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Anchors Away! Is the US retail boat sinking?

By | Economics

If you put one or more buildings together and form a complex of shops representing merchandisers, add to that interconnected walkways enabling visitors to walk from unit to unit, you get what is known as the great American shopping mall. 

1,500 malls were built in the US between 1956 and 2005, and their rate of growth often outpaced that of the population. They replaced main street and became the epicentre of communities, the foundation of retail economies, and the place for teenagers everywhere to see and be seen.

At the heart of these malls has been the main stays of American retail, the department stores. They have been come to be known as the “anchors.” Every mall has them and it is these stores that make up a large portion of the retail space being dominated by one brand. Without them, there is a very large hole to fill. 

Malls became so popular over the years that everybody wanted in until the point where the market became saturated. “We are over retailed,” according to Ronald Friedman, a partner at Marcum LLP, which researches consumer trends. There is an estimated 26 square foot of retail for every person in the US, compared with about 2.5 square foot per capita in Europe. Howard Davidowitz, famed retail analyst says, “the US has 5 times more retail space per capita than that of Japan, Canada, UK or France.”   

Like anything else, the good times were bound to come to a halt. By the mid-2000s, the decline began slowly. The rise of the internet brought with it the rise of online shopping. The financial crisis of 2007 – 2008 brought a blow to retail that led to a drop in sales and foot traffic at big-brand retailers like Sears, JCPenney and Macy’s that anchored many of the country’s malls. Between 2010 and ’13, mall visits during the holiday season, the busiest shopping time of the year, dropped by 50%. It is clear from the chart below that Sears was badly wounded in 2007 and never recovered, in spite of all the promises of Eddie Lampert to turn the struggling retail giant around.

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When Sears merged with K-Mart in 2005, the two chains had a total of 3,500 US stores between them. As of May 5, 2018, Sears Holdings operates 894 retail locations under the mastheads of Sears (506 full-line and 23 specialty stores, for at total of 529 locations) and Kmart (365 locations), though after a round of closures announced on May 31, that number will drop to about 820.

In August 2016, Macy’s announced the planned closure of 100 stores, or about 15% of Macy’s store base at the time. 

JC Penney has about 600 mall-based stores and another 400 smaller standalone stores in smaller markets. JC Penny announced and closed 140 stores back in 2017. The King of Prussia Mall is a 2.8 million-square-foot shopping center outside Philadelphia. The 50-year-old complex has more than 50 food venues and a concierge lounge. However, a J.C. Penney department store closed in 2017 as one of the planned closures, created a hole in the anchor-store lineup.

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The closings of these stores are having an obvious impact on shopping malls across America. The malls that are not able to find an anchor to replace the legacy department stores are seeing their foot traffic dry up as the remaining stores in the mall close up or move, leaving an empty shell. Industry experts say 25 percent of US malls likely will close in the next five years, or about 300 out of the existing 1,100.

According to a recent Credit Suisse report (Credit Suisse US Retail Store Closure Index), 2018 is on track for another peak footage closure year. It shows the US retail industry is tracking to an annualized -59% YOY reduction in store unit closures in 2018 (after hitting an all-time high in ‘17). The closures are skewing toward much bigger box concepts (Toys R Us, Sears, Sam’s). The report states, “We expect elevated closures to remain a primary operational distraction and stock risk for the US retail space for several years.”

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A report by Cushman & Wakefield, states, “There were nearly 8,500 store closures in 2017, surpassing the number that occurred during the Great Recession. Closures in 2018 are expected to match or exceed that level. Announced store closures have reached approximately 4,500 year to date.” Cushman & Wakefield estimates that this figure will reach over 9,000 this year.

As we have seen many times before, there is also that familiar Gorilla at the front door waiting to make its mark on the brick and mortar market! Jeff Bezos and Amazon are making inroads into the apparel space. According to Morgan Stanley, the e-commerce giant will become the top player of the US apparel industry in 2018, having gained 1.5 percent of market share last year. To date, Amazon trails only Walmart to claim the top spot among other apparel retailers Target, Kohl’s and TJ Maxx.

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Should this be something for brick and mortar retailers to be worried about? Last year Fitch Ratings published a report that presented how a “hypothetical” rapid rise in Amazon’s U.S. apparel market share could have significant credit implications for existing retailers, REITs and CMBS (Commercial Mortgage Backed Securities) transactions.

“The Fitch shock scenario assumes an accelerated three-year apparel market share shift to as a price-competitive and convenient alternative to traditional in-store purchases. The hypothetical rapid growth in Amazon’s apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress. Assuming Amazon’s share gains are concentrated in lower price points, low to mid-tier apparel retailers, including JC Penney, Kohl’s and Dillard’s, would face intense competitive pressure in such a scenario.”

The focus of our article on troubled anchors did not go unnoticed by Fitch. 

“REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure. We estimate that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions.”

Although online has picked up some of this business and will continue to do so, the reduction cannot all be attributable to e-commerce. The desire to grow and get bigger clearly over stepped its boundaries leaving a glut of retail space on the American market. Increasing consumer debt loads in the way of car loans, credit card loans, and student loans are not positioning the consumer to be in any position in the future to come to the rescue. In fact, roughly 10% of employment in the US is in retail. All these additional closing will only put the consumer in a more precarious situation.

The death of the great American shopping mall may be a bit premature, but for the moment it is “Anchors Away” and unless these malls find a way to fill the hole or reinvent themselves fast the future doesn’t look so bright. 

The US Economy – Miracle or Mirage?

By | Economics

The economy of a country is a key talking point of most politicians, and rightly so. If you preside over a strong and growing economy, your political reign is reflected in a positive light.  If the economy of a country is weak as you enter, it will often be deflected and blamed on the predecessors faulty policies. However, there are times when the economy is struggling and the incumbents in power, making changes to improve it, will often point out the most impressive aspects, and mask over the weaknesses in order to convince the voter base that they are succeeding. 

My uncle had a saying, “When your neighbour is out of work, it is a recession; when you are out of work, it is a depression.” Your current personal economic situation will influence how you perceive the strength of the greater economy and what people are saying about it. If you are working in an affluent environment you may not perceive anything is wrong. You have money to go out to dinner, go on vacation or buy that new car you have had your eye on. In other words, your confidence in the greater economy will dictate your spending patterns. There is the counter situation, where you have no work and have essentially stopped looking, yet the financial media and politicians in power are telling you how strong the economy is. If they believe it, it may motivate people to go back to school and adapt their skills to the current job market. If they don’t believe it, they may weather the storm and pull back their spending (Nordstroms is off the table for now, time to head to Walmart). If enough people don’t believe it the true economy will eventually show its true colours no matter what the media and politicians say. 

So what is the true story? There are many economic indicators that are used to track the health of the economy. We looked at these indicators to see if they do provide some kind of clarity or, like many things, it is basically our perception of the current economic state that makes it strong or weak. 

Gross National Income (GNI) and Gross Domestic Product (GDP) are often used to judge the growth of the economy. For most nations there tends to be little difference between GDP and GNI, since the difference between income received by the country versus payments made to the rest of the world tends not to be significant. For example, according to the World Bank,  the U.S.’s GNI was only about 1.5% higher than its GDP in 2016. 

The graph below shows the Real GDP growth rate of the United States from 1990 to 2017 (GDP being the market value of all final goods and services produced within a country in a given period). The Real GDP growth is adjusted for price changes, as inflation or deflation and is chained to the U.S. dollar value of 2009. The Real GDP increased by 2.3 percent in 2017.

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It takes capital to fund growth and countries will increase their debt loads to increase that growth but if the growth doesn’t come they find themselves in the difficult situation of struggling to pay back the debts. The debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay back its debts. The US recorded a government debt equivalent to 105.40 percent of the country’s Gross Domestic Product in 2017. Government Debt to GDP in the US averaged 61.70 percent from 1940 until 2017, reaching an all time high of 118.90 percent in 1946 (funding for World War II had something to do with that) and a record low of 31.70 percent in 1981. At the moment, it doesn’t appear to be moving in the right direction.

It should be pointed out that the GDP is made up of Personal consumption + Investments + Government expenditure + Net Exports. Consumption makes up 70% of this GDP number. As mentioned above, if the consumer is in a good mood and confident about the future they will go out and spend. Many will even use credit to charge those purchases and pay another day. However, if they get worried they will pull back their spending and start saving. So in a sense, “So goes the consumer, so goes the economy.” 

