LiveBlog: New York Investment Consultants Summit

Melissa Shin, managing editor of Advisor’s Edge and Advisor’s Edge Report, has been reporting live from IMCA’s 2012 New York Consultants Conference. The conference has closed, but you can still read her coverage below.

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Thanks so much for joining me here in NYC. I hope you found these last two days as educational as I did!

Asset Allocation Success in a Diminished Return, Volatile Market Burt White, LPL Financial

10:32 This may be the first time a West Virginian is on an IMCA stage.

10:33 This guy has promised to talk 700 words a minute. So bear with me.

10:35 The S&P500 started 2011 at 1257.6 and ended at 1257.6. There were 9 minutes during 2011 that S&P500 was at 1257.6. The market travelled almost 3,239 pts. That’s like going around the country.

10:36 In 2011, you couldn’t do better than buying overpriced, crappy companies. It was a tough year for active managers. Value approach didn’t work last year. Last year didn’t reward rational investors. It didn’t make sense. Why? Last year was the Great Disconnect. Feelings disconnected from fundamentals.

10:38 Market sentiment was at record low, yet the facts were positive. We had record corporate profits, no crisis, and solid economic data. Yet everyone was really pessimistic.

10:39 If I told you there was going to be a quarter where we’ll grow 2.5%, and we’ll hire 1 million jobs and corporate profits would be at record highs, then would you invest? That was Q3 2011. Markets were down 15%. There’s the disconnect.

10:41 We’re in the 360,000-370,000 unemployment claims a week. That sounds bad but typical is 325,000. We’re close. The S&P500 tracks the unemployment claims line. You want to know what markets are going to do? Look at the unemployment trend line. It’s the same line. It’s never disconnected until 2011. We should be at 1412 on S&P500, not 1312.

10:42 Things aren’t great right now, but it’s not meteor-crashing times. We’re priced there, though. That’s where sentiment has been. It’s better than what this market is giving it credit for.

10:43 Consumer sentiment is a lot lower, starting in 2008, than GDP justifies. Usually it tracks GDP. It disconnected for the first in the history of the markets.

10:45 We were feeling worse in summer 2011 than at the depths of the recession. Yet in 2008, we were laying off 600,000 Americans a week. In summer 2011, we had +120,000 jobs/week, record high GDP and corporations were never as profitable as they were then. Yet we felt that the GDP was shrinking by 10% — even though it was +2.5%.

10:46 Two alternatives: GDP will fall to match consumer sentiment OR consumers need to get more confident. Confidence is rising. That’s why markets are doing better. We’re in a recession of confidence.

10:47 Consumers are spending a lot more than is justified by how they’re feeling. (Consumer confidence is low, yet consumer spending is higher.) Confidence and spending used to track each other. In last 2 years, we’ve lied to the pollsters. We’re spending at 2005, 2006 levels.

10:49 Both numbers can’t be right. So which one is wrong? Lots of smart people issued mea culpas last year. They lost 30%. Last year made smart people look stupid. This disconnect, you had to be a therapist to do well. You had to ignore the facts.

10:50 Here’s something offensive. I have 4 daughters and I’m married, incl. twin 14 year olds. (No one in room has more daughters.) So let me offend you. It’s irrelevant how many people are unemployed. 5%, 8%, 20% — it is irrelevant how many Americans are unemployed. It matters WHO is unemployed. 80% of spending is done by businesses and the top 20% earners.

10:52 Bill Gates spend more than all of us combined, so if he’s unemployed, that’s a lot worse for the economy. Bear Sterns was the first to go under, and the average salary there was $500,000. Lehman, autos, then banking…the Great Recession stunk because lots of people who were rich got laid off. We lost our best jobs first and that doesn’t usually happen in a recession. Usually the mail room gets fired first. They stopped spending and that’s 80% of spending in the economy!

10:54 Unemployment rate for college education and above is 4%, record lows. That’s an unemployment number we don’t talk about. The other one is irrelevant — socially it’s relevant, but that’s not my job. Not every person is worth the same economically. 8-14% unemployment is irrelevant, what matters is WHO.

10:55 Why the disconnect? They poll everybody, and 80% of people are upset. The top 20% with record low unemployment is spending.

10:56 So how do we win? You have to have a plan. Know what matters. We think we know what’s happening — but it changes. It used to be easy to invest. Know what the consumer’s going to do. They used to tell you. It worked for decades. It’s why smart managers outperformed before. You have to find something else now.

Rule 2: Ignore the noise. Was last year volatile? Yes. Wait… day-to-day, yes, but month-by-month there wasn’t that much volatility. Annually? We didn’t go anywhere! We had zero volatility.

11:00 Markets are worried about Italian 2-year yields. Their Fed site is in English, so you can use that info to predict how the markets will do. Let your process evolve. You DON’T know what make markets go up anymore. When the market tells you something, listen.

11:02 If I had an asset class that will get you 9.5% in the next ten years, would you invest? It’s stocks. Not going to happen, right? Inverted trailing P/E for S&P500 predicts that will happen. This has worked, every time.

11:04 Be fearful when others are greedy — well now, be greedy when others are fearful. This is the most amount of fear ever. When things are scary and cheap, the long-term investor should invest.

11:05 Diversification has changed. It doesn’t work anymore. They help, but they don’t work.

11:08 We build portfolios and think growth and value is enough. But how much, how often and try not to deliver surprise. Great portfolios outperform and do it often. Diversification is always good, right? It’s not always good. It’s just math. If you combine growth and value, it outperforms less of the time. Why? What we missed is both managers are top down managers, higher quality…we didn’t diversify by that.

11:10 It’s not just what you own, it’s HOW you invest. We diversify by holding period, how we found the idea (fundamental, technical, valuation), team that it comes from, AND asset class.

11:12 You need to stay emotionally connected without being emotional. Most PMs are “buttholes.” That’s what makes them good, they have no feelings. That worked great, until last year, because they weren’t listening to sentiment in 2011. They weren’t listening to the concern in Washington. They only watched GDP and earnings. I have to figure out how to add emotion. I’m not a caring person, so I have to replicate feelings with numbers. So we use a bull/bear ratio.

11:13 Low-risk treasuries are far from low-risk investments.

Let’s get a bit happier, a bit more confident. We’re not talking about the end of the world. We’re halfway to double-digit returns in 25 days of 2012. The market would be at 1,400 if we weren’t so scared. We’ve already priced in fear. We just have to take the coat of fear off and that’s worth 10%. The rest comes from Fed, ECB, China…that’s just gravy. The fear is worth 10%.

Q. Don’t you think govt policy and the fear of what it will do to us explains the disconnect?

A. I agree. It is something softer. It’s not about our jobs, or housing or the economy. It may not even be about Europe. It’s disgust with the childishness in Washington. I’m upset with how things are being run by the govt. So we’re expressing that in our sentiment. But we do have confidence — look at our spending.

Q. The markets can remain irrational longer than you can remain solvent. Agree?

A. Remember, the market is you. The market is you buying and selling stock. For us to say it’s irrational, no — it’s irrational because we’re irrational. I agree the market can be irrational for long periods of time. It can disconnect. It can do things it’s never done before. But over time, things get cheap and better. The meteor may never come. It’s a lot to hunker down into a bomb shelter for decades. If they don’t come, we’ll come out for fresh air. I’m not saying this is a Mary Poppins market; but it’s not a disaster.

Q. Are emotions a leading or lagging indicator? How do you use them?

A. I’m not a behaviouralist. I’ve found emotions are a lagging indicator on the recovery. Bad news comes, we don’t foresee it. Take confidence. You don’t lose confidence, you just never had it at all. The real measure of confidence is when something isn’t working.

Q. How much of US GDP is coming from cuts and layoffs, thus explaining poor consumer sentiment?

A. Record profitability is coming from lower costs (layoffs) at corporations. That’s partially true. We’ve been arguing that for 4-5 quarters now. We say we’ve seen peak margins, and they keep going up. We believe about 2%-3% come from higher-than-average cutting. 2009 was lowest level of patent applications ever. Businesses have overcut spending, so their earnings are better, but that doesn’t account for revenues within 3% of all-time highs. GDP is at all-time highs. Earnings are at all-time highs.

Q. Cash on balance sheets — re: stock buybacks, are they good or bad?

A. Depends on what you do with the cash. They’re *an* option, some companies are making them the option. I’d rather see the capital deployed for future growth and reinvested into M&A, new ideas, new ways of growth, higher-ROI activities. But in this environment, not a lot of companies feel secure enough that there are high-ROI projects. So a safer bet is share buybacks. They’re a wash over time. They’re a sign that a company doesn’t have vision as to what it can do with that extra cash. That’s scary.

Decade of Debt Carmen Reinhart, PhD, Peterson Institute for International Economics

A. The 7 periods were not similar. The shocks were different. The common thing was the economies were already highly leveraged. Most of the double dips were within the first 5 year window of the recovery (where we are now). The cause of the double dips = external factors. In the case of Japan, the double dip in Japan was worse than the initial crisis. Everyone likes to think it was bad policy, but there was also bad luck. 1997 Asian Crisis unfolded 1996 when the Thai baht came under attack. That was a major external shock for already-weak Japanese banks. In the case of the Finland double-dip, 1990s Scandinavian crisis had a lot to do with Russia. The lesson for us: What is happening in Europe could have repercussions here. It doesn’t take major events. Thailand is such a small country in Asia and look what happened.

Q. 7/15 episodes = double dip. What period? How are they similar?

A. Call him Prof. Bernanke. He wrote extensively on the Great Depression. The debt overhang then was made even worse by deflation because debt-to-nominal GDP — debt was fixed, but nominal GDP was shrinking. I expect and hope that the Fed will do a great deal in terms of getting more creative to avoid a deflationary situation. Japan saw its debt liquidated by financial repression. The problem is, with nearly 0 nominal interest rates, but deflation, they’re still paying a high rate of return on govt debt and haven’t been able to liquidate. The Fed will try to avoid a Fisherian deflation cycle.

