We are having a bit of a heat wave here in Southern California, so take your reading to the beach! I have six new recommendations, all fiction this time, all highly recommended. I hope you enjoy!

Flashlight, Susan Choi

This book begins with the disappearance, and presumed death, of Serk, a Korean man who grew up as a boy in Japan when his parents were forced into servitude following Japan’s conquest of Korea in the 1930s. The only witness to his disappearance is his 10-year-old daughter, Louisa. The novel then goes back in time, to Serk’s childhood in Japan, his college days and subsequent life in the United States as a professor. Serk’s original family is lured back to (North) Korea with promises of an ideal life, but then all communication with them is shut off. Serk marries Anne, who had given her son, Tobias, to his father to raise, a secret that is kept from Louisa until she discovers letters between him and Anne. Louisa and Tobias do eventually bond over their shared history. Flashlight is a family tragedy, heart-wrenching and poignant, where identity is complicated, where the relationships are universally drawn, and how we are connected to each other. A beautiful work by a master author.

The Correspondent, Virginia Evans

Sybil is a retired law clerk living on Chesapeake Bay. Her legal career was hindered by the prejudices against her gender, but she became an equal partner with a prominent judge and ultimately had a fulfilling career. Unfortunately, that career came at the expense of her marriage and her relationship with her daughter and a tragic incident with her young son. The novel gives us glimpses into her personal life, her relationships with family members and even two suitors in her advanced years, and does so entirely through letters that she writes and receives. It’s a remarkable achievement to draw these characters in such rich detail entirely through these letters. We come to understand Sybil as witty and acerbic, smart and tenacious, but ultimately deeply flawed.

The Curious Incident of the Dog in the Night-Time, Mark Haddon

This is the debut novel by Mark Haddon from 20 years ago, and it is a wonderfully funny, original murder-mystery. The deceased is a dog, and the sleuth is an autistic boy, a mathematical savant, incapable of understanding anything except at face value, which makes the behavior and phrases of everyone around him indecipherable. He is warned off investigating this murder because it ultimately has to do with his parents’ separation. But he persists, and this is his adventure.

The Director, Daniel Kehlmann

G.W. Pabst was one of Germany’s most prominent film directors of the 1920s and 30s, and this is the fictionalized account of his life. Success in Germany brought him to Hollywood, where he struggled with the language and navigating the politics of the studios. When his ailing mother in Austria sends word that she is dying, Pabst, his wife and young son travel there just as World War Two breaks out. Pabst cannot leave, and the Nazis force him to make films, not directly propaganda, but they tout his work as evidence of the superiority of German culture. Pabst himself is portrayed as an unwilling participant, but was he really a victim, or merely a coward, or even an opportunist? We can argue for all three, and Kehlmann uses his life to pose these existential questions about our behavior in the face of great difficulties.

Buckeye, Patrick Ryan

Two couples find their lives intertwined in small-town Ohio when an extramarital affair results in the birth of a boy. The identity of the father is kept hidden from the other adults and their respective children. This is all complicated by World War Two, when one husband is presumed dead, but is later rescued and returns home. This infidelity is neither condemned nor condoned, but the consequences become complicated when the boy is sent off to Vietnam. The families become estranged, both to each other and within themselves, as they struggle to reconcile and atone. Love and forgiveness is only partially achieved in this rich, emotional and beautiful story.

Flesh, David Szalay

A rages-to-riches-to-rags story of István, a Hungarian delinquent without any prospects. He joins the army, becomes a strip club bouncer, and then a chauffeur. A rich, elderly Englishman hires him as a chauffeur in London, where he has an on-going affair with his employer’s younger, attractive wife. István speaks little, and then mostly in monosyllables; he simply goes along with whatever life presents to him, without expectation or complaint. He really is devoid of emotion, or perhaps just incapable of articulating any, but this stoicism only serves to highlight the artificiality of the wealthy class he encounters. The one-dimensional character of István is the lens through which we see the struggles and absence of meaning in the lives of both rich and poor.

With most of the country confined to home by snow and ice, I thought you might appreciate some more book recommendations for your fireside reading. And I promise not to mention the weather here in southern California. Stay warm and enjoy!

Fiction

Wild Houses, Colin Barrett

The Irish landscape is cold and gray in this novel, and the villagers lead equally bleak lives just trying to scrape by. The action comes when a local drug gang kidnaps a teenage boy to put pressure on his brother to pay them for the drugs he was supposed to sell. The boy is deposited in the home of a reluctant host who owes the gang a favor. The heart and soul of the story is the boy’s 17 year-old girlfriend who first thinks he dumped her but then realizes that he is missing. Each character is unhappy with their lot in life, which they meet with a sad fatalism that they cannot control. But there is wry humor and a faint hint of hope that their lives will improve despite the reality that they won’t. This is an impressive debut novel that connects these small, narrow, very human lives to our empathy for their struggle.

Fonseca, Jessica Francis Kane

In 1952, the Irish novelist Penelope Fitzgerald visited an eccentric pair of sisters in Mexico, but never wrote about what happened on that trip. So Kane fills in her own story of that trip. Here, the sisters are looking for an heir to their fortune, and entice a young mother, pregnant with her third child, to visit them in Mexico with the promise of an inheritance. Leaving her husband and daughter at home, she arrives with her six-year old son, who soon charms everyone. There are multiple suitors for this inheritance, including a dashing American who, without proof, but with enough knowledge to have a plausible claim to be a relative. The trip is also an opportunity to evaluate her faltering marriage, abetted by the presence of the handsome American suitor and by her newly founded friendship with the artists Edward Hopper and his wife, Jo, who really were in Mexico at that time. Blurring fact and fiction, Kane paints a moving portrait of a woman searching for her place and meaning in the world.

Separation, Kate Kitamura

A young woman marries a handsome, charming and wealthy young man, everything, and more, that she could hope for in a husband. But soon they grow apart, as he engages in a series of affairs, and she decides it’s time to ask for a divorce. He knows it’s coming, but asks her to postpone legal proceedings until he returns from a photography trip to Greece. When he doesn’t respond to his parents’ phone calls, she is persuaded to go to Greece to find him. She feels conflicted about pursuing a man she intends to divorce, and conflicted still when she realizes she will inherit a fortune if he is not found. Her ambiguity about both finding him and a possible inheritance is the heart of this story. Kitamura draws us to her characters with intimate detail in this superbly crafted book.

Wandering Stars, Tommy Orange

Tommy Orange is one of our most astute observers about race, identity, cultural legacy and assimilation. Wandering Stars is both a prequel and sequel to his superb debut novel, There, There, with some of the same characters from the first novel. The book follows a family through 150 years and four generations, from the 1864 Sand Creek Massacre of the Cheyenne to the present day where the latest generation, with its multiethnic genealogy, ponders what it means to be "Indian." There are drugs, addiction and poverty, but also love and pride and hope. Another brilliant work by a gifted author.

The Antidote, Karen Russell

Nebraska in the Great Depression of the 1930s: a bleak landscape punctuated by a fantastical witch who keeps people’s secrets, secrets they may want to forget, or happy ones they want to preserve for posterity. A young girl aspires to become a witch, begging to be taught the mysteries of keeping, and retrieving, secrets. This is an extraordinary novel, exploring the secrets we keep and discard, and, amid the miseries of the Dust Bowl, our relationship and responsibilities to the land and the environment. An exceptional work of historical fiction.

Nonfiction

Peak Human, Johan Norberg

Norberg examines the common traits of seven great civilizations: ancient Athens and Rome, the Abbasids of Bagdad, the Song of China, Renaissance Italy, the Dutch Republic of the 17^th century and the Anglo (British-American) empire of the 19^th to 21^st centuries. What made these civilizations great was trade, not just in goods, which enabled these economies to steal, copy and adapt new technologies, but trade in people and ideas that brought fresh innovation and dynamism to each of these cultures. Likewise, the demise of these great civilizations occurred when their borders were closed to trade and their minds were closed to immigrants and new ideas. It’s hard to imagine a more timely and relevant history lesson.

The Great Transformation, Odd Arne-Westad and Jian Chen

This is a detailed history of the transformation of China from the economic disasters of Mao’s Great Leap Forward and Cultural Revolution to Deng Xiaoping’s openness to capitalism and the political battles fought within the Chinese Communist Party for supremacy during and after Mao’s reign. It stands on its own as a superb work of history. But it also serves as a reminder of the dangers of one-man rule, without checks and balances and the democratic consensus-building that is a requisite for sustainable progress. A timely lesson for today’s China, as well as every other country that bends to the will of a single man.

As we approach the holiday season, I hope everyone has time to spend with family and friends, and a good book. Not necessarily in that order. Here are my latest recommendations.

Fiction

Audition, Katie Kitamura

An acclaimed actress encounters a young man who thinks he may be her son. We learn of her past, her happy marriage, her earlier adulteries, and the abortion she had that means it is impossible for the young man to be her son. Act 2 opens in a slightly different universe, where the young man is her son, and their relationship is very different. Kitamura challenges what we know of other people, what we know of ourselves, and the deceits that pervade our lives in this elegant, disconcerting book.

Vera, or Faith, Gary Shteyngart

Vera is a precocious ten year-old child, living with her father, a Russian intellectual (a stand-in for the author) and his WASP-y wife. The plot centers around Vera’s search for her birth mother, a Korean woman whom she never knew and her father refuses to give her a name. As with Shteyngart novels, the plot is less important, it is the richly-drawn characters that capture us. Vera is smart, curious, wise, naïve and awkward, and we love her. The book is both tragedy and comedy, wholly enjoyable.

The Secret History, Donna Tartt

A scholarship student from California enrolls in an exclusive New England college and is drawn into a semi-secret world of elite students and their mysterious professor/mentor. A murder occurs, and the brilliance of this privileged group is no match for the consequences of this crime. Channeling Dostoevsky, this was Tartt’s debut novel from 30 years ago, and is still one of the best psychological thrillers ever written.

Drive Your Plow Over the Bones of the Dead, Olga Tokarczuk

A woman, unnamed and semi-isolated in her mountaintop home over the winter, muses about her life, her few neighbors, and small-town gossip. But a string of deaths occurs and she is the only one who believes they are connected. She hypothesizes that each was killed by the deer, or perhaps other animals, that inhabit the forest, in retaliation for encroaching and destroying their habitat. The deaths, or perhaps murders, are not really the point of this fable-like novel. It is a philosophical tale of life and death and nature and our connection to it all. Tokarczuk is a Nobel laureate, and her lyrical writing shows why.

Nonfiction

There’s Always This Year, Hanif Abdurraqib

Meditations on life in the gritty part of Columbus, Ohio by channeling the rise and fall and rise of LeBron James and the Cleveland Cavaliers. This is not a book about basketball, although basketball, especially Ohio legend LeBron James provides the running theme; it is about home and family and the daily challenges of getting by in the ‘hood. Nonfiction that reads like fiction: a compelling, beautifully written memoir.

Four Shots in the Night, Henry Hemming

"Intelligence does not win wars, fighting wins wars," is an old military adage. The Troubles in Northern Ireland may be the exception that proves this rule. Hemming describes the extraordinary success British intelligence had in infiltrating the highest levels of the IRA as he describes the lives and motives of some of the key informants. He makes the compelling case that the Good Friday accord that ended the Troubles was due in large part to this intelligence success. A thrilling story.

Waste Land, Robert Kaplan

The West is in decline, and technology is advancing faster than our capacity to use or control it. These were the themes, and title, of T.S. Eliot’s poem that Kaplan usurps for his analysis of contemporary geopolitics. But if the West is in decline, so is every other military power. Kaplan sees Xi as (re-)imposing a Maoist authoritarianism that is doomed to fail, and Russia as weak and in an accelerated state of rot. The notion that the US can isolate itself from the world’s problems is juvenile at best, and the most hopeful outcome would be for a rejuvenation of US leadership of the West that, unfortunately and quite likely, will not happen. Like Eliot’s poem, this is a pessimistic, cautionary and, sadly, realistic world outlook.

September is the best beach month in Southern California: the water is warm, the days are long, the crowds are gone. I have seven books to recommend, five fiction, two nonfiction. Enjoy them on the beach, or wherever you like.

Fiction

American Dirt, Jeanine Cummins

A Mexican journalist and his family in Acapulco are targeted by the drug cartels during a celebration at their home. His wife, Lydia, and young son manage to survive the attack and plot their escape to the US, where she has an uncle living in Denver. Before the assault, Lydia owned a bookstore where she formed a romantic bond with a customer whom she later discovers is the kingpin of the cartel. The characters are not fully formed, but we care about, and are rooting for them, as the plot propels us along as they make their way north. This is apolitical, just a mother and her child fleeing a horrific event, although a story that is familiar to many migrants. The author was criticized for writing this book in 2020 for writing from the perspective of a Mexican mother while not being Mexican herself, which is absurd. Cummins gives us an important lesson about seeing people for whom they are, as individuals, in all the complexities of their world.

The Wren, The Wren, Anne Enright

A story of three generations of McDaraghs: a famous Irish poet, Phil, who abandons his family for a life (and wife) in America, his daughter, Nell, a lonely widower, and her daughter, Carmel, a new mother with a young son. Each generation faces a particular trauma, but only Nell, the center of the story, does so with the dry humor the Irish are known for. Enright beautifully captures the pain of neglect and loneliness, and the bonds, and joys, of family.

Twist, Colum McCann

An Irish journalist is given a long-essay assignment on board a vessel that repairs underseas cables. He travels to Cape Town to join the boat with its enigmatic captain by the name of Conway. After a two-week voyage of repairs along the west coast of Africa, when the boat is anchored off the Congo, the captain disappears. Over the ensuing year, cables around the world are sabotaged, and the journalist wonders if Conway is the culprit. McCann is a brilliant writer, and has woven a tale of lost loves that need mending, as do the cables that carry 99% of the world’s internet traffic. Or do they, the loves and the cables, need mending? Would we be better off without them?

The Tiger’s Wife, Tea Obrecht

In the war-torn Balkans, a young doctor pursues a humanitarian mission at an orphanage on the "other side" of the war. She learns that her grandfather, also a physician, dies while she was away, and memories of her time with him come flooding back. Among these memories is a folk tale about a tiger’s wife, which of course makes no sense, but is part of the mysticism and morals of a long ago world. The writing is mesmerizing and magical, spellbound in beauty.

10 Minutes Thirty-Eight Seconds, Elif Shafak

Death is not instantaneous, but a process that takes 10 minutes and 38 seconds, in the imagination of the author. In that time, the person continues to have thoughts, and in this case, they are flashbacks of the life of the woman who is dying, a prostitute, in a trash can, in Istanbul. The first half of the book draws the characters in rich detail, and the second half offers the plots of their lives. Shafak writes with compassion about a single soul, a small community, and the things that unite humanity.

Nonfiction

Time’s Echo, Jeremy Eichler

Eichler, music critic for the Boston Globe, considers how the horrors of war, the Second World War specifically, can be expressed through music by examining four works by four great composers. Most of the book focuses on Arnold Schoenberg and his A Survivor From Warsaw, but he also examines Richard Strauss’ Metamorphosen, Benjamin Brittan’s War Requiem and Dmitri Shostakovich’s 13^th Symphony (Babi Yar). This will be especially appealing to those familiar with this music, but Eichler reaches to the broader themes of how art expresses emotions, and in particular, how to convey the horrors of war with empathy but without being reductive, how to universalize these horrors while also respecting the specific conditions and victims of each experience.

Taking Manhattan, Russell Shorto

Shorto is the foremost historian on the beginnings of New York City. His 2001 book, The Island at the Center of the World, is the definitive work on the Dutch origins of the city. Taking Manhattan picks up the story with the transfer of New Amsterdam to New York, from the Dutch to the English. New York, as we all know, is a distinctive culture, apart from any other city in the country. Shorto makes the persuasive case that this is due to the Dutch origins that not only did not disappear when the English took over, but in many ways were adopted by the new owners and continued to characterize the people and the place. Shorto is an excellent historian and an excellent writer, and this is an outstanding example of both.

Most of you know that Beach Reading is not a list of “summertime” romances or light novels, but rather my usual mix of fiction and nonfiction books that I think rise to the level of being worthy of your attention. And since we should all be spending more time at the beach, here are six new recommendations for you, three fiction and three nonfiction. With sand in your toes, I hope you enjoy them.

Fiction

The Women Behind the Door, Roddy Doyle

Another gem from Irish writer Roddy Doyle (Paddy Clarke Ha Ha Ha). Paula lives alone in a small village, still haunted by her abusive husband who was killed decades earlier. Her eldest, "perfect," daughter suddenly moves back in with her after a mental breakdown. Paula’s life is bleak and hard, but she meets each day with wit and a determination to keep going. Wry and devastating, but funny and, in the end, hopeful, this is a beautiful novel.

The Night Watchman, Louise Erdrich

This is a funny, haunting, scary, but ultimately moving story of Thomas, a night watchman in a factory on an Indian reservation in Minnesota, who is trying to save his native tribe from official termination. He composes hundreds of letters to officials in Washington protesting a bill to remove recognition of his tribe and eventually organizes a trip to meet with politicians in DC. Separately, his daughter Pixie, who works in that factory, has a harrowing adventure when she looks for her missing sister in Minneapolis. Erdrich brings her characters to life, they are very real, as is the emotions she tugs at with her sensuous writing. She brings the multiple plot lines together in the end, with a few surprises. Thomas watches over the factory, his tribe, his family, sometimes successfully and sometimes not. This is writing by a master at the top of her game.

Question 7, Richard Flanagan

His brilliant book, The Narrow Road to the Deep North, followed POWs, including the author’s father, from the Japanese internment camp to their death march in Burma. This book picks up on the theme by speculating that if the atomic bomb had not been used, the war would have been extended and those POWs, including his father, would likely have died. Flanagan moves from there to portraits of his parents to the concerns of nuclear physicist Leo Szilard and the love life of H.G. Wells. Flanagan weaves multiple themes together brilliantly: a beautiful, thoughtful, insightful book.

Nonfiction

Land Between the Rivers, Bartle Bull

Mesopotamia literally means "land between the rivers," the ancient name for what is today Iraq. Its 5,000 year history, from the Sumerians to the present, is told with a journalistic flair that provides fascinating details but also the perspective of a broad sweep of history. Even if you have little interest in the region, you will appreciate this excellent work of history.

The Right Call, Sally Jenkins

Most attempts to draw lessons from sports to the business world or even life fall far short of the mark. But Sally Jenkins shares numerous anecdotes of famous athletes, their successes and their failures, that bring to light a few common traits that we can all use. Two stood out: commitment, or dedication, to a task. Michael Phelps had many physical gifts, but what set him apart was his extraordinary commitment to improving every day. Secondly was collaboration: leaders don’t lead by edict, they build consensus. The examples of coaching legends Mike Krzyzewski and Pat Summit highlight this. Sports fans will appreciate the stories, but this has broader appeal as well.

John & Paul, Ian Leslie

Lennon and McCartney are the greatest songwriting team in history, and this superb book tells the story of their relationship and how it informed their extraordinary collaboration. We gain a deeper appreciation for the genius of both musicians. Particularly for those of a certain generation, each song mentioned instantly brings its words and tunes to mind, proof of the indelible imprint their music had on so many. The decade following the breakup of The Beatles saw a number of missed opportunities for reconciliation, but they were coming closer together just as John Lennon was shot, and we are left with what might have been.

Three nonfiction and three fiction recommendations for your fireside reading. Enjoy!

Rat City, Jon Adams & Edmund Ramsden

How does a city get rid of its rats? In the 1940s, the city of Baltimore hired researchers at Johns Hopkins to study the problem and devise an eradication program. Over the ensuing decades, the research expanded to encompass how these social animals lived and how their living conditions affected their behavior and population. Rats naturally maintained a stable population in a given area, and researchers found that forced density altered their behavior to become more aggressive and anti-social, A connection was made to humans, where overcrowding led to similar behavior and outcomes, and urban planners took note, with disastrous consequences. Some of the worst planning developments, Pruitt-Igoe in St. Louis, Cabrini-Green in Chicago, for example, were the dreadful outcomes of poor planning. Too much density is bad, but too little density has its own set of problems, such as social isolation and depression, which is what the rats taught us. As the city of Baltimore discovered, as has every city that has attempted rat eradication, it is not possible to eliminate rats: where there are humans, there will be rats. You may recoil at the subject, but this is excellent science writing on an important and timeless topic.

Reagan, Max Boot

Max Boot has written the most comprehensive biography of Ronald Reagan to date. Boot is subjectively critical of many of Reagan’s actions-his visit to the Bitburg cemetery where Waffen SS are buried, his tepid response to the AIDS crisis, his ignorance of the machinations of his aides in Iran-Contra, for example-but makes the persuasive case that Reagan was above all a pragmatist, willing to take half a loaf from a Democratic Assembly (in California) and Congress (in DC) than to hew to an ideological line. Reagan was genuinely optimistic and had a strong belief in the goodness of people. This led to a blind eye in trusting people he should not have trusted, but it was his optimism that the country needed at that time. As Boot notes, a decade before or a decade later, Reagan could not have been elected. Careful to delineate his many errors, Boot concludes that Reagan was the right person at the right time for America. You won’t agree with every assessment, but this is, for now, Reagan’s definitive biography.

A Day in September, Stephen Budiansky

Antietam was the deadliest day in American history, a tactical draw militarily, but a strategic victory for the Union as Lee’s push into Maryland was repulsed and diplomatic recognition of the Confederacy was thwarted by the outcome. There have been many books on the battle, those by Stephen Sears and John McPherson among the best, but add Budiansky to this list. Here he approaches the battle as a clash of leadership styles. Both Robert E. Lee and George McClellan are heavily criticized, the former for his rash and faulty judgment, the latter for his overly cautious ineptitude. Antietam had an impact beyond the battlefield as it was the first battle to be extensively photographed, and the first to become a tourist site. Antietam was a turning point, perhaps the turning point in the Civil War, and Budiansky adds dimensions to our understanding of that critical day.

Orbital, Samantha Harvey

Six astronauts circle the Earth in the International Space Station, sixteen orbits around the globe every twenty-four hours. What are their thoughts as they go about their daily chores, or when they pause to look out the window at the Earth below and stars above? There is no plot here, just the meditations of these six astronauts reflecting on their lives on Earth and their meaning up in space. I cannot do justice to the enormous beauty of Harvey’s prose; it is simply breathlessly astonishing.

Netherland, Joseph O’Neill

Hans is a Dutch equity analyst who has moved from London to New York with his wife Rachel and their small son. His wife soon becomes disenchanted with post-9/11 New York, and returns to London without Hans. We empathize with Hans as he tries to reconcile with Rachel even as she pushes him away. Meanwhile, alone in New York, Hans falls into a crowd of cricketers, a game he last played in college, and falls under the tutelage of a shady Trinidadian with grand plans for a cricket stadium in Brooklyn. O’Neill’s observations of the immigrant fringes of society are especially acute, and the meaning of relationships is sharply drawn. A beautiful, funny, insightful book.

Time of the Child, Niall Williams

Faha is the small, fictional Irish village in this beautiful novel. Jack Troy is the town’s doctor, a widower with three daughters, two of whom have left Faha, but the oldest, Veronica, remains living with him as his assistant. He fears that he stopped a romance years before, ensuring that Veronica would never find love, and he ponders how he might atone. Then an infant is found in a field, presumed dead, but brought to the doctor and somehow revived. Veronica bonds with the baby whose presence is kept secret from the villagers. There are more twists to the plot, but mostly this is a heartwarming story of vulnerability and love that will bring tears of both sorrow and joy. A truly beautiful novel.

On a beautiful January day that exists only in California, snow-capped mountains to the east, sparkling Pacific Ocean to the west, I saw the flames starting on a hilltop to the north. This is not uncommon in California, and I thought it would soon be brought under control. Mother Nature had a different idea.

The aerial photo above shows Pacific Palisades, the scorched mountains above us and the burned community below. My house is circled in red.

Pacific Palisades has a strong identity, it’s a pretty close-knit community. We have our share of celebrities, but most people are working professionals: law, finance, writers, agents, etc. Nestled on a bluff between Santa Monica and Malibu, it is a bit isolated, which fosters a heightened sense of community. For as long as I can remember, 40 years or so, there was a T-shirt at the local skate shop that read, "If you’re rich you live in Beverly Hills, if you’re famous you live in Malibu, if you’re lucky you live in Pacific Palisades." I think we all believed that: we were lucky to live where we did.

Fires in the mountains were expected, and we thought our emergency teams were prepared for that. Fire cutting through the town to the ocean was not, expected or prepared for. Linda, my wife, was prepared. She quickly gathered most of the family heirlooms and photos, some of which date to more than a century ago, and loaded the car while I returned to the house to collect what I could think of as I saw the flames approach down the hillside, still thinking the fire would never actually reach our home.

I missed some important items of personal value, and left behind some beautiful artwork. The house our children grew up in, with all the memories of birthday parties, sleepovers, concerts, dinner parties and holidays, is gone, subsumed in flames and left in ashes.

There is little time to grieve. With 10,000 families all suddenly looking for housing, and large parts of the city off-limits with fires still burning, our first priority was to secure a place to live. Many friends opened their homes to us, and there has been an outpouring, truly, of generosity across the city, but we knew we couldn’t stay in a guest room for long. We ran from one rental listing to another, encountering hundreds of families doing the same. Linda found a house that looked good, and the wonderful woman who owns it fell in love with our golden retriever and rented us her house. If not for Linda and Quinto, I would still be homeless. Not to mention hopeless.

There has not been time for deeper reflection of the past week. I’m not interested in how the fire started, or if anything could have been handled better by politicians or emergency personnel. I do know that the people on the front lines of the fires are heroes.

My thoughts turn toward the future, with so many unanswerable questions, from the mundane, if we rebuild will our house be insurable, to the existential, how will the community change in the coming years and will we still want to be a part of it. Some friends and neighbors have already said they do not plan to return, so the neighborhood will inevitably change. But how, and what should we do.

I want to come back to the generosity of the people here. So many friends offered to take us in, strangers across the city are giving free food and clothing to those displaced. Our new landlady opened her closet to Linda (but not to me) and said take whatever you want. Unbelievable. The community really has come together in order to heal together. That healing began even as the embers still burn.

In Joseph Conrad’s Heart of Darkness, Mr. Kurtz reflects on the destruction he has brought to Africa, and utters one of the most famous phrases in literature, "The horror, the horror." Not coincidently, the exact same words are spoken at the end of Francis Ford Coppola’s Apocalypse Now by Colonel Kurtz as he surveys the devastation of Vietnam. Those words, "the horror, the horror," came to mind when I saw the first photos of my neighborhood.

But it is the outpouring of love that dominates my thoughts now, and toward the future of rebuilding our house and our community. This is the City of the Angels, Los Angeles, and I see angels all around me.

I’m not surprised that the extraordinary Amanda Gorman has captured perfectly our emotions with her exquisite poem, Smoldering Dawn, and I leave you with her beautiful words:

All our angels have gone.
In this smoldering dawn we soldier on.
We’ve proved ourselves strong.
Not by how badly we’ve burned.
But how bravely we bond.

Apocalypse does not mean ruin but revelation.
In devastation this infernus has injured us but it cannot endure us even in the surreal, We do not surrender.
We emerge from the embers.
The hardest part is not disaster, but the after.

Scorched earth is where the heart hurts.
What we restore first where we start the work.
Today we mourn.
Tomorrow we’re born.

We end the burning.
Befriend the hurting.
Mend those who face the flame.
We reclaim our city’s name.
A revelation that only this place tells;

To find our angels, all we need do is look within ourselves.

Last month, I returned to college for a ceremony honoring my coach. I have stayed in touch with Coach all these years, it is one of my most treasured friendships, as well as with some teammates, but others I hadn’t seen in 40 years.

I was happy to hear of their beautiful families and careers: some successful businessmen, a few judges, a high-ranking elected official, a long-term public school teacher. We celebrated our reunion, but also shared thoughts of the handful of teammates no longer with us, taken much too soon, including my closest friend, George.

It was a strange experience to reconnect after all this time. Strange, as in amazement that our bonds formed long ago are so tight that we were able to pick up conversations almost as if no time had passed. I think these ties are so strong partly because they were shaped during such formative years, so experiences become deeply embedded in our psyches, and partly because the intensity of a sports team, where we spend so much time together-practicing, studying, traveling, partying-forms deep and lasting ties.

Henry David Thoreau wrote that “the language of friendship is not words but meanings.” Friendship communicates through actions and shared experiences, not only, or even, through words. All of our experiences with others form these bonds: the losses, the wins, the disappointments, the celebrations, the "pools of sorrow, waves of joy," as John Lennon wrote, all give meaning to our relationships.

The visit reminded me how much I deeply treasure these friendships. Reconnecting with teammates after a 40-year gap was joyous. The heights of my elation measured just how meaningful those relationships were and are to me, and the deep void that forms when those friendships fade.

We are fortunate, blessed even, for our friendships, and equally for our relationships with the colleagues and clients we work with every day. These relationships give meaning and depth to our lives. Seeing teammates from long ago was a reminder of just how blessed I am for these friendships, and at my good fortune to be able to work with all of you. With humility and gratitude, I offer the words of Paul Simon: "there but for the grace of you go I."

Best wishes to you, your families and your friendships this season. May these bonds strengthen and endure and fulfill your lives with love, meaning and joy.

Seven selections for your winter reading, including my Book of the Year. May you have a warm and enchanting reading season….

Nonfiction

Autocracy, Inc., Anne Applebaum

Applebaum and her neoliberal proponents had assumed that the end of the Cold War and the ascendancy of economic globalization would lead to the spread of prosperity and democracy around the world. It did not occur to them that illiberal ideas would flow from the autocracies to the world’s democracies, but that is what has happened. She demonstrates the common practices of autocracies, but reaches when she implies a coordination among them to undermine "the West." Still, this is an important book in framing a crucial development in international relations.

The Jazzmen, Larry Tye

This is more than biographies of Duke Ellington, Louis Armstrong and Count Basie, it is a portrait of cultural America in the first half of the 20th century. Tye describes the racism imposed on each musical genius, even as demand for their talents was insatiable and their impact on American cultural incalculable. It is my personal view that every development in music over the past century stems from the genius of Louis Armstrong, but Tye also highlights the enormous impact of Count Basie and, especially, Duke Ellington on American music and culture.

Fiction

Long Island Compromise, Taffy Brodesser Akner
A fictionalized account of a true story, wealthy businessman Carl Fletcher is kidnapped from his gilded mansion on Long Island. The ransom is paid, but the family will never be the same again. The chapters follow each family member as they deal with their trauma from the kidnapping and the guilt they have over the how the family fortune was made: the handsome son whose success in Hollywood disintegrates in a haze of drugs and sex, the nebbish son who is a failed lawyer, the artsy daughter who becomes a union organizer, and finally the matriarch who tries to keep the family together. Funny, often hilarious, sad and poignant, this version of the Great American Novel is a treat.

The Wizard of the Kremlin, Giuliano da Empoli
Fiction can illuminate life in ways that nonfiction cannot. This is the fictionalized account of the life of Vladislav Surkov, a longtime close advisor to Vladimir Putin. Surkov, renamed Baranov here, is clear-eyed about Putin, explaining why he supported him in the early years, and how power began to corrupt him over time. He portrays Putin as the patriot that most Russians see, even as he evolves into a ruthless dictator. Illuminating and enjoyable, giving us a glimpse into the mind of Putin.

Girl, Woman, Other, Bernardine Evaristo
This novel centers on Amma, a black lesbian playwright and ten of her friends, all women, all marginalized racially, sexually, or in some way. Each of their lives is revealed, connecting with each other. There is not much of a plot, and the novel is written as prose, with long, ungrammatical sentences. But the characters are richly drawn in beautiful passages. If there is a common thread it is an exploration of identity, artistic and cultural, that forces us to reconsider our perspectives.

Table for Two, Amor Towles
A collection of New York stories opens this collection, each a gem. The second half of the book is the most compelling story, a novella set in Los Angeles shortly after the filming of Gone With The Wind. Nude photos of Olivia de Havilland have gone missing, and the race is on to find them. In the hands of one of our greatest writers, this is a pleasure from start to finish.

James, Percival Everett
Jim is the slave who leads Huckleberry Finn on his adventures in Mark Twain’s classic novel. James is Percival Everett’s reimagining of Jim as a slave, but a wise and intelligent one with his own set of adventures as harrowing as Huck’s. Everett is a brilliant writer, endowing James with humor and humanity and moral sensibility. My Book of the Year, it is a masterpiece.

Six new books for you, all fiction, all great. I hope you enjoy!

The Sellout, Paul Beatty
This is possibly the most brilliant satirical novel since A Confederacy of Dunces. The protagonist, known by his last name, Me, is a fixture in the town of Dickens, California, a stand-in for Compton. He saves the life of one of its more famous residents, Hominy Jenkins, the last surviving member of the cast of the Little Rascals. Hominy decides to express his gratitude by becoming his slave. Me watches his city deteriorate and decides to rescue it by reinstating segregation throughout the city. He is charged with multiple counts of violating multiple constitutional amendments, and his case is heard at the Supreme Court. All absurd, of course, but Beatty is exploring how people can be oppressed in an allegedly free society. He draws the connection between yelling "Fire" in a theater, and shouting "Racism!" in a post-racial society. This was the first American book to win the Booker Prize, and it is certainly a classic. Brilliant does not do it justice.

Dead in Long Beach, California, Venita Blackburn
Coral enters her brother’s apartment in Long Beach, to find him dead from a gunshot wound. She calls 911, watches dispassionately as they remove the body, grabs her brother’s phone and leaves. For the next week, Coral goes about her daily life, interrupting to answer the texts her dead brother gets, pretending to be him: arranging future dates, making plans, telling no one of his death. As absurd as this is, it doesn’t register that way. Instead, we feel that Coral is grieving in her own unique way. So this is a novel about grief, about not making judgments, animated by sharp, precise, brilliant writing.

This Other Eden, Paul Harding
Malaga is an island off the coast of Maine, home to a small group of mixed-race families. Paul Harding reimagines its history over the course of a few years in the 1910s. The islanders live in poverty, but they are self-sufficient and content with their isolated existence. But the rise of the eugenics movement prompts the community on the mainland to intervene in the lives of the islanders, for their own benefit, of course, ultimately disrupting the "Eden" they have created. This novel is really about love, prejudice, and is written so beautifully as to make you cry. An astonishing work.

Demon Copperhead, Barbara Kingsolver
Barbara Kingsolver reimagines David Copperfield, Dickens’ chronicle of a young boy amidst the poverty of Victorian England, to Appalachia, with a distinctive voice that pierces our hearts with its description and critique of the pervasive institutionalized poverty of rural America. We see Demon’s life from his perspective, from childhood to early adulthood, through foster homes, football heroics and opioid destruction. Funny, biting, tragic, the lives of Demon’s friends and neighbors and lovers demand respect for their struggles, more so for their failures. This book left an indelible imprint, a brilliant, vital addition to the Great American Novel.

Prophet Song, Paul Lynch
An Irish family trying to survive as civil war erupts. The father, a trade unionist, is taken by the police and seemingly disappears. An emergency decree has suspended civil liberties, and Eilish, his wife, searches vainly for his whereabouts. She attempts to save her eldest son by sending him across the border to Northern Ireland, but he flees to join the rebels fighting the government. Eilish’s sister lives in Toronto and urges the rest of the family to flee, but Eilish hesitates, until it may be too late. We are not told of the reasons for the loss of liberties or what the rebels are fighting for, a purposefully ambiguous backdrop so as to universalize the story. How does a country of laws abandon them? When is it time to flee the violence, or stay and fight, or just stay and hope the violence passes? Heart-wrenching choices that Eilish has to navigate on her own as her window closes gradually but inexorably. A profound work.

The Fishermen, Chigozie Obioma
This novel, from 2015, is a biblical parable of a Nigerian family unraveling when the father is transferred to a job in a distant city and his four young boys stray from his firm grip that had kept them on the right path. The eldest brothers, once close, turn into Cain and Abel, ripping apart the family. Sad, poignant, but we are drawn to the characters, rooting for them and their relationships to heal even as they fray and dissolve. A beautiful work.

I’m happy to go to the beach year-round, but it’s now really becoming beach weather, so I have five new book suggestions for your next trip to the beach.

Nonfiction

The Blue Machine, Helen Czerski
We give little thought to the physics of the ocean, but they are complex and vital to our existence. This book goes into the science of how the ocean works, how temperature, salinity, density and topography all affect the weather, climate and the broader ecosystem. Czerski is a bubble physicist and oceanographer, and her science is detailed yet accessible. This is a fascinating tour of the oceans with an appreciation of just how important it all is to our survival.

Eighteen Days in October, Uri Kaufman
A well-researched, fast-paced account of the 1973 Yom Kippur War that reveals many insights. The intelligence failure at the start of the war has obvious parallel with the Gaza war fifty years later. We see that decisions are made with incomplete and contradictory information, how personal political rivalries can affect those decisions, how minutes so often matter in turning the tide of war. The reputations of IDF Chief of Staff David Elazar and Prime Minister Golda Meir were unjustly tarnished, and the recklessness of Ariel Sharon won the war that most Israelis believe they lost. A timely history.

Fiction

Witness, Jamel Brinkley
Ten short stories, all set in the Bronx and Brooklyn, with various characters, all struggling with their daily lives. Each story and person is carefully drawn with tight prose. We become witnesses to their lives, their grief, their hopes. Brinkley penetrates their outer selves to allow us to see what is inside their characters, and does so with grace and perception.

The Extinction of Irena Rey, Jennifer Croft
A famous Polish novelist has called her eight translators together to begin work translating a new novel. As they have before, they would all work together on the translation in her house so that the novel could be released in multiple languages simultaneously. The author, Irena Rey, distributes the new novel to them, but then she disappears, and the translators are not sure what to do: wait for her? Look for her? Translate without her? They do all of the above, and more. As we learn about their past lives and secrets, the mystery of Irena Rey’s disappearance unveils itself. Jennifer Croft is, in real life, the translator of Olga Tokarczuk, the Polish Nobel Laureate, so she knows something about translating and translators, but demonstrates her unique gifts as a writer of beautiful prose and a compelling story.

Künstlers in Paradise, Cathleen Schine
The Künstlers escape Vienna on literally the last boat out of Europe in 1939 and travel to Los Angeles, where they are part of the large, German-speaking émigré community of artists and writers that fled the Nazis. Mamie, a 12-year-old girl, adapts quickly to California, but most of the story takes place eighty years later when her peripatetic grandson, Julian, visits her from New York, just before the pandemic shuts everything down. Mamie regales him with stories of her youth, the famous people she knew, the sheer joy of being in a fairy-tale land as her old world disintegrated. The storytelling is mesmerizing, and has the effect of opening Julian’s heart. He is still directionless, but through Mamie, he has gained a maturity and perspective he never had. He learns from Mamie to leave the past behind and make the most of the present, and not to worry about the future at all. A beautiful, funny and deeply touching novel.

Seven new selections for you – 3 fiction, 4 nonfiction – while it’s still fireside reading season. Enjoy!

Fiction

Baumgartner, Paul Auster

Baumgartner is a philosophy professor at Princeton, nearing retirement. This novel begins on an ordinary day where he has a list of mundane tasks to do: call his sister, repair the basement stairs, etc., when he burns his hand on an old pot he left on the stove This leads to a series of events that causes him to reminisce about his wife, Anna, who died 10 years earlier. His life with Anna is the heart of the story. The book is really about loneliness and grief, hope and love. This is a quiet, contemplative, beautiful novel from one of our greatest writers.

Waiting for Snow in Havana, Carlos Eire

This is a memoir of a boyhood in pre-Castro Cuba, and his subsequent exile to the United States still as a child. Eire recants his childhood with wonderful humor and keen observation of his extended family and friends. On that level alone this is a marvelous book. But he also gives a glimpse of upper-middle class life in pre-revolution Cuba, and what was lost when the country was turned upside-down. Funny and poignant, witty and sarcastic, this is a memorable book.

How I Won A Nobel Prize, Julius Taranto

A billionaire recluse, B.W. Rubin, bought an island off the coast of Connecticut and built The Rubin Institute, an academic haven for the anti-woke perpetrators who ran afoul of society’s norms, from committing microaggressions to statutory rape. Scientists, writers, artists, among the most accomplished and esteemed in their fields but whose actions have been "canceled" by society, populate this island. Helen, a post-grad working on superconductivity, is enticed to come to the Institute by her mentor, a Nobel Laureate in physics. Her husband, Hew, a radical left-wing activist, is appalled with the idea. The story is told from Helen’s perspective: the details of her scientific work, her shifting relationships with the men in her life, Hew, her mentor, her father, a celebrated author also at the Institute. There are philosophical passages on politics, religion, free will that frame our contemporary debates eloquently. Helen’s messy relationships, professional and personal, are universalized for the relationships we all have, and are told with poignancy and empathy. And humor, as Helen shows her wit in describing her life. A truly enjoyable book written with pace, relevancy and humor.

Nonfiction

How Life Works, Philip Ball

How does life work? Perhaps the common answer might be that DNA contains the "blueprint" for life, which it shares, via RNA, to the proteins that build life. There is some truth to this simplistic model, but it is hardly the whole picture. Much of the work creating life occurs at the cellular level, independent of genetic instructions. Philip Ball gives us a deep dive into current biology. There is a fair amount of science that may intimidate the general reader, but we are rewarded with some astonishing revelations. For example, it is possible to rearrange the face of a tadpole, so that the eyes are where the ears should be and the nose is where the mouth goes, but when that tadpole transforms into a frog, its face is as it should be, a beautiful frog you might want to kiss. This reconfiguration does not occur through genetics. Another point: you can bisect a flatworm, which is a fairly complex organism with a brain and nervous system, lengthwise or widthwise, or dissect into a hundred pieces, and each part will regenerate an entirely new, perfectly formed, flatworm. We are our genes is only partly true, and we don’t yet have the complete picture. This book goes pretty deep into biology, but it provides an excellent overview of our current understanding of how life works.

American Rascal, Greg Steinmetz

Jay Gould was possibly the most hated man in America, the robber baron who put his fellow scoundrels to shame. Yet he was undeniably brilliant, determined, and ruled the lawless wild west of Wall Street when there were no rules. This is a sympathetic, yet balanced, biography of Jay Gould, and more, a gripping narrative of the unfettered capitalism of the post-Civil War era in America. Gould did not endow universities or libraries, and his heirs squandered their massive inheritance, so Gould is largely unknown and forgotten today. But his story is uniquely American, and it is told here with verve.

Road to Surrender, Evan Thomas

Was the US right to drop the atomic bomb on Hiroshima? And again on Nagasaki? Would a demonstration of the bomb sufficed to persuade the Japanese to surrender? There are serious moral questions about the use of the atomic bombs that killed hundreds of thousands of civilians, but Thomas is persuasive in showing that the Japanese General Staff had no intention of surrendering. Even after the bombs were deployed, the military wanted to fight to the last man. Thomas gives us a detailed look at the diaries of three men during the last few months of the war to explain the internal Japanese debate and how their messages were received by US leaders. Henry Stimson, US Secretary of War, struggled with the moral consequences of the atomic bomb, and although he ultimately approved its deployment, worked to cooperate with the Soviets on atomic weapons post-war. Carl "Tooey" Spaatz, in charge of the US Air Force, also wrestled with the implications of the atomic bomb but never wavered in following orders to drop the bombs. Shigenori Togo was the Japanese Foreign Minister who argued passionately to surrender only to be thwarted by the military leadership. Only the unprecedented intervention by the Emperor resolved the dispute. The evidence is pretty clear that the atomic bombs contributed to the Japanese decision to surrender, and that an Allied invasion of Japan would have resulted in the loss of millions of lives. This is a riveting, important story told with pace and context.

Fire Weather, John Vaillant

Fort McMurray, in northern Alberta, had 90,000 inhabitants, everyone drawn to this remote, frigid place by the tar sands that lie underground. In May 2016, the largest fire in North American history ignited there, forcing the evacuation of all 90,000 people. Vaillant gives us a gripping, almost minute-by-minute drama of how the town came to realize that this was unlike any fire anyone had ever seen, the futile efforts to contain it and the desperate, panicked fleeing that ensued. There is the obvious irony that the consumption of fossil fuels both built this town and contributed to its demise, and a timely warning of the urgency of transitioning to renewable energy. The book offers a lesson in geology, heart-pounding terror and a glimpse of what our future holds.

I hope you have a wonderful holiday season, with ample time to enjoy some good books next to a crackling fire. I have an even-dozen to recommend. Best wishes to all!

Fiction

Old God’s Time, Sebastian Barry

This is a beautiful, haunting novel that captures the memories and joys and pains of a man inhabited by his past. Tom Kettle is a just-retired policeman, detective, who has moved into a rented cottage on an island outside Dublin. The book is mostly a narrative of his thoughts to himself, of his wife and children, an abusive past and a case from long ago that still troubles him. The plot moves slowly, with exquisite prose closer to poetry, and a rush to tie everything together in the end. Sebastian Barry is masterful storyteller, a gift even among the Irish masters.

The Pole, J. M. Coetzee

"The Pole" is an aged concert pianist who is invited to perform by a music society in Barcelona. He falls for the middle-aged woman, happily married, who heads the society and tries to woo her. How we communicate is one theme, as both have to speak in English, a second language for each, and there are difficulties in getting thoughts across. Mostly, this is about how we see our self-worth: for the pianist, is his music enough for him? For the woman, educated and smart but afraid she is not taken seriously, what does a relationship with this man mean for her self-worth? A short, beautiful novel from a master.

Trust, Hernán Díaz

This is the story, or rather, stories, of generational wealth, told from multiple perspectives. It opens with the immense fortune created by Benjamin Rask in the late 19^th-early 20^th centuries, building on his grandfather’s initial fortune parlayed during Thomas Jefferson’s trade embargo. Then we hear of the fortune of Andrew Bevel, whose life bears an uncanny resemblance to Benjamin Rask’s. Bevel hires a ghost writer for his autobiography, and it is through her perspective that we discover some of the family’s secrets, until finally, the diary of Bevel’s wife, Mildred, is revealed 60 years after his death. These fortunes are built on trust, but also on distrust, and the reader does not quite know what to trust in this novel. Intriguing and intelligent, a deserving winner of last year’s Pulitzer Prize.

Afterlives, Abulrazak Gurnah

The novel takes place in German East Africa in the early 20^th century. On one level, it is about imperialism, the German pursuit of African colonies, the British determination to displace them, the devastating impact of these wars on the native population across generations. On a deeper level, this is a love story, how people survive, suffer, find happiness and love in the most trying circumstances. Mostly, this is simply a beautiful work by a master, largely unknown but deserving winner of the Nobel Prize for literature.

Tinkers, Paul Harding

It is rare for a debut novel to win the Pulitzer Prize, as Tinkers did in 2010. George Crosby lies dying in his home and reflects on his life, especially haunted by his father Howard, who was an epileptic traveling salesman who disappeared when George was just 12. Both father and son were tinkers, menders of broken objects. Both were broken men in their own way. But the true joy of this book is Harding’s prose: stunning, reflective, beautiful. A breathtaking work of art.

The Bee Sting, Paul Murray

This is the story of the Barnes family, their secrets and their unraveling, the lies they tell themselves and the truths they reveal. Each member is sketched in lush detail: the father who stepped in for his golden-haired older brother who died unexpectedly, the mother, a beauty forced to pawn her jewels and clothes, the bright older daughter who turns to drink and drugs, the younger son intimidated by bullies. Are secrets better hidden or revealed? Do truths set you free or have painful consequences? Paul Murray inherits the mantle of great Irish writers, with lush prose and sardonic wit that invest us deeply in his characters. A spectacular family saga that hums along over 600 pages that thoroughly engulfs us in the lives of this tragic family.

Let Us Descend, Jesmyn Ward

The title is borrowed from Dante’s Inferno, and for Annis, the narrator of this novel, Hell is all around her, as a slave in the antebellum South. The brutality and inhumanity of slavery stab us repeatedly in poetic passages that sear our ears and hearts. Annis is guided by the spirit of her grandmother Aza, a warrior in Africa who was captured and sold and survived the passage. But Annis is also her own woman, alternatively taking and rejecting the advice of Aza’s counsel. Jesmyn Ward is one of our most gifted writers. Let Us Descend is not her finest work: a bit overwrought and verbose. But she can move us to tears nonetheless.

Nonfiction

The Rediscovery of America, Ned Blackhawk

This is a 600-page, almost a textbook, single volume history of the United States from the perspective of, and impact on, the indigenous peoples of the Americas. The genocide perpetrated on native peoples, both intentionally and otherwise, almost defies comprehension, but Blackhawk focuses just as much on the impact this destruction and dislocation had on the development of European settlement in North America. A dense book, but an important contribution to understanding the history of the United States.

The Rigor of Angels, William Egginton

This book explores "the ultimate nature of reality," by connecting the seemingly disparate works of Immanuel Kant, Werner Heisenberg and José Luis Borges, each of whom struggle, in their own disciplines of philosophy, quantum physics and literature, with the question of what, exactly, is reality. The genius of each of these men is explored, and while their concepts are often difficult to follow, at times even for them, we are left with a deeper appreciation of their brilliance as well as just how similar their goals were. The ultimate answer to the ultimate question of what is the nature of reality is…well, I’ll leave that for you to discover in this challenging, provocative and illuminating book.

King: A Life, Jonathan Eig

This is the definitive biography of Martin Luther King, Jr. In more than 600 pages, Eig chronicles his life, with intimate, personal portraits of family along with the narrative of the civil rights movement he came to lead. It’s remarkable that King’s prominence lasted just 13 years. Sadly, in the wake of his biggest triumphs with the passage of several landmark civil rights legislation, which would never had passed had it not been for King’s influence and relationship with President Johnson, in his last few years the nation erupted in violence and even King harbored doubts about the future of race relations. Eig writes in a very straightforward way, giving us a clear picture of the life of Martin Luther King, Jr. The book lacks the detail and passion of a narrower subject, such as You Have to Be Prepared to Die Before You Can Live by Paul Kix, recommended a few months ago (https://www.angelesinvestments.com/institutional-insights/beach-reading-9). But King’s life is worth revisiting in our times. His nonviolence philosophy broke the Jim Crow laws, but fell (well) short of a reconciliation of racial tensions. Yet King’s legacy may still be our best hope for healing the divisions that rack our society today.

The Spy and the Traitor, Ben MacIntyre

The spy is Oleg Gordievsky, the most important double agent since Kim Philby. Gordievsky’s secrets, passed to MI6, and shared with the CIA, were critical in how the West handled the final years of the Soviet Union. The traitor is Aldrich Ames, whose treachery led to the execution of at least a dozen CIA assets around the world and tagged Gordievsky as a double agent. This is a heart-pounding story of Gordievsky’s life, his turn to the West, his pursuit by the KGB and his attempted escape from Moscow. A thrilling story of a man who arguably helped change history.

Liliana’s Invincible Summer, Cristina Rivera Garza

Liliana was murdered, almost certainly by her boyfriend. An arrest warrant was issued, but he was never found, and Liliana’s parents didn’t have the money to bribe the police to try to find him. Thirty years later, Liliana’s sister, the author, wants to see the police file to try to figure out what happened. Navigating the bureaucracy of Mexico is a story in itself, but the along the way through this maze we hear of Liliana’s life, through her letters she saved and the reminiscences of her friends. Cristina Rivera Garza has given is a beautiful homage to her sister, to the all-too-common violence against women and the search for justice that never comes.

September is still beach time, so I have a few more recommendations for you. One nonfiction and four fiction, including my (so far) book of the year. Enjoy!

House of Cotton, Monica Brashears

Magnolia Brown lives with her grandmother, Mama Brown, and the novel opens with her death. The teenage Magnolia tries to survive by working at a gas station and by prostitution, including with her landlord when she can’t meet rent at the end of the month. Her life takes an unexpected turn when a man suggests she consider a modeling career. We fear we know where this will lead, but Magnolia is desperate and she visits his office, which turns out to be a funeral parlor. The modeling he has in mind is impersonating the dead girls of grieving families who want one more conversation with their beloved. That may seem a strange request, but it (mostly) brings comfort to the grieving parents. Magnolia’s life is hard, and the novel portrays it in its harsh light. But Magnolia is given a degree of control through her impersonations, and we wonder who is taking advantage of whom? This is a gritty, meandering, but poignant and unique debut novel.

The Disappearance of Josef Mengele, Olivier Guez

It’s hard to believe that this is a novel. Guez puts us in the head of Josef Mengele, the notorious Nazi doctor at Auschwitz, as he escapes to South America and rebuilds his life there while pining for his wife and hoping that the world will realize the virtues of Nazism so that he can return to glory. All the while, he is deeply suspicious of traitors, and hides his identity from everyone but his fellow Nazis who have formed a small but formidable group of exiles in South America. The novel brilliantly conveys the hatred and delusions of these evil men as they live out their lives in both luxury and fear.

You Have To Be Prepared To Die Before You Can Live, Paul Kix

A gripping narrative of ten weeks that changed the course of American history. The Supreme Court had banned school segregation in 1954. The Montgomery bus strike integrated the bus system in that city. And then…nothing. Segregation remained in place virtually everywhere in the South. The civil rights movement sputtered; a protest in Albany, Georgia in 1962 utterly failed to integrate that town when the police politely arrested the protestors and then promptly released them. Martin Luther King, Jr. was racked with doubt about his ability, or even desire, to lead the movement. A do-or-die stance would be made in Birmingham, easily the most racist city in the racist South. But the well-planned protests did not go well; the Black community in Birmingham was either too fearful or too apathetic or too polarized to join the march. Paul Kix brings to life the very difficult decisions that had to be made with stakes so high, the ignorance and hypocrisy of Bobby and Jack Kennedy, the hot-headedness and the questionable sanity of James Bevel that broke the impasse, the passion and commitment of Fred Shuttlesworth, the critical support of Harry Belafonte, and the inner conflicts and unmatched eloquence of Martin Luther King, Jr. While nothing today approaches the depths of depravity inflicted on the Black citizens of Birmingham in 1963, this book helps to highlight that we have not yet fulfilled King’s vision, and our country’s promise, of full equality for every citizen. Still, those ten weeks in Birmingham in 1963 did alter our history. The heroes and villains of Birmingham are a part of our history, and Paul Kix brings us back to that time and place so that we may better understand our own time and place.

The Heaven & Earth Grocery Store, James McBride

This is the most beautiful book I have read in a very long time. James McBride is one of our greatest writers, and this is his best work (yet). Chicken Hill is the poor neighborhood in the fictional town of Pottstown, PA where Blacks and Jews live (mostly) separate lives. But Moshe, who runs the town’s theater, books some of the great Black musical acts of the 1930s, while Chonda, his wife, runs the family grocery store that caters to both communities. Relations with the whites down the hill are fraught, and the plot turns when a deaf boy is taken to a state mental ward. The story is great, but the magic is in the drawing of the characters, the community, and McBride’s mastery of words and images. He gives us searing pain and soaring love; an extraordinary work that should win every prize this year.

Crook Manifesto, Colson Whitehead

This is a great tale of 1970s Harlem, where the good guys are bad and the bad guys are worse. Ray is a one-time petty criminal turned legit by owning a furniture store. But a desire to secure tickets to the Jackson 5 at Madison Square Garden for his teenage daughter lures him back into the crime world. Whitehead draws each character to perfection, showing us all their complexities and flaws. We struggle with Ray trying to do the right thing but can’t quite get there. This is not Whitehead’s finest book (see Underground Railroad), but given his talent it is merely just excellent. It reminds me of Walter Mosley at his best, and that’s high praise.

There’s still a lot of summer left, so I have five nonfiction and five fiction recommendations for your beach reading.

Nonfiction

The Half-Known Life: In Search of Paradise, Pico Iyer

What is Paradise? Where is Paradise? Pico Iyer, a prolific writer of his many travels, visits the holy sites of Iran, Japan, Jerusalem, India and Sri Lanka to find out. He observes the paradox that so much violence has accompanied so many of the holy places, and death is especially pervasive here. Of course, Paradise cannot be found on this earth, and death is not the opposite of life, but the opposite of birth, quoting a Buddhist scholar. Iyer is a wonderful writer, with beautiful prose that will entice you to visit each of these sites. And his musings on Paradise may help us appreciate the life we have.

Oceans of Grain, Scott Reynolds Nelson

Trade built empires, not the other way around, and nothing was as important to trade, or empires, as wheat. Nelson, a professor at the University of Georgia, offers a deeply fascinating history of the grain trade, with an emphasis on Ukraine, the breadbasket of Europe. We learn also of the importance of nitroglycerin in the grain trade, and there are many insightful connections that Nelson makes between Russian serfs and American slaves, or how Catherine the Great emulated the American grain system, as examples. This is a wonderful history that brings in many aspects of social, political and technological developments, all through the critically important lens of grain.

Indivisible, Joel Richard Paul

An American identity was hardly formed in the early days of the Republic. Almost everyone identified with their state or, to a lesser degree, with their region. The Articles of Confederation that guided the country for its first 15 years expressed this in legal terms: it was the thirteen colonies that formed the Union. The Constitution altered the legal framework, with its opening words, We the People, not we the States, but a true national identity had not been formed. Yet 70 years later, millions would join together and stake their lives defending this American identity. How did that transformation from state to national identity occur? There were competing forces for how or even if an American identity would develop, and it was Daniel Webster’s version and vision that eventually emerged. Indivisible is a political history of the first half of the 19^th century United States, and Paul brings to life the key figures of the time. But his focal point is Daniel Webster, the greatest orator in American history. At our own time of national division, we would do well to remember Webster’s famous phrase, Liberty and Union, now and forever, one and inseparable. Indivisible is an excellent work of history because it has relevance today.

Sink, Joseph Earl Thomas

This is an extraordinary memoir, told first in the third person as a preteen, and then in the second person as a teenager growing up in poverty, filth, drugs, and violence of Philadelphia in the 1990s. Joey relates his life as he experiences it in an even-handed, matter-of-fact way. This lack of sensationalism makes his everyday struggles all that more powerful to absorb. His mother is a crack addict, in and out of his life. His grandmother takes him and his sister in, but she, too, is hardly around. His grandfather beats her, and beats on Joey too, but at least gives them a place to stay. Joey escapes to the world of video games and anime, but the real world never allows him to escape its travails for long. Still, Joey survives, seeking love and learning how to give love. This is an autobiography that reads like a novel, extraordinary, shocking and heart-wrenching, a remarkable debut from a gifted writer.

Easily Slip Into Another World, Henry Threadgill

Henry Threadgill is one of the great jazz composers of our era, winner of a Pulitzer Prize, and this is his autobiography. Now, I think that most autobiographies are terrible: they’re written by people who can’t write, and are either out to settle scores or to create a hagiography. Neither is true here. This book will appeal primarily to musicians, and I found it most interesting when he talked about how he approaches composing. It can be a little technical, so some musical foundation is helpful, but there is so much more to savor. Threadgill fills the book with the vivid characters among his own family, and his experiences growing up on Chicago’s South Side, his time as a soldier in Vietnam, to his development as a musician. For someone who was expelled from schools, the breadth of his erudition is remarkable. All his knowledge and experiences come together in his music. Threadgill tells his life story simply and directly. It is as much a look into the social world of his era as it is about how music is created. This should have wide appeal beyond those interested in jazz, but for those who are, this is a treasure.

The Rabbit Hutch, Tess Gunty

This is a novel about the pathetic lives of pathetic people living in a pathetic town in Indiana. It is also an astonishing debut novel that connects us to each of the characters, their humanity, their flaws, with poignant social commentary of the struggles of a Rust Belt community that seeks to revive its former prosperity. The writing is magical and mesmerizing, a worthy winner of the National Book Award.

The Vegetarian, Han Kang

This is a short, surreal, disturbing novel of a woman who has a dream that she should no longer eat meat. Her family find this behavior baffling as she loses weight and seems to fade into her own, hidden world. The story is told first from the perspective of her husband, then her brother-in-law, and finally from her sister. It contains acts of violence and sex, hallucination and nightmares. Yet each character is portrayed with such delicacy and kindness, even as each questions their grip on reality. The book created quite a stir in Korea when it was published in 2007, but its English translation in 2016 garnered the International Booker Prize. It is unsettling, but still beautiful.

Bad Summer People, Emma Rosenblum

This is perfect Beach Reading material: a close-knit community that has summered on Fire Island for generations. There’s the usual obnoxious New York City financiers and their trophy wives and trophy kids, the new tennis pro whom every woman lusts over, the nannies who endure the boredom and disregard, the unending gossip. And a murder. This is not high literature, but as a debut novelist, Emma Rosenblum captures perfectly the cadence, affectations and pettiness of the upper, upper class.

Victory City, Salman Rushdie

A nine-year old girl watches her mother walk with all the other women of the village, one by one, onto a funeral pyre, following the deaths of their husbands in battle. As the girl walks away, she is visited by a goddess, who gives her a bag of magic seeds, from which a city, and then an empire, is grown. The girl lives 248 years, witness to the rise and fall of her empire. Before she dies, she leaves a manuscript recounting the history of this empire, and her role in nurturing it for over two centuries. This is an enchanting tale, told by a master storyteller, but it is much more. Rushdie has long written about political hypocrisy, the leaders who make war in the name of peace, the intolerance of those who proclaim, and impose, their purity, and these themes flow throughout the book. Rushdie gives us lessons for our own time in this magical, enchanting book.

Signal Fires, Dani Shapiro

This is a truly beautiful, emotional novel, of two families, neighbors, over the course of fifty years. We are introduced to each parent and child, their fears and hopes and inner feelings. It is a rare gift to be able to write about ordinary people with ordinary lives in a way that touches us deeply. In the end, this is a book about caring, about love. There is nothing exceptional in the plot, or about the characters. But you will be moved by the tenderness and love in this novel.

Why does the Fed insist that low unemployment drives higher inflation? Policymakers’ imagination is being fired by useless information, and they just can’t get no….

And I’m tryin’ to make some girl, who tells me
Baby, better come back maybe next week
Can’t you see I’m on a losing streak?

It’s been a long time since Mick Jagger was on a losing streak. Sadly, the same cannot be said for those who run our monetary policy.

In 1958, William Phillips, a New Zealand economist, examined the relationship between the unemployment rate and wages in the United Kingdom from 1861-1957 and concluded that there was a correlation between a reduction in the unemployment rate and a rise in wages, and vice versa. It became known as the Phillips Curve. Subsequently, Paul Samuelson and Robert Solow, two Nobel Laureates, linked wage gains with inflation, and thus the Phillips Curve became economic orthodoxy. Policymakers could now confidently tweak the economy by accepting a little higher inflation for a drop in unemployment (more jobs is always a political winner).

But a funny thing happened in the 1970s. Beginning in 1973, the inflation rate and the unemployment rate did not diverge as the Phillips Curve promised, but rose in tandem. In 1975, both data sets then fell together, and then in 1979 both rose again in lock-step, before falling together in 1983 and over most of the next four decades. The chart below shows the unemployment rate in yellow, inflation (CPI) in white, the Fed funds rate in dark blue and the growth of money supply in light blue, between 1970 and 1984.

The experience of the 1970s contradicted the Phillips Curve: instead of inflation and unemployment moving opposite each other, they moved together. On hand with an explanation was Milton Friedman, another Nobel Laureate, who said that inflation was "always and everywhere" a monetary phenomenon, meaning that inflation reflected the price, or value, of money, and the price of anything is determined by its supply and demand curves. High inflation was caused by too much supply of money, as the chart above clearly shows (M2, the light blue line, surged in both the early 1970s and then again in the mid 1970s). Cut off the supply of money and inflation will fall. That is exactly what Paul Volker did in 1980, and inflation fell, just as Friedman said it would.

Following the Global Financial Crisis in 2009, the Fed slashed interest rates to zero and held it there for seven years. The Fed began raising rates in 2016, but in 2019 a mild downturn in the economy (from 3% to 2%; you have to squint to see it below, the purple line) caused the Fed to start cutting rates again.

The Fed raised rates in 2016, not because it recognized that zero interest rates distorts investment decisions (which it does), but because the Fed was worried that in the next recession it would not be able to cut interest rates and so it wanted to have some cushion to do so. From 2009 through 2019, inflation averaged 1.7%, and the Fed felt that 1.7% inflation was too close to zero, and deflation, falling prices, would be difficult to manage with interest rates at zero.

It’s hard to describe just how misguided this thinking was. The "best" rate of inflation is that which does not impact investment decisions. Inflation is a tax on savers/investors, and the "best" inflation rate is therefore zero. A rate of 1.7% is not too low, yet policymakers were not satisfied with this level for fear that deflation was too close for comfort.

COVID hit in March 2020 and effectively shut down the global economy. Households and businesses hoarded cash and the Fed, appropriately, met the demand for cash by supplying more of it. But as the economy re-opened, and the demand to hold cash diminished, yet the Fed continued to supply record amounts of money. The supply of money had never exceeded 15% per year (back in the grim 1970s), yet the Fed allowed money supply to grow more than 20% in 2020 and again in 2021 (see graph below). It was this explosion in money growth that led to the highest inflation in forty years.

The growth of money supply peaked in February 2021 and has been contracting since December 2022 for the first time in history (well, probably since 1932). Inflation peaked in June 2022 (white line below) at 9.1% and has fallen to 3.5% in the past year. Inflation has fallen because money supply is contracting. Yet, the Fed just hiked the Fed funds rate to 5.5%; why?

Well, apparently the new problem is that the unemployment rate is too low at 3 ½%, pushing wages higher. Back to the Phillips Curve: low unemployment = rising wages = rising inflation. So the Fed feels that it must keep rates high in order to raise unemployment, lower wages and thereby lower inflation.

The Fed is not satisfied with falling inflation and 3.5% unemployment because the Phillips Curve model does not allow for low unemployment and low inflation; remember, unemployment and inflation are supposed to move contrary to each other.

But as we have seen over the past fifty years, inflation is a monetary phenomenon. It is a function of the supply of and the demand for money. Money supply is contracting and inflation is falling.

