Author Archive for Cullen Roche

This isn’t a Stock Market Bubble, but it Could Become One

Last year I asked if we are in a stock market bubble.  My answer was no.  Much of the basis for that thinking was that sentiment was just too bearish in general.  There has been a tremendous amount of skepticism about the economy and the stock market for 5 years running.

How many times have we read articles about how the stock market is only being fueled by the Fed only to later discoverbubble that earnings growth has actually been pretty strong?  Or how many times have we read about how bad the economy is only to discover months later that it’s gotten a bit better?  That’s the fuel that drives a bull market.  Irrational apathy.

The bears are always bearish when things are bad and they look at the world so negatively that they don’t consider that that macro weakness in the economy is actually slack that is almost always waiting to be tightened.  And as it gets tightened the bears scream about the ongoing weakness and a weak economy turns into an okay economy which turns into a strong economy.  It’s at that point in the cycle when you really want to become more skeptical.   This is the point when everyone potentially becomes convinced that the market is a one way bet.

So, are we there yet?  I don’t know.  I am still inclined to argue that this isn’t a bubble.  But it is sure starting to feel like it could become one.  Practically everyone I talk to is dying to get into the stock market.  They’re just waiting to “buy the dip” – the dip that keeps on never coming.  And so dip buyers become rally chasers.  And that’s the thing of bubbles.  When people buy just for the sake of buying something that they believe can never go down.  Irrational apathy gives way to irrational exuberance and voilà!  Bubble.

Are we there yet?  Not quite.  I wouldn’t call this rally irrational.  But it’s got all the right ingredients to take us there.

Is the Global Financial Asset Portfolio the Perfect Indexing Strategy?

If there was such a thing as an indexing purist that person would simply buy all of the outstanding available financial assets in the world and call it quits.  In other words, they would “take what the market gives them” rather than trying to make active predictions about which parts of the financial asset world will perform better than other parts.  Of course, that’s not how most of us invest.  Even the so-called “passive” indexers are engaged in a form of active index picking which generally results in a portfolio that is overweight stocks. But what if you could be a purist?  What if you wanted to just accept what the “market gives you”?  And how would that portfolio perform in general?

Constructing the Portfolio

As I’ve noted previously, the global asset portfolio as comprised by this paper, is a pretty good starting point.  It looks like this as of 2011: global_portfolio

I have a few issues with the portfolio:

  1. We should be focusing on FINANCIAL assets as opposed to holding every asset in the world.  Clearly, an index of all the world’s assets is impossible to come even close to replicating so let’s stick to financial assets entirely.  Because of this focus on financial assets we are eliminating any exposure to non-financial assets like real commodities.
  2. In addition, this can be justified based on the understanding that commodities are mainly cost inputs in the capital structure that generate no real return in our financial portfolio over long periods of time (see here for more).
  3. To reduce repetitive allocations we will eliminate the “hedge fund” component” and instead allocate this portion in accordance with the HFRI Equal Weight Index.
  4. Private equity is is just equity on the primary markets so for simplicity of replication and practical implementation let’s just roll that into equity.
  5. Cash and all cash equivalents are not being included in this analysis, but it should be acknowledged that cash is an ever present asset class in any realistic portfolio that will require management (see here for more).

When we rearrange the portfolio based on the above assumptions we get a portfolio that looks roughly like this:


That’s basically a 55% bonds, 39% stocks, 6% REITs portfolio.  Keep in mind there are lots of different types of instruments within each of these components (like MBS, municipal bonds, high yield, etc).  But this is a good approximation of what the Global Financial Asset Portfolio might look like.  And it’s easily replicated through available funds.

Portfolio performance 

Because of the unavailability of some asset classes we can only backtest this portfolio to 1985.  The numbers are pretty impressive though:

Compound Annual Growth Rate (CAGR):  8.7%

Standard Deviation: 6.89

Sharpe Ratio: 0.73

Sortino Ratio: 1.32

Correlation to International Markets: 0.54

For perspective, a 60/40 stock/bond portfolio over this period generates the following:

Compound Annual Growth Rate (CAGR):  9.5%

Standard Deviation: 9.51

Sharpe Ratio: 0.5

Sortino Ratio: 0.77

Correlation to International Markets: 0.95

In other words, the stock heavy 60/40 portfolio is just leveraging the equity component of the GFAP which generates a better nominal return, but a worse risk adjusted return.  An indexing purist wouldn’t be shocked by that if they were an advocate of the GFAP as their ultimate benchmark.  Of course, most indexers are actually “asset pickers” who engage in a degree of asset class forecasting or factor based asset allocation strategies.   But just as with anything involving dynamic markets there is a certain degree of forecasting, guesswork and imprecision involved.  Given the limitations of this research there are some important caveats and further details that will require another post in the coming days.

In part 2 I’ll tackle the most important question:

“Is the Global Financial Asset Portfolio the perfect indexing strategy?”


1.  Global Market Capitalizations, World Federation of Exchanges, July 2014.

2.  The Global Multi-Asset Market Portfolio, Ronald Q. Doeswijk, Trevin W. Lam & Laurens Swinkels, January 2014.


AI, Robotics, and the Future of Jobs

CR here: This is a good piece sent courtesy of John Mauldin.   It goes well with this video which is a pretty scary perspective of what the robots could do to us all.  Enjoy!

By Aaron Smith and Janna Anderson

Key Findings

The vast majority of respondents to the 2014 Future of the Internet canvassing anticipate that robotics and artificial intelligence will permeate wide segments of daily life by 2025, with huge implications for a range of industries such as health care, transport and logistics, customer service, and home maintenance. But even as they are largely consistent in their predictions for the evolution of technology itself, they are deeply divided on how advances in AI and robotics will impact the economic and employment picture over the next decade.

Key themes: reasons to be hopeful:

1) Advances in technology may displace certain types of work, but historically they have been a net creator of jobs.

2) We will adapt to these changes by inventing entirely new types of work, and by taking advantage of uniquely human capabilities.

