Dollars and Jens
Wednesday, February 28, 2007
The Bureau of Economic Analysis made its second guess as to Q4 GDP growth, and it's a 2.2% annual rate, down from the first guess of 3.5%, but around where people expected it to be revised to after some trade and inventory numbers came out in the past month. GDP-ex-fixed-residential-investment, with today's data, looks to have stuck uncannily close to 31/4% for the past three quarters, suggesting that we still aren't getting a clear sign of spill-over from the housing sector into broader weakness. Perhaps more promising, inventory reduction took even more out of GDP than did the housing slowdown, and that tends to precede increases in manufacturing activity as inventory has to be replaced. On the whole, it looks about as good as a 2.2% report can.

Tuesday, February 27, 2007
Diversifying Away the Crash
Diversification didn't help much today. I don't actually know this (actually, there's probably enough data online to conduct the research), but I have the strong impression that when the market really moves, especially when it really moves down, correlations tend toward one. In other words, you can hedge with short positions or put options or you can just tough it out.

Also from that blog, the following riddle:

Answer: Radio Shack and Questar.

Question: Which members of the S&P 500 went up today?

NYSE Glitch
I had wondered about this:

When the Dow Jones industrial average plunged to its low of the session Tuesday, it happened with incredible swiftness — a matter of seconds — because of a computer glitch that kept some trades from being immediately reflected in the index of 30 blue chip stocks.

Dow Jones & Co., the media company which manages the flagship index, said around 2 p.m — just two hours before the New York Stock Exchange was to close — it was discovered computers were not properly calculating trades. The company blamed the problem on the record volume at the NYSE, and switched to a backup computer.

when I saw this:
the market fell sharply around 2:58 and then rebounded a bit over the next 20 minutes

Wednesday, February 21, 2007
Japanese interest rates
The Bank of Japan raised short-term interest rates to 0.5%, less than a year after the cessation of "quantitative easing" in which banks were more or less simply handed as much money as they could lend out. I haven't been paying as much attention to the Japanese economy as the Bank of Japan has — or, if I have, we're all doomed — and this came as a bit of a surprise to me, though it probably shouldn't have; the short end of the Japanese yield curve has been at 50bp pretty much since the first hike (to 0.25%). My feelings at the time, though, were that "not zero" is enough different from "zero" that might be good to leave it at 25bp for a while. (And, in fairness, they did for about six months.)

Inflation there is within the margin of error of zero, incidentally.

Monday, February 19, 2007
On the Success of Analysts
From 1998 through 2006 I tracked the annual performance of the four stocks analysts most loved (those with unanimous ``buy'' recommendations for a large number of analysts) and the four they most hated (those with a high percentage of ``sell'' recommendations).

Over the nine years from 1998 through 2006, the stocks the analysts loved posted an average annual loss of 3.7 percent. The despised stocks did better, down 0.2 percent annually. Neither group beat the overall market.
Light but interesting.

Friday, February 16, 2007
A fellow named John Whitehead over at Environmental Economics quotes from an L.A. Times article:
Environmentalists and investment bankers are working together to put a price tag on nature. The new 'greens' think that human beings are ready to start paying for Mother Nature's services—and that calculating their financial worth will save the planet.


If ecosystems that do a great deal for people are to be recognized as of great monetary value, "ecosystem services" will have to become a household phrase.

Despite the snooze-inducing moniker, ecosystem services have occasionally appeared on the public-consciousness radar. ... The next visibility boost for ecosystem services came in 1997, when a team of scientists led by Robert Costanza, then with the University of Maryland, published a study in Nature that estimated the value of all the ecosystems and natural capital on the planet. The very rough figure: $33 trillion a year.
He notes
In the past we've written about how this methodology isn't based on sound economics because the resulting value of the ecosystem service is greater than income...
You're encouraged to look it over.

I just posted my own comment, which I'll reproduce here in full:
Prices, in neoclassical economics, are essentially derivatives. They are marginal values. When you start to get to economy-sized numbers, aggregating total costs becomes epistemologically sketchy. (I would assert that even talking about the federal debt is a bit meaningless, but that's not low-hanging fruit for my point, so you should probably just ignore this parenthetical.)

In any case, some meaning can be attached to a large-scale number if we have a way of comparing one thing to another. It's no longer actually a derivative; we're acknowledging a finite change, and some nonlinearity. It's still an affine space, though; if we're going to talk about the "benefit" provided by the environment, we have to be comparing it to a benchmark of some kind. "Smouldering cinder" seems a popular benchmark, but, unless there are some gung-ho smouldering-cinder—advocates out there, I'm not sure it's a meaningful one. If we're looking to trade off "big hunk of change in environmental condition" versus "big change in man-made lucre", we can construct numbers based on differences between alternatives that are actually on the table (or, at least, we can try). If we're trying to use price to do something else meaningful -- something that isn't "make a desperate plea for attention" -- we may actually have to try to understand the question we're trying to answer, and look for an answer that's appropriate to the question.

