Dollars and Jens
Friday, February 27, 2004
latest numbers
4Q GDP revised up to 4.1%, from a previously reported 4.0%. The market was reportedly expecting a downward revision instead. The deflator was revised up from 1.0% to 1.2%.

ORCL's PSFT takeover bid blocked
The Justice Department said it would file suit to block Oracle Corp.'s $9.4 billion hostile buyout of PeopleSoft Inc. because the proposed takeover would reduce competition in the market for complex software programs used to run corporations and institutions.

This is an interesting game Larry Ellison has been playing; he has threatened to take over PSFT and discontinue support for its products. Many believe he has no intention of actually doing so, and is just trying to scare off new customers from PSFT, who would be reluctant to purchase software or systems that might not be supported a year or two from now. PSFT has thus made a strong attempt to block the takeover; whether blocking the takeover benefits shareholders or not, appearing to be making a strong attempt to block it surely does, at least versus anything else but agreeing to the takeover offer. If it looks like justice is going to block the takeover, that helps PSFT get customers.

Thursday, February 26, 2004
latest numbers
I commented last week that the initial claims number, since the beginning of the year, has been 350,000 a week plus or minus noise; well, no noise this week, as the official figure is 350,000.

4Q GDP revisions come out tomorrow.

Yes, I realize there's noise in that number. Don't email.

Wednesday, February 25, 2004
Greenspan urges Social Security cuts
That political independence thing, maybe there's something to that.

If you match up anticipated cash-flows from Social Security and its tax, Medicare and its tax, and general funds and the other taxes, and discount back to present, Medicare and Social Securty absolutely dwarf the general funds shortfall. One step in the right direction is Bush's partial "privatization" scheme, which makes near-term cash flows worse but long-term cash flows better. Certainly the two steps Greenspan is said to mention in the link — increase the full-benefits retirement age and link cost-of-living ajustments to a measure of inflation that doesn't consistently overstate it — should also be taken, but even all three may not be enough to really establish solvency.

Saturday, February 21, 2004
Postrel on the New New Economy
The great Virginia Postrel has a piece in the New York Times about why the payroll survey shows fewer jobs than the labor-force survey, which we discussed here a few weeks ago. That's not how she characterizes it, but it's essentially the same topic.

Friday, February 20, 2004
Brokertec's new cash market
This post has a point, and a relatively short one, but I'm going to puff it up with a lot of background first.

Background : workup state Decades ago, you traded bonds by calling up a broker. If you left an offer with him, and somebody decided to buy at your price, you'd get a call telling you about it. If the other person was looking to buy more than you were offering, the broker would ask whether you wanted to sell more at that price, and you could increase your volume on the phone, even if someone else was offering bonds at the same price. It was logistically easier than to force you to make a new offer and put that behind the other one. When markets went electronic, they retained this system; when a trade executes, the market halts for a time while the parties executing the order negotiate the volume. This leads to strange behavior and occasional games when the market would want to move a lot. Young traders view it as archaic.

Background : price improvement A couple years ago, one of the large tenants at the top of the World Trade Center was Cantor Fitzgerald; while many of its employees were killed, it's still around, and it's still the biggest bond broker. A year or two ago, in search of a new revenue stream, they began offering to let people bump ahead of each other for a higher commission; by buying "price improvements", you could bid at 106-13 and have your order executed ahead of another bid at 106-13, even if the other bid was there first. There would be no market for this if tick sizes weren't so large compared to both the commission and the typical bid-offer spreads, but by letting you effectively bid an extra tenth of a 32, but one that Cantor rather than the other dealer gets to keep, Cantor gets to make a little more money. This offends many traders' views of fairness.

News Brokertec (recently acquired by Eurex US) will soon be offering a market in which the work-up state has been eliminated. Brokertec never had "price improvement", but hasn't had the kind of liquidity that Cantor has; the interesting thing to watch will be whether they draw much flow based on their market design.

