Happiness Runs – Janus, By Bill Gross

 Happiness is wanting what you have

And not wanting what you don’t have.

Shakyamuni Buddha, 500 B.C.


The three grand essentials of happiness are: something 

to do, someone to love, and something to hope for.

Alexander Chalmers

Happiness runs in a circular motion…

happiness runs, happiness runs.

Donovan, 1969


I think a lot about happiness – what makes a person happy, whether or not happiness should even be a life’s priority – things like that. A good high school friend stunned me at the early age of 17 by suggesting we should not necessarily try to be happy. Sacrifice, service, devotion to a cause were higher orders, he felt, although presumably, since those were choices, their pursuit could secondarily lead to happiness.

Through the years I’ve accumulated a short list of quotes that express a personal view of what makes people happy. You, I’m sure, have your own candidates, but most of them probably resemble some of the ones listed above: Stay busy doing something you enjoy; be mindful of other people and the world in, around, and above you; don’t let your reach exceed your grasp; find someone to share your happiness with. My favorite of all of these is the one above by Donovan – that somewhat kooky “love generation” folk singer of the late 1960s. “Happiness runs in a circular motion…happiness runs, happiness runs.” There may be more to this refrain, however, than appears at first glance, the entirety of which I’ve tried to encapsulate artistically in my open-ended smiley face that wasn’t ever-popular when Donovan crooned the tune. For years I thought that the gist of Donovan’s phrase was the obvious – the “pay it forward” allusion that suggests what goes around, comes around – and it undoubtedly is. But there are hidden nuances, at least to me. The “running in a circular motion” also connotes a self-contained, inward-looking, self-satisfaction that equates happiness to being content with yourself as a person. And the last phrase – “happiness runs, happiness runs” may speak to the Buddhist philosophy of impermanence and the priority of the moment. Donovan might not rank up there with Kant and Spinoza, but his little song packs a powerful message. Rock on, flower child, wherever you are.

And while happiness may run in a circular motion, it seems history may too – or at least it may rhyme, as Mark Twain once said. Pictured below are two of my notes written not recently, but in 2003. They are as relevant today as they were then. “Financial repression” runs…in a circular motion, it seems. In 2003, though, central bankers had rarely contemplated the monetary policy instruments that could lower and then artificially cap interest rates. Although my notes correctly allude to “all means including ‘ceilings’ ” to keep the cost of financing low, the expansion of central bank balance sheets from perhaps $2 trillion in 2003 to a now gargantuan $12 trillion at the end of 2016 is remarkable. Not only did central banks buy $10 trillion of bonds, but they lowered policy rates to near 0% and in some cases, negative yields. All of this took place to save our “finance-based economy” and to raise asset prices upon which that model depends. As any investor would admit, these now ongoing policy panaceas have done just that – promoted higher asset prices and engendered a modicum of real growth. In the process however, as I have frequently written, capitalism has been distorted: savings/investment has been discouraged by yields/returns too low to replicate historic productivity gains; zombie corporations have been kept alive in contrast to Schumpeter’s “creative destruction”; debt has continued to rise relative to GDP; the financial system has not been cleansed and restored to a balance where risk and reward are on a level plane; disequilibrium has replaced equilibrium, although it is difficult to recognize this economic phantom as long as volatility is contained.



But in order to control volatility, and keep a floor under asset prices, central bankers may be trapped in a QE-forever cycle, (in order to keep the global system functioning). Withdrawal of stimulus, as has happened with the Fed in the past few years, seemingly must be replaced by an increased flow of asset purchases (bonds and stocks) from other central banks, as shown in Chart I. A client asked me recently when the Fed or other central banks would ever be able to sell their assets back into the market. My answer was “NEVER”. A $12 trillion global central bank balance sheet is PERMANENT – and growing at over $1 trillion a year, thanks to the ECB and the BOJ.

Central Bank Balance Sheet (US$)


Source: Bank of England website “Following Bank of England money market reform on 18 May 2006 the Bank of England ‘Bank Return’ was changed. This series forms part of the new Bank Return, with data starting on 24 May 2006.”


An investor must know that it is this money that now keeps the system functioning. Without it, even 0% policy rates are like methadone – cancelling the craving but not overcoming the addiction. The relevant point of all this for today’s financial markets? A 2.45%, 10-year U.S.Treasury rests at 2.45% because the ECB and BOJ are buying $150 billion a month of their own bonds and much of that money then flows from 10 basis points JGB’s and 45 basis point Bunds into 2.45% U.S. Treasuries. Without that financial methadone, both bond and stock markets worldwide would sink and produce a tantrum of significant proportions. I would venture a guess that without QE from the ECB and BOJ that 10-year U.S. Treasuries would rather quickly rise to 3.5% and the U.S. economy would sink into recession.

So what’s wrong with financial methadone? What’s wrong with a continuing program of QE’s or even a rejuvenated U.S. QE if needed? Well conceptually at first blush, not much. The interest earned on the $12 trillion is already being flushed from central banks back to government fiscal authorities. One hand is paying the other. But the transfer in essence means that monetary and fiscal policies have joined hands and that the government, not the private sector, is financing its own spending. At an expanding margin, this allows the private sector to finance its own spending and fails to discriminate between risk and reward. $600 billion in the U.S. for instance goes into the repurchase of company stock, whereas before, investment in the real economy might have been a more lucrative choice. In addition, individual savers, pension funds, and insurance companies are now robbed of the ability to earn rates of return necessary to maintain long-term solvency. Financial Armageddon is postponed as consumption is brought forward and savings suppressed and deferred.

For now, investors must go with, indeed embrace this financial methadone QE fix. Quantitative easing will continue even though the dose may be reduced in future years. But while a methadone habit is far better than a heroin fix, it has created and will continue to create an unhealthy capitalistic equilibrium that one day must be reckoned with. Yields will likely gradually rise (watch 2.60% on the 10-year Treasury), yet they will stay artificially low due to the kindness of foreign central bank quantitative easing policies. But that is not a good thing. Happiness runs…Happiness runs, and so one day, will asset markets, artificially supported by quantitative easing.

