• “Kee” Points with Jim Kee, Ph.D.

    • Markets and Events
    • Interesting China Points

    Markets and Events

    So far stocks are up since the United States launched a limited military strike against Syria, over allegations it used poison gas on civilians. Sometimes markets react with apprehension leading up to events like this, only to resume their trend once action is taken. Actions tend to provide clarity, for example, over whether anticipated actions will be expansive or limited, and how other interested parties like Russia will respond. That seems to be the case so far, so we’ll see.

    Trade tensions between China and the US continue, and I read a piece on China that I thought might interest Kee Points readers. It was a speech given by Asian Times writer David Goldman and delivered at Hillsdale College. That’s a pretty conservative venue, so I apologize for that (I really do try to avoid bias), but he has served as a consultant for the National Security Council and the Department of Defense, and the following excerpts (taken directly) I think help fill out one’s understanding of China’s importance in the world:

    Interesting China Points

    China is a phenomenon unlike anything in economic history. The average Chinese [person] consumes 17 times more today than in 1987.

    Over the same period, China has moved approximately 600 million people from the countryside to the cities – the equivalent of moving the entire population of Europe from the Ural Mountains to the Atlantic Ocean (over 7,000 miles, more than from New York to Los Angeles and back).

    To accommodate those people, it built the equivalent of a new London, plus a new Berlin, Rome, Glasgow, Helsinki, Naples, and Lyons.

    China’s Communist Party is a merciless meritocracy…if you’re in Chinese leadership, you made it there by scoring high on a long series of exams, starting at age twelve – which means you haven’t met a stupid person since you were in junior high school.

    The Chinese Communist party is terrified that a rebel province like Taiwan can set in motion centrifugal forces that the Party will be unable to control. So the adhesion of Taiwan to the Chinese state – the imperial center – is for the Chinese government an existential matter. They will go to war over it.

    China does something Japan, Korea, and other Asian nations do – it massively subsidizes capital investment in heavy industry. From the Chinese standpoint, a steel mill or a semiconductor fabrication plant are public goods – the Chinese look at these things the way we look at highways and airports…America has been pushed out of any major capital-intensive manufacturing.

    What it means in practical terms is that America can’t build a military aircraft without Chinese chips. That’s a national security issue.

    China’s “One Belt, One Road” policy, announced by President Xi in 2013, is a plan to dominate industry throughout Eurasia – by both land and sea (I should mention that the State Council of the People’s Republic of China refers to this as “a bid to enhance regional connectivity and embrace a brighter future.” And indeed trade does tend to be cooperation-enhancing).

    A couple of years ago, I (Goldman) visited the headquarters of Huawei, China’s telecommunications company – the biggest in the world – which hardly existed a dozen years ago. It has a campus that makes Stanford look like a swamp.

    China’s share of high tech exports has risen from about five percent in 1999 to about 25 percent at present. America’s has plummeted from about 20 percent to about 7 percent…the Chinese have broadband everywhere.

  • “Kee” Points with Jim Kee, Ph.D.

    • Politics and Stocks
    • Themes: Go Small?
    • Volatility

    Politics and Stocks

    I know that the headlines have been focused on the return of market volatility lately, but the most interesting thing I saw last week was a Wall Street Journal article on ethical investing. The article looked at the relationship between politics and mutual funds/ETFs (exchange traded funds) that invest with a Social, Governance, or Environmental purpose, known as “ESGs.” Fund flows into ESGs grew throughout the Bush presidency and then flat-lined (pretty strikingly) during a lot of the Obama Presidency before increasing again, under President Trump. The assertion was that money flows into these funds when it looks like the government is going to be lax on ESG issues, and it flows out of them when it looks like the government is going to be ESG-vigilant. For a rather striking example, in the month after the 2015 Paris Climate Agreement, $50.1 million flowed out of environmental-focused funds. In contrast, $98.8 million flowed into these funds when President Trump withdrew the US from the agreement in 2017. The implication is that investors use ESG investing to express their political preferences, or to counter thwarted preferences. The real acceleration of funds into ESG occurred from 2012 onward, and while the authors didn’t make this case, I would tie that to the rise of the tea-party and the Republican takeover of the house that occurred in 2012. The implication is that ESG investors perceive Republicans to be soft on ESG issues.

    Themes: Go Small?

    To test this, I thought, what would be the Obama-era version or analog of this? That is, what investment vehicles did non-Obama voters pursue? If you followed the press and the internet during that era you know the answer was, “buy gold.” To quote The Economist magazine back in 2011, “The demand for gold depends on airier considerations, such as whether you think Barack Obama is the Anti-Christ.” That’s exactly what we saw. Looking at gold prices, the price of gold actually fell going into the Great Recession but bottomed around the 2008 Presidential election. It then rose straight up, from around $720 per ounce that fall to a peak of over $1800 by….2012. After 2012 it declined to as low as $1050 by 2016, and currently trades at around $1328.5 (04/09/2018). Gold and ESG investments of course have multiple drivers, but the political story here fits the data pretty well.

