Author Archive for Cullen Roche

Pragmatic Capitalism – First Reviews…

Some of you may already know this, but my first book “Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance” is set to publish in July (see more via Amazon).  We’re still in the late stages of production, but some of the first reviews are trickling in.  This one is from Publisher’s Weekly:

“In friendly, clear prose, financial consultant Roche introduces the macroeconomic principles that readers need to know as they venture into the world of investing. Roche explains basic concepts: the difference between saving and investing, how to understand a corporate balance sheet, and the function of the Federal Reserve. He is fond of claiming to dispel widely held myths—for example, the stock market does not produce the level of returns most people think. (A few of the myths he debunks seem curious choices; post-Great Recession, does anyone believe that “economists have all the economic answers,” or that owning a house is a great investment?) Though the book is more explanatory than how-to, Roche cautions against paying high fees, and gives tips for picking a money manager. In one of the most valuable chapters, an overview of behavioral finance, Roche urges readers to look beyond specific financial assets and instead focus on an investing process. A very good suggested reading list rounds out the book. This fine resource, which focuses on the larger picture more than most personal finance magazines and blogs do, would be a good addition to individual investors’ libraries and would make a savvy gift for recent graduates. (July)”

I’ll have a lot more detail on all of this when the production process is completely wrapped up, but my goal was to create a clear, concise, macro view of the investment world and monetary system that serves as an educational and principle based perspective of this complex monetary economy we live in.   As you guys know, I am all about trying to explain what is and doing so in a very understandable way. I am hoping I achieved that in this text.

More to come….


Robo Advisors – Awakening a Giant for the Benefit of All

A lot of people have started asking me about some of these Robo Advisor services like WealthFront and Betterment in recent months.  I’ve started digging into the businesses in more detail, but while I am in the process, I did want to pass on some pretty cool news from Vanguard – they’re getting into the game also.

The rise of the Robo Advisor is good and bad.  I’ll add details later, but the good news is that these low fee providers are driving down costs, automating processes (portfolio management is all about process, process, process) and driving out bad advisors.  I also think they’re perfectly positioned to help the lower income investor which is great news for people who are hesitant to pay up for something they might not need.  Those are huge wins for everyone who’s an investor.   But the Vanguard product is cool because it takes Vanguard’s low cost platform, embeds automation AND offers you the personal touch that is often necessary with financial planning and portfolio advisory.  As Erik Brynjolfsson says, we have to learn to work with the machines, not against them.  Vanguard seems to have gotten the message.

This is all good news.  I’ve long said that the biggest problem in the investment business is the fee structure and if nothing else, this is fantastic news for all involved (except maybe the Robo Advisors who now have to compete with the giant they kicked in the shins).  And hey, while we’re all complaining about the economic consequences of the rise of the robots, let’s not forget that a lot of good is coming from it as well.  This being exhibit A.

* I have no business relationship with any of the firms mentioned above.  I am just an independent financial consultant watching them all duke it out…. 

Not Everyone in Finance has Their Head Buried in the Sand….

Paul Krugman asks an interesting question this morning:

“The question is why so many people in finance gravitate toward that view [that emphasizes the dangers of deficits and monetary expansion], and cling to it despite what is at this point overwhelming evidence that it’s wrong.”

He goes on to cite how so many in the world of finance thought that high deficits and QE would lead to higher interest rates, a potential solvency problem in the USA, high inflation, etc.  He goes on to argue that you didn’t need to understand the financial asset world to understand what was going on, but needed a macroeconomic understanding of the liquidity trap concept.  But this can’t be right because there were lots of people in finance (like most of the readers of this website) who understood that the aforementioned concerns were legitimate. And we understood those concepts through an operational understanding of the monetary system, not an understanding of “liquidity traps”. For instance, I’ve consistently, for 5 years, pointed out:

These were important predictions.  And I know lots of other people in the financial world who understood the concepts perfectly well without having to understand what a liquidity trap is.  In fact, all that was required was a basic understanding of the monetary system.  As to why so many people continue to believe these things are problems despite the overwhelming evidence otherwise – my guess is politics rules over reason….

