- Long term trends that will hold down inflation and consumption:
- Current high levels of debt inhibit consumption
- Capital market arbitrageurs enforce monetary and fiscal discipline
- Aging demographic fosters savings
- Global trading that promotes low wage growth
- Financial assets benefit more from the transition to lower inflation than from lower inflation itself—disinflation boosts bond prices, expands P/E, and improves corporate earnings.
- Make bigger bets when odds are more favorable! Good ideas warrant concentrated bets, not to be diversified away. As in blackjack, when odds are in favor, ignore the short-term winnings/ losses and maintain a long-term view.
- Have secular (3–5 year) view of macroeconomic trends (average length of business cycle)—demographics (most important), globalization, monetary policy, fiscal policy, strength/ weakness of the dollar. Shorter, too much noise; longer, too much unknown.
- Demographics is the most important (and highly predictable) trend. Developed countries’ populations are aging rapidly; young populations are found in emerging countries. Consumers (U.S.) increase spending dramatically from their 20’s to 40’s (at a decelerating rate), but spending decreases drastically from their 50’s onward.
- Jesse Livermore: “the big money was never made in the buying or the selling. It was always made in the waiting.”
- Seek to invest in countries with all these favorable characteristics:
- economic policies that promote high GDP growth
- stable political environment
- disciplined central bank
- competitive currency
- low debt/ high savings rate
- legal system that protects individual property rights
- The Plankton Theory: look to the lowest member of the economic food chain, for without their participation, markets will not move higher. For example, the first-time home buyer for real estate.
- Investing is largely psychological—know your weaknesses (i.e. adjust your timing if you are always early or late) and eliminate your ego.
- Gross forecasts about 6% for bonds and 8% for stocks for 1997–2000. In a likely 6% return world, a 1% management fee is a 15% commission! Real estate commissions are only 6%. Why should liquid stocks and bonds be more?? The maximum fee to pay for a (core) active fund should be only ½ of the category’s average fee.
- Option volatility exceeds realized volatility, in part because the extreme values of its legs are mis-modeled. Extreme values are less likely than predicted by stochastic models because extreme volatility causes actions (government and economic) to counteract it. Fischer Black describes it as market noise overpricing options. It pays to sell noise (short volatility).
- Increase maturity for short-term cash. Big difference in yield between 1-month money market instruments and 9–12-month instruments. Perceived illiquidity risk from managers less concerned with short yields than with immediate access to cash (to buy stocks). Extending maturity in the ultra-short area is best risk/ reward trade-off.
- Inflation is a disguised form of tax. For revenue, governments can tax, borrow, or print money.
- Mortgage bonds have negative convexity—maturity is lengthened in bear markets and shortened (prepayment risk) in bull markets, just the opposite desired investor outcome. However, their higher yields may be attractive in a stable interest rate environment.
- Bonds beat stocks in only 15% of 25-year rolling periods since 1801 (although all those periods occurred before the 20th century). Therefore, a portfolio shouldn’t be 100% stocks.
Finished: 1-Jan-2009