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Bacon sure is popular. McDonald’s, which probably has the best pulse on Americans’ culinary tastes, introduced Cheesy Bacon Fries for a few months earlier this year, to great acclaim, and this week announced it is rolling it out nationwide next month. In that same announcement (https://news.mcdonalds.com/stories/our-food-details/worldwide-favorites-menu), the company also said it would add a new Grand McExtreme Bacon Burger, which has been very popular in Spain, to its worldwide menus. Between the two items, you’ll get 1347 calories and 115% of your daily fat quota (78 grams).
Americans consume about 10 million metric tons of pork each year, about the same as we eat of beef. The Chinese, however, are in a completely different league, consuming 55 million metric tons of pork annually, almost all (96%) produced locally. To meet this demand, there are around 430 million pigs in China, half the world’s total.
African Swine Fever was first described in Kenya in the 1920s. The good news (for humans) is that it cannot be transmitted to people, and it is not a food safety issue. The good news (for American farmers) is that the disease has never (yet) occurred in the US. The bad news (for pigs) is that it is a highly contagious virus with no known vaccine and is 100% fatal. The only treatment we know is to destroy every infected animal.
The first cases appeared in China last August, and the Ministry of Agriculture and Rural Affairs (MARA) assured everyone that the situation was under control. But it appears they miscalculated. The disease has spread in China (see map below), and also to Vietnam and Mongolia. Given the four-month gestation period for pigs, and the time to wean, nurse and feed pigs, it will probably be 20 months before the outbreak can be contained. The USDA estimated last month that more than 130 million pigs in China will have to be destroyed this year.
Lean hog prices in the US are up 70% in the past three months (graph below). The Chinese Ministry of Agriculture warned last week that prices could surge another 70% later this year.
Interspersed among this mix of insatiable demand, plummeting supply and soaring prices is the on-going, and escalating, trade war. Last year, China slapped a 62% tariff on US imports of pork in retaliation for US tariffs, hurting Chinese consumers in the form of higher prices, and American farmers in lost export revenue, estimated to be over $1 billion. There are few winners in a trade war.
The genesis of the phrase bringing home the bacon is unclear, but the best origin story is that of the Dunmow Flitch, so that’s what we’ll go with. In the year 1104, in the town of Great Dunmow in Essex, a couple so impressed the Prior of Little Dunmow with their strong marital fidelity that he awarded them a flitch (side) of bacon. Centuries later (c. 1395), in The Canterbury Tales, Geoffrey Chaucer references this tradition:
But never for us the flitch of bacon though,
That some may win in Essex at Dunmow.
To this day, every four years, the town of Great Dunmow holds the “Flitch Trials,” in which couples compete to impress upon a jury of six local bachelors and six local maidens of their unbreakable marital fidelity. The next Trial will be held in February 2020 (https://www.dunmowflitchtrials.co.uk/). Tickets are just £45/person. Which, at the rate we’re going, may be cheaper than buying a flitch of bacon.
Say “inversion” to a Californian, and the most likely word association is “layer.” It’s our topography that causes this phenomenon, accounting for the haze, smog and “June Gloom” we experience. It’s not a modern phenomenon either: Juan Rodriguez Cabrillo called it Baya de los Fumos, from the dozens of native Tongva campfires that filled the air when he sailed into Santa Monica Bay in 1542.
Normally, air temperature drops with altitude. But in Southern California in the spring and summer, the colder marine air comes ashore to meet the warmer air on land that rises above the ocean air, which then traps emissions, resulting in haze and smog (which is its own made-up word combining smoke and fog).
Another type of inversion is in headlines recently: that of the yield curve. An inverted yield curve occurs when longer-term yields are lower than near-term yields, and the witches of Wall Street see this as an ominous omen of impending disaster. That is because each of the previous recessions of the past 50 years was preceded by an inversion of the yield curve. There was also one instance of an inversion that did not portend an imminent recession (August 1998). Still, if you’re out camping and hear a growl, it might be your partner’s stomach, but it might be more prudent to assume it’s a bear.
