Two classic understatements

China’s policies have focused on addressing the economy’s significant and longstanding financial vulnerabilities. But the shift in priority toward stabilizing growth may mean slower progress on deleveraging and heightened medium-term risks for China and the entire region. – Emphasis mine [Link]

This one from Barry Ritholtz:

You can have a committee of 10 geniuses that proves collectively to be a moron [Link]

The quote is attributed to Cliff Asness by Barry Ritholtz.

The legend and the myth of Warren Buffett

Fans of Warren Buffett must read these two blog posts. The scales fell from my eyes a long time ago. I am glad that Michael Lebowitz captures the strengths and contradictions of Warren Buffett rather well. Eric Cinnamond is a blogger I like increasingly. It is instructive to read that value investors are tired, very tired. I don’t blame them too. This market cycle has tired me out too. Big time.

Pro-cyclical finance

Eric Cinnamond, a blogger, I discovered recently wrote:

As the current expansion marches on, I’ve been thinking more and more about business cycles and how I incorporate cyclicality into my valuation process. [Link]

He cautioned against extrapolation of current record earnings and the need to normalise earnings for cycles.

But, a recent Wall Street Journal article on how financial institutions are ramping up personal loans now is an eye-opener for those who are not convinced of the cyclicality of finance:

American Express Co. , Goldman Sachs Group Inc., LendingClub Corp. and Social Finance Inc. are among those behind an onslaught of unsolicited mailings offering unsecured loans, known as personal loans, as large as $100,000. In the first half of this year, lenders mailed a record 1.26 billion solicitations for these loans, according to market-research firm Competiscan. The second quarter marked the first period that lenders mailed out more offers for personal loans than credit cards, a much bigger market, according to research firm Mintel Comperemedia. [Link]

The increase in personal loans as the economic cycle has matured is amazing. Once again, lenders are taking on more risk at the peak of the cycle and are also persuading borrowers to take on more risk at this late stage in the economic cycle. The chart embedded in the article offers telling evidence of that.

personal loans

This should not be surprising at all:

Now, as the market gains momentum, borrowers who took out personal loans more recently are falling behind on payments at a faster rate, according to TransUnion, and several lenders are reporting higher losses.

This should be very worrying, of course:

Last year, more than 1.5 million personal loans were given to people with credit scores below 601, on a scale that tops out at 850, according to TransUnion. That is the highest number in more than a decade. Currently, borrowers with credit scores considered prime or better account for just over half of personal-loan balances, according to TransUnion.

But, newspapers that were responsible once upon a time are focusing on the wrong finance problem: campaign finance of the President of the United States of America!

How much more recklessness?

Just yesterday, I wrote that the argument by Martin Sandbu that central bankers missed a trick by not being more reckless in the years following 2008 than they already were was monstrous non-sense.

See these blog posts by Jesse Felder. How can one argue, even after seeing these posts, that central bankers were not responsible for this recklessness on the part of investors? How much more reckless would investors have been, had central banks become been even more reckless?

Callous arguments such as those are simply astounding and mind-boggling.

One more sample of bond market ‘efficiency’

Despite tight restrictions on foreign exchange, Chinese investors have spent $30.4bn on US residential real estate in the past year, according to the US National Association of Realtors, while our monthly consumer survey shows that household demand for foreign exchange has only increased since the turmoil of early 2016.

Outflows have been balanced by record inflows from foreign investors, particularly into the onshore bond market. June data suggested these investors took the depreciation at the end of that month in their stride, but growing signs of currency risk could convince them to sell. [Link]

Why would anyone with a good awareness of risk and return buy Chinese onshore bonds? The yield pickup is not great and the risks are high. Unless, they were so confident that China would not really deleverage and would not allow defaults. Otherwise, it makes no sense investing in China bonds when the country’s non-financial debt to GDP ratio is already too high, when growth is slowing and trade tensions are escalating.

So much for investors’ ability to balance return considerations with risk.

That extract was from an article on RMB risk published by FT Confidential Research. Against America, China is indeed very keen to retaliate with RMB depreciation. But, they know very well that it is a double-edged sword. Capital outflows will accelerate. Same problem with their holding of US Treasuries. If they dump it, they face capital losses. The dollar will weaken, everything else being equal.  Rising US interest rates will push up Chinese cost of capital too. Yields on China bonds will rise too. It will be a self-defeating exercise too.

The best 30-minute investment of your time

I am a regular reader of Tim Price’s blog. I catch up with it in spurts. Towards the end of June, I had chanced upon his blog post recommending a talk by Morgan Housel in the microcapclub in September 2017. I had bookmarked to watch the video but the video is gone now. Taken off the internet.  Sad. But, luckily, a transcript is available. It might take 30-35 minutes to read and absorb the 19-page transcript. But, it is probably a very good investment of your time. The title of the talk is ‘what other industries teach us about investing?’.

I would draw three lessons from his talk:

(1) One is on the Wright Brothers’ invention. The lesson he draws from it is this:

when innovation is measured generationally, results shouldn’t be measured
quarterly.

I am not disputing it. I am adding another lesson. If you notice, the Wright Brothers’ invention of the flying machine was ignored for a few years. But, it was happening. Therefore, the best inventions and scientific breakthroughs are the ones that are happenign off the prying eye. Most invesment value lurks there. It does not lie in the investments that are brought to your mailbox through investment newsletters.

Second lesson is finding that one investment is easier in hindsight! That is, one may have to invest in ten such ideas to find one that succeeds tremendously. Luck, diversification and an awareness of one’s maximum loss absorbing capacity are needed.

(2) Timing in investment matters. Looks like American Presidents’ ‘State of the Union’ addresses are great contrarian indicators. Buying in the years 1999 or in 2000 and holding the stock(s) or the Fund for ten years would have yielded a very different annual return than buying them at the beginning of 2003. See this tweet for some statistics on the best and the worst ten-year returns. In other words, buying with a margin of safety matters. That is a great insight, attributed to Ben Graham, from the talk:

The purpose of the margin of safety is to render the forecast unnecessary.

(3) The final lesson from his talk:

Since most of what he says is simple, they will also be the hardest for us to do. That is one of the early lessons from his talk itself – from the discussion of the episode on cancer treatment vs. cancer prevention.

Risk axioms

A good article by Gillian Tett on where risks lurk. She concludes that it lurks in places where we don’t look. Quite. It has been that way and it will always be that way. We are simply not wired to anticipate risk. We are poor predictors. Recall the post I had written two days ago from Sir Martin Rees’ book as to how little we were able to predict in 1937 about the things that actually materialised in the remainder of the century.

From the article flows the following ‘risk’ axioms:

(1) No crisis is, by definition, anticipated. If it is anticipated, it will be handled, very likely, before it becomes a crisis.

(2) There are no catalysts to a market crash that is known ex-ante. It is actually a corollary of (1) above. All catalysts are clearer only in hindsight.

(3) ‘Early warning’ indicators anticipate the last crisis well.