Q. If near-term global growth is below expectations and US GDP is weaker, what are the odds of domestic deflation?

A. Yes. To be fair, I received the stimulus policy with open arms. I think it made a key distinction between stabilizing the situation to avoid a collapse. But going forward, it’s been 5 years. Debts are either repaid through adjustments (racking up the revenue and reducing expenditures) or are reneged on. So in terms of future burden, there’s a growing one — incl. unfunded liabilities. I have data back to 1790 and I’ve never seen debt accumulation on the magnitude that it’s at today.

Q. Does borrowing today put undue burden on our children and grandchildren?

A. Good news: most treasuries are bought by central banks. They’re not buying because they think the returns are great. They’re intervening in the forex market to avoid an appreciation of their currencies. Unless you can convince me China, Brazil, Korea are going to be more comfortable in allowing their currencies to appreciate, we’re going to continue to see demand for US Treasuries from abroad.

However, nominal interest rates are not good predictors of financial crises. They are not leading indicators, they are coincident indicators. We should not be complacent that the private demand for treasuries from abroad will continue to be there.

Q. Should we expect to see as much foreign consumption of treasuries going forward?

A. US private debt has been in an upward trend since 1916. I don’t expect that we’ll return to the 1982 household debt level (45%). In 2008, household debt was over 100% of GDP. Look how painful and slow it’s been to get to 90% of GDP. It’s a grinding, slow process even if it’s not a full reversion.

Q. Since our generation is consumption oriented and far from the depression, might we not deliver as much as in past crises?

10:01 It’s not true that we’re too globalized to think about controls on interest rates and capital flows.

9:59 Countries go to great lengths to avoid default and restructuring. 1980-2007, real interest rates were negative 10% of the time. Interest rates have been negative 50% of time between 2007 and present.

9:57 Inflation + low nominal interest rates = negative real interest rates on a consistent basis. For all advanced economies, between 1945 and 1980, real interest rates were negative half of the time. That’s how you liquidate debt, it’s a tax on the bondholders. Financial repression is a form of debt relief.

9:53 Now we’re going to talk about financial repression. After 1929 crash and 1931 major banking crises in almost all advanced economies, there was a backlash against globalization and laissez-faire financial markets. It’s the common response after severe crises.

9:50 Spain, Greece, Ireland, Portugal all had record capital inflows before their current problems. Brazil, Korea are attracting lots of inflows, and internal leverage has risen. Their currencies have appreciated. There are vulnerabilities in those countries that weren’t there 2 years ago. The EMs did well because they reduced their external debts.

9:48 Central banks will go to great lengths to keep interest rates as low as possible for as long as possible. Subpar economic activity with excess capacity — the inflation concerns will be on the back burner. Low interest rates in the advanced economies make yields on emerging markets financial instruments very attractive. Over past 2 years, there have been some sense of optimism that EMs are the right destination, the engine of growth and have tended to extrapolate that environment into the future. Large capital inflows can be called too much of a good thing and be destabilizing.

9:46 Portugal is likely next. Ireland is a candidate too. Italy and Spain aren’t in that group because they’re “too big to fail.”

9:44 Since independence in 1830, Greece has been in default about 50% of the time. Last was in 1960s.

9:42 Private debts before the crisis become public debts after the crisis. Look at Fannie and Freddie. In Ireland, the govt started with low debt and a manageable fiscal situation, but now has public debts close to Italian levels, because it’s taken on bank debt. Where there are high levels of debt, default has followed (restructuring, which is a partial default).

9:38 The environment we’re in has never been experienced in our lifetimes. This is not melodrama, but there’s no comparable reference point until the 1930s. A lot of things we’re seeing we never thought possible. We thought an emerging market would default or have a banking crisis that would cause a drop in 8% in output. But not seen as possible in the advanced economies. Advanced economies did default and restructure, and the pattern we’re seeing in Europe and US is common. The whole process we’re living now begins with financial innovation, liberalization. That facilitates credit booms. During that boom phase, asset prices soar. We all feel wealthier and borrow more. The boom in private debts end up in a severe financial crisis. However, the crisis morphs — economic activity implodes and creates a severe and protracted recession. The fiscal side is hit by an implosion in revenues and worsens the deficit.

9:37 I was at Bear Sterns during crisis in 1982 and saw the spectacular recovery. Why did it happen? Household debt in 1982 was about 45% of GDP. Now household debt, even after deleveraging since 2008, is still double that (90% of GDP). So the capacity for households to respond is very different in these two environments.

9:35 Deleveraging in the private sector kept economic activity subdued. The debt builds 7-10 years before the crisis. The duration of the deleveraging is of about equal length. 2012 marks the beginning of the 5th year after the crisis in 2007. Deleveraging doesn’t start big time until 3 years after the crisis.

9:33 Advanced economy record on unemployment is worrisome in the decade after a crisis. For advanced economies, median unemployment rate is 5 percentage points higher in the decade after a crisis.

9:31 The issue of double dips: in 7/15 scenarios we studied, we saw a double dip. The renewed weakness had external origins. US is a prime candidate. When you’re highly leveraged, it’s more difficult to respond.

9:30 Normal rate of growth is about 3%. In the decade after a crisis, it’s about 2%. So 1% drop.

9:29 If you study the severe financial crises (advanced or emerging markets) they cast a long shadow. We looked at the decade following and before the crises. What happens to growth, unemployment, housing prices? Decade after is dominated by deleveraging (7 years) and puts a damper on economic activity. GDP growth and housing prices are lower and unemployment is higher in the decade after.

9:25 I’ll also touch on the emerging markets. And a global issue that affects everyone: the return of financial repression. Financial repression is a term that’s been around for decades, about describing a system in which there’s a much stronger connection between govts, central banks, and financial industry in a much more regulated environment.

9:23 Today we’re going to focus on debt situation — public and private. We’ll also talk about Europe.

DAY 2

Keynes vs. Hayek: What Government Can and Cannot Do to Repair the Economy Jared Bernstein, PhD, Center on Budget and Policy Priorities (representing Keynes) Russell Roberts, PhD, George Mason University (representing Hayek)

We just did a show of hands, and the room is overwhelmingly Hayekian. Rap chorus playing in the room. Love it.

RR: I like gridlock. [laughter] When the Republicans had all 3 branches, spending was out of control. Main diff between Republicans and Democrats is they like to spend money on their friends, they just have different friends. But the financial system is the friend of both. And there’s nothing to get rid of the backscratching. Obama, Romney, Gingrich are all tied to the financial sector. Our biggest problem is that spending is out of control. The size of govt is too large, we have to show some restraint. We have to do that with respect to entitlements. Even Greece will face reality. I don’t want America to be in that position.

A. JB: We need to reinject facts into the debate. Mitt Romney thinks spending on low-income programs go to bureaucrats. Not true. 91% goes to the people. Every day I’m hearing misinformation in these campaigns. We can’t diagnose our problem if we’re stuck in a fantasy world. Facts have to guide us back to a self-correcting political economy. A system that can’t self-correct can’t survive.

A. [Silence.]

9:15 Q. We need to get past the gridlock in Washington DC. How?

A. JB: It’s tougher to get a mortgage because lots of people are underwater on their mortgages. Impossible to get a refi when that is happening. There’s a risk aversion right now. You have to have a high FICO score. Banks are very tight with credit right now.

RR: My favourite quote of Hayek: The curious task of economics is to demonstrate to men how little they know about what they think they can design. We’ve been trying to design the housing market to increase the homeownership rate. The homeownership rate fell in 1980s and that was likely because of divorce rates rising. The govt was scared that was because of affordability and tried to engineer the market. Now, we’ve got lots of people underwater and the homeownership rate is right on trend based on what happened in 1980. What a human failure.

Q. Why can’t people get mortgages with all the bank bailouts?

A. RR: We HAVE been regulating leverage. Mortgage-backed securities and European sovereign debt were once thought of as “safe” debt. Quote from rap: “Capitalism’s a system of profit and loss, if you bail out the losers, there’s no end to the cost.” We’re doing that. Taxpayers shouldn’t have to pay for these bailouts. The Fed hasn’t injected resources into the economy, it’s been injected into the banks. Not the same thing. Fed is paying interest and that’s a bad thing. Banks DO have capital reserves!

A. JB: Keynes was worried about bubbles caused by speculation. Adam Smith concerned about that too. Stability in the macroeconomy leads to instability in the financial markets — a Keynesian insight. Shampoo economy: bubble, bust, repeat. It’s damaging. Cozy relationships between govt and financial markets are destructive. So what do you do? I agree it needs to stop, but how? Sarbanes-Oxley, etc. have been ineffective. I would definitely make a rule having to do with capital reserves that financial institutions have to hold so leverage ratios stop going through the roof. That’s what amplifies the financial mess we just came out of. A hedge fund (MF Global) went bankrupt. 44:1 leveraged on discounted southern European debt.

Q. What would Keynes say about stopping bubbles?

A. RR: They have it half right. There’s lots to be worried about on Wall Street. Gov’t’s relationship with Wall Street is a little too cordial. [laughter] There are grps that shouldn’t be scratching each others’ backs. That’s what I would do to make economy healthier is stop that. It destroys people’s faith in economy and democracy and mis-allocates capital. So what will happen in the political world? Keynes was in disgrace in 1980s, 1990s. He’s back in vogue. I understand the impulse to do something about the GDP contraction, but it didn’t work. Hayek is back in vogue too. But the Republicans don’t have a candidate who can articulate Hayekian economics.

Q. How does the Hayek view factor in an Occupy Wall Street world?

9:01 JB: Unemployment insurance/food stamps are used less as the economy recovers. It’s automatic. That’s the bulk of the spending. It’s important to recognize on debt — stimulus itself was temporary. Russ talked about debt, and the nervousness of adding to future debt. Permanent programs like Bush tax cuts and healthcare burden add to debt, not temp programs. Stimulus was less than one half of 1%. That’s not driving the debt. Congress doesn’t like to take things away. Payroll tax cut — good Keynesian stimulus. But it needs to be shut off when economy gets better.

