Without precise definitions you end up in forecast hell

Topic: Imprecise definitions lead to useless models and conclusions

Discussion: If you’re performing macroeconomic research, which inflation are you talking about, which growth, which interest rate? The answers to those questions can be of crucial importance for your eventual investment outcome.

Length: Short — maybe 5 minutes reading time

Teaser: It’s easy to predict the weather. Not to mention stock market returns

PODCAST TIP: listen to my latest podcast episode (#6) on Future Skills with philosopher Alexander Bard. We talk about definitions of infantile grown-ups and much much more. Check it out on iTunes here, or your favorite Android app here.


Dream Warriors

Are you dreaming about making perfect economic forecasts, and using them for producing amazing equity investment returns? How does this sound to you:

Weather and production bottlenecks in combination with monetary policy induced growth are starting to cause higher commodity prices. Inflation is already showing in their wake. People worry about rising interest rates, just take a look at OIS spreads. Some central banks are turning less dovish. Higher interest rates means less funds for investments, lower growth, lower profits and lower share prices. Higher interest rates mean lower bond prices, higher borrowing costs, lower real estate prices among other things. Higher inflation means money loses its value. And this time it’s at a time you can’t hide in stocks or bonds. You could hide in gold. One bar of gold is always one bar of gold. Maybe that’s why the gold price in dollars is rising (despite obvious manipulations and jaw-boning from various authorities).

Does the above fit your view? Higher commodity prices => higher interest rates => sell stocks, bonds and real estate and use cash to buy gold and soft commodities, until the cycle turns again?

Well, hold your horses for just a little while.


What’s your definition of a boombastic jazz style?

Which commodity prices are you talking about exactly, when you say their prices are rising? Wheat, hogs, orange juice? Iron ore, coffee, cacao? Silver, cobalt? Platinum, palladium?

Similarly, which interest rates are you referring to? The Fed funds rate? Treasury bills, longer term bond market rates? Corporate bond rates, bank lending rates (to consumers, to corporate clients, to house builders?), peer to peer lendning rates? Intrabank market swap rates?

Oh, I almost forgot, “inflation” you said. Would that be the (ever manipulated and ever changing) CPI measure? Or the PPI gauge? Input our output PPI? How about house price inflation numbers? Or energy price inflation? Avocado prices?

My point in this post is that if you don’t clearly define exactly what variable you are talking about it becomes exteremly difficult to make any kind of coherent analysis, not to mention draw any practical conclusions whatsoever from the exercise. Macroeconomic research is difficult enough as it is without averaging everything together, whether it be “the inflation”, “the interest rate”, “the oil price”, “the stock market” or “GDP”.

Take that last one, e.g., GDP. What does Gross Domestic Product really tell you? What conclusions can you draw from it even if you knew its exact trajectory going forward a few quarters? How about nominal GDP vs. real GDP (using which deflator measure?), or GDP per capita? Then there are data series for wages, wage growth, hours worked, hourly wages, lost jobs, added jobs, seasonal adjustments (many orders of size larger than the actual net number), employment (measured in at  least three different ways depending on, e.g., how to define somebody without a job, based on whether he’s searching for a job or doesn’t care).

And what’s so special about GDP growth by the way? There’s zero useful correlation between real GDP growth and stock market returns. How about a house price recession like the one that began in 2006, several years before the ‘actual’ recession. Don’t even let me begin to talk about the NBER’s definition of a recession (no it’s not “two quarters of contracting real GDP”

 

“a significant decline in economic activity

spread across the economy, lasting more than a few months,

normally visible in real GDP, real income, employment, industrial production,

and wholesale-retail sales.”

 

No matter the problems of making macroeconomic models work at all, you don’t want to make it even harder by using impractical and vague definitions. My message in this post is that you need to make sure your definitions are practical and at least theoretically can lead to better decisions.

After that we can talk about the ephemeral character of macroeconomic causations and correlations, not to mention their flimsy associations with actual stock market behavior.

For now take this with you: Knowing what you know and knowing what you don’t know, is paramount in uncertain environments. And the financial markets are as uncertain and stochastic as they come.

Thus, make sure you do define all concepts and ideas about their connections precisely. That’s your only chance of keeping track of what you know and what you don’t. In addition, it’s your only fair chance of creating a feedback loop of increasing knowledge and strategy adaption.

Such directed or deliberate practice is in similar fashion your only chance of coming out on top in the arguably most competitive sport known to man (and yet untrained newbies gladly step into the ring and bet their life saving’s on themselves).

