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The capital asset pricing model (CAPM) is insidious. It creeps into almost every discussion on finance. For instance, every time you mention alpha and beta you are tacitly invoking the CAPM, because the very separation of alpha and beta stems from the CAPM model.
A brief history of time
Let's take a step back and examine a brief history of the origins of CAPM. It all started way back in the 1950s when Harry Markowitz was working on his PhD. Markowitz created a wonderful tool which allows investors to calculate the weights to give each stock (given expected return, expected risk, and the correlation) in order to achieve the portfolio with the greatest return for a given level of risk. Effectively investors using Markowitz's methods will have mean-variance efficient portfolios; that is to say, they will minimize the variance of portfolio return, given expected return, and maximize expected return given the variance.
Markowitz gave the world a powerful tool that is much used and loved by quants everywhere. However, from there on in, the finance academics proceeded down a slippery slope. Somewhere around the mid-1950s Modigliani and Miller came up with the idea of dividend and capital structure irrelevance. They assumed that markets were efficient (before the efficient market hypothesis was even invented), and argued investors didn't care whether earnings were retained by the firm or distributed as income (this will be important in a little while).
In the early 1960s the final two parts of efficient markets school dawned into the unsuspecting world. The first of these was CAPM from Sharpe, Litner and Treynor. In the wonderful world of CAPM all investors use Markowitz optimization. It then follows that a single factor will distinguish between stocks. This all encompassing single factor is, of course, beta.
The second was the summation of all ideas, the birth of the efficient market hypothesis itself from Eugene Fama (another PhD thesis). I don't want to rant on about market efficiency as my views on this topic are well known.
CAPM in practice
It is worth noting that all these developments were theoretical. It could have been very different. In a parallel world, David Hirshleifer describes:
A school of sociologists at the University of Chicago proposing the Deficient Markets Hypothesis: that prices inaccurately reflect all information. A brilliant Stanford psychologist, call him Bill Blunte, invents the Deranged Anticipation and Perception Model (DAPM), in which proxies for market misevaluation is used to predict security returns. Imagine the euphoria when researchers discovered that these mispricing proxies (such book/market, earnings /price, and past returns), and mood indicators such as amount of sunlight, turned out to be strong predictors of future returns. At this point, it would seem that the deficient markets hypothesis was the best-confirmed theory in social sciences. To be sure, dissatisfied practitioners would have complained that it is harder to actually make money than ivory tower theorists claim. One can even imagine some academic heretics documenting rapid short-term stock market responses to new arrival in event studies, and arguing that security return predictability results from rational premia for bearing risk. Would the old guard surrender easily? Not when they could appeal to intertemporal versions of the DAPM, in which mispricing is only correct slowly. In such a setting, short window event studies cannot uncover the market's inefficient response to new information. More generally, given the strong theoretical underpinnings of market inefficiency, the rebels would have an uphill fight.
If only we lived in such a parallel reality! In general our industry seems to have a bad habit of accepting theory as fact. As an empirical skeptic my interest lies in whether CAPM works. The evidence from the offset has been pretty appalling. Study after study found that beta wasn't a good measure of risk.
For instance the chart below is taken from Fama and French's 2004 review of CAPM. Each December from 1923 to 2003 they estimate a beta for every stock on the NYSE, AMEX and NASDAQ using 2-5 years of prior monthly returns. Ten portfolios are then formed based on beta, and the returns tracked over the next 12 months.
The chart below plots the average return for each decile against its average beta. The straight line shows the predictions from the CAPM. The model's predictions are clearly violated. CAPM woefully under-predicts the returns to low beta stocks, and massively overestimates the returns to high beta stocks. Over the long run there has been essentially no relationship between beta and return.
Of course this suggests that investors might be well advised to consider a strategic tilt towards low beta and against high beta - a strategy first suggested by Fisher Black in 1993.
Nor is this simply another proxy for value. The table below (taken from some recent work by Vuolteenaho) shows the beta arbitrage strategy holds across book to price (B/P) categories. For instance, within the growth universe (low B/P) there is an average 5% differential from being long low beta, and short high beta.
Within the value universe (high B/P), a long low beta, short high beta created an average difference of 8.3% p.a. over the sample. So both growth investors and value investors can both exploit a strategic tilt against beta.
A recent paper from the ever-fascinating Jeremy Grantham of GMO reveals that amongst the largest 600 stocks in the US, since 1963 those with the lowest beta have the highest return, and those with the highest beta have the lowest return - the complete inverse of the CAPM predictions. Yet more evidence against the CAPM.
