Jan 03

Today’s News 3rd January 2018

  • SpaceX Will Launch Mysterious Project Zuma On Thursday

    SpaceX has come a long way since one of its rockets exploded on the launch bad in September 2016 (though the company has assembled a humorous bloopers reel to show that it has a sense of humor about its humble beginnings).

    And on Thursday, it will launch a rocket from Cape Canaveral Florida that will carry a satellite into space for the US government. Though the project is top secret, and it’s unclear which government agency commissioned it, or if the satellite is for military or reconnaissance purposes.



    Indeed, the only thing the public knows about this project is its codename: Project Zuma. And after an initial delay, the launch is finally here, according to Sky News.

    SpaceX is preparing to send into space a satellite for the US government that is so secret the public cannot know even which branch of the administration commissioned the launch.

    A weather report ahead of the launch released on Tuesday described the conditions as excellent.

    Unlike the private aerospace company’s previous classified launches for the military’s National Reconnaissance Office and the super-secret space-plane it took into orbit for the Air Force, there is almost no information available about the “Zuma” payload.

    Zuma is known to be a low Earth orbit satellite (orbiting within 2,000km) which is an orbit necessary both for spy and military communication satellites.

    The secrecy surrounding the launch and the involvement of defense contractor Northrup Grumman in building and operating the spacecraft has led many to speculate that it is defense-related. The National Reconnaissance Office has denied that Zuma belongs to them. The launch window opens at 8pm local time on Thursday at Cape Canaveral in Florida.

    According to Northrup Grumma communications director Lon Raid: “This event represents a cost-effective approach to space access for government missions.”

    “As a company, Northrop Grumman realises that this is a monumental responsibility and has taken great care to ensure the most affordable and lowest risk scenarios for Zuma.”

    The launch had been pushed back despite a US Government desire to launch Zuma before November of last year.

  • Paul Craig Roberts Asks: "How Much Death And Destruction Awaits Us In 2018?"

    Authored by Paul Craig Roberts,

    The New Year is one full of economic, political, and war threats.



    Among the economic threats are stock, bond, and real estate markets artificially pumped up by years of central bank money creation and by false reports of full employment. It is an open question whether participants in these markets are aware that underlying reality does not support the asset values. Central banks support stock markets not only with abundant liquidity but also with direct stock purchases. The Japanese central bank is now one of the largest owners of Japanese equities. Central banks, which are supposed to provide economic stability, have created a massive fraud.

    Throughout the Western world politics has degenerated into fraud. No government serves the public’s interest. Except for some former Soviet satellites in Eastern Europe, European governments have defied the will of the people by admitting vast numbers of refugees from Washington’s wars and others pretending to be refugees. The European governments further imperil their citizens with their support for Washington’s rising aggression toward Russia. The universal failure of democratic politics is leading directly to war.

    The Saker explains that Americans with intelligence, honor, courage, and integrity have disappeared from the US national security establishment.

    In their place are arrogant morons high on hubris who believe: (1) We can buy anybody, (2) Those we cannot buy, we bully, (3) Those we cannot bully, we kill, (4) Nothing can happen to us, we live in total impunity no matter what we do.

    Scott Bennett reports  that US soldiers are being propagandized that Russia is an enemy with whom we are headed to war.

    The Anglo-Zionist empire is trying to overturn the Iranian agreement and to restart the attempt to overthrow the government of Syria. Lebanon’s Hezbollah is also in the empire’s sights. Washington is arming Ukraine in order to enable an attack on the breakaway provinces of Novorussia. Threats against North Korea escalate. Even little Venezuela is threatened with military intervention simply because the country wants to control its own destiny and not be controlled by Washington and the New York banks.

    In the opinion of some, Russia’s very cautious diplomacy has increased the likelihood that Washington will miscalculate and give the world a third world war. By not accepting the requests of the breakaway Russian provinces in Ukraine to be reunited with Russia, the Russian government paved the way for Washington to provide the military means for its Ukrainian puppet to attempt to reconquer the provinces. Success would damage Russian prestige and encourage Washington in its aggressive actions. Sooner or later Russia will have to stand and fight.

    Russia’s premature declaration of victory in Syria and withdrawal has made it possible for US forces to remain in Syria and attempt to restart the effort to overthrow the Assad government. Russia would have to defend its victory, or by the failure to do so encourage more aggressive actions by Washington.

    Hopes have evaporated that President Trump would restore the normalized relations between the nuclear powers that Reagan and Gorbachev made possible. The question for the New Year is when does Washington’s aggression against Russia ignite a hot war.

    Your website will be examining these issues as they unfold in 2018. From the perspective of today, it is unlikely that the New Year will be a happy one. Nowhere in the West is there a sign of leadership toward peace and the well-being of humanity.

