Dissociative Amnesia

Psychology, my college major, is a social science, not regulated by real math or hard science, but governed by just-conceived “statistically significant” theories. The field of study is fraught with periodic eliminations of previously-thought treatable medical diagnoses (neurosis of the 1950’s) and re-definitions of old disorders (was multiple personality-now dissociative identity disorder). Without diving deeper into today’s psychology theories, let’s focus briefly and admittedly amateurishly, on one of the newly-defined dissociative disorders, dissociative amnesia.
The Mayo Clinic states the main symptom of dissociative amnesia as “…memory loss that’s more severe than normal forgetfulness and can’t be explained by a medical condition…an episode may last minutes, hours, or, rarely, months or years.” Many of us have necessarily resorted to self-imposed, periodic onsets of dissociative amnesia when asked to discuss or understand today’s money matters. As we have gradually slipped into a world of global economics, we have been asked to forget a lot of what we learned was true about national financial certainties.Today, we are lectured that it is not important that any one county is literally insolvent, bankrupt, if you may.

That countries in Europe may be running ridiculous deficits to support their own political promises seems no more or less significant than our own country’s claims that being trillions (yes…12 zero’s after a number!) of DOLLARS in debt is inconsequential . Let’s once again try to comprehend the number trillion. (A) You are able to carry $10,000 of hundred dollar bills in your pocket easily. (B) You can stuff $1,000,000 worth of hundred dollar bills into a grocery bag and walk around with it. (C) $100,000,000 of hundred dollar bills can fit inside your walk-in closet or gun safe in the basement on a standard pallet. (D) For a billion…$1,000,000,000 of hundred dollar bills, it is possible fit all of the hundred dollar bills inside your triple-car garage. Now, get ready for this visual:

This is the number of PALLETS (double stacked) of hundred dollar bills it would take to total a trillion dollars, $1,000,000,000,000. It is not necessary for you to try to count these pallets, only to attempt to contemplate how much larger a trillion is than a billion, let alone a million.
Back to dissociative amnesia. Each of us, including the Chair(wo)man of the Federal Reserve and President of the United States, must immediately self- impose this psychological disorder in order to postulate how unimportant something so mundane as the federal deficit is today. We are also required to NOT associate national or global deficits with recent massive gains in the equity markets . We must not consider deficits when predicting future economic growth WITHOUT central bank stimulus. Additionally, it is mandatory that we now conveniently “forget” about ever again receiving reasonable interest rates on our retirement savings bank accounts.
Any of us who is determined to understand or discuss subjects like national deficits, seemingly endless stock market gains, or current non-existent interest rates, simply needs to forget virtually everything that used to be “normal,” AND as we have recommended above, merely self-impose dissociative amnesia. It is not necessary to place a time limit on our disorder, as only the future will dictate when we are allowed to remove it from each of our daily economic analysis efforts. As it has always been advertised that “misery loves company,” be assured that you are not the only one in the room experiencing cases of self-inflicted DISSOCIATIVE AMNESIA.

Tulip bulbs or bubblegum?

It may be a decent time to recall Tulip Bulb Mania from Dutch history of the 1600’s. When the tulip contract market became primary to the overall Dutch tulip industry, limitless differentiations such as coloration, size and supposed rarity began to dictate price variations in tulip bulb contract purchases. While growing popularity and demand were contributing factors to increasing prices, “flippers” drove reasonable prices to skyrocketing levels. By the time tulip prices peaked in February, 1637, one single tulip bulb demanded ten times a normal worker’s annual income.

As more and more people insisted on participating in rising prices, tulip contracts even began to be traded on the London Stock Exchange and in Paris, too.  Eventually, defaults on contracts began the bursting of the bubble and markets plunged, resulting in an economic depression that lasted years for the Dutch.  A few people made a lot of money during the rise of tulip prices. But, like any other subsequent bubble-mania, the last-ones-in experienced financial losses that impacted the rest of their lives.