3) Technology will free us from day-to-day drudgery, and allow us to define our relationship with “work” in a more positive and socially beneficial way.

4) Ultimately, we as a society control our own destiny through the choices we make.

Key themes: reasons to be concerned:

1) Impacts from automation have thus far impacted mostly blue-collar employment; the coming wave of innovation threatens to upend white-collar work as well.

2) Certain highly-skilled workers will succeed wildly in this new environment—but far more may be displaced into lower paying service industry jobs at best, or permanent unemployment at worst.

3) Our educational system is not adequately preparing us for work of the future, and our political and economic institutions are poorly equipped to handle these hard choices.

Some 1,896 experts responded to the following question:

The economic impact of robotic advances and AI—Self-driving cars, intelligent digital agents that can act for you, and robots are advancing rapidly. Will networked, automated, artificial intelligence (AI) applications and robotic devices have displaced more jobs than they have created by 2025?

Half of these experts (48%) envision a future in which robots and digital agents have displaced significant numbers of both blue- and white-collar workers—with many expressing concern that this will lead to vast increases in income inequality, masses of people who are effectively unemployable, and breakdowns in the social order.

The other half of the experts who responded to this survey (52%) expect that technology will not displace more jobs than it creates by 2025. To be sure, this group anticipates that many jobs currently performed by humans will be substantially taken over by robots or digital agents by 2025. But they have faith that human ingenuity will create new jobs, industries, and ways to make a living, just as it has been doing since the dawn of the Industrial Revolution.

These two groups also share certain hopes and concerns about the impact of technology on employment. For instance, many are concerned that our existing social structures—and especially our educational institutions—are not adequately preparing people for the skills that will be needed in the job market of the future. Conversely, others have hope that the coming changes will be an opportunity to reassess our society’s relationship to employment itself—by returning to a focus on small-scale or artisanal modes of production, or by giving people more time to spend on leisure, self-improvement, or time with loved ones.

A number of themes ran through the responses to this question: those that are unique to either group, and those that were mentioned by members of both groups.

The view from those who expect AI and robotics to have a positive or neutral impact on jobs by 2025

JP Rangaswami, chief scientist for, offered a number of reasons for his belief that automation will not be a net displacer of jobs in the next decade: “The effects will be different in different economies (which themselves may look different from today’s political boundaries). Driven by revolutions in education and in technology, the very nature of work will have changed radically—but only in economies that have chosen to invest in education, technology, and related infrastructure. Some classes of jobs will be handed over to the ‘immigrants’ of AI and Robotics, but more will have been generated in creative and curating activities as demand for their services grows exponentially while barriers to entry continue to fall. For many classes of jobs, robots will continue to be poor labor substitutes.”

Rangaswami’s prediction incorporates a number of arguments made by those in this canvassing who took his side of this question.

Argument #1: Throughout history, technology has been a job creator—not a job destroyer

Vint Cerf, vice president and chief Internet evangelist for Google, said, “Historically, technology has created more jobs than it destroys and there is no reason to think otherwise in this case. Someone has to make and service all these advanced devices.”

Jonathan Grudin, principal researcher for Microsoft, concurred: “Technology will continue to disrupt jobs, but more jobs seem likely to be created. When the world population was a few hundred million people there were hundreds of millions of jobs. Although there have always been unemployed people, when we reached a few billion people there were billions of jobs. There is no shortage of things that need to be done and that will not change.”

Michael Kende, the economist for a major Internet-oriented nonprofit organization, wrote, “In general, every wave of automation and computerization has increased productivity without depressing employment, and there is no reason to think the same will not be true this time. In particular, the new wave is likely to increase our personal or professional productivity (e.g. self-driving car) but not necessarily directly displace a job (e.g. chauffeur). While robots may displace some manual jobs, the impact should not be different than previous waves of automation in factories and elsewhere. On the other hand, someone will have to code and build the new tools, which will also likely lead to a new wave of innovations and jobs.”

Fred Baker, Internet pioneer, longtime leader in the IETF and Cisco Systems Fellow, responded, “My observation of advances in automation has been that they change jobs, but they don’t reduce them. A car that can guide itself on a striped street has more difficulty with an unstriped street, for example, and any automated system can handle events that it is designed for, but not events (such as a child chasing a ball into a street) for which it is not designed. Yes, I expect a lot of change. I don’t think the human race can retire en masse by 2025.”

Argument #2: Advances in technology create new jobs and industries even as they displace some of the older ones

Ben Shneiderman, professor of computer science at the University of Maryland, wrote, “Robots and AI make compelling stories for journalists, but they are a false vision of the major economic changes. Journalists lost their jobs because of changes to advertising, professors are threatened by MOOCs, and store salespeople are losing jobs to Internet sales people. Improved user interfaces, electronic delivery (videos, music, etc.), and more self-reliant customers reduce job needs. At the same time someone is building new websites, managing corporate social media plans, creating new products, etc. Improved user interfaces, novel services, and fresh ideas will create more jobs.”

Amy Webb, CEO of strategy firm Webbmedia Group, wrote, “There is a general concern that the robots are taking over. I disagree that our emerging technologies will permanently displace most of the workforce, though I’d argue that jobs will shift into other sectors. Now more than ever, an army of talented coders is needed to help our technology advance. But we will still need folks to do packaging, assembly, sales, and outreach. The collar of the future is a hoodie.”

John Markoff, senior writer for the Science section of the New York Times, responded, “You didn’t allow the answer that I feel strongly is accurate—too hard to predict. There will be a vast displacement of labor over the next decade. That is true. But, if we had gone back 15 years who would have thought that ‘search engine optimization’ would be a significant job category?”

Marjory Blumenthal, a science and technology policy analyst, wrote, “In a given context, automated devices like robots may displace more than they create. But they also generate new categories of work, giving rise to second- and third-order effects. Also, there is likely to be more human-robot collaboration—a change in the kind of work opportunities available. The wider impacts are the hardest to predict; they may not be strictly attributable to the uses of automation but they are related…what the middle of the 20th century shows us is how dramatic major economic changes are—like the 1970s OPEC-driven increases of the price of oil—and how those changes can dwarf the effects of technology.”