The personal saving rate is calculated as the ratio of personal saving to disposable personal income and refers to these strategies of accumulating capital for future use by either not spending a part of one’s income or cutting down on certain costs. In 2017 it amounted to 2.4 percent, as opposed to 10.4 percent in 1960. This was equivalent to just over 384 billion U.S. dollars in the fourth quarter of 2017. In June 2018, the personal saving rate in the US suddenly spiked and amounted to 6.8 percent.

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It is also worth looking at the household debt to income levels of the consumer to know if they are tapped out or not. Households debt in the US increased to 78.70 percent of GDP in the fourth quarter of 2017 from 78.50 percent of GDP in the third quarter of 2017. The households debt To GDP in the US averaged 57.79 percent of GDP from 1952 until 2017, reaching an all time high of 98 percent of GDP in the first quarter of 2008 and a record low of 23.80 percent of GDP in the first quarter of 1952. The consumer, not surprisingly deleveraged after the 2008 financial crisis, however on a historical level they are still indebted well above the average. 

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We won’t even bother looking at retail, as many in the financial media do, to determine the health of the consumer. An increase in Target’s earnings or any other retailer could have a myriad of reasons behind better numbers. Better revenues could be the result of taking advantage of the demise of other retailers (JC Penny or Sears for example). It could be more astute marketing or just better managed. Equally, increased earnings could come from stock buy backs, one off charges or any number of other accounting engineering tricks. 

A much better indicator reflecting the potential health of the consumer are the employment levels. These figures, particularly the unemployment rate, tells us the percentage of the labor force that is unemployed. Since unemployment insurance records relate only to people who have applied for such benefits, and since it is impractical to count every unemployed person each month, the government conducts a monthly survey called the Current Population Survey (CPS) to measure the extent of unemployment in the country. The CPS has been conducted in the United States every month since 1940. In 1994, the CPS underwent a major redesign in order to computerize the interview process as well as to obtain more comprehensive and relevant information. There are about 60,000 eligible households in the sample for this survey. This translates into approximately 110,000 individuals each month, a large sample compared to public opinion surveys, which usually cover fewer than 2,000 people. However, they are essentially polls and we have seen in the recent past how accurate polls can be. 

The chart shows a clear decline in unemployment, yet does it really tell the true story? As campaign Trump said (video below), “Don’t believe those phony numbers.”

That was an impressive speech by candidate Trump. So what do the UI numbers tell us. We took a look at the numbers from the NFP back in June (video below).

The current UI numbers are indicating a very tight labour market. Companies just can’t find the workers. However, normally when that happens a company is forced to become more competitive with other employers and increase wages in order to attract the workers they need. Yet, that doesn’t look to be happening as we see from the chart that wage growth has been pretty stagnant. 

Currently there are roughly 96 million Americans no longer in the workforce. How has that affected the poverty levels? The official poverty rate is 12.7 percent, based on the U.S. Census Bureau’s 2016 estimates. That year, an estimated 43.1 million Americans lived in poverty according to the official measure. According to supplemental poverty measure, the poverty rate was 14.0 percent. This should be considered high considering that it exists in the most affluent country in the world. 

The Hutch ReportPoverty rate in the US as a % of population – US Census Bureau

At the moment, it is not worth looking into the country’s import/export situation considering that President Trump has pulled the country into a trade war. Nobody knows how this will turn out and what the repercussions will come from it.

So in summary the charts show that US GDP growth is relatively stable, US government debt is increasing, US households savings are trending up and household debt is decreasing albeit it is still high, there is low unemployment but no wage growth and poverty is increasing. Some of the signs are a bit paradoxical such as the low wage growth which could be a partial reason why the poverty levels are increasing and consumer spending is decreasing.

So we have looked at some of the principle indicators that should provide some insight into the true health of the economy. You can take it how you see it but regardless, you have to admit that the picture is not crystal clear. Despite that, the financial media’s use of exaggerated claims such as, “Strong,” “Booming,” or “Firing on all cylinders,” gives the indication that we have entered a new era. President Trump seems to have changed his stance on the figures, touting and taking credit for the unemployment numbers that he criticized as candidate Trump. He also recently said, the US is “setting records on virtually every front” and is “probably the best our country has ever done.”

In the end, if the general public truly believe these claims, experience it in their neighbourhoods and families, they will have the confidence to go out and spend. Greater consumption patterns will improve the health of companies and they will hire. You would expect wage growth thereby lifting the standard of living across the nation. If the public does not believe the hyperbole, they will pull in their spending and try to reduce their personal debt levels. They will protect themselves.

In the end perception wins out. You be the judge.

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The Debt Jubilee – “There ain’t no such thing as a free lunch”

By | Economics, Finance

It should be no surprise to anybody who has been reasonably informed about what has gone on in the last 15 or so years that debt is becoming a burden. This has become an issue not only in the US but pretty much everywhere all over the world. The debt has come in many forms such as student loan debt, credit card debt, medical debts, personal loans, and on a national scale you have the national debt, underfunded pension liabilities, medicare etc. 

The big issue is how to manage it. A few are talking about it but only in the form of a warning, “someday soon we will have to deal with it.” They keep pushing it off. However the longer you push off a problem like the one we face, the more pressing the problem becomes and that tends to eliminate the bulk of your options to deal with it when it really comes due. 

There has been a potential solution that has been bantered about for the past few years. However, it has been presented as the only solution that will be left when it becomes too late to entertain any others. The solution is known as the “Debt Jubilee,” or debt forgiveness. It means what its name implies, that if someone owes you money you just forgive the debt. The debtor is no longer required to pay back the money he/she owes.

This idea has in fact been around for a long time. Historians have counted around thirty episodes of general debt cancellations from 2400 to 1400 BC, noting they were occasions of great festivity which often involved the physical destruction of the tablets on which liabilities were recorded. One of the most famous episodes of debt forgiveness comes from ancient Babylon (modern-day Iraq). In 1792 BC, the self-proclaimed King Hammurabi of Babylon forgave all citizens’ debts owed to the government, high-ranking officials, and dignitaries (read more from our post about Hammurabi here). The Code of Hammurabi, which currently sits in the Louvre in Paris, declared:

“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” 

The main thing to remember is that at that time the main creditor in most cases was the King himself, and/or institutions closely aligned with the monarch. It was relatively easy for the King to abolish debts owed directly to himself or the royal institutions, or even to a substantial proportion of wealthy creditors.

Debt forgiveness was also practiced during the time of the Old Testament. In Jewish Mosaic Law, every seventh Sabbath year saw the wiping away of all debts, where creditors cancelled all the obligations of their fellow Israelites. Every 49th year (seven Sabbath years) was the ‘Year of the Jubilee’ when freedom from all debt and servitude was proclaimed throughout the land.

This practice of debt forgiveness was not purely altruistic on the part of the creditors and ruling class. History has shown that if debtors become too enslaved to their creditors and ruling class, too disenfranchised, it opens the door for opposers or competing rulers to recruit the debtors in revolts to overthrow the ruling class. In current times, protests such as those led by the Occupy Movement show that these issues are still prevalent today and are never too far from boiling over.

At the end of World War I, Europe emerged mired in debt and in a depression. By the mid-1930s, many countries began to abandon the Gold Standard in an attempt to reflate their economies without the burden of an exchange-rate system. As part of this process, most of Europe’s governments had a significant portion of their liabilities written-off for good.

As recent as World War II the practice of debt forgiveness has been exercised. Following the end of WWII, the London Debt Agreement of 1953 saw the abolition of all of Germany’s external debt. The total forgiveness amounted to around 280% of GDP from 1947-53. This last episode is important because it is central to why a debt jubilee may not be the panacea that many believe. 

Michael Hudson highlighted why jubilee, debt cancellations, cannot now be replicated exactly:

“……the main credit/debt transactions initially were undertaken directly between the (ultimate) creditor and (ultimate) debtor. The largest credit relationship was between the government and taxpayers. Nowadays a very large proportion of all financial transactions are intermediated via financial institutions. Any attempt to cancel some category of debt, say government debt or personal mortgages, would immediately drive those financial intermediaries holding such assets, e.g. banks, pension funds, investment trusts, into insolvency.”

There are many economic and ethical problems with the debt jubilee concept. It would essentially amount to the government stealing wealth from all lenders and giving it to all borrowers. The more nefarious or corrupt you were prior to the jubilee, the more you would make out like a bandit as a result of the jubilee. A debt jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. In an era of secu­ri­tized finance, the own­er­ship of debt is engrained in society in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend. Debt forgiveness would eventually destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders. 

