Wheel of Fortune?

Where are you on the wheel of fortune?

Wheel of Fortune. Source: Wikipedia

When I was growing up one of the most popular TV game-shows was “Wheel of Fortune.” Contestants would solve a word puzzle similar to “hangman” and spin a giant carnival wheel to win cash and prizes. The show has run for over 30 years. It’s appeal is that it encourages viewers to play along–to try and guess the mystery phrase before the contestants.

But before there was a TV show, there was another wheel of fortune, or rota fortunae. It’s a concept from ancient and medieval philosophy that characterizes fate, or chance. The goddess Fortuna would spin the wheel at random, changing the positions of those on the wheel. Some would suffer misfortune, others would gain windfalls. Fortune herself was blindfolded.

Wheel of Fortune woodcut by A. Durer. Source: Wikipedia

The concept has come down to modern culture, although Fortuna is sometimes replaced by Lady Luck. Jerry Garcia co-wrote “The Wheel” and performed it with the Grateful Dead in the ‘70s and ‘80s. In the TV series Firefly the main character notes “The Wheel never stops turning” several times.

It’s important for investors to understand the role of fortune in their portfolios. The investment world is not an orderly and logical place. Much of investing is ruled by luck. Every once in a while, someone makes an outsized bet on an improbable outcome that ends up working out and ends up looking like a genius. But whether a decision is correct can’t be judged just from its outcome. A good decision is one that’s optimal at the time it’s made, when the future is unknown. A good decision weighs the probable outcomes and measures potential risk and reward.

In sixth century Rome, the philosopher Boethius was awaiting trial—and eventual execution—on a trumped up charge. While in prison, he reflected on how to be content in a world beset by evil. He concluded that current conditions are always in flux—rolling on the rim of the Wheel of Fortune. The only thing we can control is ourselves. True happiness comes from inside.

Boethius imprisoned. Source: Wikipedia

In the same way, investors can’t control the circumstances of the market or the global economy. Market prices are always fluctuating. But they can control the quality of the securities they hold. Circumstances may be volatile, but economic values don’t change all that much.

The Wheel of Fortune is always turning, lifting us up or taking us back down. Bad things can happen to good companies. We need to look inside what we own to see what our investments are really worth.

Douglas R. Tengdin, CFA

Chief Investment Officer

A Bit Here, A Bit There

Bitcoin is impossible.

Salvadore Dali: “The Persistency of Memory.” 1931. Source: MOMA

Although the digital-currency is accepted by more and more merchants, it’s hard to see why someone should convert dollars into bitcoins just to have a merchant convert them back. All these transactions are recorded at a bank, so there’s no real gain in anonymity—bitcoin’s main selling point.

Almost no one is paid in bitcoins; the folks with the best incentive to use them are those who bought some earlier and are now cashing out. The currency’s appreciation is its principal problem: there’s no incentive to invest. Since the supply of bitcoins is ultimately fixed, they become more valuable just by sitting in an account–or on a flash drive. Monetary deflation—with its attendant problems—is inevitable. Credit dries up. An economy stagnates without credit—just look at Japan.

But that doesn’t mean that there aren’t lessons to learn from the technology. A key part of what makes bitcoin work is its blockchain—the distributed database that validates every transaction—tracing the coin back to its creation. Blockchain has the potential to make bank payments and securities transactions more efficient and safe. Currently it takes over a month to settle some securities after they’ve been traded. Our financial infrastructure is centralized, antiquated, and insecure—based on 1980s technology.

Just because something’s impossible doesn’t mean it’s worthless. Thomas Edison once quipped that he hadn’t failed, he’d just found 10,000 ways that won’t work. Hopefully, it won’t take that many false starts to learn from bitcoin.

Douglas R. Tengdin, CFA

Chief Investment Officer

Something Old, Something New

What countries are the most innovative?

