• "Kee" Points with Jim Kee, Ph.D.

    September 17, 2019


    • “Key Points” for Volatile Times 

     “Key Points” for Volatile Times 


    Navigating the global investment landscape can be challenging at times because there is always so much going on. Trade wars, debt (sovereign and private) concerns, “populist” movements, geopolitical events, central bank actions, etc., all converge to create a bewildering environment for investors. But remembering a few very simple rules can help keep anyone on track. Here are some of my favorite insights for avoiding mistakes and ensuring success:

    1) Modern finance in a nutshell. Don’t talk about returns without talking about risk in the same sentenceI often hear professionals and amateurs (friends) talk about the returns of a particular investment with little mention of the risks that were born. Typically, however, truly outsized returns come with outsized risk. But there is a huge silver lining here. If you combine risky assets that have similar long-term expected returns but whose prices – in the short term – move in opposite directions (or just differently), the combined portfolio will have less risk, that is, less up and down movement, than either asset separately. That is what diversification is all about, and it forms the bedrock of our investment philosophy.

    2) Don’t react to volatility. Time and again, peer-reviewed research as well as proprietary studies like Dalbar’s annual Quantitative Analysis of Investor Behavior show that individual investors tend to earn about half of what the market earns, largely because they sell during plunges and buy during rebounds. Volatile periods tend to contain the handful of good days every year that account for a good portion of an investor’s long-term returns. The absolute best investment advice I could give to anybody would be: don’t react (i.e. buy or sell) to market volatility!

    3) Your horizon is not the media’s horizon. You and the media have entirely different goals: yours is to have a well-diversified investment plan and stick with it; theirs is to have you obsessing about every data release, Trump tweet, and international event. If you own equities your horizon is 5, 10, 15 years and beyond, not next week’s Fed meeting.

    A Fond Farewell!

    As you may have heard by now, this will be my last Kee Points, as I will be retiring from South Texas Money Management to pursue academic interests. College teaching is something I have been wanting to get back to for some time. With my youngest child starting college, and the firm in such capable hands, this feels like the right time to make my transition back into teaching. I would like to take this opportunity to thank all Kee Points readers for their kind comments and feedback over the years. Going forward, I am extremely confident that CAPTRUST will fill this gap for you and then some! I wish you all the best and thank you for your support over the years.

  • "Kee" Points with Jim Kee, Ph.D.

    • Topical news
    • Avoid “Investment by Data Release”
    • Three Cheers for Supply Chains


    Topical news 


    Last week Hong Kong leader Carrie Lam announced that she would fully withdraw the extradition bill that has fueled massive protests in Hong Kong. Hopes are a little higher for U.S./China trade talks, which resume next month, following Treasury secretary Steven Mnuchin comments that the U.S. and China have a “conceptual” agreement on trade enforcement concerns (a key issue). China has also loosened its monetary policy by cutting reserve requirement ratios again, which makes three reductions this year. Banks in China (as elsewhere) hold a portion of their deposits as reserves (i.e. required reserves), loaning the rest out. Friday’s cut lowered reserve requirements for China’s larger banks by ½ a percentage point, to 13%. That means these banks can lend out more of their reserves — an estimated $127 billion more. These positives have somewhat offset concerns over slowing growth in China, and global markets were up for the week. Other positives include some U.K. legislation aimed at preventing a no-deal Brexit (i.e. preventing a hard exit), as well as expectations of other central banks (including the Federal Reserve) tilting more toward stimulus than tightening (WSJ).