Argument #3: There are certain jobs that only humans have the capacity to do

A number of respondents argued that many jobs require uniquely human characteristics such as empathy, creativity, judgment, or critical thinking—and that jobs of this nature will never succumb to widespread automation.

David Hughes, a retired U.S. Army Colonel who, from 1972, was a pioneer in individual to/from digital telecommunications, responded, “For all the automation and AI, I think the ‘human hand’ will have to be involved on a large scale. Just as aircraft have to have pilots and copilots, I don’t think all ‘self-driving’ cars will be totally unmanned. The human’s ability to detect unexpected circumstances, and take action overriding automatic driving will be needed as long and individually owned ‘cars’ are on the road.”

Pamela Rutledge, PhD and director of the Media Psychology Research Center, responded, “There will be many things that machines can’t do, such as services that require thinking, creativity, synthesizing, problem-solving, and innovating…Advances in AI and robotics allow people to cognitively offload repetitive tasks and invest their attention and energy in things where humans can make a difference. We already have cars that talk to us, a phone we can talk to, robots that lift the elderly out of bed, and apps that remind us to call Mom. An app can dial Mom’s number and even send flowers, but an app can’t do that most human of all things: emotionally connect with her.”

Michael Glassman, associate professor at the Ohio State University, wrote, “I think AI will do a few more things, but people are going to be surprised how limited it is. There will be greater differentiation between what AI does and what humans do, but also much more realization that AI will not be able to engage the critical tasks that humans do.”

Argument #4: The technology will not advance enough in the next decade to substantially impact the job market

Another group of experts feels that the impact on employment is likely to be minimal for the simple reason that 10 years is too short a timeframe for automation to move substantially beyond the factory floor. David Clark, a senior research scientist at MIT’s Computer Science and Artificial Intelligence Laboratory, noted, “The larger trend to consider is the penetration of automation into service jobs. This trend will require new skills for the service industry, which may challenge some of the lower-tier workers, but in 12 years I do not think autonomous devices will be truly autonomous. I think they will allow us to deliver a higher level of service with the same level of human involvement.”

Jari Arkko, Internet expert for Ericsson and chair of the Internet Engineering Task Force, wrote, “There is no doubt that these technologies affect the types of jobs that need to be done. But there are only 12 years to 2025, some of these technologies will take a long time to deploy in significant scale…We’ve been living a relatively slow but certain progress in these fields from the 1960s.”

Christopher Wilkinson, a retired European Union official, board member for, and Internet Society leader said, “The vast majority of the population will be untouched by these technologies for the foreseeable future. AI and robotics will be a niche, with a few leading applications such as banking, retailing, and transport. The risks of error and the imputation of liability remain major constraints to the application of these technologies to the ordinary landscape.”

Argument #5: Our social, legal, and regulatory structures will minimize the impact on employment

A final group suspects that economic, political, and social concerns will prevent the widespread displacement of jobs. Glenn Edens, a director of research in networking, security, and distributed systems within the Computer Science Laboratory at PARC, a Xerox Company, wrote, “There are significant technical and policy issues yet to resolve, however there is a relentless march on the part of commercial interests (businesses) to increase productivity so if the technical advances are reliable and have a positive ROI then there is a risk that workers will be displaced. Ultimately we need a broad and large base of employed population, otherwise there will be no one to pay for all of this new world.”

Andrew Rens, chief council at the Shuttleworth Foundation, wrote, “A fundamental insight of economics is that an entrepreneur will only supply goods or services if there is a demand, and those who demand the good can pay. Therefore any country that wants a competitive economy will ensure that most of its citizens are employed so that in turn they can pay for goods and services. If a country doesn’t ensure employment driven demand it will become increasingly less competitive.”

Geoff Livingston, author and president of Tenacity5 Media, wrote, “I see the movement towards AI and robotics as evolutionary, in large part because it is such a sociological leap. The technology may be ready, but we are not—at least, not yet.”

The view from those who expect AI and robotics to displace more jobs than they create by 2025

An equally large group of experts takes a diametrically opposed view of technology’s impact on employment. In their reading of history, job displacement as a result of technological advancement is clearly in evidence today, and can only be expected to get worse as automation comes to the white-collar world.

Argument #1: Displacement of workers from automation is already happening—and about to get much worse

Jerry Michalski, founder of REX, the Relationship Economy eXpedition, sees the logic of the slow and unrelenting movement in the direction of more automation: “Automation is Voldemort: the terrifying force nobody is willing to name. Oh sure, we talk about it now and then, but usually in passing. We hardly dwell on the fact that someone trying to pick a career path that is not likely to be automated will have a very hard time making that choice. X-ray technician? Outsourced already, and automation in progress. The race between automation and human work is won by automation, and as long as we need fiat currency to pay the rent/mortgage, humans will fall out of the system in droves as this shift takes place…The safe zones are services that require local human effort (gardening, painting, babysitting), distant human effort (editing, coaching, coordinating), and high-level thinking/relationship building. Everything else falls in the target-ri ch environment of automation.”

Mike Roberts, Internet pioneer and Hall of Fame member and longtime leader with ICANN and the Internet Society, shares this view: “Electronic human avatars with substantial work capability are years, not decades away. The situation is exacerbated by total failure of the economics community to address to any serious degree sustainability issues that are destroying the modern ‘consumerist’ model and undermining the early 20th century notion of ‘a fair day’s pay for a fair day’s work.’ There is great pain down the road for everyone as new realities are addressed. The only question is how soon.”

Robert Cannon, Internet law and policy expert, predicts, “Everything that can be automated will be automated. Non-skilled jobs lacking in ‘human contribution’ will be replaced by automation when the economics are favorable. At the hardware store, the guy who used to cut keys has been replaced by a robot. In the law office, the clerks who used to prepare discovery have been replaced by software. IBM Watson is replacing researchers by reading every report ever written anywhere. This begs the question: What can the human contribute? The short answer is that if the job is one where that question cannot be answered positively, that job is not likely to exist.”

