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The many insights of prospect theory

My latest column in the Financial Times looks at some of the helpful ways that prospect theory illuminates how asset prices are set and fund managers are rewarded.  Prospect theory originally developed from studies carried out by psychologist Daniel Kahneman and his colleague Amos Tversky. Prof Kahneman’s must read book Thinking Fast, Thinking Slow continues to ride high in the bestseller lists. To read the column on the FT website follow this link.

Written by Jonathan Davis

July 2, 2014 at 12:41 PM

The cost of Europe’s deal

The latest Greek deal appears to have a fair chance of working in the short term, but it has not been without significant costs, especially for investors in European sovereign debt, as Jim Leaviss of M&G explains in this latest comment on the firm’s always excellent Bond Vigilantes blog. Of the five lessons he draws from the latest deal, his last is probably the most important from a long term perspective.

This was a bad deal, not because bond investors took losses, but because the losses they took were too small.  Even under heroic growth assumptions Greek debt to GDP will barely get down to 120 percent. The population will live with austerity for years and Greece will probably default again anyway.  And as others implement extreme austerity too, we’ll see the rise of extreme politics across the Eurozone. One lesson that policy makers across the world keep missing is that imposing punishment on moral hazard “sinners” is a luxury we don’t have in the middle of this series of crises. There have rightly been comparisons made between the terms of the Greek restructuring and the reparation terms that Germany was forced to accept after the First World War.  The biggest wave of defaults has yet to happen – not in the bond markets, but with the breaking of promises (retirement ages, pension entitlements, healthcare) made to complacent western populations.

Whether the Greeks default sooner rather than later, we will all be living with the consequences for a long time. The security of European sovereign debt has been downgraded, without yet solving the problem the deal is designed to address. It may have.prevented a short-term crisis, in other words, for which investors could be grateful, but at what longer term cost we don’t yet know. More government promises will inevitably be reneged on in the years ahead.

Written by Jonathan Davis

March 2, 2012 at 1:25 PM

New Year hopes

My suspicions back in the autumn that a market rally was on the way have, I am happy to say, been borne our by events. Not for the first time, the peak of rhetorical despair – this time about the dire outlook for the world economy should the Eurozone crisis not be resolved – has turned out to be the moment to turn bullish. The rally since the failure of the Cannes summit has been impressive.

The MSCI world index is up by more than 20 per cent since its October low and has risen for seven straight weeks in a row, something that has not happened since the spring of 2009, according to the equity strategists at Societe Generale. Equity markets have made an even stronger start in 2012, with January producing one of its best monthly returns for many years. Contrarian sentiment indicators, such as the venerable Investors Intelligence survey of investment advisors in the United States, once again proved invaluable in identifying a turning point back in the autumn.

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Forecasts be damned

If someone told you that the end of the world was coming tomorrow, and the day passed without incident, would you be inclined to believe the same person the next time they came out with a piece of radical advice? I doubt it.  Yet one of the wonders of markets and economics is how quickly even sensible investors will switch their assumptions about the future without missing a beat.

The latest example of this bizarre phenomenon was evident in the Chancellor’s Autumn Statement. The independent Office for Budget Responsibility, run by Robert Chote, a formidably bright former economist colleague of mine on The Independent, has drastically reduced its forecasts of future economic growth. They are radically different from the forecasts the same body presented just a few months ago. Yet by some magical process they are already being treated as gospel truth. Read the rest of this entry »

Written by Jonathan Davis

December 3, 2011 at 11:30 AM

Time to watch that basket closely

An interesting range of views from market-watchers in this story from the Financial Times today.  Investors are slowly waking up to the lopsided nature of the currrent global market dynamics, in which there is an apparently real risk of a severe negative market event – either in Europe or in the United States – but one which still falls short of being a likely outcome.

How to position yourself  if you rate the probability of this occurring at say 20%? Is that high enough to justify taking extreme defensive action in anticipation of just such an outcome? That will ultimately depend on your tolerance for risk. A number of well regarded fund managers whose opinions I track have taken their holdings of cash to higher than normal levels in recenet weeks, although few have taken it as far as George Soros, whose Quantum Endowment Fund,  as I noted yesterday, is reported to be 75% in cash (although this is likely to include a range of currencies, which these days are often treated as proxies for other types of investment).

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Written by Jonathan Davis

July 29, 2011 at 6:08 PM

Economists and banks

Some observations on economists from veteran US investor Laslzo Birinyi, writing in the Financial Times.