    Avoid “Investment by Data Release”


    Also last week, the Bureau of Labor Statistics (BLS) indicated that Nonfarm payroll employment increased by 130,000 jobs in the month of August. I thought that was a good number; it indicated good growth, albeit at a slower pace than a year ago. The media talked about this all day on Friday, but most real experts agree that monthly data (labor, housing, industrial production, etc.) is just too volatile to draw any strong conclusions from. For example, the UCLA Anderson Forecast Center points out that Friday’s 130,000 number was lower than the 164,000 new jobs reported in July, and way below the January estimate of 312,000. But it was a lot better than February and May, which produced a mere 56,000 and 62,000 jobs respectively. If you study those numbers for a second, you will see that they had little relevance as to whether the next month’s number was likely to be higher or lower. So monthly payroll data are of limited value to investors, and that’s also true of other data releases, like quarterly GDP growth numbers. That is, one quarter’s GDP growth number has little ability to predict what the next quarter’s is likely to be. The key lesson from all of this is that it is foolhardy to follow a strategy of “investing by government data release,” even if that is what business news reporters seem to be encouraging you to do.



    Three Cheers for Supply Chains

    Finally, UCLA economist Jerry Nickelsburg, while discussing an expected exodus of manufacture from China (hoping to escape 25% tariffs), pointed out in a recent paper that this exodus was already underway due to increasing wages in China relative to other parts of Asia and even Mexico. But more sophisticated supply-chains are probably here to stay. In fact, in a great article titled, “Why U.S. China Supply Chains Are Stronger Than the Trade War,” Wharton Business School Dean Geoffrey Garret argues that U.S. and Chinese firms are far more integrated (and mutually dependent) than they used to be. This began with containerized shipping and intensified with the internet. The result, says Garret, is to make a true, full-blown 1930s-style trade war less likely. As evidence, he cites the fact that, despite numerous threats to cut off both Huawei and ZTE from doing business with America, U.S. firms are still selling to them. “Here are my three cheers for supply chains,” writes Garrett:

    • Supply chains are at the core of the modern global economy.
    • Supply chains will help resolve the China-U.S. trade war.
    • Supply chains will make a new Cold War less likely.
  • "Kee" Points with Jim Kee, Ph.D.

    Quick Thoughts on What’s Ahead

    Trade concerns, slowing growth, and an inverted yield curve with historically low global interest rates have been the evolving story over the past year. But as Credit Suisse strategist Jonathan Golub points out, that is why US market returns have been “flattish” over the past 12 months. The next twelve months will depend not upon things that have occurred, but on things that have yet to occur.

    On trade, I tend to agree with economist Victor Canto (La Jolla Economics), that “the US beef with China should be the technology ‘transfer’ issue, not the currency manipulation or the trade balance.” If President Trump’s focus narrows to that, then I think the markets will respond positively. The G20 or Group of Twenty countries have recently acknowledged that the World Trade Organization is in need of reform, particularly its trade dispute settlement policies, which is where the technology transfer issues fall. Of course, enforcement is always a stumbling block with international agreements, whether they are about weapons, environmental concerns, human rights, or trade. Nobody expects perfection on the trade front here, just incremental improvements. I continue to think that is a reasonable expectation.

    On the inverted yield curve, any “recession” signal is seriously distorted by things influencing long-term rates, like negative rates internationally, the global safe-haven status of US treasuries, and automated program trading by banks and insurance companies (WSJ). Futures markets imply a steepening of the yield curve, with five rate cuts (i.e. lower short-term rates) expected by year-end 2020, and a slight uptick in 10-year treasury yields expected over the same period (Credit Suisse). Most strategists point out that low bond yields continue to make stocks attractive, as 8 of the 11 broad stock market sectors have a dividend yield that exceeds the 10-year US treasury yield. Indeed, simple dividend-discount models (e.g. the Gordon Growth Model) point to higher valuation levels (Credit Suisse).

    Interestingly, the US Treasury Department has shown some interest in issuing (or looking at issuing) 50-year or even 100-year bonds. As an economist, my first thought was, “of course they should,” and “why not issue perpetuities?” Many of my fellow economists agree. For a great (longer than I can do here!) read on this topic, see University of Chicago economist John Cochrane’s blog, The Grumpy Economist.