Today’s advice holds true for everyday life as well. I don’t know how many arguments with friends I could have saved, had we only defined the concepts and words precisely at the outset…


Stock market forecasts coming up

I’ll soon write a follow up on this article, where I’ll explain how stock market returns can be reliably forecast in much the same way as the weather can be accurately forecast. For now this teaser will suffice:

Just as I know there’ll be snow in the middle of Sweden on quite a few days every year between December and February, and almost completely certainly no snow 99 per cent of the time between June and August; a highly priced market will produce very low rates of return, and a lowly priced will produce high rates of return over the coming decade or so. But more detailed notes about next time and the exact implications for the current situation. Stay tuned.


FUTURE SKILLS: Don’t forget to check out the super energetic conversation with Alexander Bard on Future Skills Ep. #6! You’ll find it on iTunes here, or your favorite Android app here.

 

What does a famous retired hedge fund manager invest in in 2017, and why?

Topic: my view of a few macro indicators as well as my personal investments

Summary: growth, inflation and bond yields going lower; USD, stocks, housing going up; bitcoin, gold and uranium going up longer term, but first sideways and possibly down in a bottoming formation; stocks: undecided and binary; I’m 100% long stocks but only very specific companies, and no large caps or story stocks.

Lesson: make your own macro and micro run through, and make sure it holds water. Mine is a bit leaky…

/Sprezza-Mike, June 21, 2017

Svensk? Swedish? Testa gärna Nextorys erbjudande om en gratismånad med sommarens bästa e-böcker och ljudböcker på mobilen eller läsplattan här. Du kan avboka när du vill under perioden utan kostnad. Nextory-erbjudandet får du via min podcast 25 minuter.


It’s the economy, silly

Many investors keep too close track of their investments.

I think I, however, might be too lazy and lenient with my holdings. Only every now and then, I summarize my views of the world, as well as tally my holdings to see if they make at least a quantum of sense.

I see no reason to monitor either macro or micro developments in detail. I do want them to be coherent and mostly compatible though. In short, this is my view of the general economy:

Right now I’m counting on continued economic weakness in most of the world, with Sweden as one notable exception. I’m also expecting continued monetary stimulus, including not least in Sweden with a deeply negative policy rate despite the booming Swedish economy*. Consequently I’m long risk assets, including private and public equity. Those holdings are complemented with more insurance like holdings in gold and private loans.

*The Swedish economy is heavily dependent on exports, not least to Asia, which means that serious weakness in the global economy will have adverse effects on Sweden. In addition, the Swedish stock index usually tracks the US indices quite closely, in particular when stocks are going down. Hence, my sanguine view of Sweden is both relative and temporary.


An overview of macro indicators

Growth: going down, weakening after the Trump head fake. His policies are all working for a stronger USD and weaker economy, not the opposite. After a long cycle, most low hanging fruit has been plucked in terms of employment and capital utilization. The cycle is not dead as some claim. More likely, the cycle will come back with a vengeance after this long experiment with ultra-low interest rates.

Inflation: flat to down after the Trump reflation hype. Inflation expectations were mostly based on just that: expectations, and not real factors. Commodities, e.g., are weakening, and employment and wages are not showing signs of strengthening ahead – rather the opposite, especially if the economy weakens, as I think it will.

USD: going up after the recent weakness (the weakness was based on unwarranted growth hopes in Europe etc). Other central banks will be more dovish again, and the US economy is still the least dirty shirt. Yellen seems set on “normalizing” the policy rate as quickly as possibly, quite the opposite of what the ECB and BOJ are doing. She will keep raising rates until the stock market breaks, at which point she’ll save the day by rapidly cutting rates, thus completing the full retard cycle. Before that though, increasing interest rate differential and a relatively strong economy vs. Europe will push the dollar higher.

Bond yields: undecided, sideways with a downward bias. All economies are weak, the economic cycle is peaking (i.e., soon turning downward), weak growth, weak inflation. Bond yields always fall in recessions, even if they are already ridiculously low. They are a safe haven, the only one for investors shunning gold.

Bitcoin: due for a big correction downward, but I would still bet on it long term; looking to buy massively at 100-1000 (!)… or gradually wherever it may otherwise trade the coming year (even if that means higher prices than today). I hold very little in bitcoins today.

Stocks: binary, expensive, forming a peak, but there are islands of value in forgotten non-ETF stocks. Phase transition blow off upward as likely as a normal 10-20% correction downward (that could be the start of the real downturn of 50-60% with ETFs liquidating ETFs, margin calls on leveraged longs, euphoria turning to despair, falling margins and profits etc.). Beware of getting caught holding illiquid small caps if you can’t afford to hold them for years to come. I’m not entirely comfortable with my portfolio of publicly listed small caps.

Gold: going sideways; trying to bottom technically, cheap vs stocks, expensive vs oil, probably need a catalyst to move significantly. In addition, commodities are weak in general and not getting any help from growth or inflation.