Big values do not raise the environmental consciousness so much as they lower credibility. The reason $33 trillion per year intuitively seems bogus is because it is.

Tuesday, February 13, 2007
Speaking of fecklessly trying to teach economics to politicians, how incompetent do you have to be run the economy of an oil exporter into the ground?
Meat cuts vanished from Venezuelan supermarkets this week, leaving only unsavory bits like chicken feet, while costly artificial sweeteners have increasingly replaced sugar, and many staples sell far above government-fixed prices.

President Hugo Chávez's administration blames the food supply problems on speculators, but industry officials say government price controls that strangle profits are responsible.

Such shortages have sporadically appeared with items from milk to coffee since early 2003, when Chávez began regulating prices for 400 basic products as a way to counter inflation and protect the poor.

Yet inflation has soared to an accumulated 78 percent in the last four years in an economy awash in petrodollars, and food prices have increased particularly swiftly, creating a widening discrepancy between official prices and the true cost of getting goods to market in Venezuela.
Here's what you do: eliminate the price controls, and replace the central banker with a monkey. As long as it's not a trained monkey — or at least not one that's trained to print money — you ought to see a dramatic improvement.

Bernanke will spend the next couple days trying to teach very basic economics to Congressmen.

Every job has its burdens.

Monday, February 12, 2007
inflationary pressures
I recently read an economic analysis that suggested that one risk to a benign inflation forecast was the potential mean reversion of labor's share of national income, thereby creating wage inflation. I'd like to note that this seems exactly backward to me.

Labor's share of income is lower than it has been historically, though very recently it's begun to tick up again. (It's probably, at this point, within the margin of error, though.) The change in the percentage of national income that goes to labor is necessarily the difference between unit labor costs and the GDP deflator; if the share of income going to labor is ticking back up, unit labor costs will be higher than broad measures of inflation, particularly consumer inflation. The best sense I can make out of what I read is that something would necessarily keep broad inflation measures in place, so that a relative increase in unit labor costs is going to mean an absolute increase in unit labor costs of the same magnitude — and then, unless one is worried about unit labor costs per se, presumably one fears these will feed back into broad inflation, causing that to rise, too.

I suppose it depends on the mechanism for the reversion to the mean, but what I've been envisioning for the past couple years — I like to think I'm not wrong, merely premature — has been that a renewal of competitive pressures results in a lack of pricing power for producers, while labor costs (per hour) continue to be driven by the tightness of the labor market just as they always have been; one would then envision the mean-reversion coming into effect by means of a decrease in broad inflation measures — though I should admit that the current unemployment rate probably suggests some unit labor cost acceleration.

It could be that the difference will come from an increase in unit labor costs, and it could be that the difference will come from a decrease in inflation. It could be some combination of the two; I don't see why more than all of it should come from the former.

economic report of the President
It's like Christmas morning.

Though, frankly, it doesn't look quite as juicy as it sometimes does. I took me a gander at the catastrophe insurance section, and it's reasonably interesting; I'm looking forward to some extent to the energy chapter and foreign exchange rate chapter that follow it.

Wednesday, February 07, 2007
productivity and labor costs
Today's productivity report was ridiculously good. Real hourly compensation up at a 6.6% annualized rate, with unit labor costs at 1.7%, and productivity at 2.4% (3.0% for nonfarm business). This suggests that inflation is not, at the moment, coming in from labor, though it also indicates some transfer of GDP back toward labor, and stockholders might want to consider the possible places for that to come from.

economic report of the President
Last year the Economic Report of the President came out on February 15, and it is required to be
transmitted to Congress no later than ten days after the submission of the Budget of the United States Government,
which took place earlier this week.

Not that I'm over-eager or anything.

Tuesday, February 06, 2007
risk premia
Credit derivatives, the fastest-growing business on Wall Street, are squeezing returns for bondholders to an all-time low.

Contracts that protect investors against defaults are being sold in record numbers and then bundled into securities known as collateralized debt obligations. CDOs are driving down the cost to protect against non-payment so much that even the government of Argentina, which reneged on $95 billion of debt five years ago, is paying less than ever to borrow.

CDOs, as with other marvels of financial engineering, allow risk-profiles of investors to be better tailored, but you should always be careful to be aware of exactly how much something you're getting for just how much nothing:
``It's like a free lunch,'' says Gorgeon. ``You're immune to default.''
Oh, you can't possibly say that without expecting it to send our spidey senses tingling.

