Saturday, May 31, 2014

Nobody Puts A Rich Man In The Corner

You may remember that I claim to be wealthier than the richest man in the world from 100 years past. I came across an anecdote to support this thesis and provide a little evidence contra Piketty.

A few weeks ago I was eating lunch at a new, moderately priced restaurant in downtown OKC, Park House. While enjoying a conversation with my lunch companions, I noticed that a familiar face was being seated at a nearby table. The man did not standout in any particular way from the other patrons, but I recognized him as Harold Hamm.  While only one table separated our dinning experience, about $12.4 billion separates our net worth.

Around us was a broad cross section of folks some in suits and ties, some in shorts and flip flops. Undoubtedly, Mr. Hamm has a lot of opportunities I and the other customers don't have. He could have ordered everything on the menu without breaking a sweat and the charge would be a rounding error in his life. A second entree would have a very expensive luxury for me that day. Regardless, the fact remains he couldn't have eaten or enjoyed the meal more than me in any practical sense. Heck, I was even seated at a slightly better table.

We are not economic equals, but you wouldn't have known it from observing us at lunch that day. There are roughly two types of realistic egalitarian societies: those that are so poor that no one is able to become unequally wealthy and those that are so rich that fortunately only few are not able to live alongside the technically wealthy.

Partial Compilation of the Wisdom of Max

As originally posted to Facebook (most recent first) over the past year and a half with slight edits for clarity, I give you

The Wisdom of Max

Me: "Max, put on your jammies."
Max: "I don't want to wear jammies."
Me: "Look, I'm wearing jammies."
Max: "No you're not! Jammies have airplanes and stuff on them. You're just wearing regular clothes!"

Max: "Do you know why they call them black widows [pronounced 'weiddos']? Because they are so weird looking."

Max: "It's really easy to kill zombies. You just get a sword and hit them a bunch. It's pretty fun." Who says Minecraft doesn't teach you anything.

Max: "Birthday parties are gooder than everyphrang because ... Getting older ... sigh..."

Max: "Old people are lucky. They can't go to jail. Guess why. Because they forget so much."

[from April] "It's chalk and water. When I asked him what he was doing he said, 'MOM, I'm sciencing.' Well, I guess I can't argue with science."

Max referring to a friend at preschool: "Heston's not really a bully. He's just kinda the boss."

I'll be vague to protect the innocent, but Max's quote was good: "Mom, tell your friend next time to NOT put nuts in the chocolate chip cookies."

In this photo we see Max explaining that "the inside of a bean has seeds that are like bullets. If you break it open and put them in a straw, you can fire them like bullets." Thank you, Papa, for that helpful bit of knowledge.

Max thinks this bird poop on the car window is cool because it looks like a rocket ship.

Max is at a friends birthday party. A few of his observations:
     "I can never trust a hot dog."
     "My real name is Max, but in your gang my name is Zane."

He's been working in this all morning running around fretting, "I don't know if this will work..."
It is an "Opathenator". He told me what it does, but it is too complex for me to summarize in a Facebook post. (notice the use of a laser)

(At Victoria's The Pasta Shop) Max said, "Bring me all the lemons."

Max wants everyone to know he had three dreams last night (2 bad and 1 good): 
  1. We as a family were going on a train ride and he fell in the river. 
  2. He was being chased by dragons and one ate him. 
  3. A jet landed right by our garage (this was the good one. He said I would like it and maybe I'll have it sometime). 
     He then said, "Dreams are like listening to music with headphones only without headphones."

Max: "If you put honey all over [which he pronounces as 'O-er'] your yard, you'd have ants EVERYWHERE!"

Max: "I AM happy. I'm just not acting happy."

Max: "Guess what whiskers are for."
Me: "What?"
Max: "To shave."
Walked right into that one. But he continue, "They actually are just to give you something fun to shave."

Max: "If you tell somebody you went potty, but you didn't, and you don't tell them the truth, it's a lie. . . . 
I thought of that all by myself. That's what I do. I think of interesting things."

Laying down with Max while was going to sleep and me thinking from the long silence that he was, he raised up to say, "If I had some hot macaroni and there were ants nearby, I'd put it on the ants so they would die. Ice would work too."