9:00 RR: What works. Forecasts don’t work. If you look in your heart, or your brain, they don’t work. Taleb’s example (Black Swan) in Washington DC and trying to get to Chicago, and need a map, and someone says I have a map of Europe, “That’s better than nothing!” No, it’s not. It’s more misleading. That was a pretty bad recovery, the worst in our lifetime. Worse than 1981. We had a terrible recession then and the govt didn’t do much, and we recovered. This is the fight of the century. We don’t understand why some recoveries are better than others. Let’s be honest.

8:56 JB: Forget the estimates. Let’s argue based on what really happened. The contraction stopped. Things were falling off a cliff, we did stuff, now they stopped. So Keynes works. You’re taking a pool that’s half empty and try to fill it back up. Workers wouldn’t have been working otherwise, without gov’t help. You couldn’t move water from one pool to another. There wasn’t water. We had 600,000 reported jobs attained or created. Reported by employers themselves. They wouldn’t have created those jobs anyways.

8:54 Rebuttal from JB: This was a straw man argument. The recovery act did work. This exercise of guessing what the future would have looked like is alchemy — I disagree. Sales forecasts happen all the time. It’s not different than an estimate. Earnings forecasts happen everyday. Expectations.

8:51 RR: Man has to learn he cannot acquire the full knowledge that would make mastery of the events possible. Shouldn’t shape the results as a craftsman, but rather provide an appropriate environment like the gardener does for his plants. (paraphrased Hayek) This doesn’t mean doing nothing. We shouldn’t put our children in debt to create projects of dubious of value to jumpstart the economy when there’s no evidence the cables are connected to the economy.

We should improve our tax system, let the housing market get healthy, and pursue monetary policy.

8:50 RR: Some people think we should have spent $2 trillion and other think we should have spent $0. That’s embarrassing. We’re not in the realm of science, we’re in the realm of ideology (or, if you want to make it less embarrassing, philosophy). [applause] From the rap: “Economatricians are ever so pious. Are they doing science or confirming their bias?” Economics isn’t rocket science, it’s a lot harder. We’re not capable of delivering what the world wants from us. “The economy’s not a class you can master in college. To think otherwise is the pretense of knowledge.”

8:48 RR: Economics is more like biology than physics. There is no way we would ask a biologist to predict the impact on the squirrel population in 10 years if we increased the number of trees by 20% in 3 years. Could you possibly evaluate this? So many things would have happened. Macroeconomics is practiced as fake science.

8:46 RR: Why didn’t they look at the actual data? CBO said those data aren’t helpful. Isolating the effects would require knowing what would have been happened without the stimulus. They used the previous model (that mispredicted what output would be after stimulus). In other words, the model didn’t work anyways, so why use it to figure out what the stimulus did?

8:45 RR: You’ll hear those CBO numbers showing that stimulus prevented higher unemployment over and over again. However, they’re misleading. All they did was take their previous predictions and use the actual spending number to use $825 billion instead of $787 billion. That’s not an estimate, it’s a prediction. It has nothing to do with what actually happened in the economy. That’s madness.

8:43 RR: You know how you know a macroeconomist has a sense of humor? They use decimal points. [laughter] But we’re in an imprecise world.

8:41 RR: Quote from rap: “Wow, one data point and you’re jumping for joy. Last I checked wars only destroy.” Spending doesn’t always hurt the private sector of course. But it suggests there isn’t an automatic benefit from war. When the war ended, govt spending fell 60% and many predicted this would be catastrophic. Another quote from rap: “When war spending your friends cried disaster, but the economy only grew faster.”

8:38 RR: When gov’t spends money the resources have to come from somewhere. When workers use steel and concrete, is there enough in other parts of the economy? When gov’t spends stimulus money to increase R&D on Parkinson’s disease, does that help Nevada carpenters go back to work? WWII is the usual example of how Keynesian economics work. Did wartime spending create prosperity? Yes, for weapons manufacturers. But what about the rest of the economy? Was there a multiplier effect? Did the private sector boom? No.

8:36 JB: My conclusion: Millions of people unemployed, credit system freezing — economy was in seizure. In Hayek’s world, you would have sat there in fall 2008 and let everything play out. Or, you can act aggressively to help the bank lend money and get people back to work. Temporary deficits, yes. I’m glad we chose the latter.

8:33 JB: The best story about the recovery act: unemployment would have gone up without the stimulus. Instead of peaking at 10%, it would have been +11%. Best argument for the Keynesians. (There’s another scenario — worst case — unemployment would have been a little bit higher without the recovery act. The confidence interval is very wide. There’s a lot here we don’t know. Hayek had a point, we never know what will happen with these interventions.)

8:31 [Ed note: things are getting feisty in here. Slide titles are something along the lines of “Bring it, Russ.”] JB: Some would say, the unemployment rate was 7% when you passed stimulus, 9.5% after, and so it doesn’t work. Well, what would have happened otherwise? Unemployment would have been higher than that.

8:27 JB: So, does Keynesian policy work? Shortly after stimulus came into play, GDP contraction rate got smaller. 9% before Obama took office. We were hemorrhaging jobs. Hayek says sit on your hands. Instead, we rolled our sleeves up (like in the video) and legislated the Keynesian stimulus. The rate of GDP loss contracted, and by second half of 2009, economy started expanding and has been ever since.

8:25 JB: Central planning is the complete opposite of Hayek. Hayek believes free markets, but didn’t recognize that an economy like ours can’t exist successfully on either side. You have to have a hybrid. Federal govt has to create economic activity that wouldn’t happen otherwise (bust = Keynes). In boom, Keynes backs off. A hybrid economy = Keynesian.

8:22 JB: Take this test to decide if you’re in favour of Keynes or Hayek. Does involuntary unemployment exist? (just not enough jobs for them) Yes = Keynes. Hayek didn’t admit. Do you believe risk debt was accurately priced up to the mortgage bubble? (Hayek believed yes. Keynes believed no) Are financial markets stable? (If yes and police themselves, Hayek, no = Keynes) Do private costs always equal social costs (are there externalities, like pollution)? (Hayek says yes, Keynes says social costs can be higher than private)

8:21 JB: Hayek formed his ideas when liberals (in favour of free market liberalism) feared that Soviet central planning looked good to a lot of people. Hayek was much less interested in the mechanics of macroeconomy than freedom and individual choice in the microeconomy. These are static ideas. Keynes added dynamics/cycles. The best theories are ones that explain events and Keynes’ does.

8:18 JB: Capitalism was on the ropes in the 1930s. Soviet-style planning looked good. When economists say “price signals” they are citing Hayek. But he pushed it too far. He denied possibility of incomplete information causing market failure. The idea that members of the economy (people) don’t always have all the info we need to judge whether risk, commodities are accurately priced. He forgot this.

My key conclusion: To side with Hayek is to consign millions to unnecessary harm. Which fared poorly and which fared better? Keynesian policies predicted the future far better than Hayek. That’s the best way to test a theory.

8:17 JB: This is not an academic debate. (well, the rap video kind of confirmed that.) Growth is consistent and positive, but too slow. There’s significant fragility. We’ll be back here if we don’t learn our lesson.

8:16 Jared Bernstein is representing Keynes “in a much more gentle discourse than that prizefight we just saw.”

8:13 This is the most awesome conference I’ve ever been to. The rap is so good. (Choice quotes: “I want real growth, not a series of bubbles.” “Capitalism’s about profits and loss, you bail out the losers there’s no end to the costs.” “The fight continues, Keynes and Hayek going down”)

8:11 Ok, I just saw one of our speakers topless because he’s boxing in the video. Now I’m concerned. Oh, it’s an actor. It wasn’t him. Whew.

8:10 We’re watching another one of the raps he’s done. Some of the older folks here look a bit concerned.

8:07 Russell Roberts has a video on Youtube. It’s a rap. Keynes versus Hayek. ‘Nuff said. WATCH.

8:05 We’re going to have a debate on the relative merits of Keynesian and Hayekian economics.

8:03 Welcome back, everyone! We’re looking forward to another half-day of insights and information.

Finding Investment Opportunities in a Climate of Fear Paul Quinsee, JP Morgan Asset Management

A. The CEOs are actually desperate for higher interest rates in the insurance, banking interest rates. I think the benefits from low labour will continue.

Q. We’ve seen strong margin expansion in last few years, it’s been driven by low labour headcount and low interest rates. What happens now that those have peaked?

4:55 Liquid alternatives: all alternatives rely more on manager skill than market return. But you have to be really comfortable with the manager that they can deliver, skill minus fees. For most people, the traditional arrangement is a much better way to invest.

4:54 Minimum volatility funds: you want to achieve a reasonable return with less volatility. There’s something to this paradox. The most volatile stocks over time don’t necessarily give you the premium to justify the risk. The concept is a reasonable one, but the timing now is not great. After the second half of next year, volatility stocks are underpriced and I wouldn’t want to shift to low-volatility stocks and miss the upside/recovery.

4:53 The central issue around P/E ratios vis high earnings — there are some places where profits are high, but that has to do with the benefits of tech and US companies competing in more places. That isn’t going away anytime soon. It’s a secular shift towards American companies making more money. There are parts of the markets where profits are still depressed. We have to expect profits to slow down, but margins won’t mean-revert in a few years.

A. If you add it up, yes. More than twice that number has gone into bonds, though. There’s been a massive asset allocation shift towards fixed income. A lot of the activity in ETFs is trading oriented, not investment oriented. Roughly, half the demand for equities have gone to ETFs.

Q. Is money going into ETFs instead of mutual funds?

4:48 Final excuse: everyone’s getting out of US equities. The peaks and troughs — the money is always going the wrong direction. When you see a powerful trend going the other way, it’s something to be scared of. The opportunity is to be contrarian and invest in US equities. Things aren’t perfect, but given the strength of American companies, and the starting prices, there’s nowhere better to be. People are going to realize they’re missing one of the best investments and try to get back in.

4:46 $73 billion in SPDR Gold ETF and rising rapidly. Demand is going to completely offset supply. But gold isn’t going to provide the biggest return since lots of money has already moved.

4:45 People want to own anything other than stocks. If you’re chasing low-volatility assets, you’re missing out on a lot of upside. If you’re basing your strategy on hedge fund manager’s skill, that can get you in trouble (ref: 2011).