The Economic Risk of Ignoring Arithmetic, John P. Hussman

“Let us not, in the pride of our superior knowledge, turn with contempt from the follies of our predecessors. The study of errors into which great minds have fallen in the pursuit of truth can never be uninstructive… Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one… Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome… Nations, like individuals, cannot become desperate gamblers with impunity. Punishment is sure to overtake them sooner or later.”

Charles MacKay, Extraordinary Popular Delusions and The Madness of Crowds, 1841

When we observe the greatest follies of our predecessors, the episodes of speculative madness that come most immediately to mind are the pre-crash bubble peaks of 1929, 2000, and to a lesser extent, 2007. Unfortunately, we are in the midst of yet another episode of equivalent speculative madness, but one that will only be recognized in hindsight, and in the recollections of our children. They too are likely to take pride in a feeling of superior knowledge, forgetting the same lessons, and eventually creating another bubble and collapse of their own. The herd mentality is human nature. As in 2000-2002 and 2007-2009, when the S&P 500 collapsed by 50% and 55% respectively, we’ll likely see that herd mentality expressed on the downside soon enough. That also is human nature.

The stock market bubble that ended with the September 1929 peak began in August 1921, running just a few days beyond 8 years in duration. The bubble that ended with the March 2000 peak began in October 1990, running fully 9 years and 5 months in duration. Those two episodes represent the longest bull markets in U.S. history. The current half-cycle began at the March 2009 low, and has now run 7 years and 10 months in duration, making it the third-longest advance in history, placing it just 2 months short of the 1929 instance, but a full year and 7 months short of the 2000 instance.

What’s notable here is that by the time the bubbles that ended in 1929 and 2000 reached a duration similar to the present, they were already experiencing a significant increase in volatility and the frequency of corrections. From a time-perspective, for example, 7 years and 10 months into the bull market that began in October 1990, it was August 1998, about the point that the S&P 500 took a nearly 20% dive. By July 1999, the S&P 500 had eclipsed its mid-1998 high, followed by a correction of over -12% during the next 13 weeks (taking the net gain from mid-1998 to just 5%). The S&P 500 then rallied again into December 1999, followed by a nearly -10% correction over the next 8 weeks. Immediately after the final market high in March 2000, the S&P 500 quickly gave up more than 11% in the following month, wiping out a year of gains, and the bear market had hardly even started.

Likewise, by the time the bull market from the 1921 low extended into late-1928, the market became much more susceptible to corrections. Following a peak in November 1928, the Dow Jones Industrial Average lost nearly -13% in a month. The next peak in February 1929 was followed by a -8% correction over the following two weeks. A fresh high in May 1929 was followed by a -10% correction over the following four weeks. The final high in September 1929 was followed by an initial drop of nearly -15% over the next 6 weeks. Put simply, once the bull market was as mature as the present one has become, further market gains were not smooth. Nor were they ultimately durable.

 From a valuation perspective, the current run is similarly mature. The most reliable market valuation measure we’ve identified across history (having the strongest correlation with actual subsequent market returns) is the ratio of nonfinancial market capitalization to corporate gross value-added (MarketCap/GVA), with Warren Buffet’s old favorite, the ratio of market capitalization to gross domestic product, just slightly behind, followed somewhat further by a variety of measures that normalize earnings in one way or another (by comparison, neither the ratio of price/forward operating earnings nor the Fed Model even come close). By the time valuations reached levels similar to recent extremes during the advances toward the 1929 and 2000 bubble peaks, it was already mid-1929 and late-1999, respectively. The market losses over the subsequent 10-12 year periods directly reflected the extent of the corresponding overvaluation. At present, we estimate S&P 500 nominal total returns averaging just 0.8% annually over the coming 12-year horizon. If our measures of market internals were to improve materially, particularly across interest-sensitive sectors, we would be inclined to allow leeway for valuations to become even more extreme. But in the end, richer valuations would only imply steeper losses over the completion of the current market cycle, and even weaker returns on a 10-12 year horizon. For a review of current valuation extremes, see Economic Fancies and Basic Arithmetic.

As we enter 2017, the great risk for investors is not in missing out in an exhausted run that already rivals the 1929 and 2000 extremes, but in failing to contemplate a 50-60% market retreat over the completion of the current cycle. The chart below presents some of the most reliable valuation measures we follow, showing percentage deviations from their pre-bubble norms. S&P 500 forward earnings and revenues are imputed prior to 1980 based on their relationships with available data having a longer history. The measures below have correlations as high as 94% with actual subsequent S&P 500 total returns, particularly on a 10-12 year horizon. At present, they range between 120% and 150% above their respective historical norms. A run-of-the-mill cycle completion, even ruling out historically undervalued levels, would imply a 50-60% market loss.


In recent weeks, we’ve observed the single most extreme syndrome of overvalued, overbought, overbullish conditions that we define. I’ve noted before that with one exception, each instance of this syndrome has been associated with a major market peak (1929, 1972, 1987, 2000, 2007), though in a few cases an initial signal was followed by a secondary signal several weeks later that marked the final high. The sole exception was a set of extremes in late-2013 and early-2014 during the height of enthusiasm about zero interest rates and quantitative easing. Our excruciating lesson in the half-cycle since 2009 was that in the presence of zero interest rates, overvalued, overbought, overbullish extremes were not enough to generate risk-aversion among investors. One had to wait for market internals to deteriorate explicitly before taking a hard-negative market outlook. Given that the Federal Reserve is now in a tightening mode and our measures of market internals have turned negative, my impression is that investors are playing a dangerous game by ignoring present extremes in the belief that this is anything but a mature and vulnerable financial bubble.