As we mentioned earlier, the example of Germany’s debt foregiveness after World War II is an important one. LSE Professor of Economic History Albrecht Ritschl conducted research into how Germany was able to pay off its debts after the two World Wars:

“In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II.”

When polled whether or not Greece should be the recipient of some form of debt cancellation from the eurozone, only 16% of polled Germans agreed. The irony may have been lost on some.

The world’s financial system is more interconnected than ever. Debt forgiveness would take on an unimaginable complexity. There are a large number of counter-party risks as shown by the Deutsche Bank example below:

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This would no longer be a one to one abolishment of debt as in the days of Hammurabi. Any debt forgiveness of one party would affect a number of other parties. As free market economist Milton Friedman once said, “There ain’t no such thing as a free lunch.” It may be time to devise another plan, and quickly. 

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Is a strong middle class the key to a strong economy?

By | Economics, Politics

In our previous article titled “Where did the US go off track?” The article was meant mainly to revisit Bernanke’s planned wealth effect from quantitative easing and indicate that it was an ill advised idea that put many into deeper trouble than before. The title was a general statement of wonder as opposed to identifying where the US did go off track.

This time we look at where the US went off track by identifying when the US was at its strongest and why. If we can understand where it really went off track then we can look for solutions or at least understand what kind of solutions are required.

Economies have ebbs and flows. In spite of what they teach you in economics 101 nothing is ever in equilibrium. There are just too many parts as well as internal and external influences although there are times when activity is stronger than others.  The US built one of the greatest economic powerhouses on earth after World War II, however it was already well on its way from the 1800s as it built out its infrastructure and put many to work. There was a time when the US consumed the majority of what it produced as a nation and then exported the remainder. Who was responsible for the consumption? It was the middle class. The middle class made up the majority of the population. They had jobs and respectable salaries. So what happened?

According to a research report by the Pew Research Center in 2012, “The Lost Decade of the Middle Class”they state:

“For the half century following World War II, American families enjoyed rising prosperity in every decade—a streak that ended in the decade from 2000 to 2010, when inflation-adjusted family income fell for the middle income as well as for all other income groups, according to U.S. Census Bureau data.”

The above graph shows that the 50s and 60s had the strongest middle class. In 1950 and 1951 the US had successive years of 8% GDP growth. The report also highlights how the net worth of middle income families—that is, the sum of assets minus debts— took a hit from 2001 to 2010 from the Federal Reserve’s Survey of Consumer Finances. Median net worth fell 28%, to $93,150, erasing two decades of gains. So we have a situation where consumer debt has increased over the years and incomes have fallen. There are a large number of reasons for this. The manufacturing base has shrunk as companies chose to produce goods in other countries in order to take advantage of cheap labour so they could give themselves pricing advantages. There is, what has become to be known as the “Walmartization” of America. Author John Atcheson writes, “If you want to know why the middle class disappeared and where they went, look no further than your local Walmart.  People walked in for the low prices, and walked out with a pile of cheap stuff, but in a figurative sense, they left their wages, jobs, and dignity on the cutting room floor of the House of Cheap.” Driving prices lower and lower is just a race to the bottom that erodes everyone’s quality of life.

This is just scratching the surface. There is also the invention of the 401k. We hold a total of $17.5 trillion in retirement funds – the single biggest source of money the big banks, Wall Street, and assorted other speculators use to play with.

The power of capitalism has been the freedom for entrepreneurs to create and provide value to others which has in turn provided jobs and increased wealth. However, we are now seeing that there are limits to that. The Economist recently revisited some of Karl Marx’s thinking regarding capitalism:

“Marx argued that capitalism is in essence a system of rent-seeking: rather than creating wealth from nothing, as they like to imagine, capitalists are in the business of expropriating the wealth of others. Marx was wrong about capitalism in the raw: great entrepreneurs do amass fortunes by dreaming up new products or new ways of organising production. But he had a point about capitalism in its bureaucratic form. A depressing number of today’s bosses are corporate bureaucrats rather than wealth-creators, who use convenient formulae to make sure their salaries go ever upwards. They work hand in glove with a growing crowd of other rent-seekers, such as management consultants (who dream up new excuses for rent-seeking), professional board members (who get where they are by not rocking the boat) and retired politicians (who spend their twilight years sponging off firms they once regulated).”

What country currently resembles the US of the 1950s with roughly 8% GDP growth? You probably guessed right, China. Aside from the fact that China has been handed every manufacturing job in the world from others, the result has been a growing middle class which will soon become larger than the population of the US. According to a study by consulting firm McKinsey & Company, 76 percent of China’s urban population will be considered middle class by 2022. That’s defined as urban households that earn US$9,000 – US$34,000 a year. (That might not sound like a lot, but adjusted for prices, it delivers a roughly comparable “middle class” existence to other countries.) In 2000, just 4 percent of the urban population was considered middle class.

So if building the middle class back up is to make the US stronger once again, what are some solutions? Providing better paying jobs for Americans by bringing back the manufacturing base to the US? Prices may increase but if your job is providing you a salary that enables you to afford it you may not mind. That would mean forcing US companies back to the US. That would mean providing them incentives in the form of tax breaks. We have already seen that those tax breaks are turning into stock buybacks. This is just exacerbating the situation, meaning, the government will forgo potential revenue that could have come in the form of those taxes. The tax breaks are not being used for capital investment, which would flow into the economy. The result is a larger national debt burden. How about incentivizing foreign companies to move their manufacturing to the US? Forget the financial engineering of the economy, the focus has to be on developing enterprises, but only to a point.

Companies like Amazon and Walmart have destroyed many small and medium sized companies by driving prices lower at the expense of putting many out of work. We have seen no evidence that Amazon and Walmart have created more jobs than they have destroyed. Google and Facebook have essentially taken over the advertising industry. So would it make sense to cap how large a company could grow? There are laws against monopolies and oligopolies however their political capital has become so strong that they can easily avoid these laws. However, it may make sense to break these companies up.

We can follow Marx and reduce the number of corporate bureaucrats that are sponging off the system, many of whom are found in banks. Banks are now much larger than the too big to fail era. Now they are way too big to fail. Breaking them up is currently being discussed. In fact, investment banks should be completely separated from commercial banks, or better yet community banks. Banks that serve only their communities. In this way, if investment banks makes bad decisions they are penalised by their investors, as opposed to sucking money out of their commercial counterparts in turn penalising the depositors (beware the coming bail-ins during the next financial crisis)! Regardless of the solutions implemented, it has to be accepted that they will not please everyone.

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Where did the United States go offtrack?

By | Economics

While the war between Trump supporters, anti-Trump protestors and the media rages on over everything from Trump policies to Trump tweets, there is an evident truth lurking beneath the surface of all the bravado. The truth is that the country is no longer the land of milk and honey nor the example for everyone else to follow. In spite of what financial media would have you believe regarding full employment and a booming economy, it is not the reality for many. As my uncle used to say, “When your neighbour is out of work it is a recession, when you are out of work it is a depression.”

According to the recent released United Nations Human Rights Council document titled, “Report of the Special Rapporteur on extreme poverty and human rights on his mission to the United States of America,” the United States is a land of “stark contrast.” The report relies principally upon official government statistics, especially from the United States Census Bureau.

According to the report’s findings, it seems to be more clear that the wealth effect promised by Bernanke’s Fed did materialize, only the wealth trickled up and not down. In The Washington Post , Ben Bernanke wrote on November 4, 2010, “the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.” He went on to say, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending”.

So how did that work out? The report explains:

“…its immense wealth and expertise stand in shocking contrast with the conditions in which vast numbers of its citizens live. About 40 million live in poverty, 18.5 million in extreme poverty, and 5.3 million live in Third World conditions of absolute poverty. It has the highest youth poverty rate in the Organization for Economic Cooperation and Development (OECD), and the highest infant mortality rates among comparable OECD States. Its citizens live shorter and sicker lives compared to those living in all other rich democracies, eradicable tropical diseases are increasingly prevalent, and it has the world’s highest incarceration rate, one of the lowest levels of voter registrations in among OECD countries and the highest obesity levels in the developed world.”

It has become painfully clear for many that Bernanke, student of the Great Depression, made some serious miscalculations about how money would flow and to whom. According to the report, the United States now has the highest rate of income inequality among Western countries.

So there was a slight miscalculation regarding the Fed’s monetary policies. When those don’t work out as planned, you turn to fiscal policies. How is that working out?