4:45 Profit growth will slow down, dividends will continue to pay out — these are all good for stocks.

4:43 Dividend payout hasn’t peaked, either. Market loves them. Dividend funds are growing. Buybacks are continuing.

4:42 This doesn’t mean profits have peaked. We can see a lot of things that can go wrong. Think about financials — investment banks making 4%-7% returns? They used to be making 20%. They can get to the low teens without much effort. Housing still has to improve. Profits are at trend, not above.

4:41 Another excuse: Earnings have peaked. Corporate (US) 2011 earnings were up 16% from 2010. That’s a tremendous recovery. Margins are really strong.

4:40 The macro outlook for EMs is better, but American companies have the fundamentals.

4:38 We think EMs will grow by 10% in nominal terms in 2012, and US will do 4%-5%. But you don’t buy that! Companies work because the managers can raise capital, and invest capital at good returns, and reinvest cash flow well. Well guess what, American companies can do that really well.

4:37 Another excuse: Why don’t I just buy emerging markets? There’s two problems with that. You’re not buying GDP when you invest in stocks. You’re buying companies.

4:36 Premium for good active management is worth more now. When 8% is the standard, 1%-2% premium is huge.

4:35 Valuation didn’t work last year. Many measures didn’t work because they tended to get you on the wrong side of the macro — people bet things would get better. They didn’t. Exception: dividends. S&P also outperformed. But none of these are going to continue.

4:33 Another excuse: why should I bother with active management when I can get an ETF? Less than 20% of active managers beat the index net of fees last year.

4:31 ETF trading increase has been a reaction to volatility, not changing the market itself. The level of trading will come down once the markets calm down. This year, ETF trading as a % of stock exchange trading is down to 15%, not 25%-27% in 2011.

4:30 Lots of volume is good for a long-term investor — trading costs have gone down. Also, not a lot of evidence of HFT making more money. We haven’t seen HFT company IPOs. We haven’t seen unbelievably wealthy investors that have made money from HFT. There are some technical areas that justify regulatory scrutiny, but the game hasn’t changed. Volatility causes more trading, not the other way around. Same applies to ETFs.

4:28 High frequency trading (HFT) is more prominent, yes. Traders are trying to take of short-term moves in the marketplace. So there’s a huge volume increase in stock markets. Average daily volume on American stock exchanges has risen from $1 billion (late 1990s) to $4 billion (2000-2006) then the line went vertical — $9.7 trillion/day and starting to come down a bit. This has to do with volatility too, but HFT has enabled this.

4:26 Stocks have been moving together at an unprecedented level. More last year than after Lehman collapse. So it makes it hard to be stock picker, but it’s going to be hard for this to last. It’s exhausting. The level of correlation will come down as people face the reality of our world.

4:24 Another excuse: there’s too much volatility. Over history, volatility has been 0.7%. Peak was 3.3% in 2008, and 1930s has similar volatility to now. In 2005, there were 2 days the value of S&P500 changed by more than 2%. Last year, there were 68 times. It’s unrealistic to expect this to continue. It’s not permanent. Try not to be a victim of volatility — don’t sell low and buy high.

4:23 Experience in US is looking better than the rest of the world (Europe). Europe is in a recession, and our economy is starting to outperform.

4:21 We are in a period of economic growth that’s a lot less than 1980s and 1990s. It’s likely that will continue. We won’t see a sudden acceleration. But economy is not falling apart, either.

4:20 A reason not to invest in equities: macro, macro, macro. I’m fed up with those headlines.

Panel Discussion—Working with Women Susan Hirshman, MBA, CFA^®, CFP^®, CPA, SHE LTD; Alyssa Moeder, CFP^®, Merrill Lynch; Moderator: Marie Dzanis, CIMA

SH: There’s a sea change. The control of wealth is moving towards the female marketplace. We see it in family businesses. They used not to take over family businesses, and Harvard Business Review said 35% of businesses are thinking of daughter taking over. In 1990, it was only 10%.

Q. Many graduating classes in business, etc. are predominantly female. What do you think about that?

SH: Microfinance has taught us that if you give the money to mothers, the family learns. Women feel guilty they don’t know this. Get rid of the guilt. Where are you supposed to learn it? It’s up to the advisor to be the educator.

You might want to talk about long-term care to frame that discussion.

AM: It depends on what their financial situation is. My experience is when it’s a woman in transition, the focus is on maintaining lifestyle and status quo for children. They don’t want to sell their home or change their neighbourhood. If there’s enough after that, then they think about a legacy.

Q. Thinking about children is something women do right away (putting away money for college). I don’t generally hear discussions about educating children about inheritances (or no inheritances to fall back on). Do a lot women ask about leaving something for children?

AM: You don’t have to be a woman to help women lead. It’s an equal opportunity for both men and women to be good advisors.

SH: It depends. In reality, there aren’t enough women advisors to serve all women. They want to work with people who listen, understand and can develop a relationship. Even apologizing to a client is a big thing. Women want to know you care.

Q. Does a woman want a woman or a man advisor?

2:41 MD: Women take 75 min a day for personal grooming. Men are 81 minutes!

2:40 SH: It comes back to planning, aligned with portfolio management.

2:39 SH: Really listening. Let the person talk more. Don’t talk too much about who you are. Is your process in line with the way neuroscience works for your client?

AM: Making an investment in the relationship. Really get to know the person across from you. It’s not that important to some male clients. For women, it’s not the money. It’s just a means to an end. Understand that the ends are more important.

2:38 MD: What are some keys to success?

2:37 SH: When I ask, “Why don’t you want to be involved,” they say it’s boring, don’t have the time, makes my husband feel good to do it. Understand the why. If it’s time, show how it’s going to be a succinct amount of time (during lunch, say). The husband often doesn’t know. Ask if you can email her. Another thing, don’t just email to one spouse. Think about emailing both.

2:33 AM: You run the risk of when relationship breaks up, one spouse will leave. Have the wife think of you. But how, if she doesn’t come to the meetings? That’s something we are constantly working on. Sometimes it’s the male who helps us to get the spouse at the table. Instead of making the performance review about the investments, but making it a conversation about estate planning and the kids — that gets them to the table. Invite the children to events. Talk about things that matter to them.

2:32 SH: 57% of women over 50 are thinking about divorce. It’s the fastest-growing group of divorcees.

2:30 AM: It’s a long lead time for women in transition. It’s more challenging to develop the relationship when the transition is happening. Clients want advisors who are like them, and work with people like them. I’ve not had great success with formal seminars, but I have had lots of informal conversations with women that turn into leads (get a few people together for breakfast). If the husband makes the investment decisions, that’s a delicate situation. The wife may not have any decision-making authority. So you have to be careful how you handle that. The man sees you as a threat. I have a lot of situations like that, but I maintain those relationships. I had a woman who wasn’t making the decisions, but then got a huge divorce settlement from a hedge fund manager, and she came to me.

2:29 MD: How do you articulate your brand for women?

2:28 SH: Asking about context and what’s important to clients — it can change the meeting’s tone.

2:26 SH: Can you listen? Do you have the time to serve women? Their brains never rest. How do I behave, and how does that affect the person sitting across from me.

2:25 AM: On the flipside, there is no better referrer than a woman. Yes, the portfolios may be depleting, but they’ll bring in new business.

2:24 SH: $15 million settlement. Turned out she was spending $1 million a year and was 50 years old. You have to have that talk. Women who don’t work outside as well — you gotta tell them, this is it.

2:23 AM: The other challenge — women in transition can have assets they’re depleting over time. Not every financial advisor is interested in that.

2:22 AM: Most women in transition pay the bills but don’t make investment decisions. So you have to invest up front in education. There might be a settlement or life insurance payout. So there might be 2 years before I invest the cash. It could take that long to have that woman realize what her lifestyle needs are. There’s no concept of “Can I still live my same lifestyle?” They don’t know how much they’re spending. We go through their VISA and monthly statements to get a handle on what they’re spending. We usually inflate the first 2 years on the spending side. Some is therapeutic [laughs]. We budget, we show them what they’ve spent, and show them where they are. They never had to keep track of the inflows and outflows before.

2:20 SH: How to find them? They refer each other. Go back to your book. Inform your married clients that you specialize with transition planning. If you have friends who are going through that, have them call me.

2:18 AM: Women in transition is the greatest opportunity (divorce, widow, health issue). I’ve worked with many in transition. Some financially sophisticated, some not. But when you’re going through a transition, you’re not focused on finances. It’s also the critical time to make sure they have an advisor. They’re making huge decisions that can affect them and their families for a long time. Statistically, women who are with an advisor with the spouse don’t stay with that advisor, especially in a divorce. So it’s growing as a market segment and there’s a huge need.

2:16 SH: Women are retiring at 50 to take care of parents, too. Long-term-care is a woman’s issue, and you need to talk to them about it. Otherwise you’re doing them a disservice. Women are the population of nursing homes.

2:13 Alyssa Moeder: We do need to look at women differently. Even though we’re speaking in generalities, women tend to be juggling a lot of things. As such, they’re multitaskers. A lot of how we approach women is in recognizing where they are in different milestones in their lives: executives, entrepreneurs, inherited wealth, head of household, and in transition. Their needs are very different. Women can also be in multiple segments at any one time.

For example: retirement. When you think about it for a woman versus a man, it’s very different. 55, 65, you exit the workforce. A woman could retire at age 30. She could decide to leave the workforce, but the husband could pass away. We have women in the retirement box at way different traditional ages. A woman who’s widowed at 58 (average age), they have a really long time to plan for living off that income.

2:13 Marie Dzanis: Alyssa, how do you think of different segments of women?

2:12 SH: Half your book right now is women. If you’re not focusing on that market, there’s issues. They come into play once the husband dies, and most women stay with advisor less than a year after that.

2:10 SH: Women want to seem engaged, so they nod, say mm-hmm, even if they don’t agree with you. If men agree, they’re stoic. They’ll say yes only if they agree.

2:08 SH: If a male advisor goes straight to a solution with a female client, that might not work. She may not be engaged. If you’re woman advisor and you talk to a male client without giving the solution right away, that won’t work. Think about how you work. Take some self-analysis. When I sit down with a client, what’s my process? Think about the person in front of you, too. Again, Sales 101.

