The Creatures of Zircon-212 by Jeffrey Dow Jones Thursday September 02nd 2010, 7:52 am | Printer Friendly

Once again, it’s been another volatile week.

We got the ISM Purchasing Mangers Index yesterday — it came in at 56.3.  This is tremendous news.  It’s an increase from the prior month and it’s a better number than was estimated, but it’s still below the high of 60.4 in April.  The market rallied almost 3% yesterday and justifiably so.  I’ve been in the “slow GDP but no double-dip” camp for most of 2010 and I think a number like this really closes the book that forecast.  Unless things totally fall off a cliff in the next few months, we are not going to see a double dip recession this year.

The ISM-PMI might be my single favorite bit of economic data because it’s such a powerful leading indicator and it’s really easy to interpret.  A reading above 50 means that the manufacturing sector is expanding and a reading below 50 means it’s contracting.  Simple.  It’s also one of the Three Amigos!

Tomorrow we’ll get the jobs report.  As long as I can remember there has been a “data point du jour,” one particular piece of data that everyone in the media and the marketplace seems to fixate on.  For a long time during the tech bubble it was Alan Greenspan and the Fed Funds rate.  It seemed as though everything in the market depended on what Greenspan would do with short term interest rates.  CNBC shot closeups of his briefcase to try and see if it was stuffed with papers or had nothing in it.  Supposedly that meant something.  I think it just meant that we were all insane back in 1999.  Clearly.

Nowadays the focus is on the unemployment report and this disturbs me.  It disturbs me because the monthly non-farm payrolls number is a ridiculously unreliable and shifty piece of data.  As initially published, it simply isn’t an accurate reflection of reality.  Typically the data point will be +/- a few hundred thousand workers.  A month later they’ll revise that data point, sometimes as much as a few hundred thousand workers.  Then they’ll revise it again, and keep revising it.  The total revisions can be huge.  I’ve seen gains of a couple hundred thousand turn into losses and vice versa.  Then there are the birth/death adjustments; I won’t even go into those.  That’s for seriously hardcore econ wonks.  All the rest of us need to know is that a full year after the numbers are published they undergo — you guessed it — another gigantic revision.

On top of all that, the U.S. labor pool has about 150 million workers.  The consensus estimate for tomorrow’s number is a loss of 120,000 jobs.  With a labor pool of 150 million workers, that’s like, a rounding error.  There is little economic relevance contained in that report.  Right now it looks like the economy lost jobs in August.  Probably.  A year from now we’ll know for sure.  Sort of.

Don’t ever read too much into the jobs number and certainly don’t try and trade off it.  It doesn’t tell you anything about anything a normal person would care about.  The only specific relevance of the monthly jobs report is as a political talking point.  As I said, not the sort of thing that normal people care about.

The only thing about the jobs report that you need to know is that, on average, the economy needs to create about 150,000 jobs per month just to keep up with demographics and population growth.  And don’t get me wrong, the level of unemployment is a really important factor in the economy, but focus on the longer-term trends of the data set.  Ignore these monthly reports.

I’d rather look at the big picture.  But that’s only because the details of the individual data points are less interesting to me than the broader story that they tell.

What I’ve been thinking about lately has nothing to do with data…

Our story so far

As always, it started with an idea.

It began with this notion that we could do nothing and get paid for it.  Clever creatures, humans.  Clever enough to immediately develop a corollary, a rationalization that if we were smart enough or had enough money, we should get paid really well for all the work we didn’t do.  We deserved it.

Who were we to think otherwise?  After nearly two decades phenomenal economic success and a stock market that went straight up year after year, why on earth wouldn’t we think that all we had to do was “invest” our money where it would “work for us” and create more money on our behalf.  We dreamed about retirement, a magical kingdom where we could put our feet up, recline and indulge in the fruits of our labor and our Social Security.  We could golf every morning.  Or watch daytime television.  This dream was more than a dream; it was a future that each and every one of us was entitled to.  At least the clever ones.

The last thing we needed was the dot-com bubble, the kind of technological revolution that happens once in a lifetime.  As Americans – as humans — we felt imbued with godlike power to reshape the world as we saw fit.  Wealth was easy.  All we had to do was buy NotYetBusted.com at 9:30am and sell it before the close.  The Internet was changing the way all business would be done.

Why would we want to imagine a world any different?

But it was a fantasy, and maybe we knew it all along.  Even still, fantasies are fun, funny things and it’s in our nature to cling to them.  So we felt bad when it all went poof.  We pointed fingers at the Pets.com puppet.  And Congress.

But hallelujah, we got a second chance!  We discovered a new idea, one in which it was possible to make money out of nothing.  All we had to do was talk to our bank, borrow some cash, and buy the house next door.  The less of our own money we used, the better!  Maybe we weren’t really cut out to be day traders, but Real Estate Tycoons: now this was the life for us!  It was silly to think that hollow tech stocks would be our ticket to retirement.  Flipping McMansions with a view was a better way to do it.  Maybe we’d even keep one for ourselves.  One with a nice deck.  Where we could put our feet up.

That went poof too, and we all know why.