We’re certainly open to the possibility that market internals will shift to a more favorable condition (when investors are inclined to speculate, they tend to be indiscriminate about it, so the uniformity of market action across a broad range of individual stocks, industries, sectors and security types is a useful measure of investor risk-preferences). Yet while a constructive shift would at least temporarily suspend our hard-negative market outlook, a strong safety-net would remain imperative. Even in a bullish world where the current advance might extend to match or surpass the duration and valuation extremes of the 1929 and 2000 bubbles, investors should brace themselves for amplified volatility in the near-term.

The economic risk of ignoring arithmetic

 I’ve previously detailed why arithmetic of demographics and productivity suggests a likely central tendency of less than 2% annually for real GDP growth over the coming 8 years, with even 3% growth being both optimistic and rather implausible. Increased allocation of savings toward productive investment would certainly benefit the country over a period of decades, but is unlikely to materially alter the course of economic growth over the span of a few years. In my view, the primary economic risks here are clearly to the downside: years of Fed-induced yield-seeking speculation have already set the financial markets up for an equity market collapse on the order of 50-60% over the completion of the current market cycle, coupled with a secondary crisis in a mountain of covenant-lite debt, as the indebtedness of U.S. corporations (even after netting out cash holdings) has been driven to record levels relative to corporate gross value-added.

To understand our muted enthusiasm about the economy here, recall that GDP growth is driven by the sum of employment growth and productivity growth. While there may be some vicarious gratification in the idea of “getting tough” with companies about domestic jobs and imports, the fact is that even if we assume a 2% unemployment rate in 2024, built-in labor force demographics would still limit annual growth in U.S. employment to just 0.7% annually in the interim. That demographic fact will not be altered by the disturbing practice of singling individual companies out for intimidation, as a substitute for informed, uniform policies and equal treatment under the law. From an economic standpoint, the spectacle is little but a carnival sideshow, because the job numbers at issue are absurdly small relative to the ordinary turnover of the U.S. labor force. In 2016, for example, there were 5.2 million jobs created in an average month, with an average of 5 million job separations, for a net increase in payrolls averaging about 200,000 jobs per month (JOLTS data – yes, employment turnover is that high). Entertainment value aside, the likely contribution of employment growth to GDP growth in the coming years is likely to be in the range of 0.2-0.7% annually, barring an economic recession that could pull this figure to negative levels.

Aside from short-run outcomes, any durable and sustained acceleration in GDP growth will have to come from productivity growth. That, in turn, is highly dependent on gross domestic investment (broadly defined to include intangible investments such as education and job-training initiatives to boost labor productivity). This is the component of economic growth that faces the largest downside risk in the coming years. See, productivity growth is highly dependent on growth in gross domestic investment, and it’s here where the incoming administration seems to have little understanding of economic arithmetic.

Part of that arithmetic can be expressed as the “savings-investment identity,” which is not a theory but an accounting equality. We can state it as follows. U.S. gross domestic investment is always identical to the sum of: household savings, government savings, corporate savings, and savings acquired from foreigners.

The other bit of arithmetic has to do with trade. You can think of it this way. For every dollar of “stuff” we import from foreign countries, we have to pay for it by transferring an equal value of “stuff” in the other direction. That stuff can either be goods and services, or securities. We obtain the savings of foreigners by exporting securities to them, rather than goods and services. But here’s the accounting hitch. A net import of foreign savings is equivalent to running a trade deficit. By exporting more securities than we import, we obtain foreign savings to finance U.S. gross domestic investment, but it must then also be true that we’re exporting fewer goods and services than we import.

Here’s the problem: pursue a policy to reduce the trade deficit, and you automatically (and possibly unintentionally) pursue a policy to reduce the import of foreign savings. Now, that may be all well and good when domestic sectors are running surpluses. If the combined savings of households, businesses and the government are more than enough to finance our own gross domestic investment, the U.S. can run a trade surplus and can lend the excess savings to the rest of the world, becoming a net creditor. The problem is that’s not anything close to the position of the United States.

Our nation relies heavily on the import of foreign savings to finance our gross domestic investment. If the new administration pursues larger fiscal deficits, that financing gap will become greater, not smaller. If it pursues larger fiscal deficits (reducing government saving to even more negative levels) while also pursuing punitive trade policies and import restrictions (reducing the import of foreign saving), the net effect will be to crowd out and sharply restrain gross domestic investment. In theory, a boost to the sum of household and corporate savings could ease the gap, but in practice, the two are negatively correlated, because the corporate share of GDP is relatively high when wages and salaries are low as a share of GDP, and also because boosting household savings by refraining from consumption tends to depress corporate earnings and resulting saving.

The bottom line is that large and sustained increases in U.S. gross domestic investment have always been achieved by financing a substantial portion of the increase with foreign savings. Booms in U.S. gross domestic investment are systematically associated with “deterioration” in the trade balance. Conversely, declines in U.S. gross domestic investment are systematically associated with “improvement” in the trade balance. The chart below provides a good picture of how this relationship looks in practice, in data since 1947.


Outcomes are not independent of initial conditions. While there are certainly policy shifts that could encourage greater productive investment and raise the long-run trajectory of economic growth, no shift in economic policies is likely to produce rapid, sustained economic growth in the next few years because the underlying factors that drive rapid, sustained growth aren’t presently in a position to support it. GDP growth is the sum of employment growth plus productivity growth. Strong employment growth typically emerges when there is a relatively large pool of available and unemployed labor, because that pool of available labor provides the economy room to run. Strong productivity growth requires expansion in gross domestic investment, which in turn is enabled by deterioration in the trade deficit. As a result, rapid productivity growth typically begins from points where the trade deficit is relatively narrow or even in surplus. That’s why the economic booms following the 1982 and 1990 recessions were so strong – both expansions started from a high unemployment rate coupled with a trade surplus. At present, we’ve got a low unemployment rate and a rather deep and persistent trade deficit. Rapid growth will emerge from much different conditions than we observe at present, and one doesn’t want to be exposed to a great deal of economic risk in the interim, because the risk during that transition period is emphatically to the downside.