Revisiting Price Compression

5 weeks ago I posted some thoughts on the concept of “price compression” (see here).  I said:

“Price compression is when market participants price in many years worth of future performance into the current price.  They are, in effect, buying today with the expectation that future earnings will justify current prices.   When you combine this concept with an understanding of behavioral finance and the understanding that market expectations can become irrational, you can build some understanding behind the concept of market bubbles.  As I’ve described before, A bubble is an environment in which the market price of an asset has deviated from the underlying asset’s fundamentals to an extent that renders the current market price unstable relative to the underlying asset’s ability to deliver the expected result.”

Along with that explanation I posted a chart of the iShares Biotech Index saying “Who buys stuff like this?”  Since then, the index is off 15%.  I wasn’t making a market call.  In fact, the purpose of this concept is not to make market calls.  But to be able to understand certain market dynamics and when the market appears to be getting ahead of itself.

The concept of price compression isn’t intended to help you time bubbles or short the market.  It’s a concept that helps us merely identify markets that may be a bit irrationally exuberant or irrationally bearish.  In better conceptualizing the markets through an understanding of pricing dynamics we can be better prepared to manage certain risks that will inevitably arise.

Investors Want More…Investment

No, dummy.  We’re not going to talk about “investment” in the sense that everyone abuses the term – as in stock market “investing”.  We’re going to talk about real investment – spending, not consumed, for future production.   Anyone who’s read my primer on the monetary system knows that investment is one of the most important drivers of overall economic growth.  And while investment has been relatively robust over the last 5 years it is interesting to think about how much more robust this could be.  For instance, take these two charts.  The first is from Goldman Sachs showing how corporations are spending:


Now look at what investors want companies to be doing with their spending:

Cash usage


Corporate balance sheets were never a big problem during the crisis (with the exception of banks and many non-bank financial firms).  But what’s interesting is that investors really want more capex and yet corporations seem to be involved in their usual pro-cyclical increases in dividends and buybacks.  It all makes one wonder – why aren’t corporations actually pouring more money into their own firms as opposed to just handing it back to shareholders?  My best guess is that it’s a lack of demand combined with the short-termism that has come to dominate corporate board rooms.  After all, buybacks are a great way to “make numbers” and boost short-term incentives without hurting the corporate income statement.

Martin Wolf: “Understanding the monetary system is essential”

Martin Wolf has a fantastic new piece in the Financial Times discussing some of the flaws in the thinking that has driven irrational fears around QE and hyperinflation in the last 5 years.  It reads like something I could have written so of course I like it.  But in all seriousness, you should read his article and you should seriously understand the monetary system.  It won’t just help you better understand policy.  It will help you avoid many of the portfolio pitfalls that hurt investors during the last 5 years.

On Portfolio Differentiation

The latest from Howard Marks of Oaktree is as good as always.  But I wanted to highlight something that I found particularly important – differentiation.  Marks says:

“Here’s a line from Dare to Be Great: “This just in: you can’t take the same actions as everyone else and expect to outperform.” Simple, but still appropriate.

For years I’ve posed the following riddle: Suppose I hire you as a portfolio manager and we agree you will get no compensation next year if your return is in the bottom nine deciles of the investor universe but $10 million if you’re in the top decile. What’s the first thing you have to do – the absolute prerequisite – in order to have a chance at the big money? No one has ever answered it right.

The answer may not be obvious, but it’s imperative: you have to assemble a portfolio that’s different from those held by most other investors. If your portfolio looks like everyone else’s, you may do well, or you may do poorly, but you can’t do different.”