Tom Standage, digital editor for The Economist, makes the point that the next wave of technology is likely to have a more profound impact than those that came before it: “Previous technological revolutions happened much more slowly, so people had longer to retrain, and [also] moved people from one kind of unskilled work to another. Robots and AI threaten to make even some kinds of skilled work obsolete (e.g., legal clerks). This will displace people into service roles, and the income gap between skilled workers whose jobs cannot be automated and everyone else will widen. This is a recipe for instability.”

Mark Nall, a program manager for NASA, noted, “Unlike previous disruptions such as when farming machinery displaced farm workers but created factory jobs making the machines, robotics and AI are different. Due to their versatility and growing capabilities, not just a few economic sectors will be affected, but whole swaths will be. This is already being seen now in areas from robocalls to lights-out manufacturing. Economic efficiency will be the driver. The social consequence is that good-paying jobs will be increasingly scarce.”

Argument #2: The consequences for income inequality will be profound

For those who expect AI and robotics to significantly displace human employment, these displacements seem certain to lead to an increase in income inequality, a continued hollowing out of the middle class, and even riots, social unrest, and/or the creation of a permanent, unemployable “underclass”.

Justin Reich, a fellow at Harvard University’s Berkman Center for Internet & Society, said, “Robots and AI will increasingly replace routine kinds of work—even the complex routines performed by artisans, factory workers, lawyers, and accountants. There will be a labor market in the service sector for non-routine tasks that can be performed interchangeably by just about anyone—and these will not pay a living wage—and there will be some new opportunities created for complex non-routine work, but the gains at this top of the labor market will not be offset by losses in the middle and gains of terrible jobs at the bottom. I’m not sure that jobs will disappear altogether, though that seems possible, but the jobs that are left will be lower paying and less secure than those that exist now. The middle is moving to the bottom.”

Stowe Boyd, lead researcher at GigaOM Research, said, “As just one aspect of the rise of robots and AI, widespread use of autonomous cars and trucks will be the immediate end of taxi drivers and truck drivers; truck driver is the number-one occupation for men in the U.S.. Just as importantly, autonomous cars will radically decrease car ownership, which will impact the automotive industry. Perhaps 70% of cars in urban areas would go away. Autonomous robots and systems could impact up to 50% of jobs, according to recent analysis by Frey and Osborne at Oxford, leaving only jobs that require the ‘application of heuristics’ or creativity…An increasing proportion of the world’s population will be outside of the world of work—either living on the dole, or benefiting from the dramatically decreased costs of goods to eke out a subsistence lifestyle. The central question of 2025 will be: What are people for in a world that does n ot need their labor, and where only a minority are needed to guide the ‘bot-based economy?”

Nilofer Merchant, author of a book on new forms of advantage, wrote, “Just today, the guy who drives the service car I take to go to the airport [said that he] does this job because his last blue-collar job disappeared from automation. Driverless cars displace him. Where does he go? What does he do for society? The gaps between the haves and have-nots will grow larger. I’m reminded of the line from Henry Ford, who understood he does no good to his business if his own people can’t afford to buy the car.”

Alex Howard, a writer and editor based in Washington, D.C., said, “I expect that automation and AI will have had a substantial impact on white-collar jobs, particularly back-office functions in clinics, in law firms, like medical secretaries, transcriptionists, or paralegals. Governments will have to collaborate effectively with technology companies and academic institutions to provide massive retraining efforts over the next decade to prevent massive social disruption from these changes.”

Point of agreement: the educational system is doing a poor job of preparing the next generation of workers

A consistent theme among both groups is that our existing social institutions—especially the educational system—are not up to the challenge of preparing workers for the technology- and robotics-centric nature of employment in the future.

Howard Rheingold, a pioneering Internet sociologist and self-employed writer, consultant, and educator, noted, “The jobs that the robots will leave for humans will be those that require thought and knowledge. In other words, only the best-educated humans will compete with machines. And education systems in the U.S. and much of the rest of the world are still sitting students in rows and columns, teaching them to keep quiet and memorize what is told to them, preparing them for life in a 20th century factory.”

Bryan Alexander, technology consultant, futurist, and senior fellow at the National Institute for Technology in Liberal Education, wrote, “The education system is not well positioned to transform itself to help shape graduates who can ‘race against the machines.’ Not in time, and not at scale. Autodidacts will do well, as they always have done, but the broad masses of people are being prepared for the wrong economy.”

Point of agreement: the concept of “work” may change significantly in the coming decade

On a more hopeful note, a number of experts expressed a belief that the coming changes will allow us to renegotiate the existing social compact around work and employment.

Possibility #1: We will experience less drudgery and more leisure time

Hal Varian, chief economist for Google, envisions a future with fewer ‘jobs’ but a more equitable distribution of labor and leisure time: “If ‘displace more jobs’ means ‘eliminate dull, repetitive, and unpleasant work,’ the answer would be yes. How unhappy are you that your dishwasher has replaced washing dishes by hand, your washing machine has displaced washing clothes by hand, or your vacuum cleaner has replaced hand cleaning? My guess is this ‘job displacement’ has been very welcome, as will the ‘job displacement’ that will occur over the next 10 years. The work week has fallen from 70 hours a week to about 37 hours now, and I expect that it will continue to fall. This is a good thing. Everyone wants more jobs and less work. Robots of various forms will result in less work, but the conventional work week will decrease, so there will be the same number of jobs (adjusted for demograp hics, of course). This is what has been going on for the last 300 years so I see no reason that it will stop in the decade.”

Tiffany Shlain, filmmaker, host of the AOL series The Future Starts Here, and founder of The Webby Awards, responded, “Robots that collaborate with humans over the cloud will be in full realization by 2025. Robots will assist humans in tasks thus allowing humans to use their intelligence in new ways, freeing us up from menial tasks.”