  • "Everything Is Overvalued": Public Pensions Face Dangerous Dilemma In 2018

    As  we discussed  a few weeks ago, being a pension investor these days has absolutely nothing to do with “investing” in the traditional sense of the word and everything to do with gaming discount rates to make their insolvent ponzi schemes look more stable than they actually are.  Here was our recent take on CalPERS’ decision to hike their equity allocation to 50%:

    CalPERS’ decision to hike their equity allocation had absolutely nothing to do with their opinion of relative value between assets classes and nothing to do with traditional valuation metrics that a rational investor might like to see before buying a stake in a business but rather had everything to do with gaming pension accounting rules to make their insolvent fund look a bit better.  You see, making the rational decision to lower their exposure to the massive equity bubble could have resulted in CalPERS having to also lower their discount rate for future liabilities…a move which would require more contributions from cities, towns, school districts, etc. and could bring the whole ponzi crashing down. 

    The new allocation, which goes into effect July 1, 2018, supports CalPERS’ 7% annualized assumed rate of return. The investment committee was considering four options, including one that lowered the rate of return to 6.5% by slashing equity exposure and another that increased it to 7.25% by increasing the exposure to almost 60% of the portfolio.

    The lower the rate of rate means more contributions from cities, towns and school districts to CalPERS. Those governmental units are already facing large contribution increases — and have complained loudly at CalPERS meetings — because a decision by the $345.1 billion pension fund’s board in December 2016 to lower the rate of return over three years to 7% from 7.5% by July, 1, 2019.

    Overnight the Wall Street Journal poses an interesting question: what happens when real world fundamentals don’t line up with pension boards’ artificial goal seeking exercises on discount rates?  The answer, of course, is that pensions, and therefore taxpayers, are forced to take on more and more risk as they stretch for returns…

    Retirement systems that manage money for firefighters, police officers, teachers and other public workers aren’t pulling back on costly bets at a time when markets are rising around the world.

    Some public pension funds are adding to traditional allocations of stocks and bonds while both are expensive. 

    Others are loading up on more private-equity or real-estate holdings that are less liquid and sometimes carry high fees.

    …a phenomenon that has resulted in a massive reduction of safer bets on bonds as pensions have been forced to chase returns via investments in expensive private equity and real estate allocations.

    Indeed, as one of the people interviewed by the WSJ puts it best, how much risk to take is a question facing all investors as they enter 2018. And the punchline” “Everything is overvalued,” said Wilshire Consulting President Andrew Junkin, who advises public pension funds. “There’s no magic option out there.”


    As our readers are aware, this is hardly a new topic for us. As we pointed out a year ago in a post entitled “CalPERS Board Votes To Maintain Ponzi Scheme With Only 50bps Reduction Of Discount Rate,” each year CalPERS has to weigh mathematical realities against the risk of disrupting the ponzi scheme and forcing several California cities to the brink of bankruptcy with lower discount rates…‘mathematical realities’ rarely win that fight.

    But a CalPERS return reduction would just move the burden to other government units. Groups representing municipal governments in California warn that some cities could be forced to make layoffs and major cuts in city services as well as face the risk of bankruptcy if they have to absorb the decline through higher contributions to CalPERS.


    “This is big for us,” Dane Hutchings, a lobbyist with the League of California Cities, said in an interview. “We’ve got cities out there with half their general fund obligated to pension liabilities. How do you run a city with half a budget?”


    CalPERS documents show that some governmental units could see their contributions more than double if the rate of return was lowered to 6%. Mr. Hutchings said bankruptcies might occur if cities had a major hike without it being phased in over a period of years. CalPERS’ annual report in September on funding levels and risks also warned of potential bankruptcies by governmental units if the rate of return was decreased.

    Of course, the pension managers – unless they happen to be traders in the early 20s who have never encountered an even modest bear market or market correction – are quite aware of the underlying tension of allocating cash to stocks at all time highs:

    Increasing its allocation to stocks is also risky. “This may not be the most opportune time to take on additional equity risk,” investment manager Dianne Sandoval said at a December board meeting.

    Why whatever could she be referring to: the $18 trillion in central bank liquidity which this year will finally shrink for the first time ever, or the ominous up/downside equity investment calculus going forward.

    Meanwhile, this is not just a U.S. phenomenon as the WSJ notes that a major Canadian pension fund is also planning a bigger bet on illiquid assets. The $202 billion Canadian pension fund Caisse de dépôt et placement du Québec plans to move money into investments such as real estate, private equity, infrastructure and corporate credit, said President and Chief Executive Officer Michael Sabia, of CDPQ. “Today, liquid assets—traditional government bonds and public equities—account for the majority of our investments,” Mr. Sabia said in a statement. “A few years down the road, this will no longer be the case.”

    Of course, when going all-in on the various asset bubbles around the world inevitably fails, taxpayers, as always, will be forced to pick up the pieces: the question is whether or not the public pension ponzi will be too big to bail.