In my experience, economists are not equipped by training or discipline to provide insight and guidance on stocks. As manifest by an number of cliches, the bond market is about here and now, while stocks are always looking ahead. Hence economists, almost by definition, “lead from the rear”.

Their recent concern regarding the banks and the implication for the financial system may indeed be correct, but I would note that the recent weakness of the traditional banks is actually the norm. In the nine bull markets back to 1962, 48 per cent of banks’s ultimate gains was made in the first two months of the rally. In the last two bull markets, after the first two months, banks not only underperformed, they were actually down the rest of the rally.

US bank shares certainly have been going nowhere for some time.

Meanwhile, as the market has been indicating since the weekend, the narrow Greek vote in favour of the austerity programme – although it does nothing but defer the country’s inevitable sovereign debt default  - looks likely to be the trigger for a reversal of the straight line fall in equities and bond yields which has been such a striking feature of the last two months in the markets.

Written by Jonathan Davis

June 30, 2011 at 6:41 AM

Consistency In fund performance

According to the multi-manager team at Thames River Capital, only 16 out of the 1188 funds in the 12 main UK sectors have delivered top quartile returns in all three of the last three fiscal years (March to March). Only 102 of the funds, or less than 10% of the total, managed to achieve even above average returns in all three years. In many sectors, including all the bond funds, not one fund managed to be top quartile in each of the three years. Shock horror? No, this lack of consistency should come as no surprise, since most funds tend to follow a consistent style and thus their relative performance invariably changes when the market itself changes direction, as it notably did in March 2009. Read the rest of this entry »

Written by Jonathan Davis

May 28, 2011 at 4:54 PM

Anything but gilts

My latest piece in The Spectator discusses what might make a future trade of the decade to match that which was the standout (and therefore widely ignored) long term trade at the time of the Prince Charles- Princess Diana wedding in 1981. Then the trade was to buy UK Government bonds; now, I argue, it would be to buy anything but gilts, and concentrate on assets which can withstand the inevitable arrival of inflation.   Note that I am discussing here the best long term buys and sells facing investors today, not which asset class might do best in the next few months (when I fear that a new deflation scare, which would be positive for gilts, remains a distinct possibility).

Written by Jonathan Davis

May 22, 2011 at 9:07 PM

Crunch time for America and Japan

The US is likely to lose its AAA credit rating in 2013, and that will also be the last year in which both Japan and the States will be able to carry on borrowing at risk-free rates without sorting out their unsustainable fiscal deficits. That was the blunt warning today from Willem Buiter, former member of the Bank of England Monetary Policy Committee, now Chief Economist at Citigroup.

Speaking at the CFA Institute conference in Edinburgh, Mr Buiter added that the bond market might well force the inevitable 3% rise in US Treasury bond yields even earlier than that date, for example if Chicago was about to go bust. The best chance of the US finally getting to grips with its huge debt burden would be immediately after the 2012 elections, but as yet there are absolutely no signs of a bipartisan approach to a solution.

Written by Jonathan Davis

May 10, 2011 at 3:27 PM

Something different, something new

Having decided against taking up a job in the City three months ago, I have been adding instead to my portfolio of outside interests with a couple of non-executive appointments, as a director of the Jupiter Primadona Growth Trust and as a member of the investment committee of D&G Asset Management, a firm which specialises in prime central London residential property. Starting today, following a brief interlude, I have also resumed a monthly column in the Financial Times, in which I comment on the Buffett/Sokol affair and Jeremy Grantham’s latest Quarterly Letter. (You can also read here an interview I did with Grantham in 2007, when he advocated extreme caution ahead of the credit crisis). More new things to follow.

Written by Jonathan Davis

May 9, 2011 at 6:50 PM

Posted in Editor, Uncategorized

Currency debasement (continued)

Highlight of the first morning of the CFA Institute conference in Edinburgh, which I am attending in various capacities, was a laconic and entertaining session with Jim Grant, the Editor of Grant’s Interest Rate Observer, in which he cleverly skewered the follies of US monetary policy and advocated the return of some form of market-based monetary system (preferably backed by gold) in place of the current debasement system he described as the “PhD standard” (so called in ironic tribute to Ben Bernanke’s academic credentials). He quoted approvingly William Buckley’s comment: “I would rather be ruled by the first 450 names in the Boston phonebook than by the faculty of Harvard”.