Nor is this purely a US problem. With the aid of the Rui Antunes of our Quant team we tested the performance of beta with the European environment. The chart below shows that low beta on average has outperformed high beta! Yet another direct contradiction of the CAPM.
Another of CAPM's predictions states the cap-weighted market index is efficient (in mean-variance terms). With everyone agreeing on the distributions of returns and all investors seeing the same opportunities, they all end up holding the same portfolio, which by construction must be the value weighted market portfolio.
There is a large amount of evidence to suggest that CAPM is wrong in this regard as well. For instance, in a recent issue of the Journal of Portfolio Management Clarke, de Silva and Thorley showed that a minimum variance portfolio generated higher returns with lower risk than the market index.
Rob Arnott and his colleagues at Research Affiliates have shown that fundamentally-weighted indices (based on earnings and dividends, for example) can generate higher return and lower risk than a cap-weighted index. Remember that the fundamentally-weighted index is still a passive index (in as much as it has a set of transparent rules which are implemented in a formulaic fashion).
The chart below shows the return per unit of risk on selected Fundamental Indices vs. the MSCI benchmark. It clearly shows the cap-weighted indices are not mean variance efficient. On average the Fundamental Indices shown below outperformed MSCI cap-weighted equivalents by an average 278bps p.a. between 1984 and 2004. They delivered this outperformance with lower risk than the MSCI equivalents, the Fundamental Indices had a volatility that was an average 53bps lower than the MSCI measure. Something is very wrong with the CAPM.
Of course, those who believe in CAPM (and it is a matter of blind faith given the evidence) either argue that CAPM can't really be tested (thanks for a really useless theory guys) or that a more advanced version known as ICAPM (intertemporal) holds. Unfortunately the factors of the ICAPM are left undefined, so once again we are left with a hollow theory. Neither of these CAPM defenses is of much use to a practitioner.
Ben Graham once argued that "Beta is a more or less useful measure of past price fluctuations of common stocks. What bothers me is that authorities now equate the beta idea with the concept of risk. Price variability, yes; risk no. Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic changes or deterioration in management".
Why does CAPM fail?
The evidence is clear - CAPM doesn't work. This now begs the question as to why. Like all good economists when I was first taught the CAPM I was told to judge it by its empirical success rather than its assumptions. However, given the evidence above, perhaps a glance at its assumptions might just be worthwhile.
CAPM assumes:
1. No transaction costs (no commission, no bid-ask spread)
2. Investors can take any position (long or short) in any stock in any size without affecting the market price
3. No taxes (so investors are indifferent between dividends and capital gains)
4. Investors are risk averse
5. Investors share a common time horizon
6. Investors view stocks only in mean-variance space (so they all use Markowitz's optimization model)
7. Investors control risk through diversification
8. All assets, including human capital, can be bought and sold freely in the market
9. Investors can lend and borrow at the risk-free rate
Pretty much all of these assumptions are clearly ludicrous. The key assumptions are number 2 and number 6. The idea of transacting in any size without leaving a market footprint is a large institution's wet dream... but that is all it is - a dream.
The idea that everybody uses Markowitz optimization is also massively wide of the mark. Even its own creator Harry Markowitz when asked how he allocated assets said "My intention was to minimize my future regret. So I split my contributions 50-50 between bonds and equities". George Aklerof (another Nobel Prize winner) said he kept a significant proportion of his wealth in money market funds; his defense was refreshingly honest: "I know it is utterly stupid". So even the brightest of the bright don't seem to follow the requirements of CAPM.
Nor is it likely that a few 'rational' market participants can move the market towards the CAPM solution. The assumption which must be strictly true is that we all use Markowitz optimization.
Additionally, institutional money managers don't think in terms of variance as a description of risk. Never yet have I met a long-only investor who cares about up-side standard deviation, this gets lumped into return.
Our industry is obsessed with tracking error as its measure of risk not the variance of returns. The two are very different beasts. Tracking error measures variability in the difference between the returns of fund manager's portfolio and the returns of the stock index. Low beta stocks and high beta stocks don't have any meaning when the investment set is drawn in terms of tracking error.
To tracking-error-obsessed investors the risk-free asset isn't an interest rate, but rather the market index. If you buy the market then you are guaranteed to have zero tracking error (perhaps a reason why mutual fund cash levels seem to have been a structural decline).