US Stock Market, 1969-2019, with Recessions (Grey) and Yield Curve Inversions (Green/Red)
So the fact that an inverted yield curve has preceded every recession of the past 50 years would seem to be cause for alarm. But before we hit the panic button, we should understand the context of past inversions in relation to today’s environment.
In the past, short-term rates above long-term rates signaled a tightening monetary policy. The Federal Reserve accomplished this tightening by draining bank reserves, thus removing liquidity from the banking system, which responded by curtailing credit, which contracted the economy (the definition of recession). Each previous instance of an inverted yield was thus accompanied by high real rates, a signal of a lack of financial liquidity. The graph below plots the real Fed funds rate since 1954, with the red arrows marking recessions. Each recession was preceded by high real rates (between 3%-9%). Today’s real Fed funds rate is 0.55%.
It’s not even clear that the yield curve is even inverted. The front-end is negatively sloped, but the intermediate-to-long end is pretty steeply positive.
Treasury Yield Curve, 9 April 2019
Source: Bloomberg, L.P.
Recessions occurred in the past when monetary policy tightened sufficiently to choke off the availability of credit. This tightening was seen in an inverted yield curve, but also in other indicators of a shortage of liquidity, such as high real interest rates and a shrinkage of banking reserves held at the Federal Reserve. The real Fed funds rate is low, there is approximately $1.5 trillion of excess bank reserves at the Fed and credit spreads are low and stable (see below), default rates are low and stable, interest coverage ratios are high and rising. There is no shortage of liquidity.
US High Yield Index Option-Adjusted Spread, 2010-2019
“Inversion,” in addition to its meteorological and yield curve usage, also has a meaning in logic. The great German mathematician, Carl Gustav Jacob Jacobi, said he created his famous eponymous elliptic functions (don’t ask; see graph below) with the approach, “invert; always invert.” (His precise quote was: man muss immer umkehren).
Inversion in logic means solving a problem backwards. For example, rather than thinking of the steps needed to achieve a goal, work backwards to consider all the actions that could prevent accomplishing that goal. Inversion emphasizes avoiding the things that could go wrong instead of focusing on the steps that have to go right. In other words, try not to be stupid than strive to be brilliant.
Drawing a direct line from yield curve inversion to recession is neither not stupid nor brilliant.
Archaeological evidence suggests that, for thousands of years, the people who inhabited the Great Plains of North America, stretching from present-day Canada to Mexico, from the Rockies to the Appalachians, were among the wealthiest in the world. Anthropometric data reveal that they were likely the tallest people on earth. Their wealth and health is surprising, because in every other historical case, prosperity was associated with large population centers built by trade or conquest or, more often, both. But the people of the Great Plains never coalesced into a large empire. Trade and war, while present, were not the sources of their affluence. So what was?
Bison. For approximately 10,000 years, bison were the sole economic activity of the people of the North American Plains. Upwards of 30 million bison roamed the continent, providing a reliable, plentiful, and inexhaustible, source of food and wealth. The arrival of Europeans to North America, first the Spanish, then the English and the French, gradually constricted the range and size of the bison herds. This accelerated with the completion of the Transcontinental Railroad, that was built through a series of treaties that specifically restricted the number of bison that could be taken. Despite losing more than half its original habitat over the previous century, there were still approximately ten million bison on the Great Plains when Leland Stanford drove the Golden Spike through the last tie of the Transcontinental Railroad in 1869. Then disaster struck.
Bison hides are tough, very hard to work with, not nearly as malleable, or desirable, as deer or lamb, for example. But in 1871, tanners in Germany and England developed new technology that could make bison hides nearly as supple as other skins, and demand soared. By 1875, one million hides were being exported annually to Europe, treaties with Native Americans notwithstanding, and bison began disappearing from the North American continent. The last communal bison hunt by the Sioux occurred in 1882. By the middle of that decade, fewer than 500 bison remained in North America, all held in captivity. The map below shows the range of the bison in 1730 (the lightest region), in 1870 (the darker region), and the six small, remaining herds in 1889. Tribal territory boundaries are also marked in the continental United States.
Source: The Slaughter of the Bison and Reversal of Fortunes on the Great Plains, Donna Feir, Rob Gillezeau, and Maggie E.C. Jones, November 29, 2018.