  • US Empire Is Running The Same Script With Iran That It Ran With Libya, Syria

    Authored by Caitlin Johnstone via CaitlinJohnstone.com,

    Two weeks ago a memo was leaked from inside the Trump administration showing how Secretary of State and DC neophyte Rex Tillerson was coached on how the US empire uses human rights as a pretense on which to attack and undermine noncompliant governments. Politico reports:

    The May 17 memo reads like a crash course for a businessman-turned-diplomat, and its conclusion offers a starkly realist vision: that the U.S. should use human rights as a club against its adversaries, like Iran, China and North Korea, while giving a pass to repressive allies like the Philippines, Egypt and Saudi Arabia.

    “Allies should be treated differently — and better — than adversaries. Otherwise, we end up with more adversaries, and fewer allies,” argued the memo, written by Tillerson’s influential policy aide, Brian Hook.

    With what would be perfect comedic timing if it weren’t so frightening, Iran erupted in protests which have been ongoing for the last four days, and the western empire is suddenly expressing deep, bipartisan concern about the human rights of those protesters.







    So we all know what this song and dance is code for. Any evil can be justified in the name of “human rights”.

    In October we learned from a former Qatari prime minister that there was a massive push from the US and its allies to topple the Syrian government from the very beginning of the protests which began in that country in 2011 as part of the so-called Arab Spring. This revelation came in the same week The Intercept finally released NSA documents confirming that foreign governments were in direct control of the “rebels” who began attacking Syria following those 2011 protests. The fretting over human rights has occurred throughout the entirety of the Syrian war, even as the governments publicly decrying human rights abuses were secretly arming and training terrorist factions to murder, rape and pillage their way across the country.

    We’ve seen it over and over again. In Libya, western interventionism was justified under the pretense of defending human rights when the goal was actually regime change. In Ukraine, empire loyalists played cheerleader for the protests in Kiev when the goal was actually regime change. And who could ever forget the poor oppressed people of Iraq who will surely greet the invaders as liberators?

    In 2007 retired four-star General Wesley Clark appeared on Democracy Now and said that about ten days after 9/11 he learned that the Pentagon was already making plans for a completely unjustified invasion of Iraq, and that he was shown a memo featuring a plan to “take out seven countries in five years, starting with Iraq, and then Syria, Lebanon, Libya, Somalia, Sudan and, finishing off, Iran.”

    So it’s an established fact that the neocons have had Iran in their crosshairs for a good long time.

    This is all coming off the back of the nonstop CIA/CNN narrative being advanced that Iran is a top perpetrator of state-sponsored terrorism, which is just plain false. I have a lot of Trump-supporting followers, and I would like to stress to them that the group of intelligence veterans who authored this memo about Iran is the same group who released a memo dismantling the bogus Russiagate narrative; these are good people and you can trust them. I encourage you to read it.




    Trump is lying when he says Iran is “the Number One State of Sponsored Terror”. This is the same exact script they run over and over and over again, and people are falling for it again like Charlie Brown and the football. It is nonsensical to believe things asserted by the US intelligence and defense agencies on blind faith at this point, especially when they are clearly working to manufacture support for interventionism in a key strategic location. In a post-Iraq invasion world, nothing but the most intense skepticism of such behavior is acceptable.

    Luckily, because a full scale invasion of Iran would be far more costly and deadly than the invasion of Iraq, support for this will need to be manufactured not just in America but within an entire coalition of its allies. This will be extremely difficult to do, but by God they are trying.

    Please keep your skepticism cranked up to eleven on this Iran stuff, dear reader, and be very loudly vocal about it. My Trump-supporting readers especially, I implore you to think critically about all this and look closely at the similarities between the anti-Iran agenda and the other interventions I know you oppose. Together we can kill this narrative and spare ourselves another senseless middle eastern bloodbath.

    *  *  *

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  • Compliance At Steve Cohen's New Firm Resembles Big Brother

    The first of the year has come and gone and, for the first time in nearly half a decade, Steve Cohen can legally manage outside money. To wit, his new firm, Stamford Harbor Asset Management, the successor firm to both his family office Point72 Asset Management and one-time “criminal enterprise” SAC Capital Advisers, is aiming to raise between $3 billion and $4 billion of outside capital to augment the $10 billion of Cohen’s own money that will be managed by the fund.

    We memorably picked up on the SEC investigation into Cohen’s former firm there years before SAC pled guilty to insider trading – “Is SEC’s Insider Trading Case Implicating FrontPoint Really Just A Sting Operation Aimed At SAC Capital?” And it appears, according to a Bloomberg profile of Cohen’s new firm, that CYA is once again a top priority for the legendary hedge fund trader, who managed to evade prosecution despite years of work by the SEC and then-US Attorney Preet Bharara. Though some of his former employees weren’t so lucky.



    Even though reversals by appellate court judges in recent years have made it more difficult for prosecutors to prove insider trading – they must now prove that the person supplying the information received some material benefit for the tip – Stamford Harbor will be operating under the watchful eye of an outside monitor who reports directly to the SEC.