We are left, then, with a hypervalued and mature market advance that now rivals the two greatest speculative mistakes in U.S. history; with extreme overvalued, overbought, overbullish conditions coupled with a tightening Federal Reserve and dispersion across key measures of market internals; with an incoming administration that by all evidence values spectacle and coarse provocation over diplomacy and informed, dignified leadership; and with an economic agenda so lacking in the foundations of basic arithmetic that a needless retreat in U.S. gross domestic investment may be the unintended consequence.

As for stocks, last week, my friend Jesse Felder published a piece headed with a cartoon of Lucy snatching away a football while a trusting Charlie Brown tumbles upside-down after attempting a kick, imagining that this time might be different. This time will not be different. Look carefully at the advances that led to the 1929 and 2000 peaks, but look only backward, ignoring what was ultimately to come. Look at the 2007 peak, or the 1972 peak, or the 1987 peak, with the same backward-looking perspective. Overvalued bull markets lure investors to hold on precisely by convincing them that at every seemingly overvalued point in the recent past, prices have triumphed to achieve even higher levels. It’s important to recognize that during the majority of those preceding advances, extreme overvalued, overbought, overbullish syndromes were absent, and market internals typically demonstrated broadly positive uniformity, indicating that investors remained inclined to speculate despite rich valuations.

In contrast, in market cycles across history, by the time extreme valuations were joined by extreme overvalued, overbought, overbullish syndromes and deteriorating market internals, whatever potential gains remained were purely transient, and were overwhelmed by losses over the completion of the market cycle. The half-cycle since 2009 was different only in that the Federal Reserve’s deranged policy of zero interest rates and quantitative easing encouraged investors to continue speculating long after extreme overvalued, overbought, overbullish syndromes emerged. The extension of this speculation was admittedly frustrating for us. In the presence of zero interest rates, one had to wait for internals to deteriorate explicitly. Even after the adaptations we introduced in mid-2014, the combination of an extended top-formation and a performance-chasing rush toward passive indexing hasn’t created much opportunity to demonstrate the benefit of historically-informed, value-conscious investment discipline. Still, we’ve demonstrated the benefits of our integrated discipline nicely in previous complete market cycles, and we remain convinced that it is well-suited to navigate the completion of this cycle and those to come.

While we’re seeing persistent signs of dispersion, particularly across interest-sensitive sectors, my sense is that investors are mistaking the market gain in 2016 as a repudiation of the idea that extreme valuations, dispersion across market internals, and overextended conditions are of real concern. My own expectation is that even if there is a longer life to this bull market, the 2016 gain will be erased rather soon, in a quite ordinary late-stage correction, much like those that emerged with increasing frequency approaching other major market peaks. Our outlook will change with conditions, particularly with respect to valuations, market internals, and the presence or absence of overextended syndromes. For now, the stock market is now much like Wile E. Coyote temporarily hovering just past the edge of a cliff. The moment of descent isn’t clear, but I believe it would be a mistake to climb onto his shoulders.

Cinco frases que condensan la filosofía de inversión de Charlie Munger Funds People

Warren Buffett es una de esas personas que aparecen cada cierto tiempo en medios de comunicación, incluso aunque no haya protagonizado ningún hecho noticioso; su amplia experiencia y sabiduría en los principios de inversión value han hecho del “Oráculo de Omaha” un inversor seguido y respetado. Ahora bien, comparativamente no es tanta la atención que se presta al que ha sido su mano derecha durante los últimos 55 años, Charlie Munger.

David Clark es un inversor, abogado y coautor de ocho libros sobre Warren Buffet que acaba de publicar asimismo un libro sobre Charlie Munger. Ha detallado recientemente para MarketWatch una selección con sus cinco citas preferidas del inversor, que denomina “munguerismos”.

1-“El deseo de enriquecerse rápidamente es bastante peligroso”

“Munguer me enseñó cuando era joven que intentar hacerse rico rápidamente es peligroso”, afirma Clark. Se refiere por una parte a la amplitud de instrumentos con los que operar en el corto o muy corto plazo (derivados, contratos, oscilaciones en el precio de una acción, futuros…): “Una enorme suma de gente está intentando hacer lo mismo, muchos de ellos están mucho mejor informados de lo que estoy yo, y el movimiento en el corto plazo de cualquier valor o derivado está sujeto a todo tipo de giros exagerados debido a acontecimientos que no tienen nada que ver con el valor real en el largo plazo del negocio subyacente”, explica.

Otro atajo para generar rentabilidad es mediante el apalancamiento. Clark también tiene advertencias al respecto: “Para enriquecerse rápidamente, con frecuencia tienes que utilizar el apalancamiento para amplificar las pequeñas oscilaciones de precios para conseguir grandes ganancias. Si las cosas van en contra de nosotros, también se pueden convertir en pérdidas verdaderamente grandes”.

Por estas razones, continúa el experto, Munguer y Buffett han evitado el apalancamiento a lo largo de su carrera profesional, centrándose sólo en apuestas largas basadas en los fundamentales económicos de largo plazo de las empresas.

2 “Saber qué es lo que no sabes es más útil que ser brillante”

En este caso, Clark pone un ejemplo real de esta afirmación. A finales de los 90, muchos inversores se lanzaron a comprar negocios tecnológicos basados en internet, alimentando así la burbuja que pinchó en 2001. “Munguer sabía que no entendía estos nuevos negocios de internet, por lo que él y Berkshire Hathaway los evitaron por completo. Gran parte de Wall Street pensó que había perdido su toque. Pero cuando la burbuja bursátil puntocom finalmente estalló, y se perdieron muchas fortunas, fue cuando Munger pareció brillante”, resume Clark.