This was a disaster for the bison, but it was an equal calamity for the people dependent on them. Recent research by three economists at the University of Victoria (https://ideas.repec.org/p/vic/vicddp/1701.html) examined the outcomes of the people of the Great Plains following the demise of the bison and came to some startling conclusions. For those that lived in regions where the slaughter of the bison was sudden and swift, their subsequent generation was about 9cm (3.5 inches) shorter than those who lived where the loss of bison was more gradual. From being the tallest people on earth, within a generation they were among the shortest.
The Native Americans of the Great Plains were placed on reservations where they were prohibited from leaving without permission from a government official. This policy was relaxed only in the 1930s. No economic activity was permitted except agriculture, an enormous burden for a people who had been dependent solely on hunting bison for thousands of years and had no history or knowledge of agriculture. This subjugation ensured poverty that persisted for generations.
By 2000, when the data were collected, per capita incomes of bison-dependent tribes were 20-40% lower than for other Native Americans. This material difference becomes even more significant when we consider the average per capita income of Native Americans was only $10,500 in 2000. The sudden loss of livelihood and human capital with the demise of the bison, and the subsequent policies to restrict movement, limit education and deny opportunity contributed meaningfully to the economic deprivation of Native Americans for generations. And not just economic deprivation: the formerly bison-dependent people of the Great Plains have the highest rates of mortality and despair (suicide, drug addiction) in the country. There is a growing body of work in the psychological literature that suggests that trauma may be transmitted across generations. While causality cannot be proven, the evidence seems to connect the trauma of the loss of the bison with the subsequent deprivation of succeeding generations.
Truth or Consequences was one of the longest-running shows in American media history. It began on NBC radio in 1940, created and hosted by Ralph Edwards. For the tenth anniversary of the program, Edwards announced that he would broadcast the show from the first town to change its name to the program, which is how Hot Springs, New Mexico became Truth or Consequences, New Mexico. The radio show switched to television in 1950, and ran continuously through 1988. Contestants could either answer a question truthfully, or face the “consequences” (usually performing a zany skit).
Robert K. Merton essentially invented modern sociology. One of his seminal works was his 1936 paper, The Unanticipated Consequences of Purposive Social Action, which offered a systematic analysis of why some deliberate acts to affect social change could have unintended consequences. He identified five areas that could lead to unanticipated consequences: ignorance, analytical errors, favoring short-term interests over long-term ones, basic values that skew or prohibit certain actions, and self-defeating prophecy that prevents what it predicts from happening.
Merton gave us the conceptual framework for unanticipated, or unintended, consequences. The sudden, near-extinction of the bison destroyed the economy and culture of those dependent on the animal. That was the consequence of the swift near-extinction of the bison, and perhaps it was unintended. But let’s make a distinction between unintended and unforeseen. The economic and social deprivation among the indigenous people of the Great Plains was not merely unintended, its persistence across generations, to this day, was completely unforeseen. Economic repression, high mortality rates, drug dependency, generation after generation, are the unforeseen consequences of the sudden demise of the bison.
Which leads to the question, what are the unforeseen consequences of our actions today? Climate change is one obvious area to consider. The unintended consequences of climate change are abundantly clear in the unprecedented rise in drought, fire and floods. But looking beyond those natural disasters, what are the unforeseen consequences years in the future? What are the effects of climate change on health, for example? Is there a connection between climate change and the likelihood of mass epidemics? We don’t know, and we are likely to be surprised.
Another question might be, what are the consequences of our degenerative civil discourse? We are as politically polarized as we have been in this country. One unintended consequence of this polarization was the election of a president whose norms of behavior would have previously been disqualifying for that office. But what are the unforeseen consequences? The erosion of our institutions that safeguard democracy? Habitual abuse of power that leads to demagoguery, as the Roman Republic descended to Empire and eventual collapse? We don’t know.
As we contemplate the unforeseen consequences of our actions, we must summon the will to regain control over our future: to reverse the emissions of carbon that will lead to climate catastrophe; to throw out the extremists would divide us and elect those to promise to work to unite us; to right past injustices, unintended, unforeseen or otherwise.