    To help mitigate the appearance of wrongdoing, Cohen has hired a 50-person compliance team who will be situated in the middle of the trading floor, listening to conversations, monitoring emails and flagging anything suspicious that they should come across.

    Bloomberg compared it to “Big Brother.”

    Inside what will be his Stamford Harbor Capital sits a command center in the middle of the trading floor. There, a 50-member compliance team is strategically positioned to listen in on traders’ conversations in real time, comb through emails for suspicious language and even veto job candidates.

    The room is part of billionaire Cohen’s preparations to open the fund after his two-year ban on managing outside capital ended last week. The new firm, based in the same Stamford, Connecticut-based building as his family office, is slated to manage $3 billion to $4 billion of client money in addition to his own $10 billion-plus fortune. Through the internal oversight, Cohen looks to be trying to ensure that no one ever calls his new venture a “criminal enterprise.”

    That’s the description that former U.S. Attorney Preet Bharara gave Cohen’s previous hedge fund SAC Capital Advisors.

    Four years ago, the firm pleaded guilty to securities fraud and paid a record $1.8 billion fine to settle a seven-year federal insider-trading probe. Ever since, Cohen, who wasn’t charged with any wrongdoing, has been working to rebuild his reputation at his Point72 Asset Management, the firm that manages his own fortune.

    Back in 2015, Cohen hired a former high-ranking Justice Department official to lead his compliance team.

    In 2015 he hired chief legal officer Kevin O’Connor, who once held the third-highest ranking position at the Justice Department. As part of his deal with the government, there’s an outside monitor — Michael Considine, an attorney at Seward & Kissel, who reports directly to the U.S. Securities and Exchange Commission and will continue to file periodic reports until at least the end of 2019.

    There’s also an “Intelligence Team” that will help SAC root out risky hires.

    The firm’s so-called Intelligence Team includes analysts who have five to 10 years of prior experience working in the U.S. intelligence community or as investigators, according to a job posting on LinkedIn late last year.

    According to Bloomberg, some long-term traders have bristled under the increased scrutiny. Perhaps this is why one of Cohen’s top traders left late last year just as the firm was preparing to accept outside money once again.

    After moderating his expectations for the outside capital raise – to between $3 billion and $4 billion down from $10 billion – Cohen is seeking the same onerous terms that made SAC infamous for being one of the most venal firms on Wall Street. Not only is Cohen asking investors to agree to lock up their capital for up to three years, he’s demanding management fees of 2.75% of total assets plus 30% of any profits.

    As stocks have climbed to record highs, fees on index tracking ETFs have fallen to a few basis points – much lower than they were when SAC pleaded guilty in 2013.

    Whether Cohen is successful in reaching his goals for outside money remains to be seen.


  • Trump Warns Kim: "I've Got A Bigger Nuclear Button Than Yours"

    Perhaps we should not be shocked any more by the tone of President Trump’s tweets but he has kicked off 2018 with bang and his latest shot across North Korea’s bow is quite stunning in both its seriousness and its juvenileness.

    Apparently responding to what North Korean leader Kim Jong Un said in a New Year’s Day speech – that he had a nuclear launch button at his desk, and that the international community would have to accept North Korea’s status as a nuclear-armed nation as a “reality.”

    President Trump responded by tweeting “Will someone from his depleted and food starved regime please inform him that I too have a Nuclear Button, but it is a much bigger & more powerful one than his, and my Button works!”



    Happy Newclear Year World…



  • Arizona National Guard Deployed To Cuba To Support Guantanamo Bay

    Despite ongoing talk of its closure, Fox News reports that an Arizona Army National Guard unit will begin the New Year in Cuba – deploying to Guantanamo Bay for approximately nine months.

    Once there, they’ll be on a joint task force helping to augment staff.

    These soldiers leaving for Guantanamo Bay in the coming days in support of Operation Enduring Freedom.

    “There was some discussion some time back about actually shutting it down. Right now that’s not what’s going to happen so it’s still very important for us service members to be prepared to go and continue that mission,” said Arizona Army National Guard Command Sergeant Major Fidel Zamora.

    That’s exactly what nearly 50 Arizona Army National Guard soldiers will soon be doing.

    “Part of that is being able to inform and advise the Joint Task Force Commander there on military police tasks and procedures and part of that is just making sure that the staff runs effectively on a day to day basis,” said Colonel Rich Baldwin, the Land Component Commander of the Arizona Army National Guard.

    This mission is so sensitive we were asked not to show the faces of these soldiers and their families.

    “We don’t want to telegraph to the world who is going, who’s there and who’s performing this mission because they all have families that are still back here while they’re overseas doing this mission,” Colonel Baldwin said.

    Fox notes that these soldiers won’t have contact with the detainees and they are expected to be deployed for about nine months.

