The Business of Bears

by Matt Malick

Over the last two years, the press has obsessed over stories about and interviews with the experts that “predicted” the financial crisis.  In most cases, “predicted” is a relative term.  After all, many of these forecasters were anticipating a financial crisis for five, ten or even twenty years.  The analogy that “a stopped clock is right twice a day” is apropos. 

Presently, it is interesting that many of these same commentators have not changed their views.  They are now predicting a double-dip recession, a debt crisis, persistently high unemployment, a governmental breakdown, and unsustainable national debts and deficits.

Because markets and economies generally move in cycles of boom and bust, it would seem likely that our economy will recover, just as it has historically done over and over again.  More importantly, the majority of the economic evidence is showing stabilization or growth, which has been the trend for more than six months. 

So, why would a cadre of analysts remain so vocally negative and bearish?  The answer: it pays.  Let us take a look at two of the most prominently negative commentators.

The Atlantic Monthly’s website in early February reported on the perks enjoyed by one of these economists.  “Nouriel Roubini . . . was christened ‘Dr. Doom’ by no less an authority than The New York Times.  The notorious nickname has helped Roubini become a global economic rock star, recently seen partying with models in St. Barts.”

When not painting the town red with fashion models, Roubini works with economic models as a Professor of Economics at New York University’s Stern School of Business, as a columnist for Forbes.com, and as the cofounder and Chairman of economic consultancy RGE Monitor. 

According to a March 30, 2009 article in the now defunct Portfolio Magazine, RGE Monitor successfully monetizes its prognostications: “Subscription prices range from $10,000, for ‘reading rights,’ to more than $100,000, which includes personal meetings and consultations with Roubini or his staff.”

So, is the persistently negative Roubini more right than wrong?  That is difficult to ascertain, but a review of his many predictions indicates to us that his record is highly spotty. 

The London Times reported on October 4, 2008, during the height of the financial crisis, that he “told a London conference that hundreds of hedge funds are poised to fail as frantic investors rush to redeem their assets and force managers into a fire sale . . . He said: ‘We've reached a situation of sheer panic.  Don't be surprised if policymakers need to close down markets for a week or two in coming days.’” 

In hindsight, neither of these predictions materialized.  Very few hedge funds failed and markets across the world remained open throughout the crisis.

Another persistent naysayer is Nassim Taleb, the author of two highly successful and critically acclaimed books, Fooled by Randomness and The Black Swan. 

The fundamental point of Taleb’s Black Swan framework is that highly improbable and unforeseen events happen more frequently than experts acknowledge and that these events have a disproportionate impact on outcomes.  Therefore, according to Taleb, predictions are nothing more than a fool’s game. 

Hypocritically, for someone who does not believe in predictions, Taleb has spent most of his career in the investment management and trading professions. 

In August of 2009, on the cable financial news network CNBC, Taleb predicted that “choking debt, continued high unemployment and a system that rewards bad behavior will hamstring an economic recovery,” according to CNBC.com. 

Recently, Taleb had an interview published in ai5000 Magazine, where he revealed a fabulous calculation about investor Warren Buffet: “George Soros has 2 million times more statistical evidence that his results are not chance than Buffett does.  Soros is vastly more robust.  I am not saying that Buffet does not have skill – I’m just saying we don’t have enough evidence to say Buffett isn’t doing it by chance.” 

Like any other successful person, Mr. Buffet has had luck on his side, but we are doubtful that Mr. Taleb can quantify such good fortune.  This made-for-media comment just happens to (randomly) correspond to the launch of the paperback edition of The Black Swan and also helps to promote Taleb’s next book, for which he has received a multi-million dollar advance.

In The Great Crash 1929, John Kenneth Galbraith astutely observes, “It requires neither courage nor prescience to predict disaster. . . Historians rejoice in crucifying the false prophet of the millennium.  They never dwell on the mistake of the man who wrongly predicted Armageddon.”

Our current view of the market and the economy happens to coincide with that of hedge fund manager Barton Biggs, who described his framework in a recent Bloomberg interview: “I am often wrong, always in doubt.”  But Mr. Biggs presently feels that “People are nervous and apprehensive . . . and if you are an optimist, as I am – that things are going to work out – that’s what provides an opportunity.”  And as a professional “go anywhere” hedge fund manager, Mr. Biggs has a significant financial incentive to be correct, not just blindly optimistic.