CAPM today and implications
Most universities still teach CAPM as the core asset pricing model (possibly teaching APT alongside).
Fama and French (op cit) wrote "The attraction of CAPM is that it offers powerful and intuitively pleasing predictions about how to measure risk and the relation between expected return and risk. Unfortunately, the empirical record of the model is poor - poor enough to invalidate the way it is used in applications." Remember this comes from the high priests of market efficiency.
Analysts regularly calculate betas as an input into their cost of capital analysis. Yet the evidence suggests that beta is a really, really bad measure of risk, no wonder analysts struggle to forecast share prices!
An entire industry appears to have arisen obsessed with alpha and beta. Portable alpha is one of the hot topics if the number of conferences being organized on the subject is any guide. Indeed the chart below shows the number of times portable alpha is mentioned in any 12 months. Even a cursory glance at the chart reveals an enormous growth in discussion on the subject.
However every time you mention alpha and beta remember that this stems from CAPM. Without CAPM alpha and beta have no meaning. Of course, you might choose to compare your performance against a cap-weighted arbitrary index if you really wish, but it hasn't got anything to do with the business of investing.
The work from Rob Arnott mentioned above clearly shows the blurred line that exists between these concepts. The fact that Fundamental Indices outperform cap-weighted indices, yet are passive, shows how truly difficult it is to separate alpha from beta.
Portable alpha strategies may not make as much sense as their exponents would like to have us believe. For instance, let us assume that someone wants to make the alpha of a manager whose universe is the Russell 1000 and graft in onto the beta from the S&P500. Given these are both large-cap domestic indices the overlap between the two could well be significant. The investor ends up being both potentially long and short exactly the same stock - a highly inefficient outcome as the cost of shorting is completely wasted.
Now the proponents of portable alpha will turn around and say obviously the strategy works best when the alpha and the beta are uncorrelated i.e. you are tacking a Japanese equity manager's alpha onto a S&P500 beta. However, if the investor is already long Japanese equities within their overall portfolio, they are likely to have Japanese beta, hence they end up suffering the same problem outlined above - they are both long and short the same thing. Only when the alpha is uncorrelated to all the elements of the existing portfolio can portable alpha strategies make any sense.
My colleague Sebastian Lancetti suggested another example to me. It is often argued that hedge funds are alpha engines, however, the so called attack of the clones suggests that they are in large part beta betters (a point I have explored before, see Global Equity Strategy, 11 August 2004 for details). If their performance can be replicated with a six factor model, as it is claimed by the clone providers, then there isn't too much alpha here.
Alpha is also a somewhat ephemeral concept. A fund's alpha changes massively depending upon the benchmark it is being measured against. In a recent study, Chan et al found that the alphas delivered on a variety of large cap growth funds ranged from 0.28% to 4.03% depending upon the benchmark. For large cap value managers, the range was -0.64% to 1.09%.
The terms alpha and beta may be convenient shorthand for investors to express notions of value added by fund managers, and market volatility, but they run the risk of actually hampering the real job of investment - to generate total returns.
A simple check for all investors should be "Would I do this if this were my own money", if the answer is no, then it shouldn't be done with a client's money either. Would you care about the tracking error of your own portfolio? I suggest the answer is no. In a world without CAPM the concept of beta-adjusted return won't exist. In as much as this is a fairly standard measure of risk adjustment then it measures nothing at all, and potentially significantly distorts our view of performance.
Perhaps the obsession with alpha and beta comes from our desire to measure everything. This obsession with performance measurement isn't new. Whilst researching another paper (on Keynes and Ben Graham) I came across a paper written by Bob Kirby in the 1970s. Kirby was a leading fund manager at Capital group where he ran the Capital Guardian Fund. He opined:
Performance measurement is one of those basically good ideas that somehow got totally out of control. In many, many cases, the intense application of performance measurement techniques has actually served to impede the purpose it is supposed to serve - namely, the achievement of a satisfactory rate of return on invested capital. Among the really negative side effects of the performance measurement movement as it has evolved over the past ten years are:
1. It has fostered the notion that it is possible to evaluate a money management organization over a period of two or three years - whereas money management really takes at least five and probably ten years or more to appraise properly.
2. It has tried to quantify and formulize, in a manner acceptable to the almighty computer, a function that is only partially susceptible to quantitative evaluation and requires a substantial subjective appraisal to arrive at a meaningful conclusion.