We should be celebrating that there are more than 156 million people employed in the country, the most ever (chart below).

The labor force participation rate, at 62.6%, is below the February 2020 level of 63.3%, and well off its peak of 67.3% in January 2000, but this is because our population has aged. With aging, the percentage of people in the labor force will decline. Adjusted for demographics, the participation rate is actually the highest it’s been in thirty years (chart below).

The Fed is looking for dragons to slay. A low unemployment rate is not a problem, just as the 1.7% average inflation rate of the 2010s was not a problem.

The Fed was not satisfied with rising unemployment in the 1970s and thought that higher inflation would bring the unemployment level lower. Instead, it got both higher inflation and higher unemployment. The Fed was not satisfied with 1.7% inflation in the 2010s, and tried to engineer higher inflation with zero interest rates that distorted investments. Now the Fed is not satisfied with low unemployment, fearing it pushes inflation higher, despite all the evidence to the contrary that inflation is caused by the supply/demand curves of money not by the unemployment rate. It seems our policymakers are relying on the unemployment rate to justify tight monetary policy when they should be focused on money supply. It’s just as Mick said:

When I’m driving in my car
When a man come on the radio
He’s telling me more and more
About some useless information
Supposed to fire my imagination

Useless information is firing policymakers’ imagination. Rising employment and labor participation are welcomed developments, and contracting money supply is leading inflation lower. Hoping for a rise in unemployment as a means of containing inflation only means that jobs will be lost, income and wealth destroyed, and the Fed’s next policy error will push inflation higher.
Mick Jagger was not singing about the Fed, but he could have been.

I can’t get no, I can’t get no
I can’t get no satisfaction, no satisfaction
No satisfaction, no satisfaction

Most of you know that I don’t favor romance novels for reading on the beach (or anywhere else, for that matter, although that’s not a judgment about people who like them!), and I apologize that this list is heavy on nonfiction, which is strictly a function of what I’ve been reading the past few months. But some of these books are as thrilling as any Tom Clancy or Dan Brown novel, and I hope you’ll enjoy them.

The Number Ones, Tom Breihan

Breihan edits the musical blog, Stereogum, and has looked at the thousands of songs that reached number one on the Billboard charts. There are some surprising omissions: Bill Haley’s Rock Around the Clock preceded the publication of the Billboard 100, so it was not included. Bob Dylan, Led Zeppelin and Bruce Springsteen never had a number one hit (Blowin’ in the Wind was taken to number one in 1963 by Peter, Paul and Mary and Mr. Tambourine Man to number one by The Byrds in 1965; Zeppelin’s Whole Lotta Love peaked at number four in 1969; Springsteen’s highest was Dancing in the Dark, at number two in 1984). Breihan has selected 20 number one hits that were not necessarily the "best" or highest selling, but were, in his opinion, the most important for changing the direction of popular music. Chubby Checker’s The Twist in 1960 started popular music’s dance craze, Vision of Love from 1990 began the juggernaut that was Mariah Carey, Buy U a Drank performed by Shawty Snappin’ in 2007 introduced composer T-Pain’s use of Auto-Tune software that revolutionized (or destroyed, depending on your view) popular music. This is a fun journey through popular music of the past 60 or so years.

Dead in the Water, Matthew Campbell & Kit Chellel

The oil tanker Brillante Virtuoso was attacked by pirates off the Yemeni coast in 2011. Or was it? This book is a superb piece of investigative journalism, a fast-paced thriller with unpredictable twists and turns. That alone makes this book so enjoyable. But the authors, journalists at Bloomberg, have written more than a thriller: they provide an education in both the centrality of maritime shipping in the global economy and the role the insurance market plays in this landscape (or seascape in this case). The many and varied personalities in this incident are brought to life, and the final outcome may surprise and dismay you. This is a brilliant piece of reporting and an engrossing read.

A Fever in the Heartland, Timothy Egan

We associate the Ku Klux Klan with the American South, but surprisingly, its largest membership was found in the Midwest, Indiana in particular. This was due to the organizational skills of a gifted scam artist, D. C. Stephenson. Egan traces the origins of the K.K.K., from the ashes of the Civil War, its eradication during Reconstruction, to its resurrection in the early 20^th century (stoked by D.W. Griffith’s Birth of a Nation). The perverse prejudices and atrocities committed by the Klan are well-documented here, but the truly astonishing fact is how widespread its appeal was. Political leaders at all levels of government were Klansmen, and the Klan controlled wide swaths of society. Stephenson is the book’s focal point, and his downfall, not at all a certainty, signaled the gradual demise of the Klan. This is a fascinating story in itself, told in fluid and riveting prose. But the truly profound impact is how pervasive such hatred was throughout society, and how that well of hatred never really ran dry, it is being tapped today. James Baldwin wrote that "history is not the past, it is the present." Nothing validates that more than this important book.

Wild New World, Dan Flores

The scope, diversity, the magnificence of the animals that inhabited North America are on full display in this broad history. Mammoths, tigers, horses, camels, rodents the size of dogs, all roamed the continent. This remarkable menagerie is full of wonder. But it is also a tale of the irreversible loss of species, from the colorful Carolina parakeet to the billions of passenger pigeons and many more. Sober and sad, but also spectacular in describing what was once.

Indigenous Continent, Pekka Hamalainen

At the end of the 15^th century, Europeans "discovered" a new world, a virgin land sparsely inhabited by a primitive indigenous people, destined to be swept aside by the superior technology and enlightened moral basis (at least, or especially, in the eyes of the Catholic Spaniards) of their European conquerors. Pekka Hamalainen, a Finnish professor at Oxford, is one of the leading historians of indigenous North America, and he shows us how this narrative is simplistic, incomplete and erroneous. He describes in detailed but fluid prose the highly developed civilizations that existed well before European contact, and the very successful methods that delayed, halted or reversed the European conquest of the continent, which took 400 years to complete. Nothing can diminish the tragedy that befell the indigenous people of America, but this is history that will change and enrich your view of that struggle.

The Blazing World, Jonathan Healy

If pressed, a few of us might be able to cite some notable events that took place in 17^th century England: perhaps we recall that the Pilgrims departed for Massachusetts, and maybe someone named Oliver Cromwell was briefly in charge of England. But Healy brings the events to life, provides the context, and makes a strong case for just how revolutionary an era it was that paved the way for both the American Revolution in the following century and the development of modern Great Britain. Healy writes with an energy and accessibility not usually associated with the Oxford don that he is. 17^th century England was a momentous period, largely ignored or misunderstood, and there is no better introduction to it than here.

An Immense World, Ed Yong

Every dog-owner knows that dogs experience the world through their noses, sniffing at odors that we cannot detect. Eagles are, well, eagle-eyed. We all learned that birds navigate by the Earth’s magnetic field and that bats utilize echolocation to catch moths (although we may not have learned that moths can sense that bat’s sonar signal and jam it by emitting false clicks). We probably did not know that a crocodile’s face is as sensitive to touch as our fingertips, or that there is a tree frog embryo that can detect a nearby predator and release an enzyme that dissolves its casing and allow escape. Part of the joy of this book is learning about the extraordinary (to us) sensory examples throughout nature. The bigger message is that the way each species experiences the world is equally valid and should be respected as we disrupt the abilities of some species to coexist with our own comforts. Let’s dim the artificial lights that disturb the path of sea turtle hatchlings or songbird navigation. And let’s give our dogs a few extra seconds to sniff the grass before pulling them away in our hurry.

Fiction

The Incredible Events in Women’s Cell 3, Kira Yarmysh

Anya is a student hoping to enter the diplomatic service when she attends an anti-corruption rally in Moscow and is thrown into jail. She shares a cell with five other women, all in for petty crimes. Conditions are pretty good, the guards respectful, so this is an unusual prison novel. Anya’s interactions with her cellmates, the bond that develops among them, and Anya’s unraveling mental state are all at the core of the novel. There are flashbacks and references to the political freedoms lacking in Putin’s Russia, appropriate for the author who is Alexey Navalny’s press secretary, but this is less a political novel than a personal journey that we are allowed to accompany.

Six fiction and seven nonfiction books to recommend. Happy reading!

Fiction

Lessons in Chemistry, Bonnie Garmus

Elizabeth Zott is a talented chemistry student, pursuing a graduate degree in 1961 when she runs into the pervasive sexism of the era that prevents her from advancing in her degree and relegates her to a job well beneath her intelligence. By chance, she is asked to host a daytime cooking show, which she insists on doing as a chemistry class, to the chagrin of her TV producers. This novel is a perceptive critique of the sexism of the 1950s and 60s, a reminder of how much talent goes to waste in a world of prejudice and discrimination. But this is also a hilarious romp as the often oblivious Elizabeth Zott becomes a true hero. You will love this book.

Didn’t Nobody Give a Shit What Happened to Carlotta, James Hannaham

Dustin Chambers goes into prison for twenty years for a robbery he unwittingly joined, and returns to his (her) Brooklyn neighborhood as Carlotta, a transwoman. Her friends and family don’t recognize her at first, and her son wants nothing to do with his dad who is now a woman. Snapshots of Carlotta’s previous life and her struggles to rejoin a world she hardly recognizes are poignant commentary on how we treat the marginalized in our society, and a Black, transgender woman with a felony is about as marginalized as it gets. But Carlotta is brave, determined and hilarious, as is this novel. Don’t let the title fool you: you will care deeply about Carlotta.

Palmares, Gayl Jones

Almeyda is born a slave in late 17^th century Brazil. She marries, her husband runs off to fight the Portuguese, and Almeyda escapes to a fugitive slave plantation called Palmares. From there, she travels across Brazil looking for her husband, guided by a mystic. The author shifts between languages, memories are recalled in fragments, mysterious characters appear and disappear. This is fantasy, this is poetry, this is genius.

Lessons, Ian McEwan

This is a thoughtful, even-paced novel that raises big philosophical questions through the life of very common man. Roland is sent to boarding school as a child, feeling abandoned by his parents. A piano teacher molests him and, seemingly, Roland enjoys this sexual relationship through his teenage years. Roland was not exactly complicit, he was only 14 at the time, but he was also a willing participant. Forty years later, the police approach him to help in building a case against the teacher, and Roland has to wrestle with helping them prove the sexual assault or facing his own feelings about the relationship. The second plot thread involves Roland’s German wife who disappears a few months after their son is born. Roland files a missing person report, but is content to let the police try to find her, or not. She eventually surfaces as a famous author, her ambition all along, and it raises the question of whether she would have been successful had she stayed with Roland and their son, or even if that should matter. Roland is an everyday man, with the usual disappointments in life and a passivity to all life’s events, but he is still sympathetic, and McEwan has crafted (another) beautiful novel that pulls on our emotions and challenges our beliefs.

Nightcrawling, Leila Mottley

Kiara is a 17-year old in East Oakland, trying to keep her life together under impossible circumstances. Her father died in jail, her mother is currently in jail, her older brother won’t get a job because he wants to be a rapper. Kiara takes in her neighbor’s nine-year boy when his mother abandons him, and Kiara desperately needs money, so she turns to prostitution. She becomes the favorite of some Oakland police, who pimp her out for their parties. The novel is inspired by a true story, but this is entirely an original work, remarkably, the debut novel by a 20-year author. Empathy is the key here, as we are both shocked by the constant struggles and sympathetic to Kiara’s determination to survive. If Leila Mottley can write like this at the age of 20, she has a very bright future.

Chilean Poet, Alejandro Zambra

Poetry is Chile’s national obsession, having produced two Nobel Laureates. Zambra uses poetry as the way to explain Chile’s collective character, not primarily as tragedy, although the references to the horrors of the Pinochet years are poignant, but more as comedy, as a group of young poets try to make their marks on the national conscience. This is told through the story of Gonzalo, an aspiring poet, his love for Carla, who prefers Argentine football players, and Carla’s son Vicente, who eventually also becomes an aspiring poet. Their relationships are really the heart of this beautiful story, wrapped in an obsession with poetry that gives this novel flair.

Nonfiction

If Nietzsche Were A Narwhal, Justin Gregg

What is intelligence? And what is its purpose? Gregg purposefully challenges our assumptions about the superiority of human intelligence. Most animals are satisfied with learned association, i.e., one action leads to another, but humans are uniquely obsessed with causal inference, why one action leads to another. This enables us to decode the genome, but it also often leads to ambition beyond our needs or understanding. By domesticating the natural world, for example, we are sowing the seeds of its (and our) destruction. How clever are we, really? Gregg gives the example of pigeons that were able to identify malignant tumors more accurately than radiologists. The pigeons clearly don’t understand X-rays or tumors, but their eyesight is so good that they can see things we can’t, in this case, "see" as in vision not "see" as in understanding, and does it matter if they are able to spot malignancies better than humans. With wit and wisdom, Gregg, an expert in dolphin communications, asks us to look at intelligence in a much broader way than we are used to. And you have to love the title.

The Rebel and the Kingdom, Bradley Hope

Adrian Hong is a Korean-American from Los Angeles who is moved by stories of the oppression in North Korea and dedicates his life to rescuing escapees. His remarkable story is told with frenetic pace. We are astonished by Adrian’s sacrifices, and outraged by the failure of the rest of the world, especially the US government, to do more to help these enslaved people. A true-life thriller.

Negroland, Margo Jefferson

This is Margo Jefferson’s memoir about growing up among the elite class of African-Americans in Chicago. She uses her personal stories as a window to the expectations and mores of this privileged class, but also beyond, to the broader society. For example, she distinguishes between privilege, which is what her family and circle of friends had and fought for, recognizing that ultimately this privilege could be withheld or withdrawn by the larger white society, and entitlement, which was an unalterable condition enjoy by whites. She captures the tension between how she was expected to behave, to achieve, a version of noblesse oblige, and the undeniable fragility of her, and her social group’s, standing in broader society. She ruminates on the great writers on race-Douglass, Du Bois, Baldwin and others-and her personal relationship with these writers. She asks. "How do you adapt your singular, willful self to so much history and myth?" A question for everyone of us.

The Story of Russia, Orlando Figes

Russia is a country that cannot be ignored, and Figes gives us an excellent primer on 1000 years of Russian history, both the facts and the myths. He puts Putin in historical context and, importantly, helps us understand how we should interact with a post-Putin Russia. This is a clear, but comprehensive history, and an excellent guide to understanding Russia.

Away From Chaos, Gilles Kepel

Kepel is perhaps the world’s leading scholar on Middle East history and politics. This book is a few years old, but it provides an excellent primer in understanding the dynamics of this complex region in fluid prose. An outstanding history of the region.

Berlin 1961, Frederick Kempe

Kempe makes the compelling case that the Berlin crisis of 1961 was the seminal moment in the Cold War, even more than the Cuban Missile Crisis, which he ties directly to the Berlin crisis the year before. Kempe provides exhaustive research on the day-by-day events that is as disturbing and thrilling as any action film. He raises the hypothetical of what Kennedy could have done, enticing us with the prospect that the history of Europe and the world might have developed very differently had the Americans pushed back against the Wall. A deeply-researched, riveting account of this critical historical moment in time and place.

The Song of the Cell, Siddhartha Mukherjee

"Every pathological disturbance, every therapeutic effect, finds its ultimate explanation only when it’s possible to designate the specific living cellular elements involved." In other words, the cell is at the center of every disease and medical breakthrough. Mukherjee gives us a history of the cell, and a history of its discovery, and shows us how our understanding of cellular biology has transformed therapeutics. If this sounds dry and academic, be assured it is not. Mukherjee is a leading cancer physician and researcher, but he is also a beautiful writer (and a Pulitzer Prize winner in 2011 for Empire of All Maladies-highly recommended). Mukherjee combines the excitement of the medical advances that are certain to come with the humility that there is much we don’t understand. There is no better guide to medical research than Mukherjee.

Bankers have always had a bad rap. Cicero, writing in De Officiis in 44 BCE, referenced Cato the Elder, the great Roman philosopher, who, when asked his opinion about lending with interest, replied, "What do you think of murder?" William Jennings Bryan, at the 1896 Democratic National Convention, railed against the bankers who would "crucify mankind upon a cross of gold." Robert Frost (with more irony than poetry) called a bank "a place where they lend you an umbrella in fair weather and ask for it back when it rains."

This is no apology, or defense, of bankers, but we should understand the central role banking plays in the economy. Banks take in deposits, and pay for them in the form of interest, and lend those deposits to people and businesses that want to borrow: to buy a house, to expand a business, and many other uses. Taking deposits from savers and recycling that capital to borrowers is the central purpose of banking. This function is fundamental to the economy, and it entails, inherently, by design, a mismatch between a bank’s assets (loans) and liabilities (deposits). There is simply no way around this basic design mismatch of recycling deposits to borrowers.

The Federal Deposit Insurance Corporation (FDIC) was created in 1933 to guarantee bank deposits in order to prevent a run on banks. Most individuals today hold less than $250,000 (the current maximum amount insured) in their bank accounts, and their deposits are guaranteed whole by the federal government. But most of the $17 trillion in bank deposits is in accounts greater than $250,000, primarily by businesses that must have free access to their cash.

Banks’ central purpose is to recycle capital from savers to borrowers, but banks also have a central function in the exchange of money. Trillions of dollars flow every day among millions (billions) of individuals and businesses that has nothing to do with borrowing and lending. These flows represent the exchange of goods and services throughout the economy, and this exchange mechanism is the function of banks, without which the economy would fail.

Millions of businesses, ranging from your local restaurant to Wal-Mart, representing the vast majority of the economy, have monthly expenses greater than $250,000, and could not function if they were required to limit their bank deposits to that amount. Those deposits are the lifeblood of the economy. To safeguard the economy, these deposits, all deposits, must be guaranteed safe. But to do so requires a different regulatory regime.

The Bank Term Funding Program (BTFP) established last week is a step in the right direction. Banks are able to obtain loans on the par amount of collateral posted, thus avoiding having to sell government securities at a mark-to-market loss in order to meet liquidity demands by depositors. The BTFP should be extended to cover all government securities held by all banks.

Regulators should also consider a deposit "gating" measure, similar to the provisions in most hedge funds. This would limit ("gate") the amount that can be withdrawn at the bank level. For example, withdrawals of more than 25% of the deposit base will not be permitted, with allowance for sums under $250,000 and in hardship cases. This would give regulators time to oversee a timely and orderly transition of the failing bank.

The simplest fix to the inherent mismatch in banking is to eliminate the banks. A Central Bank Digital Currency (CBDC) would stop bank runs since the central bank has an unlimited balance sheet. But we should proceed with caution. A CBDC disrupts the central banking function of recycling capital, a function not well-suited to government bureaucrats. Significant privacy concerns are also raised with a CBDC. But as a monetary exchange mechanism, a CBDC could be ideal, and that should be explored.

The bottom line is that banks serve two critical functions in the economy: as a recycler of capital from savers to borrowers, and as the mechanism for the exchange of goods and services. Bank deposits cannot be put at risk without catastrophic economic consequences. All bank deposits should be made whole.

There must also be tighter controls on how banks manage their balance sheets. Shareholders and bondholders must bear the cost of bank mismanagement, but not depositors.

Banking involves an inherent mismatch of assets and liabilities: that mismatch defines banking. But we can’t allow that mismatch to jeopardize the critical role banks play in the everyday flow of capital in our economy. All deposits must be guaranteed, through stricter rules on how banks can invest those deposits, or by establishing a CBDC.

I thought the sartorial choices of the two men at the top were hideously mismatched. What do I know? British GQ Magazine had them as two of their best-dressed men of 2019. But I can live with the sartorial mismatch, just as we are going to have live with the inherent mismatch in the function of banking. Whether we like it or not.

This is what comes to my mind as I watch the debacle that is FTX imploding.

Most legal documents and court filings are painful to read: verbose, obtuse, repetitive, numbingly boring.

An exception is the Chapter 11 petition that John J. Ray III filed yesterday in the United States Bankruptcy Court for the District of Delaware on his first day as CEO of FTX Trading Ltd, et. al. It is one of the most astonishing legal documents I’ve read in a long time: concise, direct, blunt, even humorous (you can find it here).

Mr. Ray reminds the court that he has over 40 years of experience working with some of the "largest corporate failures in history," most notably Enron. Now, you will remember that Enron was the biggest case of criminal malfeasance in history, $60 billion of assets that vanished in an accounting fraud that took down Arthur Andersen as well and sent senior executives of both firms to jail.

So, knowing that Mr. Ray unraveled the accounting fraud at Enron, here’s what he said of FTX:

"Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented."

Unprecedented? And he led the Enron investigation!

There is much about this story that we don’t know, and I won’t rehash the details of what we do know, which has been widely reported. It remains to be seen whether FTX was a case of criminal fraud or just plain gross incompetence. [Or both: they’re not mutually exclusive.] But that doesn’t interest me. Nor does it surprise me that fraud was (potentially) committed: fraud has been going on for thousands of years.

What does interest me, and surprise me (although it shouldn’t), is how smart, sophisticated fiduciaries could entrust the money they are hired to safeguard and protect to an unaccountable, unregulated (sorry, by the Bahamas) entity without conducting a shred of minimal fiduciary due diligence. Unlike Enron, accounting fraud was not required at FTX because no one asked to see the accounting statements. The closest document that existed as an accounting statement was produced the day after the bankruptcy in an Excel spreadsheet that is obviously fictitious. Mr. Ray notes, laconically, "The FTX Group did not keep appropriate books and records, or security controls….Unacceptable management practices included the use of an unsecured group email account as the root user to access confidential private keys and critically sensitive information…" He goes on to say that only a fraction of the assets alleged to be held have been found, and he is trying to locate additional assets by "reviewing various third-party sources," which means, calling people and asking if they have any FTX money?

This is almost funny. Funnier was the expense control at FTX. Mr. Ray writes that employees "submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis."

"Here’s my $40,000 dinner bill. Had a great time." Some disparate supervisor: 👌

"Hey, can I expense that Lamborghini I wanted?" Disparate supervisor: 👍

Ok, I made up those exchanges. More seriously, beyond the questionable fiduciary failure that resulted in the losses of billions of dollars, is why anyone was permitted to invest in cryptocurrencies in the first place. I’m not a lawyer, but crypto seems to fall under the definition of a security as defined by the Securities Exchange Act of 1934, meaning it must be registered with the SEC. None of these cryptocurrencies have been registered, so none should have been permitted to be sold to US investors.

Even if cryptocurrencies sought to be registered, the bigger question is why should they be sold to the public at all? What public good do they serve? Stocks and bonds are issued to enable companies to raise capital to invest in their businesses. Futures contracts allow investors to hedge risks. Cryptocurrencies serve what purpose? I have searched the websites of crypto exchanges and promoters and cannot find a coherent answer. Perhaps there is some allusion (illusion/delusion) to a day when private cryptocurrencies are used to transact business, but this is fiction.

Private cryptocurrencies are wrapped in the technospeak of blockchain, a technology that someday, maybe, could be utilized as a secure ledger. Let’s put that debate aside and ask, will private cryptocurrencies ever displace government fiat currency as a legal means of exchange? Ayn Rand followers may hope so, but I cannot imagine any government ceding control of its fiat currency to a private organization. I do think there is a role for central bank digital currencies (CBDC) in the future, but not for private cryptocurrencies.

There is talk, now that FTX has blown up, for regulators to step in and "protect" the public through government control and oversight of cryptocurrencies. My proposed remedy is two-fold. First, to declare cryptocurrencies to be securities under the Securities Exchange Act of 1934 and require them to be registered to be sold in the United States. Second, to find that they serve no public interest and decline to authorize their registration. Cryptocurrencies are part hype, part delusion, and part scam, and I cannot see an argument that they should be sold to the public.

Reading Mr. Ray’s declaration to the bankruptcy court is to be amazed at the incompetence, aghast at the absence of even the most basic of operating procedures, astonished that sophisticated people threw money into this delusional scam, and occasionally amused by Mr. Ray’s depictions of ineptitude.

But that amusement comes from the pain of losses suffered by the millions who are caught up in the crypto craze. The SEC can protect investors by ending this scam.

The title of this piece comes from Mark Twain. Here is the rest of his quote: "Everything human is pathetic. The secret source of Humor itself is not joy but sorrow."

It’s still beach reading weather in Southern California, but fireside reading seems more appropriate for mid-October. I have three non-fiction and five fiction books to recommend, each superb. Enjoy!

The Fifth Act, Elliott Ackerman

The history of America’s war in Afghanistan will be written for years to come, but an important first-hand account comes from Elliott Ackerman, a Marine officer, turned best-selling author, who served in Afghanistan. The Fifth Act is both a personal account of his experience, including heart-rendering depictions of bravery and friendship among both Americans and Afghans, as well as a clear-headed analysis of the strategic and tactical mistakes we made over twenty years. The Fifth Act is poignant, painful, gripping and tragic. We come away with admiration for those who served, and anger at those who ordered them there.

Watergate: A New History, Garrett Graff

Another Watergate book? Really? Yes, and it is superb. We all know most (but not all) of the details of one of the most extraordinary events in American history, and we all know how it ends. But Graff offers meticulous detail in a gripping drama. Each of the characters come to life in fresh perspective. The brazen bigotry and law-breaking did not start or end with Watergate, and belatedly, both the president and his party chose the honorable path, analogous, in contrast, to more recent events. For those of us who lived through Watergate, or for those who only read about it in American history class, this account of Watergate will thrill and inform.

The War That Made the Roman Empire, Barry Strauss

My knowledge of Antony and Cleopatra comes primarily from Shakespeare. The good news is that the Bard got a lot of facts right. Barry Strauss gives them depth of character and puts their relationship in context with both Julius Caesar and his grand-nephew, Octavian. The political intrigue of 1^st century BCE Rome is astounding, with allies and enemies shifting frequently. But it is this triangle of Antony, Cleopatra and Octavian, with Octavian’s sister, Octavia, often added to the mix, that is at the heart of events. Cleopatra comes across as perhaps the most extraordinary political woman in history. Had she and Antony prevailed, the center of the Western world would almost certainly have shifted to Alexandria, the Roman Empire would have turned east, not west, and history would certainly have taken a different path. Strauss puts all this together seamlessly, demonstrating how he is our finest historian of ancient Rome extant.

The Netanyahus, Joshua Cohen

The great Shakespearean scholar, Harold Bloom, recounted a story to Joshua Cohen of hosting Ben-Zion Netanyahu and his family when Bloom taught at Cornell. Ben-Zion Netanyahu was the father of the future Israeli prime minister and a scholar of the Spanish Inquisition. Cohen could only tease some details from Bloom before he died, so Cohen invented the rest. On one level, the book is hilarious, as the Netanyahus impose themselves on the Blooms (Blum in this telling), with three young boys (including Bibi) that ransack their home, a wife who bullies Blum’s wife, and Ben-Zion who has nothing but disdain for the simple minds of the college where he is seeking a job. He asks Blum, for example, of one professor they meet if he is a liar in a college of fools or a fool in a college of liars. It is a humor reminiscent of A Confederacy of Dunces, albeit through a very different character. On another level, though, through Ben-Zion’s lectures and Blum’s musings, the book asks profound questions of identity and belonging and suffering. It probes the values of American Jewry and its relationship with both Israel and America, but could apply equally to any minority group. A deserving winner of this year’s Pulitzer Prize, The Netanyahus is brilliantly funny, profound and provocative.

Crossroads, Jonathan Franzen

Some of Franzen’s novels are astonishingly brilliant (Corrections), others plodding (Purity). Crossroads is brilliant, highlighting why no one constructs a sentence like Franzen does on every page of this novel. Russ Hildebrandt is an associate pastor in a Chicago suburb in the early 1970s, struggling to remain faithful to his wife and to his religion in an era where social mores are challenged by a new generation. He is jealous of a young, hip junior pastor who runs the church youth group, cleaving a gap between Russ and his four children. The big questions Franzen raises are about free will and the impact of religion on family, but the true beauty of this book is the memorable characters, some center, some peripheral to the story, each with a complexity and empathy that haunts and attracts and will be long-remembered.

The Sweetness of Water, Nathan Harris

In the days after the end of the Civil War, two former slaves, brothers, wander onto the adjacent property in rural Georgia and are employed, and befriended, by the white landowner. This causes conflict with the whites of the town who may acknowledge their side lost the war but have not accepted that their way of life should change. Tensions build as the brothers and their employer navigate their free legal status, modestly enforced by the presence of a Union general nearby, with a society that is in turmoil. The plot is gripping, but it is the depiction of rural life in the immediate aftermath of war and the complex relationships among its inhabitants that makes this book so compelling. It is an extraordinary debut novel.

Mercury Pictures Presents, Anthony Marra

Artie Feldman runs Mercury Pictures, a B-studio in 1940s Los Angeles. Maria is his assistant who rises to president of the studio, although her gender relegates her to be, officially, Artie’s assistant. Maria has a back story of escaping Mussolini’s Italy, leaving behind her father, a prominent defense attorney imprisoned for defending socialists. Artie fights his brother for control of the studio, and fights the US Senate on charges that the studio is promoting US involvement in the war. The novel is partly about Fascist horror, partly about the immigrant experience, and mostly, I think, about the nature of reality. Artifice is everywhere: in Hollywood, obviously, but it is equally present in the hypocrisy of Washington politicians as well as in the propaganda from Mussolini’s Rome. Artie is a showman, par excellence, and the words Zevin gives him dazzle with wit and the downright hysterical. But behind the laughter is tragedy, which is what makes this book so remarkable.

Tomorrow, and Tomorrow, and Tomorrow, Gabrielle Zevin

This is a remarkable debut novel. Sadie and Sam meet in a children’s hospital in LA and strike a friendship over video games. They reunite in college where each is studying creating games and they decide to build a game together. Over the years they find success and failure, but this novel works on two levels. First, Zevin conveys the artistry of the coders and developers of video games in a way I have not seen before. She has me convinced that they are the artistic equal to the movies we so celebrate. Secondly, and more importantly, this is a beautiful, flawed, tragic love story that has us laugh and cry throughout.

John Harris owned a skating rink in Pittsburgh. In 1940, he invited Olympic star Sonja Henie to skate between periods of professional hockey games to entertain the crowd. It became a crowd favorite, and Harris, along with eight other businessmen who owned skating rinks, formed the Ice Capades that same year. It soon became one of the most popular entertainment concepts ever, drawing millions of fans over the subsequent decades.

One of those nine businessmen who formed the Ice Capades was Walter Brown, a former hockey player himself who would eventually be inducted into the Hockey Hall of Fame. Brown owned the Boston Garden, and was looking for events to fill his arena. The Ice Capades was a perfect fit. It was also why, in 1946, Brown started a professional basketball team, the Boston Celtics. In 1950, he hired a scrappy Brooklyn-born player as his coach, Arnold "Red" Auerbach.

There was no question the most coveted player in the 1956 draft was Bill Russell of the University of San Francisco, and Auerbach wanted him. But the Celtics forfeited their draft pick that year by exercising a "territorial" pick to select Tom Heinsohn of Holy Cross. Still, Red wanted Bill Russell. He arranged a trade with the St. Louis Hawks, sending Ed Macauley and Cliff Hagan in return for the second pick in the draft. Both Macauley and Hagen had Hall of Fame careers, so this was a substantial concession. Still, the second pick in the draft is not the first pick, and that was held by the Rochester Royals.

Rochester is a small-market city, and the Royals struggled to be profitable. The Royals already had a center, but more importantly, there was the threat of a bidding war for Russell with the Harlem Globetrotters, a war that Royals owner Lee Harrison did not think he could win. So Walter Brown called Harrison with a proposition: if the Royals would pass on selecting Bill Russell, Brown would send the Ice Capades to Rochester for a week. Harrison accepted, the Royals chose Duquesne star guard Si Green, and the Celtics got Bill Russell. (N.B.: the Celtics selected Russell’s San Francisco teammate, K.C. Jones, in the second round, thus getting three future Hall of Famers in one draft, a record that will never likely be duplicated).

Bill Russell was a winner without parallel. He barely played in high school in Oakland, and managed just one scholarship offer from nearby University of San Francisco, with a fledging basketball program. He led the Dons to consecutive national championships in 1955 and 1956. Between graduation and the Celtics, Russell led the USA to the gold medal at the Melbourne Olympics. In his 13 years with the Celtics, he won 11 championships, the most of any individual in any team sport. The last two of those championships was as player-coach.

He was the first Black head coach in any major sport, and much as he redefined how basketball was played with a defensive intimidation that has never been duplicated, his coaching redefined how the country saw Black men. He was a head coach at a time when many Americans could not fathom that a Black man had the intellect to be a coach, much less able to be a coach that won championships.

The fact that professional basketball is dominated by Black athletes with a majority of Black head coaches is because of Bill Russell. He was basketball’s first Black superstar, its first Black head coach, a mentor to most of the great players that followed, from Kareem Abdul-Jabbar to Magic Johnson to Kobe Bryant. His impact on basketball will never be matched, but in some respects, his success in basketball was the least of his accomplishments.

He personally endured the indignities of racism. He was turned away at hotels his Celtic teammates could stay at, his house in Reading, MA was vandalized. He was an outspoken critic of the racism he saw in Boston, and had the grace much later in his life to acknowledge that progress (although not enough) had been made in that city. He was invited to stand on the steps of the Lincoln Memorial with his close friend Dr. Martin Luther King, Jr. for his "I Have A Dream" speech in 1963. After Medgar Evans was murdered in Mississippi in 1964, Russell flew down there to organize integrated basketball clinics.

And then, on April 4, 1968, the day before the conference finals against Philadelphia and Wilt Chamberlain was to start, Martin Luther King, Jr. was assassinated. Bill Russell did not sleep that night, and the next day the Celtics met in a team meeting to decide whether they wanted to play the opening game. They voted to go ahead, and flew down to Philadelphia, but no one’s heart was in it. Russell wanted to be a part of the memorial service for Dr. King in Atlanta, and he, with Chamberlain, convinced the NBA to postpone the series to allow them to be in Atlanta.

The Celtics came back in that series from down 3 games to 1, the first team ever to do so, and went on to beat the Lakers in six games for another NBA championship. That, of course, pales in importance to the assassination of Martin Luther King, Jr., but goes to the heart of who Bill Russell was. Bill Russell knew that civil rights was the critical issue of his time, and he used all his power of intellect and example to press for justice. He was all the more powerful in doing so by continuing to win championships.

Bill Russell changed the game of basketball. His defensive presence altered opponents’ offenses, his blocked shots, his incredible 22.5 rebounds per game over a career. He never cared about personal statistics though; success was measured by the number of championships won, and to win championships required a team. Bill Russell made everyone around him better. There’s a lesson for all of us in that.

Bill Russell changed America. He used his influence to advance civil rights, often at a personal cost. Every Black superstar athlete, every Black head coach follows in his footsteps, and it is not too much of a stretch to say that by altering the perception of what African-Americans could accomplish, Bill Russell enabled future generations of Black leaders in every part of society.

There will never be anyone like him. Through his influence on his sport, his example of leadership, his passionate fight for civil justice, Bill Russell taught us all how to be better colleagues, better citizens, better people. With respect to all the great athletes before and since, there is only one G.O.A.T., and he passed from our world yesterday.

Bill Russell. Requiescat in Pace.

Goat image courtesy Michael Palmer

Photo courtesy Associated Press

It is definitely beach weather, and I have a dozen recommendations for you. Happy reading!

Fiction

Day for Night, Frederich Reiken

Mesmerizing characters woven in disparate plot threads makes this a very special novel from a decade ago. There is a New Jersey doctor, a Holocaust survivor, on a trip to Florida with her marine biologist boyfriend who is dying of cancer. Their guide for swimming with manatees is a musician, who accompanies his bandmate to visit her comatose brother in Utah who had been flown back from Israel where he had crashed his motorcycle. There is an Israeli accused of killing a Palestinian boy. All these people narrate the story, tying each piece together. This weaving of plot lines is brilliantly handled and each of the characters is drawn memorably. A beautiful book.

The War for Gloria, Atticus Lish

Corey is a teenager growing up in poverty in Boston. His absent father is, apparently, a brilliant physicist at MIT, except he works there as a security guard. His best friend is indeed a genius physicist who attends MIT. These are the main characters, but the beauty of the book is depicting the struggles that Corey endures. His mother, Gloria, develops A.L.S. They have no money, Corey drops out of school to care for her, finds a purpose in mixed-martial arts, quits, looks for a series of odd jobs, is befriended by the father of a girl he has a crush on. Each character is flawed, but we see the unfairness of Corey’s life as he battles an indifferent and hostile world. This is a heart-wrenching story, beautifully written.

Mercy Street, Jennifer Haigh

Jennifer Haigh takes on that most polarizing of topics, abortion, with wit, charm and empathy. Claudia grew up trailer-poor in rural Maine and works at a women’s health clinic in Boston which is subject to daily protests. Claudia’s life, from her childhood poverty to her meaningless relationships, is described simply but with empathy. Her marijuana dealer (it’s not legal yet) is also lost, mostly in a haze of smoke, but a desire to have a relationship with his son, living in Florida, brings him a modicum of clarity. There are two other characters we get to know on the anti-abortion side, one a well-meaning religious man and the other a violent misogynist. Claudia is the center of the novel, but abortion is the frame through which we see how each (and we) has become isolated from relationships with others. No one makes out well here, and that seems right.

Great Circle, Maggie Shipstead

This is the story of two women, a hundred years apart. The first, Marion, is sent with her brother to live with an uncle in Montana after their father, a ship’s captain, is jailed after his ship sinks. A barnstorming pilot visits their town, and Marion is hooked on flying. A wealthy cattleman pays for her lessons, at first without seeking anything from her. He is also a bootlegger, and Marion wants to repay him by flying liquor in from Canada. A romantic relationship develops, but Marion does not want children, only wants to fly, and the relationship turns ugly. In the present time, Hadley is an actress, type-cast as a hyper-sexed superhero. When she decides to stop dating her on-screen superhero partner, she is abused by the fans and blacklisted by the studios and turns to drugs. She is saved by a neighbor who is making a film about the life of Marion and casts Hadley in the role. The novel moves between these women and times, with their lives filled in with tenderness and tension. This is a big, sweeping, powerful novel.

Afterparties, Anthony Veasna So

This is a series of short stories centered around the lives of the Cambodian community in Stockton, CA. Bored adolescents, meddling families, the weight and guilt of having escaped the nightmare of the Khmer Rouge are played out in the doughnut and auto body shops where they have carved out a new life. So brilliantly captures the oppression and hopes and conflicts of second-generation immigrants. This was published posthumously as So tragically died of an overdose, a young, rare talent lost.

Nonfiction

The Last Baron, Tom Sancton

The Empain family was once the richest in France, builders of the Paris Métro and most of the country’s nuclear reactors. In 1978, the grandson of the founder of the family dynasty was kidnapped in Paris and held for ransom for more than sixty days. The author, a journalist, gives us a fast-paced reenactment of that event. The tension between kidnappers and the victim, and the tensions among the family, the police, the company’s directors, are described with a pace and energy that propels us forward.

Hitler’s American Gamble, Brendan Simms and Charlie Laderman

This is one of the best examples of how history should be written. The authors avoid the trap of hindsight, where events are explained by working back from the outcome, giving an inevitability to its sequence. Additionally, they are able to explore in depth a very narrow slice of history, the five days after the Japanese attack on Pearl Harbor, and contextualize it in the scope of a world war. Many have pointed to Hitler’s decision to declare war on the United States as a major, if not the major strategic blunder of the war. That may be true, but Hitler’s range of action was constrained, as this book shows, and his decision carried a certain, tragic, logic. History exemplified.

The Power Law, Sebastian Mallaby

How did a small area around Palo Alto give birth to so many of the largest and most consequential companies in history? It’s not the cluster of world-class universities, as Boston, New York, Los Angeles, Chicago, London and others are similarly blessed. Perhaps it was the culture of innovation that encouraged risk-taking, and that may be true too, although there was a lot of innovation that came out of Edison’s lab in New Jersey or from the halls of MIT and Harvard. The key ingredient, according to Mallaby, was the development of the venture capital industry, and he makes a strong case. Here we have a history of venture capital, with the famous and not so familiar names, and the impact they had on developing Silicon Valley into the most important center of technology in history. A fascinating, fast-paced work.

The Last Emperor of Mexico, Edward Shawcross

Cinco de mayo is a fun holiday in Los Angeles, but very few know why it is celebrated. The French emperor, Napoleon III, placed an Austrian archduke, Maximillian, on the throne of Mexico in 1864. I had always thought this was simply another act of European imperialism, and it was, but it was much more complicated too. Mexico was in turmoil, and a European monarch had support from an important constituency on Mexico. European politics played a role in his ascension, as did the American Civil War. Maximillian himself has always been portrayed as naïve, a fool even, but Shawcross elicits some sympathy for him as many of his objectives were very progressive. He lasted less than three years, a small slice of history that is usually passed over quickly in the history books, but a fascinating period in world history.

The Baseball 100, Joe Posnanski

This book is only for the baseball fan. But if that is you, this is pure enjoyment. In short chapters, Posnanski explains why each of the 100 players deserves to be on his list, providing context to the statistics. Of particular value is his addition of numerous Negro League players, some well-known, such as Josh Gibson and Cool Papa Bell, but others virtually unheard of, like Oscar Charleston, whom Posnanski argues might have been the greatest player of all time. This book is baseball bliss.

Ways and Means, Roger Lowenstein

Financing wars may be less exciting as fighting them, but it is arguably just as important. The Civil War was fought on such scale, millions of soldiers were involved, that financing such an effort would require a whole new model. Leading the effort for the Union was Salmon Chase, who had no financial experience despite being Treasury Secretary. It was here that a national currency was first introduced, and a new system of banks created, both to help finance the war. In contrast, the Confederacy relied on printing money, which was an inevitable failure. Lowenstein argues that the North’s financial success guaranteed its military victory. Perhaps that’s a stretch, but the superior financing of the war was an important contributor to its outcome. Lowenstein takes what for some may be a dry, technical subject and injects it with vigor and insight. An excellent work of history.

Eight Days in May, Volker Ullrich

Hitler’s suicide on 30 April 1945 did not end the war in Europe. It continued on for eight more days. Ullrich, a German journalist who has written extensively on Hitler, describes the chaos that descended on Germany in the days following Hitler’s death. His successors failed to impose order, but also refused to take responsibility for their actions. Ullrich captures that surreal and horrific moment, transporting the reader into the hell of those last eight days in May.

When cars crash in an auto race, the yellow flag comes out. This requires drivers to slow down and stay in their positions, allowing time for the crews to move the debris off the track so it can be safe to resume the race.

Drivers have little margin for error, with their cars separated by inches, (literally) less than a blink of an eye. A safe turn can become a multi-car crash in a split-second. The economy does not turn on split-second decisions, but is guided by policies that play out over months. Fiscal and monetary policy mistakes have brought out the yellow flag for investors, for good reasons.

Inflation is the principal cause of the markets’ unease, and fully the (ir)responsibility of the Federal Reserve. We have heard numerous excuses (umm, explanations) for the rise in inflation. The president’s economic team would have us believe it is due to supply disruptions emanating from the pandemic lockdown that will soon abate as the economy reopens. That has been proven false. Other economists cling to their output gap models that "measure" the gap between the unemployment rate and the NAIRU (Non-Accelerating Inflation Rate of Unemployment, I kid you not). NAIRU is not an observable number, so economists just guess at what it might be. Economists are usually well-educated, so their guesses could be called educated ones, but they are still guesses and, more importantly, they are wrong.

As we have explained in a webinar a few months back, inflation is caused by an imbalance of the supply of and the demand for money. Inflation does not arise from a backlog of ships in LA Harbor or from low unemployment. Inflation is caused by too much money sloshing around the economy relative to the demand to hold money.

You can see a more detailed discussion on the webinar link, but the Fed has allowed inflation to take root in the economy, and this is bad news for everyone. Workers have enjoyed robust nominal wage gains, but these have been more than eroded by higher inflation, as the chart shows. Nominal gains of 4.5% over the past year have been converted by inflation to a decline of 3.5% in real terms.

Investors are harmed by inflation that devalues future cash flows. Equities are down 16% this year, while high-quality bonds are off 10%. Investors have few places to hide from the scourge of inflation.

Inflation may come down from its torrid 8 ½% pace for technical reasons, but it will not be vanquished until monetary policy tightens significantly. Despite the tough rhetoric from Chairman Powell, the Fed has not accepted that its models are wrong or that a significant and immediate tightening is required. A full percentage-point hike would be a good start. In its absence, inflation will remain elevated, stealing from wage-earners and investors alike.

The Fed will be forced eventually to tighten more than they hope. This additional tightening raises the risk of recession, not in the immediate future, but soon. Right now, there is sufficient strength in the economy to avoid a contraction. Household and corporate balance sheets are healthy, profits are high and the demand for labor is as strong as it has ever been. There are 11 ½ million job openings, the most ever. So the economy has some strong tailwinds.

China and Russia represent near-term risks to the global economy. China continues to pursue its policy of zero-COVID, requiring the lockdowns of tens of millions of people and causing its economy to slow. For more than two decades, more than half the world’s economic growth came from China, and its economic problems impact the rest of the world materially. A prolonged, or more severe economic downturn in China could push the global economy into recession.

Russia’s disastrous war in Ukraine is impacting Europe’s economy especially by withholding supplies of key materials, primarily energy, agriculture and minerals. Even should the war devolve into a lower-level conflict, the supply of materials from Russia and that region will likely remain severely constrained for some time, thus hampering economic growth everywhere.

The drop in asset prices this year has been modest in historical terms. But until inflation is brought down by tighter monetary policy, investors will continue to face a very challenging environment. We have responded by raising cash in our portfolios, and by shortening duration in fixed income and in equities by favoring high-dividend stocks. We cannot escape the downturn in asset prices, but we can hope to lessen the pain.

Policy mistakes have brought out the yellow flag. The debris on the track will not be cleaned up until inflation is under control. Only then will it be safe to resume the race.

Until then, it is a time for caution. Stay in your lane. Drive safely.

The Lincoln Highway, Amor Towles

Emmett Watson is released from prison when his father dies to take care of his younger brother Billy. Greeting Emmett as he arrives home is the banker, there to foreclose on the farm. In cleaning out the house that night, the boys discover some postcards from their mother, who had left them shortly after Billy was born. The last postcard was from San Francisco, and the boys decide to drive there and find her. Their trip is interrupted when two friends from prison, Duchess and Woolly, appear and try to persuade Emmett to join them on their own adventure to New York, to claim a fortune that Woolly’s grandfather had hidden. On one level, this is just a fun adventure story, thoroughly enjoyable. It is also a wonderful character study, as the four boys are distinctively drawn: Emmett, the rational, practical good soul; Billy, the savant nine-year old; Woolly, a sweet, sad naïf whom his wealthy family has shunned; and Duchess, the avenging moralist at the heart of the story. With wit and wisdom from a cast of memorable characters, The Lincoln Highway is simply wonderful.

Hell of A Book, Jason Mott

Magical is the best description of this exceptional work, winner of last year’s National Book Award for fiction. The plot is clever: an author on a book tour, promoting his book, Hell of A Book, narrates his observations about society, life, love as he passes through each city. A parallel narrative is of a 10-year boy who is both real and imaginary: a real boy who was apparently shot and killed by the police and appears to visit with the author as he travels around the country. This may sound convoluted or disorienting, but it is woven together brilliantly. The author’s observations about race, anger, hopelessness, love, identity are profound. A truly magical work of art.

Kingdom of Characters, Jing Tsu

How can thousands, tens of thousands, of pictorial characters work with modern technology? China’s written script is not only vast, it is highly nuanced. The strokes of each character must occur in a specific order, and the intonation of identical characters can yield completely different meaning? Furthermore, there are dozens, even hundreds of dialects, with variations on pronunciation, intonation and even in the written form. Specifically, how did one dialect, Beijing Mandarin, become the universal language? How could Mandarin characters be used on a typewriter, and then translate to a keyboard, much less an iPhone? How could the dots and dashes of telegraphy incorporate Mandarin characters? Wouldn’t it have been better to adopt the Romanized alphabet? All these questions may seem esoteric or trivial, but the story of how the Chinese language was able to enter the modern world is addressed brilliantly by Jing Tsu, a Yale professor. She makes a persuasive case for language as the most important unifying aspect of a culture, and highlights the brilliant people who shepherded the Chinese language, and China, into the modern world. A fascinating and important history.

The Compleat Victory, Kevin Weddle

Most military histories of the American Revolutionary War focus, appropriately, on George Washington, as he was commander-in-chief of all Continental Armies. Armies, plural, because while the main American force was under Washington’s direct command, the Northern Army, under General Horacio Gates, fought a distinctly separate war. The British strategy in 1777 was for General William Howe to pursue Washington’s main army in the mid-Atlantic states while, simultaneously, General John Burgoyne attacked from Canada, splitting the New England rebels from the (assumed) more loyal colonies in the south. Weddle, a career Army officer and professor at the Army War College, describes in detail the series of battles that took place in and around Saratoga, NY in 1777 that resulted in, first, the devastating American loss of Fort Ticonderoga, and the remarkable turn of events over the subsequent few months that led to an American victory that sealed the fate of the war, even as it would be fought over the next few years. Weddle’s strengths are both in the tactical details of the campaign, the challenges, mistakes and brilliance of the generals and the field commanders on both sides (including the mercurial Benedict Arnold), and equally eloquent on the strategic picture that helped and hindered each side, as well as the critical importance of the American victory (primarily, by bringing France into the war). This will appeal mostly to those with an interest in military history, and as such, it is one of the best of the hundreds I have read.

The Aristocracy of Talent, Adrian Wooldridge

Plato argued for Athens to be governed by an enlightened aristocracy chosen by merit. Ancient China developed an extensive course of study and grueling exams to select the very best scholars to advise the emperor. Meritocracy appealed especially to the founders of the United States, eager to shed the advantages of birth and class so ingrained in Britain. Yet meritocracy has come under attack recently, from both the academic left and the populist right. The left argues that meritocracy cannot be objective when there are systemic biases in the system. The populist right decries the so-called expert class that has led the country astray, be it in war (Vietnam, Afghanistan) or public health. The author, an editor at The Economist, comes down firmly on the side of meritocracy, while acknowledging some of its criticisms. You don’t have to agree with his prescriptions (greater use of standardized tests, for example) to appreciate the balanced overview of this important sociopolitical topic.

It’s beach weather in LA this week, but in deference to the rest of the country, we’ll stay with Fireside Reading. Three amazing novels and one fast-paced nonfiction romp through the world of commodities. Enjoy!

The Promise, Damon Galgut

This is a saga of the Swart family over three decades of tumult, tragedy and transition in South Africa. The four chapters cover four funerals of family members, exploring the family drama that each death brings forth. On this level, The Promise is an elegant, moving character portrait of a family in (literal) decline. On this level, the novel resonates deeply, each character so perfectly developed and recognizable. But this is South Africa, and this family’s story takes place amid the backdrop of apartheid and renewal, truth and reconciliation and lingering bitterness. Galgut beautifully renders each aspect of transition, for the Swart family and for the nation. Galgut seamlessly moves from one character perspective to another, reminiscent of Faulkner. This is an extraordinary work.

The Death of Comrade President, Alain Mabanckou

Alain Mabanckou grew up in Congo (he now teaches at UCLA), and his books are often autobiographical, capturing life in the 1970s through the lens of boy. The narrator, Michel, is an observant 13-year-old, watching and listening to the absurdities of life and the adults that run it. The handful of characters is sharply drawn: his parents, schoolmates, and, especially, the woman who runs a small market shop. When a military coup kills the current president, as announced on the radio, Michel’s world is altered forever, although he won’t know it till the end of the book. The Death of Comrade President is as much a wonderful study of characters as a comment on the absurdity of politics and coups. Mabanckou is a distinguished writer, recipient of numerous awards, as he proves in The Death of Comrade President.

The Love Songs of W.E.B. D Bois, Honorée Fanonne Jeffers

This is an extraordinary book, an epic in every sense: an 800-page saga of a family and its land over the centuries. The chapters move among the various generations to inhabit a small piece of land in Georgia, beginning with the native Creeks, displaced by white settlers and, eventually, their slaves. Jeffers creates the most tangible characters, brilliantly capturing their language and cadence, thoughts and feelings, and their attachment to their land. Jeffers weaves in the philosophy of W.E.B. Du Bois, the "Double Consciousness" of African Americans through the ages, in dialogue and debate, shedding light on their unique history and struggles and resilience. Jeffers calls this a Black Feminist novel, and it is. But it is so much more. Jeffers writes like the poet she is, perfectly capturing the place and people of rural Georgia over five centuries. After 800 pages, I did not want to leave Chicasetta, the fictional town, or any of the people I felt like I came to know intimately. I run out of superlatives for this wonderful, beautiful work.

The World For Sale, Javier Blas and Jack Farchy

Fascinating recent history of the middlemen who source and trade commodities, with larger-than-life characters, including Marc Rich, the American fugitive who spawned some of the biggest trading houses today after his ouster from his eponymous firm. In the early days, post-WW2, these middlemen were the only ones willing to take business (and personal) risks in the Soviet Union, communist Europe and in the heart of Africa. The rise of China in 2001 led to a decade of profits by these traders that exceeded even the combined profits of Apple and Coca-Cola. The fine line between business and corruption was crossed frequently, but often these illegal trades served the purposes of the rich world, providing a lifeline to the Kurds or Libyan rebels, for example. Mostly, the story is one of the extraordinary personalities who built and dominated commodity trading for two generations, chronicling, in fast-paced prose, an era now past.

To fail or to suffice? It doesn’t quite have the cadence of Shakespeare, admittedly. It is not the existential question that grips (and eventually destroys) Hamlet. But it is a fundamental question that confronts many of us in our daily lives.

To fail or to succeed is not a choice; of course, we would choose to succeed. The practical challenge for many of us is, are we content to get by, to suffice, or should we pay a cost, even risk failure, in hopes of achieving greater goals.

The vast majority of people are content to get by. There is no judgment in that statement, merely an observation. Most people just do their jobs, fulfill their minimal obligations, without exerting more effort than is required.

For example, think about your last memorable shopping experience. Was there even one? You have encountered hundreds, thousands, of store clerks over the years, and how many really stand out? Most people will struggle to think of a single example.

Once a week I walk into my local Ralph’s, one of the 2,700 supermarkets in the Kroger chain, to stock up on basics. Every week I see Rick, stocking shelves or bagging groceries, and every time he greets me with a smile and "welcome, it’s so good to see you."

Now the cynic might say that’s just what everyone who works there is trained to do, and every time we hear those words we dismiss them as a platitude, a convention. When someone says, "how are you?", it’s not as a therapist or a medical doctor; he/she does not really want to know the state of your health. So we answer with, "fine" or "great." These are our social conventions.

Not so with Rick. He is genuinely happy to see you, to welcome you. You can see he is grateful to be doing his work, and is sincere when he asks if there is anything he can do for you. His positive attitude, genuinely held, is remarkable because it is so rare.

Like almost everyone in Los Angeles, Rick wanted to be an actor. He had a few appearances on TV and in movies, but when his mother took ill, he needed a steady job to take care of her. He worked as a receptionist at a real estate firm for many years, but was laid-off in the 2009 recession. His weight ballooned to more than 350 pounds, and he was really struggling. He took the only job he could find, the lowest entry position at Ralph’s.

Each year, Kroger selects an "associate of the year" from among their more than 400,000 employees. A few years ago, that was Rick. I can only say, it was a very good choice.

Year-end is a time for reflection, but more importantly, it is a time to reaffirm values and renew goals. In pondering the question, to fail or to suffice?, I hope the choice is, to fail. Because to fail means to have tried. Some goals are difficult to reach: to lose weight, to learn a musical instrument or a new language. But not even trying is not a choice; it is a sentence of stagnation and decay.

Our values are expressed in our actions. And our actions are determined by our goals. Whether those goals are difficult and costly, or relatively simple and easy, and whether we achieve them or fall short, we only fail we if we don’t make the effort.

Most of us will never be employee of the year, like Rick. But every time I see him, I’m reminded that a little effort can have a big impact. We can all make that effort to achieve greater goals.

From everyone at Angeles, may your holidays be healthy and healing, and the new year bring renewed commitment and high aspirations, for our families, our communities and our world.

Photo courtesy Aleksandar Pavlovic

I was expecting this to be a Fireside Reading post, but we are having a heat wave in Southern California that is sending me to the beach. So here are a few suggestions for your literary consideration, at the beach or in front of a fireplace.

The Story of a Brief Marriage, Anuk Arudpragasam

Dinesh lives in a refugee camp among thousands fleeing civil war in Sri Lanka. In subtle, yet piercing prose, the author captures the disruption caused by political violence at the most personal level. Survival is foremost, but Dinesh tries to bring meaning to his life through small acts of kindness and generosity amidst the devastation and despair. Arudpragasam captures the intimacy of a soul in day-by-day survival with prose that is poetic and elegiac. A deeply moving novel.

All the Frequent Troubles of Our Days, Rebecca Donner

Mildred Harnack grew up in Wisconsin, met a German student at the University of Wisconsin, married him and moved to Germany as the Nazis took over the country. She organized one of the largest underground resistance movements against the Nazis and was executed specifically under Hitler’s orders. The author is a great grand niece of Mildred Harnack, so this was a personal endeavor, but she has pieced together thousands of letters and diary entries to re-create an almost day-by-day account of this remarkable woman’s activities, thoughts, hopes and fears. We all know how the story ends, but Donner maintains a pace and tension that held my interest throughout.

Gambling with Armageddon, Martin Sherwin

I did not have high expectations for this book. Yes, Professor Sherwin is our most distinguished historian of the atomic bomb. A World Destroyed was published more than forty years ago and is still the standard on the bombing of Hiroshima. He won a Pulitzer with American Prometheus (highly recommended), the definitive biography of J. Robert Oppenheimer. Gambling with Armageddon takes on the Cuban Missile Crisis. There have been thousands of books, articles and movies on this subject, but Robert Kennedy’s Thirteen Days was one of the first and still is the most powerful interpretation of that event. Whatever your views of the Cuban Missile Crisis, it most likely came from that book (or movie, from 2000, starring Kevin Costner). Even though we all know the story and how it ends, Sherwin somehow manages to convey the tension and pace of the narrative that is riveting. The military makes a persuasive (and unanimous) argument for bombing the missile sights and invading Cuba. Blame for the crisis is laid squarely with Khrushchev, but he saw it as a calculated gamble, not intending to start a war. JFK worked to build consensus around a diplomatic solution even as we prepared for war. Had one not come, we were a day or two from attacking Cuba and, given that there were 42,000 Soviet troops there, likely beginning World War Three. Sherwin brings to light new evidence of two peripheral events that could have started a war but for the heroic interventions of a Soviet submarine captain and a U.S. Air Force officer, both of whom overrode instructions to launch nuclear missiles. Those instructions were unintentional, but they were both confirmed and standard operating procedures should have launched both those missiles. Gambling with Armageddon holds many lessons for us, most importantly the necessity to evaluate all options and the value in keeping as many open for as long as possible. Lastly, it conveys this decisive moment in history, and its lessons, in a gripping narrative.

The last commencement address I gave was in 1978. No one remembers what I said. I know this for three reasons:
1. I don’t remember what I said
2. No one remembers what any commencement speaker says
3. I haven’t been invited to give another address in 43 years.

My college hired a new basketball coach and he invited me to visit with the team to tell them about life after basketball. Being on a team in college is almost all-consuming, certainly a defining experience, and difficult to imagine a life afterwards. I couldn’t just recount my career path because no one would care or remember what I said. But in thinking about the topic, life after basketball, I realized that there really isn’t life after basketball. And that was my message to the team.

I told them to look around. One of these guys will be their best friend for the rest of their lives. It may be hard to appreciate how valuable that is now, but over the next 40, 50, 60 years, you will see that as one of the most important things in life. It’s not wealth or accolades. Your health, your family and your friends are really the only things that matter. George was my best friend on the team, and he is still among my best friends. He was stricken with ALS twenty years ago, so it’s difficult to communicate with him frequently, but he is in my life every day.

We all should have learned in kindergarten to be nice to each other, but we had an incident freshman year that brought this message home to me through a negative example. We were playing a Division 1 school (we were Division 3, the lowest level, and therefore should not have have been remotely competitive), ahead by one point with a minute to play, shooting the front end of a one-and-one (if you make the free throw you get another). We missed, they scored, we lost the game. We played our hearts out and nearly won, and as we shook hands with the other team, their coach said to our coach, "We should have won by 20 points, you’re lucky we let you stay in the game." Not, "congratulations, you played a great game," or "you played great, good luck with your season," or anything close to polite. That coach went on to win national championships and is in the Hall of Fame, but I’ve never forgotten or forgiven him for his rudeness. But he taught me a lesson about treating people with respect and dignity, especially when you’re the one on top. You’re not going to win every game, but you can be polite and respectful every time. He wasn’t, and that taught me the lesson.

A similar lesson on how to treat people came a few years later. I noticed that our coach yelled at some players, corrected some publicly, and spoke privately with others. I asked him why he didn’t approach everyone the same and he gave me his perspective. We carried 15 players and the starting five were content, because they were the starters. The bottom five were fine because they knew they weren’t as good as the starters and were happy just to be on the team. The middle five was where the challenge was…players who were not quite as good as the starting team, but perhaps thought they were. These were the ones requiring the most attention because a) they had the potential to contribute a lot to the team and b) they had the potential to be the most disruptive to the team’s cohesion. As I moved into a position of managing (I don’t dare say mentoring) people, thinking about the basketball team’s dynamics reminds me first to understand the perspective that each person has and to try to relate to them on that level. We all come with our own anxieties and aspirations and each is unique, and we need to meet them where they are.

The final story I told the team was a game in which we were ahead by 20 points or more with a few minutes left. The coach took out the starters to give others some playing time. Each one on the team was probably a star at his high school, and their lack of playing time in college was likely a let down. One player who went in the game still thought he was a star. He took a pass at half court, took a few dribbles and launched the ball from 25 feet. There was no 3-point line back then, so a 25-foot shot did not make sense. But we were up by a lot and he thought he was a star. Swish, nothing but net. He strutted back with a big smile and the coach leaned over to me and said, "the worst thing that can happen to a bad shooter is he makes his first shot." I had no idea what he was talking about, but coach often said things that didn’t make sense to me until much later. The next time down the court, same thing, he got the ball at half court, took a few dribbles, and this time launched the ball from 30 feet. A brick off the backboard. Next time down, same thing, another brick, not even close. Coach just gave me a look, like, see? We evaluate investment ideas every day, we look at thousands every year. Every one of the pitches we get shows good prior performance. Our job is to try to separate skill from luck, in other words, are we looking at a bad shooter who made his first shot, or a truly skilled shooter. Whenever I see a new investment pitch, I think about that game.

There is no life after basketball. The friendships and lessons learned never leave. There is nothing the team will, or should, remember about me. I just wanted them to know that amidst their day-to-day battles, lessons and friendships were being formed that will shape their lives.

They cannot be expected to comprehend the profound impact these moments will have on their lives, but I can. We are all shaped by the people we meet, even by the lout, rude coach who couldn’t congratulate us on a good game. I am grateful to all of my teammates, but especially to George Mazareas, who inspires me every day, and to Coach John White, who taught me more than any professor and remains a friend today. There really is no such thing as life after basketball, and I am grateful for that. I don’t need to give another commencement address.

A few more outstanding books for your summer reading…

Black Buck, Mateo Askaripour

This is an exceptional debut novel about a brilliant (Bronx Science valedictorian) Black man working at a Starbucks for unclear reasons: a lack of ambition, a desire to take care of his mother, fear of failure, who knows? He meets a customer who leads a start-up selling mental health services to large corporations and is invited to join the sales team. His journey changes him, for better and for worse: midway through I wanted him to return to Starbucks and his old self. The book is satirical, funny, a penetrating examination of race and character and morality. It is a cautionary tale, but really it is a message of hope and encouragement for anyone to pursue their dreams in the face of obstacles. A very unique, special book.

Wild Minds, Reid Mitenbuler

This is the colorful (sorry) history of American cartoon animation in its first half century. From Felix the Cat and Betty Boop, which dominated culture in the 1920s, to Mickey Mouse and Bugs Bunny in the 1930s and beyond. There is only passing mention of Theodor Geisel and Charles Schultz, but their influence really flourished in the 1960s and later, and this book essentially ends with the death of Walt Disney in 1966. The birth of this new technology, marrying cartoons with movies, was largely trial and error, and most early animators also had to invent the machines to process and project the artwork. Imagine hand-drawing 24 individual slides per second of film! Efficiency gains were realized when animators realized they could draw a background once and then draw each subsequent cell on a transparency overlay, saving a lot of time. Studios eventually adopted assembly-line processes by dividing the work among the highest skilled (who drew the most difficult poses), the intermediate artists (who drew most of the standard scenes), and the semi-skilled (who filled in the colors). I can’t claim a strong affinity for cartoons (or any stronger than most people), but the history of how this industry developed, the personalities of the artists and their characters, the seriousness of this art form, were all fascinating.

The Awkward Black Man: Stories, Walter Mosley

Walter Mosley has been one of my favorite authors for decades. He is the heir to Raymond Chandler: Easy Rawlins is as memorable as Philip Marlowe, his postwar Los Angeles as vivid as Robert Towne’s prewar Chinatown. Mosley has left Easy Rawlins behind in recent years, but has not lost his gift for character and scene. This book is a departure from his novels, a selection of short stories, mostly depicting the struggles of everyday life of ordinary people. Not a word is wasted or misplaced in these haunting, poignant stories.

A Swim in a Pond in the Rain, George Saunders

George Saunders gained prominence (and a Booker Prize) for his novel Lincoln in the Bardo. When not writing prize-winning novels, he teaches a master class in writing at Syracuse University, covering short stories by the great Russian authors of the 19^th century. This book is essentially that class. Saunders breaks down each short story in detail, describing how each one "works" and why these great writers are great. As importantly, Saunders explains why great literature matters, how it can shape our views of the world and enrich our lives.

