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Journey with DWM to
What's Next |
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Some economists say "up" and some say "down". The truth is, no one knows the future. But affluent, enlightened investors recognize that DWM strategies perform in up markets and protect in down markets. Regardless of what the future holds, with DWM, savvy investors are ready for what's next. | |
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Computers: Algorithms Keep Getting Better | |
In the end, the humans on "Jeopardy" surrendered meekly. Ken Jennings, famous for winning 74 games in a row on the show, acknowledged the obvious: "I, for one, welcome our new computer overlords."
Watson, developed by I.B.M. as a "question answering machine" is actually quite a breakthrough. Watson can understand questions posed in natural language and answer them. Analyzing and categorizing language, with its ambiguity and subtlety, still remains a formidable hurdle for computers. This challenge facing Watson was far greater than the one I.B.M. overcame in 1997 when its Deep Blue chess-playing computer beat the world champion Garry Kasparov.
A computer, of course, cannot understand words. Instead, algorithms scan mountains of text seeking patterns and probabilities. Algorithms are coded short cuts to certain ends, with assumptions, goals and even values built in.
Google recently made a major change in its algorithm used for one of its billion searches a day. Steve Lohr in the New York Times explains the search process this way: "Goggle can be thought of as a supercharged, automated reference librarian for the Web." When you type in a few words in Google's search box, Google doesn't have the answer but suggests you try other web sites.
Google's algorithm has been fast, powerful, and apparently reasonably predictable. Accordingly, Web entrepreneurs have tailored their sites to get mentioned early and often. Google felt some of those sites, upon review, were "low quality" sites and therefore it retooled its algorithm. Amit Singhal, a Google fellow, says that Google is committed to improving the language understanding of the algorithm and become more like answer machines, like Watson.
The algorithms go beyond Jeopardy and Google. Now, as computers are getting better at mimicking human reasoning, they are claiming work done by people in high-paying professions. Software is making its way into tasks that were the exclusive province of human decision makers; like loans and mortgage officers, tax accountants, computer chip designers, and, especially lawyers.
The New York Times reported Friday: "Armies of Expensive Lawyers, Replaced by Cheaper Software." The article compared a large "discovery" task (providing documents relevant to a lawsuit) in which six million documents were examined in 1978 by a platoon of lawyers and cost the client $2.2 million versus 1.5 million documents that were analyzed recently for less than $100,000.
The new "E-discovery techniques" include linguistic and sociological elements. Under the linguistic approach, the software filters documents through a large web of word and phrase definitions, like "dog" or "man's best friend." Sociological elements add an inferential layer of analysis (think Sherlock Holmes), asking questions such as "who did what when" and "who talks to whom". The objective is the chain of events. Then the computer captures "digital anomalies", such as "call me" moments, when a criminal decides to hide a conversation by having a private conversation. Pretty amazing.
These new forms of automation have renewed the discussion over the economic consequences of technological progress. It certainly will be huge. David Astor, an economics professor at MIT, says "new jobs are coming from the bottom of the economic pyramid, jobs in the middle are being lost to automation and outsourcing, and now job growth at the top is slowing because of automation." Tom Mitchell, of Carnegie Mellon, puts it this way: "We're at the beginning of a 10-year period when we're going to transition from computers that can't understand language to a point where computers can understand quite a bit about language."
Who knows? Maybe ten years from now, Watson will be writing this newsletter for us.
For more information:
http://www.nytimes.com/2011/03/05/science/05legal.html?emc=etal |
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Ask DWM: Does the Declining US Dollar Mean the "End of America"? | |
Lately, we've seen a number of reports and videos proclaiming "Time is Running Out", "The US Dollar is About to Crash", "The Crisis has Begun", and "The End of America is Upon Us." Mark Twain's "Reports of my death have been greatly exaggerated" comes to mind. Reports of the "End of America" are
similarly grossly overstated.
They are often based on the premise that the debts assumed by the Western democracies will "overwhelm their economies and lead to the end of our current dollar-denominated, global currency regime. " "As the US dollar (USD) collapses and is abandoned as the world's reserve currency (as the British pound was in the early 1970s), our economy will turn into a banana republic" (like Germany in 1922/1923 and Yugoslavia as recently as 1993/1994). "Our US standard of living will plummet and our country's role in the world will be decimated. " Of course, these folks have the answer- sell your American assets and invest overseas with them.
