Arete's Observations 4/9/21

Market observations

The S&P 500 shot higher on Monday on strong ISM data and then pretty much stayed in a holding pattern the rest of the week. In one sense, the news is good as it clearly reflects economic improvement. Further, improving conditions are corroborated by other measures such as the financial conditions index in the graph below.

My only question is why was the market response so positive? After all, in the context of increasing vaccinations, decreasing restrictions and ridiculously easy year over year comps, how much of a surprise should improvement be?


The graph below puts in stark relief the cost of boosting short-term economic growth by adding debt. Number one, the marginal benefit of the debt continues decreasing and number two, the endgame is insolvency unless something major changes.


The graph below provides a nice illustration of the longer-term costs of the pandemic to the labor market. While a decline in the unemployment rate should be celebrated, recognition of the permanent damage caused should also be kept in mind. There will be no return to “normal” for the labor market unless and until there is a major effort to retrain workers and match them up with the jobs that exist in the current market.


1 in 4 plan to bolt job post-pandemic

“A quarter (26%) of workers plan to look for a job at a different company once the pandemic threat has subsided, according to Prudential's latest Pulse of the American Worker Survey, conducted by Morning Consult in March.”

“That number is even higher (34%) for millennials, the largest generation in the workforce today. Of those planning to leave their current job, 80% are concerned about career growth, and nearly 75% say the pandemic made them rethink their skill sets.”

One phenomenon that is being supercharged by the pandemic is the increasing focus workers are placing on their career path. Partly this is a function of geographical and other barriers rapidly coming down. Partly, though, this is the result of a long period of declining investment by companies in human resources. Most workers know their company will not look out for them and as a result are becoming more proactive in managing their own careers.

Then (“Observations” 3/26/21):

“The higher up the corporate ladder one goes, the harder it is to match up employer with employee because of all kinds of constraints. Relieve those constraints, many of which are geographical, and employees can start working where they want and with whom they want. Companies with toxic cultures and/or bad people managers could face an exodus of people who suddenly have better options and don’t have to put up with it any longer.”

Now (summary from Axios):

“High-performing workers are the most concerned about career advancement in their current jobs, and they no longer feel geographically tied to local employers in a remote world.”


Substack’s success shows readers have had enough of polarised media ($)

“They’re not paying because they’re getting something in return; they’re paying because they want to support journalism that they think . . . needs to be heard,” Greenwald says. “That’s what Substack in a lot of ways has become: this kind of brand that people are eager to support as a cause.”

“Substack’s success makes it clear that not all readers like this polarised landscape.”

This piece is near and dear to my heart. As a researcher, I have found the information content of many news and media sources has eroded over the years. As distribution has shifted to digital and audiences have broadened, content has become more accessible and more entertaining but less informative. These trends are especially true of investment research.

The good news is more “investment research” is available to people than ever before. The bad news is most of it is of extremely low quality and often quite deceptive. I founded Areté and established “Observations” to push back against these trends by providing extremely high-quality investment insights in an extremely accessible way. Often this involves telling hard truths and being extremely objective to a degree that is out of sync with many popular outlets. In this respect, I feel like I have found a philosophical home on the Substack platform.

Part of my mission is to address the portion of the investing public that doesn’t like the saccharine narratives of Wall Street or the sanctimonious fluff of mainstream media or the tribalism of social media. I absolutely believe there are investors who are smart, thoughtful, and analytical, and value objective and independent insights. This is a unique audience so if you know of anyone of a similar mind, please share this newsletter and spread the word! 


China is betting that the West is in irreversible decline ($)

“Recently, however, China’s risk calculations have seemed to change. First Yang Jiechi, the Communist Party’s foreign-policy chief, lectured American diplomats at a bilateral meeting in Alaska, pointing out the failings of American democracy. That earned him hero status back home.”

“China is increasingly sure that America is in long-term, irreversible decline, even if other Western countries are too arrogant and racist to accept that “the East is rising, and the West is in decline”, as Chinese leaders put it. China is now applying calculated doses of pain to shock Westerners into realising that the old, American-led order is ending.”

These comments go some way in explaining the purpose of contentious meeting in Alaska between the US and China. In the language of business euphemisms, it was about “expectations management”. It appears as if the Chinese increasingly view the US as being in decline and are keen to re-establish the balance of power. While this has widespread implications, it is very quickly spilling over into the business environment …

Consumer boycotts warn of trouble ahead for Western firms in China ($)

“In the eyes of the [Chinese] boycotters, the [non-Chinese] firms erred by declaring concern over allegations that China’s cotton industry includes the forced labour of Uyghurs, a mostly Muslim ethnic minority in the north-western region of Xinjiang. Their bosses hope that the controversy will fizzle out. But they and other Western executives in China cannot shake an unsettling fear that this time is different. Their lucrative Chinese operations are at rising risk of tumbling into the political chasm that has opened between the West and China.”