2:06 Susan Hirshman: “The problem of communication is the illusion that it actually happened.” – George Bernard Shaw. That’s what happens in the sale. Step 1, understand their communication style. Sales 101. But, as a male working with a female or vice versa, we have additional challenges. It comes down to our brain structure. Women integrate language and emotion, and they think like ping-pong. Men have more linear conversations with logic and action.

2:05 We’ve got a top 100 Barron’s (5 years straight) financial advisor, Alyssa Moeder, who works with 9/11 widows among other clients.

2:04 [Editor’s note: there are a lot of people at this session. That’s encouraging!]

2:03 Challenge: this is a “broad” topic (no pun intended). Working with women is just like working with people. There are multiple facets to working with women.

2:02 Moderator is Marie Dzanis, CIMA.

A Non-Normal World: Rethinking Diversification, Risk, Asset Allocation, and Modern Portfolio Theory Tom Idzorek, MBA, CFA^®, Morningstar

A: It’s not an asset class. Volatility is a derivative of what’s going on within securities that make up the global market portfolio. It’s deriving itself from the global market portfolio itself, and isn’t an asset class. If you were an insurance company and writing GMWBs on top of a deferred variable annuity, you might want to invest in volatility — it’s like portfolio insurance.

Q: Volatility as an asset class?

1:49 Pension plans have a liability. They are legally obligated to pay that. The reasons the assets exist are to pay for that pension liability. Almost all portfolios (individual investors) have a liability — like retirement for investors. Most people want to enjoy a real income throughout retirement. It’s like a liability. A slight extension of the Markowitz framework or CVaR is to add in a liability to that optimization. You can constrain an optimizer to capture the characteristics of a liability and then set your asset allocation policy. This is called surplus optimization. It’s like laddered zero-coupon bonds, each year a bond matures, and you can set that up as a liability stream.

A. Advantages of adopting a fat-tail curve (truncated Levy flight dist. or lognormal dist.) mean we can account for those extreme events. We now use CVaR. We also recommend practitioners calculate conditional correlations to focus on correlations that occur during extreme events. For tactical asset allocation, use one of these conditional correlation matrices in your optimizations and it might change how you allocate assets.

Q. How have you changed your input level because of recent extreme events?

1:43 Bonds won’t outperform stocks over a long time horizon. Generally, professional forecasters have become more pessimistic re: GDP growth.Warning signs of recession include widening credit spreads, falling stock prices, relatively flat yield curve. Morningstar chief econ thinks we (USA) are in recession. Europe is a troubling situation. But over long-term, bonds will still not outperform stocks.

1:41 Active management is a losing game after fees. So you have to believe they exist, that you have the skill to find them and repeat that over time. That’s difficult.

1:39 Be careful of risk parity concept, too. It says, let’s ignore return entirely and focus on diversifying risks to the degree that we can, and that should yield better portfolios. But we see no justification of that (again, ref. Morningstar studies). Would a portfolio of levered bonds outperform stocks? (check by levering up so risk matches an equity portfolio) It did outperform tremendously from 1929-1954. Then it became an even horserace. Note, nobody would probably do this in practice.

1:37 Asset managers are promoting idea of basing asset allocation on optimizing risk factors instead of optimizing asset classes. But there’s no evidence to risk factor optimization being better (ref. Morningstar studies). So I caution you on buying into that approach.

1:35 Using mean Conditional Value at Risk (CVaR), 6% annual withdrawal rate means the probability of failure is actually 10% better. (10% lower probability of running out of money!)

1:32 We need to be concerned with Skewness (are we skewed towards good or bad events?) and Kurtosis (how fat are those tails?). Global high yield and US REITs have high Kurtosis. REITs have great Sharpe ratios when viewed from Markowitz lens. But REITs lose more when things go south.

1:31 Markowitz’s approach is the gold standard, but it assumes normally distributed returns, or the client only cares about expected return/standard deviation. I argue we need to go further.

1:29 We should also rethink our definition of risk. We all use standard deviation, and Value at Risk. A better definition: Conditional Value at Risk. Conditional on one of the worst 5% events occurring, what is my expected loss? So this helps us to go beyond Markowitz’s standard mean variance approach.

1:27 Monte Carlo simulation tools expect that standard deviation associated with a given asset class assume that returns are normally distributed. But that’s wrong, so they tend to underestimate risk. After one year, your expected loss will be different under a lognormal, truncated Levy flight simulation, Monte Carlo. What’s the best way to do this in front of clients? Not sure, but you shouldn’t just use normal distributions!

1:23 So what’s a better model for distribution of returns? Use monthly returns, not annual returns. Risk models are understating when we should expect a 2008-like event — reality is 10x more often. The lognormal distribution predicts almost perfectly.

1:20 The flaw of averages – don’t ignore the pits. Annual returns of S&P500 1926-2009 organized by distribution show 3 years < -30%, 3 years -20% to -30%…normal distribution. The details matter, though. Returns follow a normal distribution, but ignore things like 2008.

1:18 Don’t invest in all small-cap if you have a long time horizon, even though they’ve done well 1926-2010. (12.1% compound annual return) But it took a long time to get out of a rut that lost 90% (approx. 1926-1940)

1:17 Cash had a 0% return in March 2009 to Dec 2011. The worst thing to happen in March 2009 was to throw in the towel. If they got out and put their money in cash, they’ve had no ROI. S&P500 return in March 2009 to Dec 2011 has been 80%. As a result, what can we do better?

1:15 If you’re bond-like (professor), you should invest in equities moreso. For most people, wages tend to rise with inflation. To hedge assets, your human capital is a wonderful inflation hedge. But as you get closer to retirement, your total economic worth is dominated by financial capital. You no longer have a built-in inflation hedge. So as a result, retirees need to think about hedging inflation with financial capital and asset allocation.

1:14 An investment banker in NYC — in 2008, investment banking activity dried up. Incomes probably dropped. The typical IB probably had to tap into their savings to pay for their living expenses in 2008. So that IB should actually invest more conservatively than the tenured university professor.

1:13 What are the cash flow characteristics of human capital? It’s like a junk bond. During good times, there’s nice steady cash flow with human capital, but periodically there’s a interruption where the cash flow is volatile (unemployment, breaks in career). The typical person has 70% bonds, 30% equities characteristics. Tenured university professor can’t get fired, so they know they’re going to get paid with certainty. So they might be more bond-like. Because of that, they can take on more risk if they want to because of the safe aspect of their human capital.

1:11 Human capital is a huge part of economic wealth that advisors tend to ignore. Human capital involves capacity to save, earning potential, skills, intelligence, charisma. For young people, they have mostly human capital and little financial capital. But as time goes on, converts from human to financial capital. This has implications for asset allocation.

1:09 Ibbitson (now part of Morningstar) was one of the first firms to design a risk tolerance questionnaire. We used behavioural finance profs to help. But if you cornered them in a room and asked for their true opinion, they’d probably say they don’t do a great job of measuring risk tolerance. But as an industry, it’s what we have to use. So we need to take a holistic approach to measure both preference and capacity for risk.

1:07 Jan 2008 to Dec 2008 — Aggressive portfolio: $100 became $63. Conservative: $100 became $94. If markets going up, people forget about their risk tolerance. If markets doing poorly, start moving conservatively. So we need to take a holistic approach. Risk tolerance should have two components. The questionnaires shouldn’t be called risk tolerance questionnaires. They should be called risk preference questionnaires. It’s about how well you sleep at night. Risk capacity is what should be measured.

1:06 5.25% returns for bond funds. But many were reaching for yield.

1:05 Diversification didn’t fail in 2008. Focusing on individual U.S.-listed stocks, 25% lost at least 75% of their value or more in 2008. Yet only 4 of the 6,600+ open-ended mutual funds lost more than 75% of their value in 2008 (excludes money-market, leveraged, bear-market funds).

1:03 We’re back, greeted by a huge compliance slide from Morningstar. So disregard everything our speaker says. 🙂

Global Macro Outlook and Real Asset Allocation John Brynjolfsson, MBA, CFA^®, Armored Wolf

11:57 Q. What do we need to move upward globally?

A. We’re in a competitive world. The biggest competition is that the U.S. system is being challenged and tested. Socialism in Europe isn’t working well either. China is competing globally in commodities, products, tech, talent — is that a better system than in the U.S., when the government doesn’t try to pick winners and losers? None of the three systems — U.S., Europe, China — are perfect, but over the next 15 years it’ll be clear which one is the best positioned to compete in the future.

11:52 Q. Where does global macro fit in strategic asset allocation?

A. The key to outperforming benchmarks is alpha. You can’t generate alpha by investing in asset classes — you have to invest in brain power. That can relate to manager selection, relative value, finding and extracting value within markets (fixed income arbitrage). That’s what consultants have to focus half their time on. 80% of assets are buy and hold for long-only managers. Their fees on the 20% they’re getting a hedge fund fee, which is fine as long as they’re delivering hedge fund returns. Hedge funds should be pure alpha generation.

For global macro, returns in asset classes are being driven by global macro. It doesn’t matter if the CEO of Yahoo! stays, or the CEO of a chemical company moves to a train company…that’s not driving return. What is: inflation, deflation, central banks (are they properly targeting inflation or are they getting into the credit world and changing the valuation between bonds and equities). These macro issues — and they’re changing every week or two — are changing the returns on every asset class. If you have a firm that’s hired talent, by having a process to capture global macro, then you have a chance of generating alpha. If not, you’re rolling the dice.

11:49 Current debt-GDP ratio is 80%, if you exclude social security trust fund. But why would you exclude? The ratio is closer to 100%. Because interest rates are so low, people are borrowing more. That reminds me of the turkey on the turkey farm that thought it was lucky to be fed so much — to be killed for Thanksgiving.

11:46 Q. What about US deficit? If we don’t take care of it, will China’s appetite for our debt decline?