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“The $1.5 trillion in tax cuts in December 2017 overwhelmingly benefited the wealthy and worsened inequality.”

Curiously, since the tax bill was signed, a number of companies have been doing a lot of buybacks. Share buybacks in 2018 have averaged $4.8 billion per day, double the pace from the same period last year, according to an analysis the market data firm TrimTabs provided to CNBC.

It has only been 6 months since the tax cuts have been enacted and it takes time for these moves to make their way through the system, however, according to findings in the report you shouldn’t expect any surprising results.

“The share of the top 1 per cent of the population in the United States has grown steadily in recent years. In 2016 they owned 38.6 per cent of total wealth. In relation to both wealth and income the share of the bottom 90 per cent has fallen in most of the past 25 years. The tax reform will worsen this situation and ensure that the United States remains the most unequal society in the developed world. “

The report addresses the singular optimistic views of new technologies in regard to their benefits yet fail to highlight specific impact of these new technologies on the lives of the poor in American society today. Robotics may help McDonalds create efficiencies by doing away with order takers but will most likely only exacerbate the existing wealth inequality issues.

The current heated debate on Trump’s immigration policies have put the plight of the innocent immigrant children in full view. Nobody wants to see children taken from their families. At the same time that this debate is raging with the constant flow of images from CNN to hammer home the point that it is wrong, they fail to recognize the current situation that many American children experience daily.

“Poor children are also significantly affected by the country’s crises regarding affordable and adequate housing. On a given night in 2017, about 21 per cent (or 114,829) of homeless individuals were children. But this official figure may be a severe underestimate, since homeless children temporarily staying with friends, family or in motels are excluded from the point-in-time count. According to the Department of Education, the number of homeless students identified as experiencing homelessness at some point during the 2015/16 school year was 1,304,803.”

One can argue that there is always the Supplemental Nutrition Assistance Program (food stamps), which was put in place to help this portion of the population. According to findings, the program kept 3.8 million children out of poverty in 2015, and in 2016, the earned income tax credit and the child tax credit lifted a further 4.7 million children out of poverty. However, Trump may just blow up the farm bill over demanding food stamp work requirements. That demand, could mean tens of billions of dollars in cuts to the anti-poverty program.

The report pulls no punches and highlights a number of concerning issues such as, Treatment of the poor in the criminal justice system, Criminalization of the homeless, Environmental pollution, and Confused and counterproductive drug policies.

Not everyone agrees with the way in which the report is written as Fox News highlights in an opinion piece, “UN poverty report blasting Trump, US for ‘hatred for the poor’ uses data from last year of Obama’s presidency.” But once again, regardless of the facts, they spin it into a political positioning attack.

Although the report does list a number of recommendations, we find it hard to believe that the current government parties will put doing the “right and effective thing” in order to get the country back on track, in front of doing what is most effective at getting themselves re-elected.

The Hutch Report

Market Forecasting is Dead

By | Economics, Finance

The ability to forecast the markets is dead. It can also be argued that it never existed.

Regardless of that oversight, we are entertained by a constant stream of “experts” on financial media who profess to understand why the market has acted on any given day, or how it will act tomorrow. Everyone of them is trying but very few get it right. When they do get it right you can attribute it to pure chance, as their track records for being consistent are far and few between.

Many investors, individual as well as institutional, rely on market experts and forecasters when making investment decisions, regardless of the fact that they keep coming up short. For example, on 3 January 2015 Thomas Lee predicted that the S&P 500 index would be at 2325 one year from his prediction. The S&P 500 ranged between 1867 and 2122 during this period, and closed at 2012 on 4 January 2016, well short of the goal. There have been several previous analyses of forecaster accuracy, both in academic literature and also in the financial press in the past. Although many will correlate with the S&P 500 during years of stability (where you could essentially just apply a variety of statistical methods to extrapolate into the future), they have been seen to be surprisingly unreliable during major shifts in the market. For example, an analysis by Nir Kaissar found that the strategists overestimated the S&P 500’s year-end price by 26.2 percent on average during the three recession years 2000 through 2002, yet they underestimated the index’s level by 10.6 percent for the initial recovery year 2003.

There are a variety of reasons why forecasting the markets is a futile exercise. As Nassim Taleb puts it – “The tragedy is that much of what you think is random is in your control and, what’s worse, the opposite.” Regular savings are in your control, your expectations and behaviour is also in your control, however, stock market moves in an uncertain world are not.


Fundamentally, businesses usually go public to raise capital in hopes of expanding. The ownership of the business is then spread among a large group of shareholders. If the company’s earnings are solid and consistent, the share price is valued higher and the shareholders get rewarded for putting their money at risk. These companies issue quarterly and yearly earnings reports in order to provide current and any potential future shareholders a snapshot of the health of the company at that moment. To do so they usually apply what we call, “Generally Accepted Accounting Principles.”

But as the MIT Sloan Management Review recently pointed out,

“Lurking within the financial statements and communications of public companies is a troubling trend. Alternative metrics, once used sparingly, have become increasingly ubiquitous and more detached from reality.”

They went on to provide the following example:

“In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the U.S. Securities and Exchange Commission (SEC) issued a comment letter questioning Groupon’s use of a profit metric it called “adjusted consolidated segment operating income.” To our knowledge, no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain.”

This is not an isolated example, and the use of these so called, “Accounting tricks” have only become more sophisticated. What was once analysis of a business’s operations and their ability to satisfy customers and grow has become an exercise of forensic accounting analysis in order to spot the manipulators! Try forecasting the next clever income statement adjustment!

The Federal Reserve

What were once pretty much free markets have become markets that have become pretty much dependent on the next Central Bank intervention. QE1 took place in November 2008 when the Fed spent $600 billion on purchase of Mortgage-backed Securities (MBS) in order to “save” the financial system from ruin (which could be argued that they facilitated in the first place). But they didn’t stop there. They continued with QE2, Operation Twist, Operation Twist Extended and QE3. It didn’t stop with the Fed, as they do work closely with their central bank colleagues, such as the ECB and BOJ.

Total Assets of Major Central Banks

Was there an impact on the financial markets? Of course there was. They drove interest rates pretty much to zero for an extended period. As Quicken Loans pointed out, there will be a time when the Fed has to get out of their positions and when that happens:

“A new buyer, or more likely several of them, would have to pick up the slack and buy lots of MBS in order to keep mortgage rates where they are right now. No one has a crystal ball as to when the Fed will start to get out of the MBS market, either.”

So without a crystal ball or being privy to what the Federal Reserve has planned regarding future manipulations of the market, trying to forecast them is a futile exercise that serves no purpose.

High-Frequency Trading, Spoofing, and other Shenanigans

In addition to accounting trickery and central bank intervention, here are a few more choice headlines and examples as to why forecasting the markets is dead.

“Six banks fined $5.6bn over rigging of foreign exchange markets”

“HSBC faces fresh suit alleging forex manipulation”

“BNP Paribas pleads guilty to forex manipulation”

“Wells Fargo Accused Of Manipulating Business Banking Data”

Since 2007 we have seen a new player in town, high frequency traders. High-frequency trading is an automated trading platform used by large investment banks, hedge funds and institutional investors that utilizes powerful computers to transact a large number of orders at extremely high speeds. This has completely changed the dynamics of the markets. As JP Morgan pointed out in their own report of June 13, 2017:

“While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals,” Marko Kolanovic, global head of quantitative and derivatives research at JPMorgan, said in a Tuesday note to clients.

Kolanovic estimates “fundamental discretionary traders” account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago, he said.

Which introduced another brilliant market manipulation called “spoofing,” and another choice headline to present:

“Gold, Silver Manipulation: CFTC Fines Deutsche, USB, HSBC For Spoofing Markets”

The CFTC announced earlier this year that Deutsche Bank, UBS and HSBC faced fines totaling $46.6 million. Deutsche Bank was the hardest hit as it was fined $30 million. UBS was ordered to pay $15 million and HSBC was fined $1.6 million.

How about naked short selling? Naked short selling, or naked shorting, is the practice of short-selling a tradable asset of any kind without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale.

Paul Craig Roberts described this process as it is used in the gold markets:

“This manipulation by the Fed involves the short-selling of uncovered Comex gold futures. “Uncovered” means that these are contracts that are sold without any underlying physical gold to deliver if the buyer on the other side decides to ask for delivery. This is also known as “naked short selling.” The execution of the manipulative trading is conducted through one of the major gold futures trading banks, such as JPMorgan Chase, HSBC, and Bank of Nova Scotia. These banks do the actual selling on behalf of the Fed.”

