idea that investors do not like to be associated with losers. They sell stocks with poor prospects down to levels even lower than they ought to be. A positive turn of events can boost Value stock prices significantly.

We don’t know when the next decline will come. Age alone does not end a Bull Market. Be careful not to abandon your long-term strategy out of fear of a short-term decline. In addition, protect yourself by finding generally successful companies selling at unusually low valuations. And finally, look further afield and consider international markets where valuations are lower than here in the U.S. In these uncertain times it is important to read the financial news but equally important, to read the tea leaves of your own emotions and behavior.

bull market pg 2.jpg

Can We Find a Cure for Aging?...

cartoon pg 3.jpg

According to Joseph Coughlin, an expert on aging and founder of MIT’s AgeLab, there are two simple questions that can determine how well you’ll navigate your later years: “Who’s going to change the light bulb, and how are you going to get an ice cream cone?” These appeared in a recent New Yorker article by Adam Gopnik, who visited Coughlin at his AgeLab.

These two questions pretty much cover things. The light bulb is about how you deal with the small tasks you never used to think about but that start requiring effort as you slow down and begin to ache and creak. The ice cream cone is about what you can access and enjoy in the world at large as you age. How far away is that ice cream cone? What if you can’t drive? What if you have no one who can bring the ice cream cone to you?

There’s a lot that can be done in the way we design homes, communities, products and services so that older people can live easier, fuller lives for longer. That’s one way to think about improving the experience of aging – and that’s what Coughlin, who wrote a book called The Longevity Economy, is interested in doing.

But there is another way to think about the challenges of aging. David Sinclair, a researcher on the biology of aging at Harvard Medical School, invites us to imagine this: Your doctor notices when you are 45 that your blood sugar is getting high and that you’re losing muscle mass. “Listen,” your doctor says, “I see you’re starting to age, so let me give you something for that.” That could mean holding off cancer, heart disease, dementia and other age-related illnesses for long periods of time.

As incredible as this may sound, it may no longer be so farfetched. There are dozens of companies and labs researching different pathways to extend human lifespans. Scientists already have expanded the lifespans of simple organisms like yeast and worms and extended that to animals like mice and monkeys. The study of aging is moving to the forefront of science – and it’s not the 20th century way of tackling one disease at a time, but a focus on treating aging at its source.

It all may seem a bit fantastic, but there has been a significant shift in the way we think about aging. Until very recently, we have viewed aging as a natural process – something inevitable to be accepted and managed. But now scientists are starting to think that there’s no valid reason for aging to be inevitable. They are thinking that aging might involve issues at the cellular level that can be corrected. In effect, they are thinking of aging not as a natural process, but as a disease that can be treated.

That’s a huge mental shift. The consequence is that aging research is getting much more attention than it used to. Sinclair noted in a recent interview that researchers focus on what is considered treatable, not what seems inevitable. This was true of cancer, which was considered a natural part of life for a century, but when it was shown in the 1970s that the disease process could be modified, the thinking changed.

Multiple pathways to counter aging are being explored. Perhaps the most interesting is cellular reprogramming, which involves introducing a combination of genes into an animal’s cell and seeing if that tissue rejuvenates as if it’s young. Essentially it is taking old cells and turning them into young cells, and it has shown promise – but just in mice, so remember it’s still early days.

A few other things to keep in mind: First, it’s not immortality that scientists are after -- people don’t want to live forever, but rather to be healthier for longer. Second, the FDA is a long way from being able to assess anti-aging therapies because it still views aging as a natural process. In contrast, the World Health Organization recently declared aging a treatable condition. Finally, there’s a lot of hype that makes it hard to separate fact from fiction. David Sinclair said that one of his challenges has been removing his face -- and Harvard’s name -- from websites for anti-aging products that he has nothing to do with and would never endorse.

The Yield Curve as Recession Predictor…

Economists and policy makers are spending a lot of time talking about the yield curve these days. This bond market metric plots the yields investors receive for different maturity bonds. Because they demand more compensation for holding longer-term debt, the yield curve typically slopes upward to the right (see chart below ). On rare occasions, however, the curve inverts and longer-term maturities offer lower yields than shorter-term maturities.

curve pg 4.jpg

So why should we care about a bunch of lines on a graph? The yield curve recently inverted, a development that occurred just prior to 9 of the past 10 economic downturns. The lag time between the yield curve inversion and the actual onset of recession ranged from 8-20 months with an average time of one year. To understand why the yield curve might have predictive powers consider that prevailing interest rates are actually a reflection of millions of investors’ views. When these investors expect the Federal Reserve to lower rates in reaction to a slowing economy, they flood into higher yielding long-term debt. This increased demand drives down long-term yields relative to short-term yields.

Several economists, however, are now suggesting that the outlook may not be as bad as it seems. More specifically, they claim that the increased demand for long-term Treasury debt comes not from investors’ fears of recession but from other recent developments in the bond market. To meet post-crisis regulatory requirements, banks have had to boost their reserves of ultra safe assets like Treasuries. Meanwhile, insurance companies and pension plans looking to reduce funding risk have also soaked up long dated bonds. Finally, the U.S. government may be playing a role. The U.S. Treasury finances most of its growing budget deficit by issuing short-term debt. This increased supply is likely driving up short-term relative to long-term rates.

Before you breathe a sigh of relief, consider the possibility that the yield curve may be less a predictor of recessions than a cause of them. The reasoning here is pretty straightforward. Banks fund their lending activity with short-term borrowings. When these funding costs go above what they can earn on long-term loans, lending dries up and with it general economic activity. Further, businesses may react to yield curve inversions by cutting back capital spending and other investment plans.

While the yield curve’s inversion can’t be viewed as a positive, investors should take a deep breath before running for the exits. First, measures of the “real” economy like unemployment and consumer confidence are holding up pretty nicely and research has shown that when the yield curve is flashing red and the real economy is doing well, it’s best to pay attention to the real economy. Second, economic predictions are notoriously bad (consider that most economists failed to see the global financial crisis coming).

spread pg 4.jpg

Unfortunately, we cannot know with any accuracy when the next recession will hit. But if history holds, when it arrives it will be neither fatal nor permanent. How to prepare? Make sure your current mix of bonds, stocks and cash is in line with your overall tolerance for risk. And don’t forget to hold sufficient cash to cover short-term (3-12 months) spending needs. In a down market, nothing soothes the nerves like cold, hard cash.