The Nine Lives of Pakistan, Declan Walsh

Declan Walsh is a journalist who spent a decade in Pakistan. This is his memoir, observations about the leaders and people and history of Pakistan. There is no deep analysis here, just a chronology of his travels and meetings and thoughts on what he sees. Pakistan matters because of geography, bordering India, China, Afghanistan and Iran. Walsh begins with its creation, carved out of the British Raj. He makes a strong case for British culpability for the greatest refugee crisis in history. Initial hopes for a secular nation at peace with India faded in time, and it was the Islamification imposed by General Zia, in a long line of military dictators, that really polarized the country. Walsh’s description of a country unraveling could be told too many times in too many places, but it is also a universal warning how extreme political views can lead a country into a descent to chaos.

Beach weather is upon us in Southern California, so here are some book suggestions from my last few months of reading.

Love, by Roddy Doyle

Two old friends, Joe and Davy, reunite after many years apart. Pub-crawling through Dublin, they catch-up on their lives since they were in school together. There is no plot, just dialogue between two people. But truly exceptional dialogue from a master writer. The two men struggle to find the right words, but even when they do, words can have more than one meaning or the wrong meaning. Doyle is brilliant in crafting dialogue, at examining the meaning of words, and it seems that two friends getting drunk together is merely the pretext for a display of his linguistic talents. That would be sufficient to recommend this book. But it takes a sudden turn at the end, when they leave the last pub, to attend to what brought Davy back to Dublin after all these years away. In a few final pages, Doyle reveals the love underlying the entire story. Doyle’s masterly language and powerful message left me in awe and in tears.

Interior Chinatown, by Charles Yu

Funny, poignant, brilliantly constructed: there’s a reason Interior Chinatown won the National Book Award. The book describes a TV crime show shot in Chinatown where the characters play out their roles as dictated by the script, but also act out their own, real lives. The dialogue jumps frenetically between what is a TV script and real life, and that, perhaps is his point. We all, on some level, are playing our roles that have been written for us, but in the end, this doesn’t bring us happiness. Better to write our own scripts. "Interior" in the title refers to the physical location of the action, but also to the inner fears and hopes that we each have. The reference applies equally to communities as to individuals, as the collective works to fit in with the broader national group. The fictional TV series is called Black and White, and much of the action describes how the Chinese characters in this show (and in real life) are categorized (neither black nor white, neither fully accepted nor wholly rejected). Charles Yu is a very gifted writer, and Interior Chinatown is a masterpiece.

The Return, by Hisham Matar

Jaballa Matar was a senior military officer in Libya, stationed in London in 1969 when a captain named Muammar Qaddafi overthrew the corrupt monarchy that ran the country. He returned to Libya supportive of the coup and was subsequently named a diplomat in the United Nations delegation. Jaballa soon broke with the regime, becoming its most prominent opponent. He fled to Cairo, where he was abducted and sent to prison in Libya. The Return is his son’s account of his 20-year search for what happened to his father, whether he was alive or was killed, and if so, when and under what circumstances. Interspersed throughout are stories of his childhood in Libya, and those of his many relatives. Hisham Matar paints the Libyan landscape with his poetry and illustrates the many small gestures of his relatives that give us an understanding of their lives. But this book also plots his relentless search for the truth about his father. An extraordinary book.

Hades, Argentina by Daniel Loedel

The bleak history of Argentina of the 1970s and 1980s as seen through the eyes and reminiscences of one of its victims/perpetrators. This is a novel, but the descriptions of terror and places of terror are real. Tomás, living in New York, returns to Buenos Aires and encounters the ghost of girlfriend, killed by the junta. She had asked him to be embedded in a notorious torture cell as the medical doctor to feed her information about the dictatorship. He did, but of course worked closely with the torturers as well. Thus was Tomás both victim and abettor of the dictatorship. The prose is sparse, fitting for the descriptions of terror, and Tomás’ unreconcilable position as a first-hand observer of torture and an informant to the revolutionaries haunts both him and the reader.

The Last Kings of Shanghai, by Jonathan Kaufman

The history of China cannot be told without its businessmen, and Jonathan Kaufman, a Pulitzer-Prize winning journalist, illustrates the century or so of two dominant families in Shanghai. The Sassoons came first, in the mid-19^th century, fleeing Baghdad for Mumbai, where the opium trade with China helped them establish another fortune, before moving the family to Shanghai permanently. They brought other Baghdadi Jews into their business, including the Kadoories, who became their biggest rivals. Kaufman portrays all the color of pre-Communist Shanghai and the important roles these two families in making Shanghai one of the great cities of the world. While mostly bitter rivals, the families worked together to fund the resettlement of 18,000 refugees from the Nazis. All their property and businesses were confiscated with the Communist takeover in 1949. The Sassoons departed China for good, but the Kadoories moved to Hong Kong to begin again, rebuilding their business empire while cultivating political ties to the mainland Communist Party. An entertaining and informative perspective of China’s development through two remarkable families.

The Secret Life of Groceries, by Benjamin Lorr

You may not think much about how food arrives at our grocery stores, but it is one of the world’s logistical marvels. Lorr highlights many of the aspects of this global supply chain through the stories of a handful of people. All are small cogs in this enormous canvas, although one is well-known: Joe Coulombe, founder of Trader Joe’s, who comes across as a hero (I had the great pleasure to know Joe and his remarkable wife, Alice, and can attest to their wit and intelligence). Lorr shows how Trader Joe’s success was as the anti-grocery store. There are wonderful portraits too of a woman who is long-distance trucker, an entrepreneur trying to launch a new product (Slawsa: cole slaw and salsa mix), and a Thai fisherman held in effective slavery. All along this enormous food chain are ethical dilemmas and odds stacked high against the average worker. The book is highly entertaining, enlightening without being preachy, and conveys the deep appreciation we should have for the countless people who toil to bring us our food.

Jesse Livermore was a legendary stock trader of the early 20^th century. Mere rumors of his involvement in a stock could send its share price soaring.

Back then, Livermore organized stock "pools," in which his friends, the titans of industry and finance, would trade with each other, pushing the price of a stock up. This would attract other speculators, driving the price even higher, until the insiders dumped their shares at an enormous profit, wiping out those who came in late to the game.

In 1934, the Securities Exchange Act banned this practice of "pump and dump." Section 9 of the Act makes unlawful "for any person, directly or indirectly," the "raising or depressing the price of [a] security, for the purpose of inducing the purchase or sale of such security by others."

Last week saw an "uptick" in trading in selective stocks. Blackberry (yes, it’s still around), normally trades about 10 million shares per week. It saw 1.3 billion of its shares traded last week. AMC Entertainment, the largest movie theater chain in the country, which trades around 20 million shares per week, saw more than 3 billion of its shares traded last week. The volume would have been more had trading not been temporarily halted.

The poster child for all this is GameStop, today’s equivalent of Blockbuster, whose stock has soared from $4 to $470 (see Chart). Last summer, whether out of genuine investment analysis or nostalgia for "the good ol’ days," presumably defined as when we all walked around with Blackberries, when theaters were the only place to see a movie and we had to go to a physical store to buy a physical game, someone posted an opinion that GameStop was undervalued and should be bought.

What began as one person’s investment opinion, one among literally millions, took on a life of its own when others learned that GameStop was a heavily shorted stock by hedge funds. The forum, most prominently WallStreetBets on Reddit, became an organizing center to encourage readers to buy GameStop stock, not so much because it was deemed undervalued, but because (evil-goes without saying) "hedge funds" were short GameStop, and a "squeeze" on those shorts would inflict losses on these funds. A read of the comments on WallStreetBets (known as a "subreddit’) shows the vast majority profess a desire to disrupt "Wall Street" rather than to engage in a reasoned, profitable trade. That description is a bit generous: much of the commentary is filled with hateful expletives about "the system" and targets for harassment certain finance people specifically.

No one will feel sorry for fund managers who make obscene amounts of money, which may be the only thing both Ted Cruz and Alexandria Ocasio-Cortez agree on. And the "Redditers" applying this short squeeze have a legitimate complaint about "the system." Following the mortgage collapse in 2008, the banks were bailed out while millions lost their homes and their jobs. Monetary policy has helped to inflate financial assets, benefitting the wealthy while incomes stagnate for nearly everyone else (we’ve written about this frequently, most recently here https://www.angelesinvestments.com/insights/investment-insights/4th-quarter-2020-na-triobloidi and here https://www.angelesinvestments.com/insights/investment-insights/2nd-quarter-2020-dreams-deferred.

So where does this leave us and how will it all end?

I see these events raising considerations in three broad areas. The first is among professional investors and their risk controls (or lack thereof). GameStop was one of the most heavily shorted stocks, with 260% of its float shorted. Its stock price had fallen from over $45 to under $3 in the previous five years. Why were managers still short this stock? Were they hoping to squeeze the last drops of profits in a stock that was massively short and had already lost more than 90% of its value? And what was the sell discipline when the stock started rising? Why weren’t the shorts covered at $5 (September) or $10 (October) or $20 (December) instead of $300 (January)? Holding these shorts under these conditions can only be attributed to greed, and failing to implement a sell discipline can only be characterized as incompetence. No one is weeping for these so-called professionals.

The second consideration is in the area of regulation. There is an argument that the actions of the "Redditers" violate Section 9 of the Securities Exchange Act of 1934. That is a legal technicality. The real question is whether the public is served by restricting this behavior. There is the platitude of protecting the "integrity of the market," but that seems to me to be a vague and naïve argument. My understanding of the intent behind the Securities Exchange Act, and subsequent securities laws and regulations, was to protect the unsophisticated public from unscrupulous financial professionals, not the other way around. So I do not favor additional regulation to protect financial professionals from the public, or the public from themselves.

Lastly, and most importantly, is the social dimension of this phenomenon. There is an element at play here of hateful populism, personal harassment directed at specific individuals and a driving vengeance to tear down "the system" that is seen as inherently corrupt and unfair. One can reasonably disagree with this characterization, and cite the confluence of social media and free stock trading as contributing to the rising power and anger of a "mob." But one cannot deny the extremes in wealth and income inequality that fuels much of this anger.

The power of social media to organize large groups of people is a fact. We have seen that power used to instigate violence and subvert our democracy. And to squeeze the shorts of some hedge funds. But that same power can effect positive change for racial justice, economic equality and climate change.

How will this short squeeze end? Badly; most people will lose most of their money. That is how it always ends. Jesse Livermore, whom some consider the greatest stock trader in history, died penniless.

Since my last update a few months ago (https://www.angelesinvestments.com/institutional-insights/still-beach-reading), I’ve moved from the beach to the fireplace, and am happy to share my reading highlights.

Before the Storm, The Invisible Bridge, Nixonland, Reaganland, Rick Perlstein

A decade ago, Rick Perlstein embarked on a political history of the United States through the lens of the conservative movement. Before the Storm chronicled the rise of Barry Goldwater, Nixonland took story to Watergate, The Invisible Bridge to the edge of Reagan’s triumph in 1980, and finally Reaganland. Each book is superb, and while the principal focus is on the conservative movement, that movement is often best defined by its liberal counterpart. Politics reflect society, and these books are as much social commentaries as political histories. Thoroughly researched, balanced and accessible, this series makes a foundational contribution to modern political history.

Lost Children Archive, Valeria Luiselli

This is a truly exceptional work. The plot is not central here: a family of four drives from New York to Arizona. The characters have no names: Ma, Pa, boy, girl. The parents are sound documentarians, who met on a project to record the sounds of New York City, and the husband decides his next project will be to record the sounds of Apacheria, the land of the Apaches, the last native people, led by Geronimo, to surrender to the whites. The wife wants to document the immigrant children along the border as they are processed and deported. None of this really matters. In truly beautiful prose, the author weaves multiple narratives: the mother’s ruminations on her eroding marriage, her relationship with her children, and the plight of the immigrant children arriving at the border; the boy’s recordings of the car trip and adventures for the benefit of his younger sister who is too young to remember the details; the father’s stories of the Apaches; and finally, excerpts from a fictional book about migrant children. Interspersed are references to William Golding, T.S. Eliot, Ezra Pound, Virginia Woolf, Cormac McCarthy and David Bowie. This is a complex, erudite novel, but also a brilliant and beautiful one.

The Sea, John Banville

The book moves between the present, where his wife is dying, and reminisces of the past, a summer spent along the coast when he was a boy. It is a beautiful meditation on grief and memory, written with extraordinary beauty by one of the great Irish writers of our time.

Deacon King Kong, James McBride

This book is brilliant on so many levels. Mostly, it is a portrait of a community, a housing project in Brooklyn in 1969, filled with a colorful cast of Runyonesque characters. The everyday challenges faced by this community, as individuals and collectively, evoke the 1950s South-Central L.A. of Walter Mosley. Good people slip-up, but they are still good people. The plot centers on an old alcoholic nicknamed Sportcoat, his dead wife, Hettie, with whom he argues every day, the intrusion of heroin into the neighborhood, and a lost treasure hidden for an Irish mobster by an Italian one. It is a mystery novel and a crime novel, a traditional Western novel and a Shakespearean comedy all-in-one. But mostly it is a hilarious and heart-wrenching work of art about the profound difficulties a community faces on a daily basis, where some do not make it through, but most exhibit uncommon courage and resilience. This is a phenomenal novel from one of our greatest writers.

There are twenty amino acids in the human body. Amino acids are the chemical links that make up proteins. Proteins perform all sorts of essential tasks. Hemoglobin, for example, is the protein molecule in red blood cells that carries oxygen from the lungs to the body’s tissues and returns carbon dioxide from the tissues back to the lungs. Keratin is the type of protein that makes up your hair, skin, and nails. The spike (S) protein plays a key role in the receptor recognition and cell membrane fusion process in SARS-CoV-2.

There are approximately 30 trillion cells in the human body. Each cell contains between one billion and three billion proteins. How can a mere 20 amino acids make billions of proteins?

The answer is how each protein folds on itself to form its final shape. We can see this through X-ray crystallography, which sends electromagnetic radiation to interact with molecular crystals that reveal each atom of a molecule. This is great, but X-ray crystallography is time-consuming and very expensive.

The great molecular biologist, Cyrus Levinthal, estimated that there are 10³⁰⁰ possible configurations of a typical protein. Brute calculation of each variation is impossible: it would take longer than the age of the universe (almost 14 billion years) to identify each combination. Another approach is required if we hope to know the structure of proteins.

Every two years since 1994, scientists have gathered for a competition to see who could create an algorithm that could accurately predict the shape of proteins using only a list of its amino acids. The competition is called the Critical Assessment of Protein Structure Prediction, and the answer is no one. Participants are given 43 proteins to model, and the best programs were able to get two or three right. Until 2018, when DeepMind’s AlphaFold program successfully predicted 25 of the 43 proteins (the second-place program got three right). The competition was held again last month, and DeepMind’s newer version, AlphaFold2, achieved an astonishing accuracy of 92.4%.

A folded protein can be thought of as a "spatial graph", and DeepMind (based in the UK and owned by Alphabet) built a neural network that uses evolutionarily related sequences, multiple sequence alignment (MSA), and a representation of amino acid residue pairs to refine and interpret this graph while reasoning over the implicit graph that it’s building. By iterating this process over a few days, AlphaFold developed strong predictions of the underlying physical structure of the protein and was able to calculate which parts of each predicted protein structure are reliable using an internal confidence measure.

AN OVERVIEW OF THE MAIN NEURAL NETWORK MODEL ARCHITECTURE. THE MODEL OPERATES OVER EVOLUTIONARILY RELATED PROTEIN SEQUENCES AS WELL AS AMINO ACID RESIDUE PAIRS, ITERATIVELY PASSING INFORMATION BETWEEN BOTH REPRESENTATIONS TO GENERATE A STRUCTURE.

This is an extraordinary accomplishment: from a list of the 20 amino acids that comprise a protein, AlphaFold was able to predict the shape of that protein, out of 10³⁰⁰ possibilities, to an accuracy of 92.4%. Earlier this year, AlphaFold predicted several protein structures of the SARS-CoV-2 virus, including ORF3a and another coronavirus protein, ORF8, whose structures were previously unknown. Experimentalists have confirmed the existence of both these structures.

The implications of this achievement cannot be overstated. A misshapen protein is thought to be the cause of Alzheimer’s and many other diseases. If we could only identify the shape of that protein, we could have a chance to correct it. For the first time, with AlphaFold, we now have that chance. We will be better able to determine which drugs are likely to bind to a particular protein and to effectively design proteins to catalyze chemical reactions.

In 2003, the Human Genome Project (and Celera Genomics) successfully mapped the entire human genome. Since then, the Universal Protein database has collected 180 million protein sequences, but only 170,000 have had their structures determined because of the time and expense required to do so. AlphaFold represents an exponential leap forward in being able to determine protein structures, and thus is a huge step toward the effective treatment of diseases.

As investors, we obsess over the vicissitudes of our political discourse (such as it is) as if it were a sporting contest. We scrutinize each economic release and infer the hidden meanings of a central banker’s pronouncements. Most of what fills our working days is noise, and we are easily distracted from the achievements that will profoundly determine our future. AlphaFold’s success is one such achievement.

This is not the first time we have heard from DeepMind. Three years ago I wrote about AlphaGo, DeepMind’s game program that defeated world champion Lee Sedol in Go (https://www.angelesinvestments.com/insights/investment-insights/3rd-quarter-2017-ghost-moves). I noted that there are 10¹⁷⁰ legal arrangements of the stones on a Go board, more than there are atoms in the universe. Like the placement of Go pieces, the number of protein shapes are too massive to crunch through every combination. And as with AlphaGo, AlphaFold found a shortcut. DeepMind took its champion gaming skills and applied them to unlocking the mysteries of biochemistry. It’s not just a game; it is how our civilization advances.

Last month, the Federal Reserve unveiled its new monetary framework, following an intensive 18-month review. The principal change was to abandon a target inflation rate (2%) in favor of an average inflation rate (still 2%). Most observers take this as the Fed communicating that it will not begin to tighten monetary policy even if inflation rises above 2%, but will rather tolerate a higher inflation rate for some time to compensate for the (long) period of inflation below 2%. In practical terms, the Fed expects interest rates to remain at the current very low levels for the foreseeable future (at least until 2023, and probably beyond).

Big deal, you say. Well, maybe so, but inflation and interest rates are pretty important variables in virtually every aspect of the economy. My own 18-day, non-intensive review of this new framework affords the opportunity to share some thoughts on inflation, interest rates and Fed policy.

First, with respect to this policy shift, there is little immediate impact. The Fed has pegged the overnight lending (Fed funds) rate at 0-0.25%, and that doesn’t change. Investors expected policy to remain unchanged for the foreseeable future, and that expectation remains. So, in immediate, practical terms, this is no big deal. But, there is a "but."

The new framework introduces another level of uncertainty for investors. The Fed will tolerate (even target) an inflation rate in excess of 2% for some time in order that inflation average 2% for some time. But what is some time? The US inflation rate (as measured by the core personal consumption expenditures (PCE), the Fed’s preferred reference), has averaged 1.6% p.a. for the past decade, 1.9% for the past 30 years, 3.2% over the past 60 years (see graph below). What time period will the Fed use to evaluate the average inflation rate? And will it change policy once average inflation finally reaches 2%, or would it prefer to see a period of higher inflation?

Federal Reserve staff tried to clarify the new policy with an obtuse, formula-laden paper (Arias, Jonas, Martin Bodenstein, Hess Chung, Thorsten Drautzburg, and Andrea Raffo (August 2020), " Alternative strategies: How do they work? How might they help?" Federal Reserve Board Finance and Economics Discussion Series 2020-068) that looks impressive but answers nothing (the key formula is below; it’s not that complicated, but good luck figuring out how it translates to actual monetary policy).

So, while there may be no immediate practical change in monetary policy, should inflation rise above 2%, investors will not be able to know what to expect from the Fed. Should inflation fail to reach 2%, this framework offers no method of addressing that shortfall.

The Fed is signaling that even if the unemployment rate falls to record lows, investors should not expect a tightening of monetary policy. The Fed is saying it will "tolerate" very low unemployment in exchange for rising inflation. For decades, economists, the media and the general public have had a mental model (a formal one in the case of economists, but no truer) that there is an inverse relationship between unemployment and inflation, the so-called Phillips Curve: rising unemployment translates to lower inflation, and higher inflation comes with declining unemployment.

The Phillips Curve was wrong when it was promulgated in 1958. William Phillips, a New Zealand economist at the London School of Economics, wrote a paper on unemployment and wage rates in the UK between 1861 and 1957 that suggested this empirical inverse relationship. A decade later, Milton Friedman and Edmund Phelps refuted the study. Friedman correctly characterized inflation as purely a monetary phenomenon: too much money chasing too few goods. The Phillips Curve has persisted as a working model of the economy because, in the very short-run, a sharp rise in unemployment can lead to an immediate decrease in demand for goods, and thus an oversupply, causing prices to fall. As unemployment falls, spending increases, so goes the theory, as do prices.

The fallacy in the Phillips Curve is that it ignores the great virtue of capitalism, that is, that it is dynamic, and thus able to adjust to changes in demand. If people want to buy more Chevrolets, General Motors will gladly produce more Chevys. If GM raises the price of Chevys, consumers will buy another model, or take the bus. Supply adjusts to demand, with no longer-term impact on the general price level. That can only be affected by too much money circulating in the economy relative to its demand.

The graph below charts the unemployment rate and the core inflation rate in the US since 1960. There is no correlation between these two series. Actually, its correlation is positive 0.26; not even negative 0.26. This notion that low unemployment signals rising inflation, and vice versa, is simply untrue, yet somehow persists in the general public and in economists’ models. Even in the Fed’s new framework, the Phillips Curve is assumed to exist; the Fed is just not going to be as sensitive to it as in the past. I suppose that’s some progress.

Unemployment Rate and Core Inflation, United States, 1960-2020

So why did the Fed change its monetary framework? My guess is that the Fed is concerned about its policy levers in the next recession. Historically, interest rates were slashed about 5 percentage points in a recession, providing much-needed monetary stimulus to counter the economic contraction. A higher inflation rate would allow the Fed to raise interest rates in order to give them some needed ammunition in the next downturn.

This argument is illogical and ill-considered. The Fed wants higher inflation so that they may justify raising interest rates so that they may then cut interest rates in the next recession. Perhaps that makes sense to someone, but the logic escapes me.

There is a more fundamental problem with this framework: why is 2% the magic inflation number? Inflation is a tax on the purchasing power of money. In other words, inflation erodes the value of money over time. At an inflation rate of 2%, money loses half its value in 36 years. At a 1% inflation rate, the value of money falls by half in 71 years. At an inflation rate of 0%, money retains fully its value. Inflation in the US (again, core PCE) has averaged 1.6% over the past decade, 1.9% over the past 30 years. There is no inflation problem in the US, and certainly not that it’s too low.

Even if higher inflation were desirable, why does the Fed think it can conjure this rise when other central banks have failed for decades? Core inflation in the Euro area has averaged a little over 1% p.a. for the past 20 years, whereas inflation has been zero in Japan for 30 years (see graph below).

Core Consumer Prices in Japan (1961-2020) and the Euro Area (1997-2020)

Source: OECD

Japan’s experience is instructive, yet has received very little serious consideration by American media or policymakers. Yes, its demographics are ahead of and worse than America’s, although our severe restrictions on immigration mean we are catching up faster to the prospect of a shrinking population. Still, the Bank of Japan (the BOJ, its central bank) has been buying every asset it can find, including a fair chunk of the equity market as well as the majority of every bond the Ministry of Finance pumps out in eye-popping amounts. The result: zero inflation. Inflation is a monetary phenomenon, full stop. Central bank ballooning of balance sheets and purchases of every available financial asset does not cause inflation, as the BOJ has demonstrated. I am perplexed why central bankers think otherwise.

The Fed hasn’t come close to the magnitude of intervention the BOJ has engaged in, but it thinks that it will be able to create higher inflation, how, exactly? The US economy is not running at any supply constraints. Capacity utilization is 71%, but it never exceeded 80% in the past decade. The massive amount of debt we incurred to counter the short-term impact of closing the economy this year will retard growth over the next few decades. Most importantly for inflation is that it cannot rise when money velocity is plunging (see graph below). The Fed, the BOJ, the ECB have all added trillions of dollars (yen and euros) to the ledgers of banks, available to lend to businesses to invest and to households to spend, but businesses and households are doing neither.

Velocity of M2 Money Stock, Quarterly, 1959-2020

Business investment is low and consumer spending is weak because uncertainty is high. When uncertainty is high, the demand for cash is high. Corporate balance sheets are bursting with cash, households have de-levered, and investors are selling stocks and holding cash and bonds. This expresses pessimism and anxiety.

There are powerful deflationary forces in the world: some are structural, some the residual of deflated asset bubbles, and some an expression of risk aversion. In the face of these forces, massive expansion of bank reserves and central banks propping up every asset class has not engendered higher inflation, and will not because that is not what causes inflation to rise. Even more to the point, higher inflation is not desirable. We are left with a policy goal (higher inflation) that is misguided and an approach (asset purchases) that is ineffective. It’s like the old joke about the restaurant who’s food is bad but at least the portions are large.

Policymakers should focus on establishing a consistent framework and supportive environment that encourages business formation and innovation. Inflation expectations should be firmly anchored at zero.

One is the loneliest number (we are told), and two can be as sad as one (it is, after all, the loneliest number since the number one). But zero is best of all. A dynamic, innovative, growing economy with inflation at zero (not one, or two, or higher for some time) should be the goal.

It’s still beach weather here in Southern California, so I have a few more suggestions for beach reading.

Begin Again by Eddie S. Glaude, Jr.

When I was in school, James Baldwin was unapproachable: his writing was nuanced and complex and personal. It was disturbing and incomprehensible to me. With the passage of a few decades, however, I have begun not only to appreciate Baldwin’s brilliance, but also to marvel at his relevance today. Eddie Glaude, a professor of history at Princeton, also avoided Baldwin, until graduate school, and he has been studying him for the past 30 years. This book is mostly a synopsis of Baldwin’s thinking, and how it evolved before, during, and after the civil rights movement. Glaude directly ties Baldwin’s words to today’s racial turmoil and challenges. Baldwin began in the 1950s trying to persuade the white majority to embrace black equality for their own sake and salvation. The assassination of Martin Luther King, Jr. was an inflection point for Baldwin, and his later writing expressed more disillusionment. But Baldwin’s consistent message, through hope and despair, was that the fight for racial justice was never about laws and speeches, but about morality and love. I found some of Glaude’s opinions to be reductionist, for example, he characterizes Reagan’s victory over Carter in 1980 as white America’s repudiation of Black equality, whereas I saw it more as a repudiation of Carter’s incompetence. But Glaude shows us that Baldwin has never been more relevant and important than right now.

Death in Mud Lick by Eric Eyre

Eric Eyre won a Pulitzer for his reporting on the opioid epidemic in West Virginia, and this book is his full story. He presents the truly shocking statistics of abuse that befell these rural communities, and the criminal pursuit of profits and power engaged by drug manufacturers and (especially) distributors and their political allies. Along the way, Eyre describes the financial disaster that threatens his newspaper from forces beyond anyone’s control. His reporting almost single-handedly uncovered the causes of our opioid crisis, and reminds us of how invaluable an independent, local newspaper is to every community in America.

The Whiskey Rebellion by William Hogeland

The Whiskey Rebellion of 1791 was one of the (many) events glossed over in history books. If remembered at all, it’s probably that there were a group of bootleggers in the West who didn’t want to pay federal taxes on their moonshine, so George Washington led an army to put them in their place. But a closer examination reveals both the bigger picture of the rebellion and its particular complexities. For example, the excise tax was the brainchild of Treasury Secretary Alexander Hamilton, the key to his plan to assume the war debt of the states. Behind this was Robert Morris, the financier of the Revolution, who had bought up the heavily discounted bonds of the states and looked to be paid back at par (the Paul Singer of his day). Westerners could not transport their grain to the East as the bulk and poor roads made it unprofitable to do so. But converting grain into liquor made transportation economically viable, and also served as a currency in a wide region where coinage was scarce. Westerners saw this tax as targeting them, specifically, benefiting Eastern speculators at their expense. From this perspective, the Whiskey Rebellion takes on a much more important light in the early history of this country, and Hogeland does it justice.

Underworld, Don DeLillo

This massive (800 pages) novel was written more than 20 years ago, and I’m only now getting to it. It is an extraordinary on every level. It begins in the Polo Grounds, 1951, with Bobby Thomson’s famous home run, and then loosely follows that ball from out of the ballpark through various hands over the subsequent five decades. DeLillo captures the underside of America, from the Bronx to the Arizona desert, with both dignity and despair. The plot is secondary to the characters, their mundane and desperate and hopeful lives, with language that is colorful, profane and brilliant, not occasionally, but on every page. "She glided through the hotel lobby in high heels, like a B-movie actress awash in alimony and gin." "They sat on the stoop drinking Old Mr. Boston, a rye whiskey unknown to the Cabots and Lodges." There are hundreds more. It’s never too late to discover a masterpiece.

The Big Goodbye, Sam Wasson

"Chinatown" is one of the great movies ever made, and this book is a deep dive into its making through the perspective of four of its principals: actor Jack Nicholson, director Roman Polanski, screenwriter Robert Towne and producer Robert Evans. Each complex personality is well presented, but the great pleasure of this book is how each one perfected his craft, and how they collaborated (fought) to bring forth this film. It is also a look at how movies were made, with a particular focus on the many talented people behind the camera. Polanski emerges as the hero of this story, the driving force behind a convoluted script, a meddling producer and temperamental actors (some things never change). Ironically, and sadly for its creators, Chinatown was released the same year as The Godfather Part II, which (rightfully) swept the awards, save one, for best original screenplay. Wasson positions Chinatown at the moment of inflection of an industry pivoting from seeing itself as an art form to a purely commercial enterprise.

Answer: Markets reflect the dynamism and adaptability of private companies, not geopolitical events or socioeconomic upheaval.

Many find this conclusion surprising, non-intuitive, but on our recent webinar (for those who missed it, or just want to watch it again, it can be found here: https://www.angelesinvestments.com/insights/videos/2020-webinar-how-can-markets-be-at-all-time-highs-when-the-world-is-collapsing), I presented historical data that I think supports this conclusion. Here, I offer a more succinct narrative.

Markets are a mystery to most people, perhaps more so today than ever before. Our economy contracted 9.5% last quarter, the largest decline since 1946. This was the fourth sharpest drop since the founding of our country. Thirty million people are receiving unemployment benefits, and five million have been infected with the COVID-19 virus. Normalization of the economy appears a long way off.

The state of political affairs is, if anything, worse than our economic morass. We are deeply polarized politically, unable to agree even on the facts, much less be able to have a constructive dialogue with our fellow citizens. Working-class families have seen their incomes stagnate for decades while a new class of elites garnered unfathomable wealth. Minority groups decry the ever-present repression of racism, demanding redress. We are fearful, anxious, worried. Three-quarters of Americans think the country is on the wrong track.

Amidst all the financial hardships, social turmoil and vicious political polarization, the stock market is near an all-time high! How can that be? Many assume that the market must be manic, driven by crazy or bored (those are not mutually exclusive) Robinhood-millennials soon to get their comeuppance. Hence the strongly bearish sentiment among most investors reflected in surveys (such as AAII) or the high cash balances held at banks.

Bearishness has been characteristic of this market since its bottom in March 2009. Not coincidentally, the market is up 400% in that time. Investor bearishness, or certainly skepticism about future prospects given all the troubles we see around us, misses a fundamental understanding of what the stock market is and what it reflects.

There is overwhelming historical evidence that the market quickly absorbs and adjusts to major geopolitical events. The bombing of Pearl Harbor was one of the most significant acts of the 20^th century. The US stock market fell 20% in its aftermath, but was back above its pre-attack high within the year. Many see close parallels today with 1968, a year that began with the Tet offensive in Vietnam, saw two major political assassinations in Martin Luther King, Jr. and Robert F. Kennedy, and riots across the globe, from the occupation of Columbia University to the Democratic Convention in Chicago to the Mexico City Olympics. The market was up 7.7% that year.

Another year of political turmoil and social unrest was 1975. Puerto Rican terrorists (the FALN) began the year by bombing historic Fraunces Tavern in New York, killing four and injuring 53 people. A few days later, the Weather Underground set off bombs in Washington, D.C. and in Oakland, CA. The FALN was back in April with four bombs detonated simultaneously across Manhattan. In September, President Ford survived two separate assassination attempts, and at the end of the year, a bomb at LaGuardia Airport killed 11 people and injured 75. Croatian nationalists were suspected, but never caught. The market rose 37% that year.

So how to explain this disconnect between political, social, and economic upheavals and the stock market? If the market does not reflect the chaos and turmoil in our world, what does it reflect?

Part of the answer is technical: the market is not the economy. The five largest companies (Apple, Microsoft, Amazon, Facebook and Alphabet) make up more than 20% of the market capitalization, but employ only around 1.3 million people (mostly at Amazon), which is less than 1% of the total employment in the US.

The more important explanation is that markets reflect the dynamism and adaptability of the private sector to changing conditions, good or bad.

"Survival of the fittest" was not Charles Darwin’s phrase; it was Herbert Spencer’s summary after reading On the Origin of Species. A more accurate summary of Darwin’s work, although not as pithy, might be "survival of the most adaptable." It is not the biggest, strongest species that survive, but the most adaptable to a changing environment (think of the dinosaurs that disappeared while horseshoe crabs, for example, survived). The same applies to companies, which is why we call large, lumbering companies "dinosaurs," about to become extinct for failing to adapt to new technologies or threats to their businesses.

Companies fight for their survival every day, just as most species do, and those that successfully adapt to the changing political, social and economic environments will endure. Those that fail to adapt will die (go bankrupt or get bought by a nimbler company). This is what the market reflects: the adaptability of companies in the face of new challenges. This is what lies at the heart, and defines the success, of capitalism.

There is no question we face enormous challenges in our society. We may navigate these obstacles with skill, or we may manage them poorly. Some companies will adapt and thrive, others will stagnate and die. That is capitalism, and that is what the market reflects.

One of the upsides to confinement over the past few months is that I’ve been able to raise my reading capacity. Here are my exceptional encounters. This is mostly "serious beach" reading, if you’ll excuse the oxymoron.

Caste: The Origins of Our Discontents, Isabel Wilkerson

Caste is, I think, destined to be one of the most important books of our time. Wilkerson, who won a Pulitzer for her first book, The Warmth of Other Suns (I also highly recommend), asserts that American racism is the superficial manifestation of an underlying caste system in which people are slotted into a rigid social hierarchy predetermined by some marker. In India, that marker is birth: one is simply borne into a caste that cannot be changed, thus relegated to the limitations society imposes on that caste. In America, that marker is melatonin, skin color. Most of us can see the idiocy of a predetermined social hierarchy when looking at India, but cannot see the parallel with skin color in our country. By drawing that connection, and supporting it with logic and data, Wilkerson helps us understand that American racism reflects underlying social beliefs that oppresses classes of people. As with the Dalits in India, so it is with African-Americans here. India and America both enacted laws that proscribe discrimination, but laws cannot overturn centuries of deeply embedded social structures. Wilkerson writes with grace and prose, sharing her personal experiences to illuminate her points. Caste is thoroughly researched, compellingly argued, beautifully written and, deeply disturbing.

The Hardhat Riot, David Paul Kuhn

The late-1960s and early-1970s saw hundreds of protests across the country, many that were violent, against the Vietnam War. Perhaps the peak (or nadir) of these protests occurred at Kent State, in Ohio, where National Guardsmen shot and killed four students. A few days later, New York City was engulfed in protest marches, first uptown at the funeral of one of the slain Kent State students who was from New York, and then downtown, near City Hall, and across from where the World Trade Center was under construction. Hundreds of workers on that site, most of whom were veterans themselves, spontaneously walked off the job and attacked the antiwar protestors while the police stood by. This is a fast-paced account of that moment, pieced together by interviews and media reports at the time. But the book is about much more than this single event. It delves into how our country was split by opposite world views, galvanized by the Vietnam War but running much deeper. It draws a clear and direct link from that clash 50 years ago to the subsequent evolution of the two main political parties to our present political polarization. The riot itself is told in graphic detail, thrilling in its way, but the deeper exploration of its causes, and the wider implications of its aftermath, show how relevant history is to us today.

Black Wave, Kim Ghattas

It is impossible to write a single, authoritative history of anything, much less an entire region of the world, much less a region as complex as the Middle East, but Ghattas sets a strong foundation for understanding the recent history politics of that region. She focuses on the year 1979, which most of us remember as the year of the Iranian Revolution, when forces aligned with Ayatollah Khomeini overthrew the Shah. That same year, another transformative event took place when militants captured the Grand Mosque in Mecca, directly challenging the legitimacy of the House of Saud. These two simultaneous events sparked a rivalry, driven not by theology (Sunni-Shi’a), as most Westerners assume, but by political power. This conflict set off by these two events in 1979 has defined the region ever since. Ghattas captures the fervor of all sides of this seminal year, details its lasting consequences, thereby enriching our understanding of the history and complexities of this part of the world.

Boom: Mad Money, Mega Dealers, and the Rise of Contemporary Art, Michael Shnayerson

An interest in contemporary art is helpful, but this book is about the business of art rather than the art itself. Famous artists and their works-from Pollack and Warhol to Basquiat and Koons and many more-come in and out of the story, but the focus is on the dealers, especially the most prominent ones, whose names will be familiar to everyone with even a passing interest in contemporary art. Their role in supporting and promoting artists is well described here, providing a good overview of where and how the money (tens of billions of dollars annually) flows. I was struck, however, with two observations about the art business. The first is that, of all the players in this game, the artists get the short end of the stick. Dealers, and collectors, get the vast majority of the riches, while most artists get the (relative) crumbs (Jeff Koons and Damien Hirst perhaps the exceptions). The second thought is that I wonder if we’ve seen the end of this business model as Internet technology displaces these old conventions. Boom is a good place to start for the history and description of the business of art.

Until the End of Time, Brian Greene

There are hundreds of books on cosmology/astrophysics. I think I’ve read half of them. Brian Greene, professor at Columbia, never disappoints. Half of this book covers the "usual" topics of energy, gravity, universe expansion, etc. Greene then connects the rules of physics with biology, which I found illuminating, thus giving us new insights into evolution. He is hopeful that physics can one day even explain consciousness, and many readers will be so persuaded. The heart of the book is Greene’s personal reflections on time, specifically, eternity, a concept we reach for, but can never quite touch. Ultimately this is philosophy, not physics, but in the hands of a master like Greene, there is little distinction between the two.

The Vanishing Half, Brit Bennett

Bennett creates a fictional town in Louisiana, founded by light-skinned African-Americans, who collectively choose to propagate into ever lighter-skinned generations. Two sisters break ranks and leave the town, each going her own, very different, way. This clever construction is a way to examine racial identity, but also the issues of intergenerational relations and the conflict between individual freedom and community responsibility. I found some of the relationships not quite fully formed, but the book is beautifully written and provocative.

Source: NASA

Weak economic growth and low investment returns are the prospects we discussed in the first two parts of this series (https://www.angelesinvestments.com/institutional-insights/sunrise-or-sunset-thoughts-on-a-post-pandemic-world-part-1; https://www.angelesinvestments.com/institutional-insights/sunrise-or-sunset-thoughts-on-a-post-pandemic-world-part-2). As important as the economic effects of this crisis will be, of much greater consequence will be the impact on our political system and in our societal structure. We are witnessing some of those consequences currently.

On one level, this global pandemic has been an insignificant health crisis. There have been approximately 400,000 deaths worldwide, fewer than in a typical flu season. Admittedly, the toll is still climbing, but it is unlikely to reach the more than a million who die each year from tuberculosis or traffic accidents, and much less than the ten million killed by cancer, or the nearly twenty million from cardiovascular disease (see chart below).

Even in economic terms, while the drop in output this quarter (expected to be off 40% on an annualized basis) and the rise in unemployment (to over 20%) are unprecedented, a sharp rebound is projected by the end of the year and into next. The US equity market has risen 36% off its March low in anticipation of a recovery. So, yes, the economic damage has been substantial, but likely transitory (although we outlined in Part 1 why we expect to see a sluggish pace of growth for years to come).

And yet. As I noted at the beginning of this series, something about this pandemic feels different-more significant, more fundamental-than past crises. It has accelerated shifts already underway, most clearly in our social and economic dependence on technology, exposed fractures in our society (more on this in a moment), and triggered behavioral shifts that may persist for a generation or more.

This behavioral change will manifest more clearly in certain parts of the economy. For example, in leisure and hospitality, travel and tourism, activity has fallen 90% or more. Humans enjoy socializing, we enjoy traveling, but we are now much more aware of the associated health risks, especially for those who may be more vulnerable. This awareness will make consumers more hesitant.

Public safety measures will be imposed, probably permanently. Health certifications may be required to enter buildings or public transit, as we see in some Asian cities now. Those with elevated risk may be denied entry or even prohibited from free movement in the name of protecting public health. Constitutional liberties will have to contend with public health priorities. Privacy concerns will be raised about access to personal health data. These are contentious issues, and how we resolve them will determine the kind of society we wish to have.

I commented in the introduction to this series that the pandemic has exposed profound vulnerabilities in our society. We can see these as economic issues, but their impact is as much (or more) political, for it is an expression of the nature of our society. Let me highlight two such areas of glaring inequity: health care and inequality.

Our health care system is an abomination. Not only do 28 million Americans have no health insurance, we spend far more on health care than anywhere on earth. This might be acceptable if our health outcomes were the best, but sadly, that is not the case. The United States spends more than $3 trillion annually on health care, two-to-three times more per capita than in other advanced economies. Life expectancy, one measure of health outcomes, is, however, well below that of Western Europe and Japan. We pay much more and get much less (see chart below).

These facts were true before the pandemic, but it took the concrete examples of abject failure-the unconscionable lack of testing kits, protective equipment, basic drugs, and the consequential needless deaths-to reveal the failure of the system. This is not a condemnation of the many heroic health care workers who have risked their lives to protect the public, but of an entire economic and political structure that failed on many levels to protect the health and safety of its citizens. This is the most fundamental (some might say only) requirement of government, and it fell miserably short.

This is not an advocacy for a single payer system, such as in the United Kingdom or in Cuba. Some countries have mandatory insurance requirements, such as most of Western Europe and Japan, others have a national health insurance program, such as Canada and South Korea. My own non-expertise, and space in this letter, do not permit a full debate on the optimal structure of our health care system. But surely we can agree that an insurance scheme tied to employment through massive tax breaks, a structure that leaves tens of millions uninsured yet still required to be provided for in an emergency, a system that costs far more than any in the world with outcomes that trail most other countries, needs fundamental change.

The averages, as abysmal as they are, mask important failures, namely that there is a widening gap in health outcomes for the wealthy and for the poor. Life expectancy has fallen for the bottom income quartile as it has risen for the top income quartile. This is indicative of a larger growing wealth and income gap, a gap that is as indefensible on moral grounds as it is untenable in economic and political terms.

Since 1980, real GDP per capita in the United States rose 79%, but for the bottom 50% of the population, after-tax income has risen just 20%. For the next 40%, income was up only 50%. For the top 0.01%, however, income rose 420% in this period. According to research by Raj Chetty and his colleagues, those born in 1940 had a 92% chance of earning more than their parents, but it is a coin-flip (50%) for those born in 1980 (Chetty, Raj, David Grusky, Maximilian Hell, Nathaniel Hendren, Robert Manduca and Jimmy Narang, "The Fading American Dream: Trends in Absolute Income Mobility Since 1940," March 2017). The richest 0.1% of Americans own 19.6% of the nation’s wealth, up from 7.4% in 1980. The top one-tenth of 1% own the equivalent of the combined net worth of the bottom 85%.

The pandemic has exacerbated these trends. In April, one-in-five workers were either laid-off or on furlough, but for those earning less than $40,000 per year, 40%, twice as many as the national average, were without a job. Many of those are jobs that will be slow to return, if ever.

Wealth and income inequality have been rising for many years, not only in the United States but in most advanced economies. But the pandemic has accelerated this chasm, and we all must acknowledge that the trend is unacceptable on moral grounds and unsustainable in political terms. The pandemic has brought greater urgency to addressing inequality.

There is one additional threat that this pandemic has brought into greater clarity (literally and figuratively) and that requires our urgent attention: the environment. There are important similarities between the pandemic and the looming climate catastrophe (which is already here), and both challenges require a similar approach.

A recent McKinsey study (Pinner, Dickon, Matt Rogers and Hamid Samandari, Addressing Climate Change in a Post-Pandemic World, April 2020) drew a number of parallels between pandemics and climate change. Both are systemic, with worldwide effects. Both are non-stationary, with past probabilities unlikely to be a sufficient guide to make future projections. Both are nonlinear, with impacts that expand catastrophically beyond certain thresholds. And both are regressive, hurting the poor disproportionately.

We witnessed an extraordinary experiment by shuttering much of the global economy these past few months: material declines in carbon emissions. In April, daily carbon emissions fell, on average, 17% below levels from the year before (see graph below). As desirable as this is, we know we cannot cut emissions by closing the world economy permanently.

Global Daily CO₂ Emissions

An important difference between pandemics and climate risk is the time scale. Pandemics represent immediate dangers whereas climate change poses a cumulative threat. We accepted harsh restrictions on our activity because we saw the pandemic threat as immediate (as it was/is). But so far, we have not been willing to accept any sacrifice to avert environmental catastrophe because it is on a different time scale. This is massively myopic, and recalls Hemingway’s dialogue in The Sun Also Rises: "How do you go bankrupt? Two ways. Gradually, then suddenly." That is our fate if we continue to heat the planet.

The most important trait shared by pandemics and environmental risk is that they both represent the "tragedy of the commons," a concept first articulated by Oxford economist William Forster Lloyd in 1833. He observed that each shepherd personally benefited from adding more cattle to graze on public land, which then caused the pasture to be overgrazed, thereby providing less food for everyone’s cattle. Lloyd identified that the gain of having more cattle would accrue to the individual, whereas the loss to the commons would be shared by all. Individual gain was incentivized at the expense of the common good, and this was the "tragedy."

Global pandemics and environmental dangers also represent a tragedy of the commons. Behavior that may be profitable for an individual, traveling while asymptomatic or polluting, for example, incur costs, potentially catastrophic, that are borne by all. Historically, the tragedy of the commons has been addressed by imposing rules (limits) on everyone. Overfishing, which brought the once-limitless supplies of cod in the Grand Banks, for example, to near-extinction, led to international fishing restrictions that are permitting the natural re-stocking of the species.

Viruses and CO₂ do not respect political boundaries. Global pandemics and environmental crises cannot be combated by individual countries, but only through global coordination and cooperation.

Perhaps that is the greatest tragedy of this pandemic. We (China and the US, in particular) have chosen to obfuscate, deny and attack (both their domestic critics and each other) for illusory political advantage rather than to share resources and best practices which would have contained this disaster. As we failed to coordinate to combat the pandemic, and we have missed an opportunity to cooperate on the environment. We could have imposed a carbon tax with oil prices low to invest in renewables, but we did not. Our political leaders chose to provide fiscal support to oil and gas companies, but not to renewable energy. We are jeopardizing life gradually, and then it will be suddenly.

The COVID-19 virus will be contained. Others will inevitably arise. Global warming is a threat that has been given a very short reprieve as we closed the world economy, but it is back in force as a global danger as we resume our activity.

Our most urgent challenges require collective action, across communities and throughout the globe. A failed health care system, an abhorrent disparity in wealth, future pandemics and environmental disasters all demand our attention and resources. But mostly, they require our will.

In Part 1 (https://www.angelesinvestments.com/institutional-insights/sunrise-or-sunset-thoughts-on-a-post-pandemic-world-part-1), we outlined an economic backdrop of weak growth, high levels of government debt, cautious consumers, higher taxes and rising trade barriers. This is an unpropitious investment environment.

At a minimum, we can be confident that rates of return will be lower for a prolonged period of time. A study published by the Federal Reserve Bank of San Francisco (Jordà, Òscar, Sanjay R. Singh, Alan M. Taylor. 2020. "Longer-Run Economic Consequences of Pandemics," Federal Reserve Bank of San Francisco Working Paper 2020-09) examined twelve major pandemics since the 14^th century and found that "significant macroeconomic after-effects of the pandemics persist for about 40 years, with real rates of return substantially depressed." (see chart below).

Response of European Real Natural Rate of Interest Following Pandemics

Source: Jordà, Òscar, Sanjay R. Singh, Alan M. Taylor. 2020. "Longer-Run Economic Consequences of Pandemics," Federal Reserve Bank of San Francisco Working Paper 2020-09.

The authors speculate that principal reason for low rates of return for decades following pandemics is the propensity of households to increase savings, a phenomenon we identified in the previous section. In simplified supply-demand terms, excess capital (higher savings) in relation to investment opportunities lowers the rate of return.

Another reason to expect low rates of return in the future is that government policies will demand it. Federal debt as percentage of GDP will soon exceed the high reached during the Second World War, accelerating well past that record in the years to come (see graph below).

Federal Debt Held by the Public as a Percentage of GDP, 1790-2050 (projected)

Source: Congressional Budget Office

Governments have three options to service/retire debt. Default is one, but is unnecessary in the US because debt is denominated in fiat currency, more of which can always be printed to repay debt. Default is often the only tool available to countries with foreign currency debt, but that does not apply to the United States. Secondly, higher taxes can be assessed to service/retire the debt, and this will no doubt occur. But with debt levels exceeding the size of the economy, it will be impossible to raise enough in taxes to have a meaningful impact. That doesn’t mean taxes won’t go up; they will. And so, finally, and most likely, is rate repression: creditors will bear the debt burden through negative real interest rates for years (more likely, decades) to come.

The last period of negative real rates was the inflationary 1970s (see graph below). But negative real rates can occur with modest levels of inflation. It’s just a matter of keeping nominal yields below the rate of inflation, and the Second World War period provides such an example.

Real Interest Rates, 20 Largest Economies, 1955-2015

Courtesy: Minneapolis Fed, https://www.minneapolisfed.org/article/2016/real-interest-rates-over-the-long-run

Short-term bill rates were pegged at 0.375% beginning in 1942, and long-term bond yields were capped at 2.5% (see graph below). Price caps during the war distorted reality for a time, but official inflation averaged around 3.5% in those years, modestly higher than the nominal rate investors earned on Treasuries. This rate repression was seen as necessary in order to finance the war effort. Following the war, price controls were lifted and inflation soared to 20%. The interest rate peg was allowed to drift modestly higher in 1947, but with inflation above 20%, yield curve targeting eventually became untenable and was abandoned in 1951, heralding the beginning of a thirty-year bear market in bonds that saw yields rise to more than 15% in 1981.

Yields on U.S. Treasury Securities, 1942-1951

Source: Carlson, Mark, Gauti Eggertsson, and Elmar Mertens, Federal Reserve Experiences with Very Low Interest Rates: Lessons Learned, Federal Reserve Bank of New York, 2008.

We won’t see 20% inflation in our future. Double-digit inflation was unleashed after a period of official price suppression, first during the Second World War and again in the 1970s (when President Nixon imposed wage and price controls in 1971. These were largely lifted by President Ford in 1974, and inflation reached over 14% by May 1980). Deflationary pressures, discussed in our previous section, are the more powerful force today. But nominal yields will likely be held below modest inflation, meaning that negative real rates is still a likely outcome for investors for the foreseeable future.

Government debt is an unattractive long-term investment (discussed in more detail below), but corporate debt looks more appealing. In 2019, US corporations spent more than $700 billion buying back stock and another $1.34 trillion in dividends. This $2 trillion was largely financed with $1.4 trillion of new debt issuance. Corporations have been leveraging their balance sheets. Capital investment, another potential uses of funds, has been moderate for the past decade, and a weak economic trajectory argues against higher capital spending in the future. We think this "sources and uses" of funds will shift, and we expect to see companies borrow less and divert marginal funds away from buybacks and dividends and toward debt servicing and repayment. Additionally, there are increasing political pressures to raise wages and avoid layoffs. Economic conditions and the political environment favor reducing corporate debt, a combination that is supportive for credit investors.

The recent sell-off in corporate debt, notwithstanding some rebound off the lows, has improved valuations, particularly relative to alternative investments. Spreads relative to government bonds (first graph below) and relative to equity earnings yields (second graph below) are at attractive levels.

Bloomberg Global Aggregate Corporate Bond Index OAS Relative to JP Morgan GBI Global Government Bond Index Yield, 2007-2020

Bloomberg Global Aggregate Corporate Bond Index OAS Relative to MSCI ACWI Index Forward Earnings Yield, 2001-2020

The prospect of lower overall growth, higher taxes and weaker profit margins does not auger well for stock markets, but it would be a mistake to abandon equities. Markets are dynamic, adapt to changes, as seen in the chart below. Finance and Transport dominated the equity market for its first hundred years. Energy and Materials were then the largest sectors for decades. Communications, Technology and Health Care are now growing in importance and are poised to lead in the future. Despite an overall challenging economic environment, there will certainly be companies and sectors that thrive and profit, offering scarce growth in a world bereft of it.

Sector Weights in US Stock Market History

Source: Visual Capitalist

Low rates of return are not only a challenge for most investors, it is an environment that calls into question traditional investment strategy. The challenge is that most investors have required rates of return that are higher than what may be available. For example, private foundations must (by law) spend 5% of their assets. If the foundation also wishes to protect the purchasing power of its corpus, it must earn this 5% in excess of inflation. Pension funds discount their liabilities at an assumed rate of return (around 7% for many), and if unable to achieve that hurdle will be unable to meet their future benefit obligations.

The average yield on the ten-year US Treasury note for the past 35 years has been 5%. So investors have been able to earn close to their required rate of return by owning safe, liquid Treasuries. Inflation averaged 2.6% p.a. over this time, so Treasuries provided a positive 2.4% yield over inflation. Today the yield on the ten-year note is 0.70%. The expected ten-year inflation rate is 1.2%, so ten-year Treasuries currently provide yield of 0.5% below the expected inflation for the next decade. A negative real yield is priced in Treasuries for the next 30 years.

Historically, investors owned Treasuries to earn a positive real yield for income and to provide protection in an equity market downturn. Real yields are negative, so there is an enormous opportunity (and real) cost to hold Treasuries for investors who must earn a positive return. Additionally, the fractional nominal yields provide little downside protection to a portfolio. For example, a rise of just 7% in the ten-year Treasury note would bring the nominal yield to zero. Assuming a zero-rate bound, this is all the appreciation an investor would receive in an equity market decline. To offset a 25% equity market decline, investors would have to allocate 78% to Treasuries, 22% to equities. No one would do this because the long-term expected return of that portfolio would be inadequate. In this example, equities would have to return more than 20% per year for a decade for that portfolio to achieve a 5% nominal annual return. That is not going to happen.

Long-term investors do have a potential advantage, an advantage, however, that is contingent on truly having a long-term view. This advantage emanates from the fact that standard errors of compound returns decline over time. This fact does not, in itself, improve returns, it only lowers the risk. But by reducing risk, investors are (or should be) able to hold riskier assets that will compound at higher rates of return. We say "should be" because holding riskier assets may (will) involve greater volatility in short periods of time, and many investors have innate behavioral biases to avoid declines in wealth, even if only temporary. The advantages of long-term investing accrue only to those who are truly long-term investors.

The investment period we expect, then, poses significant challenges for most investors. Earning an adequate return and constructing a diversified portfolio that offers protections from material short-term declines in wealth will be difficult. Traditional strategies will be insufficient in achieving either objective, and investors will need to alter, not only their allocations, but also their mindsets, to be successful.

The economic consequences of this pandemic we outlined in Part 1, and the investment implications we covered in this note, are considerable. As vast as these reverberations will be felt in economies and capital markets, a far more profound impact is likely to be manifested in politics and societies. We address that area Part 3.

Two and a half months of isolation engenders reflection, on what we’ve endured, and contemplation on what the future may hold.

Our reflections are incomplete, it’s still early, and our prognostications inadequate, as always. There is far more we miss and don’t comprehend than where we have clarity, and the future contains infinite possibilities rendering forecasts futile. Understanding comes only in hindsight, if it comes at all. Nonetheless, like a painting half-formed, we can begin to see shapes developing and can begin to speculate on where it is headed. This three-part series attempts to lay down our semi-cogent thoughts on this global pandemic and its implications.

Over the past decade, we encountered numerous "existential" threats to the world financial order:

• In 2011, (another) crisis of Greek government debt portended the collapse of the European Union;
• In late 2015, plunging oil prices wreaked havoc in the fast-growing energy sector, threatening to reverse the shift to energy independence;
• In early 2018, rising bond yields heralded a new era of inflation;
• In late 2018, the Fed’s non-response to weaker economic data and a burgeoning trade war presaged an end to economic expansion.

In hindsight, each of these events were mere blips in the longest bull market in history, although, at the time, all seemed to have had the potential to derail the economic recovery and reverse the markets’ substantial gains since the Global Financial Crisis of 2008. Our advice and positioning through all of these events was to stay the course, to be fully invested.

We characterized these incidents as only ripples in a long-term secular bull market, for example, we wrote in 2014:
https://www.angelesinvestments.com/insights/investment-insights/3rd-quarter-2014-plague

And again in 2018:
https://www.angelesinvestments.com/institutional-insights/breathe.

At first, the COVID-19 virus appeared to be of a similar vein: a stone in the swift current of a secular bull market, causing turbulence that would shortly abate. That was my thinking as late as the end of February:
https://www.angelesinvestments.com/institutional-insights/put-down-the-gun.

A week later, I changed my mind:
https://www.angelesinvestments.com/insights/videos/michael-rosen-on-bloomberg-tv-march-5th-2020:

This was not a stone in the river, but potentially a Category 6 rapids [n.b.: the most dangerous river designation by the American Whitewater Association, where the consequences of error are severe and rescue may be impossible.] In other words, I had a sense that this global health crisis was not a perturbation, but a paradigmatic shift in the global economy with potentially profound sociopolitical consequences.

The First World War (and its subsequent influenza pandemic) ended the Victorian Era, reordering the world economy and demolishing the social mores of the previous century. That this pandemic, responsible for only a tiny fraction of the deaths from one hundred years before (and nothing like the Black Death of the 14^th century-see chart below), would mark the breach of an old order to a new one was, is, hyperbole. And yet somehow this feels much bigger than a particularly bad, but semi-normal, flu season.

Estimated Total Deaths by Pandemic As a Percentage of the Global Population

Source: Federal Reserve Bank of San Francisco, Wikipedia.org; Courtesy: Deutsche Bank

Reflecting on that moment of realization in early March of the momentous implications of these events, I find myself surprised. I cannot quite identify, much less articulate, why this moment felt different than previous periods of turmoil. But it did, and it does. On deeper reflection, perhaps we sensed for many years the pressures building, in our economies, our politics and in our societies. Tensions that were ultimately untenable and would one day snap. How and when were unknown, but we could feel it coming. I think that COVID-19 was the how and now was the when.

This crisis has exposed serious structural imbalances in our economies, in our societies and in our world, to which we cannot, should not and will not revert. Likewise, trends that previously were nascent or unnoticeable, have been accelerated and, in the aftermath of this pandemic, will dominate our lives more quickly than we expected. The implications and consequences are widespread and profound.

The future cannot be described; the possibilities are far too complex. But we can try to outline a framework, knowing it will be, at best, incomplete, and missing salient features, hoping, though, that we can fix our gaze in the general right direction.

We begin constructing our post-pandemic framework by assessing the economic outlook, then turn to the investment implications. Lastly, we examine some of the political and societal consequences of this extraordinary crisis.

Part One: Economic Outlook

The economic expansion that began in June 2009 and ended last quarter was not only the longest in US history at 129 months, it was also the weakest, with average annual GDP growth of just 2.3%. The next period of growth may or may not be as lengthy, but will almost certainly be weaker. Three principal factors will hinder economic growth for the foreseeable future.

Public debt levels have surged in most economies at unprecedented speed and magnitude. The OECD forecasts government debt will rise $17 trillion this year, raising collective debt-to-GDP from 109% to 137%. The US exemplifies this development as a budget deficit of at least $4 trillion will raise debt levels 20% higher. That’s not quite Japan’s record level of debt-to-GDP, but it’s not far behind Italy (see chart below).

Debt as Percentage of GDP in OECD Countries

Source: OECD

This matters because high levels of debt impede economic growth. A study of European economies by the European Central Bank (Checherita, Cristina and Philipp Rother, The Impact of High and Growing Government Debt on Economic Growth, Working Paper 1237, August 2010) found that economic growth slows measurably when public debt exceeds 90-100% of GDP. A broader study by the IMF (Kumar, Manmohan and Jaejoon Woo, Public Debt and Growth, IMF, July 2010) shows an inverse relationship between initial debt levels and subsequent economic growth, measuring a 0.2% drop in growth rates for each 10% increase in debt-to-GDP levels (see chart below).

Initial Debt and Subsequent Growth of Real Per Capita GDP

Source: Kumar, Manmohan and Jaejoon Woo, Public Debt and Growth, IMF, July 2010.

The empirical data are quite clear on the deleterious effect of high levels of debt on future growth. The reasons for this are harder to pin down, but studies point to falling productivity growth as a principal cause, reflecting a general reduction in investment.

The second reason to expect slower economic growth is that household savings rates will rise, reflecting caution about future economic prospects. This was posited 200 years by David Ricardo (known as his Equivalence Theory), who suggested that as government debt levels rise, consumers will save more in anticipation of higher taxes and/or fewer benefits in the future. Regardless of the explanation, households have historically increased their savings rates following recessions (dramatically so post-2008-see graph below).

Net Private Sector Saving After Last Four Recessions

Courtesy: PIMCO

Rising government debt, falling productivity and investment, more savings and less consumption all have historical precedents, and all suggest sluggish economic growth ahead. The third factor that will lower the economic growth trajectory is de-globalization, a trend that has been building for a few years with escalating tariffs and trade tensions.

The world economy following the Second World War was driven by international trade. The value of exported goods rose to a record 26% of world GDP in 2008, fell and then recovered to 25% in 2011, and has been declining gradually since (see chart below). The last multi-year period of declining trade was in the 1930s, especially following the Smoot-Hawley Tariff of 1930, a major contributor to the Great Depression.

Trade raises economic growth and contributes to prosperity through higher productivity. The correlation between trade and economic growth is clear, as seen in the chart below.

David Ricardo (again!) established the "law" of comparative advantage, with the central concept of opportunity cost that drives gains in trade. More recently (1999), the seminal paper by Jeffrey Frankel and David Romer (Frankel, J. A., & Romer, D. H., Does trade cause growth?, American Economic Review, 89(3), 379-399) proved the causality effect trade has on economic growth. Subsequent research substantiates this conclusion.

Trade liberalization has been a principal factor in economic prosperity for decades and had enjoyed broad political support. That support is now seriously threatened with the rise of political populism on the right and on the left, marginalizing the once-dominant political center.

Trade brings efficiencies. But when shortages arise due to supply constraints and/or unanticipated surging demand, as we have seen in this current pandemic, the finely-tuned supply chains collapse, leaving countries vulnerable to urgently needed goods.

Trade is not the problem here. It is the dependence on single sources for supplies. If the entire production of a needed drug or piece of protective equipment were made at a single site domestically, there would still be shortages if that factory were not able to operate, for whatever reason. A recent study by economists at Michigan, Texas and Yale (Bonadio, B., Huo, Z., Levchenko, A., Pandalai-Nayar, N., Global Supply Chains in the Pandemic, May 2020) found that in a world without trade in inputs and final goods, the economic downturn due to the pandemic would have been marginally worse than it was as input sources are less diversified and still subject to interruption due to the pandemic. Eliminating trade in favor of domestic production does not increase security and is economically costly.

Still, it is likely that companies, and governments, will seek to diversify supply chains. The economy will lose some measure of efficiency, but it may gain in resiliency, and companies will seek the right balance between the two. Governments will be driven more by perceived political advantages in mandating sources of supply (re-shoring), and we may end up with policies that make the economy both less efficient and less resilient as a result.

Diversifying supply chains will be harder than passing a law. Priority should be given to emergency supplies, but a wholesale shift in supply chains will be difficult to achieve quickly. Approximately 20% of the value of imported goods required for domestic manufacturing in the US, Japan and Korea, for example, come from China, and relocating may be difficult. Apple, to take a specific example, has 14 of its 17 assembly plants located in China, and each one has a large ecosystem of sub-suppliers around it. There are compelling economic reasons for this, so moving away from China, which is certainly the political goal, will be difficult and expensive.

To summarize, future economic growth is almost certainly to be weaker than in the past, and this past period was the weakest (albeit the longest) on record. Consumers will be cautious in the face of uncertain prospects and in the anticipation of higher taxes to pay for burgeoning public debt. Trade, an engine of growth for the past 70 years, will continue to diminish. Supply chains will diversify, but some efficiencies will be lost.

This will be a challenging time for investors, a topic we turn to next.

The Romans had a tradition that, following a military victory, the triumphant general was paraded through the city in a four horse-drawn chariot to the adulation of the hundreds of thousands of citizens. No higher honor could be bestowed on a Roman. But riding in the same chariot, standing just behind the conquering hero, was a slave, whispering in the general’s ear, Respice post te. Hominem te esse memento. Memento mori! "Look behind. Remember thou art mortal. Remember you must die!" It was a message that the adoration would fade but the truth of mortality does not.

Sally Dungan passed away two weeks ago. She was Tufts University’s chief investment officer for nearly 20 years, and a friend. I first contacted Sally about ten years ago, in the aftermath of the global financial crisis that hit the Tufts endowment hard, because I wanted to see if I could help in any way an institution that was so formative to me. Over the years, Sally and I would talk frequently, and see each other about twice a year.

We exchanged investment ideas, but in recent years, our conversations focused more on our challenges with governance, management and mentoring, and our hopes and joys for our families. Sally loved her two boys, as you might expect, but uncommon was how much she truly cared about her team and her employer. She expressed a mother’s pride in all whom she mentored, and she sacrificed both money and political capital to make sure they were recognized.