  • "It's Different" Because "Financial Markets Are No Longer A Mechanism For Price Discovery"

    Authored by Rusty Guinn via Epsilon Theory blog,

    Bernard: If knowledge isn’t self-knowledge, it isn’t doing much, mate. Is the universe expanding? Is it contracting? Is it standing on one leg and singing ‘When Father Painted the Parlour’? Leave me out. I can expand my universe without you.

    ‘She walks in beauty, like the night of cloudless climes and starry skies, and all that’s best of dark and bright meet in her aspect and her eyes.”

    —  Arcadia, Tom Stoppard

    It is a romantic thought, that we might divorce our personal universe from the universe around us. For us investors, maybe that means to hide in a room building an elegant model to work out the true value of a thing. I mean, by itself it’s a complete waste of time…but so romantic!

    To make a prairie it takes a clover and one bee,
    One clover, and a bee.
    And revery.
    The revery alone will do,
    If bees are few.
    — “To make a prairie”, Emily Dickinson

    Since I’m bogarting Ben’s title, I might as well steal his best literary reference, too. The market isn’t necessarily tied to ‘fundamentals’ any more than a prairie is to bees. Revery alone will do, and sometimes it will do for a very, very, very long time.

    A true German can’t abide the French,
    But he’ll gladly drink their wine.
    — Faust, Johann Wolfgang von Goethe

    You don’t have to be French to drink their wine, y’all. Being part of the Epsilon Theory pack doesn’t mean buying into narratives. It means understanding that in a market, if it matters to someone, it should matter to everyone. And narratives matter to a whole lot of someones.

    Epsilon Theory started from a pretty simple idea. Ben observed that no financial or econometric model can ever fully explain the returns or volatility of financial markets. I don’t think he’ll be too mad if I point out that this wasn’t a particularly novel observation. After all, every statistical model in the world has an error term that basically accounts for this — epsilon.

    β + α + ε

    Said less vaguely, epsilon is the way in which — as people — investors respond to both financial and non-financial stimuli in various non-random ways. It is an observation that a not insignificant portion of the systematic (i.e. not diversifiable) risk and return in your portfolio is completely divorced from the risks faced by economies and businesses. It is a feature only of the markets and the people who comprise them.

    Some regard changing perceptions, sentiment and shifting narratives as a source of short-term volatility in securities prices, and little more. Indeed, that is the implication of the old Benjamin Graham trope I disputed in The Myth of Market In-Itself — that the market is a short-run voting machine, but a long-run weighing machine. Sure, sentiment may matter in the short run, but eventually truth will out! I did a fair job, I think, of identifying my issues with that point of view, but as per usual, it was Ben that really got to the heart of the issue. In his latest note, he characterizes the occasional sharp rise in unpredictability of market outcomes — not to be mistaken for volatility — as the result of a Three-Body Problem. You do yourself a disservice if you haven’t read the piece, and probably a greater disservice if you haven’t read the Liu Cixin book of the same title recommended in it. But in short, a three-body problem refers to a system that is solvable not through elegant algorithm, but only through brute-force computation. There is no closed-form solution to predict the future locations of a set of three planetary bodies in a vacuum like, say, the Earth, the sun and the moon.

    In most environments, where the purpose of markets is to efficiently and accurately price risk of various uses of capital, those markets tend to behave more or less like two-body systems. The interaction of Planet A (which we’ll call ‘fundamental data’) and Planet B (which we’ll call ‘prices’) is generally predictable. Oh sure, there’s volatility. Remember, not everyone agrees on the starting point and velocity of Planet A — at least, not since Reg FD, anyway. Information takes time to propagate. But we also know that Planet C (let’s call it ‘epsilon’) is sitting out there somewhere. Yet it’s far enough away that its gravity can’t do more than induce short- and medium term distortions in the relationship between A and B. If you knew the truth about the starting positions and velocities of Planet A and Planet B, however, you could develop a formula that would tell you within a pretty fair margin where prices would be down the line.

    In this typical state of the world, being a better investor has meant getting better at uncovering the truth about Planet A so that you can predict Planet B’s future location. It’s no wonder that a generation of investors grew up learning about traditional security analysis, the only way investment management is taught in every business school in the world.

    Still, everyone from the most well-respected market commentators to the staunchest Graham and Dodd-quoting undergrad recognizes the existence of markets in which Planet C — epsilon — contributes its gravity to the system. Among those periods in which our ability to make predictions on the basis of relationships between fundamental data and securities prices is especially poor, are those we know as bubbles and manias. William Bernstein characterizes these periods as those typified by the “flood of new investors who swallow plausible stories in place of doing the hard math.” He goes on to quote Templeton, admonishing investors, “The four most expensive words in the English language are ‘This time it’s different.’”

    Well, guess what? Roll your eyes at the expression to your heart’s content, but I’m telling you what Ben has been telling you for years now:

    This Time It’s Different.

    It’s not different because people really got it right this time (in ways they missed every other time) about some new technology that’s going to Change The World! Electric cars, cryptocurrency, AI and automation, these may all be fabulous things, and they may well prove to be game-changers for productivity and returns on capital down the line, but if you think any of those things explain current valuations, you’re nuts. You’re also wrong.