Not so fast.
Since we Americans have most or all of our assets invested here in the US, reports similar to the above are disconcerting. The world has changed significantly in the last 30 months. However, this is not Armageddon. Let's take a look at some of the relevant facts, why the USD will continue to be the primary world currency reserve, why we are not near the "End of America", and some investment thoughts in light of this information.
In fairness, there are reasons to be concerned about the continuation of the USD as the global currency standard:
1. 85% of the international commercial transactions are currently done with dollars. 62% of central bank reserves are in USD. This provides an "exorbitant privilege" to the US as the world's need for USD lets America borrow at lower cost. Many foreigners resent this. They feel that low interest rates allow Americans to live beyond their means (such a low-rate home mortgages) and the rest of the world is subsidizing our standard of living.
2. Our government's deficits are out of control.
3. Balancing our federal budget seems unattainable in the short-term.
4. The Federal Reserve continues to print money, which devalues the USD.
Today, in the wake of the most serious financial crisis in 80 years, there is again widespread criticism of America's exorbitant privilege. Since World War II, the USD has reigned supreme. At that time our economy towered over the world like none other. Our economy is still by far the largest in the world. However, many other countries are growing much faster than the US and it is expected that China will, at some point, overtake the US in GDP.
However, GDP alone does not determine the world's reserve currency. Barry Eichenberg, noted international money historian, points out that being the world's reserve currency is more than GDP. It also depends on stability, liquidity, strategic and military relationships, laws, institutions, and incumbency.
The dollar has its problems, but so do its rivals. The euro is a currency without a state. When the euro has problems, as it does now, there is no powerful executive branch with the power to solve them. The Chinese renminbi is state controlled. Access to China's financial markets and international use of its currency is limited by strict government controls. Furthermore, China has discouraged internationalism of its currency for fears that inflows of capital would lifts its value and curb Chinese exports. Japan's stagnant economy and mounting debt eliminate the yen from consideration.
There is a fundamental flaw in the thinking of those that believe the USD is about to be abandoned and a dollar crash is eminent. They believe that there is room for only one international currency. Historically, apart for the last fifty years, there has always been more than one. Hence, it is likely that in the future several international currencies will coexist. The world is growing more multi-polar. Europeans will undoubtedly settle more transactions in euros, Asians more in renminbi or yen and North and South Americans will continue to be in USD.
So, we believe, talk of the dollar crash and the End of America is overstated, for now. But, given the current situation and appropriate risk management, a savvy US investor must review their holdings, making sure they have ample allocation to international exposure and alternative investments. They should put a higher value on liquidity and diversification. It is not a time to "set and forget". Constant monitoring and appropriate rebalancing in the face of changing conditions should be employed by you or your investment manager.
Let us know if you would like to discuss this in more detail.
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Business: Warren Buffet's Bet for the 21st Century: Trains |
Warren Buffet released Berkshire Hathaway's annual shareholders letter last week. In it, he explains his sheer delight over the success of an investment in Burlington Northern Santa Fe Railway (BNSF).
At a time of hot social media start-ups and emerging economies, the world's most famous
investor decided to stay close to home- and invest in 19th century technology. Berkshire Hathaway (BH) paid $26.5 billion in 2010 to buy the 77% of BNSF it didn't own. BNSF operates freight trains in the Western United States and has since the 1840s. The purchase is vintage BH: BNSF is a big, well-managed, unglamorous, profitable company.
Overall, the freight train industry did very well in 2010, as shipping of goods increased with the start of the economic recovery. Union Pacific, the country's biggest rail company, announced a 41% increase in the fourth quarter and is expected to add thousands of new employees. BNSF made $3 billion of profit on $15 billion of revenue last year.
Mr. Buffet and his partner Charlie Munger are very optimistic about BNSF's future: "Railroads have major cost and environmental advantages over trucking. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That's three times more fuel efficient than trucking is." Trains have reduced greenhouse emissions and a smaller need for imported oil. With oil now over $100 per barrel, that's a big deal.