Francois-Dominique Armingaud, retired computer software engineer from IBM and now giving security courses to major engineering schools, responded, “The main purpose of progress now is to allow people to spend more life with their loved ones instead of spoiling it with overtime while others are struggling in order to access work.”

Possibility #2: It will free us from the industrial age notion of what a “job” is

A notable number of experts take it for granted that many of tomorrow’s jobs will be held by robots or digital agents—and express hope that this will inspire us as a society to completely redefine our notions of work and employment.

Peter and Trudy Johnson-Lenz, founders of the online community Awakening Technology, based in Portland, Oregon, wrote, “Many things need to be done to care for, teach, feed, and heal others that are difficult to monetize. If technologies replace people in some jobs and roles, what kinds of social support or safety nets will make it possible for them to contribute to the common good through other means? Think outside the job.”

Bob Frankston, an Internet pioneer and technology innovator whose work helped allow people to have control of the networking (internet) within their homes, wrote, “We’ll need to evolve the concept of a job as a means of wealth distribution as we did in response to the invention of the sewing machine displacing seamstressing as welfare.”

Jim Hendler, an architect of the evolution of the World Wide Web and professor of computer science at Rensselaer Polytechnic Institute, wrote, “The notion of work as a necessity for life cannot be sustained if the great bulk of manufacturing and such moves to machines—but humans will adapt by finding new models of payment as they did in the industrial revolution (after much upheaval).”

Tim Bray, an active participant in the IETF and technology industry veteran, wrote, “It seems inevitable to me that the proportion of the population that needs to engage in traditional full-time employment, in order to keep us fed, supplied, healthy, and safe, will decrease. I hope this leads to a humane restructuring of the general social contract around employment.”

Possibility #3: We will see a return to uniquely “human” forms of production

Another group of experts anticipates that pushback against expanding automation will lead to a revolution in small-scale, artisanal, and handmade modes of production.

Kevin Carson, a senior fellow at the Center for a Stateless Society and contributor to the P2P Foundation blog, wrote, “I believe the concept of ‘jobs’ and ‘employment’ will be far less meaningful, because the main direction of technological advance is toward cheap production tools (e.g., desktop information processing tools or open-source CNC garage machine tools) that undermine the material basis of the wage system. The real change will not be the stereotypical model of ‘technological unemployment,’ with robots displacing workers in the factories, but increased employment in small shops, increased project-based work on the construction industry model, and increased provisioning in the informal and household economies and production for gift, sharing, and barter.”

Tony Siesfeld, director of the Monitor Institute, wrote, “I anticipate that there will be a backlash and we’ll see a continued growth of artisanal products and small-scale [efforts], done myself or with a small group of others, that reject robotics and digital technology.”

A network scientist for BBN Technologies wrote, “To some degree, this is already happening. In terms of the large-scale, mass-produced economy, the utility of low-skill human workers is rapidly diminishing, as many blue-collar jobs (e.g., in manufacturing) and white-collar jobs (e.g., processing insurance paperwork) can be handled much more cheaply by automated systems. And we can already see some hints of reaction to this trend in the current economy: entrepreneurially-minded unemployed and underemployed people are taking advantages of sites like Etsy and TaskRabbit to market quintessentially human skills. And in response, there is increasing demand for ‘artisanal’ or ‘hand-crafted’ products that were made by a human. In the long run this trend will actually push toward the re-localization and re-humanization of the economy, with the 19th- and 20th-century economies of scale exploited where they make sense (cheap, identical, disposable g oods), and human-oriented techniques (both older and newer) increasingly accounting for goods and services that are valuable, customized, or long-lasting.”

Housekeeping: Turning off the Comments

I have an unfortunate bit of news to pass on to readers here.  I will be turning the comments off at least temporarily. I don’t know why, but the comments have degraded substantially here in recent weeks. Combined with the fact that I have become much busier in the last few years I just don’t have the time to monitor the website as much as I could before.  So I’ve decided to test out the site without comments on.

For those of you who have been positive contributors over the years I am sincerely thankful. This site won’t be the same without those contributions which is a loss for those of us who really try to use the site for what I always intended – education and productive discourse.

I’ll leave the forum open and probably do a Q&A more regularly, but for now I don’t know of any other solution. I also always respond to emails within a few days so please feel free to reach out if you have a question. I am usually on Twitter at least once a day using the handle @cullenroche.

I know this sucks, but it needs to be done. I am either becoming dumber (which is attracting more criticism) or I am simply too wimpy to monitor the website as it needs to be. Either way, I am sorry it’s come to this and I hope that I can continue to educate and help out through the articles, forum, Q&A’s and email.

What Backs the Value of Money?

I was reading this very good piece by Matthew Klein at FT Alphaville when I came across this line:

“The only kinds of money that reliably hold their value are the ones explicitly backed by a strong government*.”

This is an interesting point and one I don’t completely agree with.  I go into this in excruciating detail in my book, but I’ll spare you the copy and paste job from that since it’s too long.  Instead, here are some basic points on this topic which I think are important and put the above comment in the right perspective:

  • Money is primarily a medium of exchange utilized to obtain goods and services.
  • If the output of a society declines or is viewed as less valuable to its users then the money which is used as a medium of exchange will also be viewed as less valuable.
  • Spending in excess of productive capacity will cause high inflation which can threaten the viability of money.

Okay, so, no government here at all.  In theory, a totally private economy could utilize a form of “money” purely for the purpose of exchanging goods and services.  There are plenty of historical examples of this throughout time, but the problem is that, as inherently social animals, the mythical “Robinson Crusoe” concept of money just doesn’t work out very cleanly.  In other words, the existence of money impacts all of us who need it or want it.

If you live in the town next door and your town uses a different form of “money” than my town, but I want to buy the new long rifle that is only manufactured by a company in your town (who doesn’t accept my town’s money) then I have to obtain your town’s money.  You can imagine how this relationship plays out over history as money becomes an increasingly social construct in a world that is increasingly interconnected.  And since money is a social construct then money plays into other broader social needs.  While it is certainly an instrument of private exchange, it has become an instrument of public exchange due to the sheer complexity of the societies in which we live and their interconnectedness.