It is reassuring to see that good ideas such as Kirby's can be as persistent as bad ideas such as the CAPM. Kirby also knew a thing or two about the pressures of performance. During 1973, Kirby refused to buy the rapidly growing high multiple companies that were in vogue. One pension administrator said Capital Guardian was "like an airline pilot in a power dive, hands frozen on the stick; the name of the game is to be where it's at". Of course, had Kirby been "where it's at" he would have destroyed his clients' money.
Ben Graham was also disturbed by the focus on relative performance. At a conference one money manager stated "Relative performance is all that matters to me. If the market collapses and my funds collapse less that's okay with me. I've done my job."
Graham responded:
That concerns me, doesn't it concern you?... I was shocked by what I heard at this meeting. I could not comprehend how the management of money by institutions had degenerated from the standpoint of sound investment to this rat race of trying to get the highest possible return in the shortest period of time. Those men gave me the impression of being prisoners to their own operations rather than controlling them... They are promising performance on the upside and the downside that is not practical to achieve.
So in a world devoid of market index benchmarks what should be we doing? The answer, I think, is to focus upon the total (net) return and acceptable risk. Keynes stated "The ideal policy... is where it is earning a respectable rate of interest on its funds, while securing at the same time its risk of really serious depreciation in capital value is at a minimum". Sir John Templeton's first maxim was "For all long-term investors, there is only one objective - maximum total real returns after taxes". Clients should monitor the performance of fund managers relative to a stated required net rate of return and the level of variability of that return they are happy to accept.
We came closer to this idea during the bear market of the early 00s. However, three years of a cyclical bull market have led once again to a total obsession with relative performance against a market index. On this basis, roll on the next bear market!
(reprinted from John Mauldin's "Outside The Box"
commentary of January 29, 2007; Volume 3 - Issue 17.
For further information, contact John Mauldin at
JohnMauldin@InvestorsInsight.com.)
Hold the valuation rationales for the US stock market. They don't hold water or pass mustard. You can't rely on Fed action saving most US stock portfolios forever. Sure, they can hold things up while the public is fooled into doing what they normally wouldn't do, presumably for the good of the short-term economy. (Spend excessively and incur mountains of debt.) But know that this is not sustainable, although at times like this it may appear as though it is. But in the long term, valuations will prevail (they always do).... Small dividends, small value. Big dividends, big value. No rationale will ever change that; although at times like this, it is tempting to try to invent or buy into someone else's rationale. You get less than 2% yield for the S&P 500 and less most other places in the US market. So to buy it is to depend on another person or thing standing behind you to pay more than you did for your sub-2% yield. This is possible for a finite amount of time.... But for now, let's not kid ourselves. If you do this, you are not investing; you are speculating. - Martin Goldberg
When the economy begins to weaken commodity prices go down; when the economy is strong commodity prices go up. Since its May high the CRB commodity index has dropped 22%, only the 7th time this has happened since 1974. According to ISI, since 1974 every decline in the index of 20% or more has been associated with either a recession, a significant slowdown or a financial crisis. Each of these periods has also occurred following a period of tight money and an inverted yield curve.... In addition our own studies indicate that a serious economic slowdown in the period ahead is more likely to end in recession rather than a soft landing. Not only have soft landings been extremely rare in U.S. financial history, but expansionary cycles featuring a series of Fed rate hikes, an inverted yield curve and a sharp drop in the growth rate of the leading indicators have almost always been followed by a recession and bear market. - Charlie Minter
The problem with liquidity is it is impossible to measure and can instantly disappear. The world is only awash in liquidity until it is not. - Jim Bianco
It's worth remembering that markets were very upbeat in the early summer of 1914. Financial history demonstrates that the biggest liquidity problems always follow the moments of greatest confidence. Complacency can be a self-denying prophecy. - Larry Summers [former U.S. Treasury Secretary]
Current risks are ludicrously underpriced. At some point, someone is going to get an extremely nasty surprise. - Willen Buiter [professor, London School of Economics]
While a crisis scenario with an imploding hedge fund causing ripple effects through the financial sector is possible and likely, we don't need a crisis for the party to end. What we need is increased volatility which we have already seen in the commodities and bond markets; the equity and currency markets have also indicated volatility may be on its way back. As volatility increases, speculators are likely to pare down their leverage. In our assessment, the economic slowdown induced merely by an increase in volatility may be sufficient to encourage the Fed to ease monetary policy once again. Any easing in this context will, in our assessment, have negative implications for the dollar. - Axel Merk
That Federal Reserve Board rate cut? The one Wall Street's been forecasting for months? The one that's supposedly right around the corner? Forget about it! The latest economic numbers say it ain't happening. The latest moves by foreign central bankers make it unlikely. And as far as I'm concerned, the Fed is pretty much treading water in an ongoing flood of easy money into the asset markets. Unless there's some kind of spectacular financial blow-out, the Fed is out of the picture, and you should invest accordingly. - Mike Larson