I last saw Sally six months ago, and there was no hint at all about the cancer that was surreptitiously growing inside her. She was excited about her plans for the investment office, and was looking forward to spending the holidays in the house she had built in Vermont.

Her passing turns my thoughts to how I will remember her. We have already forgotten if her endowment outperformed her benchmarks, or whether she earned more or less than her peers. We remember how she touched the people in her life, her selflessness and consideration for everyone she met, her dedication to Tufts for what it represented as an institution; not because it was a formative part of her youth, as it was for me, but because she only knew how to act with integrity, compassion and purpose. Reflecting on her legacy inevitably turns into contemplating ours, and we will be no different: our relationships with our families, friends and colleagues will be all that anyone will remember.

Her passing evokes another thought. The great Roman philosopher/general, Seneca, wrote in his Moral Letters to Lucilius, "Let us prepare our minds as if we’d come to the very end of life. Let us postpone nothing. Let us balance life’s books each day." Sally’s passing reminds me how transitory, ephemeral our time is on this earth. Six months ago she was making plans for the new year, and today she’s gone. That could be any of us.

Each day, the Roman emperor Marcus Aurelius would write in his diary, which was saved for posterity and comes to us as his Meditations. One entry he wrote to himself was, "You could leave life right now. Let that determine what you do and say and think." Memento mori, remember death, so that we may live. I will miss her.

Requiescat in pace

Photo by Paul Rutherford, Courtesy: Tufts

Opening Photo: Museo Archeologico Nazionale di Napoli. This was a mosaic embedded in the floor of a house in Pompeii, portraying, in an allegoric and symbolic way, the philosophical theme of Hellenistic origin of the transience of life and impending death. The climax of the scene is a level with its plumb line, a tool used by bricklayers to control the leveling of constructions. The axis of the plumb line is Death (the skull), under which there is a butterfly (the soul) balancing on a wheel (Fortune). Beneath the arms of the level, opposing and perfectly balancing, are the symbols of poverty on the right (the pack-saddle, the beggar’s stick and the cloak) and of wealth on the left (the scepter, the purple and the crown).

I have always found that most things in life can be explained by basic economics. Well, some things, for sure. The most basic (THE most basic) concept in economics is the relationship among demand, supply and price. As you will remember from college, price is what adjusts to maintain an equilibrium between demand and supply.

Source: AmosWeb

Here’s a graph of the demand for gasoline, each week, from 1998 to present:

US DOE Motor Gasoline Total Output Implied Demand Data, July 1998 – April 2020

Source: U.S. Department of Energy

So demand is way down, around a 50% drop from the beginning of the year. Next, let’s look at supply. Below is the change in crude oil inventories since 1982: by far, a record high increase in inventories:

US DOE Total Change in Crude Oil Inventories, August 1982 – April 2020

Source: U.S. Department of Energy

So, what happens when demand falls and supply rises? (use the first graph above for help).

US Crude Oil WTI Cushing OK Spot Price, May 1983 – April 2020

Source: Bloomberg Energy

Exactly! The price falls! Oil began the year at more than $60/barrel, and today is below $20. Which is what happens when demand plummets and supply rises: the price adjusts to the new equilibrium. Economics works!

Our (government’s) reaction to all this was to broker a cut in production among the Saudis, Russians and OPEC+ in hopes of supporting the price of oil. This was a mistake. A much better approach would have been to impose a tax on imported oil and use those proceeds to invest in renewable energy. That would provide near-term support to domestic producers while accelerating the transition to renewables, which can’t be done fast enough. A missed opportunity, but it’s not too late!

It’s not quite beach weather yet, but as we are all locked in our houses waiting out this virus, we may have found a little more time for ourselves. So I offer a selection of three books I’ve read over the past three months that I thought worthy of your attention. Happy reading!

Fiction

The Nickel Boys, by Colson Whitehead

Colson Whitehead won the Pulitzer and the National Book Award with his Underground Railroad, a brilliant book that I cannot praise enough. The Nickel Boys is likewise superb, a story of a Florida school for wayward boys. Whitehead, more than anyone today, I think, portrays his characters in such vivid and intimate prose that draws you into their lives. The book is sad, funny, angry and shocking. Colson Whitehead is one of our great writers today.

History

Destiny of the Republic, by Candace Millard

There are long stretches of American history that are generally ignored as uninteresting or unimportant. The thirty-five years between Lincoln and TR contained a string of undistinguished and forgotten Presidents. But history did not stop in this period, and a few historians are examining this era to help form a more complete understanding of American history. Last year, I was drawn to The Impeachers, by Brenda Wineapple (https://www.angelesinvestments.com/institutional-insights/more-not-necessarily-beach-reading), to describe the personalities and motives behind the impeachment of Andrew Johnson, generally considered our worst President (the contest is not over). One of the forgotten Presidents of the time was James Garfield , who was President for only a few months. But Millard shows us that Garfield was a remarkable man, his rise from poverty to the presidency is almost impossible to believe. Counterfactuals are fun, and generally uninformative, but Millard makes a case that had he survived, Garfield may have been a great President. We’ll never know, of course, but Garfield deserves more attention than he gets, and Millard does an excellent job portraying this remarkable man.

The Fire is Upon Us, by Nicholas Buccola

William F. Buckley, Jr. was well known to a generation of Americans as an outspoken, over-literate apostle of conservatism. James Baldwin was briefly famous as an essayist and playwright and civil rights leader. Buccola, a political science professor, traces the arc of each man’s thinking and makes a strong case that each man was at the center, if not the origin, of a line of political thought that formed in the country after the Second World War, and came to define the intellectual political divide that stretches to today. Buccola uses a debate between the two men at Cambridge Union as the culmination of their opposing political perspectives, but the debate itself is anti-climactic. The real sparks come from the description of the evolution of political thought of both Buckley and Baldwin. Buckley was the more famous of the two, even to this day, but history proved Baldwin right. More than that, though, for those not familiar with Baldwin’s writings, the excerpts here will pique an interest in delving further, for Baldwin is surely one of the greatest essayists America has produced. His prose is poetry, his insights profound. Buccola makes an analysis of intellectual political thought, most certainly as relevant today as then, accessible, even exciting.

Tombstone, Arizona is a small town of around 1300 folks along the Mexican border. In 1881, it swelled with more than 7,000 men seeking their silver fortunes, along with thousands more women, children, Mexicans and Chinese (who weren’t counted in the census). Horse rustling, cattle theft, smuggling and shootings were common, and to protect the peace, Virgil Earp was hired as Deputy US Marshall for Pima County. He brought his brothers, James, Morgan and Wyatt, for support.

Victor Clyde Forsythe, Gunfight at the OK Corral, Lee A. Silva Collection

To get control of the lawlessness pervasive in the territory (Arizona became the 48^th state in 1912), Virgil imposed an ordinance requiring anyone entering town to deposit his weapons at a livery. Needless-to-say, this ordinance was not popular with everyone, in particular, Frank and Tom McLaury, Billy and Ike Clanton, Billy Claiborne and Wes Fuller, a gang of bandits known locally as the Cowboys. The Cowboys had a number of standing feuds with the Earp brothers and with a dentist-turned-gambler, "Doc" Holliday.

The Earps and Holliday were not expecting a fight with the Cowboys when they encountered them along Fremont Street, down from the Old Kindersley (O.K.) Corral, on October 26, 1881. But when Virgil saw the Cowboys were carrying pistols and rifles, he demanded that they turn in their weapons. It is unclear exactly what happened next, but by most accounts Billy Clanton and Wyatt Earp fired simultaneously, and thick black powder smoke engulfed the street. When the smoke cleared a minute later, Virgil and Morgan Earp had been hit with bullets, but would survive, Doc Holliday was grazed by a bullet, Wyatt Earp was untouched, and Billy Clanton, Frank and Tom McLaury were dead.

Like Billy Clanton, when confronted with a potential threat, investors often prefer to shoot first. Chinese officials first alerted the World Health Organization (WHO) of an outbreak of coronavirus (since designated COVID-19) on December 31. As the number of infections grew, deaths followed, and markets were unperturbed. Only in the past week, when cases appeared outside China, have markets reacted swiftly, with US equities falling 7.5% in the past five days. Likewise, copper prices have plunged more than 10%, oil more than 15%, and US Treasury bond yields have plummeted from 1.92% at the start of the year to 1.35% today, an all-time low.

The impact in China has been substantial. The number of confirmed cases continues to rise (as does the number of recovered cases-see below), and economic activity in China has ground to a halt. Passenger traffic (airports and train stations) is a fraction of normal activity (second graph below). The good news (and it’s not much) is that pollution levels in China are the lowest in years (third graph below).

COVID-19 Total Confirmed Cases vs. Recovered Cases in China

Transportation Hub Passenger Flow (Index) in China During LNY, 2019-2020

Air Quality Index, Top Ten Industrial Cities in China

It used to be said that when the United States sneezes, the rest of the world catches a cold (a phrase Austrian diplomat Prince Klemens von Metternich was said to have applied to France in the early 19^th century). But China is nearly, maybe more, important to the global economy than the United States. COVID-19 will impact China the most, but few countries will be immune from the effects. China is central to the global economic supply chain, responsible for the manufacture of intermediate equal to 1.7% of US GDP. That is twice the weight of Canada or Mexico. The impact on other manufacturing economies, such as Germany and Japan, is even greater, and we are already seeing spikes in delivery delays (graph below). Shipping rates have plunged 80% since September (second graph below).

Supplier Delivery Times, US-Germany-Japan, 2015-2020

Baltic Exchange Dry Index, Last Twelve Months

Markets are wobbly, new infectious cases are appearing around the world (even as new cases in China seem the be slowing), and it is unclear when China’s economy, and the world dependent on it, can get back to normal.

Following the massive Tohoku earthquake in 2011, Japanese industrial production dropped 40%. But Japanese production fully recovered in about nine months. At the moment, the economic disruption from COVID-19 is likely to shave around 1% off of US GDP this quarter, but assuming peak cases occur soon, the impact on economic output for the year should be negligible. The labor market is tight, incomes are rising, and monetary policy is accommodative. It would take a much more prolonged economic disruption to send the US economy into recession. Absent a recession, markets will tremble, but will not crash.

Shooting first did not turn out well for Billy Clanton. Shooting first during the SARS scare in 2003 or the Zika virus spike in 2015-16 didn’t work out well for investors, as US stocks fell nearly 13% each time and recovered quickly. We don’t know how COVID-19 will play out, but cool heads will prevail. Our advice to investors, as it would be to the Clanton and McLaury brothers, is: put down the gun.

Rupp Arena is one of the iconic venues for college basketball in the country. It is named for Adolph Rupp, the legendary coach of the University of Kentucky, from 1930-1972.

Rupp won five national championships at Kentucky, was national coach of the year five times, is the fifth-winningest coach in history, and is a member of the Basketball Hall of Fame. From the bench, from the stands, and from the sofa, I have watched tens of thousands of hours of basketball, and have long-wanted to see a game at Rupp. So this past weekend, I went.

According to Pew Research, half of Kentuckians are Evangelical Protestants (https://www.pewforum.org/religious-landscape-study/state/kentucky/), but the Pew pollsters conducted the wrong survey. I’m pretty sure that the two most popular religions in Kentucky are basketball, specifically the University of Kentucky basketball, and bourbon. While I have not spent tens of thousands of hours sipping bourbon (I’m working on it), the idea of spending a few hours on the Bourbon Trail was very appealing.

The game was fine (Kentucky beat Alabama, 76-67), and 23,000 fans went home happy. Most major college basketball arenas run electronic ads, and one I particularly noticed at Rupp was from Friends of Coal. I thought: that there’s something I’ll never see in Los Angeles. It turns out Friends of Coal is a group "dedicated to informing and educating Kentucky citizens about the coal industry and its vital role in the state’s future." (https://www.friendsofcoal.org/). To get its message out, it sponsors University of Kentucky basketball, and offers an official state license plate, more than a few of which I saw on the roads.

Seeing the ads for Friends of Coal distracted me (a little) from watching the basketball game. I was surprised to see the ad, and surprised to think that coal had any friends at all. The exigencies of climate change and the urgency to slash carbon emissions require an effective total ban on the use of coal (best achieved through carbon pricing that appropriately reflects the environmental cost of emissions). Friends of Coal? What about Friends of Earth?

It didn’t escape me that Mitch McConnell, leader of the U.S. Senate, represents the state of Kentucky. He has acknowledged that human behavior is causing a warming of the Earth (https://thehill.com/homenews/senate/435904-mcconnell-i-do-believe-in-human-caused-climate-change), but opposes efforts that would threaten the economy in Kentucky coal country. It would be nice to think that our political leaders would act in the best interests of our world, even if that brought additional burdens to the people who elect them. But that is an unrealistic standard. Given the importance of the coal industry in his state, McConnell’s position on climate change is understandable, made clearer when you actually visit coal country, even if you disagree with it.

Basketball and bourbon are two excellent reasons to visit Kentucky. The rolling hills and horse farms of eastern Kentucky are magical, a truly beautiful landscape, even in winter, even in the rain.

There is no substitute for physically visiting a place. My mind was not changed on the pressing need for action on climate change, but seeing first-hand the narrative in another part of the country helped me appreciate that we are not going to make progress unless we address the legitimate concerns of everyone, including those who dig coal for a living. Telling them to find other work, or to move to a big city, or to get some education is not only patronizing and insulting, it will be ineffective. For those who want action on climate change, we should probably start with some proposals on how to help those whose livelihood and communities will be disrupted.

Perhaps the most famous, certainly the most momentous, game in college basketball history occurred on 19 March 1966, the finals of the NCAA men’s basketball championship. The University of Kentucky was ranked first in the nation, heavy favorites against Texas Western, making their first appearance in an NCAA finals. The game was never really close, but more important than the outcome was that Texas Western was the first team in history to start five African-American players. There was not a single African-American player on the Kentucky roster. Texas Western won the game, 72-65.

Three years later, in 1969, Rupp recruited his first African-American player, center Tom Payne of Louisville. Rupp would never again reach the championship game, and retired in 1972. The 1966 championship game not only helped eventually to integrate the University of Kentucky basketball program, it helped to change the mindsets of those Americans who doubted a team made up of entirely African-Americans could win a championship. It was a small, but important, step in the civil rights battle.

We have become so polarized as a nation, listening only to those who confirm our views ("carrying signs [that] mostly say, hooray for our side," as Stephen Stills so eloquently wrote), and shutting off those with opposing views. We will never get anywhere until we lend an ear, and then extend a hand, to our fellow Americans.

So here’s a new year’s resolution for you: visit someplace in this country you’ve never been to before. It may give you a deeper appreciation for others, and help to heal our widening rifts. That won’t come from our political leaders, which is why it must come from you.

A massive and deadly storm was disrupting the entire Midwest, and I was grateful to get back to California. But there’s a whole country to see, from the Kentucky coal mines to the California sun, as Janis Joplin wailed. Go see it. But go see it with an open heart.

To sit near a warm fire in a comfortable chair on a cold night is one of life’s pleasures that I hope you will be able to treasure over the holidays. Following are some of the books I enjoyed over the past six months.

History

The Dreamt Land, Mark Arax

This is the history of California through the unique lens of the Central Valley and that most critical resource: water. The engineering achievements are remarkable and transformative, literally re-shaping the history and development and, of course, the geography, of the state. Arax does not extol this transformation, but rather condemns the greed and corruption that accompanies, enables and ultimately desiccates the land. Whatever the ultimate judgment, our attempts to control nature, especially our water resources, is central to understanding the history of California, indeed, of much of our planet, with far-ranging consequences.

The Will of the People, T. H. Breen

We have been taught that the American Revolution was spawned from the quills of some of the greatest political polemicists in history: Thomas Paine, Thomas Jefferson, James Madison, among others, who, collectively, laid the intellectual foundation for breaking the political bonds with Britain and taking up arms against the Mother Country. But Breen rightly recognizes that revolutions fail unless they can muster widespread support, and the decision of ordinary people to risk their lives for a political cause is a deeply difficult personal and emotional act determined by much more than mellifluous words. Breen is persuasive in emphasizing the religious element in justifying the revolt, but is most original in highlighting the lack of reprisals following victory that characterized other revolutions, notably the French and Russian. Liberty, ultimately, was defined by Americans not merely in a political, moral or religious framework, but in practical terms as well, helping lay the foundation for a uniquely American form of democracy and civic values.

Furious Hours, Casey Cep

Such a riveting tale Casey Cep has told through the person of one of our most beloved and enigmatic writers, Harper Lee. We know that Lee never wrote again after To Kill a Mockingbird, but we don’t know why. Cep discovered a trove of notes Lee had on the extraordinary life of Willie Maxwell, by all accounts an upstanding citizen in rural Alabama: exemplary worker, devoted husband, and popular Baptist preacher. But for one disturbing fact: his wives had a propensity to die under mysterious circumstances. Oh, and the Reverend Maxwell had the good fortune of holding large life insurance policies on them at the time of their deaths. The book is part an enthralling story of Willie Maxwell, and what really happened, and partly how his story consumed Harper Lee for decades. To all who wondered whatever happened to Harper Lee, the answer lies in the life of the Reverend Maxwell.

Science

Origins, Lewis Dartnell

As geological history, this is highly accessible to the lay reader. Plate tectonics, volcanism, climate change over the past three billion years are all covered here, generating a sense of absolute astonishment at the extraordinary evolution of our planet. As fine a narrative of Earth’s geologic transformation as this is, what makes this book exceptional is that Dartnell, an astrobiologist in London, connects a direct line from geological events to human evolution to socioeconomic conditions today. For example, the genus, homo (that’s us), arose in the Great Rift Valley of East Africa because the Indian subcontinent slammed into Asia and created the Himalayas. If that is not obvious, Dartnell spells it out for us. His final sentence is, "the Earth made us," and here he shows how true that is.

Horizon, Barry Lopez

Barry Lopez, dying of prostate cancer in his cabin on the Oregon coast, gives us his capstone of a life’s work, a remarkable gift to the world. On one level, these are simply the observations of one man over the decades as he travels across the globe, mostly to its most isolated places: the Antarctic and Canadian Arctic, western Australia and the Galápagos, and beyond. It is about, as he writes, "the human menace, human triumph and human failure." Our environment is under threat from human actions, but so are the unique and special cultures of the people who inhabit these lands. There is sadness in what we are losing, but so, so much beauty in his writing.

Fiction

Purity, Jonathan Franzen

I had been avoiding Purity for a few years because I know that Franzen demands close reading. He is always exhausting, sometimes deeply disappointing, but sometimes writes with astonishing ease, as he does here. Purity, of course, is a noun, but in this case, it is also the name of the protagonist. As in The Corrections, another extraordinary novel, Franzen introduces a character, weaves multiple plots, obscured with secrets and lies, and connects it all in the end. A girl searching for her birth father, a mother crazed with guilt and shame who will not reveal her secret, a Wikileaks-like character seeking justice and repentance, it all comes together in Franzen’s expert hands.

October 1987 was a memorable month for me. It began with the 5.9 magnitude Whittier Narrows quake that rocked my downtown building (like all tall buildings, it was on rollers). Two weeks later, on Wednesday the 14^th, stocks fell a record 3.8% (95 Dow points), another 2.4% the next day, and another 4.6% to end the week. After a beautiful weekend, on Monday the 19^th, we all watched in shock as the Dow plunged 508 points, or 22.6%. No one, obviously, had ever seen anything remotely close to this, the equivalent of a 10.0 magnitude stock market quake.

Early yesterday morning, my phone shook with emergency alerts, first, at 230am, with a warning of a developing fire, and then with a mandatory evacuation notice. The opening photo is the eastern sky as I left the house, after gathering photo albums and the dog. Later that morning, this was the scene from our office window.

Firefighters worked through the night, all the next day, and are still at it. Their efforts are Herculean.

Midday, I took Quincy for a walk and took this photo. It brought me back to 32 years ago. I returned home to the beach after the collapse of the stock market and saw the exact same view. I remember thinking that the world could not possibly be collapsing when there is such beauty in it. On a day when fires are destroying homes and forcing thousands to flee just miles away, the scene at the beach was surreal.

California is blessed with the most spectacular natural beauty on the planet; and natural disasters of biblical proportions. Nature’s precarious balance is ever-present for all of us here, but a balance it is. The calamities we endure, whether by our own actions or by nature’s, are compensated by the privilege of living in this magnificent land.

Of course, we mourn for those who have lost loved ones or treasured possessions. The juxtaposition of raging wildfires and the calm Pacific reminds me that there is an equilibrium in the world: beauty and sorrow, joy and pain. We are blessed to live amid such beauty, blessed to live among the courageous heroes of the Los Angeles Fire Department and their thousands of brethren across the state.

Thanks to them, my house is safe. And Quincy spent the day in the office, which brought happiness to everyone here.

Berry Gordy, the legendary founder of Motown Records, had a genius for spotting talent and creating stars: Mary Wells, Diana Ross and Gladys Knight; Marvin Gaye, Smokey Robinson, Stevie Wonder and the Jackson 5, among many others. But Gordy was much more than a talent scout; he developed a signature sound for all his artists, the "Motown Sound," that utilized sophisticated melodies, back-beat rhythms, and complex arrangements with horns and strings. The result was more than 100 top ten hits in the decade 1961-71, an extraordinary achievement.

Amazingly, no Motown artist was recognized by the Grammys until 1969, when the label’s most prominent male group won for the song Cloud Nine. The Temptations had recorded a number of influential hits, including My Girl, Just My Imagination and Papa Was A Rollin’ Stone (more than 50 years later we can instantly recall every one of them). The Temptations epitomized the magical Motown Sound, with their smooth five-part harmony and tight choreography, the group was wildly popular.

In 1970, a new sound began to emerge, edgier, with more funk. Think of Sly Stone. The Temptations broke with their past by releasing an album, Psychedelic Shack, which was, well, psychedelic. The title track was the only single released from the album, but the album contained an anti-war song written by Motown hitmakers Norman Whitfield and Barrett Strong that struck a chord with listeners who clamored for Motown to release it as a single. Gordy was reluctant to associate his top-selling group, with wide cross-over appeal, so closely with a protest song, and hesitated about issuing it as a single. Its lyrics, which Gordy thought might offend what Richard Nixon called the "Silent Majority," who bought his Motown records by the millions, contained these lines:

War is something that I despise

Because it means destruction of innocent lives

War means tears in thousands of mothers’ eyes

When their sons go out to fight and lose their lives.

It ain’t nothing but a heartbreaker

Friend only to the undertaker

War is the enemy of all mankind

The thought of war blows my mind.

War has caused unrest within the younger generation

Induction then destruction, who wants to die?

Edwin Starr had a hit record in 1968, Twenty-Five Miles, but was very much a second-tier artist in the Motown factory. His voice was rougher than the typical Motown vocalist, exuding an energy and emotion more like his idol, James Brown. Starr heard of Gordy’s hesitancy to release the song as a Temptations’ single, and he jumped at the chance to record it. We’ll come back to the song in a moment.

The media are filled with headlines this week of "Trade War," as President Trump announced higher tariffs on Chinese imports and China suspended imports of US agricultural products and permitted the renminbi to fall to its lowest level against the dollar in over a decade (graph below). The US Treasury Department then responded by designating China as a currency manipulator, which sends the case to the IMF for review, where it almost certainly will decline to support the US position. But the designation enables the president to impose more tariffs.

CNY/USD, 2009-2019

Economists don’t agree on much, except this: tariffs are stupid (I’m paraphrasing). This is what Adam Smith wrote in 1776 in Wealth of Nations, and has been the accepted wisdom for the past 223 years. Politicians have generally paid attention, as tariffs have been falling steadily since the 19^th century, with a disastrous interlude in the 1920s and 30s. The Fordney-McCumber Tariff of 1922 raised tariifs on European agricultural imports that only served to close European markets to US farmers. The infamous 1930 Smoot-Hawley Tariff sparked another round of worldwide tariffs, and helped contract global trade by 67%. Smoot-Hawley was (thankfully) repealed in 1934. Since that colossal error, tariffs have declined (see graph below) and global trade has surged, helping to create the highest levels of world prosperity in history.

Adam Smith, David Ricardo and economists ever since have decried tariffs as inefficient and counter-productive, favoring special interests while harmful in the aggregate. The theoretical basis for free trade is unassailable, and the empirical evidence confirms it. A few months ago, economists at the IMF and UC-Berkeley published a review (https://www.nber.org/papers/w25402)

of the tariff policies of 151 countries in the period 1963-2014, concluding: "Tariffs increases are associated with persistent economically and statistically significant declines in domestic output and productivity, as well as higher unemployment and inequality, real exchange rate appreciation and insignificant changes to the trade balance."

Specifically, "tariffs encourage the deflection of trade to inefficient producers, and smuggling to evade tariffs; such distortions reduce welfare. Further, consumers lose more from a tariff than producers gain, so there is "deadweight loss." The redistributions associated with tariffs tend to create vested

interests, so harms tend to persist. Broad‐based protectionism can also provoke retaliation which adds further costs in other markets." These deleterious effects are graphed below.

Let’s re-state the evidence: tariffs decrease economic output and lower productivity, raise unemployment and inequality, and have no impact on the trade balance, which was presumably the rationale for imposing tariffs in the first place. The trade balance doesn’t improve mostly because currencies adjust, as we are seeing now. A year ago (June 2018) President Trump announced his first round of tariffs on Chinese goods. Since then the renminbi has depreciated about 9% (before this week). Economists at Bank of America estimate that since this round of tariffs went into effect the US imported $523 billion of Chinese goods and imposed tariffs of $62.5 billion. But the FX depreciation of the renminbi offset 77% of these tariffs, meaning the total effective tariff on Chinese goods is $14.3 billion, or just 2.7% of the total imports from China, an immaterial amount that highlights the futility of using tariffs as a weapon of (trade) war.

Berry Gordy reluctantly consented to releasing a single version of The Temptations song with Edwin Starr as lead singer. Norman Whitfield, a co-author of the song, was sole producer on the single and imbued it with an edge more suited to the gritty voice of Starr. Released in June 1970, it quickly went to number one. It won Starr a Grammy for Best Male R&B Vocal that year, and became the anthem of the anti-war movement.

There is no question the US has legitimate trade grievances, including, most importantly, theft of intellectual property. But tariffs are poor weapons in a trade war, not only ineffective but counter-productive, causing more harm than benefit, creating more losers than winners. The answer to the question, what are tariffs good for?, is the same as Edwin Starr said about war: Absolutely Nothing! (Now, say it again!).

Edwin Starr’s memorable version can be heard here (https://www.youtube.com/watch?v=dQHUAJTZqF0), but here is the original, Temptations version (https://www.youtube.com/watch?v=D0K3LJq9KnU).

For many people, the beach is an escape, and they want their beach books to transport them to worlds of fantasy. Coming up with a recommended beach reading list is a challenge for me for two reasons: the beach is less an escape than a daily backdrop of my commute (hoping to incite some jealously), and most of the hundred or so books I read each year are weighty nonfiction tomes not generally associated with easy beach reading. Still, nonfiction can transport the reader to another world too, and in any event, the distinction between reality and fantasy seems to be blurring rapidly. With that introduction, here are five books I have read in the first half of this year I recommend to you.

History/Politics

Brenda Wineapple, The Impeachers.

History tends to gloss over the first impeachment, that of Andrew Johnson, who is usually cited as the worst president we’ve ever had (so far). But this book helps us understand the debate about post-Civil War America, which was the real underlying context of the impeachment proceedings. Wineapple shows that we were very much a divided country, and the parallels with today are readily apparent.

David Blight, Frederick Douglass.

Blight argues that Frederick Douglass is the single greatest American. I don’t know if he is quite able to elevate Douglass above Washington and Lincoln, but Blight makes a compelling case for this extraordinary man.

History/Arts

Ian Port, The Birth of Loud.

The electric guitar is rock n’ roll, but first it had to be invented, and this is its story. Leo Fender and Les Paul are the two giants featured here, although virtually every great guitarist makes an appearance. Fender and Paul came at it from completely different backgrounds, but together, with others, they changed music and our lives. This book is a must-read for guitarists.

Fiction

Jesmyn Ward, Sing, Unburied, Sing.

Jesmyn Ward makes my list with every book she writes. She is the poet laureate of the Deep South of the African-American experience. As always, she writes beautifully. Here, her theme is the parent-child relationship, intermixed with ever-present racial relations that are eloquently expressed through a ghost.

Zadie Smith, Swing Time.

Two poor girls in London bond in dance class. Their lives diverge, but they are always connected. Smith captures the transformation of a friendship, while deftly incorporating social inequalities and contradictions. Beautiful on many levels.

Bacon sure is popular. McDonald’s, which probably has the best pulse on Americans’ culinary tastes, introduced Cheesy Bacon Fries for a few months earlier this year, to great acclaim, and this week announced it is rolling it out nationwide next month. In that same announcement (https://news.mcdonalds.com/stories/our-food-details/worldwide-favorites-menu), the company also said it would add a new Grand McExtreme Bacon Burger, which has been very popular in Spain, to its worldwide menus. Between the two items, you’ll get 1347 calories and 115% of your daily fat quota (78 grams).

Americans consume about 10 million metric tons of pork each year, about the same as we eat of beef. The Chinese, however, are in a completely different league, consuming 55 million metric tons of pork annually, almost all (96%) produced locally. To meet this demand, there are around 430 million pigs in China, half the world’s total.

African Swine Fever was first described in Kenya in the 1920s. The good news (for humans) is that it cannot be transmitted to people, and it is not a food safety issue. The good news (for American farmers) is that the disease has never (yet) occurred in the US. The bad news (for pigs) is that it is a highly contagious virus with no known vaccine and is 100% fatal. The only treatment we know is to destroy every infected animal.

The first cases appeared in China last August, and the Ministry of Agriculture and Rural Affairs (MARA) assured everyone that the situation was under control. But it appears they miscalculated. The disease has spread in China (see map below), and also to Vietnam and Mongolia. Given the four-month gestation period for pigs, and the time to wean, nurse and feed pigs, it will probably be 20 months before the outbreak can be contained. The USDA estimated last month that more than 130 million pigs in China will have to be destroyed this year.

Lean hog prices in the US are up 70% in the past three months (graph below). The Chinese Ministry of Agriculture warned last week that prices could surge another 70% later this year.

Interspersed among this mix of insatiable demand, plummeting supply and soaring prices is the on-going, and escalating, trade war. Last year, China slapped a 62% tariff on US imports of pork in retaliation for US tariffs, hurting Chinese consumers in the form of higher prices, and American farmers in lost export revenue, estimated to be over $1 billion. There are few winners in a trade war.

The genesis of the phrase bringing home the bacon is unclear, but the best origin story is that of the Dunmow Flitch, so that’s what we’ll go with. In the year 1104, in the town of Great Dunmow in Essex, a couple so impressed the Prior of Little Dunmow with their strong marital fidelity that he awarded them a flitch (side) of bacon. Centuries later (c. 1395), in The Canterbury Tales, Geoffrey Chaucer references this tradition:

But never for us the flitch of bacon though,

That some may win in Essex at Dunmow.

To this day, every four years, the town of Great Dunmow holds the "Flitch Trials," in which couples compete to impress upon a jury of six local bachelors and six local maidens of their unbreakable marital fidelity. The next Trial will be held in February 2020 (https://www.dunmowflitchtrials.co.uk/). Tickets are just £45/person. Which, at the rate we’re going, may be cheaper than buying a flitch of bacon.

Say “inversion” to a Californian, and the most likely word association is "layer." It’s our topography that causes this phenomenon, accounting for the haze, smog and "June Gloom" we experience. It’s not a modern phenomenon either: Juan Rodriguez Cabrillo called it Baya de los Fumos, from the dozens of native Tongva campfires that filled the air when he sailed into Santa Monica Bay in 1542.

Normally, air temperature drops with altitude. But in Southern California in the spring and summer, the colder marine air comes ashore to meet the warmer air on land that rises above the ocean air, which then traps emissions, resulting in haze and smog (which is its own made-up word combining smoke and fog).

Source for image above: https://commons.wikimedia.org/w/index.php?curid=318568

Source: http://www.csun.edu/~hmc60533/CSUN_103/weather_exercises/soundings/smog_and_inversions/Inversions.htm

Another type of inversion is in headlines recently: that of the yield curve. An inverted yield curve occurs when longer-term yields are lower than near-term yields, and the witches of Wall Street see this as an ominous omen of impending disaster. That is because each of the previous recessions of the past 50 years was preceded by an inversion of the yield curve. There was also one instance of an inversion that did not portend an imminent recession (August 1998). Still, if you’re out camping and hear a growl, it might be your partner’s stomach, but it might be more prudent to assume it’s a bear.

US Stock Market, 1969-2019, with Recessions (Grey) and Yield Curve Inversions (Green/Red)

Source: MSCI

So the fact that an inverted yield curve has preceded every recession of the past 50 years would seem to be cause for alarm. But before we hit the panic button, we should understand the context of past inversions in relation to today’s environment.

In the past, short-term rates above long-term rates signaled a tightening monetary policy. The Federal Reserve accomplished this tightening by draining bank reserves, thus removing liquidity from the banking system, which responded by curtailing credit, which contracted the economy (the definition of recession). Each previous instance of an inverted yield was thus accompanied by high real rates, a signal of a lack of financial liquidity. The graph below plots the real Fed funds rate since 1954, with the red arrows marking recessions. Each recession was preceded by high real rates (between 3%-9%). Today’s real Fed funds rate is 0.55%.

Source: https://fred.stlouisfed.org/

It’s not even clear that the yield curve is even inverted. The front-end is negatively sloped, but the intermediate-to-long end is pretty steeply positive.

Treasury Yield Curve, 9 April 2019

Source: Bloomberg, L.P.

Recessions occurred in the past when monetary policy tightened sufficiently to choke off the availability of credit. This tightening was seen in an inverted yield curve, but also in other indicators of a shortage of liquidity, such as high real interest rates and a shrinkage of banking reserves held at the Federal Reserve. The real Fed funds rate is low, there is approximately $1.5 trillion of excess bank reserves at the Fed and credit spreads are low and stable (see below), default rates are low and stable, interest coverage ratios are high and rising. There is no shortage of liquidity.

US High Yield Index Option-Adjusted Spread, 2010-2019

"Inversion," in addition to its meteorological and yield curve usage, also has a meaning in logic. The great German mathematician, Carl Gustav Jacob Jacobi, said he created his famous eponymous elliptic functions (don’t ask; see graph below) with the approach, "invert; always invert." (His precise quote was: man muss immer umkehren).

Source: https://commons.wikimedia.org/w/index.php?curid=64896331

Inversion in logic means solving a problem backwards. For example, rather than thinking of the steps needed to achieve a goal, work backwards to consider all the actions that could prevent accomplishing that goal. Inversion emphasizes avoiding the things that could go wrong instead of focusing on the steps that have to go right. In other words, try not to be stupid than strive to be brilliant.

Drawing a direct line from yield curve inversion to recession is neither not stupid nor brilliant.

Archaeological evidence suggests that, for thousands of years, the people who inhabited the Great Plains of North America, stretching from present-day Canada to Mexico, from the Rockies to the Appalachians, were among the wealthiest in the world. Anthropometric data reveal that they were likely the tallest people on earth. Their wealth and health is surprising, because in every other historical case, prosperity was associated with large population centers built by trade or conquest or, more often, both. But the people of the Great Plains never coalesced into a large empire. Trade and war, while present, were not the sources of their affluence. So what was?

Bison. For approximately 10,000 years, bison were the sole economic activity of the people of the North American Plains. Upwards of 30 million bison roamed the continent, providing a reliable, plentiful, and inexhaustible, source of food and wealth. The arrival of Europeans to North America, first the Spanish, then the English and the French, gradually constricted the range and size of the bison herds. This accelerated with the completion of the Transcontinental Railroad, that was built through a series of treaties that specifically restricted the number of bison that could be taken. Despite losing more than half its original habitat over the previous century, there were still approximately ten million bison on the Great Plains when Leland Stanford drove the Golden Spike through the last tie of the Transcontinental Railroad in 1869. Then disaster struck.

Bison hides are tough, very hard to work with, not nearly as malleable, or desirable, as deer or lamb, for example. But in 1871, tanners in Germany and England developed new technology that could make bison hides nearly as supple as other skins, and demand soared. By 1875, one million hides were being exported annually to Europe, treaties with Native Americans notwithstanding, and bison began disappearing from the North American continent. The last communal bison hunt by the Sioux occurred in 1882. By the middle of that decade, fewer than 500 bison remained in North America, all held in captivity. The map below shows the range of the bison in 1730 (the lightest region), in 1870 (the darker region), and the six small, remaining herds in 1889. Tribal territory boundaries are also marked in the continental United States.

Source: The Slaughter of the Bison and Reversal of Fortunes on the Great Plains, Donna Feir, Rob Gillezeau, and Maggie E.C. Jones, November 29, 2018.

This was a disaster for the bison, but it was an equal calamity for the people dependent on them. Recent research by three economists at the University of Victoria (https://ideas.repec.org/p/vic/vicddp/1701.html) examined the outcomes of the people of the Great Plains following the demise of the bison and came to some startling conclusions. For those that lived in regions where the slaughter of the bison was sudden and swift, their subsequent generation was about 9cm (3.5 inches) shorter than those who lived where the loss of bison was more gradual. From being the tallest people on earth, within a generation they were among the shortest.

The Native Americans of the Great Plains were placed on reservations where they were prohibited from leaving without permission from a government official. This policy was relaxed only in the 1930s. No economic activity was permitted except agriculture, an enormous burden for a people who had been dependent solely on hunting bison for thousands of years and had no history or knowledge of agriculture. This subjugation ensured poverty that persisted for generations.

By 2000, when the data were collected, per capita incomes of bison-dependent tribes were 20-40% lower than for other Native Americans. This material difference becomes even more significant when we consider the average per capita income of Native Americans was only $10,500 in 2000. The sudden loss of livelihood and human capital with the demise of the bison, and the subsequent policies to restrict movement, limit education and deny opportunity contributed meaningfully to the economic deprivation of Native Americans for generations. And not just economic deprivation: the formerly bison-dependent people of the Great Plains have the highest rates of mortality and despair (suicide, drug addiction) in the country. There is a growing body of work in the psychological literature that suggests that trauma may be transmitted across generations. While causality cannot be proven, the evidence seems to connect the trauma of the loss of the bison with the subsequent deprivation of succeeding generations.

Truth or Consequences was one of the longest-running shows in American media history. It began on NBC radio in 1940, created and hosted by Ralph Edwards. For the tenth anniversary of the program, Edwards announced that he would broadcast the show from the first town to change its name to the program, which is how Hot Springs, New Mexico became Truth or Consequences, New Mexico. The radio show switched to television in 1950, and ran continuously through 1988. Contestants could either answer a question truthfully, or face the "consequences" (usually performing a zany skit).

Robert K. Merton essentially invented modern sociology. One of his seminal works was his 1936 paper, The Unanticipated Consequences of Purposive Social Action, which offered a systematic analysis of why some deliberate acts to affect social change could have unintended consequences. He identified five areas that could lead to unanticipated consequences: ignorance, analytical errors, favoring short-term interests over long-term ones, basic values that skew or prohibit certain actions, and self-defeating prophecy that prevents what it predicts from happening.

Merton gave us the conceptual framework for unanticipated, or unintended, consequences. The sudden, near-extinction of the bison destroyed the economy and culture of those dependent on the animal. That was the consequence of the swift near-extinction of the bison, and perhaps it was unintended. But let’s make a distinction between unintended and unforeseen. The economic and social deprivation among the indigenous people of the Great Plains was not merely unintended, its persistence across generations, to this day, was completely unforeseen. Economic repression, high mortality rates, drug dependency, generation after generation, are the unforeseen consequences of the sudden demise of the bison.

Which leads to the question, what are the unforeseen consequences of our actions today? Climate change is one obvious area to consider. The unintended consequences of climate change are abundantly clear in the unprecedented rise in drought, fire and floods. But looking beyond those natural disasters, what are the unforeseen consequences years in the future? What are the effects of climate change on health, for example? Is there a connection between climate change and the likelihood of mass epidemics? We don’t know, and we are likely to be surprised.

Another question might be, what are the consequences of our degenerative civil discourse? We are as politically polarized as we have been in this country. One unintended consequence of this polarization was the election of a president whose norms of behavior would have previously been disqualifying for that office. But what are the unforeseen consequences? The erosion of our institutions that safeguard democracy? Habitual abuse of power that leads to demagoguery, as the Roman Republic descended to Empire and eventual collapse? We don’t know.

As we contemplate the unforeseen consequences of our actions, we must summon the will to regain control over our future: to reverse the emissions of carbon that will lead to climate catastrophe; to throw out the extremists would divide us and elect those to promise to work to unite us; to right past injustices, unintended, unforeseen or otherwise.

From the brink of extinction with less than 500 individuals remaining, the bison herd in North America now numbers more than 500,000. That’s a long way from the tens of millions that once roamed the Plains, but it gives us hope that we can move to redress past errors.

The game show gave contestants the choice between truth or consequences. In reality, it’s both: the truth has consequences. It’s our choice.

My first impression when flying into Mexico City a few weeks ago was its vastness. From the air, the city seems to stretch forever. The Valley of Mexico has been inhabited for over 12,000 years, and when Hernán Cortés entered it in 1519, its population of 1 million was probably the largest in the world. Today, Mexico City is home to more than 21 million people, twice the size of the second largest Mexican city in the world, Los Angeles.

Mexico City is a great destination for tourists, with world-class museums, dining and archeology. Most of my travels are for business, and I was looking forward to being a tourist again. But on my second day in Mexico City, I began to sense a different feeling than what I had been expecting. I realized the discomfort was coming from my iPhone.

In the past, a central part of the travel experience was navigating a foreign country in a foreign language. You had to read the street signs, interpret a paper map and ask for directions with either a rudimentary level of language skills or by interpreting universal directional hand signals. Today, your phone will tell you, in your language, where and how to go. Even easier, there’s Uber (or its equivalents). Punch in the destination, and a car arrives in under a minute to take you there.

All this is very convenient, and has eliminated the need to speak to anyone. Technology has enabled us to function in isolation, but has also deprived us of the benefits we accrue by making an effort at establishing actual, interpersonal relationships. I realized that it was this lack of interpersonal communication that was the source of my agitation, so I made a conscious effort for the rest of my visit to speak Spanish to as many people as I could.

Engaging with people is challenging, especially when there is a language or cultural barrier, but I found the lack of interaction unsettling, and preferred the small discomfort of communicating in a foreign language to the isolation (and convenience) that technology affords. It was walking around Mexico City, trying to frame these thoughts, that led me to wonder if my discomfort was analogous more broadly to modern society.

"Only the lonely know why I cry," sang Roy Orbison. Sadly, loneliness is on the upswing. A Kaiser Family Foundation survey last year (https://www.kff.org/other/report/loneliness-and-social-isolation-in-the-united-states-the-united-kingdom-and-japan-an-international-survey) found that nearly a quarter of adults in the US and UK often feel lonely or isolated (see table below). The Japanese have a word, hikikomori, literally meaning "people who shut themselves in their homes." Juliane Holt-Lunstad of Brigham Young University found that loneliness was related to a 26% higher risk of dying. In response to a separate report, last year the UK appointed a new Cabinet Minister for Loneliness (Tracey Crouch).

Loneliness has many causes, including economic stress such as long-term unemployment, but a majority cite technology as a contributor (graph below).

Last year, there were more than 70,000 deaths in the US due to drug overdose, 47,000 due to suicide (see chart below), and life expectancy in the United States declined for the first time since the Spanish influenza epidemic of 1918.

Source: Centers for Disease Control and Prevention; Courtesy: Washington Post

I have not seen a formal causal link established between loneliness and these sobering facts, but it is likely there is a relationship. I also wonder if there is a relationship among loneliness, these frightening health data and political polarization.

Hannah Arendt drew a connection between loneliness and fear in her 1951 book "The Origins of Totalitarianism." Her observations are remarkably relevant today:

"What makes loneliness so unbearable is the loss of one’s own self which can be realized in solitude, but confirmed in its identity only by the trusting and trustworthy company of my equals. In this situation, man loses trust in himself as the partner of his thoughts and that elementary confidence in the world which is necessary to make experiences at all. Self and world, capacity for thought and experience are lost at the same time."

I’ve written before on political polarization (most recently here: https://blog.angelesadvisors.com/2018-investment-symposium-the-intersection-of-politics-and-investing/). As with every sociological phenomenon, there are many causes of this polarization, but it seems likely to me that all these factors (loneliness, deteriorating health and a polarized society) are connected.

A contributing cause, I think, is the insidious effects of modern media. According to Pew Research, more people rely on social media for news than read newspapers, and social media services are based on perpetuating past preferences, thus reinforcing biases. Polarization can be (is) very profitable, not only for Facebook, Fox and Google, but for politicians mobilizing their base. A lot of entrenched interests are thus highly incented to exacerbate our divisions.

Vivek Murthy, a former U.S. Surgeon General, calls loneliness an epidemic, a major public health crisis. So are suicide, drug overdoses and political polarization. The is no single remedy to any of these crises, but a step forward is recognizing the repercussions of how we use technology (or rather, how it uses us). A little less time with Facebook or Instagram, Fox or CNN, and a little more time with our neighbors seems like a right step for everyone.

"Maybe tomorrow a new romance,

No more sorrow, but that’s the chance,

You gotta take if your lonely heart breaks.

Only the lonely."

https://www.youtube.com/watch?v=ysmN7dsheE8

Sólo los solitarios. Gracias por su interés.

Time for my semi-annual book perspective. I read a lot of books, but truthfully, most of them I move through pretty quickly. In the non-fiction world, I find many to be one-dimensional, perhaps an interesting idea appropriate for an essay, but hardly requiring the expansive exposition of a full book. In fiction, I encounter good writing, but rarely transcendent prose. Here are five books that I especially appreciated in the latter half of this year:

History

On Grand Strategy, John Lewis Gaddis

John Lewis Gaddis, the dean of military historians, gives us a glimpse into his course at Yale with ten chapters on various military leaders. He writes critically of famous conquerors such as Xerxes, Alexander, Julius Caeser, Pericles and Philip II of Spain, all of whom overstretched their circumstances and capabilities. Hitler and Napoleon are also critiqued, but Gaddis chooses Augustus, Elizabeth I, Bismark, Lincoln, Churchill and FDR as exemplars of great strategic leadership. Gaddis also praises St. Augustine, Edmund Burke and Isaiah Berlin, Sun Tzu and Machiavelli, but his highest honors go to Clausewitz, and, most surprisingly, to Tolstoy, for showing us how to live with constraints and paradoxes. If you are a student at Yale, take his class. If not, read his books.

Politics

The Road to Unfreedom, Timothy Snyder

This book begins as an explanation as how Vladimir Putin expounds the narrative of Russia as redeemer of the many evils threatening its purity, thereby dominating the Russian people through persuasion and coercion. But Snyder, another Yale professor, and an expert in Eastern European and Russian history, does not stop with a critique of how Russia sees itself in the world or Putin’s tactics in maintaining power. He traces Putin’s lies, myths, distractions and crises to the present political conditions in many parts of the world, especially in the United States. The parallels with Putin are disturbingly similar, and the risk of falling into "unfreedom," is rising.

Fiction

The Only Story, Julian Barnes

Julian Barnes writes with wit and emotion in this story of a teenage boy and a middle-aged woman who fall in love in 1960s Britain. The relationship is awkward, especially in the context of the social mores of the time, but their love is genuine. As one partner degenerates into alcoholism and mental instability, pushing the other away, we feel the strains and pains of a dying love. But the original flame of love is never fully extinguished, and in the end, that is the only story.

A Little Life, Hanya Yanagihara

Four college friends move to New York to begin their various careers, promising to remain close as the years pass. Each character is richly drawn, at times exaggerated into caricature, but we connect to their lives and emotions. This book is beautifully written, but it’s the surprise discovery of a traumatic past that is both painful to absorb and impossible to forget.

Men We Reaped, Jesmyn Ward

This is Jesmyn Ward’s autobiography of growing up in rural Mississippi. She re-creates her world through her observations of the men in her life: her father, brothers and friends. While it is her life, the book is really about the experience of African-American men in the rural South. In her talented hand, we are led into that foreign (for many of us) world, and are given the gift of a glimpse into the daily struggles, tragedies, and occasional joys of this besieged community living among us. Somber and acerbic, eloquent and poignant: Jesmyn Ward is a rare talent. This book moved me deeply.

Twenty-five hundred years, Siddhartha Gautama practiced a form of meditation that involved controlled breathing. Much later, about 700 years ago, this practice, called pranayama, was codified in the most famous of Hindu texts, the Bhagavad Gita. More recently, Western science has validated the physiological benefits of pranayama. Respiratory functions are improved (increased tidal volume, ventilation efficiency, arterial oxygenation, etc.), cardiovascular system is enhanced (greater cardiac output, synchronization of vasomotion, increases heart rate variability, decreases blood pressure, etc.), and the autonomic nervous system benefits (increases vagal activity, improves phasic modulation of sympathetic activity, etc.). Here’s a simple diagram:

Source: G. D. Pinna, R. Maestri, A. Mortara, and M. T. La Rovere, Cardiorespiratory interactions during periodic breathing in awake chronic heart failure patients, March 2000.

The survival instinct is genetically encoded in humans: when we see sudden movement in front of us, we react with common physiological features: rapid heartbeat, surge of adrenaline, and increased neurological activity to assess the danger and determine whether to flee or fight. It could just be a bird in the thrush, but it might be a hungry bear.

This year-to-date chart of the S&P 500 Index demonstrates that investors see a bear in the bush, and not a bird, and are fleeing from this potential danger.

S&P 500 Index 2018 Year-to-Date

The S&P 500 Index is down a little more than 5% this year (including dividends), but it is off more than 15% from its all-time high in September. We know that equities fluctuate considerably, but how do we know if or when a bull market turns into a bear, or vice versa? The answer may be found in two areas, fundamentals and perspective.

Earlier this year, I argued that bear markets come in different flavors (https://blog.angelesadvisors.com/2018-angeles-foundation-symposium/). There are the frequently-occurring, usually swift, and generally benign bear markets of 15-20% declines. These are usually triggered by one-off events, and we recover in short order. There are the larger bear markets, with declines of 20-30%, associated with a turn in the economic cycle (recession), and can take longer to rebound to new highs. Then there are really bad bear markets, 40-50% declines, associated with some major structural imbalance (leverage, valuations, e.g.). I advised ignoring the first kind of bear market, because it would likely be over before we could respond. But what about the other two, is the economy about to contract or, even worse, are valuations or leverage so excessive we should expect a major correction?

Let’s throw out the latter scenario. Leverage is actually below historical levels. Household debt service ratio is the lowest on record (since 1980-see graph below). Yes, corporate debt is at a record high, but so are profits, and relative to equity, near an all-time low (since 1945-see second graph below).

Household Debt as Percentage of Income, 1980-2018

Nonfinancial Corporate Debt as Percentage of Equity, 1945-2018

Neither are equity valuations excessive. If anything, valuations have diverged significantly lower (see graph below showing the S&P 500 Index price (black line) over the past 10 years and its P/E ratio in green). At 17x, US stocks are not cheap, but they are just below this past decade’s average.

S&P 500 Index and P/E Ratio, 2009-2018

The conditions for a brutal bear market, excessive leverage or valuations, are not present, and a major crash is very unlikely. That leaves the economic-cycle recession, that since 1945, has occurred every five years or so and sees an average decline of 25-30%. Could that be in the cards?

Sure, but the evidence isn’t there yet for an economic contraction. Leading indicators remain strong, manufacturing output is expanding, the consumer is healthy, the labor market is tight, and monetary policy is still accommodative. I know you’re thinking, "hold on," monetary policy is accommodative? Isn’t the Fed tightening the screws? Yes, the Fed is tightening, but real yields of just over 1% are still well below long-term averages of around 2.5% (see graph below for the real yield of long-term TIPS).

Long-Term TIPS Yield, 2003-2018

The list of worries is long. Economic growth is slowing, especially overseas. China, which has been responsible for more than half of the world’s growth over the past decade, faces acute economic issues, from falling exports to rising debt levels. Europe is negotiating the impending train wreck of Brexit while France is racked with violent protests and Italy brazenly violates fiscal rules. Germany, Europe’s prime economic engine and political power, faces a change in government that is more likely to exacerbate than to heal rising political tensions. And finally, there is not enough space or enough words to describe the lamentable state of American politics, which is widening our wounds and weakening our global position.

I said earlier that there are two areas of study to help us analyze conditions: fundamentals and perspective. I’ve laid out the fundamental picture, now let me say something brief about perspective. The first chart above of the S&P 500 Index this year, shows a plunging price to new lows. Given our natural instinct to extrapolate, this is a scary chart, because we can’t see a natural bottom. But stepping back, over the past 90 years, we see a different pattern (graph below, in semi-log scale). Markets move through cycles, and there are long periods (decades) of consolidation (no firm direction) and periods of advance. It’s important to note, although harder to appreciate with this semi-log scale, that many of the wiggles, during both periods of consolidation and advancement, represent large percentage swings. I’ve only lived through (consciously) about half the period below, but I know first-hand that each of these declines feels terrible. The loss on paper is bad, but the uncertainty of where the bottom is (if there is one) and when we will get there, is worse.

S&P 500 Index, 1928-2018

But with the right perspective, we can begin to see market declines as opportunities rather than as cause for panic. The rattling in the bush may be a bear, or just a bird, or just the wind. Let’s address that with a clear head and a calm heart. Breathe.

The expression comes from Colonial America, but its exact origins are unclear, and its meaning seems to have changed over the years. Originally it was a phrase that denoted pleasant, or even silly, conversation. Today, "talk turkey" means plain, direct speech. Just the facts (ma’am). So, let’s talk turkey.

Turkey is a mess, on many levels, and it’s all self-inflicted. It is classic economic mismanagement for narrow political purposes, a pattern we’ve seen (literally) hundreds of times. Its symptoms are predictable, its cure is obvious, but the prognosis is bleak. Politics and personality are turning a manageable economic crisis into a catastrophe. Let’s briefly look at the symptoms before turning to the root causes.

Inflation in Turkey has jumped to over 15% this year, and continues to rise (see first Chart). The lira (its currency), is down about 50% this year, 30% in just the past month (second Chart).

Turkey Inflation, YTD 2018

Turkish Lira per US Dollar, July-August 2018

As money flows out of the country, its current account deficit is widening, to more than 6% of GDP (see first Chart below). This is forcing the central bank to sell down its reserves at a rapid rate (see second Chart).

Turkey Current Account Deficit as Percentage of GDP, 2013-2018

Turkey Gross Foreign Reserves, 2013-2018

Turkey has $466 billion of foreign debt, mostly (78%) denominated in US dollars, equivalent to more than half its GDP. About one-third of this debt is due within the year, and refinancing will be nearly impossible as bond investors have forced yields to more than 23% (see Chart below).

Yield of Turkey Government Bond 10.7% Due 02/2021, July-August 2018

The pattern of this economic crisis has been repeated hundreds of times, even as the details differ. Very low interest rates in the US and Europe in the wake of the 2008 global financial crash tempted Turkey to borrow excessively in foreign currencies. The money was used for uneconomic (i.e., politically-determined) projects that swelled the budget deficit. The excessive debt stimulated nominal growth, and loose monetary policy permitted inflation pressures to build unchecked. The markets responded by selling Turkish assets-stocks, bonds, the currency-exacerbating inflation and contracting the economy.

Years of economic mismanagement cannot be wished away, but the path to stability is well-documented: move the budget into a structural surplus, raise short-term rates above inflation, secure credit lines from the IMF or other creditors, accumulate foreign reserves. This will be painful-the economy will contract further, unemployment will soar, standards of living will decline-but it will bring stability from which recovery is possible. This won’t happen soon, and each day delay will only add to the inevitable pain and cost of salvaging a wrecked economy.

Sadly, Turkey seems to be following the well-worn path of so many failed states. Recip Tayyip Erdogan had been mayor of Istanbul in the late 1990s, and was elected prime minister in 2003. Initially, Turkey enjoyed strong economic growth and a vibrant democracy. But over time, Erdogan accumulated more power, and in 2014 he was able to amend the constitution to have himself named president. As power coalesced in one person, the institutions that define and defend a democracy-especially a free press-were eroded. In 2016, elements of the military, which had historically seen itself as defenders of democracy, staged a coup that was put down with much bloodshed. Subsequently, tens of thousands of military officers, teachers and civil servants lost their jobs under suspicion of supporting the coup. Since then, Erdogan has used the coup attempt as cover for gathering greater powers in the presidency and stifling political opposition. The markets believe, correctly, that there are no independent actors that can counterbalance the personal decisions of Erdogan. The new Treasury minister, Berat Albayrak, for example, is Erdogan’s son-in-law.

Turkey is a member of the NATO Alliance, and has been, for decades, a close ally of the United States. But relations deteriorated rapidly after the failed coup in 2016 when Erdogan accused Fethullah Gulen, a Muslim cleric living in Pennsylvania, of masterminding the coup attempt and demanded his extradition to Turkey. There is a formal extradition procedure that requires proof of likely complicity in a criminal act, but either that proof has not been offered or US officials found it unpersuasive. Regardless, Mr. Gulen remains in Pennsylvania.

In retaliation, or frustration, or both, Erdogan has detained numerous US citizens in Turkey and imprisoned Turkish staff working at US diplomatic missions. Serkan Golge, a Turkish-American scientist working for NASA, was recently sentenced to more than seven years in prison, and Andrew Brunson, an American evangelist living in Turkey for 20 years, is under house arrest, his release tied specifically to the extradition of Gulen. Erdogan sees these detainees are bargaining chips to mold US behavior in withholding support from Kurds fighting in Syria, and to scrap the fines imposed on the state-owned Halkbank for violating US-Iran sanctions.

Likewise, the US has demanded the release of Pastor Brunson, has clashed with Turkey over policy in Syria, and is worried by Turkey’s growing ties to Russia. Turkey, a NATO ally, announced it intends to buy the Russian S-400 missile defense system. The US will withhold the transfer of F-35 fighters to Turkey if it installs the Russian missile defense system. A few days ago, President Trump doubled the tariffs on Turkey’s steel and aluminum, to 50% and 20%, respectively. In reinstating sanctions against Iran, the US will block any country doing business there from doing business in the United States. Turkey imports most of its energy from Iran, and has few other energy options, as Iraq and Saudi Arabia are unlikely to assist a country that has become adversarial in the region. The US could block loans from the international credit agencies, and remove Turkish banks from the SWIFT money transfer system, which would likely bring financial collapse. This fight can easily escalate further.

Turkey is a minor actor in the world economy, with a GDP smaller than Los Angeles. There are a handful of banks, mostly Spanish, with relatively large loan exposure to the country, but a debt default should be able to be contained without systemic consequences. So for the world economy, the immediate consequences of Turkey’s crisis may not be all that material. But that doesn’t mean there won’t be other consequences of great importance.

A Turkish withdrawal from NATO would be a terrible blow to the Alliance, immediately and permanently. The complex and tenuous balance of relationships in the Middle East would be shattered, and a broader war more likely. Of course, the Turkish people will suffer greatly.

The erosion of democratic institutions allowed the concentration of power in a charismatic leader, which he used to further undermine democratic opposition to his rule and to antagonize former allies, thus threatening more instability for a region already in turmoil. It didn’t, and doesn’t, have to be this way.

Erdogan should release his American hostages (which is what they are), and accept the conditions imposed by the IMF for an economic bailout. Each day delay means even greater pain for the Turkish people. Unfortunately, this path is unlikely to be followed, and the consequences for the region and even the NATO Alliance, could be severe. I’m not talkin’ pretty, but I am talkin’ turkey.

I love the beach. And I read a lot. I like reading on the beach, but I am not a fan of beach reading. Beach reading is generally defined as light, pleasurable, contemporary fiction, often with some romantic angle. This is a genre I could not imagine more unappealing.

So none of these qualify as “beach reading,” but here are a few of the highlights of my reading list since my last update six months ago (https://blog.angelesadvisors.com/2017/12/not-recommended-reading/).

Politics/History/Society

Enemies and Neighbors, Ian Black. There is no ground-breaking research or insight here, but I found this to be the most balanced history of Israeli-Palestinian relations I have read. Black, a journalist for The Guardian, liberally shares the blame on both sides for missed opportunities for accommodation, but concludes that Zionism and Palestinian nationalism were and are irreconcilable, with no end in sight to the conflict.

The Garments of Court and Palace, Philip Bobbitt. This book is a narrow, but important contribution to understanding the riddles and contradictions of Machiavelli’s political thought. Bobbitt ties together Machiavelli’s two most famous works, The Prince and Discourses, in an attempt to reconcile disparate concepts, debunking many of the common interpretations of his most famous phrases (especially, the end justifies the means, not at all what we think Machiavelli meant). Bobbitt’s "breakthrough" comes by seeing Machiavelli as the first modern political scientist, the first to build a framework for how to govern the modern political state in the form of constitutional principles. It’s not surprising that Bobbitt, a constitutional scholar now at Columbia, reads Machiavelli through the lens of constitutional law, and the book is written in an erudite, somewhat ponderous prose, but Bobbitt offers a rich perspective on interpreting Machiavelli, and makes a strong case for him as "the most influential political theorist since Aristotle."

Nixon, John Farrell. I’ve read dozens of books on Nixon, of the hundreds, if not thousands, that have been published. This Nixon is straight biography by a former journalist, and is the best single volume biography on Nixon I’ve read. Farrell provides rich context for the environment and times in which Nixon lived and the evolution of his political ideology. Farrell balances Nixon’s strategic brilliance and his deep personal flaws, and embraces Nixon’s contradictions with equanimity.

An Odyssey, Daniel Mendelsohn. Do we need another scholarly analysis of Homer’s The Odyssey? Two aspects make this book special. Most importantly is the voice of Daniel Mendelsohn, one of the most brilliant people I have ever heard lecture. His assessment of Homer is succinct and insightful, painting a vivid picture of both the personal, as in Odysseus’ yearning and cunning, and the metaphysical, as in journey, reflection, and discovery. The story is humanized further when Mendelsohn’s father audits his class at Bard College, promises to sit in the back and not speak, and ends up enthralling the students and embarrassing the professor.

Janesville, Amy Goldstein. There seems to be a surge of books about the evisceration of working-class communities told through the lens of individual stories. Some are quite good, most lack depth or insight, but this one is exceptionally researched and told. Janesville, Wisconsin is a company town, General Motors in this case, and when the plant closes in 2008, the impact is pervasive. Almost every family in town struggles to find employment, but mostly, to maintain dignity. The plant closing both tears the community apart and, in some ways, brings it closer together. Goldstein, a reporter for the Washington Post, tells the story of this community with empathy.

Art/Science

Beethoven’s Symphonies, Lewis Lockwood. Lockwood is the definitive living source on Beethoven’s life and work. His 2002 book, Beethoven: The Music and the Life, is the best single volume overview of this genius. This new book is a deeper dive into each of his nine symphonies, offering new research into the artistic development of each one, developed from exhaustive notes in Beethoven’s own hand, as well as a musical analysis of each symphony. The earlier biography is suitable for general audiences, but I think this one requires both moderate understanding of music theory and a strong familiarity with each work. If you possess both, this book is richly rewarding.

Zapped, Bob Berman. Everything you wanted to know about light is here from poplar science writer Bob Berman. Actually, it’s more than everything you wanted to know because you probably did not know what there is to know about light in the first place. You may recall from high school that visible light is only a tiny part of the electromagnetic spectrum, and Berman explains each part from gamma and X-rays through ultraviolet and infrared and microwaves. What we see is not what there is.

Fiction

A Horse Walks Into A Bar; To the End of the Land, David Grossman. No summary can adequately describe the unique voice of David Grossman, an Israeli author. A Horse Walks Into A Bar is a transcript of a stand-up comedian’s set in a dingy night club. I did not find the jokes funny, although some may, but this is not a book about jokes. It is part commentary on modern Israeli life, and part reminiscing of a sad childhood, bringing in audience members along the way to sympathize, criticize or argue, or all three simultaneously. A Horse Walks Into A Bar won the prestigious Man Booker Prize last year, but I preferred Grossman’s earlier (2008) book, To The End of the Land. A mother sends her son off to the army, and embarks on a trek across the country. Her relationships with her son(s) and father(s), her struggles with both self-doubt and joy, all woven in a mystical, magical, yet very real, human world, make this a very special book.

Markets work through the forces of demand and supply. This axiom applies to all markets, from housing to marriage (as Gary Becker famously noted), and anywhere there is an exchange of goods or services (or mates). In all markets, price is the regulatory mechanism that ensures an equilibrium between the amount demanded and the amount supplied. Adam Smith called this the "Invisible Hand."

You knew all this already, because it is about as fundamental a concept in economics as exists. The price of that house is X, or the price of that automobile is Y, because X and Y are the prices that clear the market, that is, that determine that the supply meets the demand. Too many unsold houses or automobiles, and the price will fall to a level that will stimulate demand. Sudden demand for more houses or automobiles, and the price will rise. A falling price signals to cut back production, a rising price tells suppliers to make more. Most of the time, this is exactly how markets "work." Yet sometimes, we observe market behavior that seems at odds with our expectations, and we scramble to uncover the hidden forces that produce this unexpected behavior. The labor market today has many economists scratching their heads.

By all conventional measures, this is as strong a labor market as we’ve seen in decades, even in generations. The 3.9% official unemployment rate is the lowest since the tech boom of 2000. The gap between job openings and the number of unemployed was nearly 13 million (12,952,000 to be precise) in October 2009. It is virtually zero today (35,000-see the Chart below).