To see proof of this, one just has to check the latest Comex Reports to see that the current ratio of paper gold to physical gold is 176:1.


The next time you are watching your favorite financial media program providing explanations as to what the market is doing now and what the market will do,  remember the previous points. Remember to ask yourself two questions, “Does this person really have the ability to forecast the markets,” and “should I have confidence in any of their conclusions?” Because, in reality, market forecasting is dead!

The Hutch Report

The Fear of Choosing

By | Economics, Marketing, Psychology

I moved to Europe years ago from Canada and although I made the move to embrace the change and experience another way of life, the first thing I noticed was the stores closed at 6pm. There was no 24 hour convenience that would provide me some peace of mind should I run out of milk at 8pm. I also noticed that restaurants closed at 2h30 pm, once the lunch crowd was served. If I happened to get hungry at that time I was out of luck, the kitchen staff had all left.

The supermarkets, at the time, were far from the super that I knew.  Although they had all the necessities, they didn’t have all the necessities in different sizes, colours, shapes and flavors. Something that I was accustomed to.

Regardless, over time I found myself adapting to the rhythm of this world and stopped trying to fight it. I couldn’t find my beloved peanut butter so I did without and eventually found other products that were just as good and fun to experience. I discovered the joy of having fresh bread everyday, as was the custom, rather than having that loaf of Wonder Bread that would last two weeks before mold started to set in.

On a visit back to Canada I had the chance to show my new Swiss in-laws the city that I grew up in, along with many of the aspects of North American living that they only knew from movies.

In order to accommodate them I wanted to make sure that they had everything they needed to make their stay comfortable. This included their much desired morning coffee. We had instant coffee at the time and they preferred fresh brewed so no problem, I said, “Let’s go over to the supermarket and I will show you an incredible assortment of coffee to choose from.”

We arrived at the supermarket and made our way over to the coffee isle. In front of us were rows of shelves of every kind of coffee you could imagine. I said to my mother-in-law proudly “look, we are here, you can find any kind of coffee you want.” There was deep roasted, light roasted, medium roasted, french roast, instant, ground, finely ground, whole bean, and decaf. There was Mexican coffee, Ethiopian, Colombian, and Ecuadorian. Then there were the different brands. There was Folgers, Maxwell House, Juan Valdez, Nabob, Nescafé, Tully’s, Tim Horton, Van Houtte and others.

I turned to my mother-in-law and asked, “So, what kind of coffee do you want?” In a state of anguish, she replied, “I just want coffee, just regular coffee, Espresso, Espresso.” So we found the regular espresso in the regular packaging and the regular size and left the store. I then found myself actually disappointed by her reaction. I thought it would be one of amazement, such as, “wow, I can find every kind of coffee I can imagine here.” Instead, what I found was that this myriad of choice that she was presented with, in fact, complicated things for her.

I spent years in University studying all aspects of Marketing and it never occurred to me that more choice could be a problem for somebody, until I saw my mother-in-law’s reaction. In addition, it forced me to reflect on my years in Europe doing without all that choice and I actually found daily life to be easier. I gained an appreciation for basic things that we often take for granted. So, I looked a bit deeper into this choice dilemma to see why it would cause such psychological reactions in us.

We can, in fact, go back to the 14th century, where we find an analysis of the condition with the illustration of Buridan’s ass. There’s an ass (donkey) and it’s very hungry and thirsty. But because someone is very cruel, the ass has been placed at equal distances between a pail of water and a stack of hay. The donkey would try to relieve its desire for food or drink, with the choice between those depending on which is closer. But since they’re equally spaced, the donkey is paralyzed. So it stands there, and sits, and ultimately dies.

In her book “The Art of Choosing,” Professor Sheena Iyengar, S.T. Lee Professor of Business in the Management Division at Columbia Business School researched this phenomenon. A grocery store presented customers with two different sampling stations: one with 24 flavours of jam and the other with only six options. The results of the study revealed that the availability of six options resulted in 30% of consumers purchasing at least one jar of jam, while the sampling station with 24 flavors had a conversion rate of only 3%. While the larger selection attracted more onlookers, the smaller selection actually generated more sales.

When we are presented with many options, we usually fear making the wrong decision. This can be translated mathematically. When there are only two options, we have a 50% chance of choosing the right one. But when there are five options, our chances suddenly decrease to 20%. Matters become even more complicated when there are twenty options or more. Human cognitive ability cannot efficiently compare more than five options, so most of us will start looking at the first few options and then stop.

According to classical studies the consumer goes through 5 stages in the decision making process:

Image result for 5 steps decision making process

The problems begin in the Search for information and Evaluation of alternatives stage. Most consumers do not feel particularly confident, which has the potential to trigger strong emotions like frustration, confusion or annoyance. Frustrated shoppers who are unable to choose will most likely postpone their purchase, whereas confused shoppers may rush themselves only to get over with it quickly, and choose something they will regret later. Annoyed shoppers are quick to leave the store and head straight to a competitor, swearing to never ever return.

In his book, “The Paradox of Choice” (HarperCollins, 2003), author and psychology professor at Swarthmore College, Barry Schwartz said, “Consumers have always had choices, but today options have exploded beyond all reason.” “It’s the ethos of American society; the idea that freedom is good, more is better, and you enhance those ideas by offering choice. Logically, you can’t hurt anyone by adding options. It makes no one worse off, and some better. That’s the theory, but in practicality it’s not true.”

Schwartz argues that even if we do make a choice, “We end up less satisfied with the result of the choice than we would be if we had fewer options to choose from”. Increased choice, can make us miserable because of regret, self-blame and opportunity costs. Worse, increased choice has created a new problem: the escalation in expectations. Greater expectations will drive companies to increase the number of choices they offer, which will in turn make it harder for the consumer to make a choice. A vicious cycle.

What consumers have been confronted with is “Choice Overload”, a term that was first introduced by Alvin Toffler in his 1970 book, Future Shock. Toffler noted that as the choice turns to over-choice, “freedom of more choices” ironically becomes the opposite—the “unfreedom.” This choice overload has become even more evident in the new economy with the likes of super online stores such as Amazon and Alibaba.

In the end, according to Professor Sheena Iyengar, when faced with a complex multitude of options, consumers tend to disregard sound reasoning and pick a product based on what’s easiest to evaluate, not what’s most important. She says that, “We stick to the familiar or go by price because we don’t want to deal with so many choices and scrutinize label claims or nutrition information.”

Between 1975 and 2008, the number of products in the average supermarket swelled from an average of 8,948 to almost 47,000, according to the trade group, Food Marketing Institute. The business point of view, most new items are generated because manufacturers are under pressure to increase growth, even if those items are an extension of an existing product as opposed to something innovative. Yet, in spite of this point of view companies usually see just 20 percent of products accounting for 80 percent of total sales.

Tesco chief executive Dave Lewis, in 2015, decided to scrap 30,000 of the 90,000 products from Tesco’s shelves. This was, in part, a response to the growing market shares of Aldi and Lidl, which only offer between 2,000 and 3,000 lines. This has enabled Aldi and Lidl to be more competitive on price which has in turn helped them to gain market share.

Although we have highlighted supermarkets, choice overload is apparent across many industries and if more companies don’t take the same actions as Tesco then the onus is ultimately upon the consumer to deal with the myriad of choices before them. But how?

There is an overwhelming amount of studies on what makes consumers decide, how to force consumers into decisions, how to manipulate a consumers buying process and on and on. What is less available is information related to helping consumers fend off this barrage of marketing and choice overload, which would make sense since companies are making money from consumers and not vice versa, but there are solutions.

In a 2003 JPSP paper (Vol. 85, No. 1), it was reported that the bigger the assortment, the harder it is for people to choose, “except” under one condition: when they enter with an articulated preference. Nobel Laureate Herb Simon, PhD, first referred to this as a “satisficing” option: the first decent choice that fits their preference as opposed to exhaustively scanning all options until finding the perfect, or “maximising” one.

Essentially, the best thing that a consumer can do is to know as close as possible what he wants to purchase before he goes searching for it, no matter what the product is. Simplify it as much as you can. In addition, it may be wise to lower one’s standards when making a buying decision.