American history books record a couple of eras not unlike Dutch Tulip mania: the 1929 stock market mania-crash and the Dot.com bubble of the late 1990’s. Human behavior is the driving force of manias like these. Hopes of financial profits or locking in prices before inflation erodes purchasing power are both good reasons to pay over-market prices for a product. However, greed sometimes overcomes reason and causes people to pay unreasonable prices for some goods.  Just as fear of further loss may cause a person to sell a product at a less than reasonable price, greed may cause the converse behavior.

The truth is that no one can predict the size of a bubble before it explodes. Only AFTER it bursts are we able to see that it had grown too large. All of us can remember the aftermath of sticky bubblegum on our faces after we had pushed just one more breath of air into the magnificent bubble on our lips. The consequence was messy…ick!  And after every burst bubble,  we promised  to stop just a breath short of the explosion the next time.

Today’s drinking fountain discussions include these subjects: seemingly endless supply of new global investors, companies-countries whose growth appears limitless, impossible-to-comprehend computer trading activities, far above-average recent portfolio gains, apparent impossibility of normal market corrections, inconceivable size of financial product universe. …

Is it possible to be satisfied BEFORE the last breath is blown into our next bubblegum bubble?

Today, you need to be a TWENTYmillionaire!

I spent most of my life dreaming of being a millionaire. When I was a boy,  everyone my age was mesmerized by the television show, the MILLIONAIRE. A rich guy walked to the door of a financially struggling family and, POOF! That person was now a millionaire. None of us were foolish enough to believe that could ever actually happen, but many of us did spend the next 50+ years trying to become one.

In the last few decades, I wore out many hand-held calculators by building future value computations that resulted in my becoming a millionaire. In quiet conversations with my colleagues and best friends, we discussed the value of that million dollars and we all fantasized about the security it would provide us in our retirement. In the mid-1980’s, a million dollars would provide ample income if invested in a risk-free treasury bond. Furthermore, a person did not need to go very far out with maturities to get a reasonable yield. Let’s review the 30 year history of the 2 year Treasury Note yields and subsequent income on a ~$1,000,000 investment.

                1984:  ~12%        $120,000 @ year income

                2007: ~4.5%          $45,000 @ year income

                2013: ~0.22%           $2,200 @ year income

It becomes more mind-boggling when you do some simple reverse math and calculate the amount necessary to invest today in a two year treasury note in order to produce the same income as a one million dollar two year treasury note yielded in 1984: >~$54,545,545! We could include inflation as a factor included in establishing the value of $120,000 of income today as compared to 30 years ago.  If we assumed an average annual inflation of 4% for the past 30 years, our calculations would reveal that it would be necessary to have ~$3,500,000 spinning off 12% income to provide similar purchasing power as the same $1,000,000 did in 1984.

But, ladies & gentlemen, this is NOT $54 million. What happened? Today, a meager millionaire  investing  $1,000,000 invested in a two year treasury note is required to “step out of the box” and do something entirely different with his-her money to be able to expect a reasonable retirement income. Looking back just a few years, at 2007, we can see that a person could still get ~$45,000 annual income from a two year riskless treasury note. Again using reverse math…today, a person needs ~$20,000,000 invested in an identical two year treasury note to provide the same $45,000 annual income.

Differences in riskless rates of return that are this magnificent are producing at least four behavior choices for retirees and persons nearing retirement: (1) continue to use riskless investments  and consequently spend additional principle each year to maintain the same life style. (2) continue to use riskless investments, but protect principle by reducing life style costs, (3) continue to use riskless investments, but working longer or returning to the work force to provide additional monies for retirement costs, or (4) change investment philosophy and now utilize investments that have market risk in order to provide retirement income for now or later.

Decide what your risk tolerance is BEFORE changing your investment philosophy. Make sure to understand that systemic (market) risk of vehicles like common equities not only have the benefit of rising in value, but they may also decrease in value for reasons unimaginable today…terrorist bombs, CEO fraud, geological or meteorological event, legislative or regulatory changes, etc. Know that providing for a riskless retirement is a lot more difficult today than it was just a few years ago.