Oscar Wilde believed that, “The basis of optimism is sheer terror.”  While Wilde viewed the glass as half empty, Winston Churchill expressed a similar sentiment when he said, “I am an optimist – it does not seem to be much use being anything else.”

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Trends Impacting Millersville University

Based on Millersville University Fact Book data from Fall 2000-Fall 2008, Millersville has increased the number of students faster than it is hiring faculty to teach (1). Student-Faculty ratios have increased, yet due to the significant increase in temporary part-time faculty, the rate of increase in “published” student-faculty ratios is small (6,7). There is a much larger increase in student-faculty ratios when one looks at the number of students relative to full-time permanent faculty and a significant increase in the likelihood that students will be taught by temporary instructors (8,9). In contrast to published statements on Millersville's website, the MU Fact Books indicate that the number of full-time permanent faculty has decreased (2,4).

In order to keep pace with increases in enrollment, the university has hired more temporary instructor rank faculty (3,4). Relatively to tenured and tenure track faculty, temporary instructor rank faculty are generally less credentialed and experienced. Although there are competent temporary instructors teaching on campus, temporary instructors have little to no incentive to invest additional time in university service, scholarship, or student advisement beyond teaching their contracted courses.

In addition, data from the Pennsylvania State System for Higher Education (PASSHE) indicate that today's students are bearing significantly more of the cost of their education than students of just a few years ago. Hence, while paying more and being taught, advised, and mentored by fewer permanent full-time faculty, students are complaining more about crowded classrooms, computer labs and facilities, more students per faculty academic advisor, and increased difficulty finding classes during registration.

Despite hiring less expensive faculty labor resources, there is no evidence of any reduction in costs passed on to students. One explanation is that the number of executive and professional staff has increased faster than enrollment (5,11). During this 8 year period, the university hired 41 additional faculty members, all of which, on net, were temporary instructor faculty (most part-time)(4). Also during this period, the university hired 39 additional executive and professional personnel.

Combine all of these trends and the outlook for Millersville University to maintain its reputation as a competitive, quality, public higher education institution is in jeopardy.

Fall 2000-Fall 2008:

1. Enrollment at MU is up 14.2% on an FTE basis.
2. Full Time Permanent Faculty are down 4%
3. Temporary Faculty are up 66%
4. 41 new faculty employees were added over this 8 year period. On net, 100% are temporary faculty and temporary employees replaced an additional 21 positions that were full time or part time permanent in Fall 2000
5. Executive and Professional staff increased 20.5%
6. Fall 2000: Student-to-Faculty ratio = 16.8 to 1; the Student-to-Exec&Prof staff ratio = 36.1 to 1
7. Fall 2008: Student-to-Faculty ratio = 18.4 to 1; the Student-to-Exec&Prof staff ratio = 34.2 to 1 (more students per faculty member while more executive and professional staff per student)
8. Fall 2000: Student-to-Full Time Permanent Faculty member ratio = 20.8; Fall 2008: Student-to-Full Time Permanent Faculty member ratio = 24.0 (15.6% increase which may be a better measure of the actual impact of increasing student/faculty ratios)
9. Fall 2000: Student-to-Temporary Faculty member ratio = 73.0; Fall 2008: Student-to-Temporary Faculty member ratio = 50.2 (31.2% decrease which translates into a significant increase in the likelihood that a student is taught by temporary faculty members).
10. In Fall 2000, there were 3 temporary faculty to every 10 tenured or tenure track faculty. In Fall 2008, there were 5 temporary faculty to every 10 tenured or tenure track faculty, an increase of 71%.
11. In Fall 2000, the percentage of executive and professional staff to tenured or tenure track faculty was 59% and in Fall 2008 it was 73.4%, a 24% in 8 years.

The statistics above are from the Millersville University Fact Books published online at www.millersville.edu/~ir/.  This site is accessible without login if you are on the university network.  If outside the university network, you will have to request login credentials from Institutional Research.  This is public information.  Most of the statistics reflect the period Fall 2000-Fall 2008.  I encourage all readers to review the data themselves and report any errors or suggest alternative interpretations.