    It’s different because financial markets are no longer a mechanism for price discovery and the pricing of risk of capital allocation decisions.

    Markets have been made into a utility. More to the point, they have been made into a political utility, a tool for ensuring wealth and stability of our political structures. The easing tools we dabbled in to stabilize prior business cycles were brought to bear instead as tools for propping up and expanding financial asset prices. Beyond the direct marginal price impact of the easing itself, central bankers tailored communications policies to create Pavlovian responses to every narrative. Our President tweets about the policy implications when the S&P 500 hits new highs, for God’s sake[2]. This isn’t a secret, y’all. The singular intent of every central banker in the world is to keep the prices of financial assets from going down, and the singular intent of every government that puts those central bankers in power is to ensure that they do so, in order to retain social stability. Sure, there’s a dual mandate. But the mandates aren’t employment and price stability. They’re (1) expanding financial asset prices and (2) effectively marketing the idea of corresponding wealth effects to the public.

    Markets have also rapidly become a social utility, an inextricable part of every contract between governments and the governed. Underfunded pensions and undersized boomer 401(k) accounts mean that ownership of risky assets is not a choice driven by diversification or relative return expectations, but by the fact that it is the only asset they can buy that has any potential of meeting the returns they would need to be adequately funded. Let’s say that you are running a state pension plan that is 65% funded. Your legislature is telling you that no help is coming from the state budget. You and every member of your agency will be fired if you even suggest cutting benefits, if you even have that authority. Your consultant or internal staff just did their new mean reversion-based capital markets return projections, and higher valuations mean projected returns on everything are lower. What’s worse, your funded status assumes returns that are higher than anything on their sheet. You are being presented with a Hobson’s Choice — behind Door #1, you get fired, and behind Door #2, you lever up your stock exposure with an increased private equity allocation. This a brutal position to be in.

    And sure, like most markets with bubble-like characteristics, this one has become a utility for psychic value as well. Investors buy Bitcoin on the narrative-driven belief that it is an ‘investment’ in the technology, a way to participate in shifting the economy toward privately negotiated and settled transactions. It isn’t. We’ve all seen the absurd stock charts of companies who did nothing more than add “blockchain” to their names. We’ve observed TSLA, NFLX and CRM continue to trade on earnings reports that provide zero incremental data on business direction or momentum but heroic narratives that the sell side dutifully push out to the masses looking for good stories. If you must own risky assets and those assets don’t have growth, then revery alone will do, if bees are few.

    It may comfort us to say that “The market has been divorced from fundamentals for so long, but eventually it must swing back.” And it will. The point of this note, and the point of The Three Body-Problem isn’t to say that it won’t. Planet C will drift away again, and outcomes will look more like what economic and business fundamentals would predict. More like our historical analysis of what drives good, high quality investments. But too many investors are comforting themselves with the stories of the 1990s, of the Nifty Fifty, and the idea that non-fundamentally-driven markets mean return to sanity after five to ten years. But they don’t have to. And because of the utilitization of markets, because of the exit of passive-oriented investors from the price-setting margin of markets, it’s possible that they won’t for a very long time.

    This Three-Body Problem isn’t going anywhere for a while.

    The Three-Body Portfolio

    When I began this Code series at the beginning of 2017, I kicked it off with A Man Must Have a Code, a conversation about why we think that all investors ought to have a consistent way of approaching their major investment decisions. I posited that a code ought to consist of a concise list of Things that Matter, Things that Don’t Matter and Things that Don’t Always Matter (But Do Now). And so my notes have focused on investing principles that I think of as generalized solutions. These are things that I believe are true in both Two-Body and Three-Body Markets:

    1. In I am Spartacus, I wrote that the passive-active debate doesn’t matter, and that the premise itself is fraudulent.
    2. In What a Good-Looking Question, I wrote that trying to pick stocks doesn’t matter, and is largely a waste of time for the majority of investors.
    3. In Break the Wheel, I argued that fund picking doesn’t matter either, and took on the cyclical, mean-reverting patterns by which we evaluate fund managers.
    4. And They Did Live by Watchfires highlighted how whatever skill we think we have in timing and trading (which is probably none) doesn’t matter anyway.
    5. In Chili P is My Signature, I wrote that the typical half-hearted tilts, even to legitimate factors like value and momentum, don’t matter either.
    6. In Whom Fortune Favors (Part 2 here), I wrote that quantity of risk matters more than anything else (and that most investors probably aren’t taking enough).
    7. In You Still Have Made a Choice, I wrote that maximizing the benefits of diversification matters more than the vast majority of views we may have on one market over another.
    8. In The Myth of Market In-Itself (Part 2 here), I wrote that investor behavior matters, and spent a lot of electrons on the idea that returns are always a reflection of human behavior and emotion.
    9. In Wall Street’s Merry Pranks, I acknowledged that costs matter, but emphasized that trading costs, taxes and indirect costs from bad buy/sell behaviors nearly always matter more than the far more frequently maligned advisory and fund management expenses.

