Concentration risk is a global problem

 

If you thought that concentration risk was a US problem, you are wrong. It may not be as significant as we see in the US, but whether in Europe, Japan, or emerging markets, the number of stocks that will drive the benchmarks is limited. If you need to have an opinion on some stocks, focus on these. If these names start to turn, it is likely your "diversified portfolio will be following these key names. 

The decline in labor share of GDP

Lars Christiansen provides a useful, simple explanation for why the labor share of GDP has fallen, drawing on the writings of Polish Marxist economist Michal Kalecki. Kalecki was focused on centralized planning, yet his thinking seems to make sense. The profit share has increased because we have had fiscal easing with an interest rate peg. Now that interest rates are rising, we should start to see the profit share decrease and the labor share increase as a greater share of national income. Of course, we are seeing other effects, but we can say that rising interest rates should start to affect the share of national income going to profits. This does not mean that labor will be better off. It does mean, on a relative basis, that it will become a more important part of national income.

Simple modeling can help with understanding some complex problems. This is not the first time someone has suggested that the impact of labor's declining share of national income is linked to government policies that are supposed to prevent it. 

The illusion of explanatory depth - Confidence is relative

 

There is a cognitive bias that is often undiscussed yet highly relevant to investment management — the illusion of explanatory depth. It is the bias that we think we know more about how things work than we actually do. When asked to explain some process, we are often far from being able to adequately explain a concept. Our confidence drops when we are asked to explain a core concept that requires a degree of explanatory knowledge. Extreme views can be moderated by asking how a system works.

The phrase was coined earlier, but the bias was aptly shown in the experiments by Rebecca Lawson in "The science of cycology: Failures to understand how everyday objects work". When asked to explain how a bicycle works, many were unable to make a simple drawing of its mechanics. 

If you ask about how monetary policy works, how the political system works, or how a firm makes money, many may be unable to give good explanations. This will impact confidence, but will ultimately make better decision-makers.

We bring this issue up again because many news stories make assertions about how markets work, yet when you ask how the system works, many explanations become less certain.

The illusion of explanatory depth - an investment problem

Curiosity solves the information gap between what we know and what we need to know

Les vigilantes obligataires in Europe

 

As much as there is concern about rising interest rates and debt in the United States, it is a global problem, with countries with rising debt-to-GDP ratios seeing significant increases in rates relative to other countries. The current European poster child is France. Along with "school" protests/riots, there has been a significant increase in credit spreads relative to Germany and other major European countries. The reason is clear. There is no action on high debt levels. Les vigilantes obligataires are alive and present. 

The important global issues are clear: 

• Debt levels do matter, and investors want a premium for unsafe assets.
• There is no way that country-specific debt can serve as an alternative safe asset.

This is a market warning that cannot be solved in the near term regardless of energy costs.