Terms:

FTE: "full time equivalent" students measures enrollment at the university based on counting the number of full time students (30 credit hours in an academic year for undergrad and 24 hrs for graduate students). Therefore, two students, each attending the university for 15 credit hours over an academic year are counted as 1 FTE.

Full Time Permanent Faculty: 99% of these faculty are either tenured or tenure track. These faculty are eligible for promotion subject to review of their qualifications in a competitive process. These faculty are expected to engage in scholarship and university service.

Temporary Faculty: 85% of temporary faculty are part time. These faculty are are generally less likely to have a terminal degree, are generally less experienced teachers, have little or no expectation of scholarship, and are less likely to be involved in university service. Temporary faculty do not receive benefits.

Executive and Professional staff: These employees include executive management, deans, and professional employees of, for example, the Registrar, Bursar, Finance and Administration, Personnel, Human Resources, Admissions, and Financial Aid.

State Employees Retirement System

The following post is a comment on this story from NPR:

Study: States Must Fill $1 Trillion Pension Gap

Unless states like Pennsylvania pass legislation to increase retirement age, reduce retirement benefits, or significantly increase employee contributions, higher taxes or significant cuts in other government programs are the only reasonable options to the pension gap problem. Assuming state lawmakers who, most if not all, have pensions through the state's defined benefit retirement system are unlikely to pass legislation that will lower their retirement benefits to account for their failure to properly fund the system in the first place (or at least incur some of the loss in investment returns due to the recession -like almost everyone else), dramatic cuts in education, healthcare, etc. are the only likely options. Since education is one of the largest state expenditures, it is unfortunate that the likely outcome is that the current generation of students will suffer at the expense of state employees' retirement. Arguably, future tuition and fee hikes will not go to improving educational outcomes but will go to current and future retirees to offset what they lost in investment returns during the recession. Other public and private employees in defined "contribution" plans have also suffered significantly from the recent recession and will bear the full effect in their retirement years but current law requires that we make those in the state's defined benefit system whole in their retirement. I'm sure many law makers and university employees in the state retirement system haven't thought through the unintended consequences yet.

Regrettably, this is just one problem in a long list. Decades of short term thinking aimed more at maximizing votes for the next election than at long term improvements in the standard of living are strangling our economy and will very likely leave future generations progressively worse off. Don’t blame the politicians; they are playing the game we asked them to play. We will only vote for politicians who can bring home the spending and lower our taxes without thinking about the consequences on future generations.

The Erosion of Quality and Value in the PA State System for Higher Education

The data suggest that the legislative philosophy regarding the benefits of taxpayer funded higher education has changed as more and more of the cost is borne by students and their families. The state system is enrolling more students faster than it is hiring faculty and building capacity to teach. In addition, the system has not added faculty to keep pace with the increase in enrollment and the faculty category that has increased the most are relatively less credentialed and experienced temporary and instructor rank faculty. Students are being taught by more part time instructors with little to no incentive to invest additional time in university service, scholarship, or student advisement beyond their contracted course. While paying more and being taught, advised, and mentored by fewer advanced faculty, students are experiencing more crowded classrooms and computer labs, more students per academic advisor, and increased difficulty finding classes during registration.  Any savings from hiring cheaper labor resources has been offset by relatively large increases in the number and compensation of management and administrative employees. Combine all of these trends and the outlook for the state system and Millersville University to maintain their reputations as competitive, quality, public higher education institutions is in serious jeopardy.

It appears that across the country, states are squeezing their higher education budgets. Most associate these problems with efforts to deal with the effects of the recession. In addition, many states like Pennsylvania are constrained by constitutional balanced budget requirements forcing them to make spending cuts during tough economic times. No doubt tough economic conditions require sacrifices. However, a closer look at the data for our state system suggest that the recent recession may only be exacerbating pre-existing trends that have been and will continue to slowly deteriorate the quality and value of an education from a state system school -even after we recover from the recession. Some of these trends have been going on for over a decade. Is this evidence of years of mismanagement by the state legislature and Board of Governors who are making decisions for the entire system in the isolated and politicized environment of the state capital? Or is this evidence of a conscious change in philosophy regarding the commonwealth’s commitment to higher education? Maybe it's evidence of both.