This is important to understand when analyzing portfolios and constructing your own for several reasons:

  • First, be wary of people who refer to sweeping studies about portfolio manager “underperformance” when they compare all funds or managers with some broader index.  The vast majority of the studies I see are engaged in apples to oranges comparisons which take something like the S&P 500 and compare it to something like an actively managed multi-strategy hedge fund.  These are two totally different animals and if they’re not benchmarked appropriately (as most funds aren’t) then the comparison doesn’t really tell you much about anything.
  • Second, be wary of those who aren’t differentiated, but sell you their services as though it is.  There are a huge number of portfolio managers and strategies out there that merely mimic a closely correlated index without actually doing anything that differentiates the fund or strategy from the index.  They usually go by fancy sounding names like the “So and So Global Value Fund” or something, but the reality is that many of these funds are simply their benchmark masquerading as something different with a huge fee attached.
  • If you’re going to run a strategy that adds value relative to a benchmark then it needs to be differentiated.  This can be done in lots of different ways, but it’s not easy to construct a strategy like this that would outperform a closely correlated aggregate.

Differentiation is important.  But in addition to finding differentiation you have to ensure that you’re properly benchmarking it, properly evaluating it on a risk adjusted basis and ensuring that there’s more to this differentiation than a fancy sounding name and a high fee structure.

The Rise of the Secular Stagnationist

The Secular Stagnationists are growing in numbers.  This breed of analyst and/or pundit looks a lot like the Permabear, but tends not to make specific market related calls.  Instead, they tend to make broad macroeconomic calls.  And the Secular Stagnationists think the US economy is in for a long bout of low or zero growth.  I think there’s some merit to these ideas, but I also think there are some flaws in the underlying thinking.

The Secular Stagnationist clan has grown in numbers following the release of Thomas Piketty’s Capital.  The book argues that economic inequality could lead to lower than normal growth.  But there’s a substantial flaw in this thinking.  Piketty also shows us that growth has been unusually high during the last 100 years.   Since 1900 Gross World Product has averaged 3.8%.  Since 1700 it has averaged just 2.1%.  And over longer periods it’s even lower.  Piketty argues that we’re headed back to the 1-2% range or closer to the average rate of growth of 2.1%.  That’s bearish given the last 100 years of data, but not completely unreasonable.  But more importantly, it means that the present era has been a secular boom.  Therefore, if Piketty is right then we’re not entering a secular stagnation.  We’re merely growing more in-line with the historical norm.  A true “secular stagnation” would be truly abysmal growth of 0-1%.  That’s not just bearish, but aggressively bearish.  So there’s an obvious historical misrepresentation in the narrative of the Secular Stagnationists unless they all agree that growth is going to be negative or flattish.

In this paper by Eggertson and Mehrortra (via Krugman) they argue that deleveraging, a slowdown in population growth or an increase in inequality can contribute to this stagnation.  They use Japan’s experience in the 90′s & 00′s as a benchmark for much of the work.  Let’s look at each of these more closely and see how well this comparison fits.

First, I think there’s no doubt that a deleveraging puts enormous pressure on an economy since spending is a function of current income relative to desired saving.  A deleveraging cycle reduces the value of saving since it puts pressure on asset prices and is likely to also reduce incomes.  We have to be careful when comparing the USA to Japan or Europe here.  Europe, for instance, is experiencing a broad deleveraging that is primarily the result of a dysfunctional currency union that is creating wage rebalancing because there is no external rebalancing mechanism (via trade or government tax redistribution).  The USA, on the other hand, while not releveraging at a strong pace, is definitely not in a deleveraging cycle any longer.  As I mentioned last year, the Balance Sheet Recession is over.

Second, stagnant population growth puts clear pressure on an economy.  A lazy view of economic growth can be defined as:

 Growth Rate of GDP = Growth Rate of Population + Growth Rate of GDP per capita

But again, we have to be careful about painting with a broad brush here.  The USA is not Japanese in the sense of population growth.  In fact, population growth is expected to be rather robust 13% in the coming 20 years:


Now contrast that with the negative growth that Japan confronts:


And then contrast that with the more modest 2% expected growth in Europe:


Clearly, the USA does not look very Japanese at all on this front.  Europe, while not negative, certainly resembles something of a “stagnation” though.

The third claim about inequality is less clear.  Piketty argued that inequality would lead to lower growth.  But the data is very unclear on this relationship and much of Piketty’s own data is inconsistent.  For instance, between 1950 and 2012 the growth rate on capital increased from 1.2% to 3.3%, but the global economy experienced its highest growth rate ever.  So there’s no clear inverse relationship between inequality and economic growth.   In fact, one could easily conclude that growing inequality contributes positively to economic growth.  But more importantly, the Secular Stagnationists who also believe in inequality must still account for the aforementioned contradiction – growth moderating to 2.1% is not “stagnation”.  It’s just the historical norm.