Source: Morguefile

It’s not an easy question. In addition to counting the number of patent applications, you need to examine the number of peer-reviewed articles, how widely that research is disseminated, new business formation, royalty and license fees, export revenues, even video uploads onto the internet. Innovation is important. Not only is it a key driver of economic success, but it also can improve our quality of life. In Africa, for example, access to clean water allows children to attend school, rather than spending up to 8 hours per day fetching water for their families.

An academic group ranked the innovation performance of 141 countries based on 79 indicators. The most innovative economies are not surprising: Switzerland, the UK, Sweden, Holland, and the US top the list. They’re wealthy, they invest a lot into research and development, and they protect intellectual property.

But there are some surprises as well. Although Vietnam is relatively poor, it punches well above its economic weight. It imports and exports a lot of high-tech and creative goods for a developing nation. On the other side, Qatar scores fairly poorly, for an oil-rich nation—about the same as Vietnam. They don’t invest as much in education, nor do they have much of a high-tech sector.

Source: The Economist

Efficient innovators are more effective at generating new ideas, given their investment in education and infrastructure. It’s notable how large China looms—given the size of its economy and its population. Clearly, their leaders have made creativity and research a national priority.

As many countries wrestle with the recent fall in oil and other commodity prices, it’s worth remembering: wealth isn’t extracted from the ground, it’s created by people. The ultimate economic resource is the human mind.

Douglas R. Tengdin, CFA

Chief Investment Officer

Known Unknowns

Known Unknowns

“I know something you don’t know.”

© MGM 1987. Source: IMDB

In The Princess Bride one of the characters smiles during an epic sword fight as he is forced back, step-by-step, towards the edge of a cliff. When his assailant asks why, he says that he knows something the other doesn’t: he’s not left-handed. As he changes hands, the tide of the fight turns.

As the market struggles with fears of a Chinese economic slowdown, concerns about energy stocks, and questions about Europe, many participants are quietly smiling: they know something many don’t: we’ve been here before.

Not at this specific point in history with these specific problems. But the problems that we are facing are fairly well understood. Developing nations with a bloated public sector needing economic restructuring? Latin America in the early ‘90s. A stagnant, jobless recovery and fears of deflation? The US in ’03-’04. Oversupply of a key economic component leading to structural issues? Oil in the late ‘80s—just like oil today.

The triple challenges of China, Europe, and oil are weighing on the market, but they are fairly well-understood, and the global economy has faced them before. There are lots of ways for policy-makers to address them. The more the market worries about these issues, the more opportunities there are to invest profitably.

It’s not the problems we know about that should worry us. It’s what we don’t know about.

Douglas R. Tengdin, CFA

Chief Investment Officer

Diversifying Our Lives

Diversification works.

“Fright of Astyanax” by Benjamin West (1797). Source: Getty Museum. This drawing was owned by Thomas Jefferson and exhibited in his parlor at Monticello.

That’s the secret to the success of many major products. Coca-Cola was created when someone accidentally added carbonation to medicinal syrup. Play-Doh was supposed to be a wallpaper cleaner. Toothpaste started as a homemade powder made from salt and burnt bread until someone noticed Parisian painters squeezing their pigments out of lead tubes and applied the lesson.

Steve Jobs told about how he created proportionally-spaced fonts for the original Macintosh. He had dropped out of college, but continued to audit courses that looked interesting. One of these was calligraphy. He was captivated by the beautiful, subtle way that great typography can subtly convey meaning and mood to a text. 10 years later he designed the Mac to have lovely typefaces.

It’s important to diversify not just our portfolios, but our lives, and not just to improve our returns. Being able to appreciate a beautiful sunrise or a passage from Shakespeare improves our outlook on everything. Thomas Jefferson had paintings and illustrations throughout his home; he was also an accomplished violinist. There’s no proof, but I believe that music and art helped him to be a better writer and more able administrator. They certainly aided his pursuit of happiness.

We can’t connect the dots in our lives looking forward; we can only see the pattern looking backwards. We have to balance our work, family, health, and spiritual pursuits. We may never get a lucky break. But if our lives are rich enough, we won’t need luck.