Four Reasons

The following financial market commentary was written by Matt Malick and Ben Atwater of Atwater Malick LLC. Ben and Matt have developed a sound and unique investment philosophy for their clients. They regularly write market commentaries and I plan to post them here for interested followers. You can learn more about them at www.atwatermalick.com .

Last week, the S&P 500 saw its third consecutive weekly drop and has tumbled 7 percent since reaching a 15-month high on January 19^th. The index is down 3.5 percent year-to-date, having suffered its first monthly decline since October and the biggest since it plunged 11 percent in February 2009. According to the Stock Trader’s Almanac, the performance of the S&P 500 in January is a reliable predictor of how it will fare during the full calendar year. Before last year, when the index dropped 8.6 percent in January and then rose 23 percent for the year, the so-called January barometer made only five erroneous predictions since 1950. However, below are four reasons we believe that the recent selloff is part of a temporary correction amid a rally that began in March 2009 and will eventually reconstitute itself and lead to a multi-year bull market:

1. One gauge of investor sentiment, the Chicago Board Options Exchange Volatility Index (VIX), also known as the fear index, rises when buyers are speculating that equities will retreat, because the gauge, according to Bloomberg News, moves in the opposite direction of the S&P 500 more than 80% of the time. The VIX opened Wednesday the 20^th, the first day of the selloff, at 18.51 and it ended this week at 24.56, a 33% increase. In its 19-year history, the average reading on the VIX, also according to Bloomberg News, has been 20.28. Clearly, the fear index reflected relatively little investor nervousness coming into the sell-off, a potential warning of the correction we are now experiencing. Overall, this explosion in the VIX indicates to us that investors have moved from complacency to panic too fast, often a contrarian indicator.
   
2. According to Michael Santoli, writing in the Monday, January 25, 2010 edition of Barron’s, “Citigroup strategist Tobias Levkovich points out that inflows into bond mutual funds over the past six months are three standard deviations above their 10-year average, an extreme level of change that has typically had nasty implications for the asset class in question.” In other words, the extreme favoritism individual investors are showing toward bond funds is converse to the disrespect they are showing equity funds. According to TrimTabs Investment Research, December was the fifth month in a row in which mutual fund investors pulled more money out of domestic equity mutual funds than they contributed. December’s net outflow came to $7.2 billion, bringing the total since the beginning of March to $29 billion. If the market does not resume its bull market run, this will be one of the only times in anyone’s memory when mutual fund investors predicted the market’s subsequent move.
   
3. While professional investors have been better market timers than individual investors, they have also displayed an unimpressive track record. And although sentiment has improved significantly from its lows, financial market practitioners are still mostly negative. Bloomberg News reports that 43 percent of respondents in a quarterly global poll of market professionals who are subscribers to the Bloomberg Professional Service say the international economy is improving, up from 37 percent in October. Thirty-eight percent said their country’s benchmark stock index will rise in the next six months; 33 percent say it will vary little and 27 percent say it will fall. This subdued sentiment leads us to believe that professional money managers have not fully committed capital to equities, meaning there is still a great deal of money on the sidelines.
   
4. Earnings, which fundamentally should drive stock prices over the long-term, have been very strong so far this earnings season. For example, six of our companies announced earnings this week and, in five cases, these companies exceeded the average analyst estimates. More broadly speaking, Bloomberg News reports that “a record nine-quarter earnings slump for S&P 500 companies is projected to have ended in the fourth quarter with a 73 percent increase in profits.” Also according to Bloomberg, nearly 80% of the U.S. companies that have reported earnings since January 11^th have beaten analysts’ estimates (153 out of 192 companies).

Friday’s GDP report further evidenced a stronger recover than many have yet contemplated. Bloomberg reported, “The 5.7 percent increase in gross domestic product at an annual rate reported by the Commerce Department in Washington today exceeded the 4.8 percent median forecast of economists . . . Separate reports [on Friday also] showed consumer sentiment and a barometer of business activity rose more than forecast in January.

Overall, the market appears to be in the process of a natural correction following a huge rally. This correction most likely has some distance to travel. But, as far as we can tell, the recent pullback has no fundamental economic or earnings-based rational whatsoever. This means that the market is acting irrationally, based on pessimism and fear, no reason to abandon our long-term optimism.