Over time, the movement of goods in the US should increase and trains and BNSF should get a good share of that increase. However, the US today has half the usable track it had in 1970, though trains are hauling more freight than they did then. The increased volume would mean congestion unless old tracks are improved and new ones added.
Mr. Buffet intends to invest "massively" to maximize BNSF's growth. Even if federal, state, or local governments don't step up to pay for these infrastructure improvements, BH has billions of dollars in cash and is prepared to supply the funds. As Mr. Buffet puts it: "Our elephant gun has been reloaded, and my trigger finger is itchy."
For more information: http://www.berkshirehathaway.com/letters/2010ltr.pdf. |
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World Fiscal Crisis: Michael Lewis in Ireland |
Michael Lewis, one of our favorite authors, visited Ireland recently on his latest piece of financial disaster travel journalism. It's in this month's Vanity Fair. His basic take:
"Even in an era when capitalists went out of their way to destroy capitalism, the Irish bankers set some kind of record for destruction... Left alone in a dark room with a pile of money, the Irish decided what they really wanted to do was to buy Ireland. From one another."
Mr. Lewis felt that Ireland's regress is especially unsettling because of the questions it raises about Ireland's former progress. Ireland has had a history of maintaining a lower standard of living than its neighbors. As recently as the 1980s, a third of Ireland's population lived below the poverty line.
Even now, no one is quite sure how to explain the "Irish Miracle." Some theories for the rapid improvement include: the elimination of trade barriers, the decision to grant free public higher education, and the persistent lowering of the corporate tax rate, beginning in the 1980s, which turned Ireland into a tax haven for foreign corporations. In addition, Ireland legalized birth control in 1979 which had a dramatic increase in the ratio of working-age to non-working age Irish due to the resultant crash in the Irish birthrate. What occurred in Ireland before the crash is without precedent in economic history. By 2006, the Irish poverty rate was under 6% and Ireland was one of the richest countries in the world.
Of course, some saw the crash coming. Morgan Kelly, a professor of economics at the University College Dublin, noticed house prices rising madly. In 2006, he asked former students employed as Irish bank economists if the boom didn't trouble them. They all said, "No, we're going to have a soft landing".
Mr. Kelly started googling and learned that more than 20% of the Irish workforce was employed building houses. The construction industry was nearly 25% of the country's GDP. Since 1994, the average price of a home in Dublin had risen by more than 500 percent. Ireland was building half the number of houses being built in the UK, with 1/15 of the population. Mr. Kelly's concerns were submitted to local newspapers. He was called an "egghead" and largely ignored.
When the crash occurred, there were lots of changes. Mr. Lewis points out that within a few months the short-term parking lot attendants at Dublin Airport noticed that their daily take had fallen. "Their lot appeared full; they didn't understand it. Then they noticed that the cars never changed. They phoned the Dublin police, who in turn traced the cars to Polish construction workers, who had bought them with money borrowed from Irish banks. The migrant workers had ditched their cars and gone home." Mr. Lewis continues, "Rumor has it that a few months later the Bank of Ireland sent three collectors to Poland to see what they could get back, but they had no luck. The Poles were untraceable: but for their cars in the short-term parking lot, they might never have existed."
The damage has been huge. A single bank, Anglo Irish, faced losses of up to 34 billion euros. That would be like a US bank losing $3.4 trillion. Mr. Kelly estimates that total bank losses are roughly 106 billion euros ($10 trillion in US terms). Irish bank losses could absorb every penny of Irish taxes for the next three years. Unemployment is 14 percent and rising. Ireland now borrows at rates 6% higher than Germany.
Mr. Lewis seems to link the lack of rage in Ireland to the cultural differences between the Greeks and the Irish. Historically, as Professor Kelly pointed out, the Irish are "sort of a hard, pessimistic people, not looking on the bright side." Since, 2000, until the crash, a "lot of people behaved as if each day would be sunnier than the last." Now, the Irish are back to their old ways. As Mr. Lewis puts it: "Fatalism is never far from the surface in Ireland. Maintaining outrage is hard work."
Mr. Lewis's next stop is California. We'll be looking forward to that one. It will be a good read.
For more information: http://www.vanityfair.com/business/features/2011/03/michael-lewis-ireland-201103?printable=true
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