And good luck becoming a TWENTYmillionaire!

Wake up, Rip! Understand Regression to the Mean

An important mathematical concept is regression, sometimes called reversion, to the mean. Investment professionals usually recommend that people implement a buy & hold strategy and disregard daily values of portfolio ingredients, like individual stocks or managed accounts like mutual funds. Most of the time and especially over long periods, like decades, this is may be a reasonable plan. This blog will explore another mathematical truth that could reveal a short-term “selling & buying back” tactic, different from the traditional Rip Van Winkle, go to sleep for a long time, buy & hold strategy.

In an earlier blog,  Are You Normal?, I reviewed a day from high school freshman algebra… mode (highest frequency), median (exact center point of a range of measurements), and mean (statistical average). Most investment results are reported as means; that is, when we look at returns of more than a year, like 3yr-5 yr-10 yr-etc, the number is reported as an average of the compounded annual returns. Here’s an example, using $100,000 as the original investment:

2010 return: 20%…$120,000 new value

2011 return: 0%…$120,000 still value

2012 return: -10%…$108,000 end value

3 year average return: +2.60%

Using a Texas Instruments BA II Plus hand-held calculator will show that the 3 yr average (mean) annual gain is 2.6%. Make sure to understand that this number is an annual average compounded return. (If you need to better understand the difference of averaging simple interest rates from compounded rates, refer to my blog, Time a Valuable Commodity.) How could we react if this portfolio now has a sudden three-month increase of 15%? Since the mean 3 year annual gain is 2.60%, the math of large numbers would predict that the portfolio would eventually regress back towards the 2.60% mean (average). While no mathematician is able to predict WHEN the portfolio will regress, it is reasonable to expect the portfolio to eventually do so.

This mathematical game is more valid when using longer periods of time to calculate the mean, or average return. Certainly, a view of a 10 year return is a truer evaluation of average performance than a three year look, as in our example. But, in the end, looking at short term losses or gains, like three or six months, and comparing them to longer-term means or average portfolio returns may expose an opportunity. In our example, the 3 year mean return was +2.60% and the short-term three-month gain was +15%. This may indicate a selling/re-buying opportunity. If one did exercise this tactic and “moved to the sidelines” with this part of the portfolio, in order to capture a real alpha (advantage), it is important to keep sight of near-term numbers and re-purchase the same stock or manager when the value dips to a lower number. The same tactic may be used if you stock or portfolio decreases by an amount greatly different than the mean… only your action would be to buy, then sell at a higher price, the converse of the example we used here. Either of these tactics are referred to as executing a “round trip,” which means doing both a buy and a sell to capture a net gain (or loss).

Very few people use this tactic because they are taught that no one is smart enough to pick “tops & bottoms” in markets. I employ this method of portfolio management only a few times each year and I am not always right. If anyone wants to use this short-term trading tactic, make sure to “do the math,” be patient and get the advice of an investment professional to guide your transactions.

Wake up Rip, use your math, and look for opportunities to use regression to the mean! You can apply it to predicting behavior in other parts of life, too; i.e., forecasting rain, your son or daughter’s GPA, or budgeting. Let your imagination take you to other areas…age expectations, surprise events (near-Black Swans), macro climate changes, etc. I hope you have as much fun and can actually add some “alpha” to parts of your life as I have done in understanding the math of regression to the mean.

Today’s Modern Family

Know that my thoughts are supported by my own research, but like in previous and subsequent notes, I do not include reams of data with mind-numbing statistics. I am certain that anyone, including me, can find research to support a self-serving hypothesis. Surely, there are countless persons with contradictory opinions to mine, and I recognize our mutual freedom of speech to be able to express them.

