Post Modern Portfolio Theory (PMPT)

I have been asked to keep this website open and link it to users of the Generative AI program I plan to launch. This will become a place for me to comment on important current events.

What’s happening now?

The dollar is rising while all other currencies are declining because our economy is doing better than any other G20 nation. By those metrics, America is clearly winning the cold war. However, it is involved in two hot wars that are not going well. Also, Biden is spending more than any other country even though we have the highest debt to GDP ratio. 

I encourage you to read Jennifer Burns new book, The Last Conservative. She cites monetarist critiques of that huge flood of helicopter money, created by two presidents and three Fed chairs, who pumped $ 9 trillion into the economy. It did not immediately cause the inflation we are having, but it is coming.

The gigantic peak of M2 in 2021, and subsequent plunge, is a monument to the ineptness of presidents and Keynesian economists to manage the economy and manage the Fed properly. The policy changes they implemented are so drastic, I don’t see how it can be corrected without a lot of pain. Based on Powel and Biden’s past behavior, I expect more over corrections. They tried to bring us back to the 1950’s when we were an industrial superpower, but those days are gone forever. 

What could go wrong?

1. If inflation continues to rise and the Fed raises interest rates, recession fears could also rise and the stock market could drop a lot. Small probability.
2. If China Blockades Tiawan, the stock market would probably drop a lot even if America does not respond. Small probability.
3. If China ups the ante in the trade war, that would probably increase our inflation because we would be paying more for goods and it would increase our debt problem. The market could probably drop a lot.  Small probability.
4. Whether Trump wins or loses the election, chaos could rain. Probable.
5. What if AI causes chaos to rein, as many fear?

Stop right there. Probability theory is not a good tool to measure the risk of one of these chaotic events, and 5 possible chaotic events is not just 5 times worse. Stop thinking of risk in terms of probability. Read chapter 26 of “Thinking Fast and Slow” by Daniel Kahneman. Beware of the risk you don’t know how to measure! Parachute jumping has a very small probability of risk. But if the chute doesn’t open, you’re dead!

or else what? More tariffs and trade barriers?

Not quite the foreign policy of Nixon and Kissinger. Congress didn’t like China then either, so they snuck over there and cut a deal. While we were allowing Japan to put our tool and dye companies out of business by subsidizing them, and dumping steel from factories we rebuilt after we blew them up, China was emerging from a communist dictatorship to become a quasi-capitalist nation. Now, Japan is here to help us defeat our new enemy, China, and we are welcoming Japan with open arms, except of course, not allowing Japan to buy US Steel. I’m sure we could let them have Youngstown Sheet & Tube at a healthy discount. What goes around, comes around?

There has been something terribly wrong with our foreign policy for a long time. It was not wrong to open up our markets, it was the failure to regulate it that created the problem. The laws to protect American workers were on the books, but the bureaucracy to enforce the laws failed. However, the result was the greatest period of economic growth the world has ever seen. So, did globalization really fail, or was it big government bureaucracies that failed? I suggest it was, and is, the latter. Now we are in act 3, or as Ray Dalio would say, stage 5 of a 6 phase economic cycle. The $64 trillion dollar question is, how do we get out of the mess, governments for the past 20 years have created, and continue to create?

There is only one group that is capable of doing this, the people who provide the funding for the politicians to get elected, who then appoint the bureaucrats, who create the mess. Elect people who know how to run a business successfully, who understand that you get the money first, and then you invest it, to make a profit, not to just provide jobs. Deficit spending is not a solution. It just creates a bigger problem. Do what is best for the country first, the people second, and yourself, last. Get rid of all the people who have that sequence reversed.

I expect this will be my last publication. I am working on a Generative AI model for my students at Stanford, to access 24/7 to talk with my Avatar. They are located all over the world, in different time zones, and I would like to provide them a way to get their questions answered. If you would like access to this chatbot, just send me your email address. Thank you for your interest in my life’s work. Let’s change the world, and make it better for everyone, not just ourselves.

Frank Sortino, Professor Emeritus in Finance

Paper Soldiers, by Saleha Penguin, is written by a reporter who interviewed a lot of big names in government and Wall Street and tells us what they told her. She says she loves America and wrote this book because she is afraid for America’s future.  She ends with this quote, “America’s friends and foes are wondering whether U.S. economic dominance, underpinned by the dollar’s central role in the world, was worth the trouble.” I suspect they told her what they wanted to tell us:  America’s current monetary and economic policies are a prescription for disaster.