    In all of these, you’ve gotten a healthy dose of emphasis on getting beta — how we get exposure to financial markets — right. But you’ve seen precious little on alpha — uncorrelated sources of non-systematic, incremental return. Where we dealt with the usual ways in which investors seek out alpha, I have been critical. Maybe even derisive. Sorry, not sorry. There’s a reason:

    Even in normal environments, alpha is hard.

    Alpha is hard because it’s hard to measure. It’s hard to know if what we’re doing is actually something that adds value, or if we’re being fooled by randomness. We may even just be layering on some other systematic factor, or beta, that is just compensating us for taking additional risk. Every couple of years, someone rediscovers that bond managers tend to “have more persistent alpha”, and a couple of weeks later, someone rediscovers that bond managers just layer on more corporate credit risk than the benchmark. Every couple years, stock-picking strategies go back into vogue — it’s a stock-pickers’ market, they say! Fundamentals matter again! No, they don’t. You’re structurally smaller cap and loaded up on higher volatility names, and when those factors work you feel smart.

    Alpha is hard because randomness is an insanely powerful force in the universe and within our industry. Any time I hear a fund manager or financial advisor say, “Look, a 10-year track record like that doesn’t just happen by accident,” every part of me wants to scream, “Yes, it bloody well does, and if there’s anything true and good about mathematics at all, it will happen by accident ALL THE TIME.” I’m not saying that Warren Buffett’s success is an accident, but I am absolutely saying that with as many investors as there are, it is improbable that history would not create Warren Buffett’s track record. We are all looking for a way to increase returns that doesn’t involve taking more risk, and once we’ve gotten all we can out of diversification, believing in alpha is our only choice.

    In a three-body market where epsilon exerts its gravity, alpha is not just hard. Finding it emphasizes entirely different types of data and analysis. The whole point of recognizing an increasingly chaotic system is that our confidence in the causal relationships over time and between assets at a point in time drops significantly. Given that tools relying on temporal and cross-asset relationships are the ones we most often use to evaluate investment strategies, it puts us in a bit of a pickle! Sure, there are some exogenous strategies like high-frequency trading that are pretty effective across environments for mechanical reasons. But many of the “time-tested” strategies that work in Two-Body Markets can stop working for a very long time, and the “new” strategies we identify in our in-sample periods can start looking like hot garbage the second we drop them out-of-sample. The search for alpha in this kind of environment — even when it occasionally bears fruit — is time-consuming, expensive, and often leads to unintended risk, cost and diversification decisions that more than offset any positive that they generate. We get a stock pick right, but it is dwarfed by sector effects. We pick the right country to invest in, but get killed on currency. For many investors – for most investors — this means that trying to beat “the market” on an intra-asset class level or at on an inter-asset class level through tactical asset allocation should not be part of their playbook. For these people, I hope the Code to this point is a useful tool. Thanks for reading.

    But for those who know they won’t be content with that very adequate outcome, I’ll do my best to talk about alpha strategies that I think can work in a Three-Body Market. That means identifying the likelihood of success of various analytical security and asset class selection strategies. It also means giving you my perspective on what edge (ugh, I know) would even conceivably look like in a fund manager. As we close the door on 2017, I also close my series on The Things That Matter and The Things that Don’t Matter. As we open the door on 2018, look forward to a new series on the Things that Don’t Always Matter (But Do Now).

    Together, I think they’ll provide a pretty good roadmap for the Three-Body Portfolio. But I mean, even if they don’t, at worst you’ll get to read horror stories of terrible fund managers, so what have you really got to lose?

    From Texas, my best wishes for a prosperous New Year to you and yours.

  • Bitcoin "Wealth Effect" To Boost Japan's GDP Up To 0.3%

    Back in early December, the Nikkei reported that 40% of cryptocurrency trading in Oct-Nov was yen-denominated.  This means that while South Korea’s “bitcoin zombies” were a remarkable media sideshow, it was Japanese traders who have come to account for nearly half of cryptocurrency trading since China started to shut down its own crypto exchanges. The report explicitly showed that Japanese men in their 30s and 40s who are engaged in leveraged FX trading (or who used to trade but have stopped) are driving the cryptocurrency market.

    Commenting on this dominance of Japanese traders, Deutsche Bank last week observed that “the emergence of “Bitcoin wealthy” might ignite the “speculative spirit” of Japanese people with strong follower aspirations.”

    It also prompted us to wonder for the duration of 2017, and tongue-in-cheek, “if Bitcoin wasn’t a secretive ploy by the BOJ – which has had a far more permissive approach to bitcoin cryptocurrencies than its central bank peers – to boost Japanese animal spirits, which had been squashed by three decades of chronic deflation and disenchantment with rigged equities.”