Douglas R. Tengdin, CFA

Chief Investment Officer

Cheaters Never Prosper?

People cheat.

Photo: Gerd Altman. Source: Pixabay

That’s the not-so-surprising conclusion from the VW’s “Dieselgate.” But before VW installed adaptive software to sense when their cars were being tested, there was a scam involving heavy trucks. 15 years ago Navistar, Renault, and Volvo paid over $1 billion in fines for installing devices to defeat exhaust tests on their vehicles. Last year Hyundai paid $300 million for overstating mileage claims on its cars. In 1996 GM recalled half a million Cadillacs that had a chip to shut off emissions controls when the air conditioner was on.

Lest you think it’s just auto makers who cheat, check out Google and YouTube. It’s easy to learn how to remove or punch holes in a car’s catalytic converter—improving mileage and power in a lot of cars. Then type “auto inspection cheats” to see how to fool the inspector. All the outrage about VW’s scandal reminds me of the scene from Casablanca, where Inspector Renault says he is shocked, shocked to find gambling going on in Rick’s café—just before an assistant hands him his winnings.

As long as there are audits and inspections, people will try to cheat and manipulate the score–whether it’s emissions testing or high school grades or football or investment management. This has been the case ever since Adam and Eve hacked their supervisor’s ethics-evaluation system–“knowing good and evil.” We’re born to trouble as the sparks fly upward.

For VW, it will take a while to reestablish trust after a scandal like this. But people need cars and companies to build them. The struggle between mileage and performance and emissions and costs will continue. Hopefully, we’ll just keep stumbling forward.

Douglas R. Tengdin, CFA

Chief Investment Officer

Portrait of an Innovator

How do we innovate?

Our economy runs on creativity and innovation. Innovation created light bulbs. It inspired the internet. It allows new ideas to flourish, like transistors, integrated circuits, and laser beams. But where does innovation come from?


Inventor Art Fry with Post-It note. Source: Wikipedia

Innovators often feel guilty, because they didn’t really do anything. They just connected a couple of ideas and saw something new. It seemed obvious at the time. A specific problem went searching for a solution—and that solution was adapted and generalized.

A great example is the post-it note. In 1968 a scientist at 3M—makers of Scotch Tape—was trying to develop a super-strong adhesive. Instead, he accidentally created a reusable, pressure-sensitive, low-tack bonding agent. The new product went practically undeveloped within the company for five years until another scientist—Art Fry—used it to anchor bookmarks in a hymnbook he used in the church choir. Now 3M sells over $1 billion of sticky notes per year in over 100 countries.

The best innovations are often staring us in the face. People just need the freedom to tinker, experiment, and fail—because a new recipe never comes out perfect the first time. Bill McKnight, an early leader at 3M, said that if you put fences around people you get sheep—and sheep never come up with new ideas. What innovators need is room.

Douglas R. Tengdin, CFA

Chief Investment Officer

Money for Nothing Forever?

Why are interest rates so low?

Source: Morguefile

It’s easy to see our ultra-low interest rates and blame the Fed. After all, they set short-term rates; they’re the ones managing the money supply; they’re the ones that oversee the banking system. But interest rates are low everywhere—not just in the US. And real interest rates—the difference between interest rates and inflation—have been falling for decades. Well before the financial crisis, long-term bond yields around the world began falling from 4% above inflation to roughly equal to inflation.

Source: Bank Underground

The low rates we see today would have been unimaginable a generation ago. I remember a friend in the early ‘80s who was thrilled to get a mortgage for only 8%: “We’ll never see that rate again,” her banker told her. Now, however, governments, corporations, and consumers around the world can get money for almost nothing. On the flip side, though, savers get almost nothing for their money. What’s causing this?

There are lots of possible culprits: technology, productivity, slower global growth. But the explanation that makes the most sense to me is one suggested by Ben Bernanke a decade ago: there’s a global savings glut: more people are setting more money aside and there aren’t enough productive ways to put that money to work.