    And that’s what a lot of “thematic investing” really is, i.e., story-telling. That doesn’t mean it’s wrong (or right), but putting ideas into a compelling narrative is how business writers and strategists make a living. I saw a great example of this recently in a Financial Times article, “Forget big, investors should go small.” The author pointed out that big countries are at most risk from a trade war (so focus on smaller ones), big companies are most subject to regulatory/antitrust actions (so go small), and regional opportunities are better than global ones. Included in the argument was the usual ‘small-better-than-large’ assertions of more growth potential and lower debt levels with smaller companies. Countering this view is the narrative from some (e.g. Jefferies) arguing not to go small because small companies are dependent upon, that is, they sell and service to, larger companies. That makes sense too! In fact, I tested this as a strategist over a decade ago, trying to differentiate between small companies that thrive when large companies thrive (a complimentary relationship), versus small companies that compete head-to-head with large companies (an adversarial relationship). We (my team) also differentiated between small companies that were “emerging” or growing fast (the typical perception), versus small companies that were really just beaten-down former large companies (i.e. their market capitalization had fallen dramatically). There were pages and pages of great stories that this “matrix” between small and large company stocks could yield, and yet the practical investment insights (after back-testing numerous implications) were basically zero. My conclusion, one consistent with about 50 years of peer-reviewed research, was just to always own both small and large company stocks, and that’s what we do here at STMM. I make this research digression to make the point that real long-term investing success rests more on investment discipline and company-specific research than it does on compelling stories or themes.


    Back to the markets and the return of volatility, I think Jack Bogle’s advice is helpful. Bogle describes the increased daily volatility and trading with a quote from Shakespeare, “a tale told by an idiot, full of sound and fury, signifying nothing.” Of interest to speculators, says Bogle, but not to long-term investors. Great advice from Bogle.

  • “Kee” Points with Jim Kee, Ph.D.

    • Why the sell-off?
    • Trade wars and antitrust actions a bad elixir
    • Some reasons for trade restrictions

    Why the sell-off?

    US stock futures markets over the weekend were pointing to a sharply higher opening on Monday. The sharp decline in stocks that actually ensued can largely be attributed to White House attacks on Amazon, and to retaliatory tariffs coming out of China. President Trump’s tweets against Amazon, claiming that it should pay more taxes and is “putting many thousands of retailers out of business” (Wall Street Journal), have certainly sparked a sell-off in the technology sector (helped along by Facebook’s data breach problems). And China’s impositions of tariffs on US agricultural goods have certainly stoked fears of a global trade war, sparking a sell-off of global stocks.

    Trade wars and antitrust actions a bad elixir

    The tech sell-off following Trump’s attack on Amazon shouldn’t be a surprise, as it is consistent with similar actions in the past. I’ve mentioned before the work of University of Kansas economist George Bittlingmayer, who researched the impact of the government’s antitrust actions against Microsoft twenty years ago on the technology stocks in general. Interestingly, Bittlingmeyer (and Irving Fisher) argued that antitrust restraint was important to the stock market boom of the 1920s, whereas other work (e.g. Jude Wanniski mentioned in prior Kee Points) indicates that trade restrictions were important to the stock market collapse of the 1920s. So trade wars and antitrust wars are not good stock market elixirs!

    Some reasons for trade restrictions

    Most presidents have dabbled with tariffs from time to time, but usually as temporary and/or one-off actions. Most studies on the economic impacts of trade restrictions look at the higher prices consumers have to pay for items because cheaper imports are restricted; they then compare this cost with the value of the jobs saved by the restrictions. On the blackboard, free trade always has winners and losers, and the winners gain more than the losers lose. And that’s what the studies tend to show. For example, I recall from the Reagan administration days when economists, looking at steel quotas, concluded that it would be cheaper (to the country) just to allow the imports and pay domestic steel workers not to work. An equally powerful statement came from President Bill Clinton’s last treasury secretary, Larry Summers, who described the post-NAFTA Uruguay Round of free trade as “the largest tax cut in the history of the world” (Foreign Press interview, 2009).

    But because free trade has losers as well as winners, and because the losers are easy to identify (steel workers) while the winners are diffuse (“US consumers”), there is always political pressure to help the losers without fear of retribution from the winners. That’s why talk of trade restrictions never really goes away. Plus China does cheat on trade, at least by our standards. China heavily subsidizes many industries, and often requires technology transfer (sharing) as a pre-condition for doing business there (Asian Times). The most recent legitimate scholarship on trade and trade restrictions that I have seen is Dartmouth economist Douglas A. Irwin’s 2017 book, Clashing over Commerce. Irwin is a little more optimistic that Trump’s actions won’t spark a 1930s-style global trade war, because there are many global institutions – World Trade Organization, IMF, global corporations – that recognize the importance of today’s global interdependence and connectedness.

  • “Kee” Points with Jim Kee, Ph.D.