CDOs make it easy, in particular, for more risk-tolerant types to leverage up in a diversified way that won't completely break them if the world goes against them; it still pays a small premium, in today's market, to the generally risk-averse investors to take the deep tail loss, which they at least think is worth the extra few basis points they can get for it. What this chopping and meting doesn't do is reduce the probability that the underlying credits will default. If a company has a default probability that, in a world without risk preferences, would justify a 200bp spread, financial engineering like this can conceivably help them cut their financing costs from 300bp to 225bp — and, to be clear, that may be all that's happened — but unless you've found someone who just likes risk, it can't justifiably get them below 200bp.

Bill Miller
Calendar year 2006 was the first year since I took over sole management of the Legg Mason Value Trust in the late fall of 1990 that the Fund trailed the return of the S&P 500. Those 15 consecutive years of outperformance led to a lot of publicity, commentary, and questions about "the streak," with comparisons being made to Cal Ripken's consecutive games played streak, or Joe DiMaggio's hitting streak, or Greg Maddux's consecutive years with 15 or more wins, among others. Now that it is over, I thought shareholders might be interested in a few reflections on it, and on what significance,if any, it has.

A common question I've gotten is whether I am in some sense relieved that it is over. The answer is no. Active managers are paid to add value over what can be earned at low cost from passive investing, and failure to do that is failure. We underperformed the S&P 500 in 2006 and did not add value for our clients and shareholders. It is little consolation that most mutual fund managers failed to beat the index in 2006, or that most managers of US large- capitalization stocks fail to outperform in most years, or that under 25% of them can outperform over long periods such as 10 years, or that the next longest streak among active managers going into 2006 - 8 years - also ended this year, or that it is believed that no one else has outperformed for 15 consecutive calendar years. We are paid to do a job and we didn't do it this year, which is what the end of the streak means, and I am not at all happy or relieved about that.

There was, of course, a lot of luck involved in the streak... If beating the market was purely random, like tossing a coin, then the odds of 15 consecutive years of beating it would be the same as the odds of tossing heads 15 times in a row: 1 in 215, or 1 in 32,768. Using the actual probabilities of beating the market in each of the years from 1991 to 2005 makes the number 1 in 2.3 million. So there was probably some skill involved. On the other hand, something with odds of 1 in 2.3 million happens to about 130 people per day in the US, so you never know.
His fourth-quarter commentary is online (PDF).
It is trying to invest long-term in a short-term world, and being contrarian when conformity is more comfortable, and being willing to court controversy and be wrong, that has helped us outperform. "Don't you read the papers?" one exasperated client asked us after we bought a stock that was embroiled in scandal. As I also like to remind our analysts, if it's in the papers, it's in the price. The market does reflect the available information, as the professors tell us. But just as the funhouse mirrors don't always accurately reflect your weight, the markets don't always accurately reflect that information. Usually they are too pessimistic when it is bad, and too optimistic when it is good.
(Emphasis added.)

Thursday, February 01, 2007
labor statistics
When the payroll numbers come out tomorrow, BLS will also release a revision of data from April of 2005 to last March, and is expected to raise payroll numbers by 800,000 jobs or so.
Economists widely consider the payroll survey to be significantly more accurate of the two readings. But [Bernard Baumohl, managing director of the Economic Outlook Group,] and other economists say it's not accurate enough to justify the attention paid to the monthly net change in payrolls.

"The BLS says that the payroll estimate has a margin of error of 150,000 jobs, while the household survey is plus or minus 300,000 jobs," he said. "So when you see a gain of 150,000 in the payroll number, it could be zero, or 300,000. It's tough to draw any conclusions about the state of the economy from that."
Well, okay, but why do I care about the number of jobs produced? As a practical matter, there are two components to "number of people employed": number of people in the labor force, and the fraction of them with jobs. A lot of the uncertainty in the household number is due to uncertainty in that first figure; if it were all in the second, that would still amount to 0.2 percentage points on the unemployment rate, but in fact the uncertainty there is significantly less than that. The best measure of the tightness of the labor market is the unemployment rate, which comes reasonably directly from the household survey; if an exogenous event were to dramatically and suddenly change the size of the labor market without changing the number of jobs, there is no doubt that wage pressures would be affected. The payroll figures are trivia.

minimum wage
The Senate has now passed a version of the minimum wage bill that adds on other, more Republican interferences in the economy, leaving the average libertarian all the more confirmed in his dire conception of the term "bipartisan". But this isn't the political blog, so I'll stick to some economic questions about the minimum wage I've been thinking about:

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