The Market is Smarter Than You

Two pretty different links here:

1. Scott Sumner is really starting to get good at nailing down his view. It’s been fun watching his writing sharpen up over the last few years. Nobody who cares about macroeconomics can afford to ignore his blog:

In recent months central banks have resorted to using the phony “credibility” issue.  The claim is that they had to fight hard in the 1970s and early 1980s to get markets to believe they were serious about inflation.

Fortunately, that is simply not true.   Markets have little difficulty figuring out what central banks are up to.  When the central bank wants to reduce inflation (as they did after 1981) markets believe them.  When they didn’t want to, markets didn’t believe they’d lower inflation.  There never was a credibility problem.

…I’ve frequently argued that interest rate targeting is like a car with a  steering wheel that locks when you need it most–on twisty mountain roads with no guardrail.  I’ve also argued that although we rarely hit the zero rate bound in past recessions, it may well become the norm in future recessions.

2. David Merkel (who holds the opposite macro philosophy to Sumner, incidentally) with a couple good stories. I like this comment:

rapid growth in financial institutions is rarely a good thing; it usually means that an error has been made.  Two, there is a barrier in many financial decisions, where responsible parties are loath to cry foul until it is way past obvious, because the cost of being wrong is high.

Insurance companies are excellent long term investments if they’re boring. They’re boring because they can’t really grow quickly, because if they do they will die.

The smartest P&C (Re)insurers I know of have a very simple strategy: sit on your hands for about 75% of your career and pray your investors don’t fire you for it. When the market turns step on the gas. Repeat.

The effectiveness of that strategy is proportional to how much you are in the business of assuming insurance risk. Think of the insurance world as a spectrum from support businesses (IT vendors, auditors, etc) which are more or less acyclical to Reinsurers which are completely beholden to the cycle.

From least to most insurance risk:

IT vendor -> broker -> MGA -> Berkshire Hathaway ->  insurer -> Reinsurers

BRK gets its own spot because  it’s an interesting mix of ‘normal’ businesses and insurance businesses. It’s the ability to put their capital to work in something that doesn’t care about the soft market that makes them unique. They DO something with that 75% of their time.

When the market is hard, insurance is an excellent business to be in: entrance is difficult, and the mass extinction of the turn scares the bejesus out of less skilled underwriters. Finding a strategy that lets you capitalize on that but doesn’t handcuff you to soft market valuations is a big deal.

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