I’m embarking on a week-long trip, so updates will be sparse until I resume regular postings around July 20. As they say, one cannot solely rely on the intricacies of economics and finance.
Over the years, financial researchers have made significant strides in unraveling the complexities of asset pricing. This often boils down to understanding that the origins of excess returns—risk premiums—are linked to various betas or types of market risks, factors, or investment anomalies, depending on your preferred terminology. While these efforts have yielded fruitful insights, they represent only part of the journey. The next crucial step in uncovering the mysteries of Mr. Market has just begun. Efficiently managing risk factors through dynamic asset allocation is still in its nascent stages. Despite this, mastering this art remains the ultimate ambition of investment strategy.
● The Devil’s Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . and Are Ready to Do It Again
By Nicholas Dunbar
Summary via publisher, Harvard Business Press
“The Devil’s Derivatives” uncovers the uncharted narrative of contemporary financial innovation. It explores how investment banks crafted new financial products, how global investors were enticed to purchase them, how regulators were drawn in by the political allure of easy credit, and how speculators profited during the near-collapse of the financial system. Author Nicholas Dunbar clarifies the revolution that briefly elevated finance to a status akin to theoretical physics. He illustrates how bankers developed a secret trillion-dollar machine that democratized access to cheap mortgages while enriching financial innovators. Central to this tale is the transformation of ‘risk-averse’ individuals into ‘risk-takers’ driven by those eager for success. Why did people place their trust in complex financial instruments? Who were the bankers striving to piece together these intricate systems? How did this progression gain momentum, ultimately leading to collapse, bailouts, and public disillusionment with the financial elite? Provocative and insightful, “The Devil’s Derivatives” provides critical insights into the forces that ignited the most severe economic downturn since the Great Depression.
The eagerly anticipated figure has turned out to be disappointing. The net creation of private-sector jobs was a mere 57,000 in June, falling short of even May’s dismal increase of 73,000, which was revised down from an initially reported 83,000, as indicated by the Labor Department reports. There were hopes that May represented an anomaly, a temporary dip that would soon revert to the stronger job growth rates experienced in February, March, and April. The moderately promising employment update from ADP sparked some optimism. However, today’s report serves as a stark reminder that the economy will likely continue to struggle throughout the summer. Though the employment data is bleak, it does not spell disaster. Yet, it does indicate that growth has significantly decelerated and suggests that any recovery in economic momentum will face more substantial challenges ahead.
Have we evaded a significant economic setback? Today’s employment figures provide two encouraging indicators. New claims for jobless benefits declined in the past week, and the ADP Employment Report for June indicates a rebound in private-sector job creation following a sharp decline in May. While the numbers may not be outstanding, they do offer enough support to propose that the recent downturn in macro trends isn’t worsening and may actually be transitioning towards a stronger growth trajectory.
Initial indicators regarding June’s economic performance have emerged, and while they leave us with some hope, they do not completely allay fears. The latest figures from the ISM Non-Manufacturing Report suggest a slower growth rate last month. However, the June manufacturing report reveals a slight uptick in activity. The good news is that growth still prevails in both sectors, albeit at a reduced rate in the services sector, which makes up the majority of the private sector. Nevertheless, the notion that the summer of 2011 will not replicate last year’s disappointing decline remains alive and well. However, the upcoming weeks will undoubtedly test this optimism.
Given human nature, investors continuously search for the ideal investment portfolio that thrives in prosperous times while providing a safe harbor during turmoil. Such a flawless solution is, of course, elusive. If it existed, the market would quickly discover it and arbitrage any future benefits. Different asset allocations yield varying outcomes over time, thus, it’s crucial to devote time to strategizing how to manage our portfolios effectively. However, even the best-planned strategies face limitations. The challenge lies in establishing a sensible framework to weigh our options and assess potential rewards. Below is a case study of an actively managed asset allocation fund that boasts an impressive track record.
● Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Street
By Tomas Sedlacek
Summary via publisher, Oxford University Press
In “The Economics of Good and Evil,” Sedlacek presents a revolutionary perspective on economics, challenging established assumptions. He argues that while economics is often viewed as a science and a neutral mathematical inquiry, it is deeply rooted in culture and is a product of our civilization. It originated in philosophy—Adam Smith authored both “The Wealth of Nations” and “The Theory of Moral Sentiments.” Sedlacek posits that economics weaves together history, legend, religion, and ethics. He contends that even the most complex mathematical models are essentially narratives, our efforts to understand the world around us. Economics not only describes reality, but also sets normative expectations, defining ideal conditions. He views science as a belief system to which we adhere. To uncover the foundational beliefs underlying economics, he ventures beyond traditional boundaries, offering a sweeping exploration of economic thought throughout history. He examines sources from the epic of Gilgamesh and the Old Testament to the rise of Christianity, as well as figures like Descartes and Adam Smith, culminating in the consumerism depicted in “Fight Club.” Throughout, he raises profound meta-economic questions: What is the purpose of economics? Can ethical considerations coexist with technical capabilities? Is there merit in being virtuous?
June delivered a mixed array of investment results. Emerging market bonds (Citigroup ESBI-C) topped the list among major asset classes, rising by 1.1% last month. In contrast, commodities (DJ-UBS Commodity) suffered, marking a significant decline of 5.0% for the second consecutive month. Our passive market-value weighted portfolio—Global Market Index—also felt the repercussions of widespread selling, with GMI declining by 1.0% in June. This downturn follows the previous month’s losses, resulting in the index experiencing its first consecutive monthly declines in a year.
Today’s update on weekly jobless claims provides little clarity. New applications for unemployment benefits decreased slightly by 1,000, landing at a seasonally adjusted figure of 428,000, but this change is virtually negligible. Consequently, uncertainty persists about the crucial employment report for June, set to be released on July 8. There was hope that today’s jobless figures would shed some light, but the fog of uncertainty remains thick.
