Funnymentals

It’s often said that markets are voting machines in the short run and weighing machines in the long run. It’s meant to signify that speculators have a short term view while investors have a long term view and investors push the overall direction of the market. This principle only holds true if the investors with a long term view have more capital in the markets than short term speculators. When the majority of capital is invested for the longer term then markets trend in the direction of that investment and the fundamentals that investors use to make their investment decisions drive the market. If speculators have the majority of capital in the markets then the markets do not trend and money jumps from market to market following the latest trend, hot idea or event (BREXIT, US Election, FED announcement, etc.). It is at this point that fundamentals become funnymentals. Funnymentals is a term often used by technical analysts to mock long term investors and highlight that capital markets are just auctions where price and volume are really the only factors at play.

The technical analysts are 100% correct, the capital markets are just auctions where the price and supply and demands of bids drives the market. How else could the price of oil, cotton, coffee, etc. change without news events, report releases or acts of nature? When capital markets are working and investors/producers have the majority of capital the underlying business fundamentals of producers will influence the market. I believe this principle has broken down completely. There is too much money in the market speculating so that weighing machine is overpowered by the voting machine volatility is commonplace. The measures of volatility betray the impact on investors as when tight ranges are followed by large shocks and then a return to a tight range investors are reluctant to believe the shock is over for longer and longer periods and thus markets become more dominated by speculators and fundamentals stay funnymentals.

I want to state that speculation is not a bad thing. Speculators are critical for markets to function but they need to be the minority of capital at work in the market or the markets just become a casino. A casino is a place to have fun, try your luck and use the laws of probability and risk management over time to win, fundamentals have no place in a casino.

Too crazy to believe, too real to ignore

This post is a deviation from finance, well not a complete deviation but with the US election and the madness around I can’t resist a post to vent my frustrations.  The candidates are both difficult choices, not positive or inspiring choices.  Trump is extremely devise with his sarcasm, glib comments and confidence that may not be warranted.  Clinton on the other hand is by all accounts a nasty, double talking criminal and eager to use violence to “solve problems”.

At the same time the Obama administration is scaremongering about Russian hackers and central banks around the world are robbing savers of the greatest gift there ever was, compound interest.  It feels as if we are at a precipice daring to lean into the wind.  How can we be so obtuse?  How can we not see that taking steps to avoid pain today will only cause more pain tomorrow?

This continuing mortgage of our future to maintain asset prices and prevent banks and companies that have failed from admitting as much is pathetic.  The acrobatics that politicians, bankers and the like have gone through to ensure that fortunes of the fortunate were not lost is unimaginable.  It has come to a point that I pray the American people choose the buffoon over the criminal, choose Trump over Clinton.  Based on what we have seen with Clinton’s email server cover up, charity contribution cover up, health situation cover up and war mongering (Libya, Egypt, Ukraine & Syria) it’s hard to imagine that Trump could do worse.

Europe is not faring much better.  I believe European integration has gone too far.  The Euro and Schengen region are convenient to be sure.  In the 21st century with computing power and maths at our fingertips we don’t need the Euro to be a physical currency, it can be a reference currency akin to the IMF’s SDR (special drawing rights) where each country has a representation similar to an ETF.  International transactions to be made in Euro while domestic in local currency.  If a country “needs” to devalue their citizens will suffer purchasing power loss yet domestic business will gain competitiveness, it’s a trade off.  The UK is right to take back control yet at the same time many Brexit campaigner failed to fully comprehend the consequences.  When you have self determination you also have the right to screw up so best to play to your strengths.

