Ten interesting things we read last week

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At Ambit we spend a lot of time reading articles that are not directly relevant to Indian stocks. However, since the Indian economy is now umbilically linked to its global counterparts, the articles that we come across have relevance for Indian stocks and the Indian economy. In that context, this report contains the ten most interesting pieces that we read this week.

Here are the ten most interesting pieces that we read this week, ended November 25, 2016.

1) James Montier says nothing is cheap and hence GMO is holding cash [Source: Financial Times]
At a recent presentation, James Montier from GMO told the firm’s clients that GMO believes that most of the world’s assets are too expensive right now. Almost two-fifths of the group’s $27bn flagship fund sits in cash, ready for the day when asset prices have tumbled. Government bonds are judged too expensive and the group has largely abandoned the US stocks as well, aside from a small group of global companies, such as Microsoft, Johnson & Johnson and Alphabet. He also mentioned that EM is cheap on a relative basis. Mr Montier also challenged a common view that the very low interest rates of modern monetary policy justify a stock market boom. “There is no evidence that low interest rates have an effect on equity valuations, and even if they do, the effect is offset by lower growth rates,” he says. The debate within GMO then is not about whether valuations fall, and investment returns for the majority fail to match those of the past, but rather the speed of the adjustment. “The thing we disagree about at the moment is whether we are in hell or purgatory, is it a fast mean reversion or a slow mean reversion,” he says.

2) Demonetisation politics unfolds as a vast morality play [Source: Indian Express]
The ongoing demonetisation being seen in India is a watershed event. As per Pratap Bhanu Mehta, a leading political analyst, while a move on black money was required, the government has taken a gamble. He also points out how demonetisation is not about the calculus of costs and benefits. In fact, that is why there is a lack of clarity over objectives. Its distributional consequences are an afterthought. Nor is it about politics in an opportunistic sense. He also highlights that given his step comes from the prime minister’s depth of conviction and sincerity, it poses a great danger. What it threatens to institutionalise is a new kind of politics. This is politics as a vast morality play whose three central elements are personification, puritanism and punitive imagination. He says that while the economists can give a better account of the effects of demonetisation, there are warning signs about the institutional imagination that underlies it. It will unleash the state on you, in the name of protecting your own virtue. What starts as a morality play will end in more statism.

3) The return of an existential threat [Source: Financial Times]
A month before the US election, as tension flared between Moscow and Washington over the war in Syria, Russia intensified its nuclear posturing to the highest level since the Soviet era. Over a three week period, Russia cancelled three nuclear deals with the USA. While the West may be only just waking up to the threat, defence chiefs across NATO have been grappling with Moscow’s nuclear rhetoric ever since Russia’s annexation of Crimea in 2014. Moscow has even reprised cold war-style psychological games. The challenge for the West, and the Trump administration, is to understand the motives for the nuclear posturing. Some in NATO see it as a sign of anxiety, not strength and believe Russia is adopting “nuclear de-escalation” concept. This says if Russia faces defeat in a conventional conflict, it might respond with a limited nuclear strike, even with a single weapon. This would aim to shock its opponent, NATO, into backing down, or otherwise risking all-out destruction through nuclear retaliation. Notably, Russia has incorporated a limited, knockout, nuclear strike into military exercises since 2000.

4) The rebel economist who blew up Macroeconomics [Source: Bloomberg]
Paul Romer, the World Bank’s chief economist’s working paper “The Trouble with Macroeconomics,” has landed among Romer’s peers in the economics profession like a grenade. “For more than three decades, macroeconomics has gone backwards,” the paper began. Romer closed out his argument, some 20 pages later, by accusing a cohort of economists of drifting away from science, more interested in preserving reputations than testing their theories against reality, “more committed to friends than facts.” Central banks and other policy makers use the models that Romer says are flawed. The idea that consumers and businesses always make rational choices pervades mainstream economics. Romer thinks that’s not only wrong, but may lead to the misleading conclusion that government action can’t fix big problems. The problem with that worldview, says Romer, is that once you rule out policy or people as a catalyst of change, there’s often no convincing alternative. Romer has also helped pioneer the idea that human capital and innovation, which can be nurtured by government action, drive growth.

5) How Renaissance’s Medallion fund became finance’s blackest box [Source: Bloomberg]
Renaissance Technologies’ Medallion fund has managed to pump out annualised returns of almost 80% a year, before fees. This fund is open only to firm’s 300-odd employees, 90 of whom are PhDs. Few firms are the subject of so much fascination, rumour, or speculation. Everyone has heard of Renaissance; almost no one knows what goes on inside. Barring the founder Jim Simons, relatively little has been known about the small group of scientists which run the fund, whose vast wealth is greater than the gross domestic product of many countries and increasingly influences the US politics. Competitors have attributed the computing power available to Renaissance’s employees for its success. Its employees also have more, and better, data. They’ve found more signals on which to base their predictions and have better models for allocating capital. Increasingly, quants seem like saviours to investors disappointed with how mere mortals have managed their money of late. In 2016, clients plugged $21 billion into quant hedge funds, while pulling $60 billion from those that do everything else. Even old-fashioned traders, such as Paul Tudor Jones and Steve Cohen are adding to their computer scientist ranks in hopes of boosting returns.