“Any customer can have a car painted any colour that he wants so long as it is black.” — Henry Ford

The next time you purchase coffee, define as close as possible what you want before you even think about choices or enter a store. Next, lower your standards and accept the fact that it may not rank as the best coffee in the world, then you reduce the chance of regretting your choice.

Do this and you will feel better about your decision and at which time you will have made the ultimate choice you can make!

The Hutch Report

2017 Wealth Management Review

By | Economics

At the beginning of 2017, The Hutch Report completed a “Smart Money” analysis to highlight how the smart money was looking at the markets for 2017 and beyond. It was meant to provide a high level overview based on an aggregated synthesis of the macro views of the world’s Top 50 largest wealth management institutions.

Now we are looking back on all the forecasts made by these “Smart Money” managers and institutions to see how accurate they were in predicting the future or if they were just exhibiting an “Illusion of Understanding.”

Central Banks and Monetary Policy

Federal Open Market Committee (FED) 

The consensus (40%) of wealth management firms predicted two hikes in 2017 of 25 bps each hike which would bring the Fed Funds target rate to 1.25%. Roughly 8% predicted three rate hikes. No precise forecasts were provided as to how much or when but of the wealth management institution outlooks reviewed, they all indicated an expectation that Central Bank monetary stimulus policies (eg. quantitative easing) would start to weaken.

On December 12-13 the Fed raised rates for a third time. Only 8% of our wealth management professionals got it right.

The FOMC did announce a tapering plan at the September 2017 meeting and have started in October by letting $10B in bonds mature each month and will slowly increase that number to $50B. As a reminder, in 2008 the FED balance sheet was $800B. It is now at about $4.50T as a result of QE.

European Central Bank (ECB) 

Taper would commence second half of 2017. One dissenter stated the ECB would be unable to discontinue QE.

The ECB did not make any rate changes for overnight credit in 2017 and that rate remains at 0.00%. They did not commence tapering in 2017. However, they did signal in October of this year that they would start tapering in 2018 by cutting in half the monthly purchases from the current rate of €60B to €30B.

The People’s Bank of China (PBOC)

The PBOC will continue to stimulate demand through adjustments of the reserve requirement ratio (the amount of money that the banks must hold as reserves).

In September of 2017 the POBC announced that in 2018 the reserve requirement ratio would be lowered for certain banks from 200 bps to 150 bps. In return for the reduction the banks must meet certain requirements for lending to small business, agricultural sectors, entrepreneurship and education.

Changing of the Guard

The next two years, 2018 and 2019, we will see some changes to the heads of some of the world’s most influential central banks.

Most people are by now well aware that in February 2018, Yellen’s term as Chair of the FOMC expires and Trump has nominated Fed Governor Jerome Powell as the next Fed chair. The post of the Fed chair is subject to Senate confirmation. The Senate Banking Committee has approved Jerome Powell which clears the way for the Senate confirmation vote.

At the Bank of Japan the current Governor is Haruhiko Kuroda and his term will be expiring in April 2018. Current headlines indicate that there is a strong likelihood that his term will be renewed as the Japanese government has expressed satisfaction with the BOJ’s policies under Kuroda.

In 2019, the terms for Mark Carney at Bank of England (BOE) and for Mario Draghi at the European Central Bank (ECB) will expire. Due to the bylaws of the ECB which state that the term of the ECB presidency is for an eight-year non-renewable term the ECB has to find a new president and it cannot be Draghi. It remains to be seen what will happen with the BOE Governorship as Carney has been seen as a strong leader.

Governments and Fiscal Policy

The EU

The consensus for 2017 was that the EU would experience a modest recovery but mitigated by concern, seen to be short term, on political risks due to rising anti-EU and populist sentiment but that this would be limited and most likely would not extend past the UK.

The EU economy so far has actually exceeded forecasts with real GDP growth expected to be 2.2% for the year compared with earlier forecasts of 1.7%.

Everyone was waiting with baited breath to see if populism and a BREXIT, separatist, type mindset would spread via the 2017 elections in 2017 in Europe – specifically in the Netherlands, the France and Germany. However, that did not come to pass and more centrist candidates won those elections. However, this did not mean that the populist and separatist parties went away. Even though Merkel won in Germany for a fourth term, the far-right, anti-immigration party in Germany, the AFD, won seats in the Bundestag with an historic breakthrough for the party and it is the first time in 60 years that an explicitly nationalist party sits in the Bundestag.

Meanwhile in Spain, there was a big push for Catalonia to separate from Spain. While the independence movement was effectively stifled the issue is far from being resolved as manifested by pro-independence parties renewing their majority in the Catalan parliament in the regional elections just held at the end of the year on December 21.


The consensus for 2017 was that the deflationary policies of the incoming administration with Republican majority in both houses of congress, will be positive in the short term for US equities (promises of tax cuts, repatriation of foreign US earnings and higher public spending plus a pledge to invest over $1 T in US infrastructure) Caution for the longer term with potentially greater inflationary pressure and the impact of populist and protectionist ideals.

During the course of the year and up until December, the Trump administration had not succeeded in passing any legislation. This caused some doubt during the year whether the administration would be able to succeed with the measures they had promised. The Trump administration finally did succeed in passing a much contested tax reform bill which was approved by the senate in December and then passed into law and signed by Trump on December 22. Much debate is still raging on whether the new tax bill, which among other sweeping changes cuts corporate taxes from 35% to 20%,  will be effective in repatriating corporate money back into the US and whether this will translate to investment by those corporations into the US economy.

With regards to other campaign promises, notably the border wall, while many prototypes have been proposed there is still no clarity on how the wall will be paid for or what the next steps really are. Meanwhile the $1 Trillion in infrastructure spending does not have any more clarity either. In October of the year, Trump pivoted from a stance pushing for private investment and is now looking towards the treasury which would possibly imply further borrowing and using proceeds from taxes on gas.

Emerging Markets

Despite concern on a potentially rising USD along with interest rates which would negatively impact  emerging markets, especially countries with a majority of their exports to the US like like Brazil and Mexico, the wealth managers were still predicting higher GDP growth in BRIC countries in 2017.

The final GDP rates are not yet available for 2017 however so far it can be said that: Brazil has exhibited modest GDP growth so far this year and slightly surpassed initial forecasts, while   Mexico, which started off the year well in the first half of the year has not faired so well in the second half of the year due to disruptions from two earthquakes, subdued consumer spending and inflation. NAFTA negotiations are still continuing with the US and are expected to continue in 2018.


The majority of wealth managers estimated that Trump policies would help drive up the USD and provide a tailwind to Japanese fiscal policy would also weaken the Yen which in turn would strengthen the Japanese economy in 2017.

Despite a stronger Yen against the USD, Japan saw stellar export performance, supporting manufacturing activity, as highlighted by December’s PMI figure, which hit a nearly four-year high. Investment also benefited from resilient global growth, with business confidence in Q4 climbing to an over one-decade high. So the Japanese economy strengthened but not for the reason’s outlined by the wealth institutions.

Inflation Outlook

The view was that Inflation would increase slightly in developed markets and despite the big question mark whether the central banks would be able to keep inflation in check following the massive reflationary measures they have taken the consensus seemed to be that inflation would be kept in check.

Higher inflation was forecasted in Asia due to less Asian central bank intervention.

For the developed markets, the wealth institutions basically got this one correct in their outlooks for 2017. The inflation rate in both the US and Europe increased the most in the first half of the year and is still trending slightly higher than it was at the beginning of the year. Concerning inflation in Asia, directionally the wealth management outlook for 2017 was correct. Whether or not the reasoning was correct is another story. The theory was that inflation would be higher due to less central bank intervention than in developed markets. This is a subject worthy of debate and whether or not less intervention is even true. For example, the Chinese central bank, the People’s Bank of Chine (PBOC), is suspected to have intervened several times in 2017 in order to keep the yuan propped up.


The historical experiment of quantitative easing in the US, Europe and Japan has seen unprecedented buying of bonds, driving yields down to historic lows. However, with the European Central Bank (ECB) and Bank of Japan (BOJ) running out of bonds to buy and facing the unintended adverse consequences of negative rates (for banks and insurers), 2017 was seen to be the final year for quantitative easing and negative rates. It was believed that political resistance to fiscal expansion would weaken, particularly in Japan. Therefore, the consensus was that there would be nowhere for yields to go but up.

The yields on the US 10yr began the year at 2.45%, however, despite 3 rate increases from the Fed, the 10yr yield spent most of the year lower, closing at 2.405%, going against the consensus view of higher yields.

