My Amazon Review of Gregory Zuckerman's "The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution"

Code-Breaker

Wall Street Journal reporter Gregory Zuckerman offers up a biography of Jim Simons and Renaissance Technologies, his $60 billion hedge fund colossus. It is no way a complete biography because both Simons and his firm are very secretive where employees sign very strict non-disclosure agreements. Nevertheless Zuckerman accurately portrays Simons as an M.I.T. trained math nerd who cracked the code of the financial markets without ever have taken a course in finance. Simons basically used the code breaking skills he developed at the Institute for Defense Analysis along with putting together an all-star team of math whizzes from academia and industry.

One of his hires was Robert Mercer who along with his daughter Rebekah became famous in 2016 as the big money behind Breitbart News, Cambridge Analytica  and, of course, Donald Trump’s presidential campaign. Mercer’s politics stands in sharp contrast to Simons who has long been a big donor to the Democratic Party. But what Mercer brought to Renaissance was the math behind the speech recognition technology that he was developing for IBM in the early 1970’s.

Simons approach to investing was harnessing big data analytics using Markov chains, stochastic calculus and high powered computers to develop a short term trading strategy. This was done before, but no organization has done it so successfully under the guidance of world class math geniuses. The result of this is the world-beating returns of Renaissance’s flagship Medallion Fund which from 1988-2018 generated a compounded pre-fee return of 66% and a 39% after-fee return; absolutely extraordinary. Further this was done where just over half of the millions of trades made were at a profit. So don’t do this at home. The markets are still loosely efficient, Simons found a way to notice small data anomalies that could turn into profitable trades.

Zuckerman also brings up Simon’ family tragedies where two of his sons died in freak accidents and his vast charitable giving. His charitable interests include finding cures for autism, supporting high performing math and science teachers in New York City and financing a radio telescope in the Chilean desert to study the origins of the universe.

What I would have liked to know is where Simons got his money to first start trading in size, first in the commodities markets and later in currencies. I would also like to know who staked the initial $16 million in 1988 to seed the Medallion Fund. Further a few numerical examples of some the trades would have been most helpful, but that would, of course, reveal a few trade secrets. That is because what Renaissance does is far more than a simple pair’s trade which buys Coca Cola and shorts Pepsi, for example.

Zuckerman has given us a highly readable and engrossing account of Jim Simons’ life and the rise of his firm. For any reader interested in how the quant revolution came to Wall Street this is a very good place to start.

For the full Amazon URL see: https://www.amazon.com/review/R251H7H1LFMA7I/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Amity Shlaes "Great Society: A New History"

The Cost of Good Intentions

Revisionist conservative historian Amity Shlaes has written what purports to be a history of the Great Society. True it is a history, but it is far from complete. Nevertheless her book offers a host of easy to read vignettes surrounding the milieu of the 1960’s and early 1970’s. She highlights the important role UAW leader Walter Reuther played in bringing about the civil rights revolution and the role of socialist Michael Harrington in supplying much of the intellectual heft to the ideas Lyndon Johnson promoted. She surprisingly offers a sympathetic portrait of the emergence of the New Left and she is especially sympathetic to the activist role played by Casey Hayden, Tom Hayden’s first wife.

In my opinion she spends way too much time on the role of the Office of Economic Opportunity in promoting far left community groups under the rubric of “maximum feasible participation.” This front of the war on poverty ended in defeat as America’s cities exploded in racial violence. It was the unrest at home and the growing unpopularity of the Vietnam War that led to a Republican revival in 1966, an election she does not mention.

However she is especially acute in her discussion of OEO’s Legal Services Corporation which unleashed a brigade of activist lawyers that rewrote housing, welfare and health law and spawned the notion of the public interest law firm. She also devotes far too much effort in discussing Nixon’s failed Family Assistance Plan while leaving out such Nixon accomplishments of the National Environmental Policy Act, the Clean Water Act, the Clean Air Act and the Occupational Safety and Health Act. Thus it was Nixon, not Johnson who created the enlarged administrative state of today.