3 “La gente trata de ser inteligente. Lo único que intento hacer es no ser idiota, pero es más difícil de lo que muchos piensan”.

La filosofía value de Munger le lleva a adquirir compañías que han sufrido un revés en el mercado, pero cuyos fundamentales económicos siguen intactos. Las mantiene en el largo plazo, hasta que eventualmente los subyacentes impulsan la cotización.

“La única cosa con la que Munger tiene que ser cuidadoso es al no hacer nada estúpido, que en su caso suelen ser en gran parte errores por omisión como no actuar cuando ve una inversión, o comprar una posición muy pequeña cuando se presenta la oportunidad. He descubierto que esto es en realidad más difícil de hacer de lo que uno puede pensar”, resume Clark.

4 “Invierte sentado. Le vas a pagar menos a los brokers, escucharás menos sinsentidos y, si funciona, el sistema impositivo te da uno, dos o tres puntos porcentuales al año”.

En este caso, el argumento tiene que ver con que un inversor puede hacer más dinero si compra un negocio que presente unos fundamentales excepcionales y lo mantiene en cartera durante muchos años, que si en cambio efectúa muchas operaciones de compra y venta en anticipación de movimientos del mercado. “Si uno tiene paciencia para mantener una inversión durante 20 años, sólo habrá que tributar una vez, lo que según Munger es lo mismo que conseguir una rentabilidad extra de uno a tres puntos porcentuales al año”, explica Clark.

El autor pone un ejemplo de cómo obra el interés compuesto a favor de los inversores a lo largo del tiempo: una inversión de un millón de dólares que genere un interés compuesto del 4% anual habrá alcanzado al cabo de 20 años los 2.191 millones de dólares. Si a esto se añaden el 3% extra de la tributación, entonces el interés compuesto ascendería al 7%, por lo que la inversión podría llegar a alcanzar los 3.869 millones de dólares.

“De acuerdo con Munger, el tiempo está de parte de los negocios que tiene fundamentales excepcionales trabajando a su favor. Pero, para los negocios mediocres, el tiempo es una maldición”, concluye el autor.

5 Maneras de quitarle un caramelo a un niño

La última afirmación de Munger se refiere a un modismo inglés que no tiene un equivalente literal en español (“My idea of shooting a fish in a barrel is draining the barrel first”), pero que tiene que ver con la noción del inversor de qué inversiones resultan tan fáciles como quitarle un caramelo a un niño.

Clark interpreta la última pieza de sabiduría de Charlie Munger así: “A veces el mercado, que es corto de vista, ofrece una oportunidad de inversión que es tan obvia que es difícil no lanzarse a ella. Suele ocurrir cuando los inversores tienen pánico y venden todas sus inversiones, incluso las que tienen fundamentales estupendos a largo plazo”. Estos momentos son los que encierran las oportunidades: los valores caen y a Munger le resulta más fácil invertir en ellos, siempre que se traten de negocios de mucha calidad que se hayan quedado infravalorados.

For Keynesians and Austrians, “Uncertainty” means two different things By G. P. Manish and Felicia Cowley

Keynesian economics has witnessed a remarkable resurgence since the crisis of 2008. The inability of mainstream economics to predict or explain the crisis led many economists to become skeptical of its core macroeconomic tenets. Several have turned the clock back to the ideas of Keynes to make sense of the housing bubble and the ensuing recession.
One such explanation inspired by the General Theory emphasizes the endemic uncertainty of the future and its implications for market stability. Championed by Paul Davidson1 and popularized by Robert Skidelsky,2 this line of thought blames the crisis and recession on the fickle expectations and “animal spirits” that guide investment in a market economy.3
Per this thesis, in an uncertain world, entrepreneurs and investors suffer from mood swings. Optimism regarding the future abruptly gives way to pessimism. Fluctuations in economic activity are the result of these variations in outlook.
With its focus on uncertainty, this line of thought bears a striking resemblance to Austrian ideas. Moreover, its rejection of mathematical probability as a foundation for expectations is echoed by several prominent Austrian economist.
Nevertheless, while Keynesians conclude that the uncertainty of the future renders a market economy inherently unstable, Austrians embrace uncertainty without losing faith in the order generated by a market economy. What lies at the root of this puzzle?
Keynes on Expectations, Uncertainty, and Market Stability

Think of Mary, a plastic bottle manufacturer drawing up plan to open a new factory. Given the durability of the investment, her decision is based on a set of long-term expectations. How does Mary arrive at these estimations of future prices?
In a neo-classical world, she does so by absorbing as much information as possible regarding past prices. Using this information, she calculates the numerical probabilities associated with various prices and forms her expectations based on these probability distributions.

In such a world, expectations share a deterministic relationship with the past. The numerical probabilities associated with future prices are inferred mechanistically from those associated with past prices. Thus, Mary’s expectations of the future are objective in nature. Anybody else in her place would have come to identical conclusions regarding the future with the information at hand.

