Dollars and Jens
Thursday, December 28, 2006
Nasdaq to Close Tuesday
As you may have heard, former President of the United States Gerald Ford died on Tuesday.
It was expected that the stock exchanges would close out of respect for the 38th president. Financial markets have traditionally closed for presidential funerals, the last time being the burial of President Ronald Reagan in June 2004.


There was some speculation the markets would try to have at least some stock trading on Tuesday because of the four-day closure that will also include the weekend. The last time Wall Street was closed this long was in the aftermath of the Sept. 11, 2001, terror attacks, when it was closed for six days including a weekend.
So if you want to trade a Nasdaq stock in the next five days, you'll have to do it tomorrow. Of course, Warren Buffett has said
After we buy a stock... we would not be disturbed if markets closed for a year or two. We don't need a daily quote on our 100% position in See's or H. H. Brown to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?
If you're not comfortable with your holdings, you should trade tomorrow anyway. And if a four-day closure of the market makes you uncomfortable with your holdings, then you shouldn't consider yourself comfortable with your holdings.

There are also tax reasons to sell tomorrow rather than next week, if you're sitting on a capital loss. But those existed before this announcement.

I first saw the equivalent story by the Wall Street Journal, but I decided to link to a free version.

Tuesday, December 19, 2006
incentives commute
Second derivatives commute. One of the consequences of this is that, when an incentive to X increases with Y, the incentive to Y also increases with X. As an example, take the Earned Income Tax Credit.

The EITC offers an incentive for people at the bottom of the income scale to earn some income. It is designed, however, to offer higher incentives to people with children (in fact, for the childless, the EITC is almost nonexistent); thus it also provides a higher incentive to have children to those who earn income up to its peak. Because the EITC discourages earning income above a certain point, and discourages it again most heavily among those with children, it also provides a decreasing incentive to have children as one makes enough money for the credit to phase out.

Of course, the incentives are independent of which effect is intended; whether the intended public policy was to provide more inducement to have children among those who are poor than among those with more economic means, or whether it was to disproportionately encourage people with children to spend time at work, the impact is the same. (Also, of course, such incentives may be laid upon other effects that provide either encouragement or discouragement of those ends. The result is for the effects either to amplify or partially cancel; either way, particularly on societal levels, one gets more of what is incented than one would otherwise.)

I started thinking about this a couple months ago when Greg Mankiw mentioned a discussion of which he was a part in which it was suggested that medicare be "means-tested", i.e. that its benefits phase out with rising income. "Wouldn't that essentially amount to an extra income tax imposed only on sick old people?" he asked. As with EITC, when you create a greater incentive for old people to be sick when they make less money, you also create a greater incentive for old people to make less money when they are sick.

Monday, December 18, 2006
Investing and Bridge
If you assumed from the title of this entry that I'm going to try to sell you a large structure in New York City, you've misunderstood.
Aside from an affection for cheeseburgers and cherry Coke, one of the personal facts commonly known about Warren Buffett is his love of bridge, which he periodically plays online with Bill Gates.

Why bridge? Though Graham wasn't talking about Buffett at the time, he offers a clue:

"I recall to those of you who are bridge players the emphasis that bridge experts place on playing a hand right rather than on playing it successfully. Because, as you know, if you play it right you are going to make money and if you play it wrong you lose money - in the long run. There is a beautiful little story about the man who was the weaker bridge player of the husband-and-wife team. It seems he bid a grand slam, and at the end he said very triumphantly to his wife ‘I saw you making faces at me all the time, but you notice I not only bid this grand slam but I made it. What can you say about that?' And his wife replied very dourly, ‘If you had played it right you would have lost it.'"

It seems to me (and it has certainly been my experience) that it takes an enormous amount of restraint to focus on playing every investment hand "right," according to an established discipline, allowing the law of averages to work in your favor, rather than trying to win every hand. I would guess that this is exactly what appeals to Warren Buffett's temperament. Over the long-term, good investing requires it.
Your hunches may be right for a while, but be careful about trusting them.