We made some mistakes.  But despite our deep reservoir of cleverness, we couldn’t wrap our minds around the notion that we were the problem.

So then came the bailouts and with them that other sparkling corollary, that rationalization that it wasn’t in our collective interest to let all these guys fail.  Maybe.  Maybe not.  All we knew for certain was where Wall Street stood on the issue (saaave us!).  Zandi & Blinder recently estimated that GDP would be a whopping 11.5% worse without all the bailouts and stimulus.  Ouch — that’s a legitimate depression.  Perhaps failure wasn’t in our collective interest after all.  But the dodgy debt would be gone.  Those who made bad loans would have paid the price.  And taxpayers wouldn’t have been on the hook for a few extra trillion dollars.  Was it a fair trade?

It was a really tough call.  It was a defining moment in the history of our nation.  We did what turn-of-the-millennium Americans will become known for.  We exchanged acute, short-term pain for modest, long-term suffering.  In other words, we became Japanese.

I’m not smart enough to know if that was the right decision.  The existentialist in me says that it doesn’t even matter.

And that’s kind of where we’re at today.  The economy, the stock market, Republicans vs. Democrats, the unemployment rate, the strong Yen, the homebuyer tax credit, Greece… does any of this stuff really matter?

If culture and psychology were the true causes of all that went wrong perhaps it is there where the solutions lie.

I’ve talked about this before, but everybody that writes an investment newsletter has answers.  They tell you which stocks to buy, when to buy gold, or how much to pay for a house.  We all like answers, but the real reason why we tune in to all these voices is to not feel so alone.  We look for authoritative voices to validate our opinions and beliefs.  If we feel like buying stocks, we go follow Jim Cramer.  If we hate gay marriage we turn on Glenn Beck.  If Republican Blockades make us angry we go read The Huffington Post.

Whether these voices steer us in the right or wrong direction is inconsequential.  What matters is that they assuage that deep, dark fear of being alone.

A Formula for Success

Look, folks.  I don’t have the answers.

I’ve spent most of my life as an outsider, from being an awkward geek in school to a forging career in the alternative asset industry, a niche reviled by Main Street and Wall Street alike.  I’ve done a lot of introspection and self-discovery over the years and I’ve picked up a trick or two that helps me deal with who I am.  What I’ve learned has helped me get more enjoyment out of life and it’s helped me be a better investor.  Sadly, I cannot just give all these answers to you.  They are my answers.  This is the legwork you have to do on your own.

But there are some things I can pass along, some lessons of psychology and culture that have helped me in a personal and professional sense.  I think these principals will help me get through the scary times in one piece.  None of them will surprise you:

• I need to work hard.  Harder than my parents, who were already hard workers.  Harder than my Gen X cohorts and harder than the fiery Boomers before me.  You Millennials are the new benchmark and I need to show up at the office every day with that same enthusiasm and hunger.
• I need to be smart.  I need to be relentless in my quest for knowledge.  I need to know more than the other guy, and I need to know more about more things.
• I need to be careful.  There is more danger lurking around more corners than in a long time.  I need to make prudent decisions with my money and the engines that generate it.  I need to make prudent decisions with my family and in my personal life.  There will someday come a better environment for taking risks.  But today’s climate demands a focus on not screwing up.
• I need to be diversified.  I happen to be in the business of investing and in environments where the reality is that of perpetual uncertainty, I cannot afford to be overexposed to specific areas.  True diversification isn’t the quickest way to generate wealth, but it is the most reliable way to do it and it’s an absolutely critical discipline when it comes to protecting wealth.
• I need to surround myself with people that I trust and discard those not worthy of it.  Trust is always an important asset, but in these environments where everything is getting restructured and re-aligned, it’s doubly important.  I need to ensure that my businesses are also worthy of our clients’ trust.
• I need to have fun.  Ideally, I need to find a way to do all these aforementioned things in a way that is intrinsically enjoyable.  And then do all the other things in life that make me smile. Friends and family, for example.  Or fishing.  And beer.
• From that balance will come perspective, the final tactic that will help me survive without going totally nuts.

If you look at that list, it sounds full of common sense.  Those are solid values that are cornerstones of success everywhere in business and life.

But we haven’t done a single one of things in the last decade!  We loafed around, we made stupid decisions, we took a lot of risk and focused too much on specific areas.  We welcomed those unworthy of trust and for some reason were surprised when they betrayed us.  We watched and wondered as it all unwound.  Why?

Did we at least have fun along the way?

I’ve written extensively that this is the dawn of an era of sacrifice.  Everybody is going to sacrifice in different ways.  My wife and I are fortunate to have jobs that pay enough to cover our costs and support some luxuries here and there.  We’re going to sacrifice in the form of a higher tax burden in future years and more regulation and restrictions on the businesses we operate.  If you don’t make a lot of money, your sacrifices will come under the form of smaller benefits and reduced entitlements.  If you’re middle class, you’re being squeezed in a lot of areas right now, particularly in the form of competition for good jobs.  That’s not going to get much better in the years to come, and your sacrifices will be those of stagnating incomes and delayed retirement.