China, what can we say about China.  It is a financial collapse waiting to happen and a war waiting to happen.  Which one will happen first is the only guess.  My money is on war with Japan.  China has primed its population to believe that Japan today is just as evil as Japan 70 – 80 years ago and that the present Japanese society must eternally repay the debt of war from generations past.  There is a resentment of Japan’s rise after WWII but no recognition that China’s communism and the red threat both China and Russia presented to America was the reason for America’s economic support of both Japan and Korea from the mid 1950’s onward.  China needed a communist regime to keep the country together else it would have devolved to smaller kingdoms of years past yet that action came with reaction from others and thus the economic rise of Japan and Korea.  For China to punish Japan now for the horrible acts of WWII will only set the stage for future generations of Japanese to do the same to China.  Come on China, go high and end the cycle.

Africa and Latin America are still struggling and not much change or impact on the world stage expected from these areas.  Good job guys, make great products and services for your home markets, take them abroad to expand your wealth, you have a bright future and I look forward to seeing how it plays out.

 

What does it mean to be a professional banker?

We hear so often in the news that big fat cat bankers are running amuck and are akin to a plague on society.  The label of banker is just so broad as there are many different types of banks I don’t think the news organizations that use the terms understand bankers and I know that most people who don’t work in banking understand it either.  Definition of terms is of crucial importance to understanding any topic so I want to clarify my understanding of the various types of bankers.

1. Investment Banker: These are the bankers that arrange mergers and acquisitions, debt and equity origination and trading activities.  These are the fat cats.  They have incentive pay schemes that pay out millions and their incentives are not always aligned with their customers.
2. Broker/Dealers: The bankers are basically salesmen, they want more and more transaction volume but don’t take a position, no risk taken by the bank, if the customer trades doesn’t work out the bank has no loss and if the customer has a massive gain there is generally no direct upside for the bank.  These bankers not exactly fat cats but make a lot of money, much less deserving then investment bankers as they are not able to predict market moves as they claim.  Many people don’t have the time or desire to learn about markets so they do provide some value for these people but not enough to warrant the fat cat bonuses.  These are not the bankers that people complain about nor should they.
3. Commercial/Retail Bankers: These bankers are just salesmen, not a whole lot of difference between picking the right mattress and the right credit card or cash manager.  They don’t make bonuses in the range that any complains about nor should they.

The bankers that are salesmen often don’t really understand the products they sell.  They are taught how to sell them and how to use them, product A give you x type of risk exposure, etc. but they don’t really understand them.  There is a small group of people in headquarters who decide how to sell the products and they don’t have any interaction with actual customers so there can be quite a disconnect and customers are routinely misguided by salesmen trying to make targets or get higher commissions.

I have worked at banks where the sales staff didn’t understand the meaning of fractional reserve banking, velocity of money and why it matters, didn’t know the reserve requirement determined by the central bank and didn’t understand derivatives in the slightest.  These concepts aren’t necessary to understand when selling bond that a client has asked for but when considering what’s best for a client based on risk tolerance, preferences, market trends and plans for the investment proceeds it plays a factor.  When conditions change understanding why products were appropriate allows you to determine if they continue to be appropriate.  Prior to the housing collapse if bankers truly understood mortgage backed securities they would have understood that leverage was too high and we would not be in the low growth command economy that we find ourselves today.

So what does it mean to be a professional banker? It means understanding how the products work, why they are valuable to clients and under which conditions they would cease to be valuable and in fact being to harm the client.  Most banks believe it’s not practical to train sales people to this level so they have a small group to do the thinking and salesmen just pump out the sales and damn the consequences.

The fat cat group, they understand the details of what they do and generally what they do has less to do with financial products and more to do with hype.  The deal makers just find companies to match that investors would back/buy.  They are looking for what they can hype/sell.  Predator’s Ball, the Michael Milken story, outlines this very well.  Milken just designed a way to build a network of investors and debtors where he extracted a commission on the money circulating through the network.  As long as there was a market for debt that could be repaid then the network could survive.  It ultimately failed when they day came so you need enough professional bankers with the right incentives to keep each other honest.

What does it mean to be accountable?