Written by Jonathan Davis

May 9, 2011 at 1:41 PM

Posted in Uncategorized

The word from Warren Buffett

I don’t know how many of you had time to catch up with Warren Buffett’s annual appearance on the TV channel CNBC last week, timed to coincide with the appearance of his widely followed Letter to Shareholders, but I thought it might be useful to note the most important things that struck me from the transcript of his three-hour appearance. (Listening to the video of the show means having to sit through a lot of banter from the presenters, not to mention regular commercial breaks, making it a far too time-consuming way for most people to keep track of what he had to say).

This is my quick and dirty summary of the main things he had to say:

He thinks that the Federal Reserve has done enough monetary stimulus with the QE2 programme of quantitative easing.  US monetary and fiscal stimulus combined will be equal to 10% of GDP this year, a massive amount. Stimulus was important in fending off the banking crisis, but now it is time to trust in the “natural regenerative capacity of capitalism”. Again, in his words: “There is a resiliency to the American system. It does work”.

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Written by Jonathan Davis

March 9, 2011 at 3:20 PM

Is Japan a buy? A new report says yes

My friend and collaborator Dr Sandy Nairn, the CEO of Edinburgh Partners, and former Director of Global Equity Research at the Templeton/Franklin group, argues the case for taking a long, hard look at the Japanese equity market in the latest briefing paper published by Independent Investor. You can download the full 20-page report Is Japan a Buy? for free from the Independent Investor website.  Simply follow the link on the right hand side of the home page.

The case for Japan has been made many times over the last 20 years, but the trend of the market, as we all know, has been one of prolonged decline, punctuated by periodic false dawn rallies. Dr Nairn concludes however, after looking in detail at the 40 year trends in Japanese profitability, growth, national debt and demographics that there are now compelling reasons for buying into the Japanese story. Many shares are cheap and it is a myth that all Japanese companies are condemned to earn lower profits than their counterparts in other countries.

Written by Jonathan Davis

January 10, 2011 at 11:59 AM

Thoughts on 1994

My latest FT column discusses the events of 1994, when the bond market blew a fuse and caused extensive losses for hedge funds, insurance companies and investment banks. While there are many differences between the events of that year and those of 2010, there are also some interesting parallels. In particular I argue that those who have been surprised by last week’s sharp fall in bond prices should not claim to be surprised. There is no historical precedent for such a view.

Nobody knows for sure whether the 28-year long bull market in Government bonds has finally ended (although it seems more than likely to me, as I am in the camp that fears inflation more than deflation from here), but the risks of another 1994-style episode are still considerable as and when interest rates eventually rise. With luck this time however the huge leverage that caused so much trouble in 1994 won’t be repeated. Surely the banks and brokerages that lent so recklessly to fund the leveraged bond positions of those who lost so much money in 1994 won’t make the same mistake again….for a while, anyway.

Written by Jonathan Davis

December 12, 2010 at 10:12 PM

Gold still in the ascendant

Back from a break of two weeks to find that gold continues its inexorable ascent, briefly breaking the $1400 an ounce mark for the first time. It is interesting that the barbarous relic is finally becoming a subject of serious debate in mainstream institutional circles, as evidenced by the fierce debate that has greeted the President of the World Bank’s entirely sensible comment that gold should be among the indicators of inflationary expectations that are monitored by central banks.

On Saturday the Financial Times, the illustrious paper for which I write, carried a measured full page feature on the causes of the revival in interest in gold’s place in financial markets. This perhaps may have been prompted by the lively (and mostly critical) correspondence that its consistent anti-gold editorial stance over the years has engendered. To judge by the ferocity with which some mainstream economists have reacted to the President of the World Bank’s modest proposal, you would think that he had been advocating a full-blown return to the gold standard.

Jim Slater, who co-founded Agrifirma Brazil, the farmland venture in which I am also a founding shareholder,  has written a  lively defence of gold as an investment on his website. Here is an extract: Read the rest of this entry »

Written by Jonathan Davis

November 15, 2010 at 1:10 PM

Unarguable Sense From Philip Gibbs

Some bullet points and a telling slide from a recent presentation by Philip Gibbs, the  fund manager and financials expert at Jupiter Asset Management. Not much need to comment, as it is hard to argue with anything in it (although the recent performance of Philip’s funds has been somewhat disappointing by his own exalted standards).

