Everyday, the hedgehog walks through the forest. And everyday, the fox comes up with a new way to attack him. (Foxes are clever that way.) And everyday, the hedgehog rolls into his protective shell, and the fox fails. “The fox knows many little things,” concluded the ancient Greek poet Archilochus, “but the hedgehog knows one big thing.”
In this example, which philosopher Isaiah Berlin made famous in a 1953 essay, the hedgehog is superior, at least in a survival-of-the-fittest sense. But according to social scientist Philip E. Tetlock, in the human world, it’s the reverse.
Berlin used the two animals to classify great thinkers. Plato, Dante, and Hegel were hedgehogs. They each centered their philosophies around one big idea. Aristotle, Shakespeare, and Goethe were foxes. They saw the world in a more complex light — or, alternatively, they plucked insights from many different fields.
Tetlock used Berlin’s classification system to test today’s “experts” in his 2006 book Expert Political Judgment. He found that, while most experts are poor predictors, the “foxes” were correct more often. If you’re trying to predict the future, it turns out, you’re better off knowing many little things, rather than one big thing.
Now for the apology.
I’ve been absent from this blog — and especially from these investment newsletters — for far too long. Since moving to Los Angeles, I’ve spent almost all of my time writing an original screenplay, taking classes, studying the entertainment industry, and doing part-time jobs; and if, at the end of the day, I still had time to write a blog post, I confronted an almost-unusably-weak Internet connection.
At long last, the screenplay is done, the classes are winding down, the jobs have become less time-consuming, and the Internet connection is now fully functioning. So…I’m back.
But I think this little break augurs well for you as a reader of my investment newsletter. I have always been a fox, but my time spent screenwriting and working my way into the entertainment industry has expanded the “little things” I know. The result, I hope, is better investment predictions. At least, that’s my excuse.
My, How You’ve Grown!
It’s been so long since we’ve looked at the stock market that I hardly recognize it. In the past 4 months, the Dow Jones is up 5.4%, and the S&P 500 is up 7.0%:
Since the beginning of the year, the Dow is up 6.7%, and the S&P is up 7.0%. The market is now having a good year, but only thanks to the past couple months. And, as you can clearly see, this performance has not been consistent. If you’ve been betting on a rising market, you’ve had to “weather a few false starts,” as I predicted in August.
Good news: Historically, bear markets always turn into bull markets, and this one still has more upside to regain its old high.
Bad news: The weak housing market threatens to halt the recovery — and even reverse gears. If so, we may be looking at a completely different type of bear market: debt-inflicted stagnation.
So the question is…
What Kind of Market Is This: A Bad Bear or a “Real” Mega-Bear?
In August, we were mourning a deceleration in GDP growth: from 3.7% in the 1st quarter to 2.4% in the 2nd quarter. Since then, we’ve learned that 3rd quarter growth was 2.5%. Not much change…but wait! The BEA revised its estimate of 2nd quarter growth. It wasn’t 2.4%. It was 1.7%!
Bad news: We have less GDP than we thought. Good news: GDP growth is accelerating more than expected.
Meanwhile… Nonfarm payroll jobs are increasing. Weekly unemployment claims are decreasing. Manufacturing activity is increasing. Trucking and rail traffic are increasing. And small business optimism is even up a bit.
In August, I said such improvement would have to coincide with a falling dollar. While I was technically correct, it’s probably more fair to say the dollar’s value stayed roughly flat:
In my defense, my exact words were, “Sovereign debt crises aside, the dollar will continue its descent,” but I gave no indication of whether Europe would experience another sovereign debt crisis…which, of course, they are. Again, however, I’ll quote trade economist Menzie Chinn: “The euro is a relatively small component of the US trade weighted exchange rate.”
The IMF began its October regional economic outlook for the Western Hemisphere with the sentence: “The recovery of the global economy is continuing, mainly thanks to the sustained dynamism of many emerging economies.” U.S. firms need to tap into that dynamism by exporting to emerging economies.
While GDP and consumption have been below average throughout the recovery…
…exports have been a superstar.
The dollar declined from August to October, when most of our economic growth occurred, and it must continue declining for that growth to be sustainable.
My bet: Short the U.S. dollar.
For all these reasons, we’ve also been tracking Ford Motor Company and Huntsman Corporation, both of which have been rocket ships, up 26.3% and 44.0% respectively:
Ford’s credit rating still isn’t in “A” territory, but it recently reduced its debt. Look for its stock to continue to rise alongside its rating.
My bet: Long Ford Motor Company.
Interestingly, Huntsman depends on Ford. The improving automobile industry increased demand for paint, which is one of Huntsman’s most important chemical divisions. The result was 3rd quarter revenue growth of 15.7%. Keep an eye on this company’s profit margins, however. As we discussed in August and will revisit below, commodity prices continue to rise, increasing Huntsman’s costs. After the recovery is no longer as dependent on exports, it may be wise to sell, but for now…
My bet: Long Hunstman Corporation.