Source: U.S Bureau of Labor Statistics

Wait, there’s more. Continuing claims for unemployment insurance are the lowest since 1973, and initial claims for unemployment insurance are at the lowest since 1969. And today’s US labor force is twice the size it was back then. So, the data all point to a very tight labor market, and when demand for workers is rising relative to the supply of workers, the market responds by raising the price of labor (wages) and by attracting more supply (workers) into the workforce. That’s the way it should work, that’s the way it has always worked, but that is not how it is working now. Wages are rising only modestly, and the pool of available labor is shrinking. Hence, we see economists scratching their heads.

Wages are up 2.6% over the past twelve months, which is ahead of inflation (2.4%), but only modestly. Given how tight the labor market is, we would expect to see wages rising much faster. The answer to this riddle is hard to solve definitively for two reasons. First, this is a complex market, meaning there are many, many factors that weigh on demand and supply of labor, and linking specific variables to specific outcomes is nearly impossible, certainly not linearly. Secondly, proving causation is even harder, even if it were possible to draw a linkage between data.

That said, there are plausibly three broad trends that logically have combined to suppress wages: the decline in collective bargaining, automation, and global labor arbitrage. All three phenomena have been in place for decades. Union membership in 1983 (the first year the BLS collected data) was 20.1% of the workforce. It has fallen nearly in half, to 10.7%, today. For the private sector, just 6.5% of employees are unionized (it’s 34% in the public sector). We talked about the rise of robots back in 2015 (https://angeles-srv.s3.amazonaws.com/content./1441741791./2015-2.pdf), and that trend has only accelerated in the interim. The global labor arbitrage speaks directly to the forces of supply and demand. The collapse of the Soviet bloc in 1989 and the addition of China to the World Trade Organization in 2001, especially, brought billions of new workers into the global economy, nearly doubling the worldwide supply of labor. Our continued insistence on viewing markets domestically that have, in fact, become global, means we miss the important impact globalization, by expanding the labor pool, has had on workers.

Wages have advanced modestly in this economic recovery, for whatever various reasons, but of perhaps greater concern is why it has become so difficult for low-wage employees to move into higher-wage jobs. We wrote last year about the decline in generational income mobility in America (https://angeles-srv.s3.amazonaws.com/content./1509463701./angeles-commentary-3q.pdf), and a new study by the Federal Reserve Bank of New York (Can Low-Wage Workers Find Better Jobs?, FRBNY Staff Report No. 846, April 2018) highlights how few low-wage workers move to higher wage jobs. Among the lowest quartile earners, in the past year 70% stayed in the same job, 11% exited the workforce, 7% became unemployed, and 6% switched to another lowest wage-quartile job. Only a little over 5% found a better job (see graph below).

These researchers point to a lack of formal education as the principal barrier to finding a better paying job, and also note that older workers are much less likely to move up the wage ladder. Interestingly, sales positions offer better prospects for advancement, and developing interpersonal ("sales") skills could be an important path for many low-wage workers.

The other "mystery" puzzling economists is why the tight labor market has not drawn more workers into the labor force. At the peak of the last boom in 2000-2001, more than 67% of the population was in the labor force. Today, that has fallen to just 62.8%, barely up from the low of 62.3% seen in September 2015.

Now, a lot of the explanation for the low participation rate is demographic. Over the past decade, more than half of the decline is attributed to retirements (first graph below). On an age-adjusted basis, the labor participation rate has almost fully recovered to 2007 levels (second graph).

To examine the dynamics of the labor force more closely, we can put aside demographics by looking at data for prime-aged (25-54 years) workers. Despite a much weaker job market in Europe, where the unemployment rate stands at 8.5%, the participation rate for prime-aged workers exceeds that in the US (even in France, mon dieu!-see graph below for selected major countries).

Over the past decade in advanced economies, we see a sharp divide in the change in participation rates among men and women. In most countries, the participation rate for men declined, whereas it increased for women. But in the US, which saw the second largest overall decline in the participation rate in the OECD (behind Portugal), declines occurred for both men and women (graph below). So there’s something going on in the US that’s not explained by age and gender.

We have written extensively over the past year-plus(https://angelesadvisors.com/insights/#highlights) about the unique factors in the US that have worked collectively to reduce the labor supply among prime-aged workers, including high levels of incarceration, disability and addiction. To this, we can add a rural-urban divide. The fall in the labor force participation rate from 2000-2016 was widespread: every state saw declines (see graph below) but North Dakota (where there was a boom in shale oil production in the Bakken) and DC (tracing the inexorable growth of the federal government).

But participation rates in major cities were mostly much stronger compared to their surrounding areas. The graph below shows only three of the fifteen largest cities saw bigger declines than their surrounding areas (Atlanta, Phoenix and Dallas), where two (Los Angeles and New York) posted increases even as their regions saw declines.

The drop in the percentage of people working has enormous and widespread implications, both short-term and long-term. In the near-term, it may be driven by deeper structural problems, such as the afflictions of addiction and despair that tear apart communities. In the long-term, our societies are organized around people working: we rely on income to consume goods and services, we donate excess income to charities or save it for future uses, we tax income to fund government, entire communities are built around a dominant employer or industry.

The decline in labor force participation has many causal roots, and we need to consider the possible remedies for each one. To address the aging of our populations, we could expand tax credits for children, or welcome more (and younger) immigrants. To increase the percentage of women in the workforce, as has occurred in most other countries, perhaps better access to childcare, or more flexible work schedules, could be encouraged. Incarceration and drug dependency are crises in need of remediation for their own sake, even more than for the impact on the labor pool. Tax policy, based on workers’ incomes to fund Social Security and Medicare directly (and most of the rest of government in aggregate), needs to be re-thought in a world of fewer workers and more dependents. Would a tax on wealth, instead of income, be a better framework?

I do not mean for any of the above to be policy prescriptions or recommendations, only to say that the decline in the labor force participation rate is one of those economic data that gets little attention but has enormous consequences.

The title of this post references a 1959 hit song by Frank Pingatore, who was Bill Haley’s barber and songwriter (in that order). Frank re-wrote a song called Around the Clock Blues for Bill Haley and the Comets in 1955, re-titling it Rock Around the Clock. Frank wrote Everybody Out’ta the Pool for Bill Haley and the Comets, but Bill wanted no part of it, so the Comets recorded it as The Lifeguards, their one and only (modest) hit. But with Bill Haley out of the pool, the Comets, the Lifeguards, and even Bill Haley languished on in relative obscurity until Bill’s death in 1981. A fate our economy faces if we don’t find ways of getting more people back into the pool.

Last year, I introduced my big picture framework of assessing the relative attractiveness of markets Inside the Triangle through the lenses of valuation, momentum and sentiment. To recap, the ideal time to buy a market is when valuation is cheap, momentum is positive and sentiment is poor. It’s best to sell when the opposites prevail: expensive valuation, poor momentum and exuberant sentiment. The 2000 internet bubble is a recent case-in-point for conditions at a market top, and March 2009 a time when the conditions to buy were very favorable. Of course, most investors find it hard to sell at the top and buy at the bottom, and generally are doing the opposite, which is why there are market tops and bottoms in the first place.

Most of the time, however, market conditions exhibit a mix of these three factors, or sides of my investment triangle. Last year, I saw valuation as expensive (bad), momentum as neutral, and sentiment as poor (good), leading, overall, to a neutral asset allocation relative to our clients’ long-term strategy. There was a lot to be worried about last year, from a volatile new President to a nuclear North Korea, but this framework kept us fully invested, and we were rewarded with strong results (admittedly much stronger than anyone expected).

Today I see more similarity with market conditions last year than notable differences, despite (because?) of the very strong performance in almost all capital markets. Valuation is still expensive, but momentum is positive and sentiment is neutral, leading to no change in our overall positioning. I’ll share what I’m seeing through these lenses.

Valuation

Below is a chart from 1900 to the present showing the percentile valuation levels of US stocks (via the Schiller P/E ratio), ten-year Treasury yields, and Investment-grade credit spreads (measured as BAA- less AAA-rated bonds). By all three metrics, stocks, bonds and spreads are very expensive relative to history.

Over the long-term (10+ years), valuation is an important determinant of future returns. Over short- and intermediate-term periods, valuation is very lowly correlated with returns. One-year forward performance, for example, has an r² <0.10 with Schiller P/E. In my analysis, valuation is important directionally, but given relatively little weight in deciding whether/when to shift portfolios.

Momentum

The graph below shows the S&P 500 Index from 1927 to today on a semi-log scale. I added the long-term upward channel from 1946 to highlight the long-term trend.

Most investors say they are long-term in their investment horizon. If this were true, investors would not have sold equities in 2009 or fail to re-invest since (the graph below shows the cumulative flows into US bond and stock funds since 2009).

In the first chart, I also highlight two periods, 1966-1983 and 2000-2013, where the equity market fell and recovered, but it took 13- and 17-years to break to new highs. The good news for investors today is that we are in the early stages of what I expect to be a long-term (10+ years) bull market.

Sentiment

This is an aspect that is most difficult to measure, because the data are often "squishy," as they are survey-based. There are some hard data I include, such as the put:call ratio and investor cash holdings reported by some of the banks/brokerages. Below is the AAII survey showing the percentage of investors identifying as "bulls," "bears," or "neutral" (no animal has been assigned to this category). Sentiment is a contrary indicator, that is, the more bullish, the greater the concern, and the more bearish, the greater the confidence. Investors are uniformly bullish at market tops and extremely bearish at bottoms. Today the various indicators all point to neutral: investors are not as bearish as a year ago, but we don’t see the extreme bullishness that marks market tops.

So, there you have it. My investment triangle says Stay Invested. Valuations are high, but momentum is positive and sentiment is neutral. I should note that this framework is but one tool in my investment kit. It’s focused on powerful market indicators, but I also spend a lot of time sifting through the economic data (which have been strong) and, more recently, considering geopolitical and socioeconomic conditions. I’ll continue to cover those topics in future posts, but for now, I wanted to share how I see the markets at the beginning of 2018. Happy new year to all!

I don’t like recommended lists. They turn experiences into a contest (and the winner is…), and one reviewer’s preferences may have little to do with mine.

That said, since my writing covers a very wide range of topics-history and sociology to science and art and beyond-I do get asked frequently where I come up with my themes. The answer is simply, I read a lot. More than a book a week, for sure, although I don’t really keep count (or rank).

I don’t necessarily assume you would enjoy anything that I did, but, to give you a peek at some of the books I especially enjoyed this past year, I offer my five favorites from 2017 (and a few more notables after that).

Paul Auster, 4 3 2 1

I enjoyed this well-written novel. Halfway through, I became confused, as it tells the story of its protagonist chronologically, but then seems to repeat itself but with diverging outcomes. It was not till the end that I realized his life’s story was told in parallel paths, with some events in common, and others differing radically. It is quite the challenge to keep this complex structure straight in your mind, but if you can manage it, the reward is enormous admiration for the writer’s accomplishment. Here is a more detailed review if you’re interested (https://www.nytimes.com/2017/01/31/books/review/4-3-2-1-paul-auster.html), but I was truly impressed with what Paul Auster accomplished here, and it is rare that I am impressed with anything. This book is very long and extremely complex, but so well written I was compelled forward. And, at the end, simply in awe that Auster was able to make it all work.

Peter Hayes, Why?: Explaining the Holocaust

There are probably thousands of books about the Holocaust. I’ve read a lot of them, beginning with Elie Wiesel’s Night, which I first read 45 years ago. It’s been downhill since. Night is a magical, powerful, unforgettable account of a Holocaust experience, and none have been better. Night falls into the category of first-hand experience, but the other, far larger category is an analysis of the Holocaust, how it happened, and why. Many books offer partial insights, but for me, this is the first that sets forth a full explanation that I found satisfying.

Hayes, who teaches at Northwestern, addresses four questions:

1. Why the Jews? In short, after centuries of oppression, Jews were given liberties that led to very visible success, which created a backlash of jealously.
2. Why the Germans? A multidimensional national crisis occurred in the aftermath of the First World War, enabling a group of haters to seize power.
3. Why Murder? Anti-Jewish policies gradually radicalized, facing no opposition with each step. The takeover of Eastern Europe made mass deportation impossible, leading to a policy of mass murder.
4. Why So Successful? Indifference opened the path to power for haters, the logistics of mass murder were relatively easy to implement, and Allied forces were unable to prevent it, especially in the peak killing years of 1942-43.

Hayes debunks some myths as well:

• Anti-Semitism was always part of Hitler’s agenda, but was not the principal driver of his gaining power;
• Murder became policy after the invasion of Poland;
• Jews could not have resisted.

I was persuaded by his arguments, and came away from this with a much deeper understanding of why the Holocaust happened. Like all good history, Hayes not only explains the past, but provides an understanding of the conditions that enabled those events to occur. Our responsibility is recognizing that those conditions are never completely dormant; our vigilance is always required.

James MacDonald, When Globalization Fails

The early years of the 20^th-century hold a deep fascination for me. It was an era characterized by innovations and contradictions. Technology and science saw unimaginable advances, from harnessing electricity to the internal combustion engine to the profound implications of Einstein’s relativity. Art broke new ground, with Picasso’s Les Demoiselles d’Avignon and Stravinsky’s Le Sacre du Printemp. It was an age of prosperity, and of social unrest, and was to come to an abrupt and devastating end in world war.

It was also the age of globalization, where economic ties bound together the world. Trade not only created wealth, it was thought to "render war obsolete," in the words of John Stuart Mill. This story has been told, well, many times, but here MacDonald manages some original thoughts.

Most interesting to me is his notion that economic interdependence leads to vulnerability, which leads to conflict. The mad rush for colonies was born from this sense of vulnerability, and rather than improve one country’s security, it led only to greater fear and insecurity, making conflict more, not less, likely. The height of globalization, economic integration, was 1913; a year later began the First World War.

A related point is that globalization requires an enforcer. A multipolar world is not a stable one. Since the Second World War, the United States has been that enforcer, enabling the world to reach unprecedented prosperity and peace. Sadly, in my view, we have chosen, voluntarily, to abandon our world role, making another era of conflict more likely, to the detriment of all of us.

This is an insightful book about an important era in history, one with clear relevance to our own time.

John McPhee, Draft No. 4

John McPhee is a national treasure. His writing is lyrical, natural, familiar-traits of all great writers, but exceptional in non-fiction. His Annals of the Former World is 700 gripping pages of the 4.6 billion years of North American geology. If that sounds impossible, it is, except in his hands.

His most recent book, Draft No. 4, is about writing, anecdotes and insights that span 60 years of work, mostly at The New Yorker. Now in his late 80s, he still teaches at Princeton, where he grew up (his father was the college physician), a course called, oxymoronically and appropriately, Creative Nonfiction.

This is a short book, I finished it in under two hours, filled with excerpts and lessons in writing along the way. For McPhee, and I suppose most every writer, writing is about selection (which word, among the million available, to use) and, crucially, revision. Hence the title, Draft No.4: the first draft is the hardest, and rawest, but the fourth draft is pleasurable, refining and polishing to perfection, or at least self-satisfaction. He embraces Michelangelo’s idea of chipping away a block of marble to uncover the statue inside, and cites Hemingway’s similar Theory of Omission, whereby he removes words and ideas, until the essence of the story is unveiled.

Tying this concept to advice on writer’s block, he offers: let’s say you have to write about a bear, but hours go by without any words coming forth. McPhee says, write a letter to your mother, saying, Dear Mother, I just don’t’ know what to say about this bear. The words will just not come, and I’ve been stuck for hours sitting alone. Of course, this bear is really big, six feet around the belly, three feet around the neck, and he sleeps 14 hours a day, but I just don’t know what to say about it. Keep going on, McPhee says, then go back and remove the complaining parts and the salutation, and you’re left with the beginning of your story.

I don’t do justice to this anecdote, or the wisdom and wonder of John McPhee. Every writer will recognize his predicaments, and will benefit from his experiences. I’ll read anything he publishes.

Geoffrey West, Scale

Geoffrey West is a theoretical physicist at Los Alamos and the Santa Fe Institute. Scale is the result of a question he asked himself: why do organisms die when they do? This leads to a discovery of power laws that scale remarkably consistently across organisms-mammals, birds, fish, plants-and functional networks-respiratory, circulatory, renal, neural, etc. For example, if an object’s shape is fixed, its area expands as the square of its length while its volume increases as the cube of its length. Doubling the lengths of a house triples the volume of air inside to be heated or cooled. Animals can only become so big before they run out of surface area needed to cool themselves (elephants have adapted by having large ears, which are not for hearing, but for dissipating heat).

Another example is metabolic rates. Every doubling of weight results in only a ¾ increase in energy. This is true from insects to birds, dogs to humans to elephants. Plot lifespan alongside this logarithmic graph of metabolism and energy and it lines up precisely. This law determines the limits to the size of mammals and the height of trees.

One implication of these observations is that evolution is constrained by mathematical principles beyond mere natural selection. Charles Darwin only got it partially right: natural selection operates only within the boundaries of power laws.

West also finds that birth and death are linked by a universal scaling law with just two parameters: this one-quarter law, and the amount of energy required to produce one ATP molecule via the oxidative chemical process (which turns out to be 0.65 eV). Birth and death are thus linked via mass and temperature with a slope of 0.65 eV.

Here’s the relevancy: a 10⁰ C increase in temperature doubles the metabolic rate (which is why you don’t find insects in the cold: they need warmth to increase their metabolic rate). A 2^o C rise in temperature, likely with global warming, results in a 20-30% increase in metabolic rate. Among the other problems global warming will cause will be a proliferation of insects.

West applies these observable laws to cities and to companies, and time and space prevent me from describing this further. I was astonished by all these observations, and reminded of the awesome beauty that can be found in mathematics. Once I was amazed at these discoveries, I found myself asking, why do these "laws" exist? That answer remains a mystery.

Other Notables

Fiction

Jonathan Safran Foer, Here I Am. A family in pain, in love, in conflict, confronting themselves, their identity, their history. Funny, sad, provocative.

History-International Relations

Graham Allison, Destined for War. I read Allison in college nearly forty years ago, and the Harvard professor is still one of keenest observers of international relations we have. His theme is Thucydides’ Trap, the conflict between a status quo power (Sparta, US) and a rising power (Athens, China). War between China and the US is not inevitable, but neither was war between Athens and Sparta. But it happened anyway, with both sides losing.

Howard French, Everything Under the Sun. How China sees itself in the world. Read it, along with Allison, to understand US-China relations, and how incompatible our world views are. That doesn’t mean we can’t find an accommodation, but we should understand that we do have very different perspectives on how the global order should be shaped.

Robert Kaplan, Earning the Rockies. Kaplan writes so well, and is an astute observer of international relations. On one level, this is a book about his travels over the decades throughout the American West, and how it was settled. His thesis is that settling the frontier was about practicality, not idealism, and this practicality is the source of American strength. When we falter, it is because we succumb to idealism. Kaplan cites George Kennan, who worried that the US was endangered less by foreign adversaries than by the illusions of its own leaders. In foreign policy, isolationism and unilateralism are two sides of the same ideological coin, and both are wrong.

US History

Eliot Cohen, Conquered Into Liberty. The land between Albany and Montreal was called "the Great Warpath," and while it generally gets scant attention in history books-a mention of Fort Ticonderoga, a reference to Benedict Arnold (boo! hiss!)-Cohen brings attention on a vital piece of geography, from the French and Indian Wars through the American Revolution and the War of 1812. He makes a strong case that it was here that much of the national identity was forged.

Ron Chernow, Grant. Chernow is a great biographer. Too many think of Grant as a drunken slaughterer and a corrupt president. Chernow rectifies Grant’s image as a fine military strategist, a uniter of the country and a superb writer. Grant lacks any credible criticism of its subject, but given he suffers from such a poor image, Chernow may be forgiven for lacking balance.

Heather Ann Thompson, Blood in the Water. I have vague personal recollections of the uprising at Attica prison in 1971, and apparently New York State authorities were happy to keep its secrets. But Thompson is dogged in her research, and has produced the definitive, and shocking, account of what happened. There are few good guys in this story.

Dan Hampton, The Flight. There have been numerous books about Charles Lindbergh, but this is my favorite. Hampton conveys the extraordinary skill and determination of Lindbergh in making the first transatlantic flight, the immediate impact it had on the world, and then his subsequent personal failings (especially his support of the Nazis). This book recounts the era superbly, and gives a balanced, empathetic, but critical, perspective on the man.

Frances Fitzgerald, The Evangelicals. America is the land of evangelical Christianity, and it goes back before the founding of the country. Fitzgerald provides a history of the evangelical movements, how they have evolved, and the impact evangelicals have had on American life. This is a narrow view of American social history, but an important one, well researched and written.

Edward Jay Epstein, How America Lost Its Secrets. An account of Edward Snowden, his life, his lies, his actions and their consequences. Some may think Snowden a hero for exposing intelligence operations, but Epstein makes the strong case that his motives were deceptive and his actions significantly harmed American interests. Absolve yourself from any idealistic notion: Snowden is a delusional criminal who endangered lives and the national security.

Arts/Sports

Nigel Cliff, Moscow Nights. An account of a shy, young Texan adulated by Americans and Russians alike at the height of the Cold War. Van Cliburn stunned the Moscow audience with his performance at the Tchaikovsky Competition in 1958. It required approval from Khrushchev himself for the jury to award him the prize. Cliff does a wonderful job of setting the scene, and describing the surprising emotional outburst evoked by Van Cliburn, and his lifelong connections with Russian audiences.

Michael Leahy, The Last Innocents. Hardly ground-breaking, but as a Dodger fan I enjoyed this description of the 1960s Dodgers. The deep personal struggles of people like Maury Wills (it is a high crime he is not in the Hall of Fame) and Wes Parker, the important impact Sandy Koufax and Don Drysdale had on all athletes by threatening to holdout in the 1966 season, and just the memories of great players in a turbulent era.

Dominic Dromgoole, Hamlet Globe to Globe. This is an account by the director of The Globe theatre in London of their year-long, worldwide tour of Hamlet. The responses by rural audiences on African farms and wealthy elites in fancy opera houses alike illuminate the universal appeal of this great play, and the author’s ruminations on what Shakespeare was getting at are insightful and enjoyable.

Philosophy

Massimo Pigliucci, How to be a Stoic. James Stockdale received his 15 minutes of fame as Ross Perot’s running mate in 1992. He was widely ridiculed in the media for his alleged ignorance of policy. This is unfortunate because he was a Medal of Honor recipient as a naval aviator, captured and tortured in Vietnam for over seven years. I remember an interview with him about how he managed to survive, and he mentioned he read and re-read the Meditations of Marcus Aurelius. This piqued my interest, so I read them, and then I read the speeches of Cicero, and the writings of Epictetus, the founder of Stoicism. Pigliucci teaches at City College in New York, and presents a readable, coherent description of Stoicism, an important philosophy in ancient Greece, and one with great relevance today. Count me among the Stoics.

Science

Peter Godfrey-Smith, Other Minds. Godfrey-Smith is a history professor at City University New York and an experienced scuba diver. You will never look at an octopus the same way again. What an extraordinary creature: it has the same number of neurons as a mammal, but those are distributed mostly in their arms. Neural loops may give each arm its own form of memory. There is no boundary between brain and body, its skin responds to light, and it has three hearts. But it’s his description of the evolution of the octopus that challenges our assumption that only mammalian evolution led to intelligence, and makes a persuasive case that there is more than one form of intelligence.

Hell is hot, as everyone knows. Everyone "knows" this, but there really is no conclusive evidence: no eyewitness reports, no scientific instruments to measure the temperature in Hell. So, how do we "know" that Hell is hot? Well, mostly from Dante Alighieri.

In the Inferno, part of his opus magnus, La Commedia Divina (The Divine Comedy, subject of our 3Q 2007 letter, https://angeles-srv.s3.amazonaws.com/content./1441740962./2007-3.pdf,

there are Nine Circles of Hell, each with eternal punishment of increasing severity, depending on one’s earthly behavior. The Sixth Circle is reserved for heretics, condemned to eternal existence in flaming tombs. The Seventh Circle is for those who committed violence, and it contains three categories (rings). The first ring is for murderers, and they are held in a river of boiling blood and fire. The third ring of the Seventh Circle holds blasphemers and sodomites, captive in a desert of burning sand and burning rain falling upon them. These are the exact places in Hell that are hot.

A few centuries later, John Milton gave us this description of Hell, in his masterpiece, Paradise Lost:

A dungeon horrible, on all sides round,

As one great furnace flamed; yet from those flames

No light, but rather darkness visible….

Torture without end

Still urges, and a fiery deluge, fed

With ever-burning Sulphur unconsumed.

So there you have it. We know that Hell is hot because Dante Alighieri and John Milton tell us so. We have no reason to doubt them, and I wouldn’t suggest otherwise, but still, a little more evidence would be welcomed.

In the past few months, the United States was hit with a series of epic natural disasters, including three category 4+ hurricanes (Harvey, Irma and Maria) and devastating wildfires in northern California. Were these just the random occurrences of fickle weather patterns, or part of a changing climate? What is the evidence?

There is no direct evidence that ties a particular weather event with climate change, just as there are no hard data that tell us Hell is hot. But we are able to move beyond the political narratives of climate change proponents and skeptics to a growing body of evidence that (a) the Earth’s climate is warming (i.e., beyond the normal observed variation in temperature), and (b) human activity is the proximate cause of this warming. The consequences of this warming are significant, and probably understated, and our options for action are likely pretty limited. So, in order, let’s examine the evidence, the causes, the consequences, and the possible responses.

The Evidence

Let’s look at average global temperatures for land and oceans since 1880. The first graph shows average temperature by year relative to the average temperature from 1901-1960. The blue bars, mostly before 1901, show temperatures a fraction of a degree Fahrenheit below the long-term average, and the red bars show average temperatures above the long-term average. For the last thirty years, the global annual average temperature is 1.2⁰ F (0.7⁰ C) above the long-term average.

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

The next set of graphs look at multiple data sets for land temperature, sea temperature and sea level, beginning in 1860-1880. All data sets show a similar pattern of rising temperatures on land and in the sea, as well as a rise in sea levels.

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

So the last 150 years has gotten warmer, but that’s a blink in time. The next graph looks at evidence in the Northern Hemisphere over the past 1,700 years. Temperature records don’t go back that far, but proxy data, such as ice core samples, are available. The shading represents the possible range around the black regression line. However interpreted, the last decade was the warmest in at least 1,700 years.

Changes in Northern Hemisphere Temperature, 300-2015 BCE

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

If 1,700 years is not long enough, the IMF has pieced together research from NASA, the Royal Netherlands Meteorological Institute, the Intergovernmental Panel on Climate Change, et. al., to estimate average global temperatures for the past 22,000 years (note the y-axis scale is degrees Celsius). The earth was warming for the first 12,000 years, then cooling for the past 10,000 years, until the past few decades when temperatures have spiked higher.

Average Global Temperatures (Degrees Celsius), 20,000 BCE – Present

Source: IMF

Recognizing that some people prefer looking at pictures rather than at data, below are photos of the Muir Glacier in southeast Alaska in 1941 and in 2004. You will see that the glacier has retreated four miles, out of the picture. Also note that the rocky landscape in the foreground has been replaced by dense vegetation.

Muir Glacier, Alaska, 1941 and 2004

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

Below are photos of the scope of the Arctic sea ice, in 1984 and in 2016, both in the month of September. Arctic sea ice in September covered 3 million square miles in 1980, and it is now less than 1.8 million square miles, shrinking at a rate of 13.3% per year.

Range of Arctic Sea Ice, September, 1984 and 2016

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

The Causes

Natural factors, such as changes in energy from the sun or the cooling effects of volcanic eruptions, played a large role in the earth’s climate over billions of years, even millions of years. But recently, natural causes of warming have had immaterial effect on the earth’s climate. Instead, it is clear that human activity has altered the earth’s radiative balance. These factors are called radiative forcings, and they include greenhouse gases and airborne particles, et.al. We can see this in the atmospheric concentration of these radiative forcings, which have fluctuated regularly and normally over the past 800,000 years, as the graphs below show, but have spiked well beyond any level seen in this period (for those who don’t remember their high school chemistry, CO₂ is carbon dioxide, CH₄ is methane and N₂O is nitrous oxide).

Atmospheric Concentration of CO₂, CH₄, N₂O in Past 800,000 Years

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

When we collate the data for land and sea temperatures, and consider all the potential causes for the accelerating increases in temperatures, not only do the data all point to human activity as the proximate cause of global warming, there is no alternative explanation that stands up to the evidence. The graph below shows the increase in land and sea temperatures from their average since 1880 (black line) with the sources of that increase. The yellow line shows natural causes, such as solar output, volcanic activity and orbital changes. These have had very little impact. Greenhouse gases (GHG-blue line) and human factors (red line), which include GHG, ozone and aerosol emissions and land use (such as deforestation), account for all of the temperature rise.

Increase in Average Global Temperature and Contributions of Key Factors,

(Deviation from 1880-1910 average, degrees Celsius)

Source: IMF

Our oceans, covering about 70% of the earth, are taking the brunt of the damage from rising temperatures. Since the mid-20^th century, 93% of the excess heat caused by greenhouse gases have been absorbed by the oceans, making them warmer and more acidic. The acidity is caused primarily by CO₂, and more than a quarter of the CO₂ emitted annually settles in the oceans. Acidity damages marine ecosystems, from coral reefs on up the food chain.

The warming is also causing sea levels to rise. Since 1900, sea levels have risen 7-8 inches, with 3 of those inches occurring just since 1993. The first graph below shows the change in sea level over the past 2,500 years. The graph below shows the change since 1800, along with a range of model projections. Please note the scale of the y-axis of the second graph is approximately ten times the magnitude of the first. There is a massive rise in sea levels going on.

Source: Climate Science Special Report, Fourth National Climate Assessment, U.S. Global Change Research Program

There is a clear negative correlation between temperature and economic output. The graph below shows the impact of a 1⁰ C change in temperature on GDP at various temperature levels, with the red vertical lines representing the average temperature for each country grouping. Advanced economies are found mostly in temperate climates, whereas emerging and low-income countries are found in warmer places. The negative impact of warmer temperatures is thus magnified for poorer countries.

Effect of Temperature Increase on Real per Capita Output

Source: IMF

The impact of global warming on economic output thus varies. As can be seen in the first map below, Canada and Russia are probably helped, the US, Europe and China see modest impact, and the rest of the world sees a material decline in GDP for a 1⁰ C temperature rise. Unfortunately, most of the world’s population lives in the red zone. The second map is scaled by population.

Effect of 1⁰ C Temperature Rise on Real per Capita Output across the Globe

Source: IMF

The historical data are well-established facts. The projections are models, and all models are flawed. They are flawed in that they do not account, or fully account, for all the processes of the Earth’s systems (e.g., ice sheets or arctic carbon reservoirs), or all the interactions among these components. The models do not, of course, account for unknown processes, although our models have underestimated the actual temperature changes during warming paleoclimates, which suggests that unknown processes not represented in the current models are more likely to underestimate than overstate the impact of warming.

There are two types of potential surprises in the modeling, and neither one of them is good. The first is the correlation between extreme events that could result in compounding extreme events, i.e., one extreme event follows immediately on another, and so on. These may be simultaneous droughts that occur in multiple places around the globe, or droughts lasting decades, or droughts followed by flooding, for example.

The second potential surprise in the modeling are tipping points, i.e., components of the Earth’s system that are stable until they are not, when small changes are amplified by a positive feedback loop. Patterns of ocean circulation may be such an example. Most of us in California are familiar with El Niño, which is actually part of the El Niño-Southern Oscillation (ENSO). Warming temperatures are likely to trigger more frequent and stronger ENSO patterns. Another important ocean circulation is found in the Atlantic Meridional Overturning Circulation (AMOC), where cold water sinks off of Greenland. Global warming would likely slow this pattern, leading to sea rise on the eastern US seaboard. A third potential tipping point may be found in the Arctic. Warming temperatures threaten to release carbon and methane hydrates currently frozen in the permafrost, which may lead to a positive feedback loop of faster warming. There is an estimated 1,300-1,600 Gt (gigatons) of carbon, and 2,400 Gt of methane trapped in the permafrost.

What Can We Do

On one level, probably nothing, because climate dynamics play out over long periods of time. For example, a quarter of the CO₂ emitted today will still be in the atmosphere 1,000 years from now. Just as the effects of global warming will be felt for a very long time, any changes we make today will have only marginal impact over the short scale of a human lifetime. Still, as Lao Tzu observed, a journey of 1,000 li begins with a single step (in Lao Tzu’s time, one li was about 360 miles). What are those first steps?

One first step is to accept individual responsibility for global warming and change our behavior. We can put solar panels on our homes, drive electric cars, walk or bike instead of driving. There are many actions we can take as individuals, and many websites with good suggestions (here’s one: https://www.nrdc.org/stories/how-you-can-stop-global-warming).

As citizens, we can urge our representatives at all levels of government to take this challenge seriously, to take direct measures to reduce government’s carbon footprint, and also ensure that the true cost of emissions is reflected in its price. Global warming is a negative externality, in economic-speak, of "potentially catastrophic proportions," in the words of the IMF’s recent report, and government has an obligation to ensure that its costs are made explicit.

As investors, the challenge of climate change is more complex. We are free, of course, to invest our personal money in a way that reflects our personal values, but as fiduciaries of institutional assets, we have as a primary obligation the financial health of our organizations. It’s not quite so simple and straightforward to balance this fiduciary obligation with the need to combat climate change. There is a positive approach to this, and a negative one, and both have their challenges.

The positive approach is to invest in companies or projects that actively combat global warming, such as renewable power, for example. There may be specific, attractive opportunities in private equity for these projects, but returns in public markets have lagged. S&P and TSX have a Renewable Energy and Clean Tech Index. Since its inception in March 2010, it has returned 7% annualized, versus 9% for the MSCI ACWI and 13.3% for the S&P 500.

The negative approach is best characterized by divestment, by shunning investments in companies or projects that contribute to global warming. The premise behind divestment is that it will punish bad actors by raising the cost of capital and thus prodding them to modify their behavior. As a fiduciary, it is also presumed that divestment can be implemented without cost, either direct or opportunity cost, or even hoped that returns will be enhanced by avoiding irresponsible companies. All this would be nice if it were true, but the evidence is just not supportive.

The long divestment campaign against South Africa, for example, had "little discernible effect either on the valuation of banks and corporations with South African operations or on the South African financial markets," according to a study by Siew Hong Teoh of Michigan, Ivo Welch of UCLA and Paul Wazzan. Harrison Hong of Princeton and Marcin Kacperczyk of University of British Columbia have found that "sin" stocks have had higher returns than the broad markets.

There is simply no evidence that divestment campaigns have modified company behavior, or have had any noticeable impact on their cost of capital, or have been able to be implemented at no cost to investors. There is simply no evidence that avoiding irresponsible stocks does any actual good. And climate change is too important for slogans and symbols; it requires action.

The Ninth Circle

The final Circle of Hell, Dante tells us, is reserved for those who have committed treachery against those with whom they had a special relationship. There are four rings in this Circle. The first is named after Cain, who killed his brother Abel in the book of Genesis. The last ring is named for Judas Iscariot, who betrayed Jesus.

But rather than burning in Hell, those who committed treachery are actually frozen in Hell, for in the Ninth Circle of Hell is found a frozen lake, Cocytus, where the treacherous are held in varying degrees of frozenness. Cain, in the first ring, has his head above the ice, but by the time we get to the fourth ring, Judas is completely encased in the ice.

It’s worth summarizing the key findings of the US government’s recently released Fourth National Climate Assessment:

The global climate continues to change rapidly compared to the pace of the natural variations in climate that have occurred throughout Earth’s history. Trends in globally averaged temperature, sea level rise, upper-ocean heat content, land-based ice melt, arctic sea ice, depth of seasonal permafrost thaw, and other climate variables provide consistent evidence of a warming planet. These observed trends are robust and have been confirmed by multiple independent research groups around the world.

The frequency and intensity of extreme high temperature events are virtually certain to increase. It is extremely likely that human influence has been the dominant cause of the observed warming since the mid-20th century. There are no convincing alternative explanations supported by the extent of the observational evidence.

I don’t know if Dante’s description of Hell is accurate, if heretics and murderers and blasphemers are fated to burn for eternity, and if those who betrayed ones with whom they had a special relationship are condemned forever in a frozen lake. I do know that we need to advocate, agitate and act. Now. We have betrayed our special relationship with Nature, and for that treachery, I think Dante was right: we will be condemned to the Ninth Circle of Hell.

"Lost Time is never found again," advised Benjamin Franklin in Poor Richard’s Almanack. And Dante Alighieri observed, "The wisest are the most annoyed at the loss of time."

I have been thinking about replacing my seven year-old car, which has me reflecting on the notion of Lost Time. Americans average 42 hours per year in rush hour traffic, but of course, in Los Angeles it’s much more. We each sit in rush hour 104 hours per year, the worst in the world (all data here come from the definitive source of global traffic data, INRIX Research). Moscow, New York, San Francisco and Bogotá round up the top five (Sao Paolo, London, Atlanta, Paris, Miami follow).

Sitting in traffic is only part of the cost of driving, and much of it is simply unavoidable as there are often few alternatives. But there is a related cost, one we tend to overlook, one that could be avoidable, and that’s parking.

Searching for a parking space is an enormously inefficient exercise. The average American driver spends 17 hours per year looking for a place to park, although British and German drivers have it worse (44 and 41 hours per year, respectively). Still, it’s a cost to the US economy of over $72 billion. By a fair margin, the worst cities in the world for finding a parking space are New York and Los Angeles (London is pretty bad too-see table). Los Angeles drivers average 85 hours a year looking for parking, at a cost of $1,785 to each of them.

The costs of parking go beyond Lost Time. Americans spend more than $20 billion per year paying for parking they don’t use (an hour on the meter for 45 minutes of use, e.g.). In New York alone, it adds up to $1.7 billion per year, about $900 per driver (San Francisco and Los Angeles are second and third, at $404 and $384 per driver per year). And then there’s parking fines: the average Angeleno gets one per year with an average cost of $71. The table below summarizes the annual cost, per driver and by country, of this grossly inefficient parking paradigm.

The search for a parking space also adds to traffic congestion, increases pollution, and raises stress and incivility. Nearly a quarter of drivers had at least one argument last year over parking (although it’s not clear if that argument was with their spouse or the other driver). About a third of us gave up looking for a space and went home, nearly half missed an appointment while searching for a parking space, and two-thirds of us admitted to be noticeably stressed over parking.

The great Roman philosopher, Seneca, wrote, "It is not that we have so little time but that we lose so much….The life we receive is not short but we make it so; we are not ill-provided, but use what we have wastefully."

After reviewing all these data, I’m wondering if it really makes sense to replace my car. I’m already biking to work on most days, and Uber/Lyft are probably better solutions when I can’t bike. But if I do drive, I will not hesitate to use that much-maligned L.A. innovation, valet parking, "invented" by Herb Citrin (photo above) in the 1930s when he opened a valet service at Lawry’s Prime Rib on La Cienega Blvd. Thank you, Herb.

In the summer of 1966, throngs of young people crowded the Sunset Strip in Los Angeles to hear their favorite bands. Over at the Sunset Tower, Jim Morrison and the Doors were the house band, finishing up their first album (The Doors, with Light My Fire, and Break On Through, among other classics). Not to be outdone, a former policeman from Chicago, Elmer Valentine, opened the Whisky-A-Go-Go, featuring dancers in mini-skirts suspended in the air in a cage, thus inventing the Go-Go dancers. The Whisky also had a house band working on their debut album.

The year before, 1965, the Watts Riots engulfed Los Angeles in chaos. That next summer of 1966 saw tensions boiling over again in another part of the city. The clubs along Sunset Boulevard were proving so popular that residents complained about the crowds and the noise (and the drugs and the long-haired hippies). Mayor Sam Yorty imposed a strict 10 pm curfew, and had the police enforce it aggressively. On November 12, a protest against the curfew was organized, publicized on KROQ, which ensured a huge crowd. It quickly turned ugly: police wielding batons stormed into the crowd of over 1,000, cracking heads and carting people away, some in wagons, some in ambulances. Celebrities were also caught in the melee (this is LA, after all), with Peter Fonda among those handcuffed and jailed (his friend Jack Nicholson managed to escape).

There’s somethin’ happenin’ here.
What it is ain’t exactly clear.

Shocked by the violence in front of his club, the 21-year old guitarist for the Whisky’s house band sat down to write a song. The Watts Riots a year before, the Sunset Strip Riot now: something was definitely happening in Los Angeles, and in the country. Something disturbing; maybe something historic.

Watts exposed the deepening racial rift in the city (and in the country). The inciting incident may have been the arrest of Marquette Frye under suspicion of drunk driving, but the context was much broader. For instance, like many states, California law restricted where certain people could rent or own property. In 1963, the state legislature passed the Rumford Fair Housing Act, prohibiting such discrimination. The following year, the California Real Estate Association sponsored Proposition 14 to overturn the Rumford Act. It passed overwhelmingly with 65% of the votes in the state, and a majority in every county. Racial restrictions in housing was again the law. The arrest of Marquette Frye sparked the riots, but Proposition 14 was a precipitous cause, emblematic of decades of racial discrimination and abuse.

The Sunset Strip Riot a year later highlighted the growing generational gap in the country. Los Angeles was where these two fissures, racial and generational, came together to tear the country apart. It became increasingly difficult for concerned citizens to find common ground as the sides held divergent perspectives and even appeared to speak different languages. Most Americans wanted no involvement in the debate, preferring to pursue their contented lives in the apparent tranquility and prosperity of post-war America. But all Americans would soon lose the luxury of indifference: the protests demanded that they choose sides.

There’s battle lines bein’ drawn.
Nobody’s right if everybody’s wrong.

We know with hindsight that the riots in Watts in 1965 and on the Sunset Strip in 1966 did not mark the apex of the protest movements. They did not precipitate the healing in American society, but the opposite, the beginning of the open rupture of the country, as many more, and more violent, protests were to come: Newark, Detroit, Kent State, among others.
Why? Why did the Los Angeles riots lead to "battle lines bein’ drawn"? To the further entrenchment of views, to greater polarization? Could anything have been done to bridge the differences, to unite the country, without a coming decade of death and violence unimaginable at the time?

Paranoia strikes deep.
Into your life it will creep.
It starts when you’re always afraid.

The tragedy at Charlottesville last week resurrects in our collective memory these events of fifty years ago, and raises the same questions: does Charlottesville mark the beginning of an irreparable rift in our society? Will our views become further entrenched, further polarized, are we able to see the world only through one lens? Will we mend our society only after many more lives are sacrificed?

Charlottesville was a tragedy; can we turn it into an opportunity, an opportunity we missed in 1965? Racial discrimination is still pervasive, economic inequality is as prevalent as at any time in our history, and deaths from despair (suicide, drug overdose) are of epidemic proportions (https://angeles-srv.s3.amazonaws.com/content./1494344358./angeles-advisors-commentary-1qv217.pdf). Will we seek to understand the experiences of those suffering and commit our resources to help? Or are we too afraid, too paranoid, to acknowledge another point of view?

We have another obligation, before it’s too late for constructive action: we must denounce as illegitimate those who espouse, excuse or condone bigotry. Free speech does not allow "falsely shouting fire in a theater," as Justice Oliver Wendell Holmes, Jr. wrote (Schnenck v. United States, 1919); neither should it cover inciting violence and hatred. Protests over legitimate grievances seeking legal redress are welcomed, encouraged. Neo-Nazis are not. Those who see a moral equivalence are misguided and bigoted themselves. They must be condemned.

Reach out and speak up. There’s something important going down.

Opening with haunting harmonic notes on his guitar, For What It’s Worth became an instant classic, and secured the legendary genius of its composer, Stephen Stills. He did not think his song would become an icon of the protest movement, but it did. He was just trying to make sense of the riots on the Sunset Strip as artists do, through their art, pointing out the injustices in society, and demanding that we pay attention and respond. We are so obliged.

(I think it’s time we)
Stop, children, what’s that sound?
Everybody look - what’s going down?
(https://www.youtube.com/watch?v=gp5JCrSXkJY)

For me, and I think I speak for everyone on the planet, the feeling of warm sand between the toes is one of life’s great pleasures. And for virtually everyone on the planet, including those of us who look at a beach every day (ok, I may be rubbing it in), we don’t give sand much thought: it’s just there.

But sand is more than pretty beaches; it’s big business. And it’s gotten to be even bigger business with the advent of the Shale Revolution. That’s because a lot of subsurface rocks that contain oil and gas lack permeability, which prevent fluids from flowing through them. To solve this problem, engineers drill a hole into the rock and shoot under high pressure a mixture of treated water, thickened with guar gum usually, and sand. The rocks fracture, and billions of grains of sand remain lodged in the newly created pores, propping them open.

Lest you think sand is sand, not just any sand will do the trick. Only high purity quartz sand will do, very durable to resist crushing, perfectly round so it will travel easily, and of a very specific size, normally 0.4 and 0.8 millimeters in diameter. The photo below shows "normal" sand on the left, frac sand on the right. See how much more uniform (and shiny) the frac sand is?

And drillers need a lot of it, especially as the porous rock has been tapped previously. A few years ago, 1,000 tons of sand were needed for each well; today, more than 4,000 tons of sand are required per well (see graph below). Overall, demand for sand will more than double this year from last, to over 70 million tons (see second graph below).

Sand Intensity

Sand Demand

So where does all this sand come from? Well, while Texas may have blessed with oil and gas, Wisconsin was endowed with high quality sand (who knew?). But mining sand in Wisconsin and shipping it to the oil fields is expensive, about $50/ton, more than half the total cost of sand (see map below).

You can’t just dig up sand and sell it; to mine sand requires a permit, even in Texas. And this year, permits have been filed in Texas to mine about 34 million tons of sand; permits for another 11 million tons are in the works. Sand costs in the Permian Basin run about $90/ton. This Texas sand will cut that cost more than in half. That’s really bad news for the companies that own and ship sand from Wisconsin, which is why their stock prices are off 50% this year; good news for the Texas drillers.

Of course, all this is more complicated than it seems, and the hopeful sand miners in Texas face some obstacles. Money is one; One company plans to spend $225 million on a 4 million-ton capacity plant, plus will have to pay $1/ton in royalties. Another company just paid a rancher $323 million to build a 3 million-ton capacity plant on his land.

There’s also very little infrastructure in west Texas to transport all this sand. Much of the new sand is near the town of Kermit (named after Theodore Roosevelt’s son, and famous as the birthplace of the great bull rider, Jim Sharp). Kermit is big enough to have traffic lights (population: 6,300), and estimates are that at full capacity, a sand truck pass through town every 19 seconds. Folks in West Texas are very supportive of the oil and gas industry, but that’s a lot of trucks rumbling through town.

Then there’s the matter of the dune sagebrush lizards. These critters reside in a very small habitat, that with Shinnery oak. The US Fish and Wildlife Service proposed adding the dune sagebrush lizard to the endangered species list in 2011, but withdrew that recommendation the following year when Texas promised to preserve its habitat.

Every day I look at the beach (there I go again, rubbing it in), and never gave sand much thought. But now I know that my Santa Monica sand is too soft and irregular for use in fracking, but just right for sinking toes into.

According to the National Bureau of Economic Research (NBER), the self-acclaimed arbiter of economic debate in this country, the current economic expansion began in June 2009, meaning we just passed eight years of uninterrupted growth. This is now the third longest period of economic growth since the Civil War (see chart below). In May next year, we will pass the second-longest expansion, and if we can get to the summer of 2019 without a dip, we’ll have a new record. Will we get there? And does it matter?

The answers are, probably and yes.

To answer the first part, we have to look at what precipitates a recession in the first place. To answer that question, I draw on research by Goldman Sachs and the IMF. In the US, there is a clear demarcation pre- and post-World War Two (WW2). Pre-WW2, contractions were typically caused by cycles of over-investment followed by asset prices collapsing. Post-WW2, monetary tightening and oil price spikes explain most of the causes of recession. Interestingly, the two most recent US contractions, in 2000 and in 2008, were due mostly to overinvestment/price collapse (Internet stocks and residential housing, respectively), causes more common pre-WW2 than in the post-war period.

The IMF identifies five factors contributing to recessions in all countries over the past 50 years: fiscal policy tightening, external demand shocks, oil price spikes, monetary tightening and financial sector crises. Using this framework, the prospects for an imminent recession look dim. The first two factors, fiscal tightening and external demand shocks, have never caused a recession in the US absent the end of a major war. A spike in oil prices is always possible, but the shale revolution in North America makes that seem unlikely today. Another financial crisis is also possible, but banks have significantly delevered and shored-up capital post-2008, so a systemic collapse seems unlikely too. Monetary policy is tightening deliberately, and is an area of risk, but central bankers appear sensitive to these risks.

Not formally part of the IMF framework, but probably relevant to this discussion, is the pattern of overinvestment/asset bubbles/price collapse. Valuations are stretched across most (all?) asset classes today, so this bears watching, but I think we are not yet near the extreme levels that marked tops in the past. So while there are risks, the prospects for a true economic contraction in the near-term seems remote (not zero, but unlikely). The next question for investors is, does this matter?

Yes it does, because asset returns are very much dependent on whether a slowdown in economic output turns into an outright contraction or not. The graph below shows equity performance during periods of slowing growth (defined as declines in the ISM Index) since 1950. If that slowdown turns into a recession, investors see negative returns (the black line). If a recession is avoided, prices rebound (blue line).

There are also market signals to watch that presage rising risks of recession and market tops. The shape of the yield curve is one. Since 1950, every recession in the US was preceded by a flat or negatively-slope yield curve (although it should be noted that the yield curve inverted in 1966 and in 1998 without precipitating an economic recession). Today, the yield curve is positively-sloped (the 10-year/90-day spread is 130 basis points today). So the yield curve is not signaling recession either.

The length of the current expansion is now the third-longest in US history, growth has been sluggish, and it is reasonable to think about when (not if) the next recession will occur. This certainly has policy implications, but is also consequential for investors. As I’ve tried to describe, while a surprise, exogenous shock pushing the economy into a recession is always a possibility, the conditions that have historically presaged an economic contraction are just not present today at levels that would give us concern.

The economic expansion is aging, the bull market is aging, (aren’t we all?). But in the immortal words of Monty Python, (neither) is dead, yet. Even mostly dead is slightly alive.

It looks like the world is turning against humans. I’ve talked before about the rise of robots in manufacturing (2016 Angeles Independent School Endowment Symposium…see graph below). But robots are taking on increasingly more complicated tasks. We may be comfortable with robots assembling our cars (although the UAW may take exception), but most us will soon be forced to shift our perception of our family physician from Robert Young (aka, Marcus Welby, MD, which is showing my age) to Da Vinci (no, not Leonardo…see photos below).

The Rise of Robots, The Descent of Humans

It seems that investors, too, have given up on humans being able to pick stocks. Money has flowed consistently out of actively managed funds and into passive vehicles (see graph below), which now account for 40% of US funds.

It’s hard to blame investors for moving to passive management: performance by active managers has been poor for years. Using the eVestment database of 1,298 large cap, long-only, US equity funds, 761 of which are currently open (the rest have closed, merged or otherwise disappeared), holding $2.5 trillion of assets, shows that last year the median fund trailed its benchmark by 300 basis points (net of fees), the worst relative result since the dot-com boom of 1998. Only 20% of funds outperformed at all, the lowest percentage since at least 1990 (n.b.: all of these numbers were crunched by our friends at Goldman Sachs).

So, it’s no surprise that in the face of this abysmal performance investors have turned away from active managers. Regulators, too, are joining the anti-active manager chorus. The Financial Conduct Authority (FCA), the main regulator in the UK, issued a scathing report this week on the entire professional asset management community, chastising managers for high fees and poor performance, and investment consultants (not us!) for poor advice and no accountability (https://www.fca.org.uk/publications/market-studies/asset-management-market-study-I encourage you to read it).

I think the charges of the FCA report are largely valid, so I won’t offer a rebuttal. But I do want to explore this increasingly accepted notion that active managers are doomed to go the way of Rosie the Riveter and Marcus Welby.

It’s been awhile, but there have been past periods of active management outperformance (as the graph above shows), and we observe several market conditions that seem to explain part (most?) of manager relative performance. The table below summarizes these conditions, all of which currently favor passive over active management.

So, to a certain extent (maybe to a large extent), a bet on passive outperforming active is a bet that the above conditions will persist. Good luck with that bet, because I can offer no insight on this. I am highly confident that one day these conditions will change. I am also highly confident that I have no idea when that will be.

The bigger point is that for us, this passive/active debate is a false dichotomy: we don’t have to choose, and for most of our clients, we have structured portfolios with both passive and active allocations. We think it’s been an effective approach. As of the most recent (March) quarter, all of our composite strategies have outperformed their benchmarks over the trailing year (as well as over the past 3-, 5-, 7-, 10- years-although this is where I rightly warn that past performance is no guarantee of future results). Maybe we’ve just been lucky, or maybe we’re smart and hard-working (I have my opinion, you can form your own).

The current environment has been highly favorable for passive management, and low fees are certainly a very attractive attribute of passive funds. But, as Benjamin Graham taught us, price is what you pay, value is what you get. And in seeking value, we still believe in humans.

In scouring the world for investment opportunities, the chart above caught my attention. It shows the year-to-date performance of the Caracas stock exchange, more than tripling from around 30,000 to over 100,000 today. Did we miss a chance to make a lot of money?

Well, no. The stock market has tripled because the currency has lost all value. The official USD exchange rate of the bolivar is 10:1; 10 bolivares buys 1 US dollar. But the official exchange rate is a fantasy: the actual exchange rate is 7,500:1 (see graph below from www.venezuelaecon.com). That’s a 75,000 percent depreciation from the official rate. So, in US dollar terms, the +200% rise in the stock market reflects only a re-pricing of the local currency.

The currency has lost its value because inflation is around 800% (to be fair, the latest number shows a decline to 750%-see graph below). The economy is also contracting at around 20% per year, as there may now be more protesters than workers (see photo).

Of course, the real reason for Venezuela’s economic, political and social collapse is the disastrous populists policies of its long-time dictator, Hugo Chavez, who chose to loot the vast oil revenue to enrich himself and help the poor by imposing controls on prices and capital flows and by a massive expansion of government spending and control of the economy. The effect was to debase the currency, gut the economy and spur hyperinflation. His less charismatic successor, Nicolas Maduro, has continued these equally imbecilic policies, but rising opposition to the lack of food and electricity (the temerity!) has led him to suspend the legislature, overthrow the courts, and send the army to attack civilian protesters.

Venezuela is an especially sad case because of how far it has fallen. When I was young, Venezuela was a relatively wealthy, highly cultured and well-educated society. Even now, it has the largest proven oil reserves in the world. But in the 1980s, the price of oil plummeted and Venezuela’s economy was squeezed. It borrowed heavily, but failed to invest wisely, and ended up defaulting in the early 1990s. Chavez attempted a coup in 1992, failed to gain support, but became the voice of opposition, and was eventually elected in 1998 as a left-wing populist. He ruled as a dictator till he died of cancer in 2013.

This pattern is all too familiar: a once-wealthy country faces a severe economic crisis that establishment political parties cannot re-mediate, creating political division and polarization, leading to the ascent, by coup or ballot, of a populist promising to “drain the swamp,” in current political usage. As Chavez said in 2002: “We must confront the privileged elite who have destroyed a large part of the world.”

With populists, the “privileged elite” may or may not be destroyed; at best, they may be replaced by a different group of privileged elite. But what is destroyed is the economy, rule of law, political discourse and, most importantly, civil society. Venezuela is in its death throes of its own making, and we don’t yet know how much more violence and repression will be inflicted on its citizens. With the rise of populists around the world (see my talk on this last year: http://blog.angelesadvisors.com/multipolarity-presentation-by-michael-rosen-at-the-2017-angeles-investment-advisors-foundation-symposium/), Venezuela is a warning to all of the dangers that lurk.

The intersection of supply and demand determines price and quantity: there is no more fundamental principle of economics (see graph below). We rarely see this principle in action because prices for most consumer goods and services change little week-to-week. All that means is the market maintains a constant equilibrium (which is set by the price) of supply and demand: either there is little change in supply or demand, or the changes are very modest, and market forces adjust quickly to maintain that equilibrium.

Commodity prices are much more volatile than consumer goods prices, meaning there are frequent “shocks” either to demand or, more likely, to supply. Scarcity, due to weather, war or other natural or man-made factors, will drive prices higher (the supply curve shifts up to the left in the graph above), and a glut, (a supply curve shift to the right). will pushes prices lower. For many commodities, prices can remain much higher or lower than normal because it takes time for suppliers to react to the change in prices. In the case of agricultural commodities, a season will often have to pass to allow farmers to plant more or less of a crop. In the case of minerals, closing or (especially) opening a mine is a multi-year endeavor. So supply typically acts slowly to prices.

But there’s another possibility: suppliers can adjust their cost curves to align more closely with current prices. There is no better example of this than in the US oil industry.

The graph below contains three data series: the blue area graph shows US oil production, the red line is the spot price of WTI oil, and the green U-shaped line is the number of oil rigs in operation, all over the past five years.

The price of oil (the red line) collapsed in mid-2014, falling from over $90/barrel in June to $35 by January 2016. The high price of oil prior to 2014 encouraged more domestic production, which grew more than 50% from 2012. Production continued to rise for a year after the fall in the price of oil, peaking at more than 9.5 million barrels per day in June 2015. That’s when the rig count begins, and we see it plummet from around 750 in 2015 to about 250 a year later. Production likewise began to fall in mid-2015, dropping by about one million barrels per day by June 2016.

But then something interesting happened. The price of oil had rebounded modestly off its low, but producers stopped shuttering and started to add more rigs. This was not driven by higher prices for oil, which generally stayed in a range of $40-50 per barrel, half the price of just two years before. Why then would companies increase production (supply) when the new equilibrium price was 50% of its prior level? The answer is the industry shifted its cost structure lower.

The graph below estimates that the US oil industry lowered its break-even cost by 30%, to about $54/barrel over the past five years. But looking at 2016’s reserve replacement costs (RRCs) of the largest producers, reflecting their actual costs of replacing reserves last year, the industry average break-even price of oil falls to just $42/barrel.

It’s no surprise then that rig counts are up and domestic production is over 9.3 million barrels per day, not far from the recent peak. The industry has successfully shifted its cost curve lower, partly because the oversupply of workers and equipment pushed their costs lower, and partly because of more and better use of more and better technology.

Advances in technology mean the days of wildcatting and dry holes are over, although I’m still inclined to follow the advice of J. Paul Getty. When asked the secret for getting rich, he replied, “Wake up early, work hard, strike oil.” I’ve embraced two of the three; I’m still working on the third.

Today’s jobs report was disappointing: only 138,000 net new jobs created in May (the consensus had it pegged at 182,000), another 66,000 lost in revisions to the prior two months, the three-month average is trending lower with declines across all industries. Oh no! Treasury yields plunged today to the lowest levels since November, erasing all of the move following the election.

Let’s look at the employment data more closely. The first graph below shows the monthly change in non-farm payrolls over the past five years. The series is volatile, and the May print is below the average of this period, but well within the range we’ve seen over the past five years.

US Non-Farm Payrolls, Monthly Change, June 2012-May 2017

The economy has added jobs for the past 80 consecutive months. The cumulative result is seen in the graph below: a record number of employed.

US Non-Farm Payrolls, 2010-2017

The unemployment rate (U-3) fell to 4.3%, the lowest since 2001, as the next graph shows. Some think a low unemployment rate is a good thing.

US Unemployment Rate (U-3), 2000-2017

But the unemployment rate dropped last month because the labor force participation rate fell from 62.9% to 62.7% (see graph below), with the biggest decline coming from the 16-24 age group. Last month, 429,000 people who either were working or looking for work decided they no longer wanted a job.

US Labor Force Participation Rate, 2000-2017

Over the past year, the unemployment rate fell from 4.7% to 4.3% while the labor force grew 1.7 million. The economy added more than 2.2 million net new jobs in the past year, half a million more than the growth in the labor force, hence the decline in the unemployment rate.

So, yes, it may very well be that average monthly growth in jobs is falling (I suspect it is). That does not mean the sky is falling too.

Why is everyone so happy? Well, maybe not everyone, but a lot of people are as optimistic as they’ve been in a long while. Start by looking at consumer confidence, as collated by the Conference Board below. Confidence is at the highest level in the past five years (see graph below); in fact, confidence is only a little shy of its all-time peak in September 2000 (which, ominously, marked the top of the great Internet bubble).

Conference Board Survey of Consumer Confidence, 2011-2017

One finds the same results in nearly all the surveys, from consumers to small businesses to baseball fans (except, maybe, Padres fans, whose team will struggle to win a third of their games this year). Is this optimism justified? Well, if you look at the actual data, the economy is doing fine, plugging along. By my count, over the past month, positive economic surprises are outpacing disappointments by about a 4/3 ratio. Labor and housing data have been especially strong, manufacturing and construction a little light (although bad weather may account for some of that). Looking at the broadest measure of economic output, gross domestic product (GDP), it has been remarkably stable over the past five years, at around 2% p.a. (see graph below, showing quarterly changes along with the two-year moving average).

Source: Bureau of Economic Analysis

So, there’s not been a lot actual change in the trajectory of the economy, in contrast to the huge jump in confidence recently. In fact, the gap between hope and reality is the widest on record (see graph below).

So, why is everyone so happy? We can’t be sure, but we had an election that promised to sweep away the old, sclerotic ways of Washington, to be replaced by swift and decisive actions: cutting taxes, culling regulations and, especially, creating jobs (although, it should be said, the economy has created 12 million jobs over the past five years, and I’m not sure we’re going to (or can) do any better over the next five). So that’s pretty exciting.

If this explanation is right, we will keep our eyes (and Twitter accounts) on Washington. The first attempts at swift, decisive action was a little less than successful, but there will be more cracks at the bat. Like the baseball season, it’s early in the season.

You can’t eat relative returns is an old aphorism. It sounds like it could come out of Poor Richard’s Almanac (Benjamin Franklin), and I’m not really sure of its origin, but it means that we (investors) ought to be focused on the absolute growth of our money, not on its growth relative to some benchmark or peers. When we buy groceries (or make grants or award scholarships or cut pension checks), we spend ("eat") actual dollars, not an amount relative to our performance against an index. Too often, we fall into the trap of trying to copy the strategies of high-performing peers, and inevitably fall short (how many investors adopted the "endowment model" in hopes of replicating Yale’s performance, only to fall well short?).
Still, we can’t help but compare ourselves to others; it’s in our nature. When focus groups are asked if they would prefer to make $80,000/year or $60,000, virtually everyone chooses the former. But when re-phrased as would you rather earn $80,000 knowing that your neighbors earned $100,000, or earn $60,000 when your neighbors made $50,000, studies showed a very strong preference for the latter. We choose to be poorer, in absolute terms, if we can be better off than our neighbors. I hope we understand that this is a sub-optimal choice.
Still, it is in our nature to crave recognition. Adam Smith, in Theory of Moral Sentiments, noted the human desire "to be observed, to be attended to, to be taken notice of with sympathy…and approbation." For thousands of years we have created awards with artificial scarcity ("Athlete of the Year", Congressional Medal of Honor, "Manager of the Year") in hopes of promoting effort and energy toward a desirable goal. Encouraging such behaviors may spur superior results from some, but it may also cause others to take on more risks than they can handle. Studies have shown that the neighbors (!) of lottery winners spend much more on cars (conspicuous consumption) and have higher rates of bankruptcies. As Winston Churchill (who is endlessly quotable) noted, a "medal glitters, but it also casts a shadow."
A recent paper* on aviation caught my attention (because it was about aviation). The authors, three distinguished professors from universities of Denmark, Zurich and Chicago, examined the records of more than 5,000 German pilots from the Second World War. In common usage, an "ace" is a pilot with five or more aerial victories. This has become a rare achievement: in the Vietnam War, for example, only two US pilots, Steve Ritchie of the Air Force and Duke Cunningham of the Navy, were aces (with five victories each). No American pilot has achieved that status since.
The most successful pilot of the First World War was Manfred von Richthofen, with 80 victories, forever immortalized as the Red Baron, Snoopy’s nemesis. But World War Two saw some pilots reach extraordinary heights (pun intended). In that war, 409 pilots had 40 or more victories, and the vast majority (379) were German. There were three factors that account for this preponderance of German success. First was that at the start of the war, German pilots were the only ones with actual combat experience, gained during the Spanish Civil War. Guernica, the title of Picasso’s most famous painting, was the first civilian town targeted for aerial destruction in history, carried out by the Luftwaffe. Secondly, most victories came against the Soviet Union, whose planes and pilots were generally both of abysmal quality. Lastly, the Germans had a rule, "fly till you die," and unlike American crews who rotated out after 25 sorties, German pilots only stopped flying when they were shot down. This led to some impressive individual accomplishments. Hans-Joachim Marseille had 17 victories in a single day (1 September 1942), Emil Lang had 68 victories in one month (October 1943), and Erich Hartmann holds the all-time mark of 352 aerial victories (all but 7 against the Soviets). Hartmann’s last occurred hours before the war ended. His accomplishment is all the more remarkable because by May 1944, a full year before the end of the war, the Germans were losing 25% of their pilots each month.
Achievements were recognized by a mention in the daily armed forces bulletin (Wehrmachtbericht). This was considered a rare honor, reserved for spectacular accomplishments, and because it was broadcast to all forces everywhere each day, the honor was widely and instantaneously noted. To examine the impact these accolades had on other pilots, the researchers looked at the records of pilots who had previously been in the same squadron as the honored pilot, with the assumption that a prior personal contact or relationship with that pilot would likely provoke a greater motivation in other pilots. It turns out that it did.
Researchers further grouped these other pilots by their previous records, with the top 20% called "aces" and the rest called "non-aces." Figure 1 below shows the results in these two categories following a mention of a special achievement by a former flying colleague ("peer"). Victories for the top group increased significantly after hearing of a former mate’s accomplishments, from an average of 1.9 victories per month to 3.0 victories. The other 80% saw only a modest rise in victories, from 0.23 to 0.35 per month.
Remember, the only way for a German pilot to exit the ranks was to be shot down. Interestingly, the top group saw their "exit" rates decline from the baseline after a former colleague was honored. For the very best pilots then, the honoring of a former mate increased their subsequent victories and decreased their casualties. These highly skilled pilots were motivated to, and indeed did, perform better when seeing the accolades of a peer they knew. The less-skilled pilots were equally motivated, but lacking the skills of the best, did not fare as well. While their victory rate increased fractionally, their casualty, or exit, rates spiked (bottom panel). Their greater efforts resulted primarily in their higher deaths.