So the true Secular Stagnationists are those who believe growth will be negative or worse than 2% or so.  And if you ask me, there’s no clear evidence that the USA is falling into that secular stagnation trap.  In fact, the much more applicable case of secular stagnation appears to be across the pond in Europe where deleveraging and population growth appear to be much more significant headwinds in the coming 20 years.


This Statistic is Horrifying

After 5 years of de-leveraging it sure feels like things are better, right?  The debt to income ratio has fallen from 1.15 to 0.9.  Stocks are soaring.  Corporate profits are at all-time highs.  Things seem pretty good.  But underneath all of this there’s a lurking fragility that remains from the credit crisis – household balance sheets are still pretty weak.  Take this horrifying statistic (from House of Debt):

“Almost 40% of individuals in the United States either could not or probably could not come up with even $2000 if an unexpected need arose.”


This is, in large part, why the 2008 credit crisis was so damaging.  Even minor disruptions in the economy can cause big problems.  And problems send us on the verge of a crisis because the consumer is on such tepid footing.  Yes, the Balance Sheet Recession is behind us (households are now re-leveraging), but the future remains very uncertain as households continue to cautiously manage their fragile balance sheets.

Is the Reward of Entrepreneurship Still Worth the Risk?

I’ve been self employed for the majority of my adult life.  Being an entrepreneur is glorified in America.  It’s the whole “rugged individual” thing.  It’s what America was made out of and all that stuff.  But while you generally hear lots of happy success stories the reality is that being an entrepreneur is really difficult.  There were times in my working life where I worked as many hours a week as an Ibanker in NYC and made the equivalent of less than minimum wage.  There were times when I questioned my path forward and thought about dusting off the old resume.  There were times when I considered going to friends and family for short-term loans to make things work.  Sleepless nights, endless anxiety, etc.  It’s not easy.  You get the message.  But this shouldn’t surprise anyone.  After all, 70% of small businesses fail within their first 10 years.  Entrepreneurship is usually a losing endeavor.  

In the USA entrepreneurship is on the decline.  This prompted Noah Smith to ask if the USA is no longer the “land of the brave”.   But why is this happening?  Megan McArdle attributes it to the structured and regimented way in which we steer our children away from failure.   I think that’s mostly right.  And while it might seem somewhat misguided I do have to wonder whether it isn’t the wisest path in most cases.  Yes, we glorify entrepreneurs and hold them on pedestals, but being an entrepreneur is hard.  And the pay off isn’t always a billion dollar Facebook buyout (although, it does seem like they’re on course to buyout everyone and everything).

In my experience, it seems that many of the people in my generation make calculated bets based on better overall information.  They aim high, but not so high that they can fall too far.  After all, becoming a doctor, lawyer, consultant or some other high paying job is still glorified.  These types of jobs pay well, provide a sense of security and give the employee an overall sense of purpose.  Sure, it’s not like starting the next big thing, but it’s not like flipping burgers either.

And that’s what’s so interesting about the decline in entrepreneurship.  To me, it looks like the result of a calculated move by parents to steer their children in the direction of a position in life that sets the bar high, but doesn’t set it so high that you can get severely hurt by the fall.  In other words, it looks to me like more and more people are simply making a more calculated bet where they can still achieve great financial reward, but without taking the great financial risk.  Of course, you’re sacrificing some of the potential upside by not taking the entrepreneur route, but it’s arguably the better risk adjusted return for most people.

Vanguard’s Principles for Investing Success

I really liked this white paper from Vanguard.  It’s fairly basic, but it applies whether you’re a highly sophisticated trader or a more “passive” investor.  The core of the philosophy:

  1. Goals
  2. Balance
  3. Cost
  4. Discipline

These factors always matter.  Having a structured set of goals helps define your process.  Balance helps to diversify your ignorance.  Costs will always eat into returns.  And discipline is the ability to follow through with your process.