The Eurozone 10yr government benchmark yield began the year at 0.86%. It spent most of the year above this rate and closed the year at 1.05%. German 10yr yield began at 0.189% and finished at 0.427%. When referring to the Euro Zone the consensus got it right.

Japan continues to confuse many. In July, The Bank of Japan offered to buy an unlimited amount of JGBs, as it sought to put a lid on domestic interest rates pushed higher by the broad sell-off in developed market bonds. JGB 10yr yield began the year at 0.046% and finished at 0.048%, essentially staying flat.


In regards to public equity, a large majority, nearly 85%, of those with a positive outlook on equities were positive on headroom in the US equity market.  Following the US equities market there was no other region or country for which the reports reviewed indicated a majority positive outlook in general for equities, however, close to 50% were favorable on Japan, followed in this order, by Europe, Emerging Markets and then Asia.

The cap-weighted S&P 500 gained 19.42% on the year, whereas the average stock in the index was up less than that at just over 18%. Regardless, 85% of the smart money managers were correct in forecasting higher equities for 2017.

Close behind, the Japanese Nikkei gained 19.10%, where only close to 50% envisioned such a strong performance.

The Euro Stoxx 600 index closed up roughly 7%.


There was a clear and overwhelming agreement that the new Trump administration policies would be bullish for the US dollar. In addition to the US government policies, it was also believed that the Federal Reserve would begin to increase interest rates, which would in turn also be bullish for the US dollar.  Where there was lack of vision was to how high the US dollar would rise, but it was expected to rise throughout the year of 2017.

The view regarding the Chinese Yuan (also recognized as the Renminbi) was that it would remain weak against the USD for some time. However, the majority was expecting the Yen to depreciate further against the US dollar into late 2017.

There were a number of elections coming up in Europe and that was expected to increase risk and put downward pressure on the Euro. The expectation was that it would reach parity with the US dollar.

Not everything worked out as neatly as planned by our smart money managers. 2017 was a nasty combination of buy-the-rumor-sell-the-news for the Greenback. Action on Fed tightening and fiscal reform, more weight on disappointing data versus upbeat results, and the “Trump effect” left the US dollar sliding for most of the year.

The 2016 close for the EURUSD cross was 1.0517, however the close of 1.2004 destroyed the dreams of all those banking on parity.

The USDCNY cross began the year at 6.96 and ended at 6.50. The US dollar’s unforeseen slide  helped to bump up the Yuan against the USD going against the view of a weaker Chinese Yuan for the year.

Last but not least, the US dollar lost 3.69% to the Japanese Yen, going against the majority view that the Yen would continue to depreciate against the US dollar in 2017


80% of the researched wealth institutions believed that the commodity cycle had based and was set to recover, however, the market structure remained a challenge and fundamentals across many raw materials continued to point to concerns of an oversupply. For this reason, there was not an overly bullish view on commodities but a wait and see neutral one.

Concerning Oil, we found a range of forecasts from $45 to $65 a barrel with no clear majority on any one price point. Oil started the year at $52.46, fell to as much as $42 and rebounded to end the year at roughly $60 a barrel.

There was no clear agreement when it came to Gold, however, as the majority linked the performance of gold to the USD, and that same majority expected the USD to rise (indicating Gold would fall, or stay range bound at best) were all off the mark. Gold ended up roughly 13% beginning the year at $1,150oz and ending the year at roughly $1,306oz.

New Alternative Investments

What a difference a year makes! Bitcoin was a curiosity at most at the beginning of the year, however its stubbornness to sell off for any extended period, while it continued its meteoric rise, forced wealth managers to take notice.

It began the year at roughly $984 and continued to rise to $19,211 before rounding out the year at $12,610, beating any other asset class (although the debate is still raging about whether or not Bitcoin is an asset or other). Regardless, Bitcoin is now something to be reckoned with and will not be taken so frivolously as it was in the beginning of the year.

Along with the rise of Bitcoin came a host of other Alt coins and ICOs (initial coin offerings), however, as far as professional money managers are concerned, Bitcoin is the main act for the moment until proven otherwise.

We also mentioned Bitgold in our report which was the idea of a cryptocurrency backed by the equivalent amount of gold. It was believed that this would stabilize the volatility seen in pure cryptocurrencies and provide them with an air of respectability. However, it is still too early to know if this will take hold and for the moment this concept is not really of interest to the professional investment manager.

Our special report on Gold Backed Cryptocurrencies supported this lack of interest as we researched all the principle players in the area, large and small and found them largely lacking in many areas.

In Conclusion

2017 was not an easy year for our wealth management institutions in many respects. There were no great winners or losers.

Will 2018 prove to be any easier? We don’t know, but if the smart money is having such a difficult time making sense of all these moving pieces you can bet that the dumb money is at a complete disadvantage (unless they bought and held Bitcoin, which currently would make them look like the smart money….for the moment).

A principle lesson to be learned is that all these forecasts that appear in these glossy yearly outlook reports, quarterly reports, weekly reports and minute by minute reports that continue throughout the year on your local financial media networks, by all these institutions that manage the largest fortunes are just that, forecasts.

Everybody speaks in their best interests which makes following these prognostications and forecasts all the much more difficult and more often than not puts you, as an investor, at a disadvantage because you are more likely than not to be buying from those who are selling (which happen to be the same people which have advised you to buy). Therefore, don’t listen to the smart money, follow the smart money.

The Hutch Report

The Illusion of Understanding

By | Economics, Psychology

How is it that no matter how much any financial market goes up or down during the day, somebody has an answer as to why? Financial markets are made up of millions of participants making large numbers of investment decisions at any one time. In addition, we now have a large number of computers that have been programmed to trade at incredibly high speeds, even up to the milisecond, and they are making millions of these trades a day. Yet somehow financial media commentators and self proclaimed experts are able to define what it all means, all within the constraints of a 3 minute clip. There are 3 possible explanations why.

I read once where a CNBC regular guest financial commentator disclosed that any guest invited onto the show was not allowed to say “they didn’t know” as an answer to why something was occuring. It was explained that these people were portrayed as experts, and experts were not allowed to not know a fact. If they presented themselves in such a way, they would not be invited back. Since being on television can be great exposure for the individual or the company they work for, they would simply do what was asked of them. You may also have noticed that during times of advancing markets, the financial media programs tend to have a long list of guests that are bullish the markets. In times of declining markets, the long list of guests will be bearish the markets. This will help to reinforce the proper bias regarding explanations for the current state of the market.

The second possible explanation is that the comments reflect the personal motives of these guests. Many of the guests are fund managers or traders and have ulterior motives as to why they see the markets in a certain way. If they, or their employers, happen to manage a large portfolio and are fully invested, it is probably not in their best interest to tell the concerned public that the current markets are unstable and not the smartest place to invest their money. Therefore, they will provide views that support their current positions regardless of whether or not their views explain the questions asked. Since the financial media will present bullish guests during advancing markets it is rare that you will find many with contrarian views and if there are they are most likely supporting their own interests also.

There is also a third possible explanation. There is the possiblity that these experts are victims of “the illusion of understanding,” or known in psychology as the illusion of explanatory depth (IOED).  The illusion of understanding is where people feel they understand the world with far greater detail, coherence, and depth than they really do. They only realise the illusory nature of this belief when they attempt to explain a fact. Opinionated guests on financial media are normally allotted no more than 3 minutes to give their views. For this reason there is hardly enough time to delve into the subject matter in any great detail to where the viewer may become aware that these guests are not able to fully explain themselves. Therefore, they give the illusion of understanding but it is far from clear if they actually do understand the issues they are discussing.

A fact, event or situation that is observed to exist is also known as phenomena. According to R. A. Wilson and F. C. Keil., in their paper, The Shadows and Shallows of Explanation, 1998, we all encounter a vast number of phenomena on a daily basis but only possess a superficial level of understanding of most of these phenomena . In addition to a limited understanding of many everyday domains, people lack an understanding of their own understanding and tend to believe that they are much more skilled in a variety of domains than they actually are (Dunning, Johnson, Ehrlinger, & Kruger, 2003).

Stav Atir and David Dunning of Cornell University, along with Emily Rosenzweig of Tulane University designed a series of experiments testing people’s self-perceived knowledge, comparing it to their actual expertise. The researchers tested 100 individuals, who perceived themselves to be experts in personal finance. They were asked to rate their knowledge of particular financial terms which included three made-up terms (pre-rated stocks, fixed-rate deduction, and annualised credit). They found that 93 per cent of participants claimed knowledge of at least one of those three terms. Stav Atir explained, “The more people believed they knew about finances in general, the more likely they were to over claim knowledge of the fictitious financial terms.” It appears that self-perceived expertise causes people to think they know more than they really do.

