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U-turn if you want to.

U-turns have a bad reputation. To change your mind and course is seen as a sign of weakness. Margaret Thatcher, early in her years as prime minister of the U.K., laid waste to the notion of ever making a U-turn with a soundbite for the ages.

Few of us have held the same beliefs all of our lives. When the facts change, we need to change our opinions, as economist John Maynard Keynes famously said. But there is still some kind of moral bar on U-turns by people in power.

I raise these issues because the Federal Reserve just made a screeching U-turn, going from promising a steady decrease in the size of its balance sheet and flagging continued interest-rate increases to saying neither is assured within the space of six weeks. Many market participants had been clamoring for just such a U-turn, given the sell-off in risk assets in December and the surge in haven assets such as Treasuries.

And yet the response has been surprising. The market reaction has been positive for risk assets, but not as drastic as might have been expected. Yes, the Fed was expected to move in a dovish direction, so some of this was in the price before Wednesday. But nobody expected Fed Chairman Jerome Powell to embrace the dovish narrative so fully. Market doves and hawks alike seem to agree that this was an extreme act that justified opprobrium. For the Wall Street Examiner’s Lee Adler, Powell’s reversal merited comparison to Neville Chamberlain at Munich. Others vitriolically criticized Powell for giving in to markets. 

Why such anger? The main reason, I suspect, is the belief that central bankers should be especially careful about changing their minds abruptly. In an era of fiat currencies, central bank credibility is all that backs money. A U-turn as obvious as Powell’s therefore damages the credibility of the dollar itself. Central bankers wishing to make a U-turn should follow Alan Greenspan, and speak so incomprehensibly that nobody understands them in the first place, or even Thatcher, who was prepared to make U-turns and compromises where necessary, but was careful not to draw attention to them. 

A second problem with Powell’s reversal is that it didn’t seem necessary. The stock market had begun to recover from its December swoon by the time Powell spoke last week, so such a screeching U-turn wasn’t needed. And developments since then make the U-turn even harder to explain. Friday brought a startlingly good employment report. Unemployment numbers can, however, be noisy and subject to revisions. More important in many ways was the Institute for Supply Management manufacturing survey, which bounced back in a remarkable way for January. Over time, the ISM report has been a great leading indicator of GDP growth, and much less noisy than jobs. It is hard to dismiss the latest gains in the ISM as a fluke:

As a result, U.S. economic data have suddenly started to deliver positive surprises, according to the popular Citi Economic Surprise indexes. The U.S. is also pulling up the rest of the world. The Fed did not necessarily have access to all this data before meeting, but the notion that they had access to data painting a worsening picture of the economy seems hard to sustain.

So why did Powell and his colleagues change course? Most likely because of China, where the data look worrying. Former Fed Chair Janet Yellen executed a very subtle U-turn of her own only three years ago in response to weakening Chinese data. Instead of four rate hikes in 2016, as previously advertised, the Fed proffered only one. And China’s manufacturing numbers are back to where they were when the Fed made its last U-turn: 

Or alternatively, remember that it is only the Fed’s reaction function that has changed. It has not yet done anything. It has given itself freedom to stop reducing its balance sheet. With lots of new Treasuries coming to fund the budget deficit, this might prove useful. But if the U.S. economy stays strong and wage growth rises above its current level of 3.2 percent, there is nothing to stop the Fed from hiking rates again. To do so would not require another U-turn.

The hedgehog, the fox and the fund manager.

Bill Gross, the “bond king” who built Pimco into the most powerful bond investor in the planet, has retired from investing, with the announcement that he is closing his unconstrained bond fund at Janus Henderson. That fund was created four years ago, when he dramatically walked out of Pimco, but it has failed to deliver as hoped. 

Gross’s farewell interview with Tom Keene on Bloomberg Surveillance is well worth watching. His critical causes of lament are that he moved to an “unconstrained” fund, able to invest in virtually anything. In doing so, he violated one of the rules laid down by Ed Thorp, the mathematical genius who worked out how to win consistently at blackjack and how to invest quantitatively. Thorp, who lives near Gross in Newport Beach, California, held that managers should not risk more than 2 percent of their capital on any one position. Gross was far more exposed than that, notably on his disastrous bet that German and U.S. bond yields would converge. To borrow a phrase from Bloomberg Opinion’s Brian Chappatta,
Gross was too unconstrained for his own good. 

The broader message goes back to the age-old dual between the hedgehog and the fox. Made famous by the philosopher Isaiah Berlin, the concept borrows from an ancient Greek saying that “The fox knows many things, but the hedgehog knows one big thing.” In the world of nature, there are far more hedgehogs than foxes, and the same is true of the world of investment. Most of the great and famous investors did one thing truly well, or in some cases just made one really good trade.

Gross, we now know, was a hedgehog. He understood that bonds were in a huge secular bull market and remorselessly took advantage of that. In different conditions and in different asset classes, he tried to be a fox and failed. Mistaking hedgehogs for foxes has been a good way to separate investors from their money throughout history.