A: Imagine you owned a restaurant. If every week the manager was telling you, “We have some customers, but what they’re paying is not covering the price of the food and staff, and we’re losing money, and we need to borrow $100,000 every quarter,” would you answer be, ok, my fault, we need to give you more money? Why don’t I give you $150,000 each quarter? No. You’d figure out what structurally is wrong, and make changes, and until we do that there’s no point in putting more money in. Same thing with the U.S. The gains from 2004-2007 were not real profits. They were created through mortgage refis and other unsustainable things. We haven’t addressed structurally what we’re going to do differently. Europe has picked a more austerity-oriented approach, and U.S. is trying to do that.

11:42 Q: REITs in China — what do you see? A: You’re not getting diversification from equities with public REITs in US. With private REITs, it’s highly illiquid. They’re tough to include in modern portfolio allocations. In China, a luxury condo in a second-tier city like Shenzen will cost almost the same as a luxury condo in New York or Paris. $1.5 million for 1,600-sq.-ft., 2-bedroom condo. Incomes in China are 1/8 what they are in the US.

Having said that, people probably won’t lose money because the down payments in China are 30%-50%. If they put 40% down 4 years ago and the property’s appreciated by 50%, it’s almost all cash, little leverage in that market. China is still wrestling with capital controls: most of the money earned in China has to stay in China. So you can put it in a bank deposit, or the volatile Chinese stock market, gold, or real estate. So they buy a home for grandpa and grandma or they buy unoccupied luxury condos. Chinese govt managed a -5% growth rate on real estate prices.

I don’t think this means a hard landing for Chinese real estate. Chinese government won’t let construction workers get laid off — they’ll re-assign them.

11:39 Q: Oil prices? A: Usually I’m a commodity bull. Wage discrepancies are meaningful. People are making so little, so factories can afford to pay a lot of oil. Turning plastic into a dashboard has a low cost of labour now, but if wages go up, they won’t be able to pay so much for plastic (made from oil). High oil prices are being supported by Iranian and Nigerian concerns. If you have a small crisis, it could disrupt oil prices for a small period, but it won’t change the end user. It’ll draw down on excess inventories. Short-term trajectory is downward on energy prices, but longer term, over 3-10 years, commodities will continue upward.

11:38 Europe’s problems have gone from credit default to currency risk.

11:36 The IMF probably doesn’t have enough money to bail out the periphery countries. Then there’s no backstop. I am convinced the euro is going to collapse dramatically from current levels. We’re short the euro, but we trade tactically because sentiment changes week to week, day to day.

11:35 Main difference between now and 2008: in 2008 we were dealing with widespread financial problems related to private entities (homeowners). It was a private problem caused by private mistakes and the question was whether or not the government would backstop it. Current crisis is one level more serious. Now we’re dealing with global governments and the question of whether they are solvent.

11:33 China has brought down inflation and is currently engineering a “soft landing.”

11:32 Riots in China are because the Apple stores aren’t releasing enough 4S iPhones.

11:31 While I’m a capitalist, I have to admire a system where they control things like how Apple controls distribution and manufacturing. China, Inc. is a pretty well-run company. They have access to low-wage labour. Minimum wage has gone up twice in the past 18 mths in China. Both times it was raised by 25%. China is seeing a rapid convergence to the advanced world. When they had the overheating real estate problem, they tightened monetary policy and put restrictions on buying second and third homes. Couples are getting divorced so they can buy more homes (not because they are unhappy).

11:29 I’m really confident about China. They had overheating real estate prices and high inflation last year. Beijing had 20 million square feet of office space and that was called ridiculous 3 years ago. Guess what, they’re all occupied and their rent is driving rent up in Beijing. Southern Chinese cities built 12-lane highways where there wasn’t population 10 years ago. Now those cities have 12 million people living in them.

11:28 Maintaining fiscal stimulus means you’ll see a tightening of fiscal conditions. They will get more onerous as capital rules kick into place. The monetary handcuffs are tied, so that makes it difficult to print too much money (even though they are). The fiscal authorities simultaneously have their hands tied.

11:27 Europe can’t borrow more. Same is true in US. Jobs programs aren’t working.

11:25 I don’t think Europeans are going to figure out a way to solve their problems. There is not a union of minds. Germans don’t want to bring the periphery into a union. Politician and bankers do, but people don’t want their prudence and austerity to pay for the retirement plans of southern countries. And southern countries don’t want to be part of a German federation.

11:24 Movement of physical goods and materials is causing growth, so EMs doing well. Developed world is focused on intangible products.

11:22 We may be looking at 4% global GDP growth. World Bank revised to 3.5% last week. That’s in the context of China growing 8%. Other EMs (Indonesia) high single digit rates. Developed world = 0%, 1%, 2%.

11:21 The Purchasing Manager Indexes: weak growth but no contraction.

11:20 Countries are growing slower than previously. Exceptions: Argentina (was in default prior), Iraq (had zero GDP and wars). But overall, countries are experiencing slow global growth. The risk is of an event on the downside.

11:17 We have a 3-speed global economy. Europe is going into depression. U.S. is somewhere in the middle. EMs are continuing to thrive and will at worst see a soft landing.

11:16 I achieve a benchmark first, then exceed the benchmark via alpha generation. Today, we’re focusing on real asset allocation. Real quantities are denominated in consumption — in other words adjusted for inflation. The real metric for success is to grow purchasing power.

11:15 It’s my job as an investment manager to help serve the role of the client by fitting into a box. The asset allocation process, the policy portfolio — defining the goals of a given client, be it an individual or endowment or pension, is the job of the client and the asset allocation committee. The manager’s role is to make sure they meet the goal outlined by a given asset class. Thankfully we’ve come a long way from the 60/40 allocation.

11:13 I’ll give you a sense of where I see the global economy, so you can turn that into client recommendations.

Strategists Panel Speakers: Milton Ezrati, Lord Abbett & Co.; Jonathan Golub, CFA®, UBS; Moderator: Michael Santoli, Barron’s

ME: If you can get the Tea Party and the Occupy people together, we’re good. We built social security for the boomers.

11:00 JG: What’s the win for the Republican party? Embrace young people and say you’re on our side because the 60+ is the enemy. You’re paying for grandma’s retirement, vote Republican. If they could capture that, it would be a game changer.

ME: They’ve done the cuts in the past to people not paying attention (cuts for social security for young people in 1980s).

JG: We get pleasure from national parks, prisons, highway systems, judges — but closing the national endowment for the arts is just a basis point. So people think taking down national defence is good. That’s going to be harder than we think. But if you don’t take down entitlement spending down, you don’t have anything to talk about.

MS: One thing about US is we live where 1,000s show up in the capitol to say we want less debt. But then we provide the implications — reduced Medicare, higher retirement age — everyone thinks it’s waste and abuse in the government. It’s not.

10:56 ME: After 2008, Americans did readjust. Savings rates went up. $640 billion a year now. If you asked me 5 years ago, I’d have been skeptical. So they have done it. The big issue — the government. The corporate sector and household sector have cleaned up their act. We have to wait for November.

MS: Readjusting expectations — is America capable of that re: retirement?

JG: Whenever you have an economic recovery, we go to Nordstroms. If things get bad, we (the rich) trade down to Macy’s. Not that poor guy can’t go. Same things with Whole Foods versus other markets. Higher-end hotels, restaurants. Dollar stores will unwind. In very difficult times, consumer companies manage costs well. Media: movie prices gone up, even though attendance down. So they’ve done a great job of managing costs and pricing. There’s discipline now.

10:53 MS: Media? Retail? Do you carve it that narrow?

JG: Within equity markets, the consumer sectors are likely to do well. When we talk about yield, if we do total yield, the lowest yield is utilities (probably also most overvalued). Highest yield is consumer discretionary. With unemployment getting better, both staples and discretionary are likely to be a surprise. Credit balance sheets are unbelievably deleveraged. There’s lot of opportunity.

ME: Opportunity is attractive. There’s risk, but it’s the likelihoods that favour them.

JG: Emerging market equities: faster growth, stronger balance sheets, cheaper valuations. But they’re higher beta, so if the world falls apart, they will too. If they grow faster and cheaper with higher quality, that’s a natural place for opportunities.

MS: Do you perceive any underappreciated opportunities?

10:50 JG: If you’re a talented pairs trader, you can make money. Bet good apples against bad apples, not apples against oranges.

MS: Quality underperformed early this year. Hedge fund guys will say short a high-quality company.

ME: If you take out political effects, there will be lower correlations. There was a man at Occupy Wall Street with a sign that said “Stop correlations.” He got it.

JG: The way you make money in this environment: put on a trade that’s right, company’s doing well, but stocks move together and you have correlation. But if there’s a fall in correlation, you make money. Money gets made when correlations decrease. Active managers and hedge fund managers will do well this year, better than last year.

10:48 ME: The big threat is that the fundamental problem is financial — it’s the US government. That makes it much more frightening than a recession. One of the reasons for volatility is that it’s financial and political, not economic.

JG: Mother of all recessions (2008) was a 35% decline in earnings and 50% decline in stocks. You can’t tell how far down things are. A normal recession lasts 2 quarters, ugly 1 year. If we pull out in March, April (and typically you do), this would have been a shoulder shrug, and you could have had a 15% decline in profitability.

ME: If Europe flies apart, if US is downgraded again or misses an interest rate payment, or double dip occurs — we say these things are unlikely — we could reapproach the old lows if you want to scare yourself. But the risk-on trade is the best bet. But if you ordered me to make a bear scenario, the market could suffer terribly if all 3 things go wrong.

10:43 MS: If we avert disaster, in DJIA terms, what will we be looking at?

JG: The growth hasn’t really shown up in the markets. Democracy impediment? Everyone thought Japan was going to take over the world when I was in high school. If you look at China’s projections, I bet it won’t have higher growth than Europe. It’s a 10-year event that China has been powerful. We forget history. No one thought Communism was going to win, but Chinese communism is ok.

10:41 MS: How many big hedge fund managers will tell you that Europe’s dysfunctional, but the Chinese know how to run an economy. If only at a pen stroke we could say we’ll do it.

ME: Germany has an electorate to play to. They believe they’re over a barrel, but the public doesn’t. The leadership has been willing to go to the brink because the public isn’t with them. (JG 100% agrees.)