From the brink of extinction with less than 500 individuals remaining, the bison herd in North America now numbers more than 500,000. That’s a long way from the tens of millions that once roamed the Plains, but it gives us hope that we can move to redress past errors.
The game show gave contestants the choice between truth or consequences. In reality, it’s both: the truth has consequences. It’s our choice.
My first impression when flying into Mexico City a few weeks ago was its vastness. From the air, the city seems to stretch forever. The Valley of Mexico has been inhabited for over 12,000 years, and when Hernán Cortés entered it in 1519, its population of 1 million was probably the largest in the world. Today, Mexico City is home to more than 21 million people, twice the size of the second largest Mexican city in the world, Los Angeles.
Mexico City is a great destination for tourists, with world-class museums, dining and archeology. Most of my travels are for business, and I was looking forward to being a tourist again. But on my second day in Mexico City, I began to sense a different feeling than what I had been expecting. I realized the discomfort was coming from my iPhone.
In the past, a central part of the travel experience was navigating a foreign country in a foreign language. You had to read the street signs, interpret a paper map and ask for directions with either a rudimentary level of language skills or by interpreting universal directional hand signals. Today, your phone will tell you, in your language, where and how to go. Even easier, there’s Uber (or its equivalents). Punch in the destination, and a car arrives in under a minute to take you there.
All this is very convenient, and has eliminated the need to speak to anyone. Technology has enabled us to function in isolation, but has also deprived us of the benefits we accrue by making an effort at establishing actual, interpersonal relationships. I realized that it was this lack of interpersonal communication that was the source of my agitation, so I made a conscious effort for the rest of my visit to speak Spanish to as many people as I could.
Engaging with people is challenging, especially when there is a language or cultural barrier, but I found the lack of interaction unsettling, and preferred the small discomfort of communicating in a foreign language to the isolation (and convenience) that technology affords. It was walking around Mexico City, trying to frame these thoughts, that led me to wonder if my discomfort was analogous more broadly to modern society.
“Only the lonely know why I cry,” sang Roy Orbison. Sadly, loneliness is on the upswing. A Kaiser Family Foundation survey last year (https://www.kff.org/other/report/loneliness-and-social-isolation-in-the-united-states-the-united-kingdom-and-japan-an-international-survey) found that nearly a quarter of adults in the US and UK often feel lonely or isolated (see table below). The Japanese have a word, hikikomori, literally meaning “people who shut themselves in their homes.” Juliane Holt-Lunstad of Brigham Young University found that loneliness was related to a 26% higher risk of dying. In response to a separate report, last year the UK appointed a new Cabinet Minister for Loneliness (Tracey Crouch).
Loneliness has many causes, including economic stress such as long-term unemployment, but a majority cite technology as a contributor (graph below).
Last year, there were more than 70,000 deaths in the US due to drug overdose, 47,000 due to suicide (see chart below), and life expectancy in the United States declined for the first time since the Spanish influenza epidemic of 1918.
Source: Centers for Disease Control and Prevention; Courtesy: Washington Post
I have not seen a formal causal link established between loneliness and these sobering facts, but it is likely there is a relationship. I also wonder if there is a relationship among loneliness, these frightening health data and political polarization.
Hannah Arendt drew a connection between loneliness and fear in her 1951 book “The Origins of Totalitarianism.” Her observations are remarkably relevant today:
“What makes loneliness so unbearable is the loss of one’s own self which can be realized in solitude, but confirmed in its identity only by the trusting and trustworthy company of my equals. In this situation, man loses trust in himself as the partner of his thoughts and that elementary confidence in the world which is necessary to make experiences at all. Self and world, capacity for thought and experience are lost at the same time.”
A contributing cause, I think, is the insidious effects of modern media. According to Pew Research, more people rely on social media for news than read newspapers, and social media services are based on perpetuating past preferences, thus reinforcing biases. Polarization can be (is) very profitable, not only for Facebook, Fox and Google, but for politicians mobilizing their base. A lot of entrenched interests are thus highly incented to exacerbate our divisions.
Vivek Murthy, a former U.S. Surgeon General, calls loneliness an epidemic, a major public health crisis. So are suicide, drug overdoses and political polarization. The is no single remedy to any of these crises, but a step forward is recognizing the repercussions of how we use technology (or rather, how it uses us). A little less time with Facebook or Instagram, Fox or CNN, and a little more time with our neighbors seems like a right step for everyone.
