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Long article, good read. Excerpt and link.
Perhaps one of the most overlooked phenomena in this world is the relationship between cause and effect. Financial markets and economics in general are often noteworthy exhibitions of a lack of recognition of this principle. In just a few minutes watching CNBC, you are bombarded with statistics that PROVE our miraculous economic recovery. The macro data has become better; anyone who denies that is disconnected from reality. However, as the markets have vehemently demonstrated recently, the fact is that these numbers have become increasingly irrelevant. Why you ask? Because we don’t live in a society where these numbers represent organic, secular conditions anymore; instead, they reflect the increasingly contradictory and escalating political tension of the world.
Importance of Geo-Politics
While CNBC talks about things like CPI, PMI, and Cramer’s PMS instead of bigger picture geo-political developments, their importance cannot be understated. And while many traders and investors do not heavily account for such macro elements (evidenced by the fact that the global economy could be brought to its knees by a largely unforeseen housing bubble), David Einhorn, whom I have had the fortune of meeting, perfectly explains the importance of this in a speech to the Value Investing Conference in October 2009. Einhorn, known for his bottom up investment style, found a greater appreciation for the importance of macro developments after the recent financial crisis. In the speech he offers several extremely poignant predictions based upon this macro-political perspective, almost completely vindicated by the events in 2010. He said:
This ideological change has become apparent in the market more generally as well. CNBC can toot all the numbers and expectations they want, the truth is economic data has taken a back seat to political circumstances in the new market.
To understand the causal dynamics of the current recovery it is necessary to ask “how” and “why” instead of asking the much trumpeted CNBC question of “what”. From this perspective it becomes clear that the “recovery” that we have experienced draws heavily on exceptionally generous intervention. The government response was in all likelihood necessary and has resulted in improved economic data; however, it seems that the stimulus improved the (certain) numbers simply for the sake of improving (certain) numbers. As this has become increasingly apparent, there has been a paradigm shift where political conditions and events increasingly overwhelm economic data and appear to continue to do so for the foreseeable future.
Perhaps the most pressing question is: “How much longer can sovereign governments afford to provide extremely loose conditions and subsidize private sector debt?” So how early is too early to remove stimulus? Einhorn wisely prophesied that government response to the financial crisis would make previously economic issues become subject to politics:
http://shadowcapitalism.com/2010/05/...-predict-2010/
Perhaps one of the most overlooked phenomena in this world is the relationship between cause and effect. Financial markets and economics in general are often noteworthy exhibitions of a lack of recognition of this principle. In just a few minutes watching CNBC, you are bombarded with statistics that PROVE our miraculous economic recovery. The macro data has become better; anyone who denies that is disconnected from reality. However, as the markets have vehemently demonstrated recently, the fact is that these numbers have become increasingly irrelevant. Why you ask? Because we don’t live in a society where these numbers represent organic, secular conditions anymore; instead, they reflect the increasingly contradictory and escalating political tension of the world.
Importance of Geo-Politics
While CNBC talks about things like CPI, PMI, and Cramer’s PMS instead of bigger picture geo-political developments, their importance cannot be understated. And while many traders and investors do not heavily account for such macro elements (evidenced by the fact that the global economy could be brought to its knees by a largely unforeseen housing bubble), David Einhorn, whom I have had the fortune of meeting, perfectly explains the importance of this in a speech to the Value Investing Conference in October 2009. Einhorn, known for his bottom up investment style, found a greater appreciation for the importance of macro developments after the recent financial crisis. In the speech he offers several extremely poignant predictions based upon this macro-political perspective, almost completely vindicated by the events in 2010. He said:
At the May 2005 Ira Sohn Investment Research Conference in New York, I recommended MDC Holdings, a homebuilder, at $67 per share. Two months later MDC reached $89 a share, a nice quick return if you timed your sale perfectly. Then the stock collapsed with the rest of the sector. Some of my MDC analysis was correct: it was less risky than its peers and would hold-up better in a down cycle because it had less leverage and held less land. But this just meant that almost half a decade later, anyone who listened to me would have lost about forty percent of his investment, instead of the seventy percent that the homebuilding sector lost.
I want to revisit this because the loss was not bad luck; it was bad analysis. I down played the importance of what was then an ongoing housing bubble. On the very same day, at the very same conference, a more experienced and wiser investor, Stanley Druckenmiller, explained in gory detail the big picture problem the country faced from a growing housing bubble fueled by a growing debt bubble. At the time, I wondered whether even if he were correct, would it be possible to convert such big picture macro thinking into successful portfolio management? I thought this was particularly tricky since getting both the timing of big macro changes as well as the market’s recognition of them correct has proven at best a difficult proposition. Smart investors had been complaining about the housing bubble since at least 2001. I ignored Stan, rationalizing that even if he were right, there was no way to know when he would be right. This was an expensive error.
The lesson that I have learned is that it isn’t reasonable to be agnostic about the big picture. For years I had believed that I didn’t need to take a view on the market or the economy because I considered myself to be a “bottom up” investor. Having my eyes open to the big picture doesn’t mean abandoning stock picking, but it does mean managing the long- short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time.
Stimulus I want to revisit this because the loss was not bad luck; it was bad analysis. I down played the importance of what was then an ongoing housing bubble. On the very same day, at the very same conference, a more experienced and wiser investor, Stanley Druckenmiller, explained in gory detail the big picture problem the country faced from a growing housing bubble fueled by a growing debt bubble. At the time, I wondered whether even if he were correct, would it be possible to convert such big picture macro thinking into successful portfolio management? I thought this was particularly tricky since getting both the timing of big macro changes as well as the market’s recognition of them correct has proven at best a difficult proposition. Smart investors had been complaining about the housing bubble since at least 2001. I ignored Stan, rationalizing that even if he were right, there was no way to know when he would be right. This was an expensive error.
The lesson that I have learned is that it isn’t reasonable to be agnostic about the big picture. For years I had believed that I didn’t need to take a view on the market or the economy because I considered myself to be a “bottom up” investor. Having my eyes open to the big picture doesn’t mean abandoning stock picking, but it does mean managing the long- short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time.
This ideological change has become apparent in the market more generally as well. CNBC can toot all the numbers and expectations they want, the truth is economic data has taken a back seat to political circumstances in the new market.
To understand the causal dynamics of the current recovery it is necessary to ask “how” and “why” instead of asking the much trumpeted CNBC question of “what”. From this perspective it becomes clear that the “recovery” that we have experienced draws heavily on exceptionally generous intervention. The government response was in all likelihood necessary and has resulted in improved economic data; however, it seems that the stimulus improved the (certain) numbers simply for the sake of improving (certain) numbers. As this has become increasingly apparent, there has been a paradigm shift where political conditions and events increasingly overwhelm economic data and appear to continue to do so for the foreseeable future.
Perhaps the most pressing question is: “How much longer can sovereign governments afford to provide extremely loose conditions and subsidize private sector debt?” So how early is too early to remove stimulus? Einhorn wisely prophesied that government response to the financial crisis would make previously economic issues become subject to politics:
http://shadowcapitalism.com/2010/05/...-predict-2010/
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