Relative performance against peers is a powerful motivational force. There is the anecdote that during the very crucial Battle of Britain in the summer of 1940, when the outcome very much hung in the balance, the top two German aces in that battle, Adolf Galland and Werner Mölders, were tied in victories when Hermann Göring, head of the Luftwaffe, called Mölders to Berlin for consultation. Mölders protested that he would fall behind Galland, and consented only if Göring agreed to ground Galland for the three days Mölders was to be away. Amazingly, at that critical moment in battle, Göring agreed to pull his two top pilots from flying for three days.

So peer competition is a strong motivation. But fixating on our performance relative to peers may hinder our ability to achieve our own goals, and lead us to take unacceptable risks. For the few, highly skilled investors, competition may motivate us to achieve greater goals. For everyone else, taking greater risks will more likely lead not to more victories, but only to greater casualties.

*Philipp Ager, Leonardo Bursztyn, Hans-Joachim Voth, Killer Incentives: Status Competition and Pilot Performance during World War II, NBER Working Paper No. 22992, December 2016.

There are prominent voices (and tweets) urging us to pull back, dig in, and lock the gate. This rising chorus of nationalism and protectionism sees a dangerous world intent on our demise or destruction. We are assured we will be safe behind our wall, in our bunkers, while others can sort out the consequences of the chaos beyond our shores. Our enemies hate us (which is why they’re our enemies), our friends don’t appreciate us, so we first are going to protect ourselves from these threats, and then we are…well, we’ll have to see what’s next.

This narrative is dangerous, and it’s wrong. I wrote of why it’s dangerous (http://blog.angelesadvisors.com/2016/12/shock-part-3-the-end-of-pax-americana/): the United States is the only country that can maintain the world order. Wishing otherwise won’t change this fact. However hateful our enemies, or ungrateful our friends (and I suspect they are more bewildered than ungrateful), a US withdrawal from its global responsibilities will result in a more chaotic and violent world rather than one that is safer and more secure.

This nationalist narrative is also wrong, principally because its implicit assumption is that relationships (among countries, but probably also among companies and maybe even individuals) are zero-sum, that is, one can gain only if another loses. There are "winners" and there are "losers;" there cannot be "winners" and "winners."

In fact, relationships are never zero-sum. Thankfully, in my lifetime, the world order has been severely positive-sum. The first graph below shows that real GDP per capita in the US has tripled since 1960. The second graph shows the same data for the entire world: real GDP per capita has increased 20-fold!

So that makes Americans "losers," right? After all, the rest of world got much richer than we did over the past five decades. Of course not; we were all "winners." The rise in wealth was faster in rest of the world, but (a) the rest of the world is not richer than the US, and (b) even if it were, we (Americans) are (much) wealthier than we were in 1960. No, the world, in my lifetime, has been massively positive-sum.

But that doesn’t mean that the outcome can only be positive-sum. The 1930s were a good example of a period of negative-sum, an era of protectionism and nationalism, tariffs and competitive currency devaluation. That was an era of negative-sum, where we all became poorer.

In 1979, a peak number of Americans, 19.5 million, were employed in manufacturing. Today, it’s 12.3 million, up 900,000 since the economy bottomed seven years ago. While 1979 was the peak in absolute manufacturing employment, as a percentage of all labor, the peak was seen in 1943, at 38.8% (see graph below). Today, manufacturing represents just 8.5% of total employment. It has been in decline for 75 years.

One hundred years ago, about half the population of the US was working in agriculture. Even after the Second World War, 18% of the labor force, eight million people, was engaged in agriculture. Today, 2.4 million, just 1.7% of total employment, works in agriculture (see graph below). Where’s the outcry to bring back agricultural jobs?

Manufacturing jobs have been in decline in the US for 75 years, and agriculture for about 200 years. This has little to do with China or Mexico, and a lot to do with extraordinary technological and scientific advances. From an employment perspective, manufacturing is not our future (neither is agriculture).

The expansion of trade, the free flow of capital, and the rise in migration-the characteristics of the world order established by the US in the 1940s-has enriched the entire world and lifted billions out of abject poverty. But there is little recognition of this unprecedented prosperity, and calls to dismantle the global order by erecting multiple barriers to impede the flow of goods, capital and people.

There are physical barriers, such as walls, legal barriers, such as tariffs, and social barriers, such as hateful rhetoric and scapegoating. All of these barriers are harmful, to everyone, not just to those that are targeted. They are harmful economically, and more importantly, harmful socially and morally. They are not zero-sum, they are negative sum.

They are not only dangerous, but also wrong.

It’s probably no surprise to you that I see offering world-class investment advice as a valuable service for the long-term well-being of our clients. And while I think of investing as critically important, I acknowledge that there are a few issues that may be equally, or even more, central to our long-term well-being. Love is one such area. And so, in the interest of supporting your happiness and prosperity, backed our usual analytical rigor, we offer the following guide to three important activities related to love:
• How to Choose a Mate
• When to Marry
• What to Give as a Gift

How to Choose a Mate
So many choices! How do we know that this person is the "right one"? Well, Scientific American identified this as the “marriage problem” in a 1960 publication. The theory applies to whom to hire, and other decisions when faced with multiple options.
Let’s say the prospects, or applicants or candidates, if we want to think of our future spouse in those terms, appear sequentially, and your decision to accept or reject each one is final; there’s no going back once you’ve made your decision. Should you choose the first attractive one, thus forgoing a potentially more attractive spouse? But what if you pass on an attractive candidate that turns out to be the most attractive? You can’t go back to the one you rejected.
The answer to this conundrum is found in mathematics. In a simple example of three prospects, one is the best, another is acceptable, and the third is the worst. The three can be ordered in six different combinations. The best strategy is to always reject the first, then choose the next one that is better than the first. In this case, the odds of choosing the best is 50%.
Of course, when you add more than three candidates to the selection universe, the odds of choosing the best fall, but it falls to about 37%, and no lower. And so, the optimal strategy is to reject the first 37% of potential mates, and then choose the next one that is more attractive than the everyone in the first, rejected, group. The probability of choosing the best one is 37%, but that is as high as you’re going to get.
How NOT To Choose a Mate
Don’t let your parents make your match. In a detailed research paper by the World Bank in 2015, a survey of Chinese couples found that "parental matchmaking is associated with less marital harmony between the couple, more submissive wives, and a stronger belief in old-age support." Parents choose a spouse for their sons that will be best for the parents (quite a surprise). On the other hand, it does lead to a more harmonious inter-generational relationship. This is graphically shown below.

When to Marry
It seems that many people choose their wedding days with special numerical significance. Four approaches are most common: on Valentine’s Day, on sequential dates (1-2-03), on same-number dates (9-9-09), and on mirror dates (9-8-07). The graphs below show the spike in weddings on these four dates, with special prominence for popularity on same-number and mirror dates (the bottom 2 graphs).

Research by two professors at the University of Melbourne, using 1.1 million marriage and divorce registries in the Netherlands between 1999 and 2013, found that the incidence of weddings was 137-500% higher on these special dates than on other dates. Unfortunately, they also found that the odds of divorce for couples marrying on these special dates were 18-36% higher too (graphically shown below). This was even more likely for first-time marriages.

So, avoid being cute by choosing a special day to marry. I promise that that ordinary date will become special to you.

What to Give as a Gift
Flowers? Chocolates? Jewelry? In my personal experience, confirmed by my own rigorous research (asking some friends), flowers are essential, chocolates are fine, but jewelry is best. Diamonds, in particular, never fail.
But better than all of these, at least over the past 40 years, would have been a US Treasury bond, which has outperformed diamonds nine-fold! (see below). Your spouse may not appreciate the gift of a bond when she was hoping for a diamond, so you may need to show her this graph. I’m sure she’ll love you all the more.

Happy Valentine’s Day!

We began this series with a review of the likely economic policies and their implications of the new Trump administration, and discussed the long-term challenges investors face. We would have undertaken this exercise for a Clinton administration, but the election of Donald Trump represents a stark break from the broad consensus of the past 70 years favoring free (or freer) movement of goods, capital and people; the establishment of multinational treaties and supranational institutions to establish rules governing international relations; and enforcement of this world order primarily by the United States military.

As such, we expanded our review of the consequences of this election beyond the immediate implications for investors. Last week, we examined the foreign policy implications of a Trump presidency, how this likely marks the end of an era of American influence in world affairs (http://blog.angelesadvisors.com/2016/12/shock-part-3-the-end-of-pax-americana/).

The Trump presidency will likely have large consequences in world affairs. The impacts from reversing the processes of globalization, call it de-globalization, will play out over years, even decades. Some groups may benefit from this de-globalization, but the world as a whole will not, manifested economically by lower growth and politically by rising conflicts.

The election of Donald Trump is important internationally, but may be most consequential for American society, as it exposes the hideous wounds of political, economic and social polarization that have been festering for decades.

Research by Keith Poole (University of Houston) and Howard Rosenthal (Princeton) has shown that more than 90% of Congressional voting today is explained simply by ideology, the most in over a century. A decade ago, according to Pew Research, a minority of Democrats and Republicans viewed each other unfavorably. Today, nearly 50% of each party sees the other not just unfavorably, but as a threat to the national well-being.

Political polarization has not led, but rather reflects, the growing socioeconomic divide. Income and wealth are more concentrated in the top than at any time in a century. Note that this is true worldwide, just especially so for the US.

Globalization has made the world richer, but the benefits of globalization have been uneven. When growth was high, there was enough wealth to go around: the rising tide did lift all boats. But in recent decades, the gains from globalization have accrued mostly to the middle classes in developing countries and to the upper classes in developed economies. The middle class in the developed world has largely been squeezed out of the gains in global prosperity. Bruno Milanovic of The World Bank created this graphic of global income growth, which has come to be called the "elephant trunk" graph, showing the gainers and laggards in global income growth.

As distressing as political and economic polarization are, most disconcerting is the growing social divide. Elites attend the same schools, marry each other, and are more familiar with London and Hong Kong than with Wyoming or West Virginia (where Trump carried 70% of the vote).

Arthur Brooks of the American Enterprise Institute speaks of, not an Income Gap, but of a Dignity Gap. Over the past 50 years, the percentage of working men outside the workforce has more than doubled, from 10% to 22%. The employment-to-population ratio of men ages 25-64 is 6.8% lower today than in 1930 (which was not a good year, if I recall). Men without work are less likely to be married, and other than the handful of completely segregated monks, how else is one’s dignity defined but through work and family? Last year, Anne Case and Angus Deaton of Princeton shocked us with research (http://www.pnas.org/content/112/49.toc) that middle aged (45-54) white American men were the only demographic that experienced increased mortality over the past decade. Cirrhosis of the liver is up 50% since 1999, suicide up 78%, and drug and alcohol poisoning up 323% for this demographic (see second chart).

It’s not hard to connect all these dots. We’ve become a more divided society, as we’ve become richer. The post-war world order delivered prosperity to most people, until recently. In the past few decades, gains accrued to the billions in the new middle classes of developing countries, and to the rich. For the middle classes of the developed world, their incomes, their wealth, their dignity have stagnated at best, and deteriorated for many.

This is a failure of enlightened leadership of both sides of the political spectrum. Conservatives promised that the gains of wealth would be shared fairly, and offered no actions as inequality grew. Liberals chose to confiscate (I mean redistribute) wealth from the rich to the poor, hindered economic growth with more taxes and regulations, and further divided our society by pursuing identity politics, accentuating our differences over our common interests.

I don’t know if we will be able to bridge the many gaps in our society. Does anyone else see parallels today with Dickens’ description of the French Revolution:

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way-in short, the period was so far like the present period….

Donald Trump fueled, promoted and capitalized on political, economic and social polarization, but he did not cause it. His election is a result of these divides. The consequences of his election will impact the economy and diminish US influence in world affairs. Donald Trump will not bring the country together for the simple reason that he does not see it in his self-interest to do so. No political leader has been able to do so, and I’m not sure any can or will.

Our best (only?) hope will come from ordinary people, reaching across the many divides in our country to see, to understand, to empathize and to commit ourselves to Lincoln’s "more perfect union." Let that be our new year’s resolution.

We are all trying to make sense of the election of Donald J. Trump to the presidency, and a few weeks ago I outlined the possible economic agenda and its consequences the administration may pursue (http://blog.angelesadvisors.com/2016/11/shock-part-1/). In the month since the election, US stocks have risen more than 5%, and bonds have turned one of their worst months on record, as 10-year Treasury yields soared 60 basis points to almost 2 ½%. The markets’ message is that tax cuts, deregulation and large government spending on defense and infrastructure will boost economic growth with only moderately higher inflation. Apparently, trade wars and mass deportations are not on the agenda. So, celebration.

In the last post, I did caution that economic prosperity is sustained only through gains in productivity, and discussed the structural challenges investors will face (http://blog.angelesadvisors.com/2016/11/shock-part-2-the-asset-allocators-dilemma/), irrespective of the economic policies of a Trump presidency.

Our principal focus has always been on economic policies, and their implications for investors. At this very premature moment, Trump economic plans appear to have potentially widely divergent consequences, so any investment conclusions drawn would range from tentative to foolish. Some of the policies discussed in the campaign are immoderate, with severe implications for investors. And the very wide range of possible policies, and their consequences, in addition to inflammatory and contradictory rhetoric, create much heightened uncertainty and potential volatility. It is therefore especially important to pay close attention to the actual policies that the Trump administration will pursue.

The Trump administration may turn out to pursue a moderate, pro-growth agenda of lower taxes and regulatory burdens, and a less intrusive government in the economy: a modest, comfortable swing back to the center after eight years of a Democratic administration. But the election of Donald Trump as President of the United States "feels" like it could be something much different, a pivotal moment in history marking the end of one era and the transition to a new. If so, we will see the consequences in the economy and in the markets. But the most profound impacts may be beyond the economic data, in the realms of politics and society. And so, while these are not areas in which I have any special insights, the possibility that the Trump election marks a profound shift in both the global order and our society demands our attention. I’ll start with the global order.

The narrative for me begins just over a hundred years ago, when Pax Britannica reigned across the globe. In the century following the Treaty of Paris (1815), Britain secured the sea lanes, maintained a balance of power (in her favor), and provided the world with capital and its reserve currency. Her enemies and allies embraced (more or less) this protective world order. The major powers (mostly) avoided conflict with each other, trade rose to record heights, and economic growth soared.

The world order imposed by Pax Britannica brought a golden era of economic prosperity to much of the world, but by the end of the 19^th century, Japan and, especially, Germany, had gained economic strength, and with it, military might. Britain’s hegemony both permitted their economic ascent, and thwarted their political ambitions, and it was only a matter of time before this conflict boiled over and Pax Britannica would be challenged (by Germany). The United Kingdom won the first world war, but her supremacy was shattered (forever, as it turned out). Without a world power willing or able to supply the global public goods of free trade, rule of law and military enforcement thereof, the world order collapsed. The first half of the 20^th century was marked by two world wars, the rise of fascism, revolutions in Russia and China, and the deaths of 100 million people from the resulting chaos.

The United States reluctantly engaged in world affairs in the waning months of World War One by sending more than one million “Doughboys” to fight in France. But the US promptly disengaged after the armistice, and remained (mostly) apart for the subsequent two decades even as the rise of fascism brought the world into conflict again. When Germany invaded of Poland in September 1939, marking the start of the Second World War, the US Army had fewer than 188,000 active duty troops, on par with Bulgaria. It took an attack on American territory in December 1941 to bring the US back into world affairs.

At the end of that war, the United States accounted for more than half the world’s economic output, and imposed a new world order in which trade was liberalized (GATT, which became the WTO), security was protected (NATO, SEATO, et.al.), and capital was available to any country that requested it (Marshall Plan). American troops were stationed in Europe and in Asia, not to protect America, but to protect her allies (they’re still there). In the second half of the the 20th century, Pax Americana led to new heights in trade and economic prosperity for those who participated in it, underpinned by the principles of free movement of goods, capital and people. Enforced by the United States military, of course.

Pax Americana was, from the perspective of the United States, enlightened self-interest. Yes, there was a cost in an absolute sense (US military spending accounts for fully half the total military spending in the world) and in a relative sense (the US share of world GDP has halved even as it has, in dollars, more than octupled-not sure that’s a word). But Pax Americana brought the world unprecedented prosperity and allowed the United States (mostly) to advance its economic and political interests, crowned with the collapse of its principal threat, the Soviet Union.

The world order under Pax Americana is now clearly threatened. Perhaps history will see 1989, with the fall of Berlin Wall and communist regimes in eastern Europe, as its peak; perhaps in 2000 or 2008, or another year, but American dominance of world affairs is in relative decline. At the moment, that diminished power is manifested regionally, not globally, most noticeably in the Middle East, where power has diffused and Russia and Iran have ascended, and in Asia, where China has become dominant. A global challenger to US hegemony has yet to emerge (although China will double its military spending in the current decade, and is the most obvious rival to American leadership).

The Obama administration was wary of projecting American power, and the Trump administration is likely to retreat further by redefining American interests more narrowly. A single political interest may be pursued-the defeat of Islamic State, for example-and countries will align for or against this position, but American military will not likely be projected abroad for any political goal, short of a direct threat on the US homeland. Rather, international affairs will be defined by economic interests, and the tools of American diplomacy will be tariffs and sanctions rather than bombs and missiles.

This scenario may be appealing to many: the withdrawal of American military power as the "world’s policeman" and an aggressive defense of economic self-interest sounds better than putting American airmen, seamen and soldiers in harm’s way. It’s an approach that can be followed for years, as I suspect it will, but history shows that there will be eventually one of two consequences. A new world order will emerge, with the rules set by a dominant power that is not us, and we will have to accede to the rules set by the new hegemon, undoubtedly in its best interests. Alternatively, the resulting global chaos from American disengagement will force the US to intercede to restore order. It is naïve, and will ultimately prove false, to hope that US retrenchment in world affairs will proceed benignly, with benefits and little harm to the US and her allies. But this is the path I expect we will pursue.

The next post will look inward, offering an explanation for the election of Donald Trump, and some broader observations.

In Shock (Part 1) (http://blog.angelesadvisors.com/2016/11/shock-part-1/), we looked at a possible Trump economic agenda and its consequences. A large increase in government spending, tax cuts and deregulation will likely boost GDP growth in the near-term, while restrictions on trade and immigration are headwinds to growth. These policies will add to the inflationary pressures that have already been building.

Markets responded immediately to this agenda. US stocks rose to record levels, led by domestically-focused small cap companies, pharmaceuticals and banks, the prime beneficiaries of less future regulation. Trade-dependent emerging markets were sold, as were bonds, which offer little protection in an inflationary environment.

But some facts remain irrespective of who occupies the White House. Long-term, I remain bullish on US equities. But investors face two broad challenges: low returns and proper diversification.

Over the last 10 years ending October 31, a period that includes the financial collapse of 2008, US stocks averaged an annual return of 6.7%, and US bonds saw performance of 4.6% p.a. With CPI averaging just 1.7% in the decade, stocks gave us five full percentage points above inflation, and bonds added nearly 3% in real terms.

It is very unlikely investors will enjoy these levels of returns in the future. The past few decades saw a confluence of highly favorable developments. Inflation, and interest rates, fell from very high levels, to the lowest on record. Global growth was boosted by a rapid expansion of trade, gains in efficiency and productivity, and the entry of a few billion new producers and consumers into the world economy. All of these trends are either coming to an end or have already reversed. Future returns will be lower than what we’ve enjoyed in recent decades.

A fundamental principle of investing is diversification. What we really mean by diversification is a range of investments that have low, or negative, correlation with each other. That way, losses in one part of the portfolio are limited, while other areas of the portfolio are likely performing well. Since we don’t know which strategy or asset class will do well in the coming period, a well-diversified portfolio should enable investors to capture the best, while mitigating the worst, areas. The result is a more efficient portfolio, one with a better ratio of return and risk.

Stocks and bonds are the fundamental assets in portfolios, as these capture the broad macroeconomic forces of economic growth and contraction, inflation and deflation. Stocks and bonds thus represent opposing areas of the return/risk spectrum, acting as a natural hedge to the other.

For the past two decades, this played out well: the correlation between equities and Treasuries was consistently negative. Investment alchemists (i.e., asset allocators, such as ourselves) were able to conjure up well-diversified, well-balanced, more efficient portfolios by taking advantage of this natural hedge between stocks and bonds.

But the negative equity/bond correlation we’ve enjoyed for the past 20 years is not necessarily the natural order of the investment universe and, in fact, was a reversal of the order of the previous three decades. The 1970s bear market in equities was coincident with a bear market in bonds. The 1980s and 1990s was a period of bull markets for both stocks and bonds. So, it appears, the equity/bond correlation is not really stable, much less “naturally” negative.

Correlation is not causation, as every statistics professor warns, but it makes sense that the economic environment is a critical determinant of the equity-bond relationship. A positive correlation exists when there is stronger nominal GDP growth, with higher levels of inflation and interest rates. A period of low growth and low inflation, which characterizes the past decade or two, is associated with a negative correlation between stocks and bonds.

But at extremely low yields, the correlation turns more positive. It may be that at very low rates, bonds offer little yield protection from macroeconomic disruptions, and are thus a much less effective hedge for equities. This is exactly what we’ve seen recently, as the equity-bond correlation has been positive on days when equities have sold off.

If the equity/bond correlation is indeed reversing to a more positive one, as existed in the three decades before the late 1990s, our portfolios will become less efficient. That won’t matter much if the global economy can expand in real terms (1980s/1990s). But should growth slow and/or inflation rise (1970s), investors will be severely challenged.

The macroeconomic environment for the past few decades has been particularly advantageous to investors. The global labor force doubled, with the entry of China and other countries into the world economy. Trade soared at twice the pace of global growth, technology improved productivity and profits. Inflation and interest rates dropped from record highs to record lows. It has been a golden era for capital.

That era is not necessarily over. Policies that promote trade and basic research, reduce and simplify regulations and taxes and subsidies, can extend real global growth. Some of the recent campaign rhetoric was so aligned, but much of it wasn’t.

In next segment, I’ll examine some of the broader (non-economic) implications of this new era.

Shock, a sudden drop in blood flow, is a serious medical condition. Untreated, it can quickly be fatal. There are numerous types and causes of shock, including anaphylactic, an allergic reaction, cardiogenic, from heart damage, hypovolemic, from blood loss, and neurogenic, from spinal cord trauma.

The election of Donald J. Trump as President of the United States induced shock in virtually all of the people who did not vote for him, and probably even in many of the ones who did.

Thankfully, I am not a political pundit, which may now be the most disgraced profession in the country. But there’s no escaping having to make an assessment of the landscape for investors, as we must play the hand that we’ve been dealt. So I’ll try.

There are many possible paths of a Trump presidency: some hopeful, some benign, and others horrifying. The implications and consequences are far-reaching, affecting not only the economy, but politics, society, even the fabric of our country.

This will be a lengthy note (fair warning), so I’ll split it into parts. First, I’ll discuss the reactions in the markets, what investors are expecting (discounting) from a Trump economic agenda, and the economic consequences of possible policies. In the next note, I’ll focus on the investment implications of this possible agenda, with a focus on the new challenges to asset allocators. Lastly, I may venture into some of the broader areas of politics, where I am wholly unqualified to comment, but where the implications of a Trump presidency may be the most profound. Unless I first regain blood flow and come to my senses.

Markets Reaction

Markets reacted swiftly and dramatically to the election results. As a Trump victory was growing in likelihood that election night, stocks sold off 4-5%, first in Japan, the first major market to open, and again in the US futures market. This was consistent with all the prognosticators, who assumed the vast uncertainty brought by a Trump presidency would send equities sharply lower. But by the time the sun rose on the east coast of the United States, the futures market had largely recovered, and ended the day after the election more than 1% higher. In the following days, stocks continued to rise, but the bigger moves were seen in other markets: currencies, bonds and commodities. The US dollar (first chart, below) and bond yields (second chart, below) both soared to their highest levels in a year.

US Dollar Index, Last Twelve Months

US Government 10-Year Treasury Yield, Last Twelve Months

The dollar was strong against all currencies, although especially hit were emerging market currencies (JPM EM FX Index, graph below). Fears of protectionism harm the growth prospects for exporters, and a stronger dollar diverts capital flows, both bad news for emerging markets.

JPMorgan Emerging Market FX Index

Bond yields jumped on fears of rising inflation (10-Year Breakeven Inflation, chart below). Inflation, and inflation expectations, have moved higher this year, and policies to restrict trade and expand government spending are likely to contribute to inflationary pressures.

US 10-Year Breakeven Inflation Rate

It may be premature to reach any conclusions about the effects of a Trump presidency, but the markets have moved, and I’ll try to interpret the rationale.

Trump Economic Agenda (Tentative)

As a candidate, Trump made numerous comments on economic policy that were, shall we say, often contradictory. Perhaps that’s not unusual for a politician. Nonetheless, there seems to be four broad areas of focus with meaningful economic consequences:

• Fiscal Policy: more government spending, especially in defense and infrastructure projects, and targeted tax cuts are the broad areas of emphasis.
• Trade Policy: reducing our trade deficit through the imposition of tariffs and/or renegotiating or reneging on existing treaties.
• Health Care: repealing the ACA, although possibly only parts of it, and replacing it with undefined policies affecting about one-eighth of the economy.
• Immigration: restricting new immigrants and deporting many who are now here.

Judging from the jump in equities and drop in bond prices, the markets are focused on the first item, fiscal policy. A sharp increase in government spending, financed with debt, along with cuts in tax rates, should provide a boost to near-term economic growth, and this seen as friendly to stocks, unfriendly to bonds. But, at the moment, markets are ignoring (or downplaying) the restrictive aspects of protectionism and lower immigration. As for health care reform, it’s impossible to know what will be kept and what will be scrapped. On the assumption that drug prices will be unchecked, the stocks of biotech companies jumped 9% the day after the election. Hospital stocks collapsed, on the assumption that enrollment in government insurance plans will be reversed, but hospital stocks have mostly recovered since. The impact of health care reform on the sector, much less in the broader economy, is impossible to know at this point.

So the near-term boost to the economy from fiscal spending and tax cuts may be partly (mostly?) offset by restrictions to growth from less trade and immigration. But look beyond the near-term effects and the favorable growth impact becomes less clear. And the positive impact to investors becomes even murkier.

Impact on Economic Growth and Inflation

A high level of sustained government spending is associated with slower economic growth, not faster, and with lower investment multiples. Europe is the case in point, with much higher levels of government spending than the US, much weaker growth, and much lower investment multiples.

The reason for the link between higher government spending and lower economic growth is the misallocation of capital. Certainly, some government spending is net additive, if invested in projects that return more than their cost of capital. GPS satellites, originally launched to guide intercontinental ballistic missiles, enable precision farming and keeps us all from getting lost, to name just two of the benefits. These are gains in efficiencies that well exceed the costs of the 31 satellites the US Air Force currently maintains. Expanding the capacity of ports, for example, could be another such project, unless, of course, other policies restrict trade, thereby negating the benefit of greater port capacity. But roads and bridges to nowhere get us nowhere, and however well-intentioned (or not), government spending is too often driven by political, not economic, considerations. Hence capital is often destroyed, economic growth is weaker, and investment multiples are lower when government spending is high.

Trump has criticized the Fed for putting excessive restrictions on banks (one reason bank stocks surged 14% in the days after the election) and for not pushing inflation higher. We know that higher inflation is bad for bondholders, but the market may be overlooking that high inflation is also bad for real economic growth. Perhaps too few investors remember the 1970s, with high inflation and weak real economic growth, but take a look around the world and tell me of a country with high inflation and strong real economic growth. [Go ahead, take your time.]

If the above is indeed the Trump agenda, and if indeed this agenda, or most of it, is enacted, we should expect to see higher inflation, higher interest rates, a stronger dollar, and a near-term boost to economic growth. These are the expected conditions that have pushed US stocks (especially, domestically-focused small caps), the dollar and industrial metals higher, with emerging markets assets and bond prices lower.

Higher inflation, higher interest rates and a stronger dollar all make sense in this economic environment, but sustaining stronger economic growth is problematic. Higher government spending and rising inflation are associated with lower, not higher, economic growth, as I noted above. The economy can be juiced for a time, but the underlying drivers of growth are population and productivity. Working-age (16-64) population growth in the US fell from 1.52% in 1998 to just 0.32% in 2016. Positively rapid relative to Europe, where working-age population growth went from 0.24% in 1998 to -0.53% this year. And productivity growth has been anemic. The 5-year annualized growth of productivity in the OECD (34 large industrial economies) was 1.67% in 1998, and just 0.49% today. Without faster population growth or gains in productivity, economies will struggle to grow.

Enough for now; in Part 2 I’ll look at some of the asset allocation challenges investors face.

Twenty-four hours without food or drink is supposed to help focus the mind on the task at hand: atoning for the sins of the past year in hopes that your name is placed in the Book of Life for another year.

Of course, I can’t know if I was successful this year (although I have a perfect record so far). I am pretty certain that 24 hours is not enough time even to skim the surface on my multitude of sins this past year. So I have to rely (again) on a forgiving God.

We have a tradition, just an hour before the end of the day, to invite a guest to address us, perhaps to inspire, perhaps to take our minds off the rumblings in our bellies. All of our past speakers have been interesting, but this year I found the talk especially poignant. We heard from Father Gregory Boyle.

Greg Boyle is a legend in Los Angeles (and my nominee to the Nobel Committee for its Peace Prize). For many years, Father Greg was the pastor of the Dolores Mission Church, in the Boyle Heights neighborhood of East Los Angeles. It was the poorest church in the diocese, right in the middle of rampant gang warfare. Father Greg (G-Dog is his street name) established a bakery in the neighborhood, a place where gang members could have a job and learn a skill. He insisted that rival gang members work next to each other. The bakery was a success, and they added a silkscreen business. A diner followed, and expanded throughout the city, including at LAX and at City Hall (where it’s the only dining option). Homeboy Industries has touched 15,000 former gang members, offering not only jobs, but education, mental health and substance abuse services, and tattoo removal (a big deal).

Father Greg Boyle chose to dedicate his life to serving those at the margins of society: the widows, orphans and strangers, as he says. His message to us was that more than anything, more than a job or money, those who live at the margins need to feel connected to the rest of us. We all need to look beyond the tattoos and piercings and clothes to the human being in front of us. The measure of our compassion lies not in our service to others but in our willingness to see ourselves connected to them, he said.

He told us of some of the remarkable stories of former gang members overcoming child abuse, drug abuse, violence and prison. But one phrase particularly resonated with me. He admonished us to be in awe of the poor for the burdens they carry, rather than in judgment for how they carry them.

I could try to draw investment advice from this homily, presumably the reason you read this in the first place. But I don’t want to diminish the power of his words or the remarkable work Father Greg is doing in showing those at the margins of society the strength they always had within themselves to overcome their enormous burdens.

Twenty-three hours into my fast, I learned that there is no better way to atone for my sins than to embrace Father Greg’s vision for us: to stand in awe of those at the margins for the burdens they carry, and not to sit in judgement for how they carry them.

Home

I have not met Janet Yellen, but she seems like a perfectly friendly person. Yet, for some reason, investors seem to panic whenever she hints that the Fed is discussing whether and when to lift interest rates from close-to-zero to a smidgen above zero. That instinctive panic is not rational.

Part of the problem is that it appears there are so few people with a grasp of how monetary policy works, and certainly none who work in Congress or the media. So here’s a quick primer.

The Fed does not set interest rates. The Fed adds or withdraws reserves to or from the banking system, which has the effect of making more or less credit available to banks. When the supply of anything increases, its price falls, and vice versa. Adding more reserves to the banking system causes its price (the interest rate) to fall. Withdrawing reserves has the opposite impact. The Fed thus targets the price of overnight credit (Fed funds) through these liquidity operations, but doesn’t set it directly.

Beginning in 2009, and twice again later (QE1 and QE2), the Fed added reserves to the banking system (see graph below). Massively! Prior to the financial meltdown, reserves were minimal. They jumped to $800 billion in 2009, doubled to $1.6 trillion in 2011, and nearly doubled again to $2.8 trillion in 2014 (with the end of QE reserves have fallen to $2.2 trillion).

While the Fed can add reserves to banks’ balance sheets, they can’t make banks actually lend, or borrowers actually borrow. All those reserves the Fed injected pretty much stayed on banks’ balance sheets rather than feeding into the economy. In other words, the massive expansion of banking reserves had little (or no) impact in the real economy because those reserves were never turned into money, that is, circulating in the real economy. It was (is) an accounting gimmick.

How do we know this? Well, I plotted a few variables to see what, if any, impact this enormous increase in banking reserves had in the real economy (see graph below-for comparison, each data series is expressed as percent change from a year ago). The blue line on top is M2, one measure of money supply. You can see that it has bounced around, and is currently growing near 6% p.a., right around its average of the past 20 years. Real GDP is the yellow line, and it has trended a little downward over the past 30 years, as has CPI, the green line. In other words, money supply growth has been pretty steady over the past few decades, while GDP and inflation have slowed. So the relationship, or correlation, between money supply growth and real economic growth or inflation is very weak. Why?

Well, there is no relationship between the change in money supply and real economic growth. There never has been. And there is no relationship between real economic growth and inflation. Again, there never has been (although this is one of the most enduring fallacies perpetuated by the ignorant). But there is a relationship between money and inflation, which is actually tautological, since inflation is, always and everywhere, in Milton Friedman’s famous phrase, a monetary phenomenon.

Why then has inflation fallen while money supply (M2) has been growing steadily? The answer is found in the orange line at the bottom of the graph: the velocity of money (M2) has been falling. The modest rise in money supply has been more than offset by a declining velocity of money. Thus, inflation has been falling.

Let’s go back to the first graph: reserves in the banking system have exploded. But with little (or no) effect on either economic growth or inflation. Would adding more reserves have any impact? No. Would withdrawing reserves from the banking system have any impact? No.

There are many reasons why economic growth is sluggish and inflation persistently below the Fed’s 2% target. Marginal changes in banking reserves is not one of them. When (if) the Fed decides to withdraw a few reserves to move the Fed funds rate a little higher, headlines will blare, pundits will shout and markets may gyrate, but the real economy will shrug. We have nothing to fear from the Fed. Janet Yellen is your friend.

A large percentage of energy expended at Angeles is in evaluating, analyzing and judging investment managers. It is a core competency at Angeles, and we think we’re pretty good at it.

In doing this work, we crunch a lot of numbers, talk to a lot of people, and argue incessantly (and occasionally, productively) among ourselves. Success in selecting superior managers comes mostly from employing very smart, experienced people in this pursuit, and by having them interact in a structure and culture that seeks to discard the mediocrity and lowest common denominator settled by consensus, in favor of the truly outstanding, and by definition, rare, ideas.

There are no shortcuts in this pursuit, but that doesn’t stop us from looking for an edge. For example, there have been numerous studies over the past 15 years or so demonstrating the empirical evidence that, on average, women are superior investors to men. The seminal research on this was published in 2001 by Brad Barber and Terrence Odean, both then at UC-Davis (Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment, The Quarterly Journal of Economics, February 2001). They showed that overconfidence in men led them to trade 45% more often than women, costing their portfolios about 1% annually in worse performance relative to women.

We embraced this research in two ways. First, we have a lot of smart women at Angeles (we have some smart men too). Secondly, we like to see a lot of smart women at investment firms, and we inquire about that. [I don’t know for how much longer, though, we’ll be allowed to ask this as the seemingly straightforward choice of two genders has morphed in to a dozen or so choices of gender identity (except in North Carolina, where gender is defined by whatever the nurse checked on your birth certificate).]

It’s not clear whether the female advantage will persist in the future, or by how, or if we’ll be able to capture it. Not to worry, though, because there is new research that has identified another edge in selecting superior managers: hire the poor ones.

Oleg Chuprinin and Denis Sosyura, of the University of New South Wales and the University of Michigan, respectively, examined 267 investment managers between 1975 and 2012 along with Census records on each manager’s family, including his (her) parents’ income, home value, education and occupations (Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds, Working Paper).

They postulate: “a manager’s family descent and access to resources during his formative years serves as a powerful signal of managerial ability…. individuals are endowed with different opportunities at birth and, as a result, face dramatically different entry barriers into managerial roles….Because individuals from less privileged backgrounds have much higher barriers to entry into prestigious positions, only the most skilled types can exceed these high thresholds and build a career in a management profession.”

Their conclusion: “managers from families in the bottom quintile of parents’ income distribution outperform managers in the top quintile by 3.36% per year.”

Well, that’s good enough for me. We need to start selecting managers from poor families.

The quote in the title references, of course, the poet Emma Lazarus, whose poem, The New Colossus, is engraved on the Statue of Liberty. It ends with these inspiring words:

“Give me your tired, your poor,

Your huddled masses yearning to breathe free,

The wretched refuse of your teeming shore.

Send these, the homeless, tempest-tost to me,

I lift my lamp beside the golden door!”

This describes perfectly the profile of investment manager we want: tired, poor, homeless, tempest-tossed, wretched refuse. The Angeles lamp leads you to our golden door! Even better if you’re a woman. Come to think of it, Emma Lazarus would have made a great portfolio manager.

It’s good to be tall.

Tall people tend to be more highly educated, earn more over their careers, are higher in the social pecking order, and live longer with better health.

[Please don’t complain to me that these statement are untrue or unfair: these are true as generalizations, and I can cite the studies if you insist; these are fair because, well, maybe they’re not fair. But that’s not my department.]

By better health, I mean a lower risk of cardiovascular and respiratory diseases and less risk of adverse pregnancy outcomes, although there is a greater risk of some cancers. The charts below, for men, and women, respectively, show the relationship (it’s negative) between height (x-axis) and the probability of dying from any cause (y-axis), ages 50-70, between 1896 and 2006 among 62 countries.

We may be inclined to blame (or thank) our parents for being short (or tall), and that’s fair: height is certainly a heritable trait. So, it really is our parents’ fault.

But across populations, differences are attributed to non-genetic, or environmental, factors. Specifically, fetal growth and nutrition and infections during childhood and adolescence are important determinants of adult height. As such, height is a handy, single measure of a population’s health and longevity, but also of its education and economic productivity.

The good news is that both men and women are taller today than they were 100 years ago, in every single country. The biggest gains were found among Iranian men and South Korean women, who added an average 16.5 cm and 20.2 cm (6.5 – 8 inches), respectively, in height over the past century. Big gains were also seen in Japan, Greenland, Serbia and Poland. Modest gains were found throughout sub-Saharan Africa and South Asia.

The tallest people on the planet are Dutch men (an average of 182.5 cm, a hair under 6 feet) and Latvian women. Actually, Latvian men are now 4th tallest in the world and Dutch women are second. Basketball scouts should spend more time in Latvia and the Netherlands.

A century ago, American men and women ranked 3rd and 4th tallest, respectively, in the world. Today, we have slipped to 37th and 42nd (see maps below of relative world height of men in 1896 (top) and 1996 (below)).

This is an outrage! Americans need to get taller. One approach would be to improve fetal health, provide better nutrition and immunization to children. But the results won’t be measurable for a few generations.

Given the urgency of the height deficit in America, I suggest we offer immediate citizenship to anyone from Latvia and the Netherlands. We can begin to address our lagging height, and expand our pool of basketball talent. That just seems like good public policy.

Housing is a small part of the larger economic picture, contributing only about 5% to GDP (although including all the ancillary and related services probably triples that number). Still, for most people, equity in their homes represents the single biggest investment they have, and for many, maybe the only investment they own.

Many statistics about this economic recovery are disappointing, especially the very sluggish growth rate, averaging just over 2% p.a. since 2010. Other data are more encouraging, such as the halving of the unemployment rate from 10% to under 5%. One of the more impressive markers of recovery is found in the housing data. Five years ago, nearly one-in-three homes were underwater, that is, their mortgages were greater than their house was worth. Today, that number is less than one-in-eight (see below).

To be sure, this is a national average, and there are wide pockets of underwater homes throughout the country (see below), but overall, there’s been a lot of recovery in home values.

In the 35 largest MSAs (metropolitan statistical areas), Las Vegas has the highest percentage of homes with negative equity (19.5%), followed closely by Chicago (19%). California ranks pretty high, with the two lowest markets with homes underwater, San Francisco (4.0%) San Jose (2.4%).

In every metropolitan area, negative equity is more pervasive in the lower tier of homes than in the higher tier, on average, 19.4% versus 7.3%. Detroit has an especially wide gap: the highest percentage in the nation of homes underwater in the lower tier (41.4%), with an upper tier that is stronger than the national average at just 4.9%. The upper tier in Las Vegas still lags with 13.8% of homes with negative equity, a nationwide high. And again, San Jose stands out as the strongest market, with just 4.3% of lower tier homes underwater, and just 0.7% in the higher end (see table).

The improvement in the equity positions of homeowners has coincided with a declining rate of home ownership, peaking at 69.2% in 2004 and now at 50-year lows (62.9%-see graph below).

Declining home ownership is not necessarily a bad thing. In the 1990s, social engineers theorized that home ownership was a social good, to be promoted. Taxpayer subsidies of trillions of dollars supported the housing industry (still do), and it’s clear we incented many to buy homes who should not have done so. I see the lower home ownership rate as closer to restoring a sustainable equilibrium than a cause for concern.

Acknowledging the many areas of the country with a still-elevated number of homes with negative equity, especially in the poorer neighborhoods of most cities and regions, overall, there is less negative equity across the country, and (encouragingly for some of us) California is especially strong. As we learned in elementary school, multiplying two negatives results in a positive, which is the message we see in the housing data.

[nota bene: this is a long one; if you don’t have time, just skip to the summary at the end. I promise, no hard feelings.]

The political experts were remarkably accurate in last week’s UK referendum on continuing to remain in the European Union, projecting a vote of 52%/48%. The actual final tally was 51.9% to 48.1%, so chalk one up to the pundits.

Well, the numbers were spot on, but the sign was the wrong way: instead of a narrow victory to remain, the voters chose to exit. The Bloomsbury Crowd [a group of Cambridge-educated intellectuals who gathered in Bloomsbury, London in the early part of the 20^th century to discuss and affirm the importance of themselves] was shocked (shocked!).

This political earthquake sent tremors throughout the markets. The pound sterling saw its biggest single day decline since exchange rates were floated in 1971, plummeting from 1.50 to 1.33 Friday, its lowest level since 1984 (see graph below, GBP/USD 1987-2016). Stocks plunged, gold surged and government bond yields fell from minuscule to imperceptible levels, all as investors shunned risk and sought safety. Economists were quick to re-run their DSGE models (Dynamic Stochastic General Equilibrium, but you probably already knew that), and shaved a few points off of UK GDP growth. S&P and Fitch promptly downgraded the country’s credit rating from AAA to AA.

GBP/USD, 1987-2016

The immediate impact of an earthquake is physical, but the repercussions are also psychological and economic. From my perspective, the Brexit (Britain exit) vote should be viewed from three angles: economic, financial and political.

Economic

Most economists cut their GDP forecasts in the UK by around 1.25% (some higher, some lower), and by about 0.5% for the EU and 0.25% for the US. The general assumptions are that trade barriers will rise and consumer and business spending will be curtailed to varying degrees. These economists are all very smart, and their forecasts may turn out to be true (although it’s been noted that economic forecasts make astrologers look prescient). Eschewing my DSGE model for the Magic 8 ball I had as a kid, my best guess at this point is that these economists are unduly pessimistic, at least in the near-term. The world economy, and especially Europe’s, is, and has been, facing strong headwinds of growth and productivity that has little or nothing to do with whether the UK stays or leaves the EU. In other words, I don’t see economic growth as hinging on Brexit.

Financial

The financial impact has been swift and severe, but utterly rational, in my view. Markets have sold assets in-line with their sensitivities to the UK and European economies. The currencies were the first to fall, and markets have generally distinguished between those assets with more and less exposure to the UK/Europe. The sell-off in equities has not been wholesale, and the indiscriminate selling that characterizes panic has not (yet, anyway) transpired. Stocks with greater exposure to the UK have fallen more than those with little or no exposure to that market, and that makes sense.

More importantly, I don’t see any systemic financial risk, as we had in 2008. One measure of financial risk is the LIBOR-OIS spread. It has ticked-up a few (2) basis points in Europe (1^st graph below), a bit more (10 bps) in the UK (2^nd graph), but nothing like we saw in 2008, when spreads blew out hundreds of basis points (3^rd graph).

So far, then, I don’t expect much of a near-term economic impact from this vote, and I see the markets’ actions as orderly and logical. There is little risk of systemic default or liquidity freeze that threatens the normal functioning of the capital markets, à la 2008. But this does not mean that I think there are no tremors from the Brexit vote: the damage is political, and possibly severe.

Politics

Starting from the center and working out, UK politics are in turmoil. The ruling Conservatives had been split, with a small majority of MPs favoring to remain. The Prime Minister has resigned, and the party will now fight over his replacement (widely seen as the mercurial mayor of London, Boris Johnson). Virtually every (+90%) Labour MP favored (or, favoured) to remain, but the leader, the Marxist Jeremy Corbyn, was tepid in supporting Remain, his shadow cabinet has resigned, and Labour will now fight over it leadership. Unlike in the US, candidates for Prime Minister are chosen by party elites, not through direct elections. The third-largest party, the Scottish Nationals, are agitating for another swipe at independence from the rest of Britain, but the biggest (maybe only) winner is the fringe, far-right populists (bigots) of the UKIP.

Complicating political matters is a legal question: under whose authority can the UK invoke Article 50 of the Treaty of Rome (establishing the EU) to begin the process of exiting? Is the referendum sufficient? Or does it require an Act of Parliament? If the latter, the vast majority of MPs backed Remain, so it’s not clear such an Act would pass. New elections are likely, although even then it’s not clear a majority of Parliament would vote to exit the EU.

Whatever happens, British politics has been roiled. Most of London, Scotland, Northern Ireland and Wales voted to remain, as did most younger people. The Exit vote was carried by everyone else. Scotland has revived plans for another independence vote, and Northern Ireland has floated the idea of union with Ireland. Young people want to be able to backpack freely around Europe, and are waiting for the elderly, who voted to Leave, to die. The rest of England would be happy to see London engulfed in another Great Fire or bubonic plague. Don’t be misled by their quaint and proper accents: the British are at each other’s throats.

Article 50 of the Treaty of Rome spells out a two-year negotiation period for a member state to exit. Assuming a divorce agreement can even be reached, it then must be ratified unanimously by the remaining 27 countries. Good luck with that.

Some pundits (probably the same who called the vote so accurately) believe the EU will push for harsh conditions for a British exit, on the premise that the UK needs the EU more than the other way around, citing that 44% of UK exports go to the EU, whereas just 3% of EU exports go to the UK. But this argument overlooks the larger importance of Britain to the EU. It is the second-largest economy, after Germany, and has the largest military budget (3^rd in the world, behind the US and China, ahead of Russia). The long-time sclerotic political dysfunction of the EU means it has had far less influence in global affairs than its economic size would dictate, but whatever influence it has comes largely from Britain’s power. An EU without Britain would lose most of whatever small sway it currently has in global affairs.

Beyond Britain, the Brexit vote will encourage the representatives of nativism, isolationism and protectionism. Already these forces represent a sizeable portion of the electorate in many European countries, as well as in the US. Regional fracturing may gather momentum, not just in Scotland, but in Catalonia and Basque in Spain, or Lombardy in northern Italy. A majority of voters in France and Italy want a referendum held on continued EU membership, and not so they can re-affirm it. A break by one of these countries would be much more complicated and would signal the definitive end of the EU.

So, politically, the Brexit vote is likely to have far-reaching consequences. A positive outcome might be for the EU to re-think radically its entire approach of ever-greater integration and regulation imposed by bureaucrats unelected and unresponsive to citizens’ needs and interests. That seems as likely as me becoming the next Prime Minister.

Investments

In my Inside the Triangle post (http://blog.angelesadvisors.com/2016/05/inside-the-triangle/), I laid out three angles to access the investment environment: sentiment, valuation and momentum. Well, sentiment and valuation have certainly deteriorated in the past few days (a good thing), but the trend is still lower, and whether your preferred analogy is a falling knife or a moving train, catching the former or standing in front of the latter is ill-advised. That knife (or train) is gathering momentum: UK stocks are at 40-year lows relative to the developed world (see first graph below), and US stocks are ahead of European stocks by the most since probably the 19^th century (2^nd graph below shows the past 60 years).

So, despite all the gut-wrenching, hair-tearing, clothes-rendering apocalyptic prognostications and market gyrations of the past few days, I’m reluctant to stray too far from our targets. Our model equity portfolios have been over-weighted to the US for some time, and I’m not looking to change that now. But the amount of relative US outperformance is at unprecedented levels. I prefer to wait for that trend to shift before moving aggressively away from the US, but I’m also cautious about raising the stakes further after this exceptional run.

Summary

I see the Brexit vote has having little economic impact in the near-term. The global financial system is not threatened by this vote, and the risks of a 2008 meltdown are zero (well, almost). Despite the heightened volatility and swift sell-offs, the markets are functioning rationally. The repercussions of Brexit are primarily political, and these are likely to be substantial, posing longer-term threats to the long-term integration of the world economy that has propelled billions out of poverty and enhanced the welfare of billions more. But those benefits, while widespread, have not been shared equally, and the political consequences of that have now been more clearly manifest.

I’m not French, and I’m not a lawyer. So I am certainly not a French lawyer. These facts may be obvious, but I state them as a possible explanation for my lack of understanding the (tortured) logic in a Paris courthouse today.

A long time ago, in another time and place (2007 Paris, to be precise), there was a junior trader at a venerable bank (Société Générale, founded 1864 under charter granted by Napoléon III) who was supposed to be arbitraging the spread between equity cash and futures. Not a very sexy job, and one better suited to computers than humans (which it is today), but for this junior trader from Brittany, whose mother was a hairdresser and father a blacksmith, this was a very lucrative job.

Somehow, this young man, Jérôme Kerviel (photo below), ran his positions up to €50 billion, and losses mounted to €4.9 billion (about $7 billion), before the bank removed him from the trading desk. It more than wiped out the bank’s capital, and nearly brought it down.

The bank brought charges in 2008, and Kerviel was convicted in 2010 of abuse of confidence and illegal use of computers. The more serious charge of fraud was dismissed. Kerviel claimed his managers knew what he was doing (how could they not? he said), and that he was a scapegoat for the massive losses the bank had in its mortgage portfolio (that’s plausible, but hardly an excuse). He was sentenced to five years in prison. Two years later, a court upheld the conviction and sentence, and required him to re-pay the €4.9 billion he lost the bank. In 2014, another court upheld the sentence but removed the €4.9 billion fine (whew!).

So, all this is (maybe) an interesting historical footnote, with M. Kerviel now out of prison and looking for gainful employment. He is appealing his conviction, of course, but he also sued Société Générale for unfair dismissal. One might think that case a joke, but today, a labor court ruled that, indeed, Société Générale fired him unfairly, “without genuine or serious cause,” in the judge’s words, reasoning that his termination was not due to his actions, but to the consequences of his actions. The bank, in the court’s opinion, fired Kerviel not for illegally using computers but for losing €4.9 billion, which (apparently) is not a fire-able offense. For good measure, Société Générale was also ordered to pay him €450,000. So, it is now established that you can’t be fired for losing your employer €4.9 billion, at least in France.

There’s a long list of things in this world I don’t understand. That list just got a little longer today.

Oil has had a nice recovery this year (see graph for Brent, YTD), up about 18% to over $48/barrel today. Of course, this is still well below the +$100/barrel we saw from 2011 through most of 2014, so will oil continue its climb higher?

Um….no. I don’t see any oil tankers in Santa Monica Bay today, but if I looked out my window in Singapore, it would be a very different story. Through the Straits of Malacca, between Malaysia and Indonesia, one of the most strategically important shipping lanes in the world, flows more than 15 million barrels of oil every day, about 27% of the entire world oil maritime trade. Today, there are 40 supertankers anchored offshore Singapore (see map below), each holding more than one million barrels of oil. The Straits are more congested than the 405 at 5pm.

A few months ago, traders earned a positive arbitrage by storing oil in these tankers and selling later as the price jumped. But today that arbitrage is negative, anywhere from $0.48 per barrel for 30 days to more than $6 per barrel for 12 months. So this oil is not being stored for profit: we’ve run out of places to hold it.

The more oil that floats, the more the price will sink.

Surprisingly strong housing numbers out this morning: new single-family homes rose 16.6% in April to an annual pace of 616,000 (see chart below), well above expectations, and up 23.8% over the past year. Supply of new homes fell to just 4.7 months, all due to faster sales (inventories were flat). Sales are up strongly in the Northeast, solidly in the South and West, although down in the Midwest. The median ($321,100) and average ($379,800) prices jumped 9.7% and 13.5%, respectively, the last year.

There is more to come. The graph below shows the data from 1963. We may never reach the 2005 peak of 1.328 million (or, maybe we will), but housing will continue to strengthen because job growth and wages are rising, and home ownership is still low. Housing has legs.

Complexity makes investing so challenging. Unlike the pure sciences, there are no hard truths in investing, no discoverable axioms that determine outcomes with 100% confidence. At best, we can speak in probabilities, but even these probabilities come with large standard errors. Investing demands humility, even from the best of us.
This complexity comes from the infinite number of variables that affect investments. These variables are not just economic and financial, but also political, social and emotional. Investing cannot be reduced to a formula or an algorithm, however many Greek letters they may contain. It’s not just the sheer number of factors at work, it’s also the constantly changing interaction and effects each of the variables has on the others, resulting in a geometric explosion in complexity.
One traditional approach is to ignore all this: set a fixed asset allocation, and never vary. This is a perfectly legitimate strategy, but one that requires a number of conditions that rarely co-exist among investors:

• The asset pool must serve long-term needs, as any significant cash flows in or out of the pool risk occurring at a time detrimental to the long-term goals of the investor.
• Risky assets will have higher future returns than safe assets.
• The future return of a portfolio will be adequate, in absolute terms, to meet the needs of the investor.

These conditions are suspect. Many investors have significant cash flows in or out of their portfolio at inopportune times. An investor who retired in 2009, for example, likely had a pool of savings that was considerably less than it would have been a year earlier. Many endowments and foundations see their cash needs increase when portfolios values are lowest, thus draining assets at the worst time.

It’s unusual, but risky assets don’t always outperform safe assets over all periods. From 2000-2008, the S&P 500 Index lost 3.6% p.a., while long-term US government bonds gained 10.5% p.a. in that period. From 1966 to 1974, US stocks advanced just 0.1% p.a., while US government bonds returned 2.4% p.a. Between 1929 and 1942, US stocks lost 1% annually, while government bonds compounded at +4.5%.

The third point is most questionable today. Long-term government bonds yield less than 2% around the world; in much of Europe and Japan yields are even below zero. Future stock returns are uncertain, but most would estimate absolute returns to be well below historical levels. There is a substantial risk that a diversified investment portfolio will fall short, even well short, of investors’ required returns.

A fixed asset allocation does have one important distinguishing value: it stops investors from harming themselves. This is not to be underestimated. According to consulting firm Dalbar, over the past 30 years (ending 2014) the average retail investor failed to keep pace with inflation, earning 2.47% p.a. to inflation’s 2.70% rise. Forget coming to close to bonds (+7.36%) or US stocks (+11.06%). High fees are only partly to blame; this level of underperformance comes from (bad) investors’ decisions to buy high and sell low by chasing fads on the upside and bailing out at the bottom.

Thus far, I’ve presented only problems:

• Investing is complex beyond comprehension, by human or computer.
• A fixed asset allocation solves the problem of complexity by ignoring it, but suffers real limitations.
• Investor behavior is harmful to investors.

If a fixed allocation is problematic, constantly shifting strategy is likely to be worse, for two main reasons. First, as we saw in the Dalbar study, decisions are almost always wrong because successful investing is counter-intuitive, not intuitive. The moment of maximum pain (blood on the streets in Nathan Rothschild’s memorable phrase) is the best time to invest, and when markets are most euphoric is the worst time to invest. Secondly, even if we can avoid the behavioral harm we self-inflict, timing markets is impossible. Not hard, not difficult; impossible. The reason is that the majority of market returns occur in a very small number of periods. Over the past 6,000 days (25 years), an equity investor that missed the best 10 saw his return cut in half (see below). Successful timers do not have to be correct just more than half the time; they have to be right, consistently, nearly all the time. Impossible.

I’ve presented two approaches at the opposite ends of the spectrum: never altering strategy in light of market conditions, and always shifting strategy to anticipate future movements. I’ve explained why both are unsatisfactory. But we still need a framework that balances all of these forces at work in order to give us a way to formulate our investment strategy. For me, that frame takes the shape of a triangle.

I noted above that the influences affecting investing are infinitely complex, involving economic, financial, political, social and psychological factors. I said that no formula or algorithm can fully capture these variables, but three general categories of quantifiable factors can frame our analyses: Momentum, Valuation and Sentiment.

Momentum refers to a trend, up or down. It is surprisingly difficult to know if markets are trending higher or lower without looking at the historical pattern. It’s hard to see the forest through the trees. Trend analyses are used by traders to time their trades, but investors need to know if we are in a bull or a bear market. Of course, bull and bear markets do not move in straight lines, but with sufficient perspective, short-term fluctuations smooth out, and we can answer the simple question of whether a market is trending higher or lower. If higher, we generally want to maintain our exposures; if lower, we generally want to reduce them.

I noted in my last quarterly letter (https://angeles-srv.s3.amazonaws.com/content./1462378111./angeles-commentary-1q16.pdf)

that the S&P 500 Index has traded between 1850 and 2150 all but six days in the past two years. So, over the medium-term, US equities are neither in a bull nor a bear market; they are just bouncing around in a range, biding time. But with a longer-term perspective, we see that US equities broke out of their 2000-2013 range to the upside. If my investment horizon were measured in decades, I would conclude that US equities are in a structural bull market and I want to maintain exposure to this asset. The graph below, in semi-log scale, shows the S&P 500 Index from 1966 through today.

Valuation refers to whether an asset is cheap or expensive, which means its future return will be high or low, respectively. There are many valuation metrics, and the best approach is to review as many as possible to weigh the preponderance of the evidence. A common metric is the price-to-earnings (P/E) ratio. Since 1966, the P/E ratio of the S&P 500 Index has averaged about 16.5x, with a high of 29x in 1999 and a low of 7x in 1974 (see graph below). The current level of 19x says to me that current valuations are not especially cheap, but they’re not grosslyexpensive either.

Valuation is important in the short-term, but over the long-term, it matters much less for equities than the growth rate of earnings and dividends. The chart below (from MSCI) decomposes the returns of global equities into three components: dividend yield, dividend growth and valuation adjustments. Over a one-year time frame, changes in valuation account for half the performance of equities. But over 20 years, valuation adjustments contribute just 7% to the total return, with dividends, and the growth of dividends, accounting for 93%.

Sentiment measures investors’ fear or optimism, and this is a gauge that is a contra-indicator. Investors (as a group) are generally rational, but investors are also human, and therefore, emotional. When pessimism and optimism exist they do so for very rational reasons. Think back to early 2009, when it seemed the world, at least the financial world, was falling apart. Well, it was falling apart. Investors’ fears were rational, and no one knew whether the financial system could be saved. Likewise, try to remember the euphoria of 1999. The internet had exploded, and all sorts of new products, services and applications promised to deliver a better world to billions of users of this new technology. That was all true, too. So the fear of early 2009 and the hope of late 1999 were both rooted in very real facts.

But the facts are only part of the equation for investors. The implied assumptions about the future in both cases, were ludicrous. In 2009, this was most evident in the credit markets. Prices for corporate bonds fell to levels that implied about one-third of all companies would file bankruptcy. In the depths of the depression in 1932, defaults never topped 20%. Was 2009 going to be worse than 1932? Possible, but very unlikely. Of course, there are many examples throughout history of insane euphoria. The Internet bubble of 1999 was one, but the best in my memory was Japanese real estate in 1989, when the land under the Imperial Palace in Tokyo was more valuable than all the land in California.

Investor pessimism and optimism are based on rational considerations, but when they swing to an extreme, I have found them to be excellent contra-indicators. The AAII survey is one such measure of hope and fear. Below is the percentage of investors who identify as bullish, which today is about as low as reported since 1989. There’s a lot to be pessimistic about, and many are. That’s really good news for investors.

So my view of the current market is somewhat neutral. Momentum is neutral over the past two years, but more positive looking longer-term. Valuation is not cheap, may be a little expensive, but not egregiously so. Sentiment is bearish, and that’s a positive sign. I put all these together below. Ideally, we would see positive momentum, cheap valuations and bearish sentiment. The triangle would be completely green then. But that will be the exception. Most of the time, the picture will be mixed. Of course, there are many more data sets and metrics I consider, only a few have been mentioned. And this exercise can be done across different markets, asset classes and time horizons.

The long-term allocation should reflect the unique needs, risk tolerances and return objectives of each investor. But I find my triangle helpful in thinking about positioning portfolios, at the margin, because market conditions do change, creating new risks and new opportunities to consider in the context of these primary categories of momentum, valuation and sentiment. Good ideas often come from thinking outside the box, but when putting those ideas into action, I work inside the triangle.

To read more, download the full 16 page PDF:

The first quarter began with a bang and ended with a whimper. At least, that’s the message from the VIX (volatility index-see below). Bouncing around an elevated level of around 28 for much of January and February, the VIX fell 50% to 14 by the end of March.

At a high level, we have maintained a pretty neutral stance in our portfolios. I didn’t think the sell-off in the beginning of the year was the beginning of a new bear market, so we held our ground. The March rally brought global equities all the way back to flat for the year, but I don’t see cause to celebrate much. The global economy is sputtering along, and I haven’t seen any serious discussion, much less action, toward addressing the long-term declines in productivity and growth rates.

Valuations are fine, generally in-line with where they “should” be (see table below, courtesy of J.P. Morgan). I suppose oil and (US) homes look a bit cheap, and government bonds expensive, but take valuation measures as the blunt instruments they are. Equities, broadly, are close to fair value, in my opinion.

So, our models, at the high level, are in-line. There are some interesting, idiosyncratic ideas we are seeing around the world, but I don’t (yet) feel compelled to add risk broadly, or to bury gold in the backyard. Still in neutral.

In some respects, this is a golden age for labor. The unemployment rate has dropped to 4.9% from a high of 10% in October 2009. It’s not quite as low as the 3.8% in early 2000, or the post-war low of 2.5% in 1953, but it’s pretty close to full employment. The broadest measure of unemployment (U-6, which includes discouraged as well as part-time workers who would like full-time jobs) is somewhat elevated, but has fallen sharply to 9.7%, from a high of 17.1%. 143 million Americans are employed, the most ever. The average wage is over $25/hour, also the highest ever. Initial claims for unemployment benefits is just 0.18% of payrolls, the lowest on record (graph below).

To be sure, there are pockets of concern. Growth in wages has been modestly accelerating, but is still very low in historical terms, 2.2% over the past year. Low wage growth doesn’t surprise me, though, as it is consistent with the very low productivity gains we’ve seen in this recovery. Raising productivity is the key to long-term improvement in the standard of living, and there is much debate about how to accomplish this. Some, notably Robert Gordon of Northwestern, argue that productivity gains are in the past, not to be seen again. I believe he’s wrong, but I admit that’s more an article of faith than I can support with hard evidence, for now.

Beyond low productivity growth, the other structural concern I have is the labor participation rate. More than 67% of working age adults were working in 2000, dipping to 66% on the cusp of the 2008 recession. Today, less than 63% are employed (graph below).

Demographics explain a lot of this decline. The estimate below shows a “natural” decline in the participation rate to around 64% due to aging, with the remaining +1% explained by other factors. Those factors include rising disability, more education and the business cycle.

The rise in disability is poorly understood: jobs have become less dangerous as they’ve become less physical, so why would disability rolls be rising? Perhaps there has been an increase in non-physical disability, or the qualifications have been relaxed, or the aging workforce is more susceptible to disability, or all of the above or more. We do know that younger people are staying in school longer, as the participation rate fell sharply over the past 8 years for those under age 25, from 59.2% to 55.5%. Interestingly, the participation rate for workers over age 55 increased from 38.9% to 40.1% over this recent period. Lastly, the business cycle influences the participation rate. In the past 5 months, September 2015 to February 2016, as the economic recovery continued, the labor force expanded by 2.02 million workers. All, plus a few more, found jobs.

So, there’s a lot of good news on the labor front. But the long-term, let’s call it the “structural,” trend in the participation rate is likely to head lower due to demographic factors, capping the potential output of the economy. Coupled with low productivity growth, our national wealth will likely accrete at a slower pace than in the past.

Two months ago, I offered some hope that drop we saw on the first day of 2016 was a good omen for the rest of the month and year (http://blog.angelesadvisors.com/2016/01/apres-moi-le-deluge/). I noted that, of the 14 opening day declines since 1928, only 3 (1957, 1978, 2008) portended weak first months. And while 1957 and 2008 were down years for US equities, 1978 was positive. So there was hope (statistically).

Forget it. There are lies, damn lies, and statistics (as Mark Twain wrote), and this statistic certainly lied. US stocks lost 5% in January, with another fractional loss in February, making this the 17th worst start to a year since 1928. So what now? The table below provides the history.

The data say that when the first two months are down more than 5%, the next month is likely (58.8% of the time) to be up about 1% (median). That’s the good news. The rest of the year will likely be down, with a median return of -0.50% the rest of the year. There is only a 35% likelihood that 2016 can redeem itself with a positive return for the full year.