Time for my semi-annual book perspective. I read a lot of books, but truthfully, most of them I move through pretty quickly. In the non-fiction world, I find many to be one-dimensional, perhaps an interesting idea appropriate for an essay, but hardly requiring the expansive exposition of a full book. In fiction, I encounter good writing, but rarely transcendent prose. Here are five books that I especially appreciated in the latter half of this year:
On Grand Strategy, John Lewis Gaddis
John Lewis Gaddis, the dean of military historians, gives us a glimpse into his course at Yale with ten chapters on various military leaders. He writes critically of famous conquerors such as Xerxes, Alexander, Julius Caeser, Pericles and Philip II of Spain, all of whom overstretched their circumstances and capabilities. Hitler and Napoleon are also critiqued, but Gaddis chooses Augustus, Elizabeth I, Bismark, Lincoln, Churchill and FDR as exemplars of great strategic leadership. Gaddis also praises St. Augustine, Edmund Burke and Isaiah Berlin, Sun Tzu and Machiavelli, but his highest honors go to Clausewitz, and, most surprisingly, to Tolstoy, for showing us how to live with constraints and paradoxes. If you are a student at Yale, take his class. If not, read his books.
The Road to Unfreedom, Timothy Snyder
This book begins as an explanation as how Vladimir Putin expounds the narrative of Russia as redeemer of the many evils threatening its purity, thereby dominating the Russian people through persuasion and coercion. But Snyder, another Yale professor, and an expert in Eastern European and Russian history, does not stop with a critique of how Russia sees itself in the world or Putin’s tactics in maintaining power. He traces Putin’s lies, myths, distractions and crises to the present political conditions in many parts of the world, especially in the United States. The parallels with Putin are disturbingly similar, and the risk of falling into “unfreedom,” is rising.
The Only Story, Julian Barnes
Julian Barnes writes with wit and emotion in this story of a teenage boy and a middle-aged woman who fall in love in 1960s Britain. The relationship is awkward, especially in the context of the social mores of the time, but their love is genuine. As one partner degenerates into alcoholism and mental instability, pushing the other away, we feel the strains and pains of a dying love. But the original flame of love is never fully extinguished, and in the end, that is the only story.
A Little Life, Hanya Yanagihara
Four college friends move to New York to begin their various careers, promising to remain close as the years pass. Each character is richly drawn, at times exaggerated into caricature, but we connect to their lives and emotions. This book is beautifully written, but it’s the surprise discovery of a traumatic past that is both painful to absorb and impossible to forget.
Men We Reaped, Jesmyn Ward
This is Jesmyn Ward’s autobiography of growing up in rural Mississippi. She re-creates her world through her observations of the men in her life: her father, brothers and friends. While it is her life, the book is really about the experience of African-American men in the rural South. In her talented hand, we are led into that foreign (for many of us) world, and are given the gift of a glimpse into the daily struggles, tragedies, and occasional joys of this besieged community living among us. Somber and acerbic, eloquent and poignant: Jesmyn Ward is a rare talent. This book moved me deeply.
Twenty-five hundred years, Siddhartha Gautama practiced a form of meditation that involved controlled breathing. Much later, about 700 years ago, this practice, called pranayama, was codified in the most famous of Hindu texts, the Bhagavad Gita. More recently, Western science has validated the physiological benefits of pranayama. Respiratory functions are improved (increased tidal volume, ventilation efficiency, arterial oxygenation, etc.), cardiovascular system is enhanced (greater cardiac output, synchronization of vasomotion, increases heart rate variability, decreases blood pressure, etc.), and the autonomic nervous system benefits (increases vagal activity, improves phasic modulation of sympathetic activity, etc.). Here’s a simple diagram:
The survival instinct is genetically encoded in humans: when we see sudden movement in front of us, we react with common physiological features: rapid heartbeat, surge of adrenaline, and increased neurological activity to assess the danger and determine whether to flee or fight. It could just be a bird in the thrush, but it might be a hungry bear.
