When I was younger, I used to feel pretty smug watching baseball games. It was before Moneyball, but Bill James was already around. And he was such a talented writer that he could convince normalish 10-year olds that they understood very deep things about the world that eluded most others -- or even that they somehow discovered these things by themselves. So listening to announcers fill air time with popularized hogwash ("you have to bunt in this situation," "this team can't win without more speed") seemed like a constant affirmation of the scales that lay over most everyone else's eyes. And Bill James was mostly right. Don't bunt. But then you get older. And you can't help but notice how many of the things that come out of your mouth when forced to speak extemporaneously are notably idiotic. Not quite the same as sitting alone in your bedroom with a disturbingly effeminate baby blanket and a copy of Baseball Abstract. Require me to fill three hours of largely dead time 162 times a year, and I will eventually claim that Jacob was the more talented Dylan. Now switch from checkers (sabermetrics) to 3D chess (macroeconomics). Suddenly, 'notably idiotic' is pretty much your best case. I try to remember that when I read most of the limited space WSJ and NYT articles and opeds (the FT is better) or especially watch CNBC after the Fed announces something like the extension of Operation Twist. Well, I actually have not matured much at all in the spontaneous smugness department, so I mainly scold myself later.Think about how hard this job is. Operation Twist is what? It is the Central Bank rearranging the maturity structure of Treasury Debt. What effect does this have on the economy? What do stock and bond market reactions (your main talking point if you are on CNBC at 12:31pm) tell you about how this move is affecting the private sector? Here is the decision tree that you have to go through if you want to be a Macro Bill James and not a Ken Harrelson.(1) What is already priced into the asset markets? Markets are forward looking, of course. But unlike Fed Fund futures, there is no explicit market for Operation Twist futures. Even if there were, it is not at all clear that you could capture the entire effect of the announcement relative to expectations, since the announcement is almost always about more than just a decision and a dollar amount. That's why if you go through the old Fed transcripts, they spend a large chunk of time sounding like a Sterling, Cooper creative meeting ("I don't like the use of the word 'but' there" -- actual instance). Did stocks go down because Operation Twist is considered a bad thing, or did they go down because expectations were for some kind of turbocharged Operation Twist or the like, and so it was really not enough of a good thing?(2) Set aside the complication of what Twisty expectations were priced in for a minute. Even if we understood the direction in which markets were surprised, how does the surprise actually work? One possibility is that it creates something called a portfolio rebalancing effect. The idea is that by replacing longer term treasuries, which have more term premium and duration risk, with shorter term treasuries, the public will adjust its now lower risk portfolios into other assets. Those assets are likely to be riskier (to achieve the same risk as they had before), which means they are likely not to be money or near substitutes for money. This could then raise asset prices, bringing Tobin's Q effects and perhaps wealth effects, and lower interest rates on government debt -- all raising Aggregate Demand.(3) But note that it is not at all guaranteed that this will or even should happen. An argument can be made, and has been made, that an operation like Twist or QE actually increases private sector risk. That is because longer term government bonds are actually the least risky asset in private portfolios right now, because they have negative beta (they go up the most when things go worst). This would essentially mean that such a move could create the exact opposite portfolio rebalancing effect: Private agents expect a decline in the amount of countercyclical assets available so they trade out of risk into safety, depressing AD.(4) But of course both of these effects might be rendered entirely moot by a version of Modigliani-Miller irrelevance. In short, by merely shifting assets back onto its own balance sheet, the government is simply transferring risk (either high or low depending on whether you believer (2) or (3)) from the assets directly held by the public to the part of the public's portfolio represented by remaining government liabilities and tax obligations, so the public essentially has the same portfolio as before on a look through basis. Even if this doesn't work perfectly, it might be an important mitigating factor in whether this kind of thing has any effect at all.(5) If you find that annoying already, it is not even the tip of the iceberg; you then have to deal with the second most undersold tenet in Macro journalism: Joint determination: All prices in an economy "happen" simultaneously in the sense that they affect each other. The so called transmission mechanisms like portfolio rebalancing or Tobin's Q can be thought of as really just stories to help us visualize that jointly determined process. What should happen if the traditional portfolio effect is in principle accurate (operation twist works to increase AD all else equal) and is also a surprise? At first it seems like stocks should rise and bonds should rise. But wait. If stocks rise because AD is expected to increase (this of course assumes there is some nominal problem that can be improved with a better equilibrium), then you might imagine people would expect higher inflation, and also probably higher real interest rates. So you could actually see bonds decline (higher yields discount higher expected rates), even though the entire mechanism is supposedly working by raising bond prices -- the trick is that bond prices are only rising relative to where they would otherwise be -- not actually.(6) And then there is the number one undersold tenet in macro journalism: expectations matter a lot. Because there is this: Fed policy is not just about the hydraulics of what the Fed is currently doing (portfolio shifts), it is about what its thoughts and actions convey about its reaction function: What it (and the rest of the government) might do in the future given various economic scenarios. Expectations about the Fed's reaction function aren't separate from hydraulic effects like portfolio rebalancing. They interact. Even if portfolio balancing worked in principle, it might be that the Fed's statement also conveyed pessimism (meaning more tightness than expected) about future policy. Maybe the statement leads people to believe that the Fed would require more economic distress than previously assumed before implementing even more unconventional policies. It isn't really right to say that this might override other channels like portfolio rebalancing. Rather, it makes more sense to say the more direct communicative effect on expectations and the aforementioned mechanical channels all become bound up in wherever expectations (and thus behavior) end up. In other words, they are jointly determined.And this is before even talking about whether in the current state of the world nominal variables can have positive real effects, or whether the Fed even has sufficient power to credibly change nominal expectations given its current operational limitations (no helicopter drops, no purchasing shares of BODY), or whether the Fed or the Treasury will end up "acting last" in determining the structure and duration of outstanding Treasury debt. The result of this incredible complexity is that a large percentage of the media and especially investment pundit discussions of monetary policy and macro either are or sound a lot like the same empty and under-thought filler of 1980s day-night doubleheaders. But in both cases, and especially this one, it's probably because the job is nearly impossible.