Lately in the media many people claim they are accountable for mistakes but face few or no consequences. Top of the list is Hillary Clinton and her email scandal. She claims that it was a mistake, her emails were personal and we should trust her and move on. She takes responsibility for the mistake but to her that means only that she should apologize for it and promise not to make similar mistakes when President. To me that is a very low bar for accountability. Her staff who cooperated with the FBI were given immunity from prosecution and all she has to do is apologize and then get promoted? When American football players make a bad tackle on the field they are fined and suspended for a game or two. They are held to account! When others in sensitive positions such as hers make similar mistakes with classified documents or information, such as banks or intelligence officers they are fined and imprissioned as a means to be he accountable for their transgressions. 
CEOs are a group that are notoriously unaccountable for any failure but deserving of immense riches when the company is successful. CEO of an American company is the best job if you can get it. The Wells Fargo CEO is the latest example, John Stumpf. His company ran a pervasive and long running fraud on customers. He fired a large enough number of employees for fraud so that ignorance is akin to incompetence. When he testified that he was accountable yet intended to remain in a position to perpetuate incompetence it sends a clear message. 

Anyone who has been fired, looked over for promotion, demoted, fined or penalized in other ways due to mistakes they have made must be outraged at the double standard applied to people in a position of power. It inspires a dark desire for revenge against those who pay lip service to accountability or at least to wish them ill. 

A society in which there is no accountability for misdeeds breeds conflict and inequity. It’s no wonder that America finds itself in such decline that narcissists like Trump claim only they can restore greatness and criminals like Hillary claim the corrupt and inequitable America is great today. 

Age of the Geek

There can be no question this the age of the geek.  From Bezos to Musk to Zuckerberg to Page and Brin, tech savvy leaders are front and center in our world. But this isn’t the age of the geek because we have so many geeky leaders it’s the age of the geek because they didn’t need professional managers or masters of business administration to create their massively successful businesses. The success of tech entrepreneurs is proof that product and design sell better, connect to customers, better than structured decision making and “efficiency gains” through labor arbitrage.

Why now? The rationale I have outlined is not a novel one so why is now the age of the geek and not 30 years ago, 15 years ago or even 5 years ago? Today the access to cutting edge technology and means to distribute ideas has been democratized past the tipping point that if you have an idea, technical skills but don’t have the capital you can still produce and compete with well established players.

The next logical conclusion might be that the masters of business are bound to marshal the resources to employ talented tech savvy staff to compete and with superior business management skills they should overtake the likes of Alphabet, Facebook, Uber and the like.  There again you would be wrong.  The masters of business crave certainty, well known payback periods, returns in excess of hurdle rates.

For the professional manager failure is becoming more common and acceptable but only if you fail following the crowd.  If a professional manager delivers a product similar to others or in line with prevailing forecast for product direction there little personal risk.  A professional manager trying to introduce a new business model, sharing economy or gig economy, a failure would mean the end of their career.  For this reason now is the age of the geek, free from professional managers fear and doubt of business models and looking simply to create superior products and services that meet market needs.

It’ like the old saying goes, “Professionals built the Titanic, an amateur built the Ark. Don’t be afraid to try something new.”

With an idea and an Internet connection today you can change the world.

Massive Quantative Easing is Communism

In what style of government does the state own all means of production? Answer = Communism. When central banks buy up so much debt and equity in “capital markets” they are effectively nationalizing the markets and have become the owners of a large portion of production.  They have backed into Communisim as a means to save capitalism! This is crazy and the laymen is being led astray a group of economist whose record of success is worse than Shaquille O’Neals free throw shooting percentage.

So the team of quacks who have routinely to forecast acurately that which they claim to control wants to take control over banks and public business to create jobs.  This type of central planning has never worked. Some argue that while central banks are moving closer towards ownership of productive means they won’t exert control or influence I say bullshit. When GM was bailed out by the government they made executives sell their jets and drive cross country. While that may feel good to the populous it is the government dictating how capital is allocated. Idiots who buy private jets and fail to produce desirable goods should go out of business not get bailed out. Just by the act of bailing out or supporting asset prices the central banks are picking winners and losers

In a free society you have the right to chase your dreams but you are not guaranteed to hold them. 

