This note was originally published at 8am on December 26, 2012 for Hedgeye subscribers.
“Strength does not come from physical capacity. It comes from an indomitable will.”
It is a quiet week at Hedgeye and in the markets this week. Keith is spending some time with his family, so I’ve been handed the pen on the Early Look. My family decided to take a little vacation in the Canadian Rockies for the holidays. As a result, this note is coming to you from Banff, Alberta in all of its -30 degrees Celsius glory.
Similar to most vacations, I’ve taken an opportunity in the downtime to do some reading. The most interesting book I’ve picked up this holiday season is called, “Willpower”, and was written by Roy Baumeister and John Tierney. This is not one of those books in which the title has a double meaning - the book is in fact about will power.
As the authors write, when psychologists attempt to identify the key traits that lead to positive outcomes in life they consistently come up with two: intelligence and self control. Interestingly, the first trait, intelligence, is considered to be somewhat innate and researchers have thus far been unable to permanently increase a person’s intelligence. Self control, on the other hand, can be improved. In fact, according to Baumeister and Tierney, improving self control, or willpower, is the surest path to a better life.
One of the most interesting studies that support the relationship of willpower to positive life outcomes is the Marshmallow Experiment. This experiment was conducted by Stanford psychologist Walter Mischel in 1972 and its original objective was to study how children learn to delay gratification. In the experiment, four year olds were put in a room alone and told that they could eat a marshmallow whenever they wanted, or if they waited until the experimenter returned they would get two marshmallows.
Interestingly, Mischel’s daughters attended the school where the Marshmallow Experiment occurred, so he kept hearing anecdotes about the marshmallow kids from his daughters after the experiment had ended. Naturally, this led Mischel to do follow up research on the children that had participated in the experiment.
The follow up research showed that those four years olds who were able to hold off for the second marshmallow had SAT scores that were on average 210 points higher, earned higher salaries, had lower body mass indexes, and lower rates of divorce. The results of this experiment surprised many academics, since prior to this experiment it was thought that childhood characteristics were not accurate predictors of future success.
Since discipline is an attribute of most great investors, I’m sure many of those men and women that went on to have great careers as stock market operators would have waited for the second marshmallow. As for politicians, I’m not so sure. If the most recent policy stalemate implies anything, it is that elected officials don’t really want any marshmallows. The caveat over the last 24 hours is that President Obama has made the decision to end his Christmas vacation early and will return to Washington, D.C. today, thus the futures are up this morning. Santa Claus Rally anyone?
So, even as President Obama is coming back in hopes of getting his proverbial second marshmallow, it remains very unlikely that the fiscal cliff gets resolved in 2012. Senator Mitch McConnell, who has been a catalyst for prior bargains, is having none of it this year as he looks toward a re-election campaign in 2014 and recently stated:
“We don’t know what Senator Reid will bring to the floor. He is not negotiating and the president is out of town. So I don’t know what they are going to do over there.”
The Republicans in the House, of course, have also not been able to accomplish much. Speaker Boehner’s attempt before the holidays to get his members to support a tax increase on incomes over $1 million was not successful. The likely reality is that we are looking at a short term solution that allows Congress more time to negotiate. If this reminds you of the definition of insanity, doing the same thing over and over again and expecting different results, it should.
The other major concern related to the influence of politicians is the debt ceiling. According to the most recent data from the Treasury Department, the total outstanding U.S. government debt was $16.30 trillion as of December 21th. This is just shy of the statutory debt limit of $16.39 trillion, a number which is likely to be violated in early January 2013.
So, where is Washington on resolving the looming breach of the debt ceiling? Well, according to InTrade, the online prediction market, the odds of the debt ceiling being raised by year-end are currently at 10%. Similar to the fiscal cliff, our elected officials have decided to wait until both of these issues are directly upon us and volumes are back in the New Year. I suppose this is a version of waiting for two marshmallows, albeit not a positive version.
Clearly, if we get past the inability of the politicians in Washington to put their partisan bickering aside and reach a workable solution to both the fiscal cliff and debt ceiling, then 2013 may shape up to be a positive year for equities. As Keith has been writing, global growth seems to be bottoming (one of the more recent supportive global data points this week is Taiwanese Industrial Production hitting a nine month high on Monday), commodity inputs look to be on a deflationary path, and housing in the U.S. is poised for a parabolic recovery in terms of home prices.
The last point is critical for growth surprising on the upside in the U.S. as the value of the consumer’s home has historically shown a high positive correlation to their discretionary spending intentions. A sustained housing recovery is the proverbial marshmallow that many U.S. focused investors have been patiently waiting for over the last five years. Based on our models, 2013 could well be the year where that happens.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1636-1671, $106.21-109.77, $3.49-3.58, $79.13-79.99, $1.30-1.33, 1.70-1.85%, and 1419-1450, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research