Incidentally, one more eccentricity of the cash markets is that each issue really gets two markets, one for bids and one for offers. If you want to sell, you have to specify whether you're trying to sell against a bid or whether you're placing an offer; the markets lock regularly (i.e. the best bid is the same as the best offer), and occasionally the market has actually crossed, though that's arbitraged out pretty quickly. I think Brokertec will still be doing this. (The futures market doesn't do this, nor does it have work-up, nor does it have price improvements. It's frankly normal.)

grocery stocks
It appears yesterday's move was effected by an analyst's comments about the competitive position of grocery stocks vis-à-vis Wal-Mart.

Thursday, February 19, 2004
grocery strike
The stocks of the grocers involved in the southern California grocery strike/lock-out opened flat, but raced up a few percent about an hour later. No news; I can't even find rumour, but I can infer rumour, at least in broad terms.

latest numbers
Initial claims of 344,000, which the national radio news guy mentioned at the top of the hour is a drop of 24,000 from last week, the biggest since November (when three straight readings at or above 390,000 were followed by a 353,000); this time, though, the previous two readings were rather higher than those preceding it, and it's probable that last week's reading was noise above and this is noise below. It's still parked at 350,000 a week, as since the beginning of the year, until we hear sustained news indicating otherwise.

Wednesday, February 18, 2004
World news
Japan reports 7% growth. Meanwhile, the dollar/euro ratio plumbs new depths, leading the European Central Bank to state that further strengthening of the euro would be unwelcome.

The Frog to move in with the Mouse
Kermit and Miss Piggy are joining Mickey and Minnie, capping a 14-year effort to bring the Muppets into the Walt Disney family.

The Walt Disney Co. said Tuesday it will buy the "Muppets" characters, including Kermit, Miss Piggy and others, as well as the "Bear in the Big Blue House," franchise from The Jim Henson Co.

Financial terms of the deal were not disclosed.
Does this affect the chances of Disney being purchased by Comcast? Does it increase the chances that the board of directors will be re-elected? I've consulted my best forecasting tool, and it says "tails".

Tuesday, February 17, 2004
Re: Economic Report of the President
I do expect just-in-time processing (did I get the lingo right?) will reduce required inventories, but I think a substantial portion of the push to that had been made by, say, three years ago; inventories have fallen substantially since then.

Actually, we seem to be in agreement here; inventories will grow, but not to historical levels. My emphasis is on the former, yours is on the latter.

Monday, February 16, 2004
Re: Economic Report of the President
Dean points out that days of sales in inventory are at a 50-year low, and assumes that they will increase. Now, I do assume that the part of the economic cycle we're in is depressing inventories, and that we're more likely to see increases than further decreases. But I would also suppose that, structurally, the economy probably doesn't require as much inventory as it once did -- that the Internet and increasingly impressive computer systems are allowing production to more closely match demand.

Thursday, February 12, 2004
Shares of ImClone Systems Inc. were halted on Thursday after the shares fell 23 percent. Why did they fall? Well, the FDA approved Erbitux for the treatment of advanced colorectal cancer — news announced after the collapse.

So, again, why did they fall? Well, that latter link offers
Approval of the drug was widely expected in the market and indeed, many traders had professed an intention to "sell the news" when formal word of it hit. Still, Thursday's trading looked too extreme to be chalked up to normal market dynamics, and appeared to occur before the FDA posted the press release on its site.
"Still ... looked too extreme" could be termed "comic understatement."

In summary, I don't know, but I'd sure like to find out.

Update: SEC: Nasdaq Probes ImClone Stock Trading

Economic Report of the President
At the Marginal Revolution, Alex Tabarrok mentions the ERP, and Brad DeLong's reaction to the optimistic employment forecast (he's agin' it). One of the arguments is that 1.7% is too pessimistic an estimate for productivity growth, and I have to say I generally agree, but 1) I don't think the past 5-years average of 3.7% is sustainable for decades at a time, 2) we are no longer right at the very beginning of the recovery, and 3) inventories are as low as they've been in at least 50 years (relative to sales). The way productivity is measured, increasing inventories will be a substantial drag, won't they?

Wednesday, February 11, 2004
Eurex US
Eurex US volume has been quite disappointing, around one twenty-fifth the volume on CBOT's electronic platform yesterday. This is not bad for a new exchange, but expectations were rather higher.