Why Cheap is Good

Why Cheap is GoodIn 2008 the financial crisis brought down home prices, asset prices, to levels that hadn’t been seen in years. That means homes got cheap, I don’t understand why this is so bad, cheap is good! Many people could no longer afford their homes, it’s sad and unfortunate. Children being affected is the most heart wrenching outcome. This sound outcome is a terrible reason for governments and central banks to prop up asset prices and fight a war against cheap houses. 

When central banks force asset prices to increase to pre-crisis levels they acknowledge there was a bubble and prices were too high but at the same time are working to keep them high. Think about, prices are too high but don’t let them go down. 
Who benefits when asset prices stay high? Producer of assets and asset related debtors, home builders and people who took out loans. Who loses? Consumers, people who buy ANYTHING! The bigger the bubble the bigger the impact on consumers. Additionally, as I have described in earlier posts the economy is not a static equation where x input always produces y output the behavior of producers and consumers changes. Producers take less risk on new products and services and consumers reduce spending. We have seen that over the last few years company sales are going down even though stock prices are going up. This means companies are not adapting to a lower asset price economy, they are struggling with their failing business models relying on politicians and central bankers to keep the party going. 

The inherent problem is that poor people don’t have assets resulting in the high cost of consumables taking a greater proportion of income. The poor get poorer. People without significant assets slide down wealth scale while those with assets and asset producers continue to prosper. Consider this, after the financial crisis the hourly wage of construction workers has fallen but home prices have completely rebounded. The worker goes down the wealth scale while developer maintains position. If prices were allowed to fall then the worker starts a home improvement business as people are fixing homes instead of building new ones and the developer changes to multi-family homes, apartment building, as people are building fewer homes. They must be creative to come up next steps but with true market signals they are forced to change course, to adapt. 

Broken vs. Handicapped

It’s tempting to declare the economy is broken with low and negative interest rates and slowing global trade but I believe it’s just handicapped. The economy has been handicapped by politicians and quasi government bodies such as central banks. These groups took credit for beating inflation in the 70’s and the boom times from 80’s onward but then when a downturn in the came they were under pressure to “fix” the economy. Since they weren’t the architects of the boom they had no credible way to create a recovery from the bust. Yet politicians and central bankers claimed they could prevent any financial pain and eliminate recessions giving us perpetual growth. Nothing in this world works this way and the economy is no different.

The word that best describe the handicaps politicians put on the economy is manipulation which results in moral hazard and game theory. Sounds crazy right, economics is supposed to be straightforward, equations and graphs such given input x output y is produced. Anyone who has ever played rock, paper, scissors knows that while paper always beats rock you can’t predict your opponent predictably enough to throw paper every time. When politicians and central bankers manipulate economies they consistently fail to forecast that market participants, you and me, will adapt so that x input no longer produces output y or that we may throw scissors to slice through politicians paper.  This adaptation is healthy, it creates innovation and creates satisfied customers for artisanal ketchup and the dollar shave club, innovation at the high and low end of the luxury scale.

When the economy undergoes down trends politicians blame each others policies and all claim to know the “solution” to a flagging economy.  The secret is that the solution for a flagging economy is A FLAGGING ECONOMY.  What does that mean?  The cure for falling prices is falling prices, the producers that can’t compete fail, yes they have to fail, and those who are able to produce profitably at lower prices survive.  Failing companies allow new market entrants with new business plans, new technology and add value to the market.  If all companies in the industry fail then it means the goods or services they produced weren’t valued.  In today’s world where Kellog’s has the creativity and ability to sell breakfast cereal in Times Square for $6 a bowl (you can buy a box for $6) there is no excuse for manipulating markets to support failing business.