So, over time money becomes more than a private medium of exchange and becomes an instrument which can be used for public purpose like fighting wars and building roads.  And so governments begin to define what the unit of account is (things like the Dollar, Euro, Yen, etc), but continue to allow private entities like banks to issue money.  Unfortunately, we can’t trust everyone who uses money and because it is an instrument highly dependent on trust it can be helpful to have the government utilize its legal powers to enforce the use of money.

None of this government involvement in money comes first though.  You’ll notice that a viable form of money is ALWAYS preceded by a valuable private sector which produces valuable goods and services.  Almost everything the government does is after the fact in a supporting role.  As I like to say, capitalism makes socialism possible.  So yes, a government can certainly increase the viability of a form of money through things like the legal system, but we should never lose sight of the fact that money is only as good as the output it gives us access to.  And while much of that output is created by governments these days the majority of domestic innovation and production is a private undertaking.  Therefore, I would change Matthew’s comment to something more like this:

“The only kinds of money that reliably hold their value are the ones explicitly backed by strong private sector output*.”

Citi: Beware Rising HY Spreads

Worried about a potential recession and another big market decline?  Analysts at Citi say a good way to track this risk is to look at the HY bond spreads.  Specifically, spreads at 600-700 bps indicate a recession is highly probable:

Another factor that seems to flag the transition into Phase 4 is the level of HY spreads. It seems that global equities can handle an increase in spreads to around 600-700bp, but anything higher indicates that a recession is imminent. Even given the recent sell-off, spreads are now 400bp. Sure, they may go higher as the withdrawal of US QE allows spreads to recouple with fundamentals, but they are still a long way off the levels that have previously flashed warnings for equity investors. In 2007-08, they very quickly hit this danger level.


We’re far from the caution levels at present, but HY spreads can change quickly. This one’s worth keeping an eye on.

Source: Citi

More Thoughts on the CAPE and Valulations

I’ve made my opinion on valuations and the use of CAPE pretty clear - these sorts of metrics don’t tell us much about the macro environment because the whole idea of ” value” is dynamic and evolving.  If I am right then trying to calculate a market “value” through these types of metrics is likely to mislead you into thinking that the market is static and more predictable than it really is.

The point is, if valuations and market perceptions are as dynamic as I believe then the history of something like CAPE really doesn’t tell us much at all.  After all, “value” is really all in the eye of the beholder.  If investors are willing to pay more for stocks today than they were in 1950 then maybe a CAPE of 15 has no bearing on what a CAPE of 25 means.  That is, stocks could simply be perceived differently than they were in the 1950s.  Perceptions change.  And there’s no reason why stocks can’t be perceived to be inexpensive at a CAPE of 25 just because they once sold at a CAPE of 15.  In other words, what if a CAPE of 35 is the new “expensive”?   Now, I don’t know if that’s true, but in the process of managing one’s risk I think you have to consider that possibility.

I bring all of this back up because Brad Delong wrote a nice piece citing a similar view in response to Robert Shiller’s NY Times piece this weekend.  Delong basically notes that stocks were undervalued for no good reason in the past:

“Given the large number of investors and institutions in our economy with very long time horizons that thought to be in the stock market for the long-term–insurance companies, pension funds, rich individuals with grandchildren–for me the anomaly does not seem to be a CAPE of 25 (or, given historical real returns on other asset classes and very low current yields on investments naked to inflation risk, 33) but rather the CAPEs of 14-20 that we saw in the 1980s, 1960s, 1950s, 1900s, 1890s, and 1880s that Robert Shiller appears to think of as “normal” and to which today’s CAPE should someday return. “

I am going to be blunt – I have no idea if any of this is true.  I don’t know what the “value” of stocks are today.  And I don’t think anyone else really does.  And I think trying to put a value on them through these sorts of metrics is just a big waste of time that leads some people to believe they’ve been able to pinpoint the “value” of stocks at present when the reality is that they’ve simply tried to calculate, with  precision, something that is very imprecise (human perception).  Therefore, if “value” is just another dynamic and evolving concept based largely on human perception then calculating it at any given time is likely to mislead you more than it’s likely to help you.

The “Secular Stagnation” Theory is Massively Overblown

There’s been a lot of chatter in recent years about the idea of secular stagnation.  That is the idea that we’re in a prolonged period of sub-par economic growth.  The idea gained a good deal of attention in recent days thanks to a new book from VoxEU on the topic.  The authors are a who’s who of economics including Krugman, Summers, Eichengreen, Blanchard, Eggertsson , Koo and many others.  

I think it’s important to keep this topic in perspective though.  Yes, we’re in a period of sub-par growth.  But how sub-par is is this growth in historical perspective?  The following chart is from Thomas Piketty’s Capital, the groundbreaking book on wealth inequality.  One of the points I highlighted in the book earlier this year was Piketty’s idea that wealth inequality was likely to hurt future growth.  I pointed out that this idea wasn’t supported by recent economic data.  In fact, during the periods when the return on capital was highest the rate of growth appeared to accelerate.


Anyhow, when we look at historical growth in global output we see a clear trend.  And recent history has been a period of incredible growth.  The period from 1950-1990 was the highest on record.   The period from 1990-2012 was lower than the 1950-1990 period, but still substantially higher than any period before that – by a huge margin.

So yes, we might be in a period of sub-par growth relative to the 1950-1990 period.  But when you look at the long-term trends in place you can see that we’re actually still far better off than we were just a lifetime ago.   Sure, things aren’t as good as they were just a few decades ago, but they aren’t anywhere close to being as bad as they were several centuries ago.  We live in a period of incredible global expansion and output.  We shouldn’t lose perspective here just because the current decade isn’t quite as strong as recent decades.