    As for economic growth, current expectations are for 2% growth in the US. A lot of data like labor market data, housing data, loan performance data, etc., just aren’t signaling recession. The current expansion is the longest (and slowest) ever, perhaps somewhat attributable to the growing share of services (less cyclical) and the declining share of manufacturing (more cyclical) as a percentage of GDP. Global growth seems to have stabilized somewhat, though it remains particularly challenged in Europe (Credit Suisse). I still expect China to ultimately back off of Hong Kong (for now, anyway), but so far that prediction has been wrong. We’ll see what the next few months hold.

    Advice: As for the recent uptick in stock market volatility, try to remember that volatility has little meaning for investors in the sense of actionable strategies. That comes from the world’s experts on the subject (William Schwert and Elroy Dimson). Remember that market valuations within a range of, say, 5%-10% (which I regularly expect), amount to a range of movement (up and down) of 1300-2600 points on the Dow. Remind yourself that your horizon with equities is multi-year, not the press’s obsession with the next data release. If you still have concerns, consider adjusting your stock-bond allocation, but avoid all-or-nothing (completely in or out of stocks or bonds) thinking at all costs!

  • "Kee" Points with Jim Kee, Ph.D.

    • Quick Reflection on the Global Investing Landscape
    • How to Invest


    Quick Reflection on the Global Investing Landscape

    In this week’s Kee Points, I thought I would share my own mental narrative of the global investing landscape over the past 10 years. A fitting title might be, “It’s All Priced In.” That gives me great comfort (!), and I hope it does you as well:

    Since the Great Recession (2007-09), China’s economic growth rate has fallen by half, as have the prices of global commodities (Federal Reserve Bank of St. Louis). This describes the climate for emerging markets over the last 10 years, as they are often thought of as either “commodity plays” or as countries that are linked to China through trade and supply-chains. It has not been a great environment for either. Over this same period, Europe has experienced a dramatic debt crisis, populist uprisings against European Union membership, and an outright vote to exit (Brexit). And despite numerous initiatives, Japan remains stuck in the same 0%-1% growth range that it has been in for almost 3 decades. Perhaps least affected by major disruption has been the US. And impacting everything – every single industry across the globe– has been the transformational upheavals of information technology. That pretty much describes what has happened to the global economy. None of this was knowable in advance.

    Looking at how markets have performed over this 10 year period, that is exactly what they reflect! The big story, the theme over all others in stock market performance since the Great Recession, has been the dominance of US stocks over international stocks. Yes, growth stocks have dramatically outperformed value stocks, as you would expect given the information technology revolution mentioned above. But US value stocks have even dramatically outperformed international stocks. And within international stocks, those from developed countries have outperformed those in emerging markets. In other words, as these unpredictable events unfolded, market prices adjusted to reflect them. This is an important insight, and it should help inform investors as to how to invest going forward.


    How to Invest

    All-or-nothing advice was common going into the previous decade, such as “buy value,” “buy international,” or “buy emerging markets.” That seemed like great advice based upon the previous ten years, but it was poor advice for the subsequent ten years. They didn’t know which asset classes would outperform going forward - nobody does - which is why you diversify. A properly diversified portfolio is intended for how the world is, which is unpredictable.

    And don’t forget that one of the best, low-cost hedges to an equity portfolio is to lift one’s gaze. Extend your horizon. Think about how stocks will do over the next 5, 10, 15 years, not the next 6 months.

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“Kee Points” are for general informational purposes only and set forth the personal opinions of its author as of its publication date. “Kee Points” contains no recommendations to buy or sell securities or a solicitation of an offer to buy or sell securities or investment services or adopt any investment position. “Kee Points” is not intended to constitute investment, legal or tax advice and should not be relied upon as such. Market and economic views are subject to change without notice and may be untimely when presented here. You are advised not to infer or assume that any securities, sectors or markets described in “Kee Points” were or will be profitable. All material and information presented is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. Past performance is no guarantee of future results. There is a possibility of loss. South Texas Money Management, Ltd. and/or its employees may engage in securities transactions in a manner inconsistent with the above.

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