age of deleveraging chapter summary

8/11/2019 Age of Deleveraging Chapter Summary

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- Milieu: Traumatic events re:Am Goods production &distribution in 1919-1921

- Definition: The purchase ofonly those inventories needed

to meet immediate customerdemand

What were the fears of the era?- (1) Cancellation of govt

contracts for mil. Equip AND(2) unemployment amongreturning soldiers depression!

Did it happen?- Nope! (1) Exports leaped, (2)

credit expanded and (3)demand surged

- Demand soaked up excesscapacity & Prices leaped

What were the effects of the above? - Fear of shortages of raw

materials led to ordering ofmore goods (i.e. JUMP OFINVENTORY LEVELS)

- Created excess demand &artificial shortages.

- Expectations: inflation caused buying in anticipationof rising prices (customers)

The Fall- +24% in 1Q 1919 and peaked

in 2Q 1920- 1920: Bubble broke and prices

began to fall (-42%)

What were the effects? Order cancellations spiraled Retailer side: Stuck with goods

bought at much higher prices. Slashed prices

Consumer side: Curtailedspending w/ deflationaryexpectations held off buying

What was the end result?

Massive inventory-building massive production cuts Why? To liquidate inventories Steepest Economic Decline of

any recession (Real GDP declineof 13%)

**************************************OK Back to the 1970s

**************************************

What was the milieu?- Raging inflation due to excess

demand from govt spendingon Vietnam War & GreatSociety programs

- Shortages in commoditiesand manufactured goods

What was Shiller thinking?- Why steel production was so

strong?!- Much more steel was being

produced than consumed in theearly 1970s (NOT REPORTED!)

- Fears of shortages double/triple ordering ofgoods and understatinginventories to get prime slotsin allocation schedules

So what was the call?- Rapid inventory building will

lead to an inventory correctionin 1975 and a recession

- Success!

What does making money frombursting bubbles involve?

- Selling short


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2 nd Case: On the South Sea Bubble(1700)

- SSCo was formed in Englandand granted a monopoly on

Lat-Am trade in return fortaking on govt debt.- Kernel: Idea of trading English-

manufactured goods for Lat-Am G&S

- Problem: Lat-Am tradecontrolled by the Spaniardsand Philip V had no intentionsof opening trade.

- What? People bought shareswith abandon! Stock leaped by

1000% in a span of 8 months.More stocked was issued withdelayed payment to provideleverage for speculators.

- Result: Collapsed!

What was so fascinating about this?- The wide variety of speculative

public companies that formedas the speculative fever spread

- Ludicrous Samples: Wheel of perpetual motion, Company forcarrying out an undertaking of great advantage, but nobody toknow what it is

- Govt became worried anddissolved all these companies.

**************************************What were the similarities betweenTulipomania and South Sea bubble?(1) Limited substance(2) Expanded too soon(3) Burst before promises wereachieved

*Bubbles feed on the widespreadconviction that they will lastindefinitely

** only 2/3 of bubbles end incrashes

Other samples: UK Railroads (Burst in1840), US Railroads (Burst in 1873)

**************************************

On the Nifty Fifty (1970s)

What are they- Represented rapidly growing

companies (some long term,some fads)

- One Decision stock s BUY!Because they will never need tobe sold

- Result: Fail!

What Shiller said:- Emphasis was not on the basic

structure of the economy buton frivolous enterprises.

- Predicted the 1973-1975recession

On possible future bubbles- Investment money is raising

concerns about asset pricebubbles in Asian Stock Markets

- IMF cites a risk that leapingasset prices in HK are beingpropelled by a surge of fundsdivorced from fundamentalforces of supply and demand

**************************************The Anatomy of Bubbles

**************************************When do bubbles develop?

- In periods of financial andeconomic tranquility aftermemories of the last bubblescollapse have faded


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Minskys Financial InstabilityHypothesis: Eras of stability spawnbig risk taking

Samples:

Late 1920s: after rapid growthbetween 1921 and 1929 DotCom: After 2 decades of

declining inflation rates and rapidproductivity growth

Housing Collapse: Moderation ininflation/financial markets.

What are the similar steps thatbubbles have?

1. Investor Overenthusiasm Attracts new entrants eagerto cash in on opportunitiesto raise money cheaply,accumulate wealth quicklyand participate in theventure

Growth is robust and newinvestment money isplentiful such that costs areof little concern

2. Competition IPOs become prolific and

competition amongproducers start to erodeselling prices.