Chart of the day – Silly Charts Edition

Here’s a lesson in the dangers of charting.  The following quote is from John Mauldin’s latest weekly letter.  He’s making the case for a bond bubble.  This chart specifically refers to US government 10 years:

One day, all the debt will come due, and it will end with a bang. “We are building a bigger time bomb” with $500 billion a year in debt coming due between 2018 and 2020, at a point in time when the bonds might not be able to be refinanced as easily as they are today, Mr. Ross said. Government bonds are not even safe because if they revert to the average yield seen between 2000 and 2010, ten year treasuries would be down 23 percent. “If there is so much downside risk in normal treasuries,” riskier high yield is even more mispriced, Mr. Ross said. “We may look back and say the real bubble is debt.”


I have a couple of thoughts here:

1)  The debt actually doesn’t all “come due”.  In a credit based monetary system it’s actually impossible for ALL of the debt to come due because that would actually eliminate most of the money we use.  Repaying loans destroys deposits just like new loans create deposits.  But think of this specifically from the government’s perspective.  The only way the debt goes away is if the government goes away or is reduced SUBSTANTIALLY.  But the reason the government’s debt continually expands is because the services never go away.  The government tends to grow in-line with the economy and the population as the needs of the public grow.  That doesn’t mean the government can’t shrink or that debt can’t be reduced, but it’s virtually impossible for it to all “come due”.  I’m not against shrinking the size of government at all, but I think the terminology here is a little misleading.

2)  More importantly, the chart is a case of manipulating the axis on one side to make the other lines appear similar.  If you look closely you’ll see that the Nasdaq expanded over 400% over this period while the bonds are up just 33%. Using this sort of analysis could lead one to justify the idea of a “bubble” using almost any level of price rise at all.  That’s obviously not very useful and in this case a 33% rise and a 400% rise are obviously apples and oranges.

I’ve been debunking the US government “bond bubble” story for over 4 years now so you’ve probably read some version of this over the years.  But this doesn’t mean bonds aren’t potentially overpriced. Especially junk bonds and some other corporate bonds that have benefited from the chase for yield induced by the Fed. But I think we have to be careful about the term “bubble”, especially when discussing government bonds. “Bubble” implies an extraordinarily overpriced market susceptible to tremendous downside. Frankly, I don’t think Treasury Bonds look remotely similar to something like the Nasdaq….

The Contradiction of “Passive” Index Fund Investing

I am a huge fan of index fund investing.  I use index funds in my approaches and I can’t emphasize how important it is to maintain a low fee, diversified and tax efficient investment structure.  When it comes to creating an efficient portfolio approach there is, in my opinion, no better way to do this than using low fee and tax efficient index funds.

I have a minor beef with some other indexers though.  I am probably being overly precise and anal in my views here, but I don’t like the way some index fund advocates promote their approach because once one looks at this from the macro perspective it becomes clear that many indexers are hypocritical and employ a much more “active” and forecast based approach than they imply.  Let me explain.

The nice thing about taking a macro approach like mine is that we can get a very clear 30,000 foot view of the world.  If we look at the world’s financial assets in aggregate then there’s obviously just one portfolio of all the world’s assets.  This can be thought of as the ultimate benchmark for global assets.  As I’ve previously noted, this study comes pretty global_portfolioclose to establishing what that portfolio looks like.   It’s roughly a 55/40/5 bonds/stocks/alternatives allocation.  When you establish a portfolio that is different from this then you’re basically saying that the global asset portfolio is wrong and that you can outperform it.  You’re declaring that you’re smarter than the global asset portfolio.

I’m probably being too hard on indexers in general here, but the reason I find this interesting is because it means that most indexers are actually active index pickers. A 70/30 stock/bond advocate is saying that he/she is smarter than the global financial asset portfolio and can pick funds better than the aggregate because they think they can forecast the returns of equities relative to bonds better than the aggregate.  Just like the stock pickers that indexers often demonize for picking assets inside a broader aggregate, they too end up picking indexes inside of this global index.  Index fund investors often berate people for trying to “beat the market”, but that’s precisely what they’re trying to do when they construct anything other than the global index.  The fact that picking indexes is more efficient and generally less risky than picking stocks doesn’t mean they aren’t actively picking assets or trying to “beat the market”, but that’s generally how the approach is portrayed.

Of course, no one can buy the global index perfectly and it wouldn’t even be appropriate for everyone to do so because we all have differing risk tolerances and financial goals.  But it just goes to show that we really are all active investors and that the key to portfolio construction is not about getting caught up in whether you’re “active” or “passive”, but really it’s about creating the portfolio that’s most efficient for your personal needs.



The Upside and Downside of Holding Cash

Earlier this week I discussed the unfortunate reality of holding cash – if you’re an investor or asset manager who holds cash you’re automatically less correlated to your benchmark.  This creates huge amounts of career risk for asset managers who are constantly compared to that benchmark.  And unfortunately, the people doing the comparing often aren’t benchmarking correctly or make these comparisons without properly accounting for the fact that “active” managers often hold cash.  This accounts for a big chunk of the managers who underperform their benchmarks – they have cash mandates or cash flow needs that require that they not be 100% fully invested all the time so they’re increasing the likelihood that their correlated benchmark is beating them.

Now, none of this is to excuse active managers for charging the high fees or creating the tax inefficiencies that often add to this underperformance.  But when we read about studies where active managers underperform it’s not necessarily because they’re bad at what they do (though, admittedly, many are) – they just aren’t doing things precisely like the index they’re often compared to.  In other words no one can realistically invest precisely like an index fund so it’s kind of silly to constantly compare yourself to an index that exists on paper and can’t be replicated perfectly in reality.

Of course, this can all be a good thing and a bad thing.  As I previously explained, most “active” managers (and really all investors) hold some cash at times because we all have cash flow needs.  Even the most “passive” investor has cash flow issues that require reinvestment or other issues that make them an imperfect “index”.   But cash can be a powerful tool in this regard.  For instance, while that cash might be creating some non-correlation to a correlated index (and increasing your underperformance risk) it’s also got the aspect of optionality that Warren Buffett talks about.  To an indexer this optionality can mean the ability to dollar cost average, rebalance, etc.  To a more active investor it can mean buying when others are fearful (as Buffett would do), making cyclical changes or being highly active (if that’s your thing).