The American economy is like a bicycle. When it stalls, it falls. - Kurt Richebächer
I am not sure what will pop this global credit bubble, but I suspect it will not be higher U.S. interest rates or a rising yen. More than likely, it will be either pure exhaustion, something totally off everyone's radar, or simply the reverse of some scenario that everyone expects. In 1980, it took $1 of new debt to create $1 of GDP; in 2000, it took $4; and today, it takes $7. All of that extra credit is serving no productive means. It is pure speculation and it will be unwound. Nonetheless, the sheep are still grazing. - Mike Shedlock
It works like this. You have a house worth $100,000. You take out a mortgage for $50,000. Then the mortgage is mixed together with other mortgages, stirred, shaken and sold to a financial house, X. There, it is used as collateral for a loan of $500,000...which is invested in a leveraged buy-out of a Company Y...which then issues bonds worth $5 million, which are taken up by hedge fund Z, that borrowed the money to buy them from the Japanese at a low interest rate, exchanged it for dollars, and now invests in these junk bonds at twice the yield. At every step, the financial intermediaries make their commissions, their spreads, and their fees. At every step, the amount of notional 'money' in the world multiplies. Your income has not changed...your house is still the same...business Y makes no more profits. The real economy remains just as it was. This feverish financial activity...this 'financialization of the economy' adds nothing...not one jot or tittle...to the real wealth that is in the world. There are no more factories...no more diamonds...no more steak sandwiches. All this money-shuffling produces nothing but more profits for the money- shufflers and more wealth for the rich people around the table. - Bill Bonner
Credit lending standards can only go so far before bankruptcies and foreclosures force a change. That change is finally upon us, and a huge secular reversal is now under way. The Fed simply does not have the power to deposit money into consumer accounts so that bills can be paid. It probably would not do so even if it could, because it would be to the detriment of banks and creditors. Will the Fed react to a debt implosion by cutting interest rates? Absolutely. The Fed will likely attempt anything it can to help consumers service debt. History proves it, and history proves gold will benefit, as well. But the Fed cannot create jobs or revive housing, and neither can the Treasury.... The psychology of both lenders and borrowers has now changed at the margin (subprime lending). This is how cascades start. When defaults continue, it will progress further and further up the chains of creditworthiness. It is a mistake to think this will be confined to housing. It won't. If and when there is another huge hedge fund blowup, and/or there is a huge junk bond default, the leveraged buyout and merger mania markets will be hit hard. This is all poised to feed on itself once the ball gets rolling. A major credit bust is coming, and it is only a matter of time. - Mike Shedlock
But the point about debt expansion is that.... money supply growth and debt growth (credit growth) is inflation. Whether you then get it in consumer prices or in wages or in commodities, or in our case in asset prices, is irrelevant. And.... between 1921 and 29, consumer prices didn't go up very much, or wholesale prices declined at that time, and yet you had the Depression that followed the 1920s. And in Japan, between 1980 and 89, ahead of the greatest bear market that Japan experienced following 89.... you didn't have consumer price inflation you just had asset price inflation in stocks and in real estate. And ahead of the Asian crisis in 97, we didn't have consumer price inflation, we just had asset price inflation. And so the goldilocks crowd basically says, "Oh, we're in the best of all possible worlds because consumer prices aren't going up and asset prices are going up and making people richer," when they don't realize that the asset price increases is precisely the bubble that one day will be deflated. - Marc Faber
The fact is that private households have drastically curbed their mortgage borrowing. It amounted to $672.7 billion in the third quarter 2006, sharply down from $1,223.6 billion in the same quarter of last year. That is, consumer borrowing almost halved. It amazes us how little attention this fact finds. It means that the most important credit source for spending in the economy is rapidly drying up, even though money and credit remain, in general, as loose as ever. It is drying up because the decisive lever of this borrowing binge, rising house prices, has broken down; most importantly, this lever is not under the control of the Federal Reserve.... Considering the dramatic reversal in the housing bubble, a virtual collapse of consumer borrowing is definitely in the cards for the United States. - Kurt Richebächer
The poorest people in America are set to become a lot poorer. New American bankruptcy laws will lock them in as indentured serfs to the big bank and credit card lenders, thanks to their buddies on Capitol Hill who passed a law shielding them from their poor judgment in lending. The Federal Reserve will take care of the broad middle class, the big Banks and financial institutions.... But these sub-prime borrowers and homeowners are done; you can put a fork in them. The greatest experiment in fiat money and credit creation in history rolls on, to its inevitable end of a Kondratieff winter. But the winter is still not here.... - Ty Andros