The result of this incredible complexity is that a large percentage of the media and especially investment pundit discussions of monetary policy and macro either are or sound a lot like the same empty and under-thought filler of 1980s day-night doubleheaders. But in both cases, and especially this one, it's probably because the job is nearly impossible. But the fundamental job of these commentators is really not to explain; rather, their job is to capture enough viewers or readers to increase the money their media corporation can make from advertising and subscription fees. So, if you and I are watching their inaccurate or inane commentary, rather than smugly basking in our understanding of how inane these commentators are, we should realize then that these commentators have done their job very well indeed.Same for Koyabashi, Cramer, Dr. Oz, Talib et al.
Also, if you read/follow Taleb http://en.wikipedia.org/wiki/Black_swan_theory. Even if "they" are right 99% of the time. "They" are still wrong.
Thanks for posting this hr! It was a very interesting read. “no purchasing shares of BODY “ – that was funny.
Here is the decision tree that you have to go through if you want to be a Macro Bill James and not a Ken Harrelson.I'm guessing this post was your attempt to lure GM back to the board? He gone!
will play some devil's advocate.1) some of the macro factors are pretty critical/central in some big picture/industry questions. commodity sector is invariably tied to sustainability of China economy. is the imbalance between US/China, Northern Europe/Club Med creating a mirage in assets (as argued by Napier and Zervos)? is peak margin in S&P tied to record deficit spending by the government (as argued by GMO)? there seems to be an implicit carry trade here, as the US government borrows at record low rate, while the deficit spending gets (at least partially) translated to record profits, which get capitalized at higher multiples and leads to higher "asset" and positive equity/wealth? Me managing small PA and deciding whether ANF gets 400bps merch margin recovery in 2H has nothing to do with these macro factors (although lower teen unemployment helps), but running big accounts at institutions in an RORO environment with fickle clients seems to require you have a view on the macro at any given time.2) i am amazed by the number of supposedly "bottom up" investors lamenting this environment sucks for "pure stock pickers". i could be way off, but aside from higher anxiety and regular frustration, i LOVE this environment with the extra volatility. What could be better than being able to buy your favorite names when the market is risk-off? i know my return would have been lower if not for so much intra-year/quarter volatility.3) boy is this fun. we are living in an unprecedented era where so many impossible events have occured. i always think of investing as a game, and macro is just adding new twists/plots to the game. even if i never hope to understand everything, i feel i am learning something new everyday.
in an RORO environmentRORO?Good post and comment.is peak margin in S&P tied to record deficit spending by the government (as argued by GMO)? there seems to be an implicit carry trade here, as the US government borrows at record low rate, while the deficit spending gets (at least partially) translated to record profits,At least to me this is the million dollar question. The broad market and many stocks are only "cheap" if you assume that current earnings are sustainable.FWIW, gc, on an individual level I've been watching how well the chart on ULTA has held up during the last 2 months of volatility. It looks like and acts like a stock that could be a leader if another broad market upleg occurs when Ben starts the party again. I'm curious if you've looked at the name, and if so have any thoughts on the business momentum looking out 12-18 months.
RORO is risk-on-risk-off, or risk-on-reality-off, as zerohedge likes to say.with regards to ULTA, it has incredible business momentum and some real visible drivers to keep current SSS going, but it is one of the very few momo retailers that have not cracked. so i'd be careful. in case you haven't noticed, quite a few of these names have corrected meaningfully from the high. FOSL, LULU, TSCO, TPX and today AZO/ORLY/AAP. the ones still left standing are PETM, ULTA, $ stores, off-price. my suspicion is we will see more of the winners taken out and shot on any signs of weakness like ORLY today. companies like ORLY and PG are simply not supposed to miss, yet recent industry data suggests June retail took another leg down, coinciding with historically seasonally weak period for retail stocks. ironically, i have been doing more buying last few days in the space. will be early as always.
must be nice to be Mr. Einhorn -- a mere rumor of him shorting LULU is enough to bring down the stock by 8%...
Nike just laid a HUGE egg... big miss in EPS/order. big jump in inventory. global slowdown?
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