All of these improvements are at the mercy of the housing market. Observers were shocked — shocked! — that foreclosures started rising again…
…and new home sales started falling again…
…and existing home sales started falling again…
…and housing prices started falling again:
Who could have seen this coming? Well, there was a little voice warning about “almost a sure sign that home prices will come down further.” That little voice is sticking to what he said back then: “With Fannie and Freddie buying mortgages, the decline should be gradual, but it’ll still take a bite out of GDP.” That’s the difference between now and the 1930s (or Japan in the 1990s, for that matter): The government has basically nationalized the mortgage market. They can moderate its fall.
Bottom line: It’s a bad bear market, not a “real” mega-bear. But, as always, the recovery will have false starts. Keep a healthy portion of your portfolio in other investments.
Speaking of Other Investments…
The gold bubble has continued to soar, up 18.9%:
In late August, Wall Street Journal columnist Jeff Opdyke penned an argument that gold is a monetary alternative to the U.S. dollar, not a commodity. Forget that the Federal Reserve hasn’t recognized gold as a monetary alternative since 1971. According to Opdyke, the market still treats it as such. For such a belief to affect the whole market, many traders would have to expect the dollar to become worthless, when in fact “gold bugs” are a small minority in most financial circles. But let’s consider his evidence anyway.
Opdyke rests his argument on correlations: how often two assets move in the same direction. He correctly observes that there is a low correlation (0.08) between gold prices and overall inflation, a point I made in August. Then he makes a statement that betrays his lack of statistical training. Because the correlation between gold and the dollar is -0.45 (and -0.65 if you arbitrarily ignore the 1970s), Opdyke concludes that “gold is a currency.”
Statisticians use a rule of thumb for correlations, but it depends on the type of correlation. For time series — datapoints lined up chronologically — a correlation must be higher than 0.8 (or lower than -0.8) to be considered “strong.” Many unrelated time series have correlations of -0.45, or even -0.65, because they are driven by the same external factors: GDP growth, profit rate, etc.
But, since Opdyke thinks it’s okay to truncate history, let’s look at more recent history, which should be more relevant, no? Economist Scott Reamer did the math a couple years ago: From 2005 to 2007, the correlation was -0.42. From 1998 to 2007, it was -0.44. From 1990 to 2007, it was -0.28.
Opdyke points to the graph below as further evidence. If numbers tell a nuanced story, you can usually blur it by showing the graph because the human eye is less accurate than the calculator. It looks like they move in opposite directions, doesn’t it?
But something’s not right. Even if gold is a “hedge” for the dollar, why are the magnitudes so out of whack? Since they criss-crossed in the mid-2000s, it looks like the dollar depreciated by 10-20%, while gold appreciated by 100+%! That, my friends, is a bubble.
There’s nothing wrong with being a gold bull. I’m a commodity bull, and gold is a commodity. But even gold bulls think the market is too hot. Richard Russell, for instance, recently pointed out that junior gold-mining companies are outperforming the big boys — evidence that they’re making risky deals or their speculative investors are counting on outsized payouts.
As I said in August, timing a bubble is tricky business. You shouldn’t do it unless you have a lot of spare cash that you won’t need in the near future. And you shouldn’t treat it as part of your usual portfolio. If you’re brave enough to make a small wager…
My bet: Short gold.
The rest of commodities have followed my prediction much better. Rogers International Commodity Index is up 9.7%:
And, as Ambrose Evans-Pritchard reports, commodities are only going to become more important:
…purchases in developing countries rose to 45m hectares in 2009, a ten-fold jump from levels of the last decade.
…sovereign wealth funds from the Mid-East, as well as state-entities from China, the Pacific Rim, and even India are trying to lock up chunks of the world’s future food supply. Western agribusiness is trying to beat them to it. Western funds…are in turn trying to beat them.
Hedge funds that struck rich ‘shorting’ US sub-prime have rotated into the next great play of our era: ‘long’ soil.
But don’t expect commodities to be as safe as they have been for past investors. Economists Ke Tang and Wei Xiong recently published research indicating that the “financialization” of commodities — investors pouring into commodity funds and indexes — is increasing the correlation among different commodities.
In other words, you can’t expect cotton to hedge your oil bets anymore. They move together, which means big upswings and big downswings. If you have the cash to ride out the storms…
My bet: Long commodity futures.
Over the past 4 months, an equally-weighted portfolio of the 5 investments I suggested in August would have yielded a gain of approximately 12.2% (annualized = 41.5%). Not bad. Maybe I’ll consider retiring from investment-newsletter-writing now. Maybe. If not, next month we’ll finally explore international investments.
Question everything I say. Do your own research. Keep your portfolio diversified. Always consider the ethical ramifications of your investments. And remember: In the long run, the economy always goes up.
Graph sources: Doug Short, Google Finance, Federal Reserve Bank of St. Louis, Calculated Risk, Wall Street Journal, Mark Hulbert, Ke Tang and Wei Xiong.
All material presented herein is believed to be reliable but I cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.
Opinions expressed in these reports may change without prior notice. Anthony W. Orlando may or may not have investments in any funds, programs or companies cited above.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
Communications from Anthony W. Orlando are intended solely for informational purposes. I believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty of any kind. Past results are not indicative of future results.