Woodstock Quarterly Newsletter / Q4 2019
While airplanes themselves and the flight systems that the airlines use to ferry us around the country and around the world are some of the most complicated systems humans have devised, perhaps there are lessons we can learn in dealing with other less complicated systems from their travails. One commentator on Boeing’s maneuvering control system failure simply states that manufacturers and regulators need to recognize that “many current pilots are simply not up to the standard necessary to operate current systems”.
The commentator, and Boeing’s, solution is to implement “software changes to eliminate the need for the crew to recognize and respond correctly to a failure of an angle of attack sensor”. Should the manufacturer or regulator have been able to determine “the exact point when systems would become too complex for certain pilots”? The commentator’s answer is that this expectation is “not fair or reasonable”. As a passenger on both flight systems and financial systems, this takes my breath away. The inner workings of flight systems are opaque to me. The inner workings of the financial system, however, are somewhat clearer and probably, thereby, scarier. The hubris of believing that overly complex financial products and systems can be controlled, probably contributes to unfavorable unintended consequences.
Let’s discuss ultra-long sovereign bonds and negative interest rates. There are some rational reasons for holding bonds with negative yields, which on its face shouldn’t make sense. “Of approximately $15 trillion of bonds with negative yields globally, about $3 trillion was sold at their offering with negative yields, while the rest fell below zero as the securities appreciated during the global bond market rally”. The rational reasons include hedging, surcharges for keeping cash in a bank, and appreciation potential if interest rates fall further. However, it can also be “skepticism that novel responses of global central bankers to the global growth shortfall will prove effective”. Perhaps, the regulators won’t be able to control the systems.
If we look at the current stress in the US market for repurchase agreements (“repos”) would we see that worries about financial system complexity and participants and regulators deficient skill sets are overblown? A commentator suggests the solution is for the US Federal Reserve to simply guarantee all US overnight and short-term needs without participants having to post collateral as is currently needed in the “repo” market. Not exactly free market, but this commentator says there isn’t one anyway. Another commentator describes an international “shadow banking” system which relies on the “repo” market to meet international demand for US dollars because there is a shortage of long-term US Bonds which are the preferred collateral for the “repo” market. His solution is for the Fed to issue more long-term (30 to 100 year) debt: “feed the beast”. The first commentator says push the joystick forward to ascend (short-term solution), while the other says pull the joystick back to ascend (long-term solution). One is focused on US banks and the other is focused internationally. They probably both agree that “as we know from 2008, byzantine complexity can cause financial systems to collapse”. Or that regulators’ attempts to “solve” a problem, can cause bigger, unforeseen problems.
The best news is that we’ve been here before. Both in 1999 and in 2008, the correct long-term solution was to hold high-quality US stocks in an account where you are the owner. We plan to keep flying and to keep our approach to the financial system simple. As most of Woodstock’s clients recognize, it takes a lot of work to run a financially simple investment system. Our managers deal with the complexity of making it safely through a market cycle.
We know that you are the most valuable business development tool that we have. Your referral of a friend, colleague or family member to us is the most important way that we grow.
We thank you for your support and want you to know that we are dedicated to serving your best interest.
William H. Darling, Chairman & President
Adrian G. Davies, Executive Vice President
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