In a misguided attempt to prop up the housing market, the Fed will reluctantly cut interest rates. However, this will actually have the opposite effect on the housing market. The dollar will plunge sending long-term interest rates higher, exacerbating the recession, and making housing even less affordable. In the end Bernanke will feel he has no choice other than to rev up his helicopter engines. The recent strength in gold suggests that those engines might already be warming up. - Peter Schiff
Today, the elderly are in the unfortunate situation where they benefit very little from cheap imported goods manufactured in Asia - the key to what some call an "era of low inflation". Their money is increasingly spent on life's essentials - food, utilities, and medical costs - all of which have risen at a brisk pace in recent years. In many cases, the combination of a pension and a paid-off home has been replaced by a meager retirement income, high bills, and a reverse mortgage. A decade ago, homes were routinely passed on free and clear to surviving children, ten years from now heirs may be surprised to find out how little is left after years of borrowing by their parents to make ends meet. - Tim Iacono
The economic harm done by a fiat monetary system is pervasive, dangerous, and unfair. Though runaway inflation is injurious to almost everyone, it is more insidious for certain groups. Once inflation is recognized as a tax, it becomes clear the tax is regressive: penalizing the poor and middle class more than the rich and politically privileged. Price inflation, a consequence of inflating the money supply by the central bank, hits poor and marginal workers first and foremost. It especially penalizes savers, retirees, those on fixed incomes, and anyone who trusts government promises. Small businesses and individual enterprises suffer more than the financial elite, who borrow large sums before the money loses value. Those who are on the receiving end of government contracts--especially in the military industrial complex during wartime-- receive undeserved benefits. - Ron Paul (R-TX)
Quite recently Mathew Price of The Australian proudly wrote that only "the best and brightest" become journalists. I am still trying to find out if this arrogant twit is taking medication. - Gerard Jackson
In the original interview, I spoke mostly about a coming U.S. Dollar crisis and how it would be the key factor for gold in 2007. Here's what the editor wrote back: "....we would feel irresponsible building the case around the dollar decline where there are also numerous reasons to believe that global geo-political forces will not let the dollar hit rock bottom. So all things considered, we will not run the piece." YOU NEED TO APPRECIATE THIS! Because my commentary forecasted a dollar crisis despite my argument being supported by hard facts and solid assumptions, this nationally-read, so-called financial magazine would not allow my comments because they already concluded that certain forces would never allow such a thing to occur. As far as I'm concerned, not only is this unfair and unbalanced reporting, it's irresponsible...but not surprising. - Peter Grandich
Even if it were recognized that a gold standard without monetary inflation would be advantageous, few in Washington would accept the political disadvantages of living with the discipline of gold - since it serves as a check on government size and power. This is a sad commentary on the politics of today. The best analogy to our affinity for government spending, borrowing, and inflating is that of a drug addict who knows if he doesn't quit he'll die; yet he can't quit because of the heavy price required to overcome the dependency. The right choice is very difficult, but remaining addicted to drugs guarantees the death of the patient, while our addiction to deficit spending, debt, and inflation guarantees the collapse of our economy. - Ron Paul (R-TX)
The Federal Reserve system had been established to prevent what actually happened. It was set up to avoid a situation in which you would have to close down banks, in which you would have a banking crisis. And yet, under the Federal Reserve system, [in the 1930s] you had the worst banking crisis in the history of the United States. There's no other example I can think of, of a government measure which produced so clearly the opposite of the results that were intended. - Milton Friedman
What do you think the odds are that a young Latino male in California, 20 years from now, is going to pay 20% of his wages in Social Security and Medicare to support some old white broad in Massachusetts? Especially since he knows he's never going to get an aluminum nickel back? Even today, polls show that more kids believe in aliens than believe they'll see any Social Security money. - Doug Casey
As the war in Iraq surges forward, and the administration ponders military action against Iran, it's important to ask ourselves an overlooked question: Can we really afford it? If every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I'm quite certain it would end very quickly. The problem is that government finances war by borrowing and printing money, rather than presenting a bill directly in the form of higher taxes. When the costs are obscured, the question of whether any war is worth it becomes distorted. - Ron Paul (R-TX)
What is the definition of irony? It may come any day now when Fidel Castro dies - the victim of his highly
touted system of socialized medicine in the worker's paradise of Cuba. Even though Castro imported a doctor
from Spain to treat his diverticulitis - an infection in the large intestine that rarely proves fatal in capitalist
countries -; the Communist dictator is said to be in grave condition following three failed surgeries. It's not
only irony, it's poetic justice. U.S. doctors look with stunned amazement at the relatively simple health-care
problem Castro faced and the results - a hospitalization that has continued since late July. They suggest that
medical procedures on Castro were botched. I would suggest the doctors caring for Castro did everything they
could to save him. We're just now learning the truth about Cuba's health-care system after decades of lies.