An enjoyable little piece. I wish I remembered where I found it. If you don't read the whole thing, at least take a look at the chart of 20-year returns in the S&P compared to the 20-year return you'd expect if you assumed a terminal P/E of 16.7.

Thursday, December 14, 2006
Brokerage Fees
From Business Week:
Eliot Spitzer has a new racket he's chasing down on Wall Street, charging that UBS put some customers in unsuitable fee-based brokerage accounts. He's late to the party as the SEC, NASD and NYSE have been on this one for more than a year, as I wrote back in May, 2005. But it's worth reviewing the issue to ensure you're in an account that best suits your investing habits.

...In the bad old days of Wall Street, say 1990, the most common problem afflicting widows and orphans was called churning. That was when an unscrupulous broker traded in and out of stocks in an account just to generate big commissions for him or herself. About 10 years ago, the street formally looked for ways to clean up its act. A task force headed by former Merrill Lynch Chairman Daniel P. Tully examined broker compensation policies and recommended, among other things, that a switch to fee-based accounts would eliminate the incentive to churn. And that seems to have been the case as churning complaints dropped considerably.

The dark side, of course, was that some people would have been better off in an old-fashioned commission-based account because they didn't trade much.
What the author seems to gloss over is who is making what decisions. If you're putting your money in your broker's hands and saying, "I don't know what a stock or a bond or a federal reserve is — you do as you see fit," you want your broker's incentives to line up with yours. Letting him skim off a couple of percent a year makes a lot more sense than letting him skim off a couple of percent a trade (though it would make even more sense to pay him based on how well your investments do). If you are deciding how often to trade and what trades to make, paying a couple percent a year for custodial services seems pretty steep.

UBS may or may not have engaged in dishonest marketing here. Knowing Spitzer, I assume they'll end up settling either way, probably paying a price that does nothing to compensate anyone who might have been wronged.

Tuesday, December 05, 2006
factors of production
The productivity report is out, with BIG revisions downward to second quarter compensation — I'm not quite clear on what's up with that. Mind, it's the long-term manufacturing data which capture my thoughts. Output per hour has climbed seventy-some percent since 1992, as has (nominal) compensation per hour; unit labor costs are essentially unchanged in the last fourteen years, and perhaps down slightly. For durable goods manufacturing, output per hour has more than doubled, while compensation is up the same 70%.

There's a sense that, in the long run, real wages (by which I mean labor compensation) should track productivity; in manufacturing, real wages are up only about 30% in the past fourteen years, about half of what productivity is, and less than that for durable goods alone. The general relationship can be reduced to an assumption that labor receives a constant proportion of GDP — productivity times number of hours worked is real GDP, while real wages (including benefits etc.) times number of hours worked is the portion received by employees, so if the ratio is constant, the percent change in one will equal the percent change in the other. In the case of the manufacturing sector, I believe there are two major contributors to the discrepancy:
  1. Manufacturing is increasingly capital-intensive, particularly in the United States. A lot of the increase in productivity is due to investments in plants and machines, which, essentially, have to be paid off.
  2. Prices in the manufacturing sector have risen more slowly than prices in general. This is in part because manufacturing is increasingly capital-intensive, and productivity improvements there have been faster than in the service sector; unit labor costs in the service sector keep up more closely with wages, and unit labor costs dominate the production costs of services. If we adjust wages in the manufacturing sector for inflation in manufactured goods' prices, they appear to have gained a bit more than if we use overall inflation.
I'm pretty sure the former effect is larger; most of the difference is that a new worker is only that much more productive if equipped with increasingly expensive equipment, so that the gain to employees is just enough to attract enough employees into those sectors of the economy, and is not substantially higher than in other sectors, as might be supposed by simply looking at output and number of workers.

There are a lot of directions I could take this now; there are papers suggesting that the Asian Economic Miracle of Taiwan and Korea, for example, can be explained entirely by capital investment; alternatively I think I could head off on a tangent about marginal versus average values: the partial derivative of output with respect to hours worked is very different from output divided by hour worked. I should probably just leave it alone, though.

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