Tuesday, February 10, 2004
Incidentally, I no longer work in the Chicago Board of Trade building, though I will be there this Friday morning and probably the Friday morning or two after that.

Economic Report of the President
The 2004 Economic Report of the President is out. I'll be reading some of it and possibly commenting here in the future.

Update: The table of contents alone is probably interesting. Included are chapters on manufacturing (noting that its decline is not bad for the economy), dynamic revenue estimation, social security, the environment, the tort system, and a few chapters on international trade that should be of interest to dollar-watchers. It does not, interestingly, have a chapter devoted solely to jobs, though a number of the chapters, especially notably the first, make employment a major subsection.

Monday, February 09, 2004
job survey divergence
I've read in some places that this typically happens at the beginning of a recovery; small companies hire before large ones, new companies start up at an accelerated rate, and people start setting off on their own. The rap against the household survey is a greater statistical uncertainty. So I mean to construct a model combining a precisely measurable indicator of a variable with an imprecise direct measurement, with the notion that this would imply a way of taking these two numbers to get us a better real-time view of the employment situation than either gives us by itself.

Re: latest numbers
Yes, Dean, there was "a bit of a divergence" between the household survey and the employer survey, in the sense that Joe Stalin was "a bit of a jerk".

One of the just-below-the-radar stories of the last couple of years has been that workers have been regularly reporting more net job creation than the employers have been reporting. But this is just getting silly. The best explanation I know is that the self-employed are not being reflected in the employer survey, therefore the household survey is more accurate. If something else is going on, I'd like to know what it is.

Friday, February 06, 2004
latest numbers
5.6% unemployment rate, 112,000 increase in "nonfarm payrolls", i.e. the establishment survey, with last month's number upgraded from 1,000 to 16,000. Apparently the bond traders had a whisper number of 300,000 on the payroll number, so bond futures shot up on the release.

If you follow the link provided, you can see that the household survey indicates an increase in total employment of basically 500,000, so there's a bit of divergence here.

Thursday, February 05, 2004
Somebody's stock-market headline generator jammed
Stocks rise on profit-taking in spite of mixed economic data, reports the AP. I think the headline-generator got "profit-taking" and "bargain-hunting" switched, but, the way those are used by the financial media, who could really blame it?

unemployment numbers
356,000 initial claims. Household survey for January out tomorrow.

Modeling Risk
I had class Tuesday night. It was a "risk management" class; I'm still not sure quite what the aim of that class is, whether it will emphasize the quantitative or the qualitative. But there was an important point made that I thought I'd pass along:

If your model says that some risk has a ten-to-the-minus-thirteenth probability, the probability to start worrying about is the probability that your model is flawed. This was the real problem, for example, at Long Term Capital Management -- they had too much faith in their models, and believed that a 2σ event was a 12σ event.

Wednesday, February 04, 2004
CFTC approves Eurex U.S.

CFTC staff urge OK of Eurex US
U.S. Commodity Futures Trading Commission staff recommended on Wednesday the commissioners approve Eurex's application to set up an exchange in the American market that will provide new competition for the Chicago Board of Trade.


The commissioners, due to meet from 10 a.m. (1500 GMT), usually adopt staff recommendations, said one agency official.


Eurex, jointly owned by Deutsche Boerse and the Swiss stock exchange, plans to open its U.S. exchange Feb. 8.

Insurance is an interesting business. No, I'm serious. For one thing, if a company is writing unusual kinds of insurance, it has a lot of room for fudging numbers -- even more so than in most industries. When the insurer signs a contract and collects a premium, it incurs a liability equal to the expected pay-out. For an unusual contract, an insurer can easily misestimate this liability, either deliberately or honestly.

Correlation of risk is an important danger to avoid. You have to expect some claims to come in, but you don't want them all to come in at the same time. If the risks a company takes are independent of each other -- for example, 50,000 different auto insurance policies -- the company can estimate relatively well that they will have to pay, say, $30 million a year in claims. They won't know exactly which customers will have claims, and which won't, but if the company knows the odds, and if car accidents are not strongly correlated1, the payout will be pretty predictable. On the other hand, if you write flood or hurricane insurance for 50,000 homeowners in the same town, the chances are good that either a lot of them will be hit or none of them will be. The correlation is high, and the risk to the insurance company is high.