So the data suggest we crawl along for the rest of the year. Of course, the same data also said the opening day drop was likely a positive signal. But statistics is a funny thing: the fact that reality did not comply with its probability does not mean that the next observation will also fall outside expectations. At least, not necessarily, which is probably why Mark Twain had little time for them.

The eastern United States was buried in snowstorm Jonas this weekend, from 42 inches (more than a meter for our non-US friends) in West Virginia to (a mere) 15 inches on Cape Cod. Snowfall records going back more than a century were toppled from Baltimore to New York. Sustained winds in excess of 70 mph added to the mess.

Below is the view from my window this afternoon (70 and sunny here in Santa Monica). Now, if these two photos cause some jealousy, I’m fine with that. But my main point is that looking up into a snow bank does not mean the rest of the world is also buried in snow, just as I can’t look out my window and assume everyone else sees sunshine.

The same used to be able to be said for investing: losses in one market did not mean that there were losses in all markets. Alas, recently, that has not held true: investors have been buried this year in pretty much every market they turned to. Despite the strong performance of markets last week, equities (and commodities) are still down 8% in January (with a week to go).

The swift and substantial decline in equities and commodities to start the year lead investors to ask, reasonably, are there more storms to come? And, will we ever dig out from the current blizzard? The answers are, “probably,” and, “certainly. ”

“Probably” because there are many reasons for worry that will likely persist: China’s transition to a domestic, consumer economy has not been smooth, and the omniscient mandarins in control have made a number of high-profile gaffes. Commodities, oil especially, seem to have no bottom, and while excess supply is the main culprit, weaker demand is contributing: The IMF (again) cut its forecast for global growth last week.

Even the US economy is struggling. We’ll get the first estimate of 4Q GDP on Friday, but it looks like it will come in below 1%. Manufacturing is contracting, in both the US and in China (the PMI diffusion indices are below 50). And the Iowa caucus is one week from today, where the winners are likely to be named Trump, Cruz and Sanders, which no doubt boost the spirits of their supporters, but send an avalanche of fear through investors. So there is plenty to fear.

But “certainly” we will dig out of this mess (both the physical and the financial). Notwithstanding the 4Q slowdown, the US economy is expanding: job growth is strong (the best two straight years since the late 1990s), housing permits, auto sales and even personal incomes are all rising. The widening of credit spreads and the sharp declines in equities have historically been precursors of market crashes and economic recessions, but, as Paul Samuelson observed, have predicted nine of the past five recessions.

While markets are certainly volatile this year, take a look at the TED (T-bills/eurodollars) spread (below). It doesn’t get a lot of attention, but it’s a great indicator of how the market prices financial risk: Over the past decade it reached a high of 455 basis points (October 2008) and a low of 10 (March 2010), averaging 49 bps over this period. The current reading is 33, below the long-term average. This is not what you see when financial markets are about to implode. That’s because they aren’t.

Despite the rapid drop in equities and commodities this year, I don’t see the excesses in leverage or in valuations that herald a market crash. And despite some weaker economic data, neither do I see an economic contraction as likely this year. We should certainly be prepared for storms to come, but I’m confident we’ll dig out of them in due course.

In more ways than one….

We greeted the new year with an actual deluge, at least here in California, as the long-promised El Niño swooped in with force. Mudslides and traffic accidents are the prices we will pay to replenish (but only partly) our water reserves.

We were also greeted by a deluge in the markets, kicked off by Shanghai’s 7% decline on the first trading day of 2016 as investors there spent the holidays musing over the state of the Chinese economy and concluded it is not good. The ripple traveled around the globe, although dissipating with distance, as ripples do. The rest of Asia fell 3%, Europe lost 2%, and by the end of the day the US was off 1.5%. Still, it was the worst Opening Day since the horrible year of 2001.

Between the gloomy weather and the markets, it’s easy to let our moods sink too, so I’m pleased to offer some hopeful rays. The first is that opening day drops in January are historically followed by very strong rebounds the rest of the month (see Table below). There have been some exceptions (1957, 1978, 2008), but it’s a good bet (3 out of 4) that January will be a good month.

My second encouraging word is that we should all feel grateful for surviving the holidays. We may feel that the stresses of seeing families, traveling, presents given and received with disappointment are killing us, and in fact, they are. We are much more likely to die in the week between Christmas and New Year’s than the rest of the year (see Graph below). If you’re reading this, you have likely escaped a premature demise. Take heart in that!

Louis XV (photo below, and author of the title phrase above), succeeded the most renowned king in France’s history. A tough act to follow, to be sure, but ascending to the throne at the age of 5, Louis reigned for 50 years. He wasn’t the Sun King (his father), but he became known as Louis the Beloved, which is pretty nice. It turns out that Louis XV, not the Sun King, was the real tough act to follow, as his son (XVI) had the misfortune to sit on the throne as the Revolution began. There was a reason that period was known simply as The Terror. The deluge was not water, but blood, including that of Louis XVI and his wife, Marie Antoinette.

Water is pouring down Santa Monica Boulevard, and blood is flowing through Wall Street, but Après le déluge, le soleil.

This week, my college basketball team visited southern California, and I was lucky enough to spend some time with them over the past few days. I found myself re-connecting to my own seminal experience 35 years ago, when I was part of that team. The intense camaraderie of that time established lifetime relationships that are among the most treasured I have. The current crop of players cannot yet fully appreciate how meaningful this is. In time, they will.

Sports is, by definition, competitive, and we keep track of our wins and losses. I’m certain that my teams won more games than we lost, but I really have no idea what our record was. And 35 years later, I find it doesn’t matter. It is the personal connections with my teammates and coaches that have lasted, and have had a lasting impact on me.

Over the years, my teammates and I have gotten married, raised children, started businesses, and shared in each other’s joyous moments. We’ve also had our losses. One teammate, a truly great athlete, died of a rare disease. Another, my best friend, lives with ALS. I think of him every day.

I know we won more games than we lost, and I think, collectively, we have had many more joys than sorrows in the intervening years. But I’ve stopped keeping score, because I’ve come to realize that the score doesn’t really count. Winning is not everything because it is fleeting, temporary, ephemeral. What matters, because it’s permanent and profound, are the relationships that we forge.

Family and friends are paramount, but we also spend a large percentage of our waking hours with business colleagues: our employees and bosses, clients and vendors, all of whom build relationships that fill (and fulfill) our lives. Money may be a part of the equation but, like wins and losses, it is not the most important part. My Angeles colleagues have chosen to develop their careers here, and our clients have entrusted us to steward their capital. So, to my colleagues and clients, thank you for your trust. I am deeply grateful for our relationship that gives meaning to my life.

Zimbabwe is a country of 14 million people. I’ve never been there, and I can’t recall if I’ve ever met anyone from there, but I’m sure that the vast majority of Zimbabweans are very pleasant people. I’ll also stipulate that the vast majority are hard-working, although that may be difficult to prove. Of the 14 million people in the country, just 700,000 are considered officially employed.

I’m not sure what the other 13,300,000 people are doing every day, but this astonishing fact highlights for me the depth of the challenge for so many countries. Perhaps few are as abject failures as Zimbabwe, but it should be crystal clear, after three-quarters of a century of experimentation around the globe, that political choices matter.

Respect for the rule of law, reasonable regulations, open economies that are forced to compete globally: these are clear factors that lead to progress, which I’ll define as improved living standards for the majority of citizens. That’s it: these are the only three necessary and sufficient conditions for progress.

Notable is long list of items neither necessary nor sufficient for progress: foreign aid, abundant natural resources, a highly educated population, and so many others. Zimbabwe may be particularly cursed with a long-running kleptocracy that funnels the meager wealth of the country to a handful of Mugabe (see photo below) family and friends, but for many countries, there will simply be no progress unless they embrace these three principles.

Statistics like the one above, where just 5% of a population is officially employed, serve to illustrate the impossibility of progress without radical political change for many countries. That is, poor economic choices manifest first in the economies, but often spread to infect political and social structures. Tinkering with a little more aid or debt restructuring will not ameliorate the systemic dry rot that erodes the foundations of these societies.

Africa, sadly, contains dozens more examples of bad economic policies and pervasive political and social corruption. In the Western Hemisphere, Cubans are poorer today, in absolute terms, as well in relative terms, than they were in 1958, when Castro came to power. A century ago, Argentina had the same GDP as the United States; today, it is less than 1/30th of the US. In Venezuela, inflation is currently running at around 200%, just one (albeit dramatic) consequence of nearly two decades of ruinous policies instituted first by Hugo Chavez and, upon his death, by his deputy, Nicolas Maduro. Venezuela’s collapse was inevitable with Chavez’ policies, just delayed when oil prices were above $100/barrel.

India is every investor’s favorite emerging country today, with some justification: a new Prime Minister with a history of pro-business initiatives and a new Central Bank chairman who was a distinguished economist at the University of Chicago. But let’s remember the economic morass that is India, with a bureaucracy that makes the Byzantine’s seem streamlined. Amazingly, it’s easier to start a business in Gaza than in India (World Bank-see table).

It’s certainly anecdotal, but I was struck by a headline a few months ago (in the FT, which I take as credible) that the state government of Uttar Pradesh advertised for 328 entry-level job openings, including guards and tea boys (which I assume means serving tea to higher ranking bureaucrats, although I’m not sure why they can’t get their own tea). Now, the official unemployment rate in India is 5%. Uttar Pradesh received 2.32 million applications for these 328 positions. If, somehow, the state could interview 2,000 applicants per day, it would take over four years to get through everyone. You could argue that India has a lot of low-skilled workers, thus accounting for the deluge of applicants. But Uttar Pradesh also advertised for a few positions as messengers, requiring five years of education (that is, had to have completed 5th grade) and an ability to ride a bicycle. It received 25,000 applicants with master’s degrees, 255 holding Ph.Ds. Salaries start at Rs16,000/month (about $240) if you’d like to add your resume to the pile.

I suppose the point of all this is that I think about investing in some countries differently than I do in others. The usual rules of valuation, growth, profitability apply to countries with well-established rules and institutions and open economies. Where those are not present, other criteria become more important. This is not an argument to avoid investing in emerging markets, but to understand the deeper, structural issues each country faces.

In the past week, voters in Venezuela finally said Basta! (enough!) to the ineptitude of the Chavez/Maduro regime. And voters in Argentina said the same to the disastrous policies of the Peronistas. After decades of ruinous policies in both countries, these are small steps forward: small, but forward.

Zimbabwe may have to wait for Mugabe to die (which won’t come soon enough), but progress there and elsewhere will only happen when these countries embrace the rule of law, impose reasonable regulations, and insist businesses compete to world standards. If my message to investors is to be careful, the message to these countries is optimistic and straightforward: the path to progress is well-known and well-proven. It’s a bit of a mystery, and a shame, that so many countries have chosen to follow other paths.

Charles de Gaulle (photo below)-imperious, disdainful, utterly French (and venerated for it in France)-noted 50 years ago that “Brazil was the country of the future.” With more than 200 million people and encompassing nearly 3.3 million square miles (about the size of the United States), Brazil is the fifth largest country in the world by population and area, and the 9th largest economy. It would seem that the future for Brazil has arrived.

Unfortunately, it is more like back to the future. Brazil is in the midst of a classic balance of payments problem. It’s growth in the past decade had been fueled by foreign capital and rising prices for its principal commodities: soy, wheat, and especially, iron ore. It was a happy, self-reinforcing cycle of strength.

Now, with commodity prices plunging and foreign capital withdrawing, it’s an unhappy spiral down. Real GDP will fall 3% this year, the real is off 20% and inflation is 10% (and rising-see chart below, past 10years). The government is attempting to spend its way out of this hole, running a budget deficit of 7% of GDP, the current account is also in deficit (4% of GDP), and the 5-year government bond yields more than 15%. The Bovespa (stock market) is off 45% over the past year. Its economic heft notwithstanding, the average Brazilian is not especially well-off, as per capita GDP ranks about 74th in the world (IMF), ahead of Libya but behind Suriname.

All this describes the classic balance of payments crisis. The bad news is that it generally does not end without a lender of last resort (usually the IMF) stepping in and imposing massive austerity measures to slash the budget and choke off inflation. This then causes a large contraction in the economy and a drop in the currency, leaving the country poorer, although (in theory) in a better position to resume economic growth.

Many things compound the challenges for Brazil: one unique aspect is that the majority of domestic lending and wages is linked to inflation, a relic of past inflationary crises. 60% of Brazil’s workers are covered by collective bargaining agreements, for example, which contain automatic inflation escalators. Brazil is a long way from the 6,000% inflation it had 25 years ago (graph below), but inflation is likely to move higher before it will be addressed. But anyone who lived through the hyper-inflation of that period (I was there to see prices in the stores change daily) is right to be fearful.

Less unique to Brazil, but equally challenging, is the political mess. A Marxist union leader, “Lula” da Silva, came to power in 2003 and had the good fortune of seeing commodity prices rise ten-fold during his reign, and the good sense to leave in 2011. His successor, Dilma Rousseff, who actually fought as a Marxist guerrilla, has not been so lucky. And neither one of them changed the pervasive corruption of the country’s political, economic and social fabric. The results are in evidence today.

So back to de Gaulle. He was right to call Brazil the country of the future. But the full quote is more apt: Brazil is the country of the future…and always will be.

As Mick Jagger sang (screeched?) 50 years ago. The song was about turning the tables on a domineering woman (The girl who once had me down).

A bit sexist, to be sure, but the song came to mind when looking at this week’s government bond auctions around the world (isn’t my life fascinating?). Our clients have been complaining about the low yields they are earning (as if I controlled that), and my response has been: count your blessings. You can lend the US government money for a year and earn half of a percent (50 cents per $100), or extend the loan for 2 years and earn almost 1% (91 cents per $100 to be precise). That’s infinitely more than almost anywhere else in the developed world.

In Europe, all short-term government debt (except Greece and Portugal) carry negative yields. Two-year German bunds yield -0.38%, a bargain to Sweden’s -0.47% and Denmark’s -0.70%. Even Portugal (!?) sold 1-year bonds this week with negative yields. Yields in Europe have been negative for the past year, and are getting more so (Chart below). So while the yields are negative, prices have risen steadily, making those investors seem pretty smart (so far).

Most extreme is Switzerland (of course). Mattresses are (apparently) in short supply in Switzerland (so what do people sleep on?), because rather than sticking cash under a mattress, ensuring you’ll get the same amount when you want to spent it later, investors are pleading with the Swiss Central Bank to lend it money for the next decade with the promise of returning a little less of it (see below-positive yields in Switzerland are found only beyond 20 years).

Why this is, is a deeper question. I’ve talked about this in my quarterlies, and it looks like it’s a topic we’ll have to come back to. For now, we’re all under the thumb of central banks, who have us, and are keeping us, down.

The technology bubble of the late 1990s is a distant memory for most investors, and an ignorance for the rest. But back then, companies were raising huge sums of private capital on business plans made of fairy dust, which is precisely what all that money turned into. Over a span of a little more than a year (4Q 1999 to 4Q 2000), well over $100 billion was funneled to private companies. Very little of it was ever returned to investors. Over this past year, just over $50 billion has been invested in private companies, the most since the bubble era, although still about half the funding levels of 15 years ago (see Chart below-note also that more than 40% of venture funding is in software).

Early Mesopotamian art and ancient Chinese and Indian myths contain references to a mythical, single-horned animal: the unicorn. The ancient Greeks saw unicorns as real, not mythological, creatures, and so do today’s investors.

There are 123 private companies receiving venture funding at valuations in excess of $1 billion (see Charts below). These are the “unicorns” of the private equity world. Unlike their peers from 2000, many of these companies are indeed “real,” with actual revenue and reasonable business plans.

Valuation, however, is a different matter. Uber, for example, is a great service, I’ve used it around the world. Is it worth five times what Hertz and AvisBudget are combined? Is Airbnb more valuable than Marriott? or Hilton? SpaceX may one day carry tourists to space, but is it worth more than Textron? Maybe yes to all of the above. Then again, who really knows?

With each round of financing, private companies see their value rise, often exponentially. That’s the natural order of the universe. But cracks are appearing that suggest the optimism may have been a little much. Dropbox had been valued at $10 billion earlier this year. Now, Dropbox is a decent service that lets you store files on-line. For free (up to 2 GB). There are other providers of the same service, and the barriers to entry are, um, none. The company raised another $350 million last month (it must be expensive offering free services), but only by agreeing to value the company at $7.6 billion. I’m not in the business of valuing private companies, but I’m not sure either number, $10 billion or $7.6 billion, is obviously correct, although directionally seems to be on the right path.

Square, another “real” business that provides a phone attachment that lets users swipe a credit card, provides a convenient service, although hardly with an obvious competitive advantage, had been valued at $6 billion in its last round of financing. It went public today at a valuation of less than half that (although, in fairness, the stock price (SQ:N) popped 40% to bring its value to $4 billion).

This is not 2000: many of the these are real, sustainable companies with valuable products and services. Whether their valuations are reasonable or are made of fairy dust may depend on whether you believe unicorns are real or mythological.

Charts courtesy: Goldman Sachs

It’s another beautiful day in Santa Monica: blue skies, a few high wisps of stratus clouds. But 1500 miles south of here is the strongest hurricane ever recorded in the Western Hemisphere. It will slam into Mexico tonight and will likely continue into Texas in a few days. Patricia is a Category 5 storm, with sustained winds in excess of 200 mph. This morning, the NOAA recorded 880 millibars of pressure, the lowest ever (1013 millibars is “normal” pressure at sea level). The satellite image below looks benign, just another cloud layer, but that’s very deceptive. Patricia is powerful.

Experts (really, their computer models) are predicting a strong El Niño this winter. Equatorial waters of the Pacific heat-up, and the trade winds that normally blow east-to-west reverse course, bringing rain to the eastern Pacific and drought to the west. The map below shows the effect, with blue as wetter and red as drier. Note the dots are spread across the globe.

Current temperatures in the Pacific are 2.5 standard deviations above normal (see below), comparable to the severe El Niños of 1997-98 and 1982-83 (when the Santa Monica Pier was destroyed).

Assuming a strong El Niño season, the archipelagos of the western Pacific will be most negatively affected (lower GDP and higher inflation), whereas the west coast of the Americas will likely see an economic boost. But the impact will really be global: eastern Europe will suffer while the eastern Mediterranean should be helped (see below).

It’s easy to be oblivious to weather conditions that are not directly outside your window, and easy to get complacent about the weather when living in Santa Monica. But aside from the human tragedy (which is a silly phrase, as human tragedy should not be put aside; “in addition to” the human tragedy would be a better statement), weather (and climate) have measurable impact on the global economy. And it looks like the season is just beginning.

[Graphs courtesy Goldman Sachs]

No question, this has been a challenging year. Virtually every financial asset class is struggling. Stocks are down, bonds are down, gold is down, oil is down. US is down, non-US is down. Large caps down, small caps down. Industrials, financials, health care: all down. High-grade bonds, low-grade bonds: down.

Japan’s economy has flat-lined, Europe rejoices if GDP growth is fractionally above zero, and Chinese passengers should assume the crash position before their economy hard-lands. And in the US, there are a handful of crazy people running for president, some even leading in the polls.

Most of the above statements are true, yet I’ve argued we should stick with our long-term strategy. I see each of these elements as part of a normal cycle of events. Sometimes markets get ahead of themselves, sometimes they panic when fearing they are behind events.

The economy, which still matters to asset prices, is growing right around 2.5% p.a., the average of the past 6-7 years. Equity valuations are pretty close to long-term averages (see table below). I just don’t believe the end is nigh, or that asset prices are grossly out of balance. Like Switzerland, I’m pretty neutral. Like the Swiss, that’s a little boring. Sorry (both for being boring and for offending my Swiss friends).

The bears are stirring. Not yet rampaging, but there’s a lot of red ink across most markets.

Today’s jobs report was weak. No honey-coating it, it was a treat for the bears. Payrolls rose 142,000, well below the 200,000 expected, and a jump in government jobs hid a weaker private sector rise of 118,000. July and August were revised lower, so the employment picture weakened substantially in the 3rd quarter.

The unemployment rate remained at 5.1%, only because there was a huge (350,000) reduction in the labor force, bringing the labor participation rate to 62.4%, the lowest since 1977. About the only bright spot in the release was the broader U-6 data, which include both un- and under-employed: that rate fell to 10.0% from 10.3%, the lowest yet in this recovery.

With red ink spilling across global markets, sentiment has become pretty gloomy (see below).

The good news, from my perspective, is that sentiment is one of my favorite contrary indicators. Indeed, note in the chart above the coincidence of bearishness with market bottoms.

So, yes, the economy is softening in some areas-manufacturing, jobs-although resilient in other areas: auto production is soaring, housing prices and incomes are rising. A recession in the next 12 months seems very unlikely to me, although today’s data may spook members of the Fed to push out the date of their (modest) tightening. The markets now see March 2016 as most likely.

I continue to hold the view that US equities are in the midst of a multi-year bull market, where corrections, dips and gyrations should be expected. This is now a non-consensus view among the growing sleuth of bears which, as you might guess, I find encouraging.

Baseball, more than any other sport, by far, has drawn its share of colorful characters. I don’t know why that is, but it is. This week, we lost one of the greatest, maybe the greatest, of all-time, with the passing of Yogi Berra.

Yogi was easy to underestimate. He was barely over 5 1/2 feet tall, pudgy (i.e., kind of fat), with a face that looked like a child put together with a play set. His malapropisms were frequent and famous (example: on Yogi Berra Day in his hometown of St. Louis he thanked the crowd for making this day necessary). He reportedly asked a friend to cut a pizza in four slices because he wasn’t hungry enough to eat six. Not very smart, perhaps, although he managed two different teams to league pennants. As a player, he was a 15-time All-Star, winning the most valuable player award three times. He was easy to underestimate in his physical appearance and speech, but in the long history of baseball, no one had his level of accomplishment as a player and a coach. On top of it all, he was liked by everyone: fans, teammates, coaches, even Ted Williams, the great Red Sox hitter who famously hated everyone. Ted Williams liked Yogi Berra, which might be the most astonishing fact of all.

Separating fact from fiction is often difficult and, as Yogi (allegedly) noted, “I never said most of the things I said.” I often feel the same way. But one thing Yogi said fits well with how I think about investing. Yogi noted, “you can observe a lot by watching.”

We are in the midst of heightened investor nervousness. This worry stems from a number of real concerns: a sudden slowdown in China’s growth, a tenuous recovery in the US that could be threatened by tighter monetary policy, growth in Europe and Japan that have slipped toward zero, EM currencies in freefall, the rise of Donald Trump and Bernie Sanders. It’s September and the Mets have a better record than the Yankees! All of this, understandably, is unnerving.

But the data I see are more comforting. Most importantly, global monetary policy is highly accommodative, especially in Europe, but more easing will likely come from Japan and China, and the Fed just postponed it’s expected tightening. With a lag, money growth leads equities (see graph).

Also, sentiment is terrible (see first graph below), for the many real reasons listed above, but negative sentiment has always been one of my favorite contrary indicators. The vertical lines in the 2nd graph below line up with a bull/bear ratio less than one, almost always a mark of an equity bottom.

Valuations are right around historical averages, but investors are worried that record-high profits have peaked. Forward earnings estimates have turned down, but all of this comes from cuts in oil producers. Over the past year, earnings estimates of global oil producers have been slashed $148 billion, while earnings of oil beneficiaries have only been increased $9 billion. This has shaved 6 full percentage points off of global corporate earnings estimates. Yet over the past 4 years, oil consumption has declined from 5% of world GDP to just 2%, the lowest in 20 years, representing a $2 trillion transfer of wealth from oil producers to consumers.

There are many reasons investors have to worry, many of them valid. But I continue to see the risk of a recession in the US as extremely low. With a growing economy, low inflation and reasonable valuations, an implosion in equities just does not seem very likely.

Of course, I say this with a certain degree of caution. As one of Yogi’s managers, the great Casey Stengel, also among the most colorful and successful baseball managers of all time, warned, “never make predictions, especially about the future.”

Markets will fluctuate, as Pierpont Morgan caustically observed. And “fluctuate” means down as well as up. Perhaps I, too, am being caustically obvious, but I’ve long believed that a broad perspective on markets can often bring more clarity than myopic obsession.

It was in 2011 that the S&P 500 Index last fell more than 10%, apparently beyond the memory of many investors who believed these corrections were relegated to ancient history, like buggy whips and handlebar moustaches. Last month the S&P dropped more than 6%, and between 21 May and 25 August of this year, declined 12.4%, ending the 3rd-longest spell (since 1928) without such a decline.

The graphic below (courtesy Ned Davis Research) plots the S&P 500 Index since 1928 (on semi-log scale) with the number of days between 5%, 10% and 20% declines. I’ll offer two observations: first, large corrections do seem to be occurring with a little less frequency than in the past, and secondly, the Index has risen from less than 5 in 1932 to around 2,000 today, declining frequently along the way. For long-term investors, the drop from 2,130 to 1,867 (May-August) is a drop in the bucket. It’s the move from 5 to 2,000 that really counts.

Investors in Emerging Markets could be forgiven for feeling as if they’ve gone 15 rounds with Ronda Rousey (see below). Or, more like 3 years with the the best pound-for-pound fighter today (she might even give Sugar Ray Robinson, who gets my vote for best of all-time, a contest). It’s been brutal.

How brutal, you ask? EM currencies have dropped 30% in the past 3 years, while the US$ has jumped more than 20% (see first graph below). This has translated into an overall 10% decline in EM equities, 40% behind global equities and more than 50% below the return of US stocks (second graph below, showing last 3-year performance of US, World and EM equities).

Unlike the UFC, no bell will ring for investors announcing the end of the carnage. And only a fool would pretend to know when that will happen.

Markets can be (and often are) irrational at moments, but over time, there are usually good reasons for how assets perform. There are valid reasons for the pummeling of emerging market assets. Growth rates have slowed considerably, both absolutely as well as relative to developed economies. Earnings are still being revised lower. Many of the countries remain highly dependent on commodity extraction, at a time when commodity prices are down 50% and we are likely entering a multi-decade period of little price appreciation. Institutional governance-political, economic and social-is immature (I’m being polite: corruption pervades many societies). There are very few obvious silver linings here.

Still, while things could very likely get even worse for EM investors, the degree of damage has already been pretty extreme. The last big, global EM crisis was in 1997-98, when the Thai baht devalued by 90%, dragging other East Asian currencies lower, and culminating in a Russian default on its debt. That scenario is very unlikely today for two primary reasons. First, most currencies float today, thus the adjustments needed can (and do) occur in due course, rather than precipitously, as was the case in 1997-98. Secondly, most EM countries today run either surpluses or small current account deficits, and total debt-to-GDP is generally modest (China and Malaysia are exceptions). Gross external debt-to-FX reserves is one-quarter the level of 1997 (again, there are exceptions, with Brazil and Turkey seen as more vulnerable). The severe economic pressures that caused markets to collapse in 1997 are not just present today.

So while conditions have been bad, and prospects seem bleak, the markets have (mostly, appropriately) adjusted. This is not an argument to buy EM now, only to acknowledge that much of the losses have been already been realized which, in itself, mitigates the likelihood of a sudden crisis.

One round, or 15 rounds, with Ronda Rousey cannot be a pleasant experience. But investors have hung in this long, and one day, the bell will ring.

Markets have taken today’s employment release as evidence of a weakening jobs market. A mere 173,000 net new jobs were added in August, below the consensus figure of 217,000. But, coincidentally, 44,000 more jobs were added to previous months’ figures. So, you could say we were right on expectations. Clearly, today the markets disagree.

The unemployment rate fell to 5.1%, from 5.3%, and the labor participation rate remained at 62.6%, the lowest level since 1977. Baby Boomer retirements (structural) and rising disability rolls (policy-see Graph below-yes, that’s 24 million people) probably account for the bulk of the low participation rate.

So, I’m making the case that the headline numbers are not as bad as the market seems to think, and the news is encouraging even as we look a little deeper. Over the past twelve months, the economy has added more than 2.9 million net new jobs, well in excess of population growth, much less labor force growth. This growth has occurred even as part-time employment has fallen by 765,000.

Average hourly earnings are up 2.2% from a year ago, a little ahead of inflation, but hours worked are up 2.7%, so workers’ cash earnings are up 4.9%. Looking even deeper, there is reason to be optimistic about future wage growth, particularly as we see the “quit rate,” the percentage of workers switching jobs, move higher. There is a very strong correlation (0.9) between the quit rate and wage growth (see Graph below).

Markets will be volatile (to paraphrase J.P. Morgan), but the employment picture remains encouraging.

Lost amidst the market turmoil this week were a number of reports of a strengthening US economy. Consumer confidence soared last month, as did new home sales. Durable goods orders surprised with a 2% jump in July, and personal incomes rose, and are up 4.3% over the past twelve months. 2Q GDP was revised sharply higher, from a 2.3% annual growth rate to 3.7%. This pace is above the 3.2% quarterly average over the past 65 years (see Graph below).

All major components of GDP were revised higher, indicating broad strength in the economy, with business investment particularly strong. In contrast, the European economy crept just 0.4% higher last quarter, while Japan’s actually contracted by 1.6%. China grew at a 7% pace in the second quarter, or so they say.

While there is a lot to worry about in the world, that’s really always true. The risk of a recession in the US is very low, and I just don’t see a collapse in equity prices. Volatility, to be sure, but the US economy is growing and monetary remains accommodative. So we stay the course.

Two weeks ago (13 August, No Panic (Yet)) I noted that the renminbi devaluation was officially described as a modest alignment with market forces, which may have been true, but that it was strongly indicative of protracted weakness in China’s economy. I saw no need to panic two weeks ago, but last week would have been more timely; the “(Yet)” part of the title came upon us with a fury. Yesterday, US stocks lost more than 3%, but the intraday move was cumulatively more than 25%, up and down 5,000 Dow points.

But US (or European) markets are not the drivers of this volatility, it’s China. When the world’s second largest economy, accounting for the majority of the world’s growth in recent years, falters, the ripples are more like massive waves pounding the shores of economies dependent on China’s growth.

China’s equity market is down 40% from its recent high, bringing all Emerging Markets down by 28% in the past four months. This is close to the 29% drop in EM in mid-2011, although not (yet) as bad as the 66% drop in 2008. While this is a substantial move in a short time, it only represents a continuation of the trend for the past four years: relative to the the US, emerging markets are off 50% (see Graph below: MSCI EM Index vs. DM and US).

Global growth, again, led by China, is softening, and that fact impacts the US economy. But it affects us to a much lesser extent than almost any other country. The most recent economic data remain supportive of growth: 65 consecutive months of job growth (the most since at least the 1930s), record auto production, and a strengthening housing market, as we learned this morning: new home sales are up more than 25% from a year ago, the average price up nearly 5%, and inventory down to 5.2 months.

The last week has certainly been volatile, and investors should expect these periodic market shocks. But the big picture for me remains unchanged: there is little risk of a recession in the US economy, the commodity supercycle ended a few years ago, government bonds offer no real return, and equities are in a structural bull market that will see new highs in the coming years. But we won’t get there without occasional (even frequent) jolts, which is what we’ve just experienced.

I probably should not confess to enjoying Borat (full title: Borat: Cultural Learnings of America for Make Benefit Glorious Nation of Kazakhstan), 86 minutes of low-brow, sophomoric gags lest I shatter my highly refined, cultured and sophisticated image. So I’ll never admit (in writing) to laughing almost non-stop. It’s the story of a reporter from Kazakhstan traveling across America to discover what makes the country great. I don’t know how the 17 million people of Kazakhstan feel about being portrayed by an imbecile, but Sacha Baron Cohen does a pretty good job of pointing out the fatuousness of Americans.

All this is in way of introduction to what I know about Kazakhstan, most of which comes from that movie. In other words, pretty close to nothing. But while global stock markets fell 1-2% today, the good people of Kazakhstan saw their currency, the tenge, drop 22%, on top of a 4% decline yesterday as the National Bank of Kazakhstan (known widely as the NBK) allowed the tenge to float.

Most (73% to be precise) of Kazakhstan’s exports is oil, whose price, you may have noticed, has been under some pressure. As a consequence, exports are off 34% this year, pushing its current account balance into a deficit. Compounding the problem of a plunging oil price, Kazakhstan’s main trading partner, Russia (one-third of its trade), has seen the ruble fall 47% against the US$ in the past year. And its second-largest trade partner, China (18% of trade), devalued 2% last week. So the combination of a 60% drop in the price of its main export and lost competitiveness against its main trading partner has put the tenge under tremendous pressure. So today, the NBK threw in the towel and allowed the currency to plummet.

We shouldn’t make too much of the travails of a small country (its GDP is on par with Detroit’s). But I don’t think it should be entirely ignored either. I see it as indicative of the strains in the global economic balance as countries try to fight off the forces of weak growth with monetary easing and currency devaluation. And although small, the people of Kazakhstan have a great deal of pride, as Borat said:”Kazakhstan is the greatest country in the world, all other countries are run by little girls.”

Earlier this week, China devalued its currency 1.9% against the US dollar. On one level, this is not a big deal. China’s currency has been appreciating considerably for many years (see Chart 1 for the last five years; note the scale is inverted). Even in the past year, the yuan is down just 3.5%, whereas our largest trading partners-the Canadian dollar, Mexican peso, yen and euro-are each off 15-20%. So, who cares?

Perhaps we need a distraction from the Donald Trump – Megyn Kelly spat, and mid-August is typically a sparse news period, but some pundits are trying to stir concerns that this move (a) presages a coming collapse in the yuan, and/or (b) will stop the Fed from tightening rates next month, thus the devaluation is a significant event. Support for Argument (a) comes from the numerous historical examples of countries failing to support a failing currency. Argument (b) rests on the assumption that the RMB devaluation is a de facto tightening of US monetary conditions and the Fed will be hesitant to tighten further.

I don’t see the action by the People’s Bank of China necessarily leading to either event. But neither do I fully accept the official explanation that the government simply wants to be more responsive to market forces.

GDP is growing (officially) at a 7% pace, the lowest in many decades (see graph below for the past 15 years). Many believe, though, that the official numbers overstate the growth rate, which may be closer to half the official number.

As I see it, the devaluation is a clear signal that the Chinese economy is struggling, requiring more stimulus than the steps previously announced, such as easing credit and supporting stock prices. A collapse in yuan is not going to happen, not with $4 trillion of foreign reserves, and the Fed is not going base its policy on a 1.9% decline in the RMB. But China’s economy does impact the world, and a significant slowdown in its growth will be felt throughout the global economy. This small devaluation does not mean there is major turmoil ahead, but it does say that China’s growth is sputtering, and that does matter to all of us.

Japan grew from the (literal) ashes of the Second World War to become the second largest economy in the world by creating products we all wanted. Some were revolutionary, like the Sony Walkman, some just a better version of an existing product, like the Toyota automobile. And some were wildly popular for inexplicable reasons, such as Hello Kitty or Teenage Mutant Ninja Turtles.

The Japanese economy was an amazing success story. But two decades of no growth, deflation and a shrinking population combine with public comments from politicians and CEOs that are often platitudinous, mysterious and contrary to reality, leaving many investors confused and frustrated. In that confusion and frustration, it has become common to hear that Japan is just different, not like the rest of the world, where traditional metrics just don’t apply.

I am certainly no Japan expert, and there may be some truth to this characterization of Japan exceptionalism. But in recent years, I’ve come to believe two things about Japan: that the policies that led to stagnation and deflation over the past 25 years may not have been as irrational as outsiders believe, and secondly, to some degree, Japan’s current challenges are a preview of what lay ahead for the rest of the world.

I may come back to a fuller discussion of why and how I came to these conclusions, but here, I wanted to share some demographic data. As the great French philosopher, Auguste Comte, father of positivism, noted, demographics is destiny.

It was widely reported two years ago that adult diapers are poised to outsell baby diapers in Japan. Certainly, the growth trajectories have been diverging (see below). The Nikkei newspaper reported that the crossover in sales will come in five years, but Unicharm, Japan’s largest manufacturer of diapers, believes that tipping point has already occurred.

In more recent news, the elderly are now committing more crimes in Japan than teenagers do (see below). This is the first time in history a society has more elderly criminals than teenage hooligans.

Let’s remember that Japan has a crime rate one-tenth that of the rest of the world, so the image of diaper-wearing old folks running rampant through the streets of Tokyo causing mischief and unrest is not quite accurate. Still, I can’t help but think that criminals in diapers is another trend that Japan will soon be exporting to the rest of us.

Southern California just had the wettest July on record, the Angels were rained out of a home game for the first time in 20 years, and we’re all getting excited that a strong El Niño is developing for the winter.

But let’s all take a deep breath. The record July rain at LAX was about one-third of an inch. That’s about a 15-minute downpour in the rest of the country. It was a little better in San Diego, just over an inch-and-a-half. So, while welcomed, it wasn’t much, especially when we consider the (dry) hole we’re in.

The first chart shows the deviation from the 1949-2005 mean temperature in the state going back 120 years. We are now at the highest temperature in four generations, with a pretty clear upward trend.

The effect has been to extend a drought in both severity and expanse. Nearly half of the state is experiencing an exceptional drought, as the chart below shows.

We pin our hopes for an El Niño this winter on the observation that the current temperature in the Pacific is 2.88 degrees higher than average, close to the 3.06 degree difference measured at the same time and place in 1997, which presaged a huge El Niño event that soaked not just Southern California but the north as well, which is what really matters as that’s where our water supply is.

So, for now, I join with the hopeful that our immediate crisis will soon be relieved. But our enthusiasm should be tempered by the very deep dry hole we’re in. As for resolving our long-term problem, I’m a little less hopeful.

The housing recovery, from its worst downturn since at least the 1930s, has been steady, but much less robust than most had expected. There are many explanations offered, from mean banks who have tightened lending standards, to over-indebted households who have no capacity to borrow, to a societal shift away from ownership to renting. There’s probably some truth in all of these. But housing is picking up steam, and one of the phenomenon of previous bubbles, bidding wars, may be coming back.

This first graph (courtesy Redfin) shows the percentage of homes nationally selling above their asking prices: 23% last month, up 2% from a year ago, although still below the 27.4% peak reached two years ago.

The hottest markets are in the West (see below). In the Bay Area, a staggering 75% of homes are selling above asking price!

There are other data supporting a pick-up in housing activity. Building permits and existing home sales are both at their highest levels in 8 years. I don’t see these as bubble levels because we are coming off a low base. So, for now, I take these data as signs of a strengthening housing market.

Commodity prices are in free fall. The Bloomberg Commodity Price Index (5-year chart below) is off about 30% in the last year. Gold is dropping toward $1,000/oz., and oil (WTI) is back below $50/barrel.

A hundred years, Nikolai Kondratiev proposed his wave theory of capital markets, and 50 years ago Benoit Mandelbrot observed the fractal nature of these waves, their similarity over multiple time frames. When two waves of different frequencies but similar magnitudes collide, the result is a much-amplified force.

That, I think, is what we are seeing in commodity prices. Commodity prices have historically moved in long waves, super-cycles, lasting decades. Typically, ten years of soaring prices are followed by two decades of falling prices, and the cycle is then repeated. In recent memory (for some of us), commodity prices soared in the 1970s, then fell through most of the 1980s and 1990s. Prices jumped again in the last decade, and are now in a period of decline that I suspect will last another 10-15 years. Of course, within these long cycles are periods of reversal, but they don’t alter the long-term trend. At other times, the long-term trend is reinforced by short-term factors, resulting in sharp moves, amplified by the confluence of these two waves.

The proximate cause today of both waves, long-term and short-term, is China. The world’s second-largest economy accounts for nearly half of the global consumption of major commodities. Demand changes in China at the margin have enormous, and immediate, impact on prices.

So the recent drop in commodity prices tells me that the Chinese economy, notwithstanding official statistics showing 7.5% real GDP growth, is weaker than we think.

The central planners in Beijing have gotten so much right for the past three decades, that they might be forgiven for believing in their own infallibility. But it’s one thing to shuffle resources around an economy-a road here, an airport there-and quite another thing to dictate supply and demand in a large market. John Major learned the folly of fighting markets in 1992, and there have countless similar experiences both before and since.

Apparently confusing a healthy stock market with a healthy economy, the political powers in China decreed that stock prices should rise, directing banks and other lenders to lend freely to speculators. Margin loans on the “A” share market rose to $371 billion by mid-June, about 10% of the free-float market capitalization. By contrast, margin loans at the NYSE are around $500 billion, or 3% of the NYSE market capitalization. And that’s a record high in New York.

So the astute planners in Beijing decreed that margin lending had gotten ahead of itself, and shut off the spigot. As of last week, margin loans had fallen nearly 40%, to $238 billion, still about 8% of the capitalization of the A-shares market. The market itself fell more than 30%, and on Thursday of last week, the bureaucrats stepped in again to say that was enough, the market should stop falling. The chart below illustrates the extraordinary effect these decrees had on a daily basis. On Tuesday and Wednesday last week, most stocks were either limit-down or simply suspended from trading (91% on Tuesday, 80% on Wednesday), but then on Thursday 51% of stocks traded limit-up.

This is a crazy way to run a market (the oxymoron is not lost: market prices are not “run,” they reflect supply and demand forces). Still, I have some empathy for the bureaucrats. Setting reasonable rules and regulations and then stepping aside must be really hard to do. But they are learning that the alternative-decreeing the daily direction of markets-is even harder.

I’m not sure why the pundits were predicting the Greeks would volunteer to walk meekly to their certain ruin, but the vote yesterday apparently surprised these experts. European equities are down 1 ½%, bonds of Italy, Spain, Portugal are selling off, the euro is a little weaker. Risk off, but the markets are not pricing in any calamity this morning.

Of course, just because the Greeks voted against certain repression, does not mean they will avoid it. More like choosing the devil they don’t know for the devil they do. Unlike the dramas of their ancestors, there are no gods likely to come to their rescue.

The next few days and weeks will require some responses from Brussels (and Berlin, where the power resides). Greek banks will run out of cash this week, and the ECB will have to decide whether to extend emergency loans. Their charter prohibits lending to insolvent banks, and Greek banks are clearly insolvent, but Mario Draghi may yet find a way to re-interpret “insolvency” in order to maintain order. If not, the Greek government may start issuing script, a de facto drachma, as internal currency.

The technical questions of liquidity are part of a larger, and more complex, political drama. The Germans see the Greeks as profligate and unreliable, children who have lived high on German labors, and need to be cut off for their own good. Italy and Spain, struggling debtors who might be sympathetic to leniency for Greece, support a hard line because each government faces elections at the end of this year and are fearful that concessions to Greece will embolden the extremist opposition parties they face. Politically, then, Europe seems to be moving to squeeze Greece out of the eurozone, betting that any fallout can be contained, that the Union will be strengthened without a failed state that they rue having admitted in the first place.

For Greece, there is no good ending, in or out of the eurozone, all options are painful. The sad fate of the Greeks is sealed, but for Europeans, the stakes are much higher, even existential. A failed state bordering Turkey and close to Russia presents a geopolitical threat every bit as great as Ukraine. Expelling Greece may make sense on one, narrow level, but the ramifications on European security may be far worse.

On another level, the failure to come to terms with Greece symbolizes an existential failure of the European project. Centuries of horrific, internecine wars provided the impetus to create an economic, political and eventually, social union among dozens of disparate national and ethnic identities. Rather than compete economically or, worse, militarily, the fortunes of members of the European community would rise and fall together. Prosperity is the central, explicit raison d’etre of the European Union. It has not worked. Some countries have prospered, many have regressed, the remainder have stagnated.

Germany wants to make sure that debtors pay a high price for not complying with the harsh conditions imposed by creditors. But Germany, the largest beneficiary of the Union, has the most at risk if the community unravels. The rise of anti-EU political parties across Europe, not just in Greece and Italy and Spain, but in the UK, Poland, Hungary, the Netherlands, France, and elsewhere, cannot be easily dismissed.

On one level, the fate of the Greeks, not even a blip on the world economic radar, is unimportant. On another level, it portends a monumental failure of the European experiment, with grave consequences for the world. The path out of chaos is not yet evident.

An honest politician may be oxymoronic (or is just moronic?), or maybe it’s the black swan that surprises us when seen. Either way, Alejandro Garcia Padilla, governor of the US Commonwealth of Puerto Rico, stated in clear terms a 5-year old could understand (which thus qualifies it as a black swan of political clarity) that Puerto Rico cannot pay its debts; period.

This island of 3.5 million very nice people, with a GDP less than Sacramento, has amassed debts of $72 billion. As is so often (always?) the case, excessive debt is not the disease, it is a symptom of the disease. In Puerto Rico’s case, its GDP has been falling for a decade, only 40% of the working-age population works, and people are fleeing the island for the US mainland. Obviously, these three developments are all linked (see Graph below).

A decade ago (2002), Congress removed the generous tax breaks for companies doing business in Puerto Rico, and businesses pulled out, proving that there was no reason to be in Puerto Rico (cheap labor, productive workers, low taxes and regulations) but for the US federal tax exemption. Forced to compete, Puerto Rico couldn’t, or rather, didn’t. Instead, successive governors continued to grow the size of government. The most recent smart idea from Mr. Garcia Padilla is to raise the sales tax from 7% to 11.5%.

I don’t know why I am continually astonished with the absence of economic sense among politicians and pundits. I’m just politically naive, I suppose. Pro-market reforms-limited taxes and regulations, labor flexibility, etc.-lead to economic growth and prosperity wherever they have been adopted (much of Asia as exemplar primus). The opposite policies lead to stagnation and poverty. This is not theory, just empirical fact.

A restructuring of Puerto Rico’s debt is inevitable, as it is with Greece and others (Venezuela comes to mind). But absent pro-market reforms, no amount of debt restructuring (default/forgiveness/reduction) will avoid a repeat of this cycle. Delay, yes; avoid, no.

Here we go again, as Ronald Reagan used to say. Asian equities off 2-3%, Europe down 3-4%, Treasuries rallying, gold up. What’s going on?

The latest act of this tragedy was the imposition of capital controls and the closing of banks in Greece. These acts were logical following the ECB’s decision to continue to provide emergency funding to the Greek banking system, but capped that funding at the 89 billion euros it has already lent. That’s enough to keep the banks afloat, for now, but not enough for Greek banks to meet any deposit withdrawals which, as you might imagine, have been accelerating in recent weeks. Hence, the closing of banks and imposition of capital controls yesterday.

So that’s the most recent development in this saga. Greece owes the IMF 1.5 billion euros tomorrow, which it won’t pay. That is no big deal, as the ECB has signaled it will have no bearing on its own negotiations. For the IMF, it just means that Greece will go into arrears (joining stalwarts Cuba and Zimbabwe).

Next up is Sunday’s plebiscite on whether to accept the latest European proposal, which the government is urging voters to reject. They will. Then, there’s 3.5 billion euros that Greece owes Europe on 20 July which, of course, they don’t have.

The morality debate that infuses this drama is (possibly) interesting, predictable, emotional and irrelevant. Europeans (Germans, really) will argue that Greece borrowed tons of money to finance its profligacy, absence of work ethic and wholesale evasion of taxes. All true. Greece’s narrative is that the Germans are no better than drug dealers, pushing their products with cheap financing in order first to boost their economy and then to impose harsh economic conditions on naive and helpless Greeks. Partly true.

I have (some) empathy for Greece, as it has borne a 25% cut in GDP, 50% unemployment and a fiscal budget that is now close to structural balance. These adjustments are greater than the US experienced in the 1930s. But realistically, Greece is a basket case on so many levels. Greece needs to slash the size of government, cut regulations and taxes to encourage growth, but this new government is a far-left extremist party that wants to maintain retirement benefits through higher taxes on the private sector. They’re idiots (economically, that is). No one in their right mind would extend more credit to these clowns.

But it doesn’t matter what I think. It actually doesn’t matter what anyone thinks because the facts are irrefutable. Greece’s GDP is about $250 billion, and its outstanding debt is about $350 billion. There is not only no cash to make interest payments, there is no prospect of being able to do so. The debt has to be restructured, which means reduced and extended. There is no alternative. Greece cannot be forced out of the euro. The only issue in play is the conditions under which this restructuring will occur. It can be orderly, with both parties making concessions, or it can be messy. The one thing it cannot be is avoided. The drama continues.

A few days ago (Beginning’s End) I suggested 2015 might turn out to be the worst year for bond investors in the past three decades. Here are some additional pictures (courtesy of Goldman Sachs) to quantify the risks.

First we show the principal loss by the end of this year under various scenarios, with yields rising per current expectations or rising to historical means. The consensus expectation is for a loss greater than the current yield. Should yields revert to any of the historic means, losses would be greater.

Before the tears start flowing, though, consider that US investors are likely to see losses much less than our European friends. Germans, for example, could be looking at another 20% loss of value (see Graph below). This is, of course, because US yields are substantially higher than other developed countries. At 2.47% (today), the 10-year Treasury yields more than comparable bonds in Spain or Italy (each with 10-year yields of 2.1%). French OATS yield just 1.2%, German bunds just 0.8% and JGBs 0.5%. The US offers the highest yields in the OECD.

In addition to principal loss should interest rates rise, investors should also pay attention to the froth bubbling up in the high-yield (nee, “junk”) market. Loans with few, or any, covenants are at record levels, multiples ahead of the pace in 2007.

Our advice for bond investors? Caveat Emptor.

In November 1942, with the Battle for Egypt under way, Winston Churchill addressed his nation with these words:

Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.

Words meant to rally a nation engaged in an existential battle that very much hung in the balance. Churchill grasped at some tentative victories that would, in fact, mark the end of the beginning phase of the war, one which saw Allies routed from Calais to Hawaii.

Government bonds rarely post a net loss in any given calendar year. 1994 was the worst in the past 30 years, as the Fed tightened unexpectedly in February that year, and didn’t stop till the calendar flipped and overnight rates had doubled, from 3% to 6%. I recall a number of prominent bond managers appearing shell-shocked throughout that year (with commensurately dismal total returns).

As we near the half-way mark, 2015 may yet turn out to be an even worse year for bonds (see Chart below). But this time, the catalyst is not a surprise move by central bankers; indeed, the upcoming Fed rate hike has been the most anticipated event since….(well, I don’t know; I was going to say a Khardashian wedding, but that’s really poor taste). No, the Fed has no surprises for the market this time. Rather, I think, it’s just the simple math that it takes a small move when yields are so low to negate the meager coupon. I noted previously that a 30-minute sell-off in German bunds the other month wiped out 30 years of interest payments to investors.

Bond investors for the past three-plus decades have enjoyed the greatest bull market in that asset in memory, possibly in recorded history. It may yet be premature to call this year as the end of that bull market, but it is almost certainly the beginning of the end.

Some observers point to the eye-popping valuations for companies with little revenue (WhatsApp, e.g., bought by Facebook for $19 billion) as indicative of an equity market that is partying like it’s 1999, and thus on the verge of imminent collapse.

I suppose that’s possible, although I don’t think so. But I do think that investors should show a little humility when extrapolating trends, particularly into the future (as Yogi Berra wisely noted), and especially in highly dynamic industries.

The table below, courtesy of Mary Meeker, reminded me of the precariousness of corporate longevity. Most of the largest internet companies of 1995 are gone today. And there is every reason to expect that 20 years from now this list will again be dramatically different than today’s.

Investors in many of these 1995 companies lost their entire investments. But think how happy they would be if they had spread their money (equally or cap-weighted, it wouldn’t matter) over these top 15 stocks. Even assuming 100% losses in 14 of them, the nearly 20,000% increase in Apple would put smiles on everyone’s faces.

So while I don’t think these valuations suggest a 1999-like market top, investors in each of these companies should think hard about which ones will even be around in 2035. I just hope I will be.

1024″June gloom” is what you get when a warming land mass meets a cooler ocean: a layer of marine fog that the sun burns off into afternoon haze. It is the weather pattern in Santa Monica for every June that I can remember.

Ignore the “bad news” headline of Friday’s May employment report, that the unemployment rate ticked up to 5.5% from 5.4%. Job growth is robust. Payrolls grew 280,000 in May, with another 32,000 added to the two previous months. Private sector payrolls added 262,000 in May, the 63rd straight monthly gain, the longest such streak since at least the late 1930s. More than 141 million people are working, a new record (see Graph below).

The unemployment rate rose half a percent (5.443% to 5.5508%, for those who like precision in their data) because the labor pool grew 397,000, reflecting cyclical strength in the economy. The median duration of unemployment peaked at 17 weeks at the end of 2013, exactly as Congress allowed the 99 weeks of unemployment insurance to revert back to the “non-crisis” level of 26 weeks. Since then, median duration of unemployment has fallen to 11.6 weeks. Coincidence?

Average hourly earnings are up 2.3% over the past year. With average weekly hours up 2.6%, total cash to workers is 4.9% more than a year ago. The lack of inflation means that’s real money to spend.

Despite a contraction in the economy in the first quarter, the data just do not support a likelihood of a recession. The economy certainly has many challenges, and this recovery may had been stronger with better fiscal policies, but the “June gloom” we have in Santa Monica will not last, along the beach or in the broader economy.

Let me stipulate up-front: I love Greece. Everything about it: the food, the weather, the history, the music, the people. Everything.

But I wouldn’t lend them my money. Greece has a long (very long) history of borrowing money with little regard for paying it back. I’m not casting aspersions, or taking a moral stance, just saying the facts. As the calendar flips from May to June, we are about to come to (another) moment of truth about Greek debts. Or rather, their lenders are about to come to this moment of truth.

And what is that truth? Greece cannot pay. The European Central Bank and the IMF would like to think this is Greece’s problem but, of course, it’s really theirs. Over the next two months, Greece is due to repay nearly €8 billion (table below). Through various gimmicks, Greece might be able to come up with about €2 billion. You see the problem.

Greece has already undergone an enormous contraction. Its GDP has fallen 27%, and it has slashed its fiscal and current account deficits from between negative 12% and 20% of GDP to surpluses. These are Herculean adjustments.

No matter. The clock is about to run out. So it’s really not about what Greece can/will do; it’s about what the ECB/IMF can/will do. I don’t know the answer to that (I’m not sure the ECB or IMF do either). Whatever their decision, the unintended, unforeseen consequences could be momentous. Yasou!

In much of life, certainty dissipates with time. Weather forecasts are pretty accurate over the next 24 hours, a little better than a coin flip over the next week, and worthless a month from now. The same holds for our daily, mundane events: the people we will see today, the food we will eat tonight, we know what to expect. But beyond a week, a month, we just don’t know exactly what the day will bring.

For investors, the opposite is true. The day-to-day fluctuations of the markets are coin flips, impossible to predict. But over the course of years, the pattern becomes clearer, not cloudier.

The chart below (courtesy Ned Davis Research) shows the performance of equities, bond yields and commodity prices since 1900. With this horizon, a few observations may be made. One, is that the volatile assets classes (equities and commodities) have had bull-and-bear markets more frequently than bonds. Why this is the case is unclear, that is, why would asset classes with higher short-term volatility also have more frequent long-term booms and busts? I’m not smart enough to know, only to observe.

Secondly, the bull market in bonds is likely much closer to its end than to its beginning. That insight, coupled with the current yield on bonds, leads to the equally insightful prediction that bond returns are likely to be very modest, possibly negative in real terms, for the coming multi-year or -decade bear market.

Thirdly, commodities have a begun a multi-year bear market and equities a multi-year bull market. But because these two assets classes have very high short-term volatility, we should expect to see weeks or months of counter rallies. These do not negate the structural trends of bear (commodities) and bull (equities).

Most would agree that bonds and commodities are either in or will soon be entering bear markets. The secular bull equity outlook is more controversial, with opposition resting on two principal arguments: the bull market has already lasted longer than most, and valuations are high.

I don’t disagree with either argument, but offer two thoughts. First, bull (or bear) markets don’t die of old age. Historically, excesses build up over time, and policy responses are inevitably inadequate, which is why trends don’t go on forever. But rather than focus on time, better to watch for signs of excess (leverage, speculation) or policy errors. There are hints of both: record debt issuance with little or no covenant protection; questionable valuations for certain start-ups; redistributive tax/fiscal policies. But we are not near the levels of speculative excesses that marked the end of bull markets in 2008, 2000, 1968, 1929.

Secondly, most equity valuation measures look stretched, but that argues for modest forward returns, not an end to a bull market. That said, and remember I’ve conceded that valuations are a bit high, the combination of strong profits and low inflation may warrant above-average valuations. As we see from the chart below, forward returns are often poor when valuations are high, but they can also be poor when valuations are low (probably reflecting a worsening economic backdrop than even anticipated). But there is a (very) happy median valuation where future returns are moderate, but almost always positive.

I’m not (any longer) a trader. I’m an investor. The only way to be a successful investor is think, and act, for the long-term. In the short-term, changes in asset prices should have no meaning to us. We should care primarily about whether we have enough liquidity to meet all of our spending needs. Ideally, we’ll have a little more to be able to take advantage of asset bargains if prices fall. Long-term, our true investment horizon, we care not a whit about short-term volatility, only about protecting and growing our funds in excess of purchasing power.

Asset prices have historically exhibited trends over years and decades. I believe they always will. In the short-term, we may adjust portfolios at the margin in response to near-term fluctuations, but we should not lose sight of the bigger trends, and maintain our course even through the occasional, inevitable, storm.

Commodity prices rise and fall; no great insight there. Which is why most of us, mostly, take the fluctuations in stride. We (I) may get a little annoyed when the price of gasoline is a few cents higher than last week, and get a little boost of endorphins when it falls a few cents (maybe it’s just me).

Of course, some commodities are more important than others. For me, it’s not oil or gold, wheat or pork bellies. It’s cocoa, whose price has jumped 10% in the past few weeks.

The problem is Ghana, which produces 20% of the world’s cocoa, of particularly high quality, where production is off 20% from last year. Bad weather and insects are being blamed. Mother Nature and mirids (the principal pest of cocoa plants-see below for this fearsome foe of cocoa) may be especially uncooperative this year, but the bureaucrats at Cocobod (Ghana’s governing cocoa board) are the true culprits, failing to provide financing to farmers and delivering fertilizer and pesticide late, right before the rainy season washed both away.

These problems pushed S&P to lower Ghana’s credit rating to B-minus, and the cedi (Ghana’s currency) is in free-fall, off 25% this year (see below).

You may think this attention on cocoa and Ghana undeserved, as there are bigger problems in the world. Fair enough, but in my defense, I see the situation as illustrative of broader themes. Uncertainty is omnipresent in all our lives, as investors or as farmers. It’s (most of the time) not acceptable to blame the weather or insects or market “volatility” on our losses. It’s often poor policies that exacerbate “normal” fluctuations into market disasters. Also, most of us probably give little thought to Ghana, but this small country is part of the global network that infiltrates all of our lives. Lastly, I really like chocolate.

A month ago, Germany could borrow for 10 years at a rate of 0.06%. Lenders were also happy that day to earn 0.47% for the next 30 years. That’s $4,700 of annual interest for every $1 million. Investors were happy with this yield because the ECB was buying up all the newly issued bunds, deflation was omnipresent, and, well, Germany is a good credit.

Their happiness didn’t last long, as rates jumped 70 basis points over the subsequent two weeks, wiping 0ut about 30 years of income.

It’s logical to blame central bank meddling in the bond markets for these gyrations, but the market may also be saying that inflation may not be as dormant as suggested by these low yields. Indeed, the surge in government bond yields coincided with a notable rise in inflation expectations: by 20 basis points in the US, 45 basis points in Europe.

I don’t (never did) subscribe to the hyper-inflation scare of massively expanding central bank balance sheets, and I also think sub-1% inflation for decades to come puts too much weight on the end of economic growth and the ineffectiveness of monetary policy. Powerful deflationary forces remain, debt and demographics most prominently. And I expect central banks to continue to distort markets. But growth and inflation will (one day) return, and long-term investors are likely to be happier with a balanced portfolio of equities than the investors who lent 30 years at 0.47%.

The trade deficit ballooned in March to over $51 billion, $8.6 billion more than a year ago. Exports were up a little, but imports surged, up more than $17 billion from February, the biggest monthly rise in imports since 1992. Over the past year, imports are up 1% while exports are down more than 3%.

Some of the surge in imports can be attributed to the end of West Coast port strikes, which released a flood of imports (mostly cars and cell phones) into the US. While it makes sense that we should see a spike in imports, we should have also seen a jump in exports, but we didn’t, raising questions about the competitiveness of US products.

Why do we care? Well, one immediate impact will be seen in the 1st quarter GDP revision, from +0.2% to a negative number (probably around -0.5%). So the economy contracted in the 1st quarter, but another way of looking at the trade deficit is that it highlights the relative strength of the US economy: booming imports are indicative of strong demand for goods.

I still think the weakness in the 1st quarter will fade into modest growth for the rest of the year. As I emphasized in my quarterly letter (Funambulism), the biggest near-term hurdles to growth are supply-side-capital investments and labor force growth-not insufficient demand incentives. We’ll come back to this topic again, no doubt.

There will always be a debate about the relevance of history to current conditions. I am firmly in the pro-history camp, but am quick to acknowledge that historical analogies are always imperfect. They are a guide, not a blueprint, for how present events will unfold.

A related debate is how much behavior really changes over time. At the personal level, most of us would like to think that we can progress toward being “better” people: kinder, more sensitive, more empathetic, etc. The reality that is that most of us probably don’t change our behavior very much, despite good intentions. It could be laziness, or that we don’t recognize our faults, or that it’s just difficult to change.

The same observation applies to countries: behavior usually doesn’t really change that much. Certainly, there are exceptions of habitual basket cases that were able to break old bad behavior: former communist countries that shook off the suffocating idiocy of that ideology, (Czech Republic, Poland); or through tenacity and vision transformed an impoverished backwater into among the world’s wealthiest (Singapore); or were able to abandon a culture of dependency and autocracy for competition and democracy (Brazil, tentatively).

Then there are the habitual addicts, who periodically swear off the drugs of debt and corruption, but predictably lapse back into self-destructive behavior (Greece, Argentina come to mind). Last week Mexico issued a 100-year bond, denominated in euros, at a yield of just 4.2%. Mexico has made a lot of economic progress in recent years, and investors may be justified in believing that Mexico has broken with its bleak history of defaults, as the chart below sadly illustrates. Alternatively, investors’ judgment could be clouded by central bank policies that promote lending money for a century to a country that has spent a good portion of the past 200 years in default. I suspect we’ll know the answer well before 2115. Feliz Cinco de Mayo!

In 2009, there were 19 buildings in the world with heights above 1,000 feet (305 meters for the non-American readers). Today there are 79 such buildings, a four-fold increase in just 5 years! And if you have never been to China or the Emirates, you have missed most of them. 40% of these tallest buildings are in China, another 28% are in the U.A.E.

The graphic below (from Knight Frank) highlights the average annual rent (per square foot) in the top cities of the world. Despite my grumbling, LA is still pretty cheap. Although our next office may be more likely to be in Seoul or Kuala Lumpur rather than Hong Kong.

They’re going up. Total salaries and benefits moved up 4.4% in 2014, rising to 53.6% of GDP, still below historic averages, but a decided bounce off the lows recently seen (Chart 1).

One reason wage growth has held pretty steady over the past few years is that lower-wage jobs have been added at a faster pace than higher-wage jobs. But it looks like wages for these lower paying jobs are moving up more quickly than for higher paying jobs. Two different measures of wage growth show an accelerating trend (Chart 2).

Not coincidentally, we’re also seeing corporate profit margins flatten out, meaning it looks like a greater share of income is shifting to workers. This may have (negative) implications for equity markets, but it’s one of the reasons the US economy should bounce back from the anemic (0.2%) growth rate of the first quarter.

In Genesis (41:27), Joseph interprets Pharaoh’s dream of 7 fat cows followed by 7 lean (and apparently, ugly) cows, as foretelling the coming feast and then famine, enabling Egypt to prepare for the coming 7 lean years by stockpiling reserves.

Yesterday, the 10-year German bund leaped 12 basis points (see Graph below), along with a surging euro following the weak US GDP report. Now, 12 basis points is a big move, but we’ve seen bond yields move by that magnitude before. What is different about this time is that there is no yield to begin with, so yesterday’s move in the bund wiped out 7 years (!) of income.

If investing at near-zero yields for 10 years is rational, it will prove to be the worst decade for investors since the bubonic plague swept across Europe in the mid-14th century (ok, I made that up; but it could be right). But I’ll bet that it is not actually a rational investment, and monetary policy is distorting all kinds of prices and investment decisions.

Most observers would agree that equities are rich (expensive, overpriced, etc.). Corporate profits are at record highs, and the forward price-to-(optimistic) earnings multiple on the S&P 500, at 17x, is the highest since 2004.

A favorite counterargument is a relative one: stocks may be expensive, but bonds are way more overvalued. With a 2% yield, the 10-year Treasury has a P/E multiple of 50x (taking the inverse of its yield). Of course, German bunds have an infinite P/E (with its negative yield). So stocks are the cheapest house in an expensive neighborhood.

That may be true, but this counterargument isn’t really a “counter,” i.e., stocks could still be expensive on their own even if other asset classes are more expensive.

The chart below (courtesy Barclays) shows the number of monthly observations of the S&P 500 at various forward P/E multiples (left y-axis). The subsequent average 12-month return is depicted by the black line (scaled to the right y-axis). And the range of subsequent 12-month returns at each P/E multiple is shown by the colors of each bar.

I like charts that convey a lot of information simultaneously (as this does), and this one leads me to three observations. The first two are pretty obvious/intuitive, the third, a bit more interesting:

• average future returns are higher when multiples are cheap than when multiples are expensive;
• negative forward returns can occur from both cheap and expensive multiples, although are more common when starting from an expensive base;
• forward returns have always been positive when multiples are in the middle range of valuation (as we are now).

I have not seen a rigorous study to explain this third point, but I’d speculate that the middle ground of valuation reflects an equilibrium environment that balances the macroeconomic risks of growth and inflation.