Investors begin to havedoubts about its efficacy

3. Assurances from those withvested interests These come from all walks

of life! Gives the example of ex-Merrill Lynch CEO Mr.Thain

4. As overenthusiasticexpectations aredisappointed, financing driesup.

5. Followed by Bankrupciesand consolidations Companies/Investors w/

deep pockets are the onesthat ultimately survive

CHAPTER 2

************************************GREAT CALL #1:

1969-1970 Recession************************************

What were Shillers concerns? - Rising inflation rates- Why? Heavy govt spending on

Viet War and Great Societyprograms (Guns&Butter policy)

caused Fed to raise federalfunds rate

- Guns and Butter ?Demonstrates the relationshipbetween a nations investmentin defense and civilian goods. Anation has to choose betweenguns (defense/military) orbutter (invest in production ofgoods) or both!

- Ap ril 69 Forecast: Mildrecession for 1970

- Dec 69 Forecast: Majorrecession!

Why is this major recession bullish?- It would knock inflationary

psychology rising with inflation(6% p.a.)

-

If it was only a mild recession:inflationary expectationswould be intact but priceacceleration might degenerateinto runaway inflation andcredit demand would outrunany reasonable increase insupply


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- Did a recession occur? YES!But not deep (GDP falling0.6%)

Why was it a great call?

Rq1 : No recessions since 60-61downturn Rq2 : Forecasters saw no

recession in the offing Rq3 : He was right! Haha

What was the milieu at the timeanyway?

Rising stocks due to statementsthat the Nixon admin wouldnt letcurrent fiscal/monetary restraintspush the economy into a recession

Few worried about detrimentaleffects of stock price inflation

Common belief: Stocks were agreat offset to inflation and thatrising consumer prices might spurequity prices

What were the variables to Shillersstatistical model for explainingstock prices?

Money Supply Biz Sales Excess Capacity Trends in Stocks Inflation

What was his main takeaway?- This recession wasnt deep

enough to curb inflationaryexpectations and their

economic distortions aversthat this led to the inventorybuldge of the early 70s

**************************************GREAT CALL #2:

1973-1975 Recession**************************************

See Chapter 1 for inventory milieu

Why was it a great call? Rq1 : Shortages seen as artificial

and driven by a self-feedinginventory-building binge asinflationary expectations ruled.Shiller said (1) it would be thedeepest recession since the 30s;(2) there would be a decline instock prises; and (3) the demise ofthe Nifty Fifty

Rq2 : It was at variance withalmost everyone elses conviction.

Rq3 : He was right! When excessinventories were dumped in 4Q74and 1Q75, real GDP fell 1.6% and4.8% at annual rates.

**************************************GREAT CALL #3:

Disinflation (late 70s) **************************************

What was the milieu?- Stagflation: Leaping inflation

co-existed w/ highunemployment

- Frustrations over failed Vietwar and Water gate scandal

- Growing Fed Govt involvementin the economy associatedwith economic growth

- Conviction that the economywas strong enough to fight awar in Asia and embark onmassive domestic spendingw/o creating inflation &other probs!

Over-reaching by policy makers:- Thru fine tuning by policy

makers of fiscal/monetarypolicy


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- How did it go? DISASTROUS!- Effect? Aggregate demand far

in excess of supply INFLATION YO!

- Caused a shift in voter

sentiment

Why was it a great call? Rq1 : Shiller predicted that

inflation would wane anddisinflation would reign in the years ahead over-all priceswill still rise but at slower andslower rates . This was counter the conviction that inflationwas a permanent fixture

Rq2 : It was made well beforeFed hiked interest ratesmassively. It was also notaccepted by many even as itunfolded.

Rq3 : He was right!

What is the prime mover behindinflation?

What happened? Money supplyleaped at 26% annual rates andCPI inflation +14% afterwartime wage/price controlswere removed

In reality: monetary policywas the handmaiden of fiscalpolicy.

o Meaning the govt didntwanna raise taxes to payfor the leap in militaryspending (40% of GDP)so it relied on the FEDand bond sales tofinance the federaldeficit

**************************************GREAT CALL #4:

1980s Japanese Bubble

**************************************

What was the milieu?- Spectacular Post WW2 revival

of Japan

- Japanese economy developingbubble dimensions w/ high andrising levels of consumersaving fueling stock and realestate booms + industrialcapacities

- P/Es of 100 werecommonplace and value of allJap equity markets > total USstocks even if Jap economy wasonly of US.

- People worried about take-over from Japanese businesses

Why was it a great call? Rq1 : Few others expected the Jap

bubble to burst. Shiller said that itwas in the latter stages of a bubbleand forecasted an imminent end

Rq2: Nobody saw it coming Rq3 : He was right! Japanese

Central bank (Masushi Mieno)began to raise interest rates whichbroke the stock and real estatebubbles. Nkkei fell 81.9% to a lowof 7055 in 2009. Real Estate fell90% or more.

