HUMMONEY - Short Term Mindedness (Perspective)

photo courtesy Washington Times- by Greg Lewin

Since Ben Bernanke, the Chairman of the US Federal Reserve Board, announced his new program of Quantitative Easing at the Jackson Hole Economic Symposium in late August 2010 called QE2, the stock market has had a dramatic change of fortunes, turning a 2010 January – August  loss of 5% into a roaring 18% gain.  Now it is true that it can be misleading to attribute specific moves in the markets to any single event, but in this case the correlations look extremely strong and in fact can be traced to daily interventions conducted by the Fed in the markets that have led, by some measures, to a rally of unprecedented strength, length and consistency. Therefore, it behooves us as investors to examine this program and its merits a little more closely.

QE2 is a rather simple policy that effectively exchanges higher yielding assets held by banks and replaces them with lower yielding assets. So the Federal Reserve takes on the obligation of an interest paying obligation and the bank now must look for another way to create returns lost. The catch is that in the process the Fed in effect has created a low to no interest rate environment and the only place for investors to locate returns is by accepting higher levels of risk than those often found in fixed rate instruments. If we examine the overall picture of economic health since the inception of this program we see little uniform relief. Many measures have continued to deteriorate such as employment and housing and others such as real GDP (when stripped of government stimulus) and credit have at best stagnated. Therefore, by definition, if fundamentals are little changed and investors are accepting more risk by exchanging fixed rate investments for equity investments they are in effect speculating and this is never healthy.

The original quantitative easing program which began in the heart of the financial crisis was a $1.7 trillion program focused on bringing stability to the free falling mortgage-linked debt markets and thereby aiding the banking system. In contrast, QE2 had been launched with the hope of stimulating growth. But close examination may raise important questions about the impact of this growth.  For the 2 clear areas of economic growth we have seen over the past 6 months have been the price of stocks and the prices of commodities and these 2 asset classes lead to very different and troubling outcomes.

Since we know that 10% of American families control approximately 90% of investible assets, stock market gains are clearly concentrated in the hands of the few. Assuming these are the families least likely to be suffering the stress of the financial crises, it can be assumed that this incremental capital is likely saved or spent on highly discretionary purchases, not necessarily the investments necessary to drive employment and business formation. However, if we look at the other alleged by- products of the Fed’s promotion of speculation, investments in commodities have led to steep rises in commodity prices such as gasoline, home heating fuel, agricultural products and a whole host of metals. Different than stock price appreciation we know that these price increases directly and disproportionally impacts those already in stress.

So we seem to be walking down a path we have walked before. As we review earlier policies of financial intervention, complaints were loud and clear that the banks got relief that they used to rebuild their health and wealth (bonuses) while the individual and small business owners floundered. And now much of the same (albeit with slightly different actors) seems to be taking place. When does the failure of these policies to address the real issues of employment, growth and inequality begin to stress the economic platform on which we all dependent?

Long term investing is predicated on a sound alignment of fundamental progress and stock price movement. Therefore investors must judge whether the policies driving our stock market movements are worthy and sustaining.              

 ---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.

HUMMONEY - The Case of the Missing Gorilla (Perspective)

- by Greg Lewin

There’s a cognitive experiment that has been run a number of times and it goes something like this: a group of participants is asked to focus intently and complete a detailed somewhat repetitive task. In the midst of this effort a very unusual object is introduced into the environment the participants are focused on. In the example I saw the foreign object was a person in a gorilla suit. Upon completion of the task (in my example the participants were counting balls) only some of the participants were aware of the gorilla’s presence. Other participants never noticed a man in a gorilla suit walking through the scene. This can be called perception blindness, describing how unaware people can become of their environment when focused on a specific repetitive task.  This lack of awareness of change can be the sort of blindness that can lead to real risk of capital loss in the investment process.

Take last week. Global markets surged on the back of a statement by US Federal Reserve Chairman Ben Bernanke that the economic recovery was continuing to show real weakness and that additional liquidity may need to be injected into the financial system for support. Clearly, world markets were focused on the repetitive task that injecting liquidity makes markets rise but they failed to notice that, for example:

-        Another important economic official left the US administration,

-        New home sales in the US in August were the worst on record,

-        Or the stunning observation by Walmart’s CEO that just after midnight at the end of each month sales of consumer staples surge as electronic benefit cards get activated,

-        Or most importantly, that the previous attempts to inject liquidity into the global economic system have led to little to no sustained economic response.

But if we stay wed to our narrow focus and our narrow range of responses we will ultimately fail to notice the gorilla in the room or better popularized as the Black Swan.

The key as investors is to be aware of this human frailty so that you have a much better chance of combating the typical response and hopefully become aware of the much broader universe of outcomes you can choose.

In my opinion the single most important quality to becoming a successful investor is the ability to stay balanced and dispassionate so that you are in position to make the next best decision. But in order to execute with a quiet and calm disposition you must also be aware of all the relevant information present, and that is why fighting perception blindness is so important. Because who would not want to be aware of the gorilla in our midst.     

---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.