She also doesn’t really focus on Medicare and Medicaid. It is these two entitlement programs that both improved the health of American and are driving huge increases in federal spending today. As was to be expected the all-in cost of these two programs has far exceeded their initial estimates.

Shlaes offers great insight in highlighting the importance of a now forgotten filibuster in the Senate led by Everett Dirksen. At the height of LBJ’s power in the fall of 1965 organized labor made a big push to eliminate Section 14B of the Taft-Hartley Act. That section allows states to ban union shops and thus offering the option of becoming a “right to work” state. That effort failed and the way was open to industrializing the South and to the diminution of union power in the North.

To sum up Shlaes has written an interesting and enjoyable history of the Great Society, but just remember it will not be remembered as the definitive history of the era.

For the full Amazon URL see: https://www.amazon.com/review/R2GMST6VS3F9NR/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Joshua Rubenstein's "Leon Trotsky: A Revolutionary's Life"

The Permanent Revolutionary

Leon Trotsky, born Lev Davidovich Bronstein in 1879 of Jewish parents, Russian revolutionary, leader of the 1905 Petrograd Soviet, skilled polemicist, Marxist theoretician, womanizer, coleader of the October Revolution with Lenin, founder of the Red Army, outmaneuvered by Stalin, exiled and assassinated in Mexico by an OGPU agent in 1940. He had quite a life and Joshua Rubenstein tells his story in a brief and succinct biography of only 215 pages.

Rubenstein’s Trotsky comes across as a brilliant egomaniac. Whether he was right or wrong he was never in doubt as he steered a course in opposition to Lenin and as a key ally. He was a great number two to Lenin, but it seems that in the struggle to succeed Lenin, he wanted power on a plate. He didn’t know how to fight for it as he was outfoxed by the wily Stalin. He should not have been surprised because he wrote well before the revolution that that Lenin’s party in power would inevitably lead to a one man dictatorship.

In exile he became Stalin’s leading opponent where presciently noted that there was very little difference between Hitlerism and Stalinism. However he remained loyal to the revolution to the end. This was his failure because Stalin was not an aberration, but rather the logical successor to Lenin. If Trotsky had won the power struggle he would have been little different from Stalin. His brutality during the Russian Civil War demonstrated that.

Because this book is part of the Yale Jewish Lives series I have to note that Trotsky was not really different from today’s Left with respect to Zionism. Trotsky was a universalist, while Zionism is particularistic. He cared more for the working class than his own people. 

Rubenstein touches all of the bases and highly recommend this very readable book on the life of Trotsky. He doesn’t get into the weeds and for this he should be commended.

The full amazon URL appears at: https://www.amazon.com/review/R30O1N3R1MKA8N/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

Links to Ziman Center version of UCLA Forecast + Video Presentation

Ziman Center version of December UCLA Anderson Forecast

https://www.anderson.ucla.edu/documents/areas/ctr/ziman/UCLA_Economic_Letter_Shulman_12.09.19.pdf


Video of "The Two Track Economy" presentation:

https://www.youtube.com/watch?v=tCOETvmUoUs

"The Two Track Economy," UCLA Anderson Forecast, December 2019

The Two Track Economy

David Shulman

Senior Economist

UCLA Anderson Forecast

December 2019

We have become a bit more optimistic since our last forecast.[i] Several of our worries have been mitigated. They include:

·        After being locked in a 21 month trading range, stock prices have broken out and made decisive new highs. (See Figure 1)

·        The Fed cut its policy rate by 25 basis points and is supplying additional reserves into the banking system to solve a “plumbing” problem. (See Figure 2) Although the purpose of supplying additional reserves is not a new quantitative easing program, it might have the same effect with respect to the financial markets.

·        The yield curve has returned to a positive slope. (See Figure 3) Although a yield curve reversal usually occurs prior to a recession, the shortness of the inversion period might very well mute its recession signal.

·        Housing activity doing better than previously forecast.

·        Better than anticipated employment growth revealed by the October jobs report signaling somewhat faster growth going forward.