Thus far, these protests and boycotts are being treated fairly lightly – as run of the mill grievances, but there are good reasons to believe something more serious is afoot. In the context of other moves by China, the protests can be seen as a reset of expectations. The implication is that it is becoming increasingly difficult for international businesses to straddle the fence of sourcing products in China without taking a stand on policies that fly in the face of human rights. This is definitely a space to watch for future developments.

Public policy

The Morning Dispatch: Hey, Big Spender ($)

“The rollout of the plan yesterday made clear that conservatives and progressives hold differing definitions of what constitutes ‘infrastructure.’ Republicans, including McConnell, pointed out yesterday that just under 6 percent of the plan’s funding would go directly toward building (or rebuilding) roads and bridges. Biden views those provisions as necessary, but not sufficient. He said yesterday the AJP would not only repair 20,000 miles of road and 10,000 bridges—as well as build new rail corridors and transit lines—but also make ‘transformational progress’ in the fight against climate change and ‘extend access to quality, affordable home or community-based care’ for parents and caregivers.”

Just as it is important to have a good headline for writing on any digital platform, so too is it important to have a good name for proposed legislation in order to establish a favorable predisposition. As the Democrats have put the word “infrastructure” at the center of their second massive spending proposal, it is generally being received favorably. People know there is a lot of aging infrastructure that needs to be replaced and also know there are a lot of things like broadband access that can be significantly improved.

In a sense this is classic politics – just hitting the right notes with the public and the right time – and the Democrats are currently winning the game. It is a shame however, that Republicans can’t muster a more substantial objection because there will be enormous amounts of waste and enormous amounts of debt that will be a burden to future generations.

Monetary policy

How the Fed took control of the economy

“To brace the U.S. economy and stave off another Great Depression, the Federal Reserve has taken control of it through unprecedented intervention — manipulating market prices, controlling rates and propping up companies on a previously unimaginable scale.”

“The U.S. is a market-run, capitalist economy. But the market is ostensibly now governed by an unelected and largely independent group of technocrats that directs it by creating ridiculous sums of money to buy assets.” 

True, and true. This piece isn’t so notable for the insights it conveys, which have been apparent for several years, but for the boldness of the statements from a fairly mainstream media source. After all, words like “intervention” and “manipulation” are just not language one uses in polite company. Typically, commentary about the economy tends to be sugar coated and tinged with positive themes.

One possible explanation for the noticeable difference in tone is a changing narrative about the Fed. Lauded as the savior of the economy during the financial crisis in 2008, the Fed has gushed at the positive attention it has received ever since. Now that the potential consequences of its actions are becoming progressively clearer, however, the Fed’s fandom may be changing.Dion Rabouin writes about the fading public perception:

“The Fed gets its charter from Congress, which is at the mercy of voters. If voters think the Fed is hurting rather than helping, they can direct their representatives accordingly.”


CEOs are the new lawmakers

“American CEOs,forced into politics by cultural trends and staff demands in recent years, are hitting a new phase — actual lawmakers and rule-shapers.”

“Every CEO has been hit by the radical transformation of what the country demands of its corporations. And with each controversy comes CEOS scrambling, sometimes clumsily, to handle a power many would rather not have.”

The impetus for this discussion was the recent move by MLB to pull the All-Star game from Atlanta and relocate it to Denver in protest of the recent legislation in Georgia about voting rights. While this is probably not the most representative example, it does highlight the reality that a company or organization is a brand in itself and as such, needs to be attuned to the environment of social and political trends.

The suggestion by Axios that CEOs might become de facto lawmakers is superficial at least, and perhaps disingenuous, however. This is because CEOs have always wielded great power over the legislative process and in many cases have lobbyists actually write the laws. The power of CEOs to affect legislation is much, much greater than that of an ordinary citizen.

The implication that CEOs might make better lawmakers than current legislators is also a stretch that overlooks a history replete with irresponsible and exploitative behavior by corporate leaders. Were the bailouts of airlines, the abuses of share repurchases, and the skyrocketing compensation of CEOs, among others, really so far distant that people have forgotten?

The fact that the proposition is being made begs the question as to why it is being made now. In response to that question, it is true in general that part of the job of most CEOs is to balance and mediate among many different interests, i.e., to engage in politics. It is also true that most CEOs have at least some degree of accountability to accomplish things. Nonetheless, to believe CEOs would make better lawmakers than current politicians mainly speaks to the especially low esteem most people have for politicians. CEOs, however, might have a different view …

Dimon calls on companies to be policymakers

“JPMorgan CEO Jamie Dimon is calling on companies to play a bigger role in the world’s problems, saying today in his annual shareholders letter that the business sector should be a ‘responsible community citizen’."