If you think the Economic America we came to know in the 80′s and 90′s will return, you are deluding yourself.

If you think the market ahead will resemble the market we came to know in the 80′s and 90′s, you are deluding yourself.

If you think you can create profits with zero money down or if you think you can simply invest money, do nothing, and get paid handsomely, you are deluding yourself.

This is reality.  It’s time to roll up our sleeves, shoulder our requisite burdens, and earn it for a change.

First, step back from the ledge…

Take a deep breath.  This is nowhere near as bad as it sounds.

We’ve been through environments like this in the past and we’ll get through this one too.  Don’t worry, your friends at The Draconian aren’t going anywhere.  We will do it together.

Step one is a proper alignment of expectations.  You and I aren’t getting anywhere unless we have a realistic idea of what we’re up against.  The reality is tough, but it isn’t catastrophic.  This isn’t Haiti or Zimbabwe.  This is still America, dammit! There are a lot of really scary forecasts circulating now and many of these have lost touch with reality too.

All of this only going to be a problem if your expectations are improperly aligned.  This era of sacrifice will only be really painful if you’re expecting a return to the crazy days.  It might even be pleasurable if you were expecting economic apocalypse.  So try not to take it too seriously.  Relax!

This is an industry that takes itself very seriously, a little too seriously at times.

Sometimes, when I turn on CNBC I am reminded of that famous passage from Slaughterhouse Five. It’s the one where Vonnegut’s alter ego, the hack sci-fi writer Kilgore Trout, describes one of his fictitious books, “The Big Board”.  For reasons that are both obvious and less so, these are some of my favorite paragraphs in all of modern literature:

It was about an Earthling man and a woman who were kidnapped by extra-terrestrials.  They were put on display in a zoo on a planet called Zircon-212.

These fictitious people in the zoo had a big board supposedly showing stock market quotations and commodity prices along one wall of their habitat, and a news ticker, and a telephone that was supposedly connected to a brokerage on Earth.  The creatures on Zircon-212 told their captives that they had invested a million dollars for them back on Earth, and that it was up to the captives to manage it so that they would be fabulously wealthy when they were returned to Earth.

The telephone and the big board and the ticker were all fakes, of course.  They were simply stimulants to make the Earthlings perform vividly for the crowds at the zoo — to make them jump up and down and cheer, or gloat, or sulk, or tear their hair, to be scared shitless or to feel as contended as babies in their mothers’ arms.

The Earthlings did very well on paper.  That was part of the rigging, of course.  And religion got mixed up in it, too.  The news ticker reminded them that the President of the United States had declared National Prayer Week, and that everybody should pray.  The Earthlings had had a bad week on the market before that.  They had lost a small fortune in olive oil futures.  So they gave praying a whirl.

It worked.  Olive oil went up.

Seriously, read that again.  Did it make you smile?

In the grand scheme of things how important are things like yesterday’s ISM number and tomorrow’s jobs report?  Yesterday we were in rapture, tomorrow we may be in despair.  Are we just creatures in a zoo for the amusement of an alien race?

I’ve heard a lot of chatter lately about how “it’s all rigged.”  The market is rigged, politics is rigged, the economy is rigged.  Is it the Creatures of Zircon-212 who have done the rigging?  Whoever “they” are, it’s a fascinating psychological and cultural milepost.  Perhaps it’s a sign that we’re slowly becoming aware of the insignificance of it all, the existential realization that it doesn’t matter.  Unfortunately, our reaction has tilted more towards anxiety than whimsy.

What to do about it

Despite this brief excursion into the land of existentialism, I’m not about to throw my hands in the air, grab my Nietzsche anthology, and hole up in my bedroom writing socio-political manifestos.  That’s for someone else’s newsletter, some other guy spouting answers.  I only bring up the subject to offer some perspective, to remind the world that a few ticks up or down in the markets don’t matter nearly as much as we think while watching them tick up and down in real-time.  Your homework assignment is to hold that principle in mind when we get tomorrow’s jobs number.

I think we can derive some practical benefit from this existential perspective.  I think we can use it to construct better portfolios.  I know it’s a whole lot harder to make money as an investor in this kind of environment but the good news is that the benchmarks have reset.  In these kinds of environments, these secular slowdowns, it isn’t about making a ton of money.  It’s about protecting what you have and setting yourself up for the recovery.

I’ve noticed that those investors still trying to emulate the returns they grew accustomed to in years prior are the ones suffering the most frustration.  The time to re-frame your perspective was 2008, but if you still haven’t done it, better late than never.  5% is the new 10.  10% is the new 20.  Don’t worry, someday, 20% will be the new 10!  Won’t that be awesome?  Just make sure you’ve still got some money left at that point.

Today’s environment requires totally different strategy, tactics, and mindset.  There’s a reason why so few individuals are adept at outperforming their peers in both bull and bear cycles.  We, captives on the planet Zircon-212, seemed to be wired for one or the other.  Or neither.  And this is why we are so entertaining!  This is why we respond in such amusing fashion to realities that push against our expectations.

If it fails, I suppose there’s always prayer.

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