Real estate (housing): going up. It seems Swedish (Stockholm) apartment prices just can’t go down (famous last words). When I bought my first apartment in February 1997 at 14 kSEK/sq meter, I was positive I was the last fool in (“but could afford it”). Twenty years later, at least one apartment in my neighborhood recently sold for 155 kSEK/sq meter. That’s a 1000% gain in 20 years. My best guess, however,is that my apt is worth around 100 kSEK/sqm. The Swedish central bank is even more deranged than most other CBs, and the Stockholm economy is thriving with large numbers of qualified people constantly moving to the city, including boomers selling their houses and moving back into the city centre, while simultaneously buying apartments there for their kids.

Oil: flat to down, as other energy sources gain more and more traction, and US shale technology improves, while countries in the Middle East become increasingly desperate to balance their budgets. The price is already low so look out for temporary bounces, but the overall price direction will be down, I think.

Volatility: VIX going up. It could take a long time, but there is hell to pay sooner or later for anybody shorting the VIX. I’m not touching it either way though.


My holdings

Precious metals, Lemuria: A Canadian royalty streaming company exposed to gold, silver and platinum. This is my insurance policy against deep financial turmoil.

I hold rights to the physical product directly from the mines. The problem is that the company still hasn’t invested most of the money. With a little luck precious metals will come down 10-20% over the coming 12-24 months in a final bottoming formation, enabling my company to put its capital to use. There is currently a 2x difference in valuations between small private companies and larger publicly listed companies in this sector. We aim for reaching critical mass for a listing within 2-5 years, providing me with x times leverage on the gold price and an additional 2x leverage on private vs. public valuation multiples.

Sweden, Polskenet: A Swedish investment company buying small services and manufacturing family owned businesses in the northern parts of Sweden. The investments will be made over the course of the coming 3-4 years, hopefully during a market and economic downturn, but present conditions are fine too.

This is my retirement fund; whatever happens to Sweden over the coming 10 years will be my fate as well – albeit with a decent leverage to the upside in terms of purchase private small company valuations vs. future publicly listed mid cap valuations.

Growth, Torped: A manufacturing start-up, designing, producing and marketing jet powered surfboards, targeting and expanding the PWC/MSB market. This is my main exposure to a real growth company. The aim is to start serial volume production next year and then expand from there. Given current sales numbers, consumer demand, the quality of competing products etc. this looks like a home run — as long as the economy or this particular (luxury niche) market doesn’t crash completely.

Human resources, Agerus: A private Swedish human resources software company. Software/app for measuring and managing the human capital in terms of knowledge, competence, motivation, authorization etc. This is actually my currently largest exposure (through both debt and equity). It’s kind of a slow burner but there are some promising signs of explosive growth ahead, as well as possibly a structural deal and liquidity event. The important thing is getting the solutions out to personnel intensive companies and make a difference.

Trading, Anna: I have recently outsourced a small part of my listed portfolio to my girlfriend. Trading is too time consuming, and I’m neither good, nor interested in the activity. She seems to be happy swinging in bitcoin, large and small caps, IPOs, commodities (cacao, e.g.) etc. for a 10% fee.


Various private companies: (just a few million SEK in total) Fimbulvetr, Angel I, Barista, Lenovium, Creditsafe, Qvicket, 2i Invest.


Listed holdings:

Finepart (micro cap, manufacturing company, specialised precision tools, if/when they manage to get their machine delivered to SKF it has a real chance to double to previous highs of 10-12 SEK; currently 5.75)

Net Gaming Europe (gaming affiliate, operating thousands of SEO pages linking to online casinos; as long as Google doesn’t mess with the SEO algorithms NGE should be able to produce very good results in relation to the current market cap. The upside is currently 50-100% with the stock at 9.75 [it bottomed, I hope, earlier today at 8.35])

Opus (vehicle inspection, testing and certification company; secular growth, consolidator as well as acquisition target. Reasonably valued at its current price of 7.40 [P/S 1.2 and P/B 2.1] but should be a steady grower for the long term). Should triple in five years but I’ll probably get out at 10 if it gets there before a general stock market downturn.

Stockwik (recently re-aligned investment company just coming out of a period with a weak balance sheet, losses and poor operations. Profits from future acquisitions should form the basis for growth that in turn enables more acquisitions). It could be going nowhere…, or 5-7x in 5-7 years. It’s trading at 0.037 SEK today, but I’m looking for 0.25 SEK in the next upturn.

Studsvik (nuclear consultancy benefiting from increased nuclear power build out; and possibly also from a quick de-nuclearization. My main reason for holding Studsvik, however, is the potential for structural deals, such as real estate divestments etc). Will most likely trend sideways with a slight negative bias until  and if it manages to present some major positive development. I think it’s reasonable to hope for 25-50% upside (from today’s 58.50) but also easily a 25% downside.