This year-to-date chart of the S&P 500 Index demonstrates that investors see a bear in the bush, and not a bird, and are fleeing from this potential danger.
S&P 500 Index 2018 Year-to-Date
The S&P 500 Index is down a little more than 5% this year (including dividends), but it is off more than 15% from its all-time high in September. We know that equities fluctuate considerably, but how do we know if or when a bull market turns into a bear, or vice versa? The answer may be found in two areas, fundamentals and perspective.
Earlier this year, I argued that bear markets come in different flavors (https://blog.angelesadvisors.com/2018-angeles-foundation-symposium/). There are the frequently-occurring, usually swift, and generally benign bear markets of 15-20% declines. These are usually triggered by one-off events, and we recover in short order. There are the larger bear markets, with declines of 20-30%, associated with a turn in the economic cycle (recession), and can take longer to rebound to new highs. Then there are really bad bear markets, 40-50% declines, associated with some major structural imbalance (leverage, valuations, e.g.). I advised ignoring the first kind of bear market, because it would likely be over before we could respond. But what about the other two, is the economy about to contract or, even worse, are valuations or leverage so excessive we should expect a major correction?
Let’s throw out the latter scenario. Leverage is actually below historical levels. Household debt service ratio is the lowest on record (since 1980—see graph below). Yes, corporate debt is at a record high, but so are profits, and relative to equity, near an all-time low (since 1945—see second graph below).
Household Debt as Percentage of Income, 1980-2018
Nonfinancial Corporate Debt as Percentage of Equity, 1945-2018
Neither are equity valuations excessive. If anything, valuations have diverged significantly lower (see graph below showing the S&P 500 Index price (black line) over the past 10 years and its P/E ratio in green). At 17x, US stocks are not cheap, but they are just below this past decade’s average.
S&P 500 Index and P/E Ratio, 2009-2018
The conditions for a brutal bear market, excessive leverage or valuations, are not present, and a major crash is very unlikely. That leaves the economic-cycle recession, that since 1945, has occurred every five years or so and sees an average decline of 25-30%. Could that be in the cards?
Sure, but the evidence isn’t there yet for an economic contraction. Leading indicators remain strong, manufacturing output is expanding, the consumer is healthy, the labor market is tight, and monetary policy is still accommodative. I know you’re thinking, “hold on,” monetary policy is accommodative? Isn’t the Fed tightening the screws? Yes, the Fed is tightening, but real yields of just over 1% are still well below long-term averages of around 2.5% (see graph below for the real yield of long-term TIPS).
Long-Term TIPS Yield, 2003-2018
The list of worries is long. Economic growth is slowing, especially overseas. China, which has been responsible for more than half of the world’s growth over the past decade, faces acute economic issues, from falling exports to rising debt levels. Europe is negotiating the impending train wreck of Brexit while France is racked with violent protests and Italy brazenly violates fiscal rules. Germany, Europe’s prime economic engine and political power, faces a change in government that is more likely to exacerbate than to heal rising political tensions. And finally, there is not enough space or enough words to describe the lamentable state of American politics, which is widening our wounds and weakening our global position.
I said earlier that there are two areas of study to help us analyze conditions: fundamentals and perspective. I’ve laid out the fundamental picture, now let me say something brief about perspective. The first chart above of the S&P 500 Index this year, shows a plunging price to new lows. Given our natural instinct to extrapolate, this is a scary chart, because we can’t see a natural bottom. But stepping back, over the past 90 years, we see a different pattern (graph below, in semi-log scale). Markets move through cycles, and there are long periods (decades) of consolidation (no firm direction) and periods of advance. It’s important to note, although harder to appreciate with this semi-log scale, that many of the wiggles, during both periods of consolidation and advancement, represent large percentage swings. I’ve only lived through (consciously) about half the period below, but I know first-hand that each of these declines feels terrible. The loss on paper is bad, but the uncertainty of where the bottom is (if there is one) and when we will get there, is worse.
S&P 500 Index, 1928-2018
But with the right perspective, we can begin to see market declines as opportunities rather than as cause for panic. The rattling in the bush may be a bear, or just a bird, or just the wind. Let’s address that with a clear head and a calm heart. Breathe.