·        There is less pessimism on both an interim U.S./China trade deal and passage of the USMCA trade treaty with Mexico and Canada.

Figure 1. S&P 500, 16Nov14 – 15Nov19, Weekly Data

Source: BigCharts.com

Figure 2. Federal Reserve Assets, 13Nov09 -13Nov19, In $Millions, Wednesday Level

    

Source: Federal Reserve Board via FRED

Figure 3. Yield Curve, 10-Year U.S Treasury Bond minus 3 Month Treasury Bill, 4Jan82 -13Nov19

Source: Federal Reserve Board via Fred

As a result we are backing away from our long held forecast of a 3-2-1 economy where real GDP growth on a fourth quarter – fourth quarter basis would be 3% in 2018, 2% in 2019 and 1% in 2020. We now anticipate that growth in 2020 will be 1.7% compared to 1.25% previously. So call it roughly a 3-2-2 forecast with 1.9% growth in 2021. But make no mistake there remains a significant risk of recession in late 2020, albeit somewhat less than we previously thought. For those who say that we can’t have a recession in a presidential election year, I would note that recessions occurred in 1960, 1980, and 2008; all presidential election years.[ii]

For the past year economic performance has diverged as strong consumer spending has masked significant weakness in business investment. (See Figures 4 and 5) You can characterize this as a two track economy. This result is somewhat surprising because most observers including us had assumed that the significant reduction in business taxation coming from the 2017 tax act would spur a capital spending boom. Obviously that has not occurred as growing trade tensions have made it difficult for businesses to plan ahead especially with respect to global supply chains. Indeed real business fixed investment actually declined in both the second and third quarters of this year. Nevertheless we think the worst is over and we anticipated a modest recovery over the next two years.

Aside from strong spending on intellectual property, the outlook for overall business fixed investment growth will remain modest with actual declines in structures investment which is being dampened by weak spending in the oil patch. We would note that the strong increase of 4.1% in the first quarter of 2020 is due to our assumption that Boeing begins to ship its long grounded 737-Max airplane to airline customers that quarter.

Figure 4. Real Consumption Spending, 2011Q1-2021Q4F, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 5. Real Business Fixed investment, 2011Q1-2021Q4, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Department of Commerce

As you will note from Figure 4 we are forecasting a reduction in the growth in real consumer spending that will work to eliminate the recent divergence between it and business spending. Why? There is a real problem emerging in automobile credit. Lending terms have been extended to seven years and many automobile loans are underwater at the initial underwriting.[iii] Would you believe a $27,000 Jeep Cherokee with a $45,000 loan? This type of behavior is very reminiscent of home lending during the 2004-2007 bubble years. As a result with delinquencies rising, we expect there will be an agonizing reappraisal of lending standards in the second half of 2020 that will likely reduce the current run rate of 17 million units a year to below 15 million units in late 2020. (See Figure 6)

Figure 6. Light Vehicle Sales, 2011Q1 -2021Q4F, In Millions of Units, SAAR

Sources: Bureau of Economic Analysis

As was mentioned above we believe that the economy will remain on a 2% growth path from 2019 – 2021. (See Figure 7) In this environment payroll employment growth will decelerate from the 170,000/month averaged this year through October to about 80,000/month in 2020 and 50,000/month in 2021. (See Figure 8) Temporary census hiring will positively affect the data in the second quarter and negatively affect it in the third quarter of next year. In our view the unemployment rate will bottom at 3.4% in the second quarter of 2020 and then gradually rise to 3.8% by late 2021. (See Figure 9)

Figure 7. Real GDP Growth, 2011Q1 -2012Q4F, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 8. Payroll Employment, 2011Q1 – 2021Q4F, Millions, SA