These findings are of course not limited to the field of finance alone. They are present in all areas. For example, people may know that a door lock works by inserting a key and turning it, which causes the lock to unlock. This understanding may lead people to believe that they know how a lock works, even though they lack an understanding of the detailed internal mechanisms of the lock. The same can be said regarding everybody’s favorite gadget, the smartphone. The fact that people can download applications, modify the smartphone settings to change the background or a ringtone may give many the impression that they understand how the smartphone works, yet their true understanding of these incredible little computational devices are incredibly shallow.

Charlie Munger, the billionaire business partner of Warren Buffett explained it brilliantly at the USC Law School Commencement speech in 2007:

“I frequently tell the apocryphal story about how Max Planck, after he won the Nobel Prize, went around Germany giving the same standard lecture on the new quantum mechanics. Over time, his chauffeur memorized the lecture and said, “Would you mind, Professor Planck, because it’s so boring to stay in our routine, if I gave the lecture in Munich and you just sat in front wearing my chauffeur’s hat?” Planck said, “Why not?” And the chauffeur got up and gave this long lecture on quantum mechanics. After which a physics professor stood up and asked a perfectly ghastly question. The speaker said, “Well I’m surprised that in an advanced city like Munich I get such an elementary question. I’m going to ask my chauffeur to reply.”

Munger told this story in order to highlight the difference between real knowledge (as was the case with Max Planck) and fake knowledge, or the illusion of understanding (as was the case with the chauffeur).

Max Planck

So how are we able to even identify the difference between having real knowledge and our illusion of having real knowledge? How are we able to identify our own limitations or illusions of understanding? A solution was provided by and practised by the great physicist Richard Feynman.

Feynman believed that understanding something is not just about working through advanced mathematics. One must also have a notion that is intuitive enough to explain to an audience that cannot follow the detailed derivation. In other words if you can’t explain it in simple terms then you don’t know it well enough.

Explanations can be useful in helping people to evaluate their own comprehension. When people attempt to generate an explanation for a phenomenon, they not only learn what they know but also become aware of “gaps” in their understanding: those parts of the explanation that are difficult or impossible to generate (Keil, Rozenblit, & Mills, 2004). That is, people are often unaware of what they do not know until they try to explain it.

The Feynman technique of learning was laid out clearly in James Gleick’s 1993 biography, “Genius: The Life and Science of Richard Feynman.”

  1. Pick a topic you want to understand and start studying it. Write down everything you know about the topic on a notebook page, and add to that page every time you learn something new about it.
  2. Pretend to teach your topic to a classroom. Make sure you’re able to explain the topic in simple terms.
  3. Go back to the books when you get stuck. The gaps in your knowledge should be obvious. Revisit problem areas until you can explain the topic fully.
  4. Simplify and use analogies. Repeat the process while simplifying your language and connecting facts with analogies to help strengthen your understanding.

When referring back to the financial media we can now ask ourselves, “how much information that we are provided is actually real knowledge?” The answer, particularly in the case of journalism, is not always so evident as there are many participants with real knowledge, yet they are often concealed by a large number of so called “chauffeurs.”

The founders of RealVision Television recognised this. They realised limitations of a three minute soundbite on the current financial media programs and the tendency for many guests to present the illusion of understanding. So they launched a platform where the guests are given as long as an hour to discuss various financial subjects in detail. Many of their guests use the freedom of the platform to admit they do not always know why certain things are as they are. They do this because they are asked to explain their views and provide educated insights, which often have limitations. This is refreshing because we are not confronted with the illusion of understanding but the quest for understanding and in turn we are presented with a wealth of real knowledge.

Only by forcing yourself to explain does it become apparent how little you understand. Practicing explanations is the best way to fill your information gaps and also the key to form the kinds of memory you need to perform later and avoid presenting the illusion of understanding.

The Hutch Report

The Illusive Stock Market Crash

By | Economics

On October 19, 1987, 30 years ago, the stock market dropped 22.6%, with volume at 604 million shares doubling that of the previous record. So, how illusive are these crashes and how often do they happen? The panic of 1901, the panic of 1907, the depression of 1920-21, the crash of 1929, the Brazilian market crash of 1971, the crash of 1973-74, 1998 LTCM debacle, 2000 dotcom bust, 2007-08…..and on and on. I have only mentioned a few yet in spite of what history tells us, less and less people today think that it is possible for the stock markets to crash again. Why would we think this? Margin debt is at all time highs, consumer confidence numbers seem to be quite bullish in spite of what the retail sector tells us.

So are things really different this time? Will markets never go down again? In order to understand this we can look at what has changed since the last downturn in the market. 1) The Central Banks have created over $4 trillion of liquidity (more if you add up all the central bank interventions), so investors have come to believe that no matter what happens the central banks will be there to pick up the pieces and just print more money. The word for this is moral hazard. If you invest in something and believe that if you lose, somebody will support you financially, are you going to take less risk or more risk? The answer is you are going to take more risk. You would be stupid not to, seeing that you can’t lose no matter what you do. 2) High Frequency Traders (HFT) have increased in size and number. They now make up the largest portion of volume traded on the stock exchanges. This was not the case in 2007-2008 and before.

The next thing to understand is value. What is the value in the market that makes it go up? We can simplify this with an example. Let’s say a special doll has come out on the market. It cost $5 to manufacture and sells for $10. They start to sell out fast. In fact, some people buy them and resell them which pushes the price up. That pulls more people into the market which pushes the price up even more. Now you are paying $20 for the doll. In order to buy a doll you need to find somebody to sell. As long as the price goes up, people get greedy and hold out for more, which makes the price go up even more.

There is a percieved value that creates demand and pushes the price up but what happens in the inverse? Let’s imagine that the doll was made in China and suddenly news came out that the paint was toxic and making people sick. Suddenly nobody wants to buy. The price goes from $20 down to $3. The value just evaporates. In fact, the doll becomes worthless and drops to 0. Nobody wants to buy because the percieved value is 0. Who wants to buy something that will make them sick?

Now let’s go back to the markets. Just like the doll, the markets will keep going up “as long as” there is percieved value, however, if investors suddenly get worried, that value could evaporate like the value of the doll did. If a stock is trading at $200, but the percieved value becomes $20, the next buyer will be at $20 and just like that the value is evaporated (there are many companies that have alot of value and wouldn’t be expected to lose so much value, but the more extended the price the greater the potential drop). To make matters worst, HFT are basically computer programs. They are unemotional, however, when the people who are running them identify a shock to the market, they shut the machines off. These machines are currently creating most of the bids in the market. If they disappear, the bid disappears and falls like a rock. This is what happened during the flash crash of 2010.

So what about the central banks? They can just come in and print money if the market falls and help to push it back up again. There is some false logic in there because for every action there is a reaction. The money that the Fed prints does not disappear from the system. It will eventually have an effect on the US dollar. Let’s go back to the doll. Imagine the Fed was producing the dolls (they were not produced in China and the paint was not toxic). The thing is the Fed suddenly produced so many dolls that they were found in every shop on every corner. What would happen to percieved value? Well, the idea of scarcity would no longer be there. The dolls are no longer special and people are no longer going out of the way to buy them so the value would drop. It could keep dropping even below the cost price if people have no interest in buying.


This could happen to the US dollar. If the perception is that the US dollar is no longer that valuable, its percieved value would drop. What happens when it goes down? Everything becomes more expensive for everybody holding dollars. What happens if your dollars keep declining in value? You will want to get rid of them and change for something else. The US stock markets are priced in US dollars. So, if the central banks continue to print, the US dollar could lose its value to the point where people will sell their dollar denominated assets, such as stocks and bonds.

Is there anything else? Well actually yes. Over the past few years low interest rates have spurred a large number of companies to borrow in order to buyback stock. In addition, investors have been borrowing in order to purchase stock pushing up margin debt to extremely high levels. If the markets were to fall, there is a point which these individuals will get margin calls forcing them to sell their stock pushing prices lower. The same will be true for companies holding large amounts of debt that need to be paid back.

So, we have a few potential forces that could cause an incredible amount of damage to the stock markets. What will cause the start of it? That is what a few of us are trying to identify. What about everybody else? Well, it looks as though they are still pushing the price up of dolls made with toxic paint.