Simris Alg (16.90 SEK, a negligible holding for tax reasons and monitoring; a maker of omega-3 from algae [currently sub-scale and too expensive for consumers])


ETFs, commodities

URA Uranium ETF (currently 12.31 USD. An inventory overhang has pressured the uranium price the last half decennium or so. Around now, however [during 2018], there are reasons to believe we could see signs of underinvesting and future uranium supply deficit. When/if a supply deficit occurs it takes many years to get new uranium mines operational, thus creating a perfect storm for higher prices. Low oil prices and cheaper solar are two major threats, as well as increased opposition toward nuclear. Technically, I identify a triple bottom over the most recent 18 months, with the low point at 11.31 USD and a recent bottom at 11.68 (that I don’t want tested).

GDX Senior gold miners ETF (currently 21.98 USD). Gold miners have had to streamline operations (cutting costs) during the 5-6 year long downturn, thus providing lower break even prices and good operational leverage. When the gold price turns significantly upward, gold miners usually move 2x vs. the gold price. As long as it stays above 21 USD and the gold price above 1215 USD/oz (currently 1246) I feel pretty confident.

My holding in GDX is almost insignificant compared to my exposure to Lemuria, even when taking into account the leverage provided by miners vs. the metal. However I want a real time exposure to gold, and not least some exposure at all, while I’m waiting for Lemuria to put my capital to use.


Loans: I have no debts or mortgages myself. Instead I’ve lent out money to friends and acquaintances: Björn, Patricia, Jonas, Thomas, Robert… I have a few million (at 10% rate) coming due a week from now, but most of my loan exposure is longer term.


Private and public pension: Blackrock gold, Brummer 2xL (fund of hedgefunds), state pension. Enough to live off of quite comfortably, if all else fail


Apartment: A mortgage free, large apartment (200+ m^2 = 2250 ft^2, in the very central parts of Stockholm city — coincidentally it’s more or less the exact same size as the hotel room I lived in when I was in Las Vegas)


Conclusion

All in all my portfolio is mainly based on diversification, since I feel I know too little and the market situation is too unusual.

I feel incredibly uncertain these days: everything is expensive, investors seem to embrace all kinds of risk, and central bankers are growing ever more retarded. A crash seems as likely as a blow off top. Because of that scenario, I have spread my investments over several different asset classes, while avoiding debt altogether. If anything, the latter is at least different from most people. I probably should complement my portfolio with out of the money crash put options, which is how we often did it at Futuris (The Hedge Fund Of The Decade), but my current portfolio type doesn’t allow derivatives.

Gold, nuclear energy, small caps, private companies, start-ups, loans, living quarters… How are you exposed, and what are your reasons?

What if the new new things were slightly delayed

The bull has many legs
3D printing, AI, robotics, automation, CRISPR/Cas9, millennials, cheap and clean energy… there are lots of reasons for a great bull market. Maybe a bull market to eclipse all previous bull markets.

-In 2025, that is (well, starting before, but really booming by then).

But…
  • Until then, perhaps Trump’s rule won’t be that smooth (which president’s is?)
  • Perhaps retiring baby boomers mean less umph in the economy and stock markets (selling stocks to finance retirement, less borrowing, less consumption, scaling down home ownership, car churn…).
  • Perhaps interest rates won’t keep falling. Perhaps debts won’t keep rising.
  • Perhaps the highest median valuations in the history of stock markets won’t rise further. Perhaps record high profit margins won’t either.
  • Perhaps after Trump’s honeymoon months, the typical new-president-after-a-2-termer correction ensues. Perhaps, as per usual, the 7-8th years of the decade show “a bit” of turbulence (like 1987, 1997-8, 2007-8 [and, yes, it goes back further]). 
  • Perhaps Variant capital’s idea of surplus capital being eaten up by capex and rising inflation means less stock market strength. 
  • Perhaps China/Russia/US won’t be as fast friends as they been the last quarter century.

What if all those things converged and happen at the same time? What if Trump’s honeymoon came to an end in the 7-8th year of the decade? What if interest rates bottomed out? What if inflation came back and ate up surplus capital coincident with higher capex and a resurgence for commodities? What if the baby boomers born 1945-50 started retiring and consuming less around the same time, while millennials lived with their parents a while longer?

What if those things reinforced each other and caused falling margins and falling valuation multiples at the same time as slower sales and negative sentiment and negative cycle phenomena? What if increased innovation means faster churn of companies, i.e. fiercer competition, and consequently productivity surplus increasingly going to consumers again?

Perhaps then the great bull market would have to wait a few years and let a bear market clear out some cobwebs left over from the ongoing bull market first.

Perhaps we won’t see two bull markets in a row. Perhaps ever rising stock markets aren’t a human right. Perhaps things aren’t different this time

Perhaps.