Keynes sharply disagreed with this approach. Long-term expectations, he argued, are formed in a fog of uncertainty. This renders mathematical probability useless as a basis for forming one’s expectations. Since the future may differ significantly from the past, information about past prices provides “no scientific basis on which to form any calculable probability whatever” regarding the likelihood of future prices.4
Entrepreneurs and investors cannot mechanically extrapolate probability judgments regarding the future from an analysis of information regarding the past. As a result, their expectations are subjective in nature. Mary’s expectations now bear a personal stamp.
These subjective expectations share no connection to the past. The inability to use probability to form expectations renders the future unknowable to entrepreneurs and investors. Unable to turn to the past to assess the likelihood of future events, they find themselves confronted by a radical uncertainty.
In such a world, Mary’s decision to build a new factory is not the “outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” Instead, it is governed by her “animal spirits;” by a sense of “spontaneous optimism” that results in an “urge to action rather than inaction.”
Nevertheless, even in a radically uncertain world, investments must be guided by some expectations regarding the future. Instead of grounding them in an analysis of the past, Mary bases her expectations on an assessment of what others believe regarding the future.
Lurking behind her animal spirits are expectations formed as the result of an attempt on her part to “conform with the behavior of the majority or the average.” A similar striving on the part of everyone else gives rise to a “conventional judgment” regarding the future, shared by the overwhelming majority of entrepreneurs and investors.
Based on the flimsy foundations of the psychology of opinion and with no moorings in experience, this conventional judgment is subject to sudden and violent change. Like a school of fish, investors and entrepreneurs swim this way and that, always taking their cues on what to do from others, without recourse to any solid foundations in which to ground their expectations.
Buoyed by an optimistic conventional judgment, investors, with positive animal spirits pumping through their veins, rush to produce more capital goods, lifting the fortunes of workers with them. Soon the judgment turns and pessimism sets in. Investors no longer have the urge to act. They become quiescent, and unemployment increases.
Thus, for Keynes the endemic uncertainty that surrounds the future gives rise to an inherently unstable market economy. Fluctuations in output and employment are endogenous to the market and are ultimately to be traced to the shifting sands that underlie the prevailing conventional judgment regarding the future.
The path to greater market stability requires heavy government intervention. It is the job of the state to counter the waxing and waning of animal spirits and help stabilize the level of investment, output and employment.
Uncertainty and Subjective Expectations in the Austrian Framework
Prominent Austrian economists such as Mises,5 Lachmann,6 and Rothbard7 agree with Keynes’s rejection of a mechanistic relationship between past and future prices.
This rejection is the result of a consistent application of the subjective theory of value. The prices of the past result from the individual valuations that prevail in a specific set of circumstances. Two individuals, however, can form different valuations in the same circumstances. Moreover, the same individual may react differently to identical conditions at two different points in time.
It follows that the reemergence of a similar set of conditions in the future need not result in the reappearance of the same set of prices as in the past. Thus, there is no simple, deterministic relationship between the past and the future. Instead, the future is inherently uncertain.
This has implications for the formation of expectations. Entrepreneurs cannot study past prices, calculate the numerical probability associated with them and then simply extrapolate these numbers into the future. As a result, mathematical probability is not a suitable foundation on which to base expectations. However, this does not imply that we know nothing about the future. The past can still serve as a guide to action.
Entrepreneurs can still estimate the likelihood of future events. They do so by trying to understand the motivations underlying the valuations of market participants in specific situations in the past. They must peer beneath the veil of past prices and must analyze why market participants acted the way they did under the given conditions.
This analysis of unique, heterogeneous situations as they arose in the past, and not the numerical probabilities associated with past prices, provides the raw material to appraise the valuations and prices that will prevail in the future in a different set of conditions. Thus, in the Austrian framework, expectations do not rest on utilizing numerical probability but on interpreting and understanding the past.
This, as in the case of Keynes, lends them a subjective flavor. Nevertheless, the subjective expectations of entrepreneurs do not coalesce into a homogenous and ever-shifting conventional judgment regarding the future. Instead, these expectations are heterogeneous. Two entrepreneurs may come to different conclusions regarding why individuals behaved the way they did in the past. Moreover, their grounding in the past gives them a basis in reality. Thus, they are not whimsical and subject to random fluctuations.
Subjective Expectations, Profit and Loss, and Market Order in the Austrian Framework
The expectations of entrepreneurs, while subjective, exhibit a discernible pattern. The ability to appraise the future is not distributed evenly across market participants. Instead, in a market economy there are leaders, or those who are better able to formulate a judgment of the future based on the past, and there are others who are less proficient at doing so.
The profit and loss system ensures that the better appraisers are rewarded for their more successful judgments and accumulate capital. Those who are less successful at this endeavor are, meanwhile, gradually stripped of their capital. Thus, they lose influence in shaping the course of the market.
This process of entrepreneurial selection allows for the coordination of the decisions of producers and consumers. It ensures that, at any given moment in time, the best appraisers of the future are in control of making the key production decisions in the economy. Thus, in the Austrian framework, uncertainty and subjective expectations are compatible with market order and stability.
The key to ensuring this is a price system that results from the voluntary decisions of market participants to engage in mutually beneficial exchange. The prices that emerge on the various factor markets must reflect the appraisements of the participating entrepreneurs. Any interference with such a system of prices can interfere with this process of coordination and the order generated by the market.
An artificial reduction of the interest rate that results from an expansion of the money supply is an example of such an intervention. The increase in liquidity interferes with the process of entrepreneurial selection. In fact, it turns this system on its head.
Profits no longer reward those entrepreneurs who allocate scarce resources to the highest ranked ends of the consumers. Instead, they reward those who, misled by the artificially low interest rate, embark on production projects that are unsustainable. Those entrepreneurs who correctly perceive the underlying unsustainability now lose control of the capital at their disposal and gradually lose the ability to influence the course of affairs.
Thus, it is monetary expansion and an artificially low interest rate and not the endemic uncertainty of the future that generates booms and busts and market instability. In a free market, thanks to the profit-loss system, resources are allocated primarily by those who are best at grappling with uncertainty. In a world of artificially cheap credit, however, the very same system rewards those entrepreneurs who engage in the consumption of capital and the malinvestment of scarce resources.

“Stagflation On The Horizon” By Paul Brodsky

Stagflation on the Horizon

Logic and current trends suggest that declining output growth accompanied by higher prices will begin hitting economies and facing policy makers in the coming years. Markets should begin sniffing out this stagflationary macroeconomic setup this year.


We have published data showing global output growth is in decline and have argued this trend will continue. Indeed, a long term graph of US Real GDP growth implies a change in complexion since 1999, from credit-induced boom-bust economic cycles to a secular trajectory of decline (red lines on graph 1).