Socialists in this country have been holding up Cuba as a model for medical care. How many times have you
heard this lie? Yet, the real proof is that the best of Cuba's medical establishment couldn't successfully treat
Castro for a routine ailment after six months..... Keep in mind, this is happening to the Comandante - not
some sugar-cane harvesting peasant. It shows you just how bad socialized medicine gets. It atrophies to the
point where it is incapable of healing, even when doctors' lives may depend upon it. - Joseph Farah
We may actually get one or more warnings for a systemic failure, as such a failure would result from a sudden "repricing of risk" in a major financial area like derivatives or hedge funds. ("Oops, we guess we shouldn't have done that", the risk-takers will say.) This risk-repricing could in turn be caused by a sudden collapse of some overheated, exponentially rising market. A prime candidate is China, where it seems everybody wants to get rich in stocks and people are taking on mortgages and credit-card debt to buy stocks. The Chinese stock markets today show many parallels with the U.S. stock market of the 1920s.... rapid industrialization, population migration from farms to cities, thin regulation, gross overvaluation, exponentially-rising share prices. A bust is certain, but you never know when an exponential rise will break until it does. Another prime candidate is a geopolitical event (a.k.a. Middle East).
Systemic risk remains as ugly as ever, with about 2
in-3 odds that a systemic failure can occur at any
time.
A. "Inheritance" - real (normalized) "dividend and interest distribution" portfolio:
SUMMARY - "Inheritance":
Original cost: $100,000.00 (normalized)
Present value: $110,591.22 (see below)
Increase: $10,591.22 [+10.59%]
COMMENT on "Inheritance": There is no change from the last issue. The portfolio cost (normalized) is $108,800.96 with $54,424.61 currently in cash or near-cash.
B. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG":
Original cost: $10,699.00
Present value: $20,715.11
Increase: $10,016.11 [+93.62%]
COMMENT on "PIG": The PIGs actually met in January, but took no new actions. I continue to "roll over" 3 monthT-bills, one per month.
C. Roth IRAs - real portfolio:
SUMMARY - Roth IRAs:
Original cost: $28,776.19
Present value: $35,715.59
Increase: $ 6,939.40 [+24.12%]
COMMENT on Roth IRAs: There is no change from the last issue.
D. TIAA/CREF 403(b) and (non-Roth) IRA retirement plans: My TIAA-CREF and Fidelity non-individual-stocks retirement investments, both the part from which I am making monthly withdrawals and the parts that are "resting", are invested as follows: TIAA traditional, 55.57%; T-bills and money-markets, 23.91%; TIAA-CREF inflation-indexed bonds (retirement), 16.26%; TIAA real estate, 4.23%; TIAA-CREF High-Yield II, 0.03%
TIAA-CREF values, 5Feb2007: stock, 248.03; equity-index, 97.66; MM, 23.85; bond, 79.70; inflation-indexed bond, 46.45; real estate, 277.61; TIAA current yield in SRA, about 4.82%. COMMENT on NYSE "Timer's Trend": We are currently on a BUY signal of July 25, 2006.
COMMENT on NASDAQ "Timer's Trend": We're on a BUY signal given January 29, 2007.
NEXT ISSUE - will appear in March 2007.