"We are bogged down, sometimes crippling our nation, because of self-interest and the associated bureaucracy and bad thinking that follow," says Dimon.

To be lectured on self-interest and bad thinking by the CEO of a bank that has paid many billions of dollars in penalties for violating almost every trading law on the books is rich to be sure. Nonetheless, by very publicly promoting the role companies can play in making policy, he is also deftly picking up on a change in the political zeitgeist. To be fair, companies are increasingly under pressure to take stands on political issues in ways that politicians cannot or will not.

Perhaps it is the threat of further encroachment by companies on the historically political turf of policy making that got Mitch McConnell’s feathers all ruffled …

McConnell Slams "Outrage Industrial Complex" As Corporations Behave Like "Woke Parallel Government"

"From election law to environmentalism to radical social agendas to the Second Amendment, parts of the private sector keep dabbling in behaving like a woke parallel government," he [McConnell] said, adding "Corporations will invite serious consequences if they become a vehicle for far-left mobs to hijack our country from outside the constitutional order."


Gold Is Getting That Inflation Feeling Again

“Gold yields nothing and lasts forever, so should be treated like a zero-coupon long-duration asset. Higher rates make its lack of yield more unappealing. Low rates make it look better. The lowest real yields in history, as seen last year, were enough to bring the metal to an all-time high in nominal terms. So it shouldn’t be that surprising that, with real yields rising this quarter, the gold price fell.”  

Gold had a good year in 2020 but after hitting a peak in August has been trailing off since. The weak performance, especially relative to the strong performance in stocks since that time, begs a review of the rationale for gold.

One of the main reasons for long-term investors to own gold is because it has one of the lowest correlations with stock returns over long periods of time. As many assets have become increasingly correlated over time, owning assets that behave differently in different economic conditions is extremely important. Gold is one of the few assets that does this. This will become increasingly important as bond yields rise since bonds will no longer be able to cushion portfolios as they have in the past.

One of the main drivers for gold is real yield (i.e., yield minus inflation). Since gold itself does not provide any cash flows, its relative attractiveness depends in large part on the real yields of stocks and bonds. When inflation adjusted yields of stocks and bonds are positive, they are more attractive and when those yields are negative, gold is more attractive.

Two interesting things have happened over the last several years. One is that even though stocks are hitting record highs, the comparison of stocks to gold (graph below) is still a long way below its peak in 2000. This suggests much of the recent appreciation in stocks has been due to a weakening dollar as opposed to strong earnings growth. I believe this is a point many investors don’t fully appreciate.

Source: Bloomberg

As such, one way to view stocks and gold (and most assets) are as “nets” to catch some of the excess US dollars floating around. With the short-term earnings picture more positive right now due to huge amounts of fiscal spending, stocks are more attractive. When corporate debt and raw materials costs exceed pricing power, gold will look more attractive.

Another element in the equation is cryptocurrencies. Many people believe cryptocurrencies will eventually replace existing currency systems. I don’t believe that will happen but for the time being, those strong narratives do seem to be attracting interest (at the expense of gold) for some of those dollars floating around. While I am not making any predictions about short-term moves, I do believe the relatively new interest in cryptos is creating an attractive point to increase allocations in gold for long-term investors.

Implications for investment strategy

Solo Instinct to Dueling Narratives ($)

“But bond yields are a measure of the supply and demand for savings. There is no law, economic or otherwise, that says that savers will be entitled to positive real returns regardless of how many of them there are, and regardless of how few attractive things there are for them to invest in. So it's entirely possible that bonds are fairly priced for a world where everything is expensive because growth is slow. (Which, incidentally, is not a world where equities or real assets are a terribly attractive place to be.)”

This is a precious little piece of truthiness from Byrne Hobart that should be required reading for investors. He is absolutely right, “there is no law, economic or otherwise, that says savers will be entitled to positive real returns.” In short, investing in financial assets does not always work out – and we may well be entering one of those times.

Many, and arguably most, advisors and consultants rely on historical returns to establish expectations of returns for various asset classes. While that is not a bad place to start, it completely fails to account for current prices, earnings growth, or inflation expectations. In other words, actual performance may vary – by a lot!

This is an area I have been doing a lot more work on lately. Because I believe the environment has worsened considerably over the last few years for assets like stocks and bonds, I have been evaluating alternative investment strategies that can be more resilient. I will have more to say on this in coming months, but a key factor will be uncorrelated returns that generate true diversification. Given the enormous past success of stocks and bonds, I suspect it will be very difficult for an entire generation of investors, advisors, and managers to change their stripes and adapt to a very different environment.

Principles for Areté’s Observations

  1. All the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.

  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.

  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.

  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, I try to represent both sides of an argument and to express my opinion as to which side has the stronger case, and why.

  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.


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