Friday, October 07, 2011

Investment in a whitewater world

During the last half of the 20th century retail investors earned positive returns with some mixture of stocks, bonds, real estate (personal) and cash. Mutual funds, and especially index mutual funds, made middle class investing possible.

Then came the great market bubble of the 90s, the real estate bubbles of the 00s, and the rise of IT enabled economic predation. The vast flow of growth returns was diverted from the middle class investor to corporate executives and sharper, faster, players. Corporate financial statements became less and less credible as new ways were found to obfuscate financial status. In a world of IT enabled complexity, risk assessment became extraordinarily difficult. Where growth opportunities were strong, as in China, the markets were corrupt and inaccessible.

Maybe we'll return to the relative calm of the 1980s, or even the slow growth of the 1970s. Oil prices may stabilize around $150/barrel. China's economy may make a soft landing and the Chinese nation may follow Taiwan's path to democracy. The GOP may shift away from the Tea Party base and, once in power, raise taxes substantially while implementing neo-Keynesian policies by another name. North Korea may go quietly. The EU may hold together while gradually abandoning the Euro. Cultural shifts might make personal integrity a core value. Disruptive innovations, like high performance robotics and widespread AI, may slow. The invisible hand and social adaptation may solve the mass disability problem of the wealthy nations. Immigration policy, a breakthrough in the prevention of dementia, or the return of ubasute may offset the impacts of age demographics. We may even ... we may even look intelligently at the costs of health care and education and manage both of them.

If these things happen then some economic growth will return, stock prices will reflect fundamentals, bonds will become feasible investments, and interest rates will be non-zero.

Or they won't happen.

In which case, we can look forward to more of the same. The best guide to the near future, after all, is the near past. In this whitewater world then, in which financial statements are unreliable and wealth streams are diverted, what are the investment opportunities? We cannot recover the lost returns of the past 11 years, but it would be nice to be less of a chump.

Real estate seems a reasonable option, though there we face the problem of untrustworthy investment agents. There is not yet a John Bogle of 21st century real estate investment. (This, incidentally, suggests something government could do -- engineer a trustworthy investment representative for American real estate.)

The other option is to switch from prey to predator.

During the 20th century retail investors could only make one way bets. We basically had to bet on economic growth and prosperity. For a time we could shift a bit. If we thought near term growth looked bad, we could shift to bonds. If we thought a crash was coming, we could shift to cash. Basically, however, we could only get good returns by investing in stocks and betting on growth. This worked under conditions of economic growth and relatively integrity. Under the conditions of the past decade this made us prey.

Predators don't make one way bets. They make bets on downturns, on upturns, on volatility, on stability, on irrationality, on continued fraud, on reform. They make bets on bets. They play the options and straddle options games that brought down the world economy. It's too bad they won, but, with a bit of help from our AI friends, they did.

So I'm learning about options. It's not what I like to do, but I don't make the rules.


Anonymous said...

I don't think it is possible to invest in the way you suggest in a low-knowledge low-expertise low-time-investment way. If you have a full time job doing something else, then I think that those are requirements for any investment strategy. Index funds may no longer be as useful as they once were, but it is still the only game in town for amateurs like us.

JGF said...

I agree. This level of work has real impact on my ability to do economically productive work, stay health, etc.

Even the upper middle class has been locked out of the cash flows of 2011 capitalism. We are indeed member of the 99!

These are not good times.

Anonymous said...

I think options will just make you easier prey for the big guys. At least with an index fund, they can only drain you slowly.

JGF said...

My wife agrees with you!

For sure I won't get a lot of money to play with. Maybe my teaching stipend.

Anonymous said...

More problems in accounting are illustrated by this blog post:

The idea is that the distribution of numbers seen in accounting statements of companies is increasingly divergent from what you'd expect if they were honest. This definitely provides evidence that financial statements are less reliable than they once were.

And I've actually thought a bit more about index funds. One of the primary problems is that fundamentally you are relying on the 'market' being correct in its valuations. But of course the more people use things like index funds, the fewer voices are there to push the market to a correct valuation.

This is something like an information cascade where the more people rely on others for information, the less reliable that information becomes. It is a sucker's bet to rely on an index fund if everyone else is. But it is foolish to do anything else if others are picking stocks. Yet another odd paradox of the stock market.

JGF said...

Great comment on Benford's Law. I have that in my post queue to comment on. It is concrete, and strong, validation of what I suspect but can't prove -- that corporations have figured out how to destroy the signaling value of accounting statements.

The signaling problem with index funds has been long feared. I haven't seen anyone comment on it lately, but there's really very little discussion of investing opportunities any more.

Maybe more a few people fear our investment structures have turned into a trap for chumps.