In the relatively short term, making money tends to be about taking one strategy or style and sticking to it with discipline. Thus Bill Miller, the great value investor, beat the S&P 500 every year for more than a decade — but suffered a horrendous underperformance as soon as value started to lag behind during the financial crisis. Stars who make their names by making the right call during a crisis — such as Elaine Garzarelli, the strategist who called the Black Monday crash of 1987, or hedge fund investors Bill Ackman, David Einhorn and John Paulson, who all emerged from the crisis of 2008 — tend to have difficulty thereafter. Getting one call right in an important situation does nothing to show that an investor will make more good calls in different circumstances. 

In another famous incident, Fidelity’s Magellan fund, once the vehicle for Peter Lynch and the biggest mutual fund in the world, grew so big that it could no longer outperform by buying smaller companies. Instead, it shifted from stock picking to trying new strategies, like making a big asset allocation bet on bonds, and came unstuck. Taking bets like this was the only way to hope to outperform, but it also meant moving beyond the fund’s core competencies. Fidelity’s Anthony Bolton, long Britain’s most famous investor, launched a China fund later in his career and failed to replicate his success. On a smaller scale, the Amaranth hedge fund, initially set up to do convertible arbitrage, switched to playing the natural gas market when its original strategy stopped working, and eventually imploded. 

Bill Gross now joins this long list. Past performance says nothing about future results. Expertise in one area does not necessarily transfer to another, and sometimes it is hard to tell the difference between a fox and a hedgehog. 

Authers notes:

Share buybacks reach the political agenda: It’s worth reading this op-ed in the New York Times, co-written by Senators Bernie Sanders of Vermont and Charles Schumer of New York. The Democrats’ leader in the Senate and the liberal insurgent agree that it’s necessary to put limits on how much stock companies can buy back. I believe that they are right to see buybacks as central to a major economic problem, but buybacks should be seen as a symptom rather than the cause. 

The key passage is perhaps this one:

Companies, rather than investing in ways to make their businesses more resilient or their workers more productive, have been dedicating ever larger shares of their profits to dividends and corporate share repurchases. 

The problem here is that we don’t know if the companies believed they had ways to invest their cash that would make “their business more resilient or their workers more productive.” After years of widening profit margins and improving efficiency, and in a slow-growth economy, it is quite possible that they did not see anywhere to invest in their own company that would produce a profitable return. In such circumstances, a company should not throw good money after bad, but should instead return it to investors, who can then find a better place to invest. It is a way of capital markets doing their job of allocating capital to where it can be most productively used. And it is better that companies do this, rather than pour money into boondoggles or failed experiments that destroy value. 

If that is the case, then the underlying problem is a stagnant economy which is not producing growth opportunities. And we should be more concerned that institutional investors, having sold their shares back to corporations, are not finding anything new in which to invest the money. The buyback phenomenon may be a symptom of a stagnant economy and a corporate sector that has run out of ideas, rather than a motor for stoking inequality and causing that stagnation.

It is interesting to see two Democrats who do not always agree with each other come together on the issue, and it is probably good politics to attack buybacks. But the key to this measure is
to use buybacks as a tool to force better treatment of workers. See this passage:

Our bill will prohibit a corporation from buying back its own stock unless it invests in workers and communities first, including things like paying all workers at least $15 an hour, providing seven days of paid sick leave, and offering decent pensions and more reliable health benefits. 

As a measure to try to force companies to pay better wages this might make sense. It does not directly strike at any central problem that is ailing the economy. 

How’s he doing? In case you missed it, Bloomberg Opinion had a great infographic to cover the first two years of the Trump presidency. Economically, the reality is quite nuanced. The good and underreported news is that manufacturing jobs are showing a recovery.

The bad, and also perhaps underreported, news is that the budget deficit has gone through the roof. It’s well worth reading. 

Out of Time: Barry Ritholtz’s Weekend Reads included this gem from Albert Bridge Capital. To illustrate the futility of market timing, they compared a strategy of annually investing $1,000 in the S&P 500 at its low for the year every year, with a strategy of buying the S&P at its high each year. The former involves impossibly good market timing. This is how it would have done:

Now, look at the returns made by the sucker who went in at the top each year:

The good market-timer did better, as was mathematically certain. But the gap between the two is minimal given the kind of effort (or extraordinary luck) needed to invest at the best time each year. As Albert Bridge put it:

So the difference between the perfect idiot and the man with perfect foresight, is the idiot has nearly 80% of the nest egg as the impossibly accurate market-timer.

So, not only can you not pick the perfect day to invest, there isn’t even a whole lot of upside from trying!

This might be a bit unfair. Market timing is not just about when to buy stocks; it’s also about choosing when to buy something completely different. Leaping into an uncorrelated asset class every time stocks are about to fall might look more impressive.

But overall the point is well taken. Much equity market commentary, from journalists and brokers is alike, is implicitly about gauging whether this is a good time to put spare capital into the stock market and whether this is a dip to buy. And that kind of speculative timing, beyond being close to impossible, is not worth the effort. 

To contact the author of this story:

John Authers at jauthers@bloomberg.net

To contact the editor responsible for this story:

Robert Burgess at bburgess@bloomberg.net