If a small insurance company is taking on strongly-correlated risks -- or is wise enough to realize that any collection of risks will abruptly auto-correlate at the worst possible moment -- it can often buy "reinsurance" from a larger insurance company. Reinsurance will compensate the company if and only if their losses exceed a certain amount.

You might assume that the main way an insurance company makes money is to charge a premium high enough to cover the costs of insuring its risks, and that the difference is its profit. That's not quite right -- most insurance companies regularly operate with underwriting losses. You might see an insurance company refer to its "combined ratio". This is the sum of the company's "loss ratio" -- the ratio of what it pays in claims to what it earns in premiums -- and its "expense ratio" -- overhead expenses divided by premiums earned. A typical combined ratio might be 102%.

The catch is that the insurance company gets the premiums up front, and pays the claims substantially later. What the company is doing, in essence, is borrowing money from policyholders at a rate of 2%. The amount of money being borrowed is called "float", and is recorded as liabilities called "unearned premiums" and "unpaid losses". What an insurance company tries to do, then, is essentially the same thing a bank does -- it borrows money at one rate, and tries to invest it at a higher rate. Banks are more restricted in the risks they can take, and they know with more certainty what rates they will be paying. Insurance companies generally invest more in equities, and don't know precisely what combined ratios they'll get until after they see their losses come in.

The P/E ratio is a terrible valuation metric to use for an industry in which earnings fluctuate with the stock market. A back-of-the-envelope calculation I like to use to value an insurance company is book value, minus non-investment assets, plus a percentage of float. Let me explain my reasoning: if the combined ratio is consistently exactly 100%, the company can invest the float and keep the profits. If the float never shrinks -- as old claims are paid off, they're replaced with new premiums -- this is essentially equivalent to owning the float. So if the investment manager can earn a fair return on both the company's investment assets and its float, the company is worth book plus float, minus any assets used in generating the float, which I assume is all non-investment assets. If the combined ratio is 102%, and a fair interest rate is 5%, I might suppose that three fifths of the float counts as equity. This isn't a very sophisticated model -- you have to assume that the float won't evaporate, that there aren't negative surprises upcoming, that the investment manager is good, etc. -- but if I think a company is growing its float and can maintain its combined ratio, I like the model for its simplicity.

My car insurance company, Commerce Group, has been growing float and earning a consistent underwriting profit, with a combined ratio of around 98-99%. According to their latest financial reports, reflecting the end of September '03, they had non-investment assets (i.e., "bad" assets) of about $998 million, equity of $857 million, unpaid losses of $953 million, and unearned premiums of $853 million. If we sum the last three figures and subtract the first, we get a value of $1.665 billion, or about $52/share. The stock closed yesterday at $43.65.

If you buy and lose money on it, I take no responsibility for your loss2. But it looks interesting to me.

1. I would guess that the main source of correlation for car accidents is the weather -- i.e., if the weather is really bad, a lot of people will crash, or cars will experience hail damage, or whatnot. I don't know how big a factor this is, but I assume it's not huge.

2. If you make money, feel free to give me credit, though I should acknowledge that my attention was drawn to the stock -- and its impressive combined ratio -- by a fellow BU student.

Tuesday, February 03, 2004
Human Action
Perhaps one of the more difficult tasks facing the writer of this article in the Guardian on predicting the behavior of large groups of people was trying to make it sound more novel than it actually is; the people with whom I surround myself at least wouldn't be surprised to hear that people influence each other's behavior in a way that can, to a varying degree, be modeled, free will at the individual level or not. That out of the way, the examples in the article do make me want to read the guy's book on the subject, if only in the hope of more specifics.

(This post is cross-blogged.)

Monday, February 02, 2004
SCO Group
It's been a while since I mentioned the SCO/IBM Linux dispute (if you haven't been following, I quoted a story about it in December.)

I don't have an update on the case, but if you hadn't heard that this MyDoom Internet worm is causing denial-of-service attacks on SCO, well, it is. Also Microsoft.

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