Friday, September 5, 2014

Revisiting Drive: The Surprising Truth About What Motivates Us

I read the book Drive back in early 2010 and four years later I still continuously think back to its content as I see real life examples all around me. Unlike an economics or finance book, the information contained in the text is just as valuable today (if not more) because there are no outdated charts or data.

The book is about what motivates people and its findings will probably surprise you. While I definitely recommend taking the time to read the book, the following two videos provide a great preview of its content.

Drive: The Surprising Truth About What Motivates Us:

Author Daniel Pink on what motivates people:

S&P 500 - This Time Is Different

No words needed for this chart. It's just a visual reminder of where we are.

Monday, September 1, 2014

Who Is Really Enjoying Labor Day In America?

Let's review a quick summary of the "recovery" in U.S. labor markets as America takes a much needed day off work. We'll begin by looking for winners within the labor market to try and determine who should be celebrating this holiday. The following chart shows the change in real median income from 2009 to 2014 across race and ethnicity.

If we cannot find growth looking at race, where else can we look? Ah yes, class. The next chart shows the change in pay across each income level, and we have found it. The top 20% of wage earners experienced income gains during this period while the bottom 80% have declined. 

A report this week showed that within the upper middle class of the United States (income from $75,000 to $99,999), 55 percent have absolutely zero in savings. Most can be considered as having a negative net worth due to massive debt loads that continue to grow. 

So as we celebrate this labor day a select few within our borders can continue to cheer the divide that grows within America; the haves become far more wealthy while the middle class slowly erodes into the enormous pool of the poor. Those that study history know that the Roman Empire did not fall due to some great outside military force. It crumbled due to the rot that grew within the foundation of its own economy. The divide between the rich and the rest grew so large that the empire destroyed itself from within. 

Sunday, August 31, 2014

Wall Street's Black Swan Event Is The Most Likely Scenario

There has been discussion over the past few weeks throughout the financial world regarding the divergence between the S&P 500 and the 10 year U.S. treasury bond. Modern economics and finance teach us that when the economy improves, the stock market improves, and bonds usually fall (bonds fall in price when interest rates rise). Rates rise because when the economy improves, inflation rises and investors demand a higher return to compensate for inflation risk. There is also a "rotation" of out bonds back into the now more attractive world of stocks.

Since April of the year we have seen U.S. equity and bond prices rising together. Bond prices rising means yields falling, which has created the puzzling divergence in the graph below.

We're going to time travel back through history twice to try and figure out what is happening here. The first trip back in time is to the last post crash boom during 2003 to 2007. We see that during this entire period, in general, stocks and bonds rose together. It would appear that the two moving in tandem is less rare than we have been told.

Now let's flash back to 1981. Here is the key chart. Take a look at the 10 year treasury yield from 1981 to present.

You can see that treasury bonds have been in a bull market for 34 years. With hiccups along the way, yields have been falling in a steady downtrend for decades. Therefore, the only time stocks and bonds moved in opposite directions for long periods of time was when stocks were falling. This is why bonds have always been considered the "safe" investment to move into when stocks fall; because bonds always move higher when stocks fall, right?

Investors today believe that the most likely scenario under our current period of economic growth is to have money "rotate" out of bonds and into stocks. The second most likely scenario is a surprising decline in economic growth where money moves out of stocks and back into bonds (remember bonds always rise if stocks fall, right?). The third most likely scenario is that stocks and bonds continue rising together as they have been since April. With the U.S. financial markets the most desired location for global capital, why can't stocks, bonds, real estate, the currency, and everything else within U.S. borders rise in price forever?

There is a fourth scenario. It is not considered the least likely by the mainstream world, it is now considered impossible. Based on sophisticated computer programs churning data that goes back decades, we have been told this event is like the 1987 stock market crash; it can only happen once every hundred billion years.

The impossible scenario, the ultimate black swan, would be for U.S. stocks and bonds to fall simultaneously for an extended period of time. How far back do you have to go back to see this once in a billion year event occur? The 1970's, when stocks moved sideways the entire decade (experiencing free fall downdrafts along the way). The real returns on stocks were destroyed by inflation. Bonds fared far worse with rates rising steadily throughout the entire decade (bond holders lose principal when rates rise, something no one remembers is even possible).

After a decade of destruction, U.S. citizens did not want to hold stocks and they definitely did not want to hold bonds. What did they want? Gold. There were huge lines around coin shops during the final months of 1979. We know now that January 1980 was the ultimate opportunity to sell gold and move back into U.S. financial assets at their most hated moment in history. 34 years later, we are at the exact opposite extreme.

I do not believe U.S. stocks and bonds falling simultaneously is a black swan event. I believe it is the most likely scenario. I would not recommend holding U.S. stocks or bonds at today's prices. I believe that both asset classes are highly overvalued and arguably in bubble territory. The next logical question for someone living in the United States would be: "what could you possibly hold if you sold your U.S. stocks and bonds?"

It would surprise almost everyone living within U.S. borders, but we live in a global financial world and there are stock and bond markets in almost every country on the planet. Some of those currencies, bonds, and stocks are not only at fair value but some are already or close to being undervalued

(As a quick side note; most are not undervalued. Almost everything around the world is expensive today and finding value is extremely difficult; the reason for my current love for cash)

There will come a time again in the future, I hope in my lifetime, when U.S. financial assets are sold off, undervalued and hated the way they were in 1980. People at that time will promise never to return back to the U.S. financial markets again, which will signal the greatest buying opportunity in our lifetime for U.S. assets.

So is there anything actually worth buying today? I discussed a few things I am purchasing in small quantities earlier this weekend as I continue to focus on raising cash for the future, see:

S&P 2000 Vs. Silver 19.50 - Which Is The Better 5 Year Bet?

Labor Day Weekend

This cartoon perfectly sums up the relationship with my wife and I during this labor day weekend at the beach. While she would like nothing more than to leave all cell phones, ear buds and even books in the car when we head out to the beach this afternoon, I would love to be able to set up a desk bring a lap top.

We'll probably meet somewhere in the middle (I get to take my phone and an economics book to read). 

As a quick side note, I'm not some miserable person. I just enjoy the process of building a company more than staring out at the ocean. I understand that 98% of the people reading this, like my wife, will think I'm insane.

One of my favorite quotes from Mark Cuban:

“The thrill of victory in business blows away the thrill of victory in sports. Business is a sport 24/7/365. What does it take to be a successful entrepreneur? It takes willingness to learn, to be able to focus, to absorb information, and to always realize that business is 24/7 where someone is always out there to kick your ass.”

Inside The High Frequency Trading Machine

As the world's attention has once again moved away from high frequency trading (following the storm surrounding Michael Lewis' Flash Boys release earlier this year), people no longer care that the stock market is run by machines.

The following video from CNN Money gives you three minutes inside the high frequency trading monster; Citadel. As discussed numerous times here, I believe the next market liquidation will be far worse than the last because when things go bad these machines simply turn off and step away. The original flash crash was only a warm up for the big one that is on the way.

People in California found out this week that living on a major fault line of the earth's crust leads to earthquakes. The same exact argument could be made for a high frequency dominated stock market; it is only a matter of time. 

And, CNN Money asks if this is good for the average investor:

For more see:

How High Frequency Trading Crushes The Day Trader

To go much deeper down the rabbit hole to find out what the polite boys are doing at Citadel see:

Nanex - The Quote Stuffing Trading Strategy