6) The end of the era of central bank independence [Source: Financial Times]
The independence of a central bank is premised on two conditions. The first, and most important, is that there is a broad consensus on the goals of monetary policy. The second is that an independent central bank board, usually staffed by professional economists, can deliver those goals. Mr Trump has openly challenged that consensus. His economic advisers believe the US Federal Reserve had created a “false economy”, and that Trump wants to see someone at the top of the Fed who reflected his own views. Theresa May, the British PM, made an almost identical argument with her criticisms of the Bank of England when she warned of “bad side effects”. In both cases, politicians are seeking a change in the fiscal-monetary mix: looser fiscal policy, harder monetary policy.

7) Trump’s monetary conundrum [Source: Project Syndicate]
Nouriel Roubini discusses the possible path Fed composition and policy action can take under Donald Trump. According to him, Trump could appoint hawks to the two Fed Board seats that are currently vacant, and he will certainly replace Yellen when her term expires in 2018. He believes premature and excessive hawkishness would strengthen the US dollar and sharply increase the US trade deficit, undermining Trump’s stated goal of creating jobs and boosting incomes for his blue-collar, working-class electoral base. While a combination of looser fiscal policy and tighter monetary policy should, as in former President Ronald Reagan’s first term, strengthen the dollar, if Trump pushes the USA toward protectionism, he will generate economic and geopolitical tail risks that would weaken the dollar and increase US country risk. Trump’s fiscal policies would also weaken the dollar over time, after an initial significant appreciation, as the substantially higher deficit spending would be financed either with easy money or bond issues that increase US sovereign risk. The net impact of all these factors on the dollar will all depend on how loose fiscal policy becomes, and on how tight monetary policy becomes.

8) Why digital money hasn’t killed cash [Source: newyorker.com]
Never has it been easier to spend your money; the press of a button, the swipe of a card, or the wave of a phone, and it’s done. For the card-and-phone-swiping consumer, however, the question arises: will there be much need for cash in the future? The author believes there will be. The paradox of the coming “cashless economy” is that it uses and stores mostly in the form of hundred-dollar bills, ever more cash. In the last two decades, the hundred-dollar bills in circulation have gone up fourfold. One possibility cited frequently is that there is a growing demand for large US bills abroad. A recent work by the Federal Reserve economist Ruth Judson, estimates that 50% of bills in circulation are held abroad and that share has almost certainly been increasing. Some of that hidden money comes from illegal activities, like drug sales. A bigger share, though, comes from the build-up of wealth in an unreported economy of generally legal activities that are often hidden from the tax authorities. The traditional definition of money says that it is a medium of exchange, a unit of accounting, and a store of value. While cash may get displaced, a medium of exchange, with bank deposits earning near zero (or even negative) returns, storage in the form of hundred dollar bills might still continue for some time.

9) The science of waiting in modern courtship [Source: nautil.us]
Aziz Ansari, an actor and comedian, and Eric Klinenberg, professor of sociology at NYU discuss the science of communication in recent times. Their research sheds some light on why waiting techniques in modern courtship can be powerful. As per the tests conducted by Psychologists, “reward uncertainty” can dramatically increase the interest in getting a reward, while also enhancing dopamine levels so it basically feels like being coked up. If a text back from someone is considered a “reward,” resultantly, a guy or girl who texts back immediately is taken for granted and ultimately lowers value as a reward. They highlight how texting is a medium that conditions our minds in a distinctive way, and we expect our exchanges to work differently with messages than they did with phone calls. Unlike earlier days, texting has habituated us to receiving a much quicker response. Their research also threw an analogy between slot machines and texting, since both generate the expectation of a quick reply. When you’re texting someone you’re attracted to, someone you don’t really know yet, it’s like playing a slot machine: There’s a lot of uncertainty, anticipation and anxiety. Your whole system is primed to receive a message back and when it doesn’t happen, anxiety develops.

10) Skip the empathy, Mr Schultz, and focus on the coffee [Source: Financial Times]
In one of her last pieces at the FT, Lucy Kellaway takes a dig at Howard Schultz, the CEO of Starbucks. She questions the language of the note Mr Schultz sent out to his 100,000 employees that urges them to be more empathetic to people around them. She says that while he has a duty to behave decently to his staff and his customers, he has no duty, indeed no business, to be looking after their spiritual lives or telling them how to behave when they go home. She further attacks his point on ‘stripping away all differences’ by alluding to the fact that his net worth at $2.9bn is a tad bit higher than that of his employees. On his message “On this Sunday, wherever you are, whatever you are doing, know that I send you my love and respect”, she questions how he can send his love to about 100,000 people he has mostly never met and doesn’t even know the names of. She further doubts whether you can measure empathy in a single, aggregated number. Empathy is defined as the ability to understand and share other people’s feelings — and so social networking sites are not the obvious place to go in search of it. More fundamentally, empathy is not necessarily good for business or for us as individuals. She points out that empathy is dangerous if there is too much of it. For a start, it is exhausting. Jobs that require a lot of empathy, like working in a hospice, leave us shattered and on the verge of a breakdown. Second, it is a zero-sum game. If you spend all day being empathetic at work, you have none left when you go home. And finally, too much empathy can lead to bad decisions.

- Saurabh Mukherjea is CEO (Institutional Equities) and Prashant Mittal is Analyst (Strategy and Derivatives) at Ambit Capital Pvt Ltd. Views expressed are personal.