Much  is being written about the disappearing middle class, today’s modern family. While it is hard to understand why governments and too-large-to-fail financial institutions are able to run unimaginable deficits, it is important to note that families aren’t able to conduct their financial affairs similarly.  A look at evolving spending pressures on some members of the new middle class, defined being at or ABOVE average family income, may conclude that some people have unusual (maybe excessive or unnecessary) expenditures for a multitude of budget items, including housing, cars, gizmos & gadgets for communications, and entertainment . This is not a vindication of anyone in the lower 50% of income levels, only a look at those who have achieved middle class income status and seem to be struggling with monthly cash flow issues too often.

Most recently, George Friedman waxes eloquently in “The Crisis of the Middle Class and American Power” about differences in the lives of families from the 1950’s-1960’s and today,  in 2013. He concluded that for those of us who lived in the 50’s and 60’s, “It was not an easy life and many luxuries were denied us, but it wasn’t a bad life at all.” It is this admission that begs for more explanation.  Mr. Friedman continues with an adequate comparison of the costs of providing basic essentials in both time periods of then and now. It is hard to disagree with any researcher’s math of the large differences in housing costs, food & clothing, health insurance and necessary car expenses. It is easy to conclude that today’s costs are ridiculously higher for families providing these fundamental living requirements. This observation is unchallenged  by this author.

It is, however, similarly important to note that today’s middle class has accepted demands for additional luxuries as requirements for ” basic needs,” those that did not exist in neither Mr. Friedman’s nor my world in the 50’s and 60’s. Let’s review a few of these and note the additional monthly cost of each. The first of these is that today the middle class demands a different kind of housing; today’s house, apartment, or condo is bigger and better than five decades ago. Air conditioning is standard, which significantly adds to utility costs. Uncountable electric appliances are in everyone’s kitchen, family room, den, and utility room…flat screen TV’s, microwave ovens, computers, and washers & dryers…just to name a few. These demand additional  initial outlays and operation costs including increases of utility costs.

Secondly, auto selection is a lot different decision for most middle class families than the 50’s or 60’s. Rather than settling for a pre-owned  (very used) car, the primary vehicle now is probably a minivan or SUV and most likely it is replaced more frequently, in order to add the most recent driver accessory. Today, this car has a sun roof, power steering & windows, hand-free cell phone capability, a third seat area, and a TV monitor for in-ride movies.  While it is easy to blame the cost of gasoline and new car sticker price as the most important transportation cost rises, it is essential to look “under the hood” and note the additional upfront outlays for newly-necessary gadgets for our driving experiences.

Another cost that the new middle class freely elects to absorb as a now necessary ingredient of normal monthly living expenses is increased (limitless) communication abilities. A peek at this category’s expense in the 50′ & 60’s shows a $5 monthly single in-home telephone bill and the cost of a black & white TV, with free access for 3-5 network stations. Let’s take a look at today’s house: it has at least two cell phones, umpteen TV’s with cable-dish access, and internet capabilities for at least one computer. Without considering the purchasing requirements for these devices (including a new I-phone, I-pad, or I-something every few months),  a calculation of the just monthly fees for each of these embarrassingly boggles one’s mind.

A last new cost associated with the new middle class is entertainment costs. In the 50’s & 60’s most of us were satisfied with eating out once @ week, enjoying a drive-in movie (with popcorn and coke) on the weekend and playing in the back yard or sharing time with each other at neighborhood or school functions.  Not only do most of these activities seem laughable to today’s not-so-nuclear families, but the new requirements for entertainment seem boundless. A few of these are: several meals at fast food and low budget restaurants (Chic Filet, Micky D’s, Applebee’s, etc.), wrapped inside a fine dining experience once or twice a month (newest local specialty restaurant). When one adds a stop at Starbucks for a $4 cup of Java a couple times each week, just eating costs alone seem staggering. Now let’s add another required entertainment need for the new family form 2013…kid’s team sports fees,  including driving costs to-from virtually every activity imaginable for our soccer-mom kids. Today, a family actually has to pay for venues so their kids can have fun and grow up with acceptable social skills.

