Typography

A few weeks ago I claimed that the so-called value premium was really just a liquidity premium. The value premium, illustrated best by the HML, or high-minus-low strategy (shorting stocks that have high price-to-book ratios while buying stocks that have low ratios), is one of the more well-known market anomalies. By following this strategy, investors can supposedly do better than their counterparts on a risk-adjusted basis. My point was simply that stocks with low price-to-book ratios get those low ratios in the first place because they are illiquid relative to stocks with high ratios. Anyone who buys the former while shorting the latter is acting as a liquidity creator for which the HML return is a reward. Fund managers who uses this strategy to drive fund returns aren't necessarily earning alpha, they're earning a fair return for acting like a liquidity-providing bank. I got some push-back in the comments, on Twitter, and on Reddit from readers, some who were skeptical that...

In a previous post , I made the point that banknotes aren't Samuelsonian bubble assets , say like a chain letter or a ponzi scheme or bitcoin. Upon the dismantling of a central bank, each note has a senior claim on a central bank's remaining assets. Rather than being mere "oblongs of paper", as Samuelson described them, banknotes occupy the very top of the capital structure hierarchy, above stock and bonds. This quality of being "well backed" might be sufficient for notes to trade at a positive value in the first place, and also help explain subsequent fluctuations in the purchasing power of those notes. In this post I revisit these ideas. The process of dismantling a central bank would go like this. Imagine that the Reserve Bank of Fiji announces that it will wind up operations next week and recall all notes. Its assets consist entirely of Fijian dollar-denominated bonds. With the eminent end of Fijian dollars , the entire Fijian economy will have to quick...

What is this gas station using as a medium of account? Visa/Mastercard dollars or Federal Reserve dollars? In this post I'll argue that in many cases, a nation's medium-of-account doesn't consist of base money issued by its central bank, but credit card money created by Visa and Mastercard. This may have some interesting implications for monetary policy. Whoever issues, creates, or manages a nation's medium-of- account determines the general level of prices, and this makes it a monetary superpower. But before I get to that, let's revisit the meaning of the word medium-of-account. I've written a number of posts on the idea of medium-of-account because it has always seemed to me like an important concept, although admittedly it's taken me a while to zero-in on a satisfactory understanding of the term. What I like about medium-of-account is that along with the ideas of unit-of-account and moneyness , it allows us to pretty much remove "money" from th...

 The "High minus low" strategy: Source   If you haven't read Clifford Asness and John Liew's recent article on market efficiency, you should. There's plenty of meat in the article, but the one sinew I want to chew on is this above chart.  It shows the cumulative returns to a strategy called HML , or "high-minus-low." This strategy involves going long cheap U.S. stocks (as measured by their price-to-book ratio) and simultaneously going short expensive stocks. Over the last eighty-five years or so, cheap stocks have roundly beat out expensive ones. This is called the value premium . A large part of Asness and Liew's investing effort revolves around exploiting this premium for their clients at AQR Capital Management . Now as the authors point out, this outperformance could be due to a combination of two things. The behavioural explanation is that people are irrational, subject to various psychological tics that drive aberrations in prices. Perhaps inv...

Jeremiah, the prophet of impending disaster. By Rembrandt, 1690. See full version . The 1929 analog model has resurfaced. The 1929 analog is a recurring visual meme, usually a chart, that periodically plagues financial markets. All versions of this meme invariably map the bobbing and weaving of the 1929 Dow Jones Industrial Average onto movements in the present Dow, with the inevitable conclusion being that we are, by analogy, on the verge of a repeat of the 1929 crash. The most recent reincarnation originates from noted market timer Tom DeMark . His claim has been amplified by newsletter writer Tom McClellan and irresponsibly blared all over the internet by Marketwatch (see here , here , here ). I produce the chart below: Source: Marketwatch I've been following various flareups of the 1929 analog for over a decade. They usually crop up in September, just before the anniversary date of the October 29 crash. Extended bull markets are particularly fertile ground for 1929 analog beh...