Shiller on Shiller

Here is a graph we do in my office of the Shiller 10-year normalized price/earnings ratio. Remember that this is an aggregate valuation; there is a lot of variation within the market. But stocks are not cheap. (That doesn't mean they won't beat bonds over the next decade.) You'll need to click on the image to get a good look.

And here's Robert Shiller  himself, talking about the data series, bringing the numbers to life. Note that the date of the Shiller interview is from Sept. 27 of last year, when the S&P 500 closed at 1,175. It closed today at 1,351.

To be clear, this is my own graph, not his, but we use his numbers.

Soccer is More Interesting than Stocks

Fascinating to see an ECB working paper reporting that trading declines by about half when an important international soccer match is on TV, at least in a country whose team is playing. And the correlation between that country's markets and other world markets drops as well.

Which reminds me of the old joke that Dan May, a 20th century Nashville industrialist, used to tell.  A surveyor called him and asked, "Mr. May, how many people work at your factory?" He thought for a moment and replied, "About half."

The more serious academic point, which the ECB paper (I have only glanced at it) touches on, and which Robert Shiller has mentioned, is that attention is a scarce resource.

Way-Back Machine: Robert Rubin, on Jon Corzine, in 2003

Recently, I looked again at Robert Rubin's 2003 book, In an Uncertain World. I remember recommending it to friends when it came out. My goal now, as I glanced at passages I had underlined years ago, was to see how the meaning had changed since the Great Unpleasantness of 2007-to-present. I was also wondering how Rubin, a guy who wrote so intelligently on how to think about risk, could have missed the big problems that developed while he was at Citigroup.

One passage amazes me. In it, Rubin raises a red flag about Jon Corzine's risk appetite, years before l'affaire MF Global. Quoting the book (and remember, this was 2003):

...The list of firms and individuals who have gone broke by failing to focus on remote risks is a long one. Even people who think probabilistically, and are highly analytical and systematic, often dismiss remote contingencies as irrelevant.

In this regard, I often think of an example from Goldman Sachs when Jon Corzine, then the firm's exceedingly successful head of fixed-income activities, wanted to take a large position in farm credit bonds. The expectation was of a high return, and because the bonds were backed by the "moral obligation" of the U.S. government through a new agency known as Farmer Mac, the probability of their defaulting seemed close to zero. But what Steve Friedman and I asked Jon was "What if a problem develops in farm credit and as extremely unlikely as it might be, the government declines to stand by its so-called moral obligation?" 

"That's silly," Corzine replied. It was inconceivable to him that the government would not honor its moral obligation, and in a sense he was right. 

But Steve and I didn't want Goldman Sachs to cease to exist after 130 years because something that we agreed was virtually inconceivable actually happened....Too often, risks that seem remote are treated as essentially nonexistent. In this case, the remote contingency never occurred, but the decision to limit the risk was right.

The passage I just quoted is on pages 342-343 of the paperback edition of In an Uncertain World. I added the bolding. Upshot for me? Rubin was bugged enough by this encounter with Corzine to put it in print. Note the bold text where Rubin says the he "often think[s]" of this episode. It really got to him.

It was politic of Rubin to admit that the risk (Farmer Mac default) never actually materialized. I guess that is how one becomes a Robert Rubin. Yet he does, in the end, make clear his view that the decision to overrule Jon Corzine was right. Which, of course, it was.

We have now seen, with the bankruptcy of MF Global, a certain vindication of Rubin's instinct that this episode at Goldman was disturbing and worth recording.

Worth Reading

In the Financial Times (registration required), Gillian Tett on the Libor probe and other trouble that lives on in the dank, dark recesses of the financial world. She is one of the smartest, most effective, and most principled financial reporters out there right now.

In Fortune, Warren Buffett on bonds, stocks, and gold.

Investment Samsara

Any piece of investment writing that can work in a little Hindu philosophy is worth noting. "Life - and Death Proposition" is the latest monthly newsletter from Bill Gross of Pimco. I guess he sees deleverage and austerity as karma for the bubble. I can't disagree. A delight to see such a philosophical piece from a guy who manages hundreds of billions of dollars. Hope that the flame of intellectual life sometimes flickers reasonably brightly, even on the trading floor.

Jobs Report Optimism from Greg Ip

Good discussion of the increasingly optimistic tone in the U.S. economy by Greg Ip, at the blog of The Economist. He keys off of today's strong jobs report. I think he's more or less right here. My only quibble is that Europe is OK for now because of heavy intervention by the European Central Bank, but it's not actually healthy (the banks there need more capital). And I remain a little concerned with how far the U.S. economy is from an equilibrium state, with the equilibrium bringing, when it comes, higher taxes and higher interest rates. Still, though, he's right that things are improving and gives a balanced reading of the data and trends.

Tallulah Bank-Head

Nice quote this week from derivatives expert Satyajit Das, in the Financial Times:  "For the moment, policymakers are relying on the advice of actress Tallulah Bankhead: 'Cocaine isn't habit forming. I should know - I've been using it for years.' But reliance on low interest rates, like all addictions, is dangerous. It is also ineffective in addressing the real economic issues."

The full column by Das, "Low rates: the drug we can all do without," is here, but the link requires registration.

Hmmm...I see that this is my third post in the past several days that likens central bank policy to a drug. And it is the second involving a celebrity who is partaking (Elvis was the other star, in a cartoon I posted). Odd.