Today Max and Elise went to the Myriad Botanical Gardens. Max said, "Mom, I have to ask you something. Can I pick these flowers? Can I take these flowers home?"
April replied, "No, you cannot."
Max said, "Okay, I just had to ask."

So Max was drawing with Eva today. He drew this guy in the middle and said, "that's a vampire." 
Eva asked, "How do you know what a vampire is?" He answered, "A vampire is just a naked zombie." And .... now I will have nightmares.

Max: "I wish I was three! Everything was easy when I was three. But in a while I'll be five, and that will be so cool!"

[from Nana]: While keeping Eva, Max and Elise this weekend, I gave Max and Elise both orange popsicles. Max quickly ate half of his then set it in his plate. Elise laid hers which was barely touched down immediately and grabbed his.
Max: "Hey! That's mine!"
Me: "That's okay just take hers she had barely touched it."
Max: "It might have germs, she licked it."
Me: "But Max she's your sister you don't care if you eat after your sister do you?"
Max: "No, not now that she is in our family."
Me: "Well she has always been in your family, she has the same Mommy and Daddy as you, remember when she was born?"
Max: "Yes, but when we first got her we didn't eat after her or anything for a while until we finally let her be in our family."
Guess it is one of those exclusive families that only accepts the best...

Max: "Papa, sometimes people think things that aren't true, but they don't know."

More from Max: "Some times things are funny, [shakes his head] but people don't laugh."
"You know bad words? You can learn good things from bad words."

Max: "Daddy, does it frustrate you that the house is taller than you."
Me: "no, not really."
Max: "But it's frustrating when things are taller than you."
Later . . .
Max: "My favorite thing to do today is to watch Eva while she plays. That bothers her. I like distracting her."

As I was grinding coffee this morning, Max said, "If you run out of concrete you can use coffee but it is really hard to do. REALLY HARD! You have to add boiling water and wait a long time."

Max: "David Graybill [his 6'4" cousin] couldn't take a bath. He is too tall. Do you know why David grew so tall? Let me tell you. Some people grow wide [he stands with his legs apart and arms lifted out to demonstrate]. But David grew long [he stands tightly together very straight like a pencil]. It happens at night. You don't notice because it is at night. But it happens."

Max: "If Superman was a real person, he'd be made of steel. But his cape wouldn't. His cape would be made of red cape stuff."

April: "I'm sending you kids to boarding school for the summer. I can't take the fighting."
Max: "I don't want to go to boring school. I don't want to ever go to boring school. I like my house."

[at Pi on the Plaza District] Max walked up to this sign and said, "What is my imagination saying?"

Elise is watching Sesame Street. Max can't figure out for the life of him what this is.

Max: "Dreams are important. They are good for you--even bad dreams."

Playing with Eva, Max said, "Remember what we did a long, long, long time ago, before today ..?" The rest isn't important. The specification that three long times ago is "before today" was the interesting part.

[from Nana]: Last night we gave our grandson Max (age 4 1/2 yrs.) a lava rock we found in the desert on our trip to Yuma. I said, "We picked up this lava rock for you in the desert. It is from a real volcano." His eyes got a look of excitement and alarm and he took it from me the way a person would take the surprise gift of a million dollars. "Wow" he said, "WHERE DID YOU GET THIS?" I told him we found it in the desert. He continued, "I mean, HOW DID YOU PICK IT UP? IT HAD TO BE BURNING HOT!"

Max today: "Robots were invented in the olden days to help people catch rabbits and chickens." I think he's watching too much Looney Tunes.

Max is focused in school work and focused in his Martial Arts.

Max from the shower: "Elise doesn't have boy parts! Where are her boy parts! She is like a cow. Milk comes out of there." How is he just noticing this?

Max explaining: "... And then a BIG giant ball of fire came down and there was fire everywhere and it killed all the dinosaurs. Then the scientists buried them, and then there were people who grew up, but first the scientists so they could bury the dinosaurs..." He drifted off as his non-sequitur became apparent.

Seems like he'd make a good pet owner.

