A partial loss of faith in Capitalism

Despite the ubiquitous presence of reflective, hindsight-driven articles, editorials and essays on the “lessons learned” following the disastrous economic performance of most of the major economies since the summer of 2007, I must admit to not having been shaken much by their conclusions and various recipes. However, this last week has resulted in a turning point for me on this issue.

Reading up on JK Galbraith’s excellent “The Culture of Contentment” has served to soften the all-believing capitalist in me. Indeed, in the space of a few days or, to be more precise, just under 200 pages of reasoned arguments, I have come to embrace, if not whole-heartedly adhere to, the concept of capitalism as a less-than perfect model for societal progress. To borrow from a famous phrase delivered by Winston Churchill in reference to democracy, I‘d be inclined to say: “capitalism is the worst economic system except for all the others that have been tried”

Perhaps indirectly, (given the fact that none of the events of the on-going financial debacle could possibly be relayed in a book first published in 1992), there is little doubt that Professor Galbraith’s sharp observations have heightened my skepticism of the magic of the markets. With these reflections in mind I offer some thoughts.

What truly amazes me is the revelation about the extent of the “double-standards” used by those who, (at least in their rhetoric), defend the free-market in earnest and yet have no qualms betraying its basic principles. The bail-out of AIG and the remarkably ill-timed acquisition of Merrill Lynch by the (implicitly) government-backed Bank of America, are just two glaring instances of this hypocrisy in full swing.

Within the space of two short years we have been privy to the whims of a Mr. Henry Paulson, once the recipient of multi-million dollar bonuses resulting from the “extraordinary” performance of the firm (Goldman Sachs) he headed as recently as 2006. Fast-forward to 2008, and this same “visionary” is now safely entrenched as the US Treasury Secretary; green-lighting the bail-out of his former competitors and indeed his own former employer’s last-minute switch to commercial banking status in a covert effort to escape a potentially fatal liquidity crisis.

Surely this behaviour is but an aberration. Apparently not so. Day in, day out, evidence comes to the surface about the inconsistency of the so-called “laissez-faire” crowd. It seems obvious to me that an approach that can be manipulated as easily as the capitalist stance can, is not one of solid foundation and even less, of viable application.

Does this mean we should discard Adam Smith’s principles and seek a new dogma to guide us in our economic ways?. Not quite, but we must remain vigilant of the ample room available for manipulation at the hands of the powerful few. Moreover, if it were not for its imperfections, excesses and periodic boom-and-bust cycles, opportunities for value-seeking investors would be even more scarce than they are under normal circumstances.

Returning to where we started, one must not lose sight of Galbraith’s views. Although considered anachronistic during the pro-market, small-government and low-tax orthodoxies which came to prominence in the 1980s, they are now,and rightly so, at the forefront of public interest and are likely to remain that way for months and years to come.

Why Spain is not in my investing shortlist (for now)

Living in Spain and being an avid reader of both general and financial press is not a recipe for optimism in our domestic economic future, at least not in the near term. In fact, one need not read a single paper; just a saturday afternoon stroll along the main commercial thoroughfares of my home town will suffice for the evidence to surface.

We are only 5 weeks away from Christmas, in what ought to be the start of the peak shopping period, and the crowds are nowhere to be seen, even in spite of suspiciously low prices brought on by the deflationary whirlwind we find ourselves under. Still, if you happen to live in any country other than China these days, you probably think there's nothing surprising or unusual about this scene. After all, the vast majority of western economies have been suffering severe economic malaise since some "wise" fellow decided to question wether residential real estate prices could not rise indefinitely...

Whilst as of today, you'de be right to question the singularity of the scene I described earlier, it is not this current state of affairs that concerns me, but rather what's in store for this nation in Europe's southwestern corner. For you see, unlike at our (almost) equally damaged neighbours, our leaders and key economic agents have decided that the way out of this dire situation lies somewhere between doing nothing and pursuing the same policies that got us into this mess in the first place.

Anyone who's tried to either get a job, let go of an under-performing employee or god-forbid, act out an entrepreneurial desire, knows all too well the structural barriers to be faced. Our antiquated economy with its toxic mix of outdated utopian sentiment that is so prevalent among law-makers and the disproportionate power granted to its self-serving trade unions results in a formidale barrier to that much-loved yet little-attained "progress".

Amazing as it seems, our nation, or at least, its leaders has not woken up to the sad fact that doing things in the same way will not yield different results. As we face the toughest economic environment in my lifetime no challenges are made to the current labour regulations or the clearly unsustainable tax regime. More to the point, the actions that are taken are squarely aimed at perpetuating the downward spiral via tax increases and incremental fiscal deficits. Personally this policy appears more ground in arrogance than in ignorance given the evidence of more "advanced " nations such as Germany which are taking the opposite view in their tax policies. But not us.

In our quest to perform the first economic miracle of the 21st century, Spain will seek to resolve its chronic and ever-growing unemployment problems via, wait for it..., granting better and longer lasting benefits for those that find themsleves in this unfortuante situation!, and all at the expense of a public sector deficit that is partly financed via higher personal an capital income taxes!. As you can see, having a full-time job in Spain does not necessarily translate into economic well-being but rather serves to justify our "exemplary" degree of social concern...

