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The Stock Market is a Social System

In this video, I’ll explain how the stock market is a social system, not a rational system of numbers.

The easiest way to remember why stocks are unpredictable is to realize their prices are driven by human emotion and behavior.

Think of other times when you know human behavior to be unpredictable: kids on a playground, office politics, fashion trends.

It doesn’t matter what a price/earnings ratio “should” be. People can send it wherever.

Benjamin Graham, author of The Intelligent Investor, famously observed: “In the short run, the market is a voting machine; but in the long run, it is a weighing machine.”

Stocks rise over time as earnings grow over time. No indicator helps for short-term timing. No indicator is necessary for long-term investing.


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Are Smart Beta Funds Worth The Higher Cost?

In this video, I’ll explore whether smart-beta funds are worth their higher cost.

Smart-beta funds have become popular. They try to replicate various investing techniques, such as value and growth, with an automated formula.

Here’s how the funds were explained in a March 18, 2017 Buttonwood column in The Economist:

[Excerpt shown at 0:35.]

While it may be true that smart-beta funds are cheaper than active fund managers, it’s important to remember that active fund managers aren’t worth much. Most of them lose to plain Jane indexes.

So, we have to see whether smart-beta funds are worth their higher cost compared with standard index funds.

We’ll use the Russell 1000 index, which consists of the largest 1,000 companies from the Russell 3000 total US stock market index. It’s like the S&P 500, but with 1000 companies instead.

The index is available in its plain form from iShares with symbol IWB. Its smart-beta growth version uses symbol IWD, and value uses IWF. Here are their expenses:

[Chart shown at 2:51.]

The plain Jane index fund, IWB, charges a net expense ratio of just 0.15%, while value (IWD) and growth (IWF) charge 0.20%. Smart-beta is 33.3% more expensive.

Has it been worth it? Let’s have a look.

[Charts shown at 3:40.]

Sometimes value wins, sometimes growth wins, but you can’t know which in advance, so own the whole index.

Which have investors chosen? Value and growth, of course. AUM: IWB $18B, IWD $36B, IWF $34B.


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Japanese Potato Panic

In this video, I’ll look at Japan’s potato panic, and what it shows us about human behavior in the stock market.

In mid-April 2017, Tokyo-based Calbee announced it would temporarily halt sales of 15 types of potato chips due to a bad crop in the key potato-producing region of Hokkaido, which was struck by typhoons last year.

Calbee, which is 20% owned by PepsiCo, commands a 73% market share of potato chips in Japan.

The prospect of a shortage sparked soaring prices, with bags that usually sell for $1.20 going for $12 to $14.

However, as they did, plenty were available.

The possibility of shortage was enough to send prices up ten-fold, and make even people who hadn’t eaten chips in years suddenly desire them like mad!

Calbee and other chip companies are finding back-up suppliers, both inside and outside of Japan. Production will resume.

Therefore, we could say the potato panic of 2017 was irrational. By some angles, it was unjustifiable.

Historically, these prices were too much to pay, but people wanted those chips so it wasn’t irrational to them. Their emotions were goaded by media.

If products as well-known as potato chips can see their market situation change on a dime due to an emotional reaction, imagine those same emotions unleashed in the stock market. Coupled with the 24-hour news cycle, no wonder stock prices fluctuate in unpredictable ways.

Remember this the next time somebody claims to know where stock prices are heading.

The people buying and selling stocks are just like the people consuming potato chips. Weather, news, trends can cause the madness of crowds to take over at any time.

These variables fan the flames of emotion, sending both chip prices and stock prices all over the map. There’s no predicting these short-term moves because there’s no predicting the emotions that drive them.


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Is Higher Education Worth The Cost?

In this video, I’ll look at whether higher education is worth the cost.

Tuition in the United States is soaring. Look at this chart from the American Enterprise Institute using data from the Bureau of Labor Statistics:

[Chart shown at 0:16.]

Naturally, student debt is soaring as well.

The February 2017 Quarterly Report on Household Debt and Credit from the New York Fed:

[Report cover shown at 1:10.]

Reported: “Outstanding student loan balances increased by $31 billion, and stood at $1.31 trillion as of December 31, 2016.” The $31B jump was in Q4 alone.

It’s a growing percentage of overall debt:

[Chart shown at 1:36.]

And its delinquency rate is rising:

[Chart shown at 2:15.]

Why might this be? Presumably, the cost of college is rising because the value of the education it bestows is worth more, right? Wrong.

The Washington Post reported in December 2013 that between 2003 and 2012, the median income of US college graduates with bachelor’s degrees dropped from almost $52,000 to just above $46,000, both in 2012 dollars.

Four years later, how do things stand now?

According to the Class of 2016 Student Survey Report from the National Association of Colleges and Employers, “just over 46% of 2016 graduates received a job offer before graduation, down from 51% from the Class of 2015.” The median salary offer was $47,358, which is 4.9% less than the inflation-adjusted 2012 figure of $48,388.

High cost, high debt, falling compensation = no good.

Television host Mike Rowe put it aptly:

[Mike Rowe quote shown at 4:07.]

Why don’t the jobs exist anymore?

The short answer is that they’ve been outsourced or automated, and the latter trend is picking up steam. Algos and bots are the workforce of tomorrow.

Knowledge is never a waste, but we need to stop thinking about higher education as job training, and reprice it accordingly.


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Can China Lead The World Economy?

In this video, I’ll explore whether China can lead the world economy.

I recently spent time in Shanghai and Guangzhou, observing China in action, taking notes and photos.