What’s causing this? I see three major issues. First, demographics: people live longer but don’t necessarily work longer. Our life expectancy has risen, but our retirement age hasn’t gone up as much. That means more has to be set aside to pay for a longer retirement period. Second, global wealth: the rising middle class in emerging economies is generating significant amounts of new wealth. Rich and middle-class people save more than poor people. Finally, technology: the infrastructure of economic growth has changed. New industries don’t need as much capital as older industries. It takes more investment to produce concrete and steel than software and fiber optics. Also, code doesn’t pollute the environment—and doesn’t need to be cleaned up.

These are global, long-term trends. They aren’t likely to turn around any time soon—you can’t put the demographic, financial, and technological toothpaste back in the tube. Ultra-low real rates are going to be with us for a long, long time.

Douglas R. Tengdin, CFA

Chief Investment Officer

Topsy-Turvy Turnings

What’s going on? Did someone reverse the polarity?

Earth’s magnetic field, normal and reversed. Source: NASA

Everything is working backwards. In a normal world, Democrats run a free-for-all donnybrook during primary season, while Republicans are orderly and measured, choosing the next-person-in-line. In a normal world, German engineers build cars to be quietly dependable, instead of programming their autos to deceive US emissions tests. In a normal world, Greek voters change their government every couple years, instead of electing the same government to implement completely different policies.

Markets have always been a puzzle. Economist Adam Smith noted that when people pursue their self-interest, they appear to be guided by an invisible hand towards the common good—satisfying desires as efficiently as possible. Buddhist philosophy delights in paradoxical koans—contradictory questions that test one’s progress towards enlightenment—like, what is the sound of one hand clapping, or what did you look like before your mother was born. Apple’s Buddhist founder—Steve Jobs—was a ruthless competitor and an exacting boss. Is Apple a new koan?

Every million years or so, Earth’s magnetic field inverts, so the south pole becomes the north pole, and vice-versa. If that happened today, birds would fly north in the fall and extinct volcanoes would start erupting. The way things are changing, we should check which way the compass is pointing.

Douglas R. Tengdin, CFA

Chief Investment Officer

Central Banker to the World

What is the Fed’s role?

F15s and F16s over Kuwait, 1991. Photo: USAF. Source Wikipedia

Yesterday the Fed decided to keep interest rates near zero. It was a tough call. Employment has improved by more than the Fed expected, but inflation has moved away from the Fed’s target. Economists were evenly divided as to whether they would or even should raise rates this meeting.

In their statement, they comment that “recent global economic and financial issues may restrain economic activity.” Janet Yellen reinforced this in her press conference, where she said that they focused particularly on China and emerging markets. In other words, global markets spooked the Fed. They really are in a box: volatility rose and stocks fell because the Fed was expected to raise rates. With policy unchanged, volatility will fall and markets rise. And the next time the FOMC is ready to raise rates, markets will sell off again, spooking the central bank—lather, rinse, repeat.

VIX Volatility Index. Source: Bloomberg

It’s particularly notable that the FOMC chose to focus on global issues. The Fed is really acting as if they are central banker to the world. The market recent correction began in China, where concerns about their slowdown have led to a 40% pullback. China accounts for an increasing share of the world’s economy. But they have their own currency and their own central bank.

It’s hard for the Fed to be the world’s central banker. No one elected them; The UN didn’t appoint them; domestic citizens won’t understand; foreign folks will resent what seems like US hegemony. It’s a thankless task—like when King Arthur rides up to a peasant in Monty Python and the Holy Grail: she says, “You’re King? I didn’t vote for you.” But nature abhors a vacuum. Having stepped into the role, the Fed will find it hard to walk away.

It’s like being the world’s policeman—all you have is force, and there’s nothing to legitimize your power. But once you’ve begun, the alternative is chaos.

Douglas R. Tengdin, CFA

Chief Investment Officer

Douglas Tengdin's Global Market Update