Graph 1: US Real Gross Domestic Product: Percent change from preceding period is in secular decline


This trend is especially troublesome following the debt-induced wash-out recession in 2008/2009, subsequently offset by zero-bound interest rates and central bank asset purchases. Since then, real GDP growth, characterized by middling output and low consumer inflation, has languished on a low plane, bouncing between 2.5 percent and 1.6 percent (shaded box on graph 1).

The US Bureau of Economic Analysis will not release its initial GDP estimate for Q1 2017 until April 28, but credible high frequency reports suggest real US output growth is in the process of falling below its low plane. The Atlanta Fed’s GDP now forecasts growth of only 1.3 percent in the first quarter. Among the factors weighing on the updated outlook are softer projections for household spending and non-household capital expenditures. Even more ominous is that this estimated slow growth included a month (February) in which the average temperature was ten degrees above normal – the hottest in sixty years.

Weak output growth is a far cry from the Fed’s official 3.1 percent forecast based on broad econometric models. This more optimistic forecast has more influence over the Federal Open Market Committee, which establishes and executes monetary policy. Accordingly, the Fed has communicated it will hike rates today and hinted it will again two or three more times in 2017.

Declining secular growth stems from the downside of pervasive debt assumption, which retards capex and consumer spending. Unperturbed, policy makers are doubling down. GaveKal Capital published the following two graphs showing how critical Treasury debt issuance has become to US growth. The first shows how debt assumption is increasing far more than GDP ($1.05 trillion of federal debt vs. $632 billion of GDP in the latest quarter). Clearly, it takes a lot of government debt assumption to drive output growth.

Graph 2: Diminishing Impact of Federal Debt on Nominal GDP: 2007 – 2016


To prove its point, GaveKal notes a close correlation: “In the first three quarters of 2015, debt growth was held in check by the debt ceiling and fiscal conservatives in Congress. Notice the negative effect on GDP growth in this period as growth slowed each quarter. Then in the fourth quarter of 2015, the debt ceiling was suspended and the flood of federal debt began again. Predictably, growth picked up too.”

GaveKal then extended the same graph back 35 years and expressed the time series annually. We can see from Graph 3 below that output growth regularly outpaced debt assumption when a dollar of debt produced more than a dollar of output; which is to say when the US economy functioned properly. This was real economic growth – growth that was not borrowed and that was expected to be repaid someday.


Graph 3: Diminishing Impact of Federal Debt on Nominal GDP: 1980 – 2016


 As always, Treasury must service its debt by issuing new debt, and raising the debt ceiling has been a constant source of conflict among US legislators. Last week, Treasury Secretary Mnuchin asked Speaker Ryan to persuade the House to raise the ceiling as soon as possible. If Congress does not raise it above $20 trillion, experts say Treasury would default on its debt by late summer or early fall 2017.

We are of the view that Congress will once again raise the debt ceiling, but that it will come at a significant cost. One of the major sources of the recent rally in equities and higher Treasury yields has been enthusiasm over Donald Trump’s economic initiatives. If raising the debt ceiling is delayed or tied to legislation that triggers future debt retirement, then expectations for future US growth would decline, as would US equities and Treasury yields.

Even if raising the debt ceiling goes smoothly, we think global output will continue to drop. Using debt to promote output growth is playing out across the world. Despite massive debt growth, output is static or declining in Europe…






…and even India:


Where is the global driver of output growth? Which geography or segment of society has a balance sheet large enough and un-levered enough to support a return to a debt-fueled boom-bust economic cycle?

Are we to believe that changes in US fiscal, regulatory, immigration and trade policies would have the power to persuade businesses and consumers around the world to reverse course – to not care about the exchange value of their currencies – so that they produce and consume for the benefit of American output and labor? Even if President Trump succeeds at raising US GDP to 3 percent, which would be no easy feat, how sustainable would that be and would it even matter for US multinationals that must grow abroad?

Investors should take note of what should logically be one of the highest-frequency leading indicators for the onset of a recession – retail spending. S&P retail sector stocks, as expressed in the XRT ETF, have declined 13 percent over the last six months in spite of a very strong stock market, and for good reason. Table 1 shows that in the last two quarters profit margins in the retail sector have crashed:

Table 1: Leading Indicator of Recession: Retail Sector Profit Margins are crashing


Watching US market ebullience in the face of a tiring, highly-indebted US economy that lacks an obvious new outlet for credit growth is like watching a slow motion car crash. We expect continued disappointing consumption, corporate profits and real growth rates to continue in 2017, in the US and around the world, and expect it to be followed by declining global trade and economic malaise.


We expect rising inflation to accompany falling output, and to understand why we offer a wonky but practical discussion of inflation.

Classic economics suggests demand and inflation should track each other higher and lower. Such a correlation, however, is not as tight in real life as it is conceptually. Super-economic factors associated with the exogenous management of global trade and credit greatly affect supply in ways often unintended by policy makers. From time to time supply shortages arise independent of the economics of production and demand. This creates significant economic dis-equilibria, leading to substantial inflation.

The last time this occurred was in the 1970s. OPEC oil exporters, bothered by the unknown future purchasing power of the new fiat dollars they were being forced to receive in exchange for their crude, limited its supply and drove up its price. Since energy was needed for manufacturing and transporting goods and services, the general price level rose across economies, even as demand and the need for labor fell. So, policy-induced supply disruptions led to slowing output and rising prices – stagflation.

Since then a global monetary regime that prices oil and most other trade goods in fiat dollars has been in force. US policy makers have maintained a generally stable dollar and, as importantly, strong dollar-denominated assets, which have provided global suppliers with an attractive destination for their wealth.

A stable dollar and generally rising US financial assets have created a fairly stable level of perceived wealth creation across the world. Were the dollar’s exchange rate or capital markets to fall, then US dollar and asset holders (foreign and domestic) would have great incentive to liquidate their holdings. Thus, the perception of the US as the global hegemon is the key to stability in the global economy.

What would cause capital flight out of the US? The obvious answer is the general perception that the dollar and the US economy will weaken more than those of other major economies.