Read the full paper here.

Getting Bitcoin Wrong

The new VOX looks excellent.  I’m excited for Ezra Klein and Matt Yglesias and the rest of the team working there.  But I wasn’t a huge fan of this article on Bitcoin.  In fact, I think there are some serious misunderstandings in it.

The first error is the idea that Bitcoin’s decentralized model is its ultimate strength.  The author writes:

“Bitcoin’s detractors are making the same mistake as many Bitcoin fans: thinking about Bitcoin as a new kind of currency. That obscures what makes Bitcoin potentially revolutionary: it’s the world’s first completely open financial network.”

This is simply not consistent with the role of money in modern financial systems.  Modern money is denominated in a unit of account established by specific governments (the US Dollar, the Yen, the Euro, etc).  It is regulated by that government.  And it is distributed through a system either controlled by that government, a public/private partnership or a privately managed system with government oversight.   But notice that government and any credible form of money go hand in hand there.

In the case of the USA and most other modern payment systems the banks control the issuance of money and the government oversees how this system is regulated.  This strikes a nice balance by allowing private entities to compete for money issuance (loans create money) and utilizes the various strengths of government to support this system.  As the entity with taxing authority over private production as well as control of the legal structure of the system the government has an extraordinary amount of power to secure and stabilize a payment system.  After all, when the banks blow things up they don’t turn hat in hand to one another.  They usually turn hat in hand to the government to stabilize everything.  And the government is happy to help because governments know that the stability of their payment system is central to the health of, well, just about everything in the financial system.  To separate government ENTIRELY from money is to separate money from one of its most integral features.

But the credibility a government contributes to a currency is only one component of this relationship between money and governments.  Another important component of money as a credible and valuable medium of exchange is in its use for public purpose.  A government must be able to tax money in order to be able to generate revenue for public purpose.  And in order to properly tax it must maintain some level of government oversight.  This means that there is simply no such thing as having a fully decentralized monetary system.  In other words, to separate “money” from a government is to create a mythical world where government does not exist since, by definition, a government cannot exist if it has no taxing or legal authority within a monetary system where it exists.  Therefore, to create a currency that is fully decentralized is to create a currency that serves ONLY private purpose.  This is totally incompatible with the existence of modern human society and the interconnected social systems in which we live.  So no, decentralization is not Bitcoin’s greatest strength.  In fact, as I highlighted over a year ago and prior to the massive Bitcoin fraud, this decentralization is Bitcoin’s greatest weakness.

A more minor misunderstanding has to do with Bitcoin and its comparison with other modern funds transfer systems like Paypal or credit cards.  The author says:

“MasterCard and PayPal payments are based on conventional currencies such as the US dollar. In contrast, the Bitcoin network has its own unit of value, which is called the bitcoin.”

This isn’t quite right.  Credit card companies like MasterCard facilitate electronic funds transfers. Banks and finance companies use MasterCard branded cards to allow these transfers to be processed in the money they issue. To discuss credit cards or Paypal without discussing banking is missing the point of the “money” used in the means of transacting business through those funds transfer systems.  So let’s be clear – these payments are occurring inside the banking system and represent what is essentially a short-term dollar denominated loan by a bank (or, in the case of Paypal, a deposit transfer).

Further, the value of a Bitcoin is not like a “currency” at all.  It’s more like a financial asset issued by a private/decentralized system whose value is fluctuating up and down like a stock or bond based on what speculators think it’s worth at any given moment in time. And just like stocks or bonds this financial instrument called “Bitcoin” is denominated in local currency and can be exchanged into deposits.  But make no mistake – when you want to go buy 99.9% of goods and services you must convert that financial asset into good old fashioned bank deposits denominated in USD.  The reason why is because, control of money is about controlling a trustworthy payment system.  And for all its flaws, the modern banking system is extremely trustworthy.  That’s a big part of the reason why a system like Bitcoin, being decentralized, simply can’t compete with modern banking (not to mention, the banking system’s lobbyists are bit more powerful than anyone associated with Bitcoin).