I reported to Kelly Letter subscribers in early March 2017, and have condensed that report into this video.

China is routinely presented in media as the world’s next economic leader. Its growth has been impressive:

[China’s historical GDP growth shown at 0:44.]

By comparison, the 2016 nominal GDP of the United States was $18.6T, Japan’s was $4.4T, Germany’s was $3.5T, and the United Kingdom’s was $2.8T.

According to The Economist Intelligence Unit, China’s current path will make it the largest economy in the world by nominal GDP in 2026.

Three problems with the idea that China will supplant the United States as the leading economy of the world:

1. It’s not as developed as its image in media suggests.
2. It does not innovate.
3. Its growth may not continue as expected due to the rise of automated manufacturing.

We’ll take each in turn.

1. China is not as developed as its image in media suggests.
Pictures of China invariably show the skylines of Shanghai, Beijing, and Guangzhou as testament to the country’s rapid growth and modernity:

[Photo of Shanghai skyline shown at 2:20.]

That’s the Pudong skyline east of the Huangpu River, dominated by the Oriental Pearl Radio & TV Tower.

[Photo of Beijing skyline shown at 2:44.]

That’s the 3rd Ring Road into the city center past the oddly shaped and iconic CCTV building.

[Photo of Guangzhou skyline shown at 2:58.]

That’s the Canton Tower along the Pearl River.

All three are beautiful and deservedly admired, but there’s no depth to the image they present. Upon closer inspection, the advancement falls apart.

For example, the Shanghai Maglev Train is the fastest commercial electric-train in the world, with a top speed of 268 mph. I was excited to ride it.

What a letdown: The person selling the ticket at a counter looked tired and unkempt. Seat covers rumpled. Digital clock and speed readout broken.

Within the impressive city centers it’s easy to find outdated methods of construction using woodstick scaffolding.

[Photo of Guanghzhou woodstock scaffolding shown at 4:23.]

I also saw rundown streets with people carrying baskets of slaughtered chickens on bicycles, and urban wastelands of empty dormitories flanking wide concrete lots covered in dust.

[Photos of Guangzhou urban wasteland and Shanghai slums shown at 5:11.]

I looked up at the towers and wondered who in the world works in them, and where they live. Of course there are fine parts of each city, but they’re never far from third world conditions.

These real-life experiences in China are borne out in the data. GDP per capita in the United States was $57,300 in 2016. It was $48,200 in Germany, $46,200 in Canada, $42,500 in the UK, and $38,900 in Japan. In China, it was $14,300.

2. China Does Not Innovate
China’s economy grew through manufacturing. It makes more than any other country.

Apple’s iPhone is assembled by Foxconn and Pegatron, both Taiwanese. Most iPhones from Foxconn are assembled at its Shenzen, China location.

The iPhone is a good example of the problem for China. It’s designed elsewhere. China is just the factory floor.
[Photos of Foxconn shown at 7:50.]

A March 2014 article in Harvard Business Review, “Why China Can’t Innovate,” placed blame on the restrictive environment created by state control, a force weighing down on universities and companies. The Communist Party requires placement of a representative in every company with more than 50 employees. Talk about a status-quo magnet.

This does not explain the rip-off culture, though. Knock-off products everywhere.

[Fake Apple Store images shown at 9:13.]

Even in areas where Chinese innovation is slick, it’s derivative. For example: Jack Ma’s Alibaba Group.

[Photo of Jack Ma shown at 10:51.]

It runs a set of web portals and e-commerce services and retail operations descended directly from their original counterparts in the United States, such as Amazon, eBay, PayPal, and Wal-Mart using technology created in the West, such as the internet, cloud computing, mobile operating systems, and so on.

It has succeeded spectacularly, employing nearly 50,000 people and generating revenue of $21B, but hasn’t broken much new ground along the way.

Except in creative financial reports.

[Alibaba fraud news story shown at 11:47.]

It claimed to have shipped 278 million orders on a single day in November 2014, more than 7.5x greater than the 37 million orders Amazon shipped on that year’s Cyber Monday, and even more than Amazon’s 244 million users.

We could say it’s not clear where the “40 thieves” fit into China’s modern Ali Baba tale.

3. China’s growth may not continue as expected due to the rise of automated manufacturing.
Robots are coming.

[Photo of robot assembly line shown at 13:15.]

Scenes like this one will become common in all industries, not just automotive.

Foxconn plans to replace workers in its factories with “Foxbots.” It set a benchmark of 30% company-wide automation by 2020.

[Photo of Foxbot shown at 13:41.]

Already, one of its factories has replaced 60,000 workers with robots. It’s bringing 10,000 new robots online per year.

Why can’t Apple build its own robot-run factories?

China is behind the times on this front.

As of last summer, it employed just 36 robots per 10,000 manufacturing workers, compared with 164 in the US, 292 in Germany, 314 in Japan, and 478 in South Korea. This measurement is called robotic density, and is one to watch in the years ahead.

Understandable panic. If automation creates a mass exodus of manufacturing, lacking innovation results in no new ideas to fill the gap, how much impact?

According to China’s National Bureau of Statistics, manufacturing provided 20% of urban employment in 2014. While China’s services sector is gradually growing in importance, industry comprised 41% of China’s economy in 2015, according to Statista. A significant slowdown in manufacturing would greatly harm China’s economy.

Conclusion
I do not believe China can lead the world economy.

It will be held back by its largely undeveloped status, its lack of innovation, and the rise of automation.


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