Medium term investment outlook:

  • Emerging market assets and currencies are by far favoured over the developed world.
  • On a view of a few years it seems highly probable that a crisis will ensue as a result of developed world indebtedness.  Governments may have to print so much money that they will unleash inflation.  US and Japanese government bonds will probably perform terribly.
  • Western equities relying on Western consumers will face many problems as a result of this situation.
  • The Swiss Franc and gold will probably perform exceptionally well.  The dollar and the yen and sterling and the Euro look to have a dismal outlook.

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Written by Jonathan Davis

September 27, 2010 at 9:27 AM

Notes and Quotes

Here are some comments that have caught my eye in the last few days (a regular feature on this blog).

From Don Coxe, long time Canadian market strategist and commodity fund manager, in his always excellent Basic Points monthly strategy report, noting IBM’s recent offering of a three-year bond yielding (remarkably) less than 1%:

When a $1.5 billion offering of a single “A” three-year corporate bond with a 1% coupon is over-subscribed and routinely trades above-par in the after market, any talk of near-term inflation must be coming from the under-informed or the perilously paranoid.

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Written by Jonathan Davis

September 18, 2010 at 12:09 PM

Quick Thought on Gold

The news this week is  that gold has once again made a new high. It has broken the $1250 an ounce mark for the first time. While I do not count myself as a gold bug, the arguments for owning gold as a store of value and insurance against monetary instability continue to be compelling. I have a significant exposure to physical gold ETFs in my portfolio, having bought in when the price was between $700 and $800, and no intention of selling at these prices.

It may be worth taking a look at the longer term price chart of gold for understanding where we are in the gold cycle. The upturn in gold’s fortunes begain in 2001, not coincidentally around the time that Alan Greenspan, in an attempt to offset the consequences of the Internet bubble and (later) the 9/11 atrocities,  embarked on his disastrous cheap money policy, the consequences of which we are still having to deal with today.

Gold price - standard graph

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Written by Jonathan Davis

September 15, 2010 at 9:39 PM

Posted in Gold, Uncategorized

A Struggle For Hedge Funds

This item from the Financial Times caught my eye today:

Paulson & Co, the world’s third-largest hedge fund manager, has seen another painful month thanks to growing fears over the health of the US economy. The firm’s $9bn Advantage Plus fund, which aims to profit from trading corporate events, lost 4.26 per cent in August, according to an investor, wiping out gains made in July. The fund, Paulson & Co’s largest, is down 11 per cent so far this year.

Paulson & Co is far from alone in having had a difficult year. Very few hedge fund managers have reported strong performance in the past eight months.  The average hedge fund manager made just 0.17 per cent in August, according to Hedge Fund Research, and has returned just 1.29 per cent so far this year. Pressure is now on for many managers to deliver stronger returns in the next four months.

My long-held sceptical views about hedge funds as a group have not, shall we say, been tested by this latest news. The very best hedge fund managers are terrific, but they are a small minority, so you have to pick them with care (if that is, they allow you to invest with them in the first place). There is sufficient academic evidence to show beyond reasonable doubt that many hedge funds are charging very high fees for performance that they don’t really earn, while the risk-reward structure is heavily weighted in favour of the manager at the expense of the client.

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Written by Jonathan Davis

September 9, 2010 at 9:10 PM

More On The Great Optimists

Having mentioned grounds for optimism in the equity market in my last post, it is striking that the markets have perked up suddenly in the last 48 hours – no more than a happy coincidence, I fear, as for now the markets remain in their trading range and are merely reacting to individual items of  economic or political news that by their nature have little in the way of reliable or enduring meaning. The tug of war between inflationists and deflationists, and between double dippers and equity bulls, goes on, and most likely will do for some time.

The FTSE All Share chart, for instance, continues to trade in a band around its 200 day moving average, which itself is struggling to find a new direction. It is difficult to read anything into this lack of direction other for the moment  than that it is still consistent with either school of thought being ultimately proved right. At some point we will witness a breakout that gives a more positive clue as to where the markets are heading.

It was interesting to see the Financial Times reproducing Bill Miller‘s positive take on large cap US stocks in the paper yesterday. These comments in fact originally date back to his quarterly market commentary written more than a month ago, something I logged at the time. Bill is one of the professional investors I was referring to in the last post, and someone whose views I have followed for a long time, but I could name several others. Having performed very badly through the credit crisis, and misread  the last bear market completely, such is the way of the markets that few probably take much notice of his comments any more – which doesn’t mean he is wrong, merely out of favour.

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Written by Jonathan Davis

September 2, 2010 at 2:57 PM