    Adding to the speculation, in his latest discussion of Bitcoin during the press conference following the Monetary Policy Meeting on 21 December, BOJ governor Haruhiko Kuroda once again refused to slam the cryptocurrency as fraud, as so many of his peers have done, and instead merely expressed an opinion that current Bitcoin market movements were the result of speculative trading. He also commented that price movements were abnormal, even if clearly beneficial as the below analysis reveals.

    Fast forward to today, when Nomura analyst Yoshiyuki Suimon went the extra step of trying to quantify the actual profits, whether paper or realized, earned by Japan’s Mr. Watanabe et al. This is what he found:

    Figure 3 shows Bitcoin market cap and market cap divided by the weighting of yen-based trades. Assuming that the weighting of yen-based trades is equivalent to Bitcoin holdings by Japanese people, we estimate that Japanese people hold Bitcoin with a market cap of about ¥5.1trn. Assuming that the bulk of this ¥5.1trn belongs to Japanese investors, the scale of this increase in assets can hardly be ignored.


    According to a 27 December 2017 Nikkei article, the number of Japanese people holding Bitcoin has reached 1mn, and assuming average holdings of 3-4 Bitcoin per person, this is broadly consistent with our estimate.

    Meanwhile, the Bitcoin price rose by around ¥866,000 between Apr-Jun 2017 and Oct- Dec 2017, on which basis we estimate unrealized gains on Bitcoin held by Japanese people of roughly ¥3.2trn (3.7mn × ¥866,000).

    This brings us to the next logical step, the one we have hinted repeatedly is what one or more central banks may well be after, namely the “wealth effect” generated by bitcoin appreciation, and the resultant boost to consumer spending, and therefore GDP, which a global cryptocurrency bubble would enable.

    After all, central banks don’t care if consumer spending rises as a result of higher stock prices, or higher bitcoin prices: at the end of the day, whatever boosts consumer confidence, works. Plus, as Citi pointed out last summer, everything is a bubble now, so may as well spread the wealth…. effect that is.

    Here is Nomura’s calculation of how much Japan’s GDP may potentially rise as a result of bitcoin:

    We consider the effect unrealized gains from this large-scale Bitcoin trading might have on the Japanese economy. Although Japanese investors’ unrealized gains are unlikely to feed straight through to their patterns of consumption, it is common knowledge that personal consumption is bolstered as a result of increases in the value of asset holdings (ie, the wealth effect). According to earlier studies on the wealth effect in the context of the Japanese economy, an increase of ¥10bn in the value of assets bolsters personal consumption to the tune of around ¥0.2-0.4bn (a range that excludes the lower and upper limits obtained in the earlier studies shown in Figure 6).

    Although it is difficult to generalize about the patterns of spending of a person whose assets have soared in value as a result of the sharp rise in the price of Bitcoin, if we calculate the wealth effect assuming that an increase of ¥10bn in the value of assets bolsters personal consumption by ¥0.3bn, as in the earlier studies, then the aforementioned rise of around ¥3.2trn in the value of assets is likely to generate an increase of around ¥96.0bn in personal consumption by our estimate.


    Given that Japan’s real GDP is around ¥522trn (2016 calendar year-basis), the y-y boost to GDP from this spending per se works out at just 0.07ppt. That said, given that the sharp rise in the price of Bitcoin occurred mainly in 2017 Q4, if that same wealth effect is replicated in 2018 Q1, we estimate it would boost annualized q-q real GDP growth by around 0.3ppt (= ¥96.0bn / quarterly GDP of ¥130trn x 4), which on a quarterly basis
    represents an impact on a scale that cannot be ignored (Figure 5).

    Yet while higher asset prices always result in greater consumer confidence, there is one notable difference between the wealth effect impact resulting from an increase in asset value caused by a rise in the price of Bitcoin, and an increase in asset value resulting from simply share price gains. Particularly in the case of Bitcoin, the high level of price volatility means that the formation of expectations vis-a-vis future asset value will doubtless be unstable compared with share prices and other financial assets on which the earlier studies were based.  This is why as part of its analysis, Nomura shows the discounted wealth effect of Bitcoin transactions based on the volatility of both Nikkei 225 share prices and the price of Bitcoin (fig 5 above).

    While it is unclear to what extent major Bitcoin holders who have increased their assets through the end of the year will bolster consumer spending through the beginning of year remains, Nomura is confident that there is a distinct possibility that spending, and thus GDP, will exceed expectations as a result of this factor.

    And from there, we go to the final unknown: how long before rising bitcoin prices, and associated wealth effect, become part of the institutionalized calculation of GDP, and how long before the BOJ feels compelled to step in and bailout bitcoin investors should a major crash send the cryptocurrency crashing. Because remember: the wealth effect works both ways, and what may boost Japan’s (and South Korean, and US, and so on) GDP today, will lead to an equal, or greater, decline tomorrow when the drop eventually happens.

    Are central banks ready for it?


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