Take away:

1. The world is fed up with America using the dollar as a weapon. They would gladly choose an alternative if one was available.
2. We will not be able to spend our way out of this mountain of debt we have accumulated.
3. The Fed is running the show and the Treasury’s role in manipulating the value of the dollar is over.
4. This is the way past empires have ended, but look how long it took England. They’re still here, and still acting as thou they were important.

Now, what should we make of this?

1. Biden is on the phone to China.
2. Yellen is in China talking to everyone, but no one knows what they are talking about.
3. The rest of the world is watching, trying to figure out what their next move is.
4. The market is going up and worthless securities like DJT are market leaders. The market does not believe the Fed.
5. Hello world, the answer is NO!

Don’t be the last one out the door.

One simplistic way is to put your money where your probabilities are. If you think there is a 70% chance the market will go down and a 30% chance the market will go up further, then buy the market.  However, if it goes up, how much will it go up, or how much will it go down? If your answer is, it could go down 14% or up 3%:

Probability  times percentage rise or drop. 

.70 X (-20) = -14%

.30 X (+10) =  + 3%

Then, look elsewhere. For example, a high grade corporate bond ETF yielding 5% with a duration of 6 years. Now, for every 1% decline you would make a 6% capital gains while collecting a yield of 5%, for a total return of 11%. 

 I do not think probabilities capture downside deviations as a measure of risk and I do not think probabilities capture the upside potential. So, I will use the Forsey-Sortino model we gave away in our last book to compare the stock market with the intermediate term bond market.

Now, given that I have a high probability of earning 11% over the next year, what could I get investing in the stock market, assuming a 10% expected return above the market price on SPY on 2/12/2024 and a standard deviation of 12%. The FS model indicates an upside potential of 4.2% above the 10% expected return, or 14.2%. Clearly, 14.2% beats 11%. However, we also see that the downside risk is 7.9%. Therefore, the upside potential ratio of 4.2/7.9 = .53, meaning, The stock market has 67% more downside risk than upside potential. Does this change your mind about jumping into the market at this all time high? That return of 11% is not guaranteed. It is subject to interest rate risk. Hmmm, how do we calculate the interest rate risk? I leave that to you.

I have made my decision.

Well, the market’s back where it was three years ago and Nvdia is double where it was. We couldn’t keep the Atom bomb a secret and even North Korea from making one and pointing it at us. What chance is there that no other country will make a chip like Nvdia’s? How about a quantum computer that is 1000 times more powerful? IBM already claims to have one (see 60 minutes). 

Please read, “Milton Friedman, The Last Conservative.”The author, Jennifer Burns, quotes Joe Biden on the campaign trail proudley saying, “Milton Friedman isn’t running the show anymore.” She should have added, that the old spend and tax Democratic party policy was replaced by the Modern Monetary policy of, “Print all the money you want.”   Friedman was opposed to tariffs. Biden is planning on increasing them for a third time on China. Freidman was for free trade and small government. Need I say more?

I will. Time to take some chips off the table.

How long will the rest of the world follow us down this rabbitt hole?

P stands for Prices. Our solution is the: “Inflation Reduction Act.”

C stands for China.  Our solution is the “Chips and Science Act.”

T stands for Technology. Our solution is to break up big Tech companies & regulate them.

The Inflation Reduction Act (IRA) will cost an estimated $40 billion, but we will tax big tech to pay for it (Uh huh).

The Chips Act will cost an estimated $100 billion to get foreign companies to build factories in America, creating new, pollution free jobs that will save the earth.

Another way to look at the solutions:

• It doesn’t matter who is pumping money into the economy. It is the supply of money from the Inflation reduction act to build these new ESG plants and staff them that will chase the price of goods and services up.  STOP INCREASING THE MONEY SUPPLY!
• The CEO of TSMC says it will cost 4 times more to produce chips in Arizona than in Tiawan. Who is dumb enough to pay that premium? The American Government has offered American chip companies $52 billion in subsidies to buy TSMC chips in Arizona instead of Tiawan. WHAT!
• Yes, and Mr. Liu of TSMC says that $52 billion will not be near enough. What does he know? He came here and talked to all the people involved. Furthermore, the CEO of Nvidia says it will take America 20 years to become a leader in global chip production, given our current 10% of world chip production.
• The irrational fear, that AI will replace humans and we won’t be able to control them, is nothing, compared to the rational fear that we all have of the human beings governing us and those killing us on our streets, schools, and public gatherings. AI algorithms and robots will only replace humans in those situations where they are far superior to humans. Let’s deal with factual fears instead of the unknown fears of something few understand.
• Perhaps those countries with declining populations will do better than those with rising populations. If the future calls for fewer, better trained people, the more relevant question may be, how should we plan to deal with overpopulation?
• When has a government contract come in at estimated costs, and/or, on time?
• Would it be possible to build an AI algorithm that matched the supply of money the fed controls, with the demand for money in those markets it used to control?
• Would it be possible to build an AI driven robot that could find a pareto optimal solution for the expenditures that congress deals with, e.g., the budget?