So there’s an obvious upside and downside to cash just like any other asset.  But the important point is that cash is a necessary asset in our portfolio construction process and we all have to learn how to manage it.  Understanding its strengths and weaknesses is an important part of knowing how to do that.


Today’s (not so) Pretty Picture: The Europe vs US Divergence

No comment necessary on this one.


Three Reasons Europe is Struggling

I was watching this CNBC video with Chase’s Chief Economist Anthony Chan who cites three reasons why he thinks Europe is struggling:

1. Q1 weather in Europe hurting Q2 numbers.
2. Negative sentiment.
3. A lack of ECB action.

I don’t know about all of that. Those sort of sound like lame reasons for the lagging growth (no offense to Mr. Chan). I have three reasons of my own:

1. A flawed currency union.
2. A flawed currency union.
3. A flawed currency union.

This environment is and has been the result of the flawed currency union that is acting a lot like a gold standard handcuffing Europe’s economies. We experienced a small bounce back in the last few years from a minor trade rebalancing, but it’s been far from enough to generate substantial growth. And all the while the recovery has been very uneven with many of the periphery countries continuing to suffer.  The Japanification of Europe is continuing.

The Euro remains an inherently flawed currency system that has no efficient rebalancing mechanism. The ECB has done enough to quell solvency concerns at the sovereign level in the peripheral countries, but the ECB cannot fix the inherent imbalances that have arisen.

I continue to think that the only measure that can efficiently resolve this is a form of fiscal transfers that turns Europe into a single currency system with a national treasury that acts as a redistributive entity to help the current account deficit countries in the process of rebalancing as the existence of the single currency makes trade rebalancing a highly inefficient process (unlike the USA’s system). Until this is done I have a hard time seeing how the problems on the periphery can be resolved. As I’ve said a million times over the years the debts will continue to rise relative to growth because there is insufficient demand.  The lack of a real resolution here means continuing high sovereign debt levels, continued austerity and aggregate demand that is too weak to sustain high levels of growth.


Cullen Roche’s Not So “Pragmatic Capitalism”

I was forwarded a thoughtful and critical review of my book this morning.  It’s titled “Cullen Roch’s Not So Pragmatic Capitalism”.   While it would be great if everyone just agreed with everything I write it’s actually nice to get pushback so I appreciate this review.  I certainly don’t know everything and I am a perennial work in progress so I always try to view criticism as constructive rather than viewing it too negatively.  It’s easier to learn that way.

The review doesn’t seem to have any problems with my overall views on investing.  But it takes a broad swipe at my economic views.  That’s not surprising I guess.  My heterodox views are controversial and while I wish they were totally grounded in reality I know there’s a degree of theory and political philosophy involved here.  It’s clear that the reviewer is an Austrian advocate so I wanted to respond to a few points.

First, the reviewer states that inflation is an increase in the money supply. That’s fine, but even if it’s true then so what?  In a system with endogenous money the money supply is just about always increasing because the population needs more loans to fund future spending and investing.  Saying that inflation is an increase in the money supply actually tells us nothing about anything.  It just points out an obvious fact of life.  It’s like saying that the human population increases with time.  Okay.  So what.  Is that good, bad, what does it mean?  We know, for a fact, that more money doesn’t necessarily mean higher prices so what’s the point?  What’s the value in saying this?

He goes on to cite the money supply as the monetary base, but this is an obviously flawed measure.  If inflation were merely an increase in the monetary base then QE would have created catastrophic inflation.  It didn’t and the many Austrian predictions about hyperinflation, predicated on this underlying view, have been explained away with no empirical argument at all.

He goes on to claim:

“an autonomous currency issuer can never effectively reach absolute insolvency, without any specific regard for the nature of money and that which truly ascribes value to it: purchasing power”

This is not at all what I say in the book.  In fact, I say that an autonomous currency issuers primary concern should be purchasing power!

He then says:

“Roche fails to recognize that without savings, there can be no consumption or deferment of consumption, the latter of which is entirely forgotten in his work Pragmatic Capitalism. “

This appears to be a misunderstanding of one of the most essential concepts of the book.  Savings does not fund aggregate spending.  Saving money means someone else is not earning an income.  And spending means someone else has an income of which some portion can be saved.  The way we fund future spending is not through saving more (in fact, if you save more then aggregate spending will fall, all else being equal).  Crucially, it is investment (spending, not consumed for future production) which creates saving.  This is a complex point which Austrians continually fail to understand.  He goes on to say this is false, but confuses financial assets with non-financial assets which is like talking apples and oranges.

Anyhow, I enjoyed the critique even if I disagreed with it.  It’s always nice feedback.







Household Debt Accumulation Remains Tepid

The situation in household debt remains tepid according to the latest household debt report from the NY Fed.  According to the report Q2 household debt fell slightly:

“Aggregate consumer debt was roughly flat in the 2nd quarter of 2014, showing a minor decrease of $18 billion. As of June 30, 2014, total consumer indebtedness was $11.63 trillion, down by 0.2% from its level in the first quarter of 2014. Overall consumer debt still remains 8.2% below its 2008Q3 peak of $12.68 trillion.”

Mortgages, the largest component of household debt, accounted for the decline:

“Mortgages, the largest component of household debt, decreased by 0.8%. Mortgage balances shown on consumer credit reports stand at $8.10 trillion, down by $69 billion from their level in the first quarter. Balances on home equity lines of credit (HELOC) also dropped by $5 billion (1.0%) in the second quarter and now stand at $521 billion.”

Outside of housing there was a broad gain in household debt:

“Non-housing debt balances increased by 1.9 %, boosted by gains in all categories. Auto loan balances increased by $30 billion; student loan balances increased by $7 billion; credit card balances increased by $10 billion; and other non-housing balances increased by $9 billion.”


The continued weakness in housing is a direct extension of the weak consumer balance sheet.  It’s a worrisome sign to say the least.  While the de-leveraging appears to be ending (or at least slowing) there are still substantial signs of fragility at work.