Of course, no law governs this observation, and the future path of equity prices is unknown. But in weighing the evidence, I see no compelling reason to deviate from our long-term strategy.

The Ancient Mariner violated Nature by killing an albatross for sport, thus condemning his boat and crew to the purgatory of the open sea where, one by one, each of crew dies. Lamenting his fate, the Mariner cries, “Water, Water, everywhere, Nor any drop to drink.”

The Mariner realizes his sin, and wears the albatross around his neck as penance (hence the origin of the phrase “albatross around one’s neck”). His boat eventually returns to England, but the Ancient Mariner is condemned to wander the earth, recounting his tale (“rime” in the old English of Coleridge’s day) as a precaution against violating God’s will by taking a life unnecessarily.

There is a drought in California, with snowpack levels about 12% of “normal” (whatever “normal” is). Perhaps it will break next year (it’s too late now as we enter the dry season), or the next, or perhaps we are entering a multi-decade, or even century-long drought (both have ample precedents).

At the moment, it is a mild inconvenience to most of us, but it will certainly soon get more than inconvenient. For the rest of the country, drowning in record rains and snow this past winter, it may be tempting to scorn (or perhaps covet?) our mild, dry weather here. But it cannot be ignored: California feeds you. The chart below shows the percentage of US crops grown in California. Start hoarding now.

Well, maybe not dreaming, but some thoughts.

Below, my graph shows the unemployment rates for California and the US since 1976. California was generally better than the country in the 1980s, and has trailed ever since.

By my calculations, the US unemployment rate averaged 6.5% over the past 40 years, while the California unemployment rate averaged 7.5%, a full percentage point higher (on average, every year, for 40 years!). That is an enormous (many millions of people) cumulative shortfall in employment.

The graph raises two questions for me: what changed in 1990? and why has the job deficit persisted? The answer to the first question is pretty clear, especially for those of us who lived through that early period. The recession of 1990-91 hit California especially hard as the then-largest industry in southern California, defense, was eviscerated. Tens of thousands of highly skilled engineers and technicians, the people who literally made the US military into the most powerful force in the world, were thrown out of work that would never return.

The second question is more problematic, both because the answer is more complex, and because its implications are more important. It is beyond the scope of this blog (primarily because of the limitations of my intellectual capacity) to delve into this very complicated issue. But, it seems to me, every citizen of this state should ask why the state unemployment rate has been higher than the national average every single year for the past 25 years. I suspect taxes and regulations have something do with this, but there are, no doubt, other factors too.

My final point on this graph (at least, for today) is that the most recent recession also hit California harder than the rest of the country. The national unemployment rate peaked at 10% for one brief month (October 2009), whereas the state unemployment rate stayed above 12% in the fourth quarter of 2009 and for the entire year of 2010.

The good news, is that the unemployment rate has dropped an identical 45% from the peaks for both the state (12.2% to 6.7%) and the nation (10.0% to 5.5%). So while California bled more, the pace of jobs recovery has equaled the rest of the country. Let’s stop on that happy note.

A few years, I was at a conference, standing in a buffet line. I must have become fixated on extracting the blueberries from the fruit platter (I really like blueberries, and those cheap tongs at hotels are not well suited for the task of small fruit extraction…but I digress). In an attempt to position myself better, I bumped into a tall, skinny man of my age (but looked much older than me), which caused my blueberries to scatter. Of course, I was embarrassed, and apologized profusely, and not knowing what to do next, introduced myself. He said his name was Tim, and he was attending the conference for the first time. He asked me what I did, and since I wasn’t sure if he was a potential client or an annoying money manager marketing person, I explained, somewhat passionately, all about Angeles: our long experience, deep knowledge, incredibly smart, talented people, and our fanatic focus on providing our clients with the most satisfying, even sublime, investment experience possible.

Tim really perked up when he heard about our culture and philosophy, and said that he agreed that the key to success was to give clients a level of service that was unmatched anywhere else. By now, we had come to the end of the buffet line, and he was called over by someone else, but he asked to stay in touch, expressing a hope we might be able to do business together in the future.

I didn’t hear from him again. Until this morning. He reminded me of our initial conversation, which he never forgot. What really resonated for him was my comment that we obsessed about our clients’ experience with us, that it be seamless, well-integrated into their lives, helping each of them achieve whatever goals they had. He said that this was precisely his philosophy in running his company. But, he confessed, he felt like he had been about as successful as he could be in his industry, and was looking to extend his brand, and corporate philosophy, to new areas. And so, he offered to buy us, to become the cornerstone in their quest for dominance in investment advisory.

His enthusiasm was infectious, and I , too, became very excited at this prospect. But, I said, we are really not for sale. Tim replied that I hadn’t heard his price yet, which was true. He threw out a number with many zeroes in it. I asked him to add another zero, which he did immediately,but added that he would be named CEO of this venture. Without consulting my colleagues, although I was pretty sure they’d be very happy, I accepted his terms.

So, it is with great pleasure that I am able to announce that Angeles Investment Advisors is now Apple Investment Advisors, effective today, April 1st. Free iPads will be given to all clients in celebration of this deal. Future enquiries should be directed to Tim Cook, CEO. We hope you are as excited as we are. Enjoy your day!

One of the (many) perplexing phenomena facing investors is the persistent (and falling) low yields on government bonds.

Most of the time, we look to real yields to determine the impact of interest rates on an economy: negative real yields is generally highly stimulative (as it encourages excess borrowing) whereas positive real yields may discourage borrowing. In the aftermath of the financial collapse in 2008, monetary policies became quite aggressive in trying to engineer low (negative) real yields. The US and the UK, in particular, were successful in maintaining negative real rates, thus enabling their economies to grow ahead of the cost of servicing debt. As a result, debt has been reduced and economic output has surpassed previous highs.

Europe has not been as nimble, keeping positive real rates as their economies shrank and deflation set in. Consequently, unemployment rates are twice the levels seen in the US and UK (11% vs. 5.5%), debt burdens are rising and economic output is still below the previous peak.

Over the past few months, central banks in Europe have gone into battle mode. It may be too little, too late, but it does appear that they have had their epiphanies. Nominal overnight deposit rates have become negative (and even more negative in some countries), and around 2 trillion euros of government debt, about 25% of the total bond market, carry negative yields. In some countries, more than half of all government debt has a negative yield (see graph below).

As bond yields fall, bond duration rises, meaning the risk/return profile becomes ever more unattractive. Yet there are more long duration bonds than ever before: in Germany, the aggregate duration of bonds with maturities greater than 10 years is 30% higher today than in 2010, and is 70% more than the average over the years 1995-2010.

Why would investors agree to pay for the privilege of lending their money to governments (and even some corporations)? There are a few possible explanations. Some investors (pension funds, insurance companies) may be indifferent to yield simply because they are buying bonds in order to hedge specific liabilities. Putting the cash under a mattress would be better, but it would have to be a pretty big mattress and someone would have to stand watch over it. Some investors may believe that there will be further deflation, and are looking to profit by buying negative yields in hopes of selling at even more negative yields.

From the perspective of a bank, negative nominal yields reflect a desire to shrink their balance sheets: they simply don’t want more deposits, and negative yields is a way to discourage this. From the lender (investor) perspective, negative yields reflect a high degree of risk aversion and lack of confidence in government policies. In this regard, Quantitative Easing (“QE”), which is the central bank buying government bonds, may be a curious “solution:” withdrawing the supply of secure debt when the demand to hold such debt is especially high. Rather than boosting confidence and risk-taking, negative yields may have the perverse effect of heightening fear and boosting the demand to hold secure debt at ever lower (negative) yields.

The recent evidence that European central bankers are on the right track is somewhat encouraging, with equities and confidence up this year and the depreciating currency boosting competitiveness. But it is far too early to pop the Veuve Clicquot, even if it is 15% cheaper than last year.

In honor of St. Patrick, I thought I’d share this (mostly) green chart with you, showing the DJIA over the past 115 years, delineated by bull and bear markets (courtesy of Ned Davis Research).

US stocks are at all-time highs in both nominal and real terms, and you can see we are in the midst of a secular bull market. My own two punts (or cents) is that valuations in US equities are a bit stretched, but not extreme, meaning a correction of 5% or 10% should be expected. But that this would devolve into a bear market seems unlikely to me.

It is well known that there are no snakes (the reptilian kind, I can’t vouch about the human version) in Ireland because St. Patrick banished them to the sea. Scientists tells us that post-glacial Ireland never had snakes, so there was nothing for St. Patrick to banish, but like most Irish tales, I prefer the story to the facts.

But as investors, it’s just the facts (ma’am). The secular bull market demands we remain fully committed to equities, but valuations suggest we should anticipate some turbulence. But we welcome any declines, which we will put to good use by rebalancing portfolios. So fear not the snakes lurking in the grass; they, too, will be banished again. Erin Go Bragh!

Apologies for slipping on the blogs, but I’ve been traveling around the continent, from Alaska to DC.

One of the more common questions/comments we’ve heard from clients this quarter relates to the alleged benefit of global investing. Of course, this follows a year in which US equities gained 13% and non-US stocks fell about 5% (in USD terms), the widest performance gap since the 1990s. As usual, there were many valid reasons for this gap: the stronger economic growth and higher interest rates in the US favored dollar-based investors. And economic prospects, if anything, reinforced these trends: the gaps only widened in the second half of the year, promising a continuation of the trends favoring USD investors.

The dollar broke out of a long downturn last year (see graph below), accelerating at the fastest pace in the past six months since floating exchange rates were established in the early 1970s.

But markets (eventually) price in relative conditions, and the persistent weakness of the European economy and rising strength of the US economy were well understood by markets. As investors, it’s not enough to foresee the future (that’s hard enough). Success requires understanding what outcomes are already in prices. When the skew is sufficiently extreme, the successful strategy may be against the market, even if conditions do not yet support a change.

A great example was in early 2009, when credit spreads were wider than even during the Great Depression. At the time, the economy was a mess and the financial system a complete disaster, and the path out of the calamity was not clear. But the markets were pricing in an outcome that would be worse than the Great Depression. So even without confirmation of improvement, the successful strategy was to invest in those high spreads.

This year, we’ve seen something similar, on a much smaller scale, of course. The “Death of Europe” theme and the “Revival of the US” theme have been questioned, with current conditions, at the margin, improving in Europe and slowing in the US (see graph below).

Market prices are set at the margin, so one doesn’t have to believe that the European economy will outperform the US economy (I’m pretty sure it won’t over almost any time period). But when conditions go from worse to bad, that’s an improvement, or from great to good, that’s a regression, and that’s what we’ve seen this year in Europe and in the US.

Through today, European equities are up 11.5% YTD, 1000 basis points ahead of the US market. So the marginal improvement in the European economy relative to what was expected, is reflected in the markets, all as we would expect.

For investors, though, it’s never quite so simple. The rise in European equities has been accompanied by a decline in the currency (see graph below). That 11.5% equity return in euros translates to a 2% return in dollars, not much different than the 1.5% YTD return in the US market.

Trying to tie all this together, our portfolio tilts are generally pretty modest. Yes, economic conditions are improving a bit in Europe and slowing a bit in the US, favoring European assets, but the structural obstacles in Europe, political and economic, near- and longer term, are formidable, and I learned long ago as a currency trader not to step in front of a strong trend, in this case, to bet against the dollar. So I don’t see the reward in sticking one’s neck out in today’s markets, but yes, I still believe strongly in the value of diversifying globally because, one never knows.

The Consumer Price Index dropped 0.7% in January, bringing the year-over-year change to negative 0.1%. With the exception of the 2008 financial meltdown, the January decline brought the index to its first negative annual change since 1949 (see Chart below).

Energy is behind this. Energy prices fell 9.7% in January, and are down 19.6% over the last 12 months. Ex-energy, CPI is up 1.9% from a year ago.

This is not deflation, which is caused by tight money, but rather a one-off drop in the price of an important commodity.

The headline number also obscures encouraging data on income. Real (after-inflation) incomes rose for the fourth straight month, are up 2.4% from a year ago, and have accelerated to a 4.9% annualized pace over the past six months.

The decline in energy prices is a transfer of wealth from producers to consumers. It is not deflation, or anything other than that. Full stop.

Each year for clients we update a very colorful graphic ranking the annual performance of various asset classes. Each asset class has its own color, and the graphic is striking because of the kaleidoscope picture it presents: many colors, seemingly placed randomly throughout the graph.

Which is precisely the point of the graph: the colors appear randomly placed because they are. That is, it is impossible to predict the order of performance in any given year because there is no consistent pattern.

And so, the implication for investors is to diversify. If there is no way of predicting which asset will be up and which will be down in the coming year, we should own all of them, to ensure we benefit from those that do well. A disciplined rebalancing program is another good idea to smooth out the fluctuations in our overall portfolios.

Along these lines, the graph below shows performance of various equity markets in 2015. With all the woes of the energy industry highlighted in the media every day, you might be surprised that the Saudi market is up 13% and the Russian market is up 27%. This is all in the first 6 weeks of the year. The US, up less than 2%, is near the bottom of the pack, having been among the very best markets in the prior year.

Of course, this may all just be a head-fake, white noise in the background, and could easily reverse in the next 6 weeks. I don’t know. And my guess is, neither do you (nor anyone else-especially “experts” on TV, as the WSJ cartoon below conveys). Which is precisely why we diversify our portfolios.

Interest rate cycles are long: lasting not years, but decades. Consequently, we don’t have many data points for statistically significant conclusions about patterns. That said, we work with what we have, and the chart below shows 10-year US Treasury yields from 1850.

I’ll highlight three observations from this chart. First, cycles are indeed long: 40-50 years is not uncommon. Secondly, the turn to lower interest rates is preceded by a sharp (parabolic) spike higher, and then a very quick and meaningful decline. Thirdly, in contrast to the turn lower in interest rates, the turn higher occurs gently, over a long period of time.

The last big turn higher in interest rates occurred nearly 70 years ago, so very few of us have any first-hand experience. Rates peaked in 1920, following the inflation of the Great War, which induced a severe recession (the subject of Jim’s Grant excellent new book, The Forgotten Depression). Rates fell through the end of the Second World War, and didn’t break its downtrend from 1920 till 1950. Even then, it took till 1970 for yields to surpass the 1920 peak.

The turn to higher yields took even longer at the end of the previous century. Yields peaked in the Civil War and fell till 1890. Yields bounced around at low levels (around 3%) for 30 years, before moving decisively higher in 1920.

Today, we are still waiting for interest rates to reverse the decline that began in 1980. It will happen; one day. But given a history of this turn occurring over decades, it is the brave (or more likely, foolish) seer that attempts to call that date. Graveyards are filled with the bones of strategists calling the turn in interest rates (actually, graveyards are filled with the bones of strategists, period).

Sadly, I’m not smarter than everyone (anyone?) else, so my preference is to observe. Given that interest rate cycles are measured in decades, I’m not too concerned with having to predict when the turn higher comes. It will be enough to know which cycle we are in.

Apologies to Pete Seeger for stealing his song lyric, but I think bonds and flowers are sufficiently different that he wouldn’t mind.

The chart below (from our friends at Morgan Stanley) shows that net global sovereign bond issuance among the US, UK, Europe and Japan total about $1.2 trillion (first graph). But after central banks get through their bond buying to support the various Quantitative Easing (QE) programs in place, net issuance of sovereign debt is actually negative.

Investors continue to demand holding sovereign debt, but there isn’t any! Because central bankers are buying it all to feed the QE beast. Hence, when we see the lowest yields on French debt since before the French Revolution, the lowest yields on Spanish debt since the Armada sunk, the lowest yields on Dutch bonds since before tulips were planted there, we should not be surprised. Not surprised, but perhaps worried? This seems like a pretty massive distortion of the market mechanism that (supposedly) efficiently allocates scarce resources through the setting of prices. The very same political leaders who agitate about the coming Armageddon from upsetting the delicate ecological balance that nature has established seem wholly unperturbed with the multi-trillion dollar (and climbing) interference with the market mechanism. Yes, I’m equating the forces of nature with the powers of the markets, and I know it’s not a precise analogy. But I do think we would be wise to approach messing with the markets as cautiously and as humbly as we tempt Mother Nature.

My quarterly letter talks about the strength of the US dollar and why it should continue to rise (see Chart below), but I wanted to note here the huge impact currencies have had on investors in the past year.

Since January 2014, US equities are up 13%. But so are European equities, and Japanese stocks are close behind (+10%). However, these numbers are in local currencies, and the euro is off 20% and the yen off 12% against the dollar this past year, so, for a US investor, in dollar terms, European equities are not up 13%, but are actually down 7%, and Japanese stocks are not up 10% but down 2%. Conversely, European investors enjoyed a 37% gain in US stocks last year (13% + 20% + compounding) and Japanese investors saw a 27% increase. From a US perspective, the gap in returns between US and European stocks is as wide as we’ve seen in over 50 years (see Chart below).

With this sort of divergence in performance, it is reasonable to look for a reversal: US stocks to underperform non-US markets. Yet, for all the reasons I noted in my quarterly letter, the US dollar could appreciate further, especially in the context of the first graph, above, where it is still relatively low historically. Dollar strength is a headwind for non-dollar assets, which I suspect will continue to blow.

Whether the dollar continues to strengthen or turns around, US markets surge to new relative highs or mean-revert, I think caution is probably in order: take modest bets and watch them closely.

The US economy is stronger than we think: 257,000 net new jobs in January, but another 404,000 jobs were “found” (due to a recalculation) in November and December. More than 140 million are currently employed, a record high (see Chart below).

The unemployment rate is 5.7%, but if we include part-timers and discouraged, that percentage rises to 11.3%. Way too high, but making progress (see Chart below).

One of the details in the data is the number of people quitting their jobs: 9.5% of the unemployed quit their jobs, the highest percentage since 2008. This is a datum only a wonk (or a Fed Chair-Janet Yellen has singled out this number as particularly meaningful for her) could love, as it presumably shows a higher confidence among voluntary quitters that they will find another job.

There’s always lots of noise in the data, but the US economy, if not humming, is certainly chugging along.

Europe is a mess, everyone agrees: poor demographics, sclerotic and oppressive regulation, political dysfunction. European stocks lost 6% last year as the US gained 13%, about as wide a performance gap as we’ve seen in at least the past 50 years.

So how do we explain this chart: small/mid-cap French stocks are at an all-time high.

Consensus is (almost) always logical, but not always right. There are many very good reasons to avoid/underweight European assets. And it’s certainly possible that investors in small cap French stocks have become detached from reality. But it’s also possible that conditions are not as dire as we think, or that valuations more than adequately reflect this reality.

Overweighting European equities may seem like a heroic leap (and I’m certainly no hero), but when we have a combination of record performance differential, broad negative consensus and a market data point (French small caps) that is at odds with the headlines, investors would do well to remember that it’s often comfortable to be with the consensus, but not always profitable.

Mark Twain wrote in his autobiography that there are three kinds of lies: lies, damned lies and statistics. How true.

Revenue can be deferred (or accelerated), profits are easily manipulated, inventory gets adjusted: most data have to be scrutinized and dissected, and even then, can be misleading. But there are some statistics that just don’t lie, and the amount of goods hauled around the country is one of them. The reason is that no one in their right mind would haul goods from one place to another for the fun of it: real goods get moved around the country to generate real sales. It’s a pretty pure measure of true economic activity.

Trucking tonnage grew 3.5% in 2015, to an all-time high (see graph below). In the past week, we received some mixed signals about the economy’s strength, with weaker-than-expected numbers in retail sales and a decline in average wages. My guess, though, is that these are anomalies, noise, to use the technical term. As long as truckers are hauling more stuff, we can be sure the economy is growing. They are, and it is.

Back in 2011, as talk of the Eurozone disintegrating was at high pitch, investors fled to the perceived safety of the Swiss franc (CHF). Naturally, the value of the currency spiked higher, threatening the competitiveness of Swiss exports. So the Swiss National Bank (SNB-the country’s central bank) announced that it would sell an unlimited amount of Swiss francs at a rate of 1.20 per euro indefinitely, thereby effectively capping the value of the CHF.

For 3 1/2 years, investors exchanged their euros, rubles, florints or any other currency at this fixed rate, and the SNB accumulated these foreign reserves on its balance sheet. Despite the promise that the CHF would not appreciate, foreigners still wanted to hold the currency, and the SNB’s balance sheet doubled in size to more than 75% of Switzerland’s GDP (see graph below), more than twice the relative size of the Fed’s or Bank of England’s balance sheet.

As recently as last week, the SNB chairman, Thomas Jordan, reiterated the SNB’s firm commitment to maintaining the peg, calling it “absolutely essential.” It’s hard to know what turned something from “absolutely essential” last week to “unsustainable” and “unnecessary” this week, but the SNB announced last night that it was abandoning the peg. Simultaneously, in order to dissuade investors from buying CHF, the bank announced it was cutting overnight rates by 50 basis points, from -0.25% to -0.75%, and 3-month LIBOR by 100 basis points, from -0.25% to -1.25%. Yes, those are negative signs in front of those numbers.

It didn’t work: in seconds, the CHF jumped more than 30% versus the euro (see graph below) and Swiss stocks lost more than 14%, its biggest 1-day loss since the 1989 global meltdown. Nick Hayak, chairman of Swatch, called it a “tsunami” for the Swiss economy and its businesses. He is going to sell a lot fewer watches this year.

It’s hard to know the real reason for the SNB move. It may be that the SNB was getting less comfortable with the unlimited expansion of its balance sheet, and in particular, with its growing reserves of (likely) depreciating currencies. Perhaps it was tired of selling its currency at a discount to Russian kleptocrats moving their money out of rubles. Or maybe yesterday’s court ruling that permitted the ECB to begin buying government bonds was seen as leading to further euro weakness and therefore more flows into the CHF.

I don’t know what Chairman Jordan and his colleagues were thinking, but I take two broad messages from this action. The first is that no price can be pegged indefinitely, and the bigger the market, the sooner the peg will fail. Prices are determined by supply and demand, and governments can (and do) distort the pricing mechanism at their peril. Secondly, Europe is in trouble, on so many levels. Investors are eager to swap their euros for Swiss francs at a price 30% higher and a guarantee of a negative yield 100 basis points worse than yesterday. Wow.

Among new year resolutions, losing weight tops the list for the majority of Americans. Actually, I made up that statistic, but in my defense, (a) it probably is true, and (b) it most certainly should be true.

As the chart below shows, 50 years ago, more than half the population was at a healthy weight, with about one-third overweight and less than one-in seven obese. The good news is that the percentage of overweight Americans hasn’t changed much over the past 50 years, it’s still about one-in-three. The bad news is that more than one-in-five migrated from healthy to obese. So maybe we can say that we don’t have too many overweight people, we have too many obese people.

There are many diseases and ailments that are positively correlated with weight gain, unfortunately, this correlation between weight and disease is not linear: the prevalence of weight-related diseases, such as diabetes, is multiples higher among the obese than among the overweight.

There are many causes/explanations for the alarming surge in obesity. Much of the popular media lay the blame with evil corporations (which, of course, is a redundant phrase, as all corporations are evil, by definition) that (literally) push down our throats high-caloric, high-fat, high-sugar processed food-like substances that we unwittingly and helplessly consume in ever-rising amounts. There may be some truth to this. But we also encourage the consumption of low-cost, high-calorie products by subsidizing food by cost, not by quality or balance, especially among the poor, including the 47 million receiving food stamps (see graph below).

I’m not sure what the plan is to reduce the number obese (there may be no plan), but I did see that our government does plan to adopt new billing standards. The International Statistical Classifications of Diseases (known as ICD) was developed by the World Health Organization (WHO). They recently released version 10 (sort of like Windows), which will now be adopted by the US government. Version 9 had about 14,000 different diagnoses codes and about 4,000 procedural codes. The “improved” Version 10 has nearly five times as many diagnoses codes (68,000 versus the 14,000 heretofore) and, impressively, more than 87,000 procedural codes (a 22-fold increase). Some examples of the new codes are (I’m not making this up):

• W5611XD: Bitten by sea lion, subsequent encounter
• W6152XA: Struck by goose, initial encounter
• V9130XA: Hit or struck by falling object due to accident to merchant ship, initial
encounter
• W2202XA: Walked into lamppost, initial encounter
• V9027XA: Drowning and submersion due to falling or jumping from burning water-skis,
initial encounter
• V9542XD: Forced landing of spacecraft injuring occupant, subsequent encounter
• V9603XD: Balloon collision injuring occupant, subsequent encounter

It’s clear that the new billing system will increase the demand for more capable (and expensive) software, as well as more administrative jobs, so that’s great. It’s not so clear how this reduces the number of obese, but I’m sure someone in government has a good plan that will be shared with us in due course.

First, happy new year to all!

I walked into the office this morning to a crystal clear view of the Pacific. What a beautiful start to the year!

In the distance, I could see a giant container ship which, these past few months, has not been an unusual sight, although it should be.

The Palos Verde peninsula separates Santa Monica Bay to the north with the bustling twin ports of Los Angeles/Long Beach to the south. The LA harbor handles nearly half of all container shipping into the US. But if I can see container ships waiting in Santa Monica Bay, that is, the “wrong” side of Palos Verde, there’s a problem at the harbor. A problem at the harbor is problem for the entire country, not just for the nearly half-a-trillion dollars of goods that pass through LA/Long Beach, but as symptomatic of a bigger, structural challenge for and across the nation.

The longshoreman’s union has been without a contract since July, and while negotiations are proceeding, there have been reports of work stoppages by the union up and down the West Coast, but especially in LA, where as many as 18 ships are left waiting to dock.

These ships are enormous, over 1,000 feet long, some holding more than 13,000 TEUs (tons equivalent units) of containers, 50% more than ships could carry even 5 years ago. Therein, lies the problem.

The OECD studied the efficiencies of world ports (http://www.oecd-ilibrary.org/urban-rural-and-regional-development/efficiency-of-world-ports-in-container-and-bulk-cargo-oil-coal-ores-and-grain_5k92vgw39zs2-en) and concluded that most ports operate around 70-80% of maximum efficiency, with the largest ports being most efficient. 13 of the 14 largest ports in the world operate at or near maximum efficiency, all but 2 found in Asia (Haifa and Rotterdam are in the top ranks). But Los Angeles operates around 70% and Long Beach around 55% of peak efficiency (see graph below).

Part of the issue is that the ports built separate terminals for each shipping line, but shippers have have moved to working together, in the name of efficiency, so that no space on a ship is wasted. Thus, containers of multiple companies are now found on each ship. Not only does this often overwhelm the capacities of the individual terminals, it also requires the trucks and railroads more time to sort the containers when they arrive on the docks.

Efficiency gains will come partly from restructuring the terminals, but investing (large sums) in technology is really what is needed. Of course, this will impact the number of longshoreman jobs, and port operators have been reluctant to confront the union on this. But labor stoppages are not the real issue (even if they are causing real pain for everyone).

The latest and greatest whiz-bang innovations coming out of our garages and labs are rightfully lauded as engines of economic progress. But not everything streams over the Internet. Trucks and rails, airplanes and ships are (literally) the true engines of the global economy, and we neglect them at our peril.

We must invest in our infrastructure. We will make (and break) many new year’s resolutions. Let’s keep this one. Sailboats belong in Santa Monica Bay, not container ships.

Normally, I wouldn’t comment on any single economic release, but today’s GDP revision adds to the mounting evidence of a strengthening US economy. GDP growth in the third quarter was revised up to 5.0%, the fastest annualized pace since 2003 (see graph below).

This was not a case where the headline misled: all of the underlying components (except net exports) were revised higher. Corporate profits as a percentage of GDP reached a record high (see graph below). Following a 2% decline in output in the first quarter of the year, the economy racked up gains of 4.6% and now 5%.

GDP growth will likely slow from here (the economy is tracking around 3% growth in the fourth quarter). The decline in the price of oil is not a harbinger of imminent recession or of impending deflation. The economy is growing a little faster, inflation pressures are not yet evident, monetary conditions remain accommodative. Santa is being generous this year, and we are grateful.

Among monetary economists, there is a raging debate over the merits of the Fed’s burgeoning balance sheet. Back in November 2010, an open letter to Fed chairman Ben Bernanke was published in the Wall Street Journal (http://blogs.wsj.com/economics/2010/11/15/open-letter-to-ben-bernanke/), arguing that Quantitative Easing (QE) raised the risks of currency debasement and inflation. Some very smart economists signed on (Michael Boskin, Ronald McKinnon and John Taylor, all of Stanford), a few brilliant money managers (Cliff Asness of AQR, Seth Klarman of Baupost and Paul Singer of Elliott), and a couple of renowned historians (Niall Ferguson and Amity Schlaes), among others.

I did not sign the letter. I could say the reason was that I did not share the urgent fear others held of QE because I could see that these excess reserves would have little real impact unless they left the Fed’s balance sheet and flooded into the economy. With banks unwilling to lend and consumers unable to borrow, there was little chance these trillions of reserves would go anywhere or have any material impact. And with no requirement to manage the size of its balance sheet, the Fed could in theory expand it forever, or wind it down over a century, as it chose. I continue to believe that QE had very little real impact on the economy, benign or malign, and the end of QE and the prospects of monetary tightening need not be feared by investors.

All of the above is true, although I must admit, among friends, that the real reason I didn’t sign that letter was not disagreement and prescient foresight, but that simply, no one asked me. That’s not a complaint, just an admission.

While I continue to believe that QE had little effect on the real economy, it apparently did have a pernicious (and unforeseen, by me, at least) impact on civility, specifically, the efficiency of language. For as the Fed’s balance sheet expands, so too does its verbiage explaining its decisions (kudos to Vincent Reinhart of Morgan Stanley for keeping tabs on this important data series). Clarity and succinctness have been under assault in our society for many years, and we must resist this rising tide of words. I am hopeful that the end of QE will facilitate the return to the good old days of 200 words or less from Fed pronouncements. If the authors will amend their 2010 letter to emphasize this point, I’ll happily sign it now.

Take a look at the price of a barrel of good ol’ West Texas Intermediate (see graph below). Two things jump out at me: big declines occur in recessions (which makes sense as demand falls), and there’s a fair amount of fluctuation all the time. The recent 50% drop is unusual in that it has not occurred during a recession (unless we’re in one now and don’t know it; but I don’t think so). So, why has the price of oil fallen so dramatically? And what else has been impacted by this plunge? And how should investors think about opportunities in the energy sector? Well, a full answer requires more space than this blog allows, but I’ll try to hit the highlights.

As I noted two weeks ago (here and here), this is a supply-driven price decline, not a demand-driven one. The Saudis simply decided to stop acting as the swing producer, as they have for the past 40 years, thereby allowing a glut of oil to develop in the world markets. So, far from signaling a global recession, the drop in crude will boost the wealth of consumers (at the expense of oil producers).

The effect has not been limited to the commodity: oil-sensitive assets have sold-off as dramatically. The Russian ruble has lost half its value (see chart below), and credit spreads for high-yield energy companies have blown out (see second chart).

Yesterday, Russia raised its overnight rate from 10.5% to 17% in an attempt to stem the sell-off of the ruble. The last time such a dramatic action was taken was in 1998 when Russia eventually defaulted (admittedly, that was a much more dramatic episode: the overnight rate went to 150% before the entire system collapsed).

I am not an advocate of stepping in front of moving trains (or catching falling knives…choose your metaphor). I don’t know where or when the bottom is for oil, but I’m pretty sure the energy cycle (like the commodity cycle, the business cycle, the economic cycle, the bi-cycle…sorry) is alive and well. Oil didn’t go up forever (as was the consensus view in 2007, 1989, et. al.), and it will not go to zero (at least it won’t stay there for long). But I’d rather invest in projects that assume oil at $55 rather than at $110.

I don’t have a view on timing of oil prices, but I do have a concern at a potential repeat of a previous policy mistake. Following the collapse of the hedge fund, Long Term Capital Management and the subsequent Russian default in late 1998, central bankers flooded the markets with excess liquidity. That liquidity found its way in to a very small segment of the equity markets, the so-called "dot-com" companies, creating the following year perhaps the most excessive valuations ever seen in US equities.

As I said last week, a decline in the price of oil (or any other good or commodity) is not a monetary event, it does not cause deflation. It is strictly a wealth transfer from oil producers to consumers. The Fed should be careful about misinterpreting the effects of an oil price decline, and avoid over-stimulating an economy that is kicking into a higher gear already.

Europe’s unemployment rate is 11.5%. Europe is currently growing at less than 1%. A rule of thumb is that it takes excess growth of 2-2.5% to drop the unemployment rate by 1%. I think you see the problem. This is not advanced math.

Mario Draghi, head of the European Central Bank (ECB), would like to juice the economy with some monetary stimulus, but he’s finding that there is a gap between what he would like, what the Germans would like, and what can actually be done.

In the midst of the barrage of news about plunging oil prices and winter storms, you may have missed last week’s party held by the European Central Bank (ECB) where all the Eurozone banks were invited to attend to grab free money. A similar party was held in September, and between the two auctions, up to 400 billion euros were made available to banks. The idea was to give banks 3-year loans at essentially no cost, and banks would then lend these funds to European companies and households, earning a nice spread for the banks and boosting the region’s economy. Nice in theory, but banks declined to take their full allotment, taking down just 212 billion. Banks in the periphery countries drew all they could to bolster their weak balance sheets, but banks in the core countries took only about one-third of the funds that were offered, citing a lack of funding constraints as the primary reason for declining more funds, with poor loan growth as a secondary consideration. In other words, the banks said to the ECB, “we don’t want your money, we have more than we need.”

So an attempt to inject liquidity into the financial system fell way short of expectations, leaving Europe with both a growth rate and an inflation rate less than 1%. At these rates, the debt burden continues to grow for most countries. What is a central banker to do?

The ECB is currently buying asset-backed securities (ABS), but this is a relatively small market, and is having little impact. There is talk of buying sovereign bonds, as the Fed and the Bank of England have done, but this is highly uncertain: to begin with, there are no European sovereign bonds, only the bonds of member countries. So, which bonds will the ECB buy? German bunds yielding less than 1%? to what purpose? Greek national bonds? Really? Even assuming the ECB has the legal mandate to do so (which it doesn’t: it is prohibited by its charter from buying the sovereign bonds of member countries), under what conditions and criteria, and how much and in what proportion of bonds would they buy? These questions have no answers yet.

The Fed, in three rounds of quantitative easing (QE) purchased about $1.4 trillion of bonds, whereas the ECB, through various programs, is expected to buy no more than 350 million euros (see chart below). Even assuming it can execute this (far from a given), will it have any impact?

It is highly controversial among economists as to the effect Quantitative Easing has on an economy. Proponents argue it adds needed liquidity to keep the financial system afloat, thus enabling an economy to repair its balance sheet with minimizing dislocations. Critics believe it only serves to enlarge the presence and influence of the central bank by expanding its balance sheet, setting the economy up for more pain down the road when that balance sheet must contract.

My own two cents (which may not even be worth a penny), is a third perspective: QE has had no meaningful impact on the real economy, but it has served as notice that the central bank is ready, willing and able to provide unlimited liquidity to the financial system, thus eliminating the concern of a systemic default. This signal has some value.

Unfortunately, the poor results at last week’s TLTRO (Targeted Longer Term Refinancing Operation) signal the impotence of the ECB. Rather than boosting confidence, the ECB reinforced concerns that it might not have the tools or process to avoid or reverse a potential systemic default. I’m not suggesting one is imminent, or even likely, just that Europe faces many structural hurdles, among them, the efficacy of its central bank.

Meanwhile, the US data point to accelerating strength. Last week, retail sales were especially strong, and this morning, industrial production is just smoking. Production jumped 1.7% in November, the fastest monthly gain since 2010, and is up 5.2% over the past 12 months. Capacity Utilization rose to 80.1%, the highest level in nearly 7 years. A tale of two regions, indeed.

The dramatic (40%!) drop in oil prices has caused some hysteria in the media about the rising risks of deflation. After all, lower energy prices is deflationary. Well, that’s not quite true.

Inflation is a measure (imperfect, to be sure) of the general level of prices, not the relative price of one good versus another. If the price of steak rises relative to the price of chicken, people will consume less steak and more chicken. This has no impact on the overall price level in the economy. Likewise, the economy may spend less on energy, but then more on other stuff. The price of energy relative to everything else is falling, but that’s not the same thing as the prices of everything are falling.

No, the relative change in prices is simply a wealth transfer from one part of the economy to another, in this case, from energy producers to everyone else. It has no effect on overall prices.

This may be the most misunderstood economic concept, apparently, even among experts who should know better. Part of the confusion stems from the 1970s, when a huge spike in the price of oil was followed by rising inflation, leading many to assume the latter flowed from the former. Not so: the rising inflation of the 1970s was engineered by the Federal Reserve. The Fed believed (probably correctly) that the spike in oil prices in 1973-74 would cause an economic recession in the US, and thus they opened the monetary spigots, attempting to mask the rise in oil with a rise in overall prices. It was loose monetary policy that caused inflation to spike in the 1970s, not OPEC’s curtailment of oil. The spike in oil prices represented only a wealth transfer from consumers to OPEC, but instead of accepting this reality, the Fed’s misguided reaction was to pump more liquidity through the financial system. The result was the highest levels of inflation seen in US peacetime history.

Likewise, today’s drop in oil prices should be seen strictly as a wealth transfer from producers to consumers. That’s it. Now, of course, we will see CPI reported as a bit lower in the coming months, because consumers will, at first, save a portion of this windfall, but over time, spending will adjust and we’ll see CPI rise a bit more than it otherwise would. Unless, of course, the Fed changes course and decides to treat the temporary decline in reported CPI as a signal of deflation. That would be a mistake because (a) it is not a signal of deflation, as I just described, and (b) it would put the Fed further behind in normalizing monetary policy.

The Fed has done a pretty good job of navigating the economic shoals of the past 6 years: money supply is growing at a reasonable rate (see chart below), and interest rates are below the economy’s nominal growth rate, thus allowing incomes to grow faster than debt service and for balance sheets to de-lever.

As long as these conditions continue, and that is what we expect, the “noise” about deflation in the US is only noise. The same cannot be said about Europe, however. The ECB has allowed money supply growth to shrink dangerously (see chart below), and while Signore Draghi has promised to accelerate the money supply, we haven’t seen that actually happen yet. Until he does, Europe’s risk of deflation will remain elevated.

Take a closer look at these two charts. M2 in the US is growing around 6%. Real GDP is up at 4%, inflation around 2%. In Europe, M2 growth is less than 3%, with real GDP a little over 1% and inflation around 1%. It’s not precise, but it’s no coincidence that these numbers (real GDP plus CPI ~= M2) add up.

So don’t be fooled by all the loose talk of oil prices and deflation. Deflation (like its cousin, inflation) is all about money, not oil (or cows, chickens or anything else).

Oh, this was a strong report this morning, on every level:

• 321,000 net new jobs in November.
• 10 consecutive months of +200,000 payroll gains (228,000 on average over the past year).
• Labor force expanded 119,000, and the labor participation rate held steady at 62.8%, its average of the past 8 months, so perhaps it is leveling off.
• Median number of weeks of unemployment fell to a recovery-low of 12.8.
• Quitters rose to 9.1% of those unemployed, signaling rising confidence in being able to find another job (this is one of Janet Yellen’s favorite stats).
• Average hourly wages rose 0.4% and total hours worked rose 0.6%, so cash earnings were up 1% in November, the most for any month since 2006.

In stark contrast to the rest of the world, the US economy is not only strong, but may be getting stronger! Good for USD-based assets, and we expect the Fed to begin raising rates in 2Q next year.

Declining oil prices provide a net benefit to the global economy. A rule of thumb is every $10/barrel transfers around $330 billion, about 0.4% of world GDP, between oil producers to oil consumers. So there are winners (consumers) and losers (producers), but overall, the decline in oil should lead to global GDP growth around 0.5% higher next year than it otherwise would be.

The US is both a large consumer and producer of oil, but we are still net importers. Petroleum-related costs should fall about $280 billion, whereas the losses to US producers will be around $130 billion, for a net benefit of $150 billion, around 0.8% of US GDP. A US-rule of thumb is every $10/barrel change translates to $38 billion, or 0.2% of GDP.

So, the big picture is a net positive for the US and world economy. Clearly, last week the capital markets adjusted valuations accordingly, with those countries most sensitive to the price of oil seeing the biggest adjustments in both equities (first chart below) and in currencies (second chart below).

The price decline will hurt North American energy producers, but not as much as one might think. Even just a year ago, the working assumption in the industry was that North American tight (shale) oil had a marginal extraction cost of around $85-90/barrel, but with better data and (almost daily) advances in technologies, 80% of tight oil is profitable between $50-69/barrel, with a number of regions well below that (see chart below). The result is that oil at $65-70/barrel may have little impact on North American production. Rather, the biggest losers will be those with high marginal costs of extraction and those seeking to attract capital for new projects (Brazil, Mexico).

The geopolitical implications are potentially vaster and more profound, but also much more uncertain. The OPEC cartel may have finally imploded permanently. One implication is that instead of the cartel (really, just the Saudis) adjusting supply to manage the price, the price will now adjust to establish the supply/demand equilibrium. This means higher price volatility, but also a more efficient distribution of resources.

The Saudis are clearly using lower prices to inflict pain on Iran, as that regional rivalry intensifies. Russia has generally supported Iran politically, and the Russian economy will suffer from lower oil prices. But it is unclear whether this economic pain leads to moderating political behavior by the Iranians and Russians, or to more desperate, destructive actions.

For the past few years, oil has held steady at around $100/barrel, as supply and demand were largely held in check. Supply was disrupted in Libya and South Sudan, Venezuela saw production tumble due to incompetence and inefficiencies plus sanctions on Iranian exports more or less offset rising production in North America. But about 6 months ago, the world economy (esp. China, but also Europe, Japan, Brazil, et.al.) began to slow at the moment when Libya quadrupled its output to 1 million bpd. When weakening demand collides with a spike in supply, the result is a plunge in prices, in this case, from about $110/barrel to under $70/barrel.

Historically, the Saudis acted as the supply governor in world oil markets: as prices rose, they pumped out more, as prices fell, they throttled back, helping to stabilize the price (see Chart below). Until July, when the the Saudis met the surge in Libyan production with a shrug, keeping their production at close to a record 10 million bpd. Thus followed a swift and sharp 40% drop in the price of oil. But, why did the Saudis allow this to happen?

Politics. Who is most hurt from the big drop in oil prices? Venezuela? certainly, as oil revenues pay for 65% of its budget, but Venezuela is a complete mess, grossly mismanaged on every level for over a decade. Russia? yes, but Putin has accumulated a few hundred billion dollars of rainy day reserves, and while the drop in oil will send the Russian economy into a recession, Putin still has money, nuclear weapons and leverage over the Europeans dependent on Russian gas this winter. Iran? now we’re talking! Iran is Saudi Arabia’s natural enemy: a formerly great and powerful civilization strategically positioned geopolitically and self-anointed leader of Shi’a Muslims worldwide, a direct threat to the Saudis, Sunni guardians of Mecca and Medina, Islam’s two holiest sites. The Saudis and Iranians are engaged in proxy wars from Syria to Yemen. But Iran’s economy is in shambles, and it is highly dependent on oil revenues.

So I see what’s happening in the oil markets through a geopolitical lens, a move by the Saudis to inflict maximum pain on arch-rival Iran. You’re welcome to agree or disagree with this narrative, but irrespective of the causes, the drop in oil has enormous global consequences. More on that in the next post.

Successful investing is frequently about balancing valuation with growth prospects. We would all love to invest in cheap assets with strong prospective growth, but most of the time, we’re forced to choose: valuation usually reflects prospects.

Emerging markets (EM) equities is one of those areas that offer seemingly cheap valuations with attractive growth. But upon closer inspection, the picture is a little more complicated.

First, to valuation. The MSCI EM Index trades at a forward P/E multiple of 10.8 times, well below the MSCI World Index of nearly 15 times. But the EM Index is heavily skewed by the cheapness of China and Russia: those two countries trade at less than 7 times forward earnings while the rest of EM trades at 12.5 times. 12.5 times is cheaper than the World Index, but it is not historically cheap (it peaked at 14 times in 2008). So, EM looks cheap, but it’s really because China and Russia are especially cheap.

Next, to growth prospects. Historically, there has been a close correlation between earnings and equity prices. Over the past 5 years, the MSCI EM Index is up just 0.79% p.a.. It’s no coincidence that earnings in that index are essentially flat over this period (see Chart 1). So there’s been no earnings growth, and no gains in equities. Likewise, the relative performance of EM to developed markets (DM) is closely correlated to the relative GDP growth rates. In 2008, EM countries were growing at a 7% pace faster than DM countries; today, that differential has shrunk to just 4% (see Chart 2).

Most EM countries have high valuations along with faster growth (Thailand and the Philippines, especially, stand out). There are some countries within EM that may offer the combination of cheap valuation and rising growth (Brazil, Korea, India, perhaps).

EM (broadly) will outperform when profits and economic growth accelerate relative to the rest of the world. It would be additionally helpful if valuations were also cheap. With a few exceptions, those two conditions, relative growth and low valuations, do not yet appear in the EM world.

There’s no doubt that the headline unemployment rate (5.8%) does not tell the full picture of the job market. Specifically, there have been three areas of concern not reflected in the (low-ish) unemployment figure: the decline in the overall labor force (the labor participation rate), the elevated duration of unemployment, and the rise in the number of part-time workers. Each of these metrics suggests a weaker employment picture than by glancing at the 5.8% unemployment rate. Let’s tackle the last issue, the large number of part-time workers with the chart below by Julie Hotchkiss of the Atlanta Fed.

I like charts that display multiple data, and this is one. All the data compare to the same month in the previous year: so the June 2014 number is versus the level in June 2013, for example. The black line compares the total change in employment, the green bars show the change in full-time workers and the purple bars show the change in part-time workers. Clearly, through October 2010, when year-over-year employment began turning positive, the gain in part-time workers (the purple bars) far exceeded any gains in full-time employment (green bars). Since then, full-time employment has vastly outstripped part-time employment and, in fact, that’s been true for every single month since August 2011. Since October 2010, 95% of the 8.2 million new jobs have been full-time, not part-time jobs.

The fact that there are still a lot of part-time workers is a residual of the hiring we saw from 2008-2010. Since then, we’ve been adding full-time jobs. All this suggests that the US economy is not as weak as some have asserted, at least in this one particular area. On balance, the data point to continued growth in the US economy. There are risks to the downside, to be sure, but the surprise may be more on the upside. We remain believers in the US economy.

Yes, we all know the European economy is not growing: stagnant, sclerotic, etc. But this fact is not a crisis. It’s a concern, a problem, a challenge, but not a crisis.

It is hard to get politicians to act (a global observations, not just in Europe or the US), harder to get them to act in ways that actually benefit the economy, and nearly impossible to get them to favor the long-term if it involves pain in the short-term (I’m using short-term and long-term as defined by the election cycle: short-term is before the next election, long-term is afterward). Unless there is a clear and present danger; there’s nothing like a crisis to focus the mind. In early 2012, there was much (and serious) talk of multiple sovereign defaults in Europe, the break-up of the euro, all leading to the collapse of European social order. The then newly-appointed head of the ECB, Mario Draghi, broke with his predecessor (Jean-Clause Trichet, the dour Frenchman who acted as the Bundesbank’s spokesman), and certainly did not consult with Chancellor Merkel when he announced the ECB would do "whatever it takes" to ensure currency stability in the Eurozone. That helped: markets re-priced sovereign default from near certainty (Greece) to low probability. Crisis averted.

Well, the crisis was averted, but not the problem (or challenge, if you prefer). Smarter minds and more powerful computers than I have continually assess the probabilities of multiple outcomes in the capital markets, but here’s a very simple rule of thumb that captures most of what is important: if the nominal growth of an economy is greater than the nominal interest rate a country borrows at, all will eventually work out. The relationship is flipped, that country has a problem. Houston (I mean, Greece), you have a problem. Greece’s nominal GDP growth is around 1% (yes, that makes it one of the stronger economies in the Eurozone). But, as the chart below shows, over the past 2 months, the cost of borrowing rose from 5.5% to over 8%. So, in simple math, if Greece can grow at 1% but has to borrow at 8%, its debt will continue to grow 7% per year. Now, this calculation is only a guide, not an axiom, but it highlights 2 points: without even modest growth, Greece was continuing to sink into a deeper debt hole. Secondly, with the spike in yields, it is now sinking faster and deeper.

The Greek economy has shrunk more than 20% over the past few years, its official unemployment rate is over 25%, Greek equities are down 30% this year, and its budget deficit is still 3% of GDP (an improvement, but the sign is still negative, so the debt builds). Even with a planned cash injection next month, it will run out of cash mid-next year. More loan assistance is possible, which will postpone the crunch another year, but it’s just kicking a can without some economic growth.

This is no longer a mere problem for European politicians, it is now a crisis. But I’m not sure they know it yet.

An interesting graphic from Ken Leech of Western Asset showing that spreads in Bondland this year are pretty much unchanged from the start of the year. This, despite the rally in US equities and solid economic growth. Thus, Ken concludes, spread products remain attractive.

I agree. There are numerous risks in fixed income, but that’s often the case. An economy that suddenly slumps will likely cause spread widening (although likely offset by rising bond prices). An unexpected economic boom could push bond prices lower (but spreads should hold true, if not tighten). An environment of moderate growth and low inflation should be favorable to spread products. And that’s my view.

When the Fed embarked on Quantitative Easing (QE), many prominent economists warned this would lead to hyperinflation (or, at least, an wanted surge in inflation). Didn’t happen. With QE ended, many economists (mostly different, but some, amazingly, the same), warn that deflation will soon engulf us, leading to economic ruin.

One lesson to take from these public debates is that it is usually best to ignore predictions (especially about the future, and maybe especially from economists). But really, especially predictions that are based on theory that then do not conform with the empirical facts.

This first chart shows the growth of money supply (M2) in the US over the past 35 years. As you can see, money growth fell below 2.5% following the recession, bounced back strongly to 10%, and has settled in around 5-6% (5.3% at the latest reading). Not coincidentally, nominal US GDP growth was most recently 3.5% (real) plus 1.7% (inflation) or 5.2%. By maintaining solid growth in money supply, the Fed has ensured solid nominal GDP growth. Also, note that money supply growth has reverted to its long-term mean over the past through years despite the introduction and withdrawal of three and one-half (including Operation Twist here) of QE programs, meaning it’s hard to see any real world impact of QE (on either side).

Compare and contrast with the central banks of Japan and Europe (see charts below). The Bank of Japan has kept money growth between 0% and 5% for the past 20 years (most recent: 3.5%). The European Central Bank has been all over the map, between 1% and 11% over the past 30 years, but hovering around 2.5% over the past 5 years (3% in the latest data).

Money growth tells the stories of the economies: that US economic growth has been moderate, while Japan and Europe have stagnated. Money growth also dictates the path of the price level, since inflation (and deflation) are always and everywhere a function of the supply of money (as Milton Friedman pointed out). The anemic growth in money supply in Japan and Europe means there is an elevated risk of deflation (although still not a likely outcome if money growth can remain positive). In the US, 5-6% money growth is about just right: fast enough where deflation risks are minimal, and not too fast to stoke much higher inflation.

Some fun facts about this year (courtesy Michael Hartnett of Merrill Lynch):

• US equities (+14%) are ahead of European equities (-6%) by the widest margin since 1976.
• US large cap is beating US small cap by 950 bps, the most since 1998.
• 50% of all government bonds globally yield less than 1%.
  • Notable exception: Venezuela US$-denominated bonds yield 22%.
• Apple’s market cap ($662 billion) is one-third greater than all Eurozone banks combined, and nearly as large as every listed company in Latin America ($695 billion).

The following item caught my eye on Bloomberg:

Los Angeles City Employees’ Retirement System is scheduled to discuss a staff report requested at a prior meeting on the pension’s specialized private equity and real estate investment programs…. The programs agenda targeted “emerging managers, funds focused on underserved markets, demographically targeted partnerships, and geographically targeted investments.”

Since inception in 2004, the programs have committed $198 million to 23 funds that have earned an average annual return of 3 percent, according to the staff report. Within that, seven non-traditional real estate investments have returned negative 4 percent.

An annualized loss of 4% in real estate over the past decade?! Even 3% p.a. for 10 years in private equity?! Is this “specialized” program a bad idea or just bad execution? (the choice is not mutually exclusive-it could be both). I’d be curious to know how many other public plans have similar programs and how those programs have performed.

Kudos to whomever it was at LACERS who asked for this program to be reviewed. I’m sure (hope) the trustees will remember their fiduciary obligation is to the beneficiaries of the System, and ultimately, to the taxpayers who are on the hook for the decisions these trustees make.

Not enough attention is being paid to the work slowdown/stoppage going on at West Coast ports.

The last time there was a disruption was in 2002, and it ended 10 days later only after a presidential order.

The contracts expired 1 July of this year, and the unions (ILWU and PMA, who represent about 20,000 workers) have initiated a slowdown as part of their negotiating strategy, despite an agreement to keep operations flowing normally. The port of Tacoma, for example, reports 10-18 container moves per hour, versus the normal 25-35.

This past weekend, slowdowns were reported at Los Angeles/Long Beach, combined, the 9th largest container port in the world, and the ports of entry to about 20% of entire US imports. Surcharges are being added for shipments to the West Coast that are doubling the cost of shipping, and truckers are adding additional surcharges $50-$100/per hour.

Cargo passing through West Coast ports represent about 12% of US GDP, and a 5-day shutdown, should that occur, will reduce GDP by $2 billion per day. Spot rates on the East Coast have soared versus last year (see Chart below, courtesy Merrill Lynch). There are few alternatives: the East Coast is at capacity, Canada can’t handle the flow, Mexico is three times as expensive as US West Coast, and air is 5-6 times more expensive than shipping.

Not coincidentally, this is a key Christmas-time for every retailer, with the potential to cause major disruptions, not just in the broad economy but, more importantly, for all the good children on Santa’s list.

Between March 2000 and October 2002, the NASDAQ Index fell 75%, from over 5,000 to under 1,300. Of course, valuations were beyond silly at the peak, and I confess, following the collapse, I thought my children might one day see the index surpass its previous high.

Well, 12 years later, the NASDAQ is within 10% of its 2000 high. It’s not there yet, and it’s been a long slog to recovery, but it’s getting there.

The chart below, from Barron’s, shows the largest constituents then and now. The top 5 in 2000 still around, but 6-10 have all disappeared, either acquired or taken private. A good reminder how hard it is to stay on top.

11 November is celebrated in the US as Veteran’s Day and throughout Europe as Armistice Day, marking the armistice ending the First World War in 1918. Government agencies and banks are closed for the holiday (but we’re working here at Angeles!).

11 November, as Armistice Day or Veteran’s Day, has recently been displaced by a new holiday, created just 5 years ago, by Jack Ma, honoring not our war dead or our military veterans, but a far more important and over-looked group, long-forgotten, scorned and abused: the single consumer.

Seeing the unfair neglect of this group, who suffer in stoney silence with no partner to exchange gifts on Valentine’s Day, Jack Ma decided that single people should buy themselves gifts on Single’s Day. Only coincidentally, even unconsciously, would this selfless act of public service benefit in some modest way Mr. Ma’s company.

Well, the numbers are in. In the past 24 hours, on the Alibaba platform alone, $9.3 billion of gifts were purchased, representing 278 million discrete transactions. To put this in perspective, the two biggest shopping days in the US are Black Friday and Cyber Monday which, combined, last year generated $2.9 billion of sales.

We are grateful to Jack Ma that China’s singles won’t feel so lonely after this day. Or will they?

Wow. The good people at the Institute for Supply Management survey American manufacturers every month and ask, “how’s business?” They then create a diffusion index based on those responses: a scale from 0 to 100, where 0 is no one says business is improving and 100 is everyone says it’s getting better. So 50 means it’s evenly split. Historically, 60 has represented a high mark, 40 a low mark, although there have been occasions beyond this range.

The October index jumped to 59, and the new orders index rose to nearly 66. The strong reading translates to a real GDP growth rate of 5.2%. That may be a bit high, but here we have another datum that the US economy is picking up steam.

With apologies to Walt Disney, the global economy is getting, well, more global, and, intuitively, companies’ sensitivities to global macro factors increase in proportion to their global revenues.

When we look at conventional, market-cap weighted indices, we (implicitly) assume that 100% of the each company’s stock price is driven by domestic factors. We know, obviously, that this makes no sense logically for companies that operate globally. For example, when we own Samsung implicitly ascribe 100% of that holding to our Korea exposure. But the company gets less than 10% of its revenue from Korea, and it’s fortunes are dependent on non-Korean factors more than domestic ones. This statement holds true for many multinational corporations.

The chart shows the capitalization weights of the MSCI ACWI versus the revenue exposures of the same ACWI companies. It’s interesting that the differences are almost entirely between the US and EM: Europe, UK, Japan show little change. But the US weight falls in half and the EM weight triples when view by revenue rather than by capitalization.

No benchmark is perfect, but I suspect that over time we will gravitate to evaluating holdings on factors other than solely market capitalization.

QE3 (the policy, not a new Cunard ship) was launched 2 years ago and ended this week. The expanded it balance sheet by $1.6 trillion, or 62%.

Economists (and other, smarter people) will debate the efficacy of the program, probably forever. At the time, a large group of leading (mostly conservative) economists warned that QE3 would lead to higher inflation and the devaluation of the dollar. Well, that was wrong: inflation (from the PCE) was running at 1.5% in September 2012 and is 1.5% today. USD/Euro, for example, was at 1.29 back then, 1.28 now.

Supporters of QE (mostly liberal economists) argued then that the point of QE was to push interest rates lower in order to stimulate borrowing). Well, that was wrong too. The 10-year Treasury yield was 1.77% in September 2012, 2.34% now. Interest rates went up, not down, under QE3.

What did change in the past two years? The US economy has gained strength, and that has been reflected in the equity market. Monthly payroll growth was averaging 141,000 in September 2012, and today’s it’s 245,000. The unemployment rate fell from 8.1% to 5.9% in the past two years. And the S&P 500 is up 38%.

So, if QE3 did not have the anticipated effect of lowering interest rates, or the feared effect of runaway inflation and dollar devaluation, was it a success or failure? Again, this debate will likely go on for generations. My two cents is: neither. Perhaps it had some modest signaling value that the Fed would remain accommodative, but it’s hard for me to see any real world impact of this policy. Much ado about nothing, as Shakespeare said.

The US economy is moderately strong, inflation is low, and while there are many risks presently and on the horizon, it’s probably time (overdue, really) to abandon the zero-percent short-term rate that has punished savers for six years. The Fed will move cautiously, deliberately, but I see the coming change in Fed policy as not so much a tightening as a normalizing, and thus nothing to fear.

Oil prices are down about $30 from their highs; great news for consumers and the big oil importers (China, Korea, India). Not so good news for the big producers (Saudi, Russia, Venezuela).

Oil companies have been borrowing more, but most of the major multinationals have very strong balance sheets and generate a great deal of cash. But the biggest oil companies in the world are state-owned, and they have been especially thirsty for debt. The Latin American giants stand-out:

• Petrobras has $147 billion of sales and $123 billion of debt
• PDVSA has $127 billion of sales and $120 billion of debt
• Pemex has $127 billion of sales and $134 billion of debt

So not only are these companies levered to the price oil, they are levered to interest rates as well. Double down?

A hundred years ago, I studied international relations in school (the Sykes-Picot Treaty was a hotly-debated current topic among us). For the few of us focused on the Third World (now given the more agreeable, if not optimistic, label of developing countries), the research on Brasil could be summarized in a pithy, and unfortunately, accurate phrase: "Brasil is the country of the future; and always will be."

But then China began devouring every ounce (um..kilo) of ore and agriculture Brasil could dig or grow, thus catapulting the Brazilian economy to 7^th largest in the world. The future had arrived.

A string of competent presidents, culminating with the visionary Fernando Henrique Cardoso (1995-2002) set Brasil on the path of deregulation and free markets. Even the radical socialist Lula (formally, Luiz Inacio Lula da Silva, but know universally by one name, much like Madonna and Cher-I’m clearly dating myself) managed to recognize a good thing and for the most part kept his hands off the free market. Along with China’s limitless appetite, Brasil lifted millions out of poverty.

Lula’s hand-picked successor, Dilma Rousseff, a former Marxist guerrilla who was tortured during the military dictatorship, shared Lula’s vision of wealth distribution, but where Lula understood the economy needed to create wealth in order to redistribute it, Dilma (also universally known by her one name) prioritized redistribution. The economy never broke its dependence on mining and agriculture (although Embraer makes very good jets), and when China’s limitless appetite for minerals and food actually had a limit, Brasil’s economy tanked. Dilma never strayed from her priority of wealth confiscation (I mean, redistribution), which had the advantage of consistency, but also the disadvantage of economic self-flagellation. GDP growth is zero this year, which may be a little better than Venezuela or Argentina, but will trail every other country in Latin America.

Sunday, the voters spoke, and rewarded Dilma with another term. Monday, the markets spoke, and sent the currency, bonds and equities to new lows (the chart below is in today’s WSJ). Barring some volte-face, sadly it appears that Brasil, once again, will always be the country of the future.

In our long-term assumptions, we generally assume that the total return in fixed income is pretty close to its starting yield. That’s because a bond’s total return is a function of two variables: yield and re-investment yield. As yields move up and down, bond prices move inversely, down and up, but the re-investment rate moves positively with yields. In the short-term, changes in prices have a large impact on total return, but given enough time, the re-investment yield (almost) completely offsets the price/yield function.

The table below (courtesy Morgan Stanley), shows the effect of interest rates rising from 3% to 8% at 50 basis points a year over 10 years. The total return over this decade works out mathematically to 3%, (not) coincidentally the starting yield.

There are risks to owning bonds, primarily higher inflation, and to a lesser extent default risk. But the laws of mathematics make us highly confident that the long-term nominal return for bond investors will be right around today’s yield.

A great line from a great Monty Python movie, and another crisp cover from The Economist:

On a totally non-market subject, more young adults are living with their parents, and here’s the graph to prove it (courtesy of Hugo Scott-Gall of Goldman Sachs). Top line is US, bottom line is UK. I suspect in places like Italy, the numbers are way higher.

Goldman surveyed their interns about which items were priorities for them to own. A house was easily at the top of the list, but interestingly (at least to me), a car was no more important than an expensive handbag or watch. Maybe that’s a function of an urban-centered (and status-conscious) survey group, but I’d say it’s good news for Uber, not so good news for GM (and its peers). It’s also good news for the housing (and related) industry, but maybe the biggest winners are the long-suffering parents who can finally get their kids out the door. I’m sure their children feel the same way.

Yes, pessimism over Europe’s prospects is high, and valuations in Europe are relatively low. But both for good reasons.

Below is another data point on how the markets are reflecting the divergence in economic performance and prospects between the US and Europe. Anticipated US inflation 5 years hence is around 2.4%, a little lower than at the start of the year when it was about 2.6%. But forward inflation in Europe is sinking fast, now at just 1.7%, down from 2.2% at the beginning of this year.

I’m interpreting the spike down last week and the strong rebound in the past few days as bullish. See the chart below from Friday’s close (courtesy of our friends at Merrill).

We have held our positions in our model portfolios, neither panicking during the deluge nor trying to catch the bottom of this short-term move. Remember that much of what happens hour-to-hour, day-to-day, week-to-week, even year-to-year, has (or should have) little practical impact on long-term investors. Let’s make sure we have the cash to pay the bills and cover reasonable contingencies; after that, we can be largely indifferent to the spasms of the markets.

Nice graphic in today’s FT showing the spike in vol and sell-off in risk (Greek bond yields jumped from 5.5% to 9% in the past few days).

I still think this is mostly noise, a normal, and overdue, correction. But, stay tuned….

It’s been 3 years since US equities have corrected more than 10%. But there’s no law about how long rallies can last without a correction.

In any event, as diversified, well-positioned investors (as, of course, we believe we are), does it really matter if stocks fall 10%? or 20%? If it does matter, you probably have the wrong portfolio. For the rest of us, volatility really does equal opportunity.

Consider:

• Volatility spiked to its highest level in over 2 years.
• Global equities are in negative territory this year, led by Europe’s 10% decline.
• US 10-year Treasury yields fell more than 30 basis points intra-day yesterday.

Consider, too:

• Mortgage rates are down 100 basis points over the past year
• Jobless claims are at their lowest levels in 15 years
• Housing prices nationally are up 7% in the past year
• Gasoline prices are off 20% this year

I have no idea where the bottom is, or when we will get there. But if you believe the US economy remains reasonably robust and global growth, while slowing, will remain positive, take the recent market convulsions as a periodic regurgitation meant to damage complacent speculators rather than a harbinger of civilization’s collapse. Of course, holding a month’s supply of canned goods and ammo is a good idea, too.

Some historical data from Credit Suisse below: MLPs are off 14% this month, pretty bad. Subsequent performance (no guarantees) looks pretty strong though.

Like Scary Nights at Universal Studios (where my daughter went this weekend), it really is scary out there. I Walked into the office looking at a 300-point drop in the Dow and a +10% jump in 10-year Treasuries.

I doubt anyone woke up this morning and decided that sub-2% yields for the next decade is actually a great investment. No, it’s a classic sign of panic.

I have no idea how much further we fall, but it’s not a black hole we’re in.

I don’t believe in catching falling knives (throwing metaphors around this morning), but I see the markets much as my daughter saw Universal Studios: scary, for sure, but actually, kinda fun too (after she exited the park).

So, US economic growth is outpacing the rest of the developed world (and much of the non-developed, um, emerging, world), as seen in these charts (thanks to Goldman Sachs).

But will we converge, and if so, will it be a positive (the world rises to the US) or negative (US drops) convergence? I don’t really know (who really does?). But the US is the most self-contained economy in the world (outside of sub-Saharan Africa), thus the woes of the world impact the US much less than any other country.

Rather than worry about the US economy, it’s the EM markets that are signaling distress (in their equities and currency markets…again, next chart courtesy Goldman Sachs):