Summary & Conclusion:

The costs of current P, C, and T programs will be exorbitant, and it will take longer than the Afghan war, with the same result. I suggest we put an AI driven robot on the ballot for President in 2024. Let the people decide who would do the pareto optimal job for all the people, Trump, Biden, or R42? No question in my mind!

Presidents, Trump & Biden, made the huge mistake of establishing trade barriers to keep China from becoming the biggest economy in the world. Now the watchdog is threatening to bite Applied Materials for correcting the Trump-Biden Folly. We are not going to replace the supply side network the market created, by building a few factories our politicians erect. This is how great empires end. Camelot is in decline. We need a Lancelot to save us.

r

Fareed Zakaria is one of the few liberals that talks about the Debt problem.

Points made last week:

1. Catherine Mantel talked about the budget deficit that was running at 3% of GDP but is now 8 to 10%. She said it was sustainable when the budget deficit was effectively zero but now says: “if something can’t go on forever, it won’t.”
2. The Brit and US experts said: “We all thought the US was going to have a hard landing and China would have an economic boom. Now we have the opposite.”
3. Biden is negotiating a new world order in the middle east between Isrial and The Saudi’s. The US would build a nuclear facility in Arabia and Netanyahu would dump the far right Jews. Does that mean the Saudi’s will not join BRICKS in 1/1/24?  What does Bebe get?
4. The Saudi’s asked to join BRICKS and were accepted, but nothing has been signed yet
5. China is Saudi’s biggest customer
6. The US produces more oil than Saudi Arabia
7. If you were the Saudi Prince, would you want America, or China, to build a huge atomic facility in your country?
8. If Biden pulls all this off, he will go down in history as our greatest president.
9. If he doesen’t,

We should keep in mind, it took a long time for the sun to set on the British Empire. I can’t imagine the Saudi Prince asking the US to build anything when his biggest trading partner is China, who can do what they say, better and faster than us. I am 70% in short and intermediate term high grade corporate debt. The coupon return + potential capital gains is greater than the expected return on US equities, in my opinion. While America is trying for check mate, China is slowly eliminating all our possible GO moves.

The Asian exodus of brilliant, highly skilled, science majors from western nations, to their homeland will soon be followed by the current herd of allies following us toward the trade wars cliff.

If you believe all our politicians, it’s China. See if you still believe that after reading:

Thanks to my friend, Kal Salama, I’m sitting out the current Fed Fiasco with 40% of my portfolio in two high grade corporate bond ETFs that are still up and providing me close to 6% YTM. If Professor Roach at Yale is right, you can put the blame on the politicians and ignorant pundits who think the $Trillions of debt and the trade barriers and tariffs were, and still are, necessary and good for America. If Dr. Roach does not convince you otherwise, then read Dalio’s book about the changing world order. See where America stands in Dalio’s view, as a place to invest.

I think our biggest problem is a congress that thinks jobs and economic growth are appropriate goals for a central bank. I agree with Hayek and Friedman: printing fiat currency will not create jobs or economic growth. It will, and did, create inflation. Corporations create jobs and economic growth. I believe we are in a technology revolution that will reshape the world and that is where my equity holdings are, not in value stocks. Switching to value might have been appropriate for the 20th century, not now! While China is embracing that point of view, America is busy dreaming up reasons to stem the tide. I remember a time when most Americans believed : “What’s Good for General Motors is Good for America.” Does anyone dare substitute, Silicon Valley, for GM, now? Most would substitute, ESG, for GM, including the management of GM. Yes, I think everything ESG stands for is good. But not as the driving force for America.

Well, I wish you all a very Happy New Year…and please, don’t tell my grandchildren, and yes, greatgrandchildren, I held these beliefs. It would be my last lemon cream pie.