With such perverse incentives, it is hardly surprising that we lead the unemployment tables among so-called developed nations. To return to the topic in the title of this week's rant, with fundamentals like these, I'd be hard pressed at this time to recommend an investment in my much cherished homeland.

I honestly hope that sooner rather than later, Spain Inc. makes it into my investing shortlist.

Are the investing odds stacked against us?

Whilst not wanting to sound unduly pessimistic right for the first sentence, recent reflection has led me to think that as investors, as individuals, we face a challenging task in our search for decent returns.

Those that read my previous 2 posts (the many of you!), probably recall my ramblings about the emotional shortcomings that threaten to undermine our investing endeavours. As humans we do not exhibit the completely rational behaviour that is often assumed by economists in building their elegant theorems. Quite the contrary, you and I surely tend to over-react to most extreme events on both the positive and negative scales, to favour the known, to rejoice in our pre-conceived ideas and to base most of our assumptions and forecasts on the most recent of experiences.

To make things more difficult (as if we needed to...), it seems that for those of us that have had the "benefit" of a formal education in business, undergraduate, MBA or any other similar format, the concepts learned may have actually done us a disservice!. Sounds strange huh?. Surely isn't the investing hall of fame full of hot-shot MBAs and the like?.

Perhaps so, but the truth remains that fortunes built in this sector of activity owe little to the application of sophisticated and elegant-sounding techniques and concepts like the ever-present Capital Asset Pricing Model (CAPM) or its even more esoteric "beta" offspring. For those of you that have not had the fortune (or should I say misfortune!) of coming across the term "beta", let me just say that it is a statistical measure used in modern finance theory used to measure risk. So far so good, I hear some say. But wait for the best part; beta measures risk in terms of "volatility" or put in simpler terms, variation in return versus an average.

In other words, an investing asset that trades with high volatility, no matter if that variation is on the downside, (that is it becomes cheaper to acquire), is deemed to be of higher risk!. This makes no sense at all. Just think of it this way: imagine you wish to buy a nice leather jacket that you see in a shop window but for which the price today is 300 €. You come back next week to the same shop and it is offered at a 40% discount, that is, it sells for 180 €. Should you buy it?. I say YES but most professional investors using beta as a measure of risk would call this asset (substitute for "leather jacket") risky and walk away.

With "priceless" lessons like this and other gems like the ever-efficient nature of the stock market championed by proponents of Efficient Market Theory (EMT) which, by the way, last I heard still ruled the best business schools, it's no wonder even bright minds falter at this game.

But on a positive note, I'd like to leave you with a different interpretation of this state of affairs so as to rebuke my initially somber stance:

Just think for a moment that if your "competitors" (and indeed everyone else in investing is a direct competitor given the zero-sum game nature of the market) have read the same EMT-preaching authors, they will feel that nothing can be gained form trying to get an edge and as such will allow you to play against those who believe that it is simply not worth trying!.

Simple does best (at least in investing...)

One of the (many) advantages of having a young family, and the resulting evenings of endless baby-sitting, is that time not spent in seeking the new gastronomic delights my city has to offer or catching up on the latest movies, can be generously allocated for reading purposes.

Given these circumstances it follows that on this instance my expose will draw heavily on recent reading material. A couple of weeks ago I completed an almost one-sitting read of a revealing little book, the almost naively titled "The Little Book That Beats The Market" by Joel Greenblatt.

Whilst I'll be the first to admit that it hardly sounds like a riveting read, allow me to elaborate on its contents and to comment on what I think can be gained from investing a couple of hours of one's precious time on Mr. Greenblatt's book.

Firstly, in spite of covering the well-trodden path of investment-guide writing, the Little Book...is not an academic exercise performed by some high-brow theory-wielding professor whose connection with the ugly reality of the financial markets is remote at best, but rather a practical hands-on exercise proposed by a remarkably succesful investor.

Secondly, what truly makes this book exceptional is that it sings praises for simplicity as a tactic, in an industry where complexity, obscurity and downright exoticity are championed. Indeed the central (and only) strategy put forward is one of identifying 2 , that's right 2! criteria for selecting stocks and sticking with this theory for a number of years. Amazingly enough the lack of success derived from applying the tactic suggested in the book is almost solely attributed to an excessively short investment horizon (read impatient investors), as opposed to any fundamental flaw in the methodology applied.

Simple to do then, right?

Apparently not so. In fact, as humans we tend to be wary of overly simple theorems, and more worringly even if we overcome our natural tendency to discard these basic propositions, our lack of patience or conviction, lead to our eventual undoing. After reading Mr Greenblatt's volume I took two important lessons "home":

1. There is no value in being "too clever" and indeed simplicity works in one's favour in most endeavours, not least when making investment decisions.
2. Patience is indeed a virtue and one should approach an investment decision as if we only had a finite number of such choices in our lifetime with the correspondingly huge opportunity cost for erroneous selections.

In short, in investing as in many other aspects of life, it pays to focus (keep things simple) and to know one's self (identify and mitigate our own deeply ingrained shortcomings)