Proud to be an American

Happy Friday!

This week, I updated one of my favorite charts comparing Wall Street Strategists’ forecasts of the S&P 500 to the actual return. The idea is to show that forecasts don’t work, nor are they needed. It’s all about the financial plan. 

Moving on…

Is the world’s most painful trade ending?

America isn’t perfect. Taxes are too high, and our legal system clearly needs to be reformed. 

Take people who stand on moving walkways at airports. They don’t receive the death penalty, yet if I were to have unleashed my blinding rage upon that bartender last night who left an ice chip in my martini, then I probably wouldn’t see my daughters graduate college. It makes no sense and is objectively unfair.

Despite these imperfections, we still live in the greatest country on the planet for five reasons:

  1. Food independent: Vital grains and proteins are abundant here, so we don’t have to rely on any other nation to stay alive.
  2. Energy independent: We produce more than we consume, and that’s a really big deal (just ask Western Europe right now).
  3. Property rights: Uncle Sam can’t take back stimulus checks, land, cars, etc. Compare this to China who decides who can own what and when, and I’d rather eat sashimi off the lavatory floor of a Southwest flight than give up my citizenship. 
  4. Intellectual capitalism: Europe provides the world with wine and cheese. Oh, and Spotify. Big deal. Nearly all the entrepreneurship and innovation happening in the world started here for a reason.
  5. World’s reserve currency: Around 80% of global trade is transacted in USD, and over 60% of central bank reserves are in USD (the second largest is the Euro at just over 20%). 

Let’s dig deeper into that last point because, until recently, it’s been a source of pain for pretty much every country other than the U.S. 

Currencies are relative instruments. When the dollar strengthens, that means it’s gotten stronger relative to some other currency. Hence, a stronger dollar means most goods are more expensive to foreigners because so much trade is conducted in USD.

Well, a nice piece in Bloomberg this week suggests that this trade could be reversing.

The reasoning is that the Fed is about to slow down or stop raising rates, while most other central banks are expected to keep hiking this year. If so, this could be a big deal for the rest of the world. Here’s an excerpt from the article:

“The relief that a weaker dollar would bring to the world economy cannot be overstated. Import prices for developing nations will fall, helping to lower global inflation. It’s also likely to boost the price of everything from gold to as equities and cryptocurrencies as sentiment improves.  

That may help to ease some of the damage in 2022, when a stronger greenback left a trail of destruction in its wake: Inflation charged higher as the cost of food and oil jumped, nations such as Ghana were driven to the brink of a debt default while stock and bond investors were saddled with outsized losses.”

Being an American, I rarely think about the USD outside of work. I’m paid in USD, my investments are all denominated in USD, and I haven’t left the country since I had kids for obvious reasons. 

This is a privilege that most of the world doesn’t get to experience, but if this article is correct, you may want to start telling your clients to book that European vacation asap, or else that wine and cheese will get a lot more expensive. 

We’re all going to die… But not quite yet.

ChatGPT and its competitors continue to be page-one stories, but the verdict is still out on whether they provide any real value just yet. On the one hand, both Google and ChatGPT passed the U.S. medical licensing exam. That’s pretty amazing.

On the other hand, the hilarity of stories like Facebook having to take down their AI bot three days after launching because it was used to write a Wikipedia article about “bears in space” cannot be overstated.

Apparently, ChatGPT is also building stock portfolios, so I tested it out using a basic quality screen:

  • Revenue growth > 5%
  • Profit growth > 7%
  • FCF/Earnings > 80%
  • ROIC > 15%
  • Net debt/FCF < 5
  • Debt/Equity < 80%

This is what it spit out:

There’s no shot I’m going to waste time to see if this is correct, so I will assume so. The only glaring issue is that this list is based on data before September 2021, and a lot has happened since then that would almost certainly produce a different result.

Then I asked it to do the same, but this time build a portfolio (be more selective than just listing all the stocks). It came back with five mega-cap stocks along with rationale specific to the constraints listed above in like six seconds:

Before the desire to trade this screen overwhelms the senses, remember that most quant shops employ slightly more complex algorithms using data that are not readily available on Yahoo! Finance. Hence, I’m in no way endorsing this screen, nor am I suggesting that ChatGPT will put D.E. Shaw out of business anytime soon.

However, it is interesting and makes me think about how AI could be used for everyday investors and the broader impact on markets. For example, we spend a ton of money every year on tools that allow us to employ AI in our portfolios (screens, optimizations, neural networks for asset class mappings, etc.), and we had to build a team that knows how to use it all because there’s no shot I’m doing it.

But what if AI gets so good and cheap that anyone can use it? Does it make markets even more efficient over time, or do the goalposts move slightly to the left? 

For now, I’m not too worried because the more I play with ChatGPT, the more I realize that this is (1) not ready for prime time and (2) riddled with biases of those who programmed it. Here’s just one example:

Now, before anyone gets triggered, all I’m saying is that the #1 or #2 reason most professionals use quant is to eliminate biases from the investment process. ChatGPT clearly has biases programmed in. That’s it, so there’s no reason to blow a microchip. 

Besides, I’ve been poking the bear on ChatGPT all day, so I’d wager my account is minutes away from being terminated.

Enjoy the weekend…