    • Reiterations
    • Global Investment Facts


    We have seen a pretty big increase in stock market volatility this year, which to me feels a little more normal than the narrow, upward trend that characterized a lot of 2017. Trade concerns (i.e. are we “warring” or “negotiating”) probably explain most of last week’s six percent sell-off. As a media friend of mine put it, President Trump is just too much of a wild-card to not expect a continuation of the intersection between Washington and Wall Street (i.e. Trump spooking or sparking markets). I know the following points are redundant for Kee Points readers, but they are worth repeating: (1) Pull-backs and corrections (and recessions and bear markets) are “expected but not predictable”; (2) Being in the market is necessary in order to benefit from the handful of up days each year that account for a lot of the market’s long-term compounded gains; (3) Those big days (like Monday) tend to occur during choppy and unsettling times; (4) Volatile markets can create opportunity if they result in mispriced assets, but they tend to punish marketing-timing activity (i.e. getting in and out of the market). I think the last two years have probably demonstrated that last point as well as any two years in my career. Don’t let the media move your investment horizon from multi-year to day-to-day.

    Global Investment Facts

    Speaking of investment time horizons, last week I received the 2018 edition of the Global Investment Returns Yearbook, produced by Elroy Dimson and published by Credit Suisse. Most financial economists and strategists consider reading this annual update part of their own due-diligence, myself included. The Yearbook looks at the long-run performance and trends of stocks, bonds, Treasury bills (cash), inflation, and currencies. And by long-run I mean 118 years! That’s what makes it unique. “The immense value of the Yearbook,” says its authors, “is that it helps separate fact from fiction” for investors. With that, I’ll bullet-point a few items I thought might be of most interest to Kee Points readers (direct statements from the Yearbook are in quotes):

    • The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) hit an all-time low in November. That’s what I mean when I say current, higher volatility feels a little more normal!
    • “Abnormal volatility episodes (high and low) tend to “revert rapidly back to ‘normal’ volatility and have little predictive ability for future market returns.” Keep that in mind when the financial press hypes volatility numbers.
    • Over the 118 years, equities (stocks) returned 9.6% per year, bonds 4.9%, T-bills (cash) 3.7%, and inflation averaged 2.9%. 
    • The authors refer to the additional return from owning equities (risky) over Treasury bills (low risk) as the equity risk premium (ERP), which averaged 7.5% over the period.
    • Variation in the ERP is huge, with the lowest being -45% in 1931 (stocks down -44.3%, T-bills +1.1%), and the highest being +57% 1933 (stocks +57%; T-bills +.3%).
    • World Wars were less damaging to world equities than peacetime bear markets, like the 1929-31 Wall Street Crash, 1973-75 Oil shock/recession, the 2000-02 Internet Bust, and the 2008 Crash (those were the four worst).
    • Two of the four worst bear markets in history occurred over the last 17 years. Surely (maybe? hopefully?) the next 17 will be smoother!
    • The authors feel that equities offer the highest expected returns going forward, though somewhat lower than those experienced over the past 118 years.
    • Equity returns are lower in the years following low real interest rates (interest rate minus inflation rate), like today. But prior low real rate periods were high inflation periods, unlike today.
    • Long-term data supports value stocks over growth stocks, but, “sadly, the Yearbook shows it is hard to predict or time.” That’s why we own both at STMM.
    • The US accounts for 51% of total world equity market value; Japan is in second at 8.6%, with France, Germany, China, Canada, and Switzerland next at around 3% each. Australia (2.5%) is ninth.
    • At its peak in 1990, Japan was 45% of the world index versus 30% for the US at the time. Don’t worry though, the US is not the next Japan! (something I’ve discussed before)
    • Before the 1980s, “emerging economies” were referred to as “less developed.” [note: I have seen old economic journals contain the expression “backwater economies”]
    • Different groups use different criteria to define an emerging market. MSCI (Morgan Stanley Capital Index) uses 23 variables, FTSE (Financial Times Stock Exchange) uses 13, and Standard & Poor’s (S&P) uses 10.
    • The authors prefer a “GDP per Capita Rule” of less than $25,000 (per person) as their criteria for defining emerging versus developed market, and I am a fan of that methodology.
    • Some countries, like China, Russia, and South Africa, have been emerging for 118 years. Others like Finland, Hong Kong, Singapore, Israel, and South Korea eventually made it to developed standards by most measures.
    • Portugal would still be emerging by the authors’ GDP per Capita Rule. Argentina, Chile, and Greece would have hit developed status and then slipped back to emerging.
    • The major emerging market indices only go back to 1985 at the earliest (that’s the S&P; 1988 for MSCI, 1994 for FTSE). Using their GDP per Capital Rule, the authors go back to 1900, by far the longest emerging markets time series.
    • Using that series, emerging markets actually underperform developed markets, though they do experience periods of outperformance.
    • Investors in Russia and China lost everything due to revolutions. All other countries had stock market shut downs during wartime periods but reopened.

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