JG: Everybody’s played their hand. You have to be a really good poker player to take this thing to the brink like Germany has.

MS: Germany is going to own Europe if they keep writing cheques.

JG: We’re underweight Europe (every asset allocation committee is underweight Europe). The whole world agrees. If Europe doesn’t blow itself up, it’ll be an outperformer. If Europe doesn’t have a credit event, that’s a huge win.

10:39 MS: People are saying P&G and Unilever are basically the same, and buying Unilever because it’s European and undervalued. What do you think?

ME: Valuations in Europe suggest the market recognizes there’s no easy way out. There’s an opportunity, but probably an immediate opportunity. They don’t usually say much at Davos. Europe is facing recession. If they fail, people will worry about fundamentals. They may have a cure worse than the disease. They have lots of hurdles to jump.

10:37 MS: Based on 2011, Europe would be a surprise if it outperformed. Is there a chance that Europe will do well?

10:36 ME: The housing market is finding some stability. That’s not an engine of growth. There’s huge inventory waiting in the wings. That will cap prices. We had a sector that was in freefall, so stability looks good by comparison.

JG: We decided to rent (2005), not buy, because we thought the real estate world with blow up. But then I worked for Bear Sterns, so I lost more on that trade than my house.

MS: QE wasn’t effective, and we created social unrest in emerging markets because of inflation. It created pressure elsewhere. If you look at its US impact, it wasn’t higher growth rates. You got the worst response: higher food prices and not inflation in our wages. It was unfavourable.

Corn was up same amount as copper at one point. 88% correlation between oil and S&P. You can’t shrink institutional participation in real asset markets, but it’s sort of an unintended consequences.

Jonathan, you sold your house in early 2000s because you had a bad feeling about markets.

ME: Fed is disappointed with the QEs (quantitative easing). They’re desperate that they’ve run out of tools. We need action on the fiscal side. We need the smoldering log to respond with more than a flash. In 1-2 years, I don’t want to fight the flood of liquidity.

JG: If you look at the US budget and the way we’re financed, we’re financed by short-term paper (ugly). If the Fed raised rates, we’d blow up the federal budget. Same thing — people in bonds, if you moved short-term rates to a reasonable rate, the damage to retirees would be enormous. It reminds me of a smoldering log and throw kerosene on and it keeps lighting up, but there’s no more fuel. You have to unwind it. But in the short run, the market wants more, and loves the liquidity.

ME: If we’re not getting to the fundamentals in the US, we’re not going to get to them in Europe. ECB is buying time. If they expect to solve their problems, we’re good as dead. We haven’t addressed the problems, and the market knows they exist at least through 2010. You have this ECB buying time, whether it works or not we’ll see. I have my doubts. You have to change the geopolitical model in Europe to work out these problems. Don’t fight the ECB in this case.

JG: There’s 100% chance they’ll agree on a plan, but 0% chance they’ll follow through. It doesn’t cost Greece anything to say yes I’ll have someone from Frankfurt look over my budget. But wait until the first budget, when they recommend changing the retirement age. The market is willing to accept the absurd and roll with it. A mistake I’ve made is that I haven’t bet against a statement I don’t believe.

MS: Individual investor doesn’t walk around with a benchmark hanging over his head (versus professional), that’s an advantage.

Do you think the European members will have a long-term plan?

JG: Economies grow. So if we had a high water mark with a date, the market will get dragged higher because the pie gets bigger. Advisors tell clients to readjust expectations, but that’s challenging. Look at the pension plans: 60/40 portfolio with 8% return assumption — few people would recommend that. So how do I get to retirement? Luckily, I don’t have to explain that to the public.

ME: How much time do you have in investing? If you’re 26, you’ll see higher highs before you need the money before retirement. If you’re 60, you shouldn’t be betting on 2007 numbers (all time high). We have a bias to the risk-on trade, but we won’t be capturing the all-time highs anytime soon. Markets aren’t ready to stretch valuations. Markets are behind earnings over the last 3 years. We’re not going to go into a 1982-1999 secular bull market, though.

MS: The question is, is the top of the range the all time high? Can I wait it out? At the core of the debate of asset allocation, can we expect higher returns?

10:21 JG: Everyone is thrilled with 2%, but 9% deficit (nominal). That’s not a massive success. First trade deficit ever in Japan. This is a developed market issue. My caution — debt overhangs aren’t just in Europe. The market is struggling with that.

MS: 2.5% annualized rate for a few mths — perception is that something will hit. Is it that something exogenous will always happen?

ME: Double dip scares were real in 2011. If market believes 2% is sustainable, that’s a huge improvement over 2011. The market was terrified that we were going into recession. Buying the 2% explains why VIX is down, and why confidence is up.

JG: The U.S. downgrade didn’t have a huge effect. The market is saying we’ll have growth with volatility. We’re stuck with this. If growth rate on equity is lower, 12.5 sounds ok if 14 is regular. Markets could be reading the same message.

MS: What is a risk-free pool of capital that we can access? That’s a distortive thing, we don’t know.

ME: ECB was missing last year. Awakened in August 2011 to the fact that they didn’t have the resources to survive. That’s motivation for a bureaucrat. They reversed the rate increases, and said don’t worry about capital, we’ll buy you time. They’re not solving the fundamental issues. We had a market all through 2011 — there were waves of panic re: Europe. With ECB, it’s calming down the market. There’s a player who will calm these waters. It hasn’t erased this valuation thing. All you’re going to get from safety is safety, not a real yield.

JG: The market has been willing to say if you’ve taken out the downside tail risk from European banks, and the worst thing is a Greek default, that’s ok. Maybe the markets are rational.

MS: There is a disconnect. What about the non-treasury credit markets?

10:15 JG: You have a treasury market, that with under 1.9% yield screams world is coming an end. Stocks aren’t moving too much, volatility is down. There’s a huge disconnect between bond market and stock market, which embodies more optimism.

10:14 ME: We’re not going to get a mean reversion, you’re right. If you look at companies with histories of regular dividend payments and increases, their dividend yields are higher than their own bond yields. Since the best you’ll get on a bond is the yield, usually the upfront dividend yield is lower than bond yield. So the market is expecting dividend cuts, price depreciation, or both. We see opportunity, not as great as Oct 2011, but still. We are looking for high single digits on earnings.

10:11 Jonathan Golub: 2011 there was euphoria during beginning. Market has been up since Oct 3, 2011 19%. But, I’ll take the other side Milton. We had a multiple of 10.2 in Oct 2011 on stock market, VIX 46, higher than Lehman collapse. Now 10.2 has become 12.4, VIX has fallen. So what’s normal? 1970s, valuations were lower. This market compared to non-investment-grade debt, you’re close to fair value. You’re probably in an environment where multiples are 10-14.

10:10 Milton Ezrati: I disagree. We’re in the same boat as 12 mths ago. If you look at valuations, markets are braced for disaster. That’s a critical piece of info. They’ve done well, but still, with dividend yields higher than bond yields, markets are ready for disaster. On the expectation that we’ll avoid disaster, we prefer risk-on trades over the safe havens.

10:08 Michael Santoli: Last year’s theme could have been what we do know didn’t kill us. The big picture risks were well-discussed and agonized over. Yet in U.S., investment returns didn’t suffer horribly. So we’re thinking of riskier assets early this year. So Milton, how do you characterize the landscape?

10:06 Moderator is an associate editor for Barron’s, Michael Santoli, who writes the Streetwise column.

10:02 Good to know: reps from the local IMCA chapter are near the ladies’ bathroom. I know who to look for during the breaks.

9:59 This conference is ridiculously on time. I like it.

Geo-Politics and Global Business in the New Decade Speaker: Marvin Zonis, PhD, University of Chicago Booth School of Business

A. Tax code is pathetic and sick. It provides incentives that are inappropriate for this country. How could it be that Mitt Romney pays only 14% of his income when his secretary pays 30%? He understands the incentive system of the tax code in a way that minimizes the amount he pays. That’s not immoral or surprising. We created the tax code. The basic problem to me is that we need to start thinking about what the Tax Code ought to look like, and then improving it. The State of the Union is horrifying because the President wants to add structured incentives to change people’s behaviours. But it’s using the tax code for something other than raising revenues. That’s what it should be about — financing the government. If we don’t want to do that, then we shouldn’t have a government. We can’t do both anymore. Let’s face up to reality.

Q. How will the anger change in U.S.? How can we get entitlement reform when nearly half the tax base doesn’t pay tax?

A. Don’t go on an Italian cruise liner. Winston Churchill went on an Italian cruise after his second term and the British press was outraged. After he came back, they asked why, and he said, “The food is better. Second, there’s none of this nonsense women and children first.” Everybody knows the answer: Study! Get a degree! Be liberated and free and educated. Turn them loose, and they’ll be successful. There are lots who don’t get the message, and think they’re going to pump gas.

Q. Advice for young people?

A. Data makes it clear that’s the case. That’s going to leave us with fundamental questions. Returns to education are the highest — rewards go to education. That will fix inequality. Reality is, we have a horrendous problem of inequality. We can’t have political stability with the degree of inequality. U.S. has less social mobility than Europe right now. We have to deal with this. This is not the country we sought to create. There’s something fundamentally wrong with our country, and we the elites have to take some responsibility for trying to understand what the problem is and trying to do something about it.

Q. New Gilded Age = how much of an issue is the rise of wealth being concentrated in hands of few?

A. I’m pessimistic about the Middle East because they don’t have a plan for growth. They are not going to be stable except for the countries like Saudi Arabia who can buy off their citizens.

Q. Do Middle Eastern countries have a plan for growth?

9:24 And the final great news: the emerging markets. The true size of Africa: Mercator projection makes it look small, but it’s actually huge. All of China, Europe, India, U.S. fit into Africa. Countries in Africa are booming. No African bank went bankrupt during the global crisis. Transitioning from commodities to service providers. So it’s not as bad as it sounds. We’ll survive this crisis and see more economic growth beginning in 3 years.