A few other not-so-obvious new costs for 2013 middle class families pop up with a closer look at a year’s end budget review: trips to Vegas, where it is important to have an experience that “stays in Vegas,” impulsive on-line shopping, which has added a newly diagnosed middle class suburbanite: the shop-o-holic. New pressures exist to purchase must-have clothing items like the newest Nike shoes for each 13 year old future basketball phenom, the very hippest jeans and mom’s latest make-up accessory for reducing visibility of aging . Need we continue?

In conclusion, while few contest the impact that inflation has had on family living expenses for basic essentials like food and shelter since the 50’s-60’s, it appears that evolving peer pressures have resulted in increased consumer spending of middle class members. The pertinent question may be, “Once a family’s earnings provides an entry into the middle class, how does a family today continue to absorb additional costs of providing luxuries that families from the 50’s & 60’s never considered possible, let alone necessary for daily pursuit of happiness?”

While it may be possible for today’s modern family to earn the way into the middle class with education and desired employment, it is entirely possible that some families may be over-buying their way to a quick exit out of the middle class via unserviceable debt and eventual bankruptcy. I suppose the trains of progress never stop, but  it may be beneficial for some families to consider a cost-value analysis for each trip.

2013, Hansel and Gretel?

In the fairytale, “Hansel and Gretel,” after a long wondering  from home and subsequent starvation, it was hard for the children to resist the delicious gingerbread, cakes and sugars from the cottage in the woods.  If we review most statistics from 2012, it looks like we have landed in our own gingerbread investor house. After malnourishment from investment returns since the crisis of 2007, it may be similarly difficult for investors to accept that we may encounter our own “old lady-witch” if we are tricked into believing our cottage is full of only tasty treats. Are we able to take our sweets from the 2012 and know exactly when to NOT over-stay our welcome, as I’m sure Hansel & Gretel would have wished they had not done?

I categorize my investments into five groups: (1) Cash-Fixed Income, (2) High(er) yield-total return, (3) Active Asset Allocation/Living benefits , (4) Equity positions: domestic, international and alternative, and (5) Hard assets (mostly real estate). Without boring anyone with the details, a summary is simple: all five categories over-performed (especially domestic equities), some more than others. Voila! There were no stinkers in the group for first year in recent memory.

Happy New Year to 2013! While no one near my age is particularly glad about one more year’s pages being torn from the calendar of life, most of us are relieved to have the economic worries of 2012’s behind us. The year closed with a (not so) grand bargain passed by the Senate; one between America’s two political parties and the President. This deal proved that both parties have made compromises that seemed to satisfy Wall Street and the truth is now evident: 2012 was a year for the bulls and now the bears are retreating to their caves for the winter to ponder whether or not they can re-appear with an audible growl sometime in 2013.

Are we finally at the idyllic place we want to live in 2013? If we step back and look not at our results from 2012, but at the problems we face in 2013, we can see that our fairytale location may be similar to Hansel & Gretel’s gingerbread house. There may be more than one not-so-perfect confrontation if we are enticed to stay.  A few BIG problems are inside the oven in the house: Europe’s debt issues (Greece leads the list still.), our own increasing debt (now over $16 TRILLION), possible downgrades of US treasury instruments, less spending from the biggest spenders…as they will pay more taxes now, individual investor skepticism of Wall Street, aging of America as Baby Boomers retire by the thousands daily, under qualified-under employed-unemployed youth (including graduates with substantial college debt), just to name a few.

Today, we are all enjoying the treats from 2012, but each of us needs to devise a plan to become more “anti-fragile,” Nassim Taleb’s new word for the English language.  It is with this advice that we should remodel our own life plans, including investment choices for 2013. As Gretel shoved the witch into the oven so she and Hansel could avoid a tragedy, we all need to  be able to react immediately and effectively when any disaster appears in 2013, so we are able to, as Taleb instructs in his new book, “turn lemons into lemonade.”

For economics-investment addicts, like me, Taleb’s book: Antifragile, things that gain from disorder, is a great (required) read for 2013.