**************************************GREAT CALL #5:

Dot-Com Blow-Off**************************************

What was the milieu?- Late 90s: US economy and

stock market humming ince1982

- Receding inflation


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- Highlighted by corporaterestructuring (C.R.) of Ambusinesses and decline indefense spending

- (C.R.) paved the way for rise of

new technologies which droveeconomy and unleashedproductivity potential

- Result: Mushroomingcorporate earnings

So what if there was risingearnings?

- Investors convinced that therewas faster growth

- Falling inflation/interest rates

pushed P/E ratios through theroof

What were the effects of intensespeculation at the time?

- Investors counted on marketadvances continuingindefinitely (+20% p.a.)

- Savings rate plummeted- Favoring companies w/o

dividents (div yields down to1%)

- Stock market directing theeconomy vs. other economicconditions

- The surging stocks droveconsumer spending

- Whats new? Tech companiesIPO-ing at 100x sales w/oearnings (high valuation evenw/ great losses)

How did the Fed react to thislooming problem?

- June 1999: credit wastightened and yield curve wasinverted

- Greenspan makes irrationalexuberant speech to no avail

What were the 20 follies: Irrational Exuberance: Stocks

will leap indefinitely because corpearnings will grow faster thaneconomy and P/E ratios will rise

forever in the New Economyworld

Buy&Hold: W/ a continuous bullmarket, investors should buy andhold

Buy in Dips: Dips areopportunities to buy, notwarnings to get out of stocks

No Appreciation for pastmarket data: thinking that pre82 mkt data was irrelevant

Investment Allocation: invest x% in small-cap value stocks and y% in big-cap growth stocks

Cash is trash: they represent lostinvestment opportunities

Beating Benchmarks > AbsoluteReturns

Index Investing > Active StockMgt

Invest in Sector index funds tocash in on new tech

Indiv investors can beat thepros yo

Day trading = easy route toriches

Investment gains > Investmentfees

Pro-forma results > GAAPnumbers

Stock buybacks as beneficial tostock prices

AVOID DIVIDENDS T-bonds for wimps Detained pension plan profits

steady source of pre-tax corpearnings

Investing Social Securitycontributions in stocks = solvespost-war retirement prob


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IN THIS NEW ECONOMY, THISTIME IS DIFFERENT, MAN

What was the call?- 2 years before the collapse

- P/E Ratios at Nosebleedaltitudes- Rate hikes by Fed were in store- Bear market would come in a

long & frustrated saw-toothpattern along a decliningthread

- It would:o Slash NASDAQ (70-80%)o Slash S&P500 (40-50%)o Slash Dow Jones (30-40%)

- Reasoning: most of thesecompanies have no earningsand w/ little prospect ofmaking money

What are the ways new tech killsitself?

- Overinvestment- Excess Capacity- Excruciating Competition- Commoditization of products

Did CFOs believe that the stockswere overpriced?

- Hell no! 82% said they wereUNDERPRICED!

The actual bursting:- Investors continued to buy as

the bubble expanded.- Problem: Stock value

measured by sales forecastsvs. earnings.

- Rise of shady practices

What is spinning?- Underwriters awarding hot

IPOs to tech industryexecutives in return forinvestment banking business

- Repay 50% and then 65% ofthe resulting 1 st day profit incommissions

What was Shillers case for a full -

blown recession? Feds rate hikes in previous 18months

Inverted yield curve Continued vulnerability of stocks Negative effect of continuing high

energy prices Similarity between 00 US

economy and its structure at earlybiz cycle peaks

Prolong resolution of preselection and 50-50 split inCongress that wouldweaken/delay fiscal stimulus torevive economy

What was the aftermath?- Investors: Soft=landing for the

economy!- Shiller: There are rallies but

they are brief and temporary- Investors : Sky isnt falling - Shiller: Diversify portfolios!

Global diversification reduces volatility ofstock/bond portfolio

What is the behavior in periods ofhigh volatility?

- US and foreign stocks march inlockstep

- And when Americans are losingmoney they sell foreignholdings first

Reasons for Global Stock weakness- Global economic softness (due

to universal CB tightening)- Growth of foreign countries

dependent on exports


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directly/indirectly bought byUS consumers

- US recession globalrecession

Why is it a great call? Rq1 : It was important in thesense that it exposed the feeblemilieu of tech stocks at the time

Rq2 : Clearly everyone thoughtotherwise about tech stocks(irrationally exuberant)

Rq3: He was right! The DOWJONES, NASDAQ, and S&P wentdown in the manner describedand were close to his forecast.

age of deleveraging chapter summary

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