This does not seem to be the case today, at least in relative terms. Following the financial crisis, the Fed acted aggressively to de-leverage the US banking system and was then first to taper and stop quantitative easing. US dollars and capital markets attracted global wealth. More recently, the Fed was also the first among major central banks to begin raising benchmark interest rates, which has further boosted the exchange value of the dollar vis-à-vis other major currencies. The recent enthusiasm over President Trump’s economic initiatives has provided a further boost to US corporate equity. All seems copacetic presently for dollar and US asset holders around the world.

Graph 4: DXY Index: a strong US dollar


Imminent Problem: A Scarcity of Dollars

Not so fast. Relative strength in the dollar stems from positive interest rate differentials and the natural demand for dollars to service, rollover and repay dollar denominated debt. Total US credit market debt totaled over $60 trillion (before the Fed stopped publishing it last quarter), which is five times M2 and fifteen times base money – the amount of deliverable dollars available to repay it. (The $60 trillion figure does not include off balance sheet obligations like Social Security, which would boost the multiple further.)

Graph 5: US dollar Leverage


There is also a scarcity of dollars held in foreign hands relative to the scale of the global economy. This will lead to a decline in dollar reserves held abroad. Recall that global trade volume is mostly based in dollars. A decline of dollars held in reserve limits global trade, pushing global output down. This, in turn, speeds incentives to raise the status of other major currencies to compete with the dollar.

To date, US bond issuers have had an easy time servicing their obligations because the dollar has been strong and they have produced sufficient revenues in dollars. The more pressing problem may arise from non-US issuers of dollar credit, which has doubled over the last ten years to $10 trillion. This credit also has to be serviced, rolled over and repaid in dollars. We anticipate increasing pressure among non-US dollar creditors to obtain dollars as the Fed hikes US interest rates, strengthening the dollar further.

The most pressure will be felt by emerging market sovereigns, banks and other companies that have issued about $3.2 trillion in dollar bonds. While further dollar strength would increase exporters’ profit margins, it would also reduce gross trade volume. Top line output of EM economies would suffer and they would likely raise consumer prices to maintain nominal growth rates. Inflation.

A discussion of the US dollar and dollar assets (including US real estate) without a discussion of dollar denominated liabilities is like trying to clap with one hand. Depending on how one counts, 25 to 95 percent of US dollars have liabilities attached to them. To service or repay these liabilities, more dollars have to be created. Simply liquidating assets to service or repay them will not work because for every liquidation there must be a buyer and the buyer must have dollars (that do not exist) to settle the trade.

Interest rates attached to liabilities ensure that the gross amount of liabilities will grow at a compounding rate, and higher interest rates ensures liabilities will grow faster. This, in turn, puts further pressure on assets to generate returns in excess of the negative return from liabilities. Eventually, this pressures policy makers to make sure asset prices rise more than the compounding rate of liability growth.

Ultimately, helping to maintain the appearance of rational asset valuations and decent commercial fundamentals becomes secondary to policy making institutions principally charged with protecting the dollar-centric global monetary system. We are currently far along on this spectrum.

We argue the US economy, US assets, the Fed and US fiscal policy makers are displaying obvious signs of late-stage fatigue associated with protecting the current global regime at all costs. As in the 1970s, the triggers for goods and service inflation within a slowing global economy will be currency related and a dearth of supply flowing through the trade channel, but rather than oil, this time the world will lack an adequate supply of increasingly scarce dollars needed for debt service.


The Political Solution: Dollar Inflation

Milton Friedman famously noted “inflation is always and everywhere a monetary phenomenon”. In the post-Bretton Woods monetary system, the pricing and supply of money and credit are not determined by production, but rather by monetary and currency exchange policies. Central banks and treasury ministries manufacture inflation through policy administration.

This is easy to see in extremis. During the financial crisis central banks were able manipulate the general price level higher to counteract the onset of deflation. We learned from the 2008/2009 experience, however, that central banks cannot determine where new money and credit mostly flow – to production or to assets. Central banks can directly manipulate only bank balance sheets, and banks, in turn, tend to lend more to issuers and buyers of assets when the organic need for production is not increasing.

The organic need for more production in the US (and everywhere else) is falling, as evidenced by declining global output growth. The only lever US policy makers will soon have left to pull, if they want to maintain the USD-centric global system, will be coordinated currency dilution (i.e., devaluation).

Oil is still very important to manufacturing and transportation, but oil exporting countries no longer have the same influence over global pricing, thanks to Russia’s ability to compete in global trade and the more recent fracking revolution in the US. The exogenous influence that would produce global economic dis-equilibrium and bring about stagflation today would be money itself, specifically US dollars.

To produce consumer inflation coincident with declining or contracting output, there must be an exogenous influence over prices outside the reach of central banks. We believe that influence is actually – and ironically – contracting production. The less production in an economy, the less influential that economy’s factors of production are in the global economy, and the less influence its central bank has over the global supply of goods and services.

The Fed has already recognized, and communicated to the public in its statements over the last two years, that its monetary policies also consider the strength of the dollar, trade and the global economy. We think it will have to soon recognize declining global output growth and the impact a strong dollar has on it. Our guess is that the Fed would like to hike rates as much and quickly as possible over the next two years so that it can then reduce them – to weaken the dollar – as global output sinks deeper.

In the end, the Fed will not be able to protect unilateral US dollar hegemony. Officials at the Fed and other major central banks, working bilaterally and with the BIS, IMF and WTO, would have to try to bring the purchasing power value of all currencies down together in relation to the real value of global production. Doing so successfully would be a monumental bureaucratic undertaking. We imagine it will be messy from social, political, economic and, especially, financial perspectives.

The Fed will have to turn on the spigots and create dollars for US and foreign creditors and, if they are lucky, debtors too. Stagflation will appear. The markets should begin getting a whiff of this soon.