9:22 Yet we will see a massive increase in oil prices. U.S. 765 cars per 1,000 people. Italy 566. UK 426. Poor countries: India: 12, China 128, Nigeria 1. Do you think they want fewer cars than we have? We’re going to see an explosion of the internal combustion engine in emerging markets. So get ready to pay more for oil.

9:21 What are the effects of this? Mobile banking in Vietnam, nanotechnology, transformation in energy (shale gas and shale oil). U.S. will decrease amount of imported oil (used to be 60%, now 47%, this will get down to 20%). Massive $USD, decrease in balance of payments.

9:19 I’m a glass half full guy. There will be a miracle: technology. I have to credit Republicans and Democrats for not slashing the R&D budgets of the govt of U.S. Next year we will spend more than $450 billion on R&D. Gordon Moore’s law: computing power of chip will double every 18mths. That’s happened. We’re up to a billion transistors on a chip, we’ll have 2 billion in 18 mths. Don’t think about iPads or computer or iPhones — computing power will be in other stuff. The price of everything has fallen.

9:15 EU: Amount of $ needed to pay off the debt is unfathomable. 120% debt-GDP ration during WWII in USA. That’s what it is in Italy today. US: In 30 years from 120% to 35% of GDP. Could that happen in Europe? In U.S. it happened because 50% of the decrease was due to robust economic growth. GDP went up, debt didn’t, so ratio improved. “Secret” in U.S. was also substantial inflation. Greece, Italy, Spain, Portugal, Ireland = will they have robust economic growth? No. Will ECB allow substantial inflation? No. So Europe is heading towards a dead end. There are powerful companies in Europe that will be successful in exports outside Europe. But the countries will not be investable. 54% of German exports go to other EU countries so Germany will be in trouble too.

9:13 Putin will be reelected with a growing and powerful liberal opposition in St. Petersburg and Moscow. Why are we investing in Russia when Russia is not investing in Russia? Not a country of entrepreneurs. Not where we want to invest our capital.

9:11 North Korea. Pyongyang evening: only light available is to illuminate a picture of “Supreme Leader.” Worried about North Korea. Boy leader is going to be controlled by aunt and uncle. I don’t expect either collapse or war on Korean peninsula because they’re struggling internally.

9:09 High correlation between governance (ref: World Bank) and wealth (USA = 501, HK = 524, China 211, Belarus = 107, Lithuania 435). China will have a tough time getting higher than 211 quickly, so will still be middle-income country.

9:08 Xi Jinping wants people to consume to stimulate the economy. If everything goes right in China, by 2025, 45%-50% economy will be consumption. That’s the stretch case. In the U.S., 70% is consumption. So even if they do everything right, it’s not going to be enough to stimulate the economy. Consequence: They’ll be a middle income country until they get their institutions correct.

9:06 China’s imports are rising. So there’s a push for investment in fixed assets. Shanghai 1990 = empty. 2010 = tons of buildings. Fixed assets investment spending is 50% of GDP of China. No other country does that. 8%-10% in USA. That’s how China is stimulating its economy, but that’s unsustainable. Just dig holes in the ground and have other guys fill it up.

9:02 China having election in 2012. Xi Jinping has a lot of experience and is committed to business exports. Li Keqiang has been chair of youth Communist party. Built-in conflict.

9:01 Haqqani Network given intelligence by Pakistan to go into Afghanistan. Hope that Mawlawi Jalaluddin Haqqani will take over Afghanistan once U.S. leaves and be sympathetic to Pakistan.

9:00 Indians provide second-largest amount of foreign aid to Afghanistan. Karzai signed first official agreement with India. So we need to get India and Pakistan to work together to eliminate hostility, rage.

8:59 Why are Pakistanis helping Afghanistan? They’re fearful that India will take over Afghanistan. Pakistan will then be sandwiched between India and Indian-Afghanistan. Remember, they fought 3 wars. India took part of Pakistan in 1971 (Bangladesh).

8:57 President of Turkey was in France with his wife — interesting because his wife has never accompanied her husband to an official state function in Turkey, because a woman can’t wear a headscarf to attend an official state function, and she refuses to take her headscarf off. Middle East is going to look a lot more “foreign” as Islamic practices take over.

8:55 Democrats want a Palestinian state, Republicans don’t. Why? Republican party on foreign policy matters re: Middle East is dominated by Evangelicals. They support Israel overwhelmingly.

8:53 Israel doesn’t want to see Iran possessing nuclear weapons. Shaul Mofaz believes they’ll have to take out Iran to stop them from developing the weapons. I believe Iran understands the cost of developing a nuclear weapon and won’t actually develop one. They just want the option.

8:50 Saudi Arabia has the bucks to buy off their own people. No matter what happens with the death of King, you’ll see a stable country pumping out more oil. In Iran, we have a central conflict between the President and Supreme Leader. Iranian nuclear site to enrich uranium. Developing missiles. You don’t send missiles up with dynamite. Nuclear weapons.

8:48 Ragtag of competing militias are trying to run Middle Eastern countries like Libya. So it’s going to be unstable in Yemen, Egypt. 70.2% of all seats in Egyptian parliament are held by Islamists. Right-wingers in Egypt = “at least we can bring people to monotheism.” These guys don’t care about the economy, but the people do, because they’re tired of being poor. Unlike Saudi Arabia, Egypt doesn’t have oil. People will be enraged and have instability.

8:46 Bombardier (Canadian, yay!) is building planes in Mexico. They have a presidential election in Mexico. Fertility rate has collapsed. Average Mexican woman is having fewer children than to stabilize the population rate. Implication: over time there will not be Mexican immigrants into the U.S. because they’re doing well. NAFTA-like powerhouse will happen.

8:44 Income has become more unequal at all levels. Don’t be deluded by the liars in Washington. There’s only one way to deal with the crisis in America’s fiscal situation — entitlement spending. NOT education, postal, national parks. We’d still crash this ship even if we slashed those by half. The big stuff — payments to individuals, we’re not touching. Cutting spending on national parks isn’t going to do anything.

8:43 In Europe, they protect insiders and don’t let outsiders in. In U.S., that’s happening in labour force (age distribution). Those who aren’t in are all the young people. % of output of firms spent on labour has plunged.

8:41 Pew Research asked how do you get rich in U.S.? 58% of Republicans think it’s hard work, ambition, education. 58% of Democrats think it’s knowing the right people and being born into right family. This disjuncture will contribute to greater instability. For first time, old people are richer than young people. Older people don’t take to the street when they’re poor, but young people do.

8:39 Problem is, (no more Rick Perry) Santorum, Gingrich, Romney don’t have the appeal despite Obama’s bad numbers. I predict it’s unlikely that Republicans will win.

8:37 Obama’s #s: 13.2% poverty in 2008, 14.3% in 2010. Reelection unlikely. Medium income has fallen, health insurance premiums up. # of jobs fallen, inflation rate higher. Gas prices higher. National debt higher. Deficit higher.

8:35 Passenger and freight traffic has been in decline. Reflects consumer sentiment. 7 consecutive months of negative international freight transport as of Nov 2011. It’s difficult to maintain optimism. 11 countries are going to have elections this year, incl. Russia, U.S., Korea, Mexico, China, France, Finland. They account for about 50% of the world economy (PPP).

8:33 Anger, fear and mistrust = political instability. So what to do? Throw the bums out. If you’re in a democracy, lucky. If not, take to the streets. You’re going to see a mix of rioting and challenging elections.

8:32 Unemployment is humiliation because work is one of the principle sources of meaning in life. 19.2% is the U6 (total unemployment figure).

8:28 Consequence: a vicious contraction in which deleveraging reduces demand and surplus of exporting poor countries. It’s driven by 3 psychological variables: first is humiliation. Feeling disrespected, loss of pride. It makes you feel angry when you’re humiliated. Everyone in the world is being humiliated because of the financial crisis. Feeling responsible for 2008, asset base has plummeted, lost our homes, no job, worried about kids. The result: a wave of rage in the U.S. that is unprecedented in my lifetime. If you pay attention to the primaries, you see that oozing out.

8:27 How does the world work? The basic thing to remember is nationalism. Every politician reverts to this in hard times. Everybody is happy to beggar thy neighbour if good for individual country. E.g., U.S. Merkel can’t think outside the border of Germany. Sarkozy is running to be reelected, so he’s thinking about that, not the well-being of Europe. Rich countries are being driven by deleveraging. U.S. has done so, more than other rich countries, because of collapse of mortgage-backed home-buying public.

8:25 China = more instability, we’ll be stuck in a middle-income trap. They’ll have trouble continuing robust economic growth. Eurozone = over as we know it. Greece will drop out, and it’s possible euro will get stronger because weaker states are going to drop out. So don’t be waiting for a good deal.

8:23 Globalization disseminates everything, including emotion. I’m going to talk about the negative emotions we’re seeing today. U.S. = pathetic, misgoverned, misinformed, lack of successful candidates in both parties. Middle East = we’re just at the beginning, we’re only beginning to work out the political orders that will take root in that region. It’s going to be more Islamic than in the past. We’ll see less terrorism because extremist forms of Islamic expression won’t need to occur.

8:21 Optimistic we’ll see robust growth in 3-5 years. FOMC agrees. Most important takeaway: Mark Twain went to Europe and wrote The Innocence Abroad. While he was there, went to see a Wagner opera. When he came out, the journalists rushed up to him and asked how he liked it. Twain said, “It wasn’t as bad as it sounded.” That’s my message today.

8:19 Listening to Americans speak French is amazing. (Prof. Zonis is a member of the Board of Directors of the Fondation Etats Unis, Paris.)

8:18 am Wanted to start this conference with most positive message, so here we are.

Day 1

8:17 IMCA has an app that lets conference attendees ask questions in real time. Cool!

8:11 850 people are here, a 10% increase from last year’s conference.

8:04 CIMA certification video now playing.

8:02 John Mayer’s “Edge of Desire” now playing.

7:56 Good news. They were really generous with the bacon in my egg and cheese croissant. (Good thing I’m not a veggie.) John Mayer is also playing over the speakers.

7:48 ET Welcome everyone! It’s a lovely day in the Big Apple. The Broadway Ballroom is filling up and we’re going to start in 15-20 min.