The result of intervention is a handicapped market that fails to delivery to the point it appears broken.  Luckily all we have to do is remove the handicap and the market policies itself.  There will be winners and losers but a game without losers is a game without winners, not much of a game really, more like a queue where you wait your turn for the ride that just takes you back to the end of the queue.

What are banks competitive advantages?

I have been thinking a lot about banks and what makes one better than the other, for the most part it’s not clear.  I wanted to lay out my thoughts anyway, just to crystallize my thinking, I mean seriously nobody is reading this anyway so the whole blog is just me laying out my thoughts to crystallize or something to that effect.

First of all there are many types of banks with the big boys like JP Morgan iron manning it.  Different types of banks have different competitive advantages, let’s go through the list.

Bank Type	Competitive Advantage
Investment banking – Mergers & Acquisition (M&A) Investment banking – Origination Hedge Funds / Private Equity	Relationships – people with influence to get meetings and open doors make these companies successful
Investment banking – Trading (all asset classes) Investment banking – Brokerage	Technology – External facing trading bits are key but the risk management, booking workflow/settlement tech seals the deal
Commercial Banks Retail Banks	Technology & Geographical Presence – Clients want fast, cheap, flawless execution anywhere and everywhere

Let’s leave the relationship business to the side for the moment, these are event businesses that are large inconsistent payoffs.  The deal makers matter more than the banks they work for and big names take their clients with them when they change banks so not really worth considering.

It’s clear that technology is important for most banks so you would think banks would adopt best practices and have teams that fight for talent with tech service firms like Amazon or Salesforce.com.  This is not true at all.  The senior managers running banks don’t even agree that technology is their main competitive advantage, most believe it is their relationship management skills or even products/solutions.  It has been my experience that corporate and retail sales staff basically take client orders and push bank favored products as opposed to designing solutions that client’s need.  That is a job that just about anyone can do, no real competitive advantage from the sales staff.  Some senior managers believe it’s the products they offer that create an advantage but there is no intellectual property in the solutions so there’s no reason any other bank can’t copy the solution except for technology systems.

So why don’t banks compete for talent with the likes of Amazon, Salesforce.com, Google, etc.?  The big tech companies celebrate technical talent and make it the focus of their business.  Banks outsource as much as possible and put those without understanding of technology nor a vision for how to use it in charge of bank tech.  There is a large class of technology workers in banks that manage communications between bankers that don’t understand technology and developers that don’t understand banking.

What does it mean? Companies that celebrate technical staff and make it the focus of their business will eventually encroach on bank territory and usurp them.  What is preventing them from doing it today, capital.  Banks must be well capitalized, so much that any other type of company would consider it wasteful.  These days Apple and Google have more cash than they know what to do with and with negative interest rates it seems like the stage might just be set for the big banks to fall victim to not knowing their competitive advantage.

 

FinTech

I love FinTech. Let me say that again I LOVE FINTECH. 

What is FinTech? FinTech stands for Financial Technology and it is the revolution in banking and finance that will change the money industry significantly. 

Why do I love this change and what does it mean?  Most bank IT departments can be best described as Frank-Tech. The systems are cobbled around a mainframe based ledger system that has been bastardized to a degree that everyone is scared to change anything. I’m a firm believer in blaming the craftsman not the tool so the mainframe isn’t the problem, it’s the Jenga like setup that has evolved. 

Here’s the real story. Bankers believe that relationship management skill is the competitive advantage for banks. They couldn’t be more wrong, the only things that matter are product/geographical coverage, stability of service and price (in that order). The main driver behind each of these factors is technology. 

Bankers are doubling down on customer and relationship management and outsourcing technology to FinTech. At some point the FinTech companies will hire relationship managers and become banks themselves. The big banks look like they are involved with FinTech by sponsoring conferences but remember it’s not about the tool it’s about the craftsman. Big banks are using FinTech like a shinny new Jenga block and this might be the one that toppled the stack.