Sources: U.S. bureau of Labor Statistics and UCLA Anderson Forecast

Figure 9. Unemployment Rate, 2011Q1 -2021Q4F, Percent, SA

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Federal Reserve Policy

Federal Reserve Board Chairman Jerome Powell effectively made a major policy announcement at his press conference after the September meeting of the Federal Open Market Committee. In essence he said that there will a very high bar for the Fed to further lower its benchmark federal funds rate and that there will be an even higher bar to raise the rate. Thus the markets should not expect further cuts. We previously forecast that the Fed would cut in December, instead the Fed cut in September. Because we forecast a significant weakening in economy in the second half of 2020 we have penciled in another 25 basis point cut in the fourth quarter of that year. (See Figure 10)

His higher bar for a rate increase is based on inflation consistently exceeding the Fed’s 2% target. We expect that to happen in late 2021, hence we expect a 25 basis point increase late in that year. (See Figures 10 and 11) We do this only to signal that the Fed Funds rate won’t remain at 1.38% forever.  In this environment we expect that yields the 10-Year U.S. Treasury bond remain in a low 1.5% - 2.25% range.

Figure 10. Federal Funds vs. 10- Year U.S. Treasury Bonds, 2011Q1 -2021Q4F, Percent

Sources: Federal Reserve Board and UCLA Anderson Forecast

Figure 11. Consumer Price Index vs. Core CPI, 2011Q1-2021Q4F, Percent Change Year Ago

Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Housing Activity Plateaus

Housing activity continues to be range bound between 1.25 million and 1.3 million starts. (See Figure 12) Although this level of activity is more than double the lows reached during the Great Recession it still remains somewhat below the  long term historical average of 1.4-1.5 million units and well below the two million plus years associated with booms. Although our current forecast can be characterized as tepid it is 6% and 4% above what we forecast just three months ago for 2020 and 2021, respectively.

Figure 12. Housing Starts, 2011Q1- 2021Q4F, Thousands of Units, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Export Growth Stays Weak

The combination of trade tensions (apparently lessening), near recession conditions in Europe, sluggish growth in Latin America and softer growth in China along with a strong dollar make for a hostile environment for U.S exporters. After being essentially flat in 2019 real export growth is forecast to be 3.3% and 1.9% in 2020 and 2021, respectively. (See Figure 12) The reason for the uptick in the first quarter of 2020 is again our assumption that the 737-Max will ship to customers in the first quarter of 2020 as most of those customers are foreign air carriers.

Figure 12. Real Export Growth, 2011Q1 -2021Q4F, Percent Change, SAAR

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

$Trillion Federal Deficits

Given an existing imbalance between federal revenues and federal expenditures along with an economy plodding along at a 2% growth path, the era of trillion dollar federal deficits is up on us. (See Figure 13) Remember that there is no recession in the forecast horizon which means that should the economy fall into recession the deficit will double. Moreover, because interest rates are already very low, there can be very little relief coming from a further fall in rates.

Figure 13. Federal Deficit, FY2011 –FY 2021F, $Billions, Annual Data

Sources: Congressional Budget Office and UCLA Anderson Forecast

Conclusion

We modestly upgraded our forecast from last quarter to reflect improved financial conditions, a better housing and employment outlook, some relaxation of trade tensions and a modest improvement in business fixed investment.  As a result instead of forecasting 1% real growth for 2020, we expect growth to be on the order of 2% on a fourth quarter to fourth quarter basis. After going on a separate track from business investment, we forecast a slowdown in consumer spending largely coming from much weaker automobile sales as credit tightens in that sector. Overall the interest rate environment, aside from auto credit, will remain benign. But make no mistake, although we have lowered the risk of a recession, the second half of 2020 remains problematic for the economy.

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[i] See Shulman, David, “The Year of Living Dangerously,” UCLA Anderson forecast, September 2019

[ii] The recession of 2001 started in the first quarter of that year making the 2000 election year a close call.

[iii] See Andriotis, Anna Maria and Ben Eisen, “Car Loans Force more Borrowers Underwater,” The Wall Street Journal (online), November 9, 2019 and Chaney, Sarah, Auto Borrowing Rises Amid low Interest Rates, Solid Economy,” The Wall Street Journal(online), November 14,2019