So what do you do when you're playing hide-n-go seek, you are winning (not able to be found), and you have to go to the bathroom? Champions, like Max, apparently stay in place and pee their pants. ‪#‎commitment‬‪ #‎WhatChampionsDo‬

Eva has two friends over for a sleepover.
Me: "Max, let's get out of Eva's room and let the girls play."
Max: "No way! I wanna party with them!"

Max: "We talk about vinegar at school. You can drink it but it seems really bad but it is good for your bones."

Max relaxing in his new blanket-fort-house. There is a 20-foot "secret entrance" that runs behind the kitchen and around the side. It's really cool.

Max is showing Elise Minecraft. He is sad because in the zoo he built the piranha has jumped out of its pond and is going to die.

In another conversation, Me: "You need to get to sleep. It's a school night." Max's sharp reply: "I don't go to school at night!"

Max: "Your pants would be really stinky if you had cheese in them for a really long time." I am now checking all his clothing.

[from Nana]: Babysitting Max age 4 1/2 yesterday he told the dolls, "daddy has to go to work to buy food for your or else you will starve to death and Daddy will go to jail." then he looks up for a second and considers that thought, "well maybe I wont go to jail, then he continues, yes Daddy would go to jail."

April is taking Eva to the OKC Philharmonic tonight to see Sarah Chang play violin. I was telling her that a lot of people will be dressed very fancy tonight. Max said, "I don't like fancy." "What do you like?" I asked. "Cool," he replied.

At the end of her workout yesterday, April was out of breath and Max said, "Mom! When you are out of breath you have to go outside and eat some air or you might pass out!"

Max: "Flowers make nectar in their tummies like we make poop. And bees making honey. Lots of animals make things for us..." It went on from there for some time. Chickens are his favorite animal.

Max says: "You don't want the hedgehog to see his shadow - then there will be 1000 more days until fall comes."

So, Max pulled one of my books off the shelf and asked what it was about. It was Brian Greene's "The Elegant Universe", and it was opened to a diagram about relativity. He is now running through the house attempting to go fast enough to time travel. He didn't understand when I told him that if he does, I won't be able to tell.

Now this is a bubble bath.

Max: "Today at school I saw where you get Bible'd."
Me: "What?"
Max: "Bible'd!" [this actually went back and forth several times with him getting VERY insistent]
Me: "What do you mean?"
Max: "You know, with the big bathtub."
Me: "Oh, baptized."
Max: "Xactly! Daddy, have you ever been Bible'd?"
I didn't know how to answer.

Eva is at a birthday party next door that is "girls only". There is an age factor too, but that isn't something he could understand. Max: "Mom, for my birthday send a note to every girl in the whole wide world, 'No girls allowed!'"

Max: "Don't forget to set up the Montana Fire tonight in my room."
April: "What do you mean?"
Max: "You know, the thing that blows air in my face."
April: "Oh - the humidifier."

Max: "When we left on our trips, I worry about my toys and our house. What if somebody broke in and put a bomb in it. That would be crazy! I'd punch the bad guys in the tummy."

Max at Whole Foods whispering to April: "Mom, mom. I want to say that lady looks freaky, but that would hurt her feelings."

Max (in a Darth Vader voice): "Luke, I am your father . . . Son, and Holy Spirit." He might be confused.

Just after closing the door as the last of the cousins left from Christmas; Max: "Daddy, sometimes when I'm telling people goodbye, it makes me really sad."

Max: "Why did Nana make her Thanksgiving chicken on Christmas?"

He's loving his new swing set. Don't tell him it's too cold!

Max: "Did you know that you can see pictures of things in your brain? I'm looking at cool pictures right now. Can you see them?"

One of Max's rules seems to be to always stay in character.

One of his last thoughts before finally going to sleep brought Max rising straight up to ask, "What is faster a duck or a monster?" I knew immediately there is no correct answer I could give to this question as judged by him. Fortunately, he let me know, "I think a duck is faster running and flying."

Max is glad to be done practicing his Christmas program at preschool, "It was very disruptive to the day."

Max: "How did God create everything? Does he have a magic wand?"

"In Heaven can you fly? How? Do you say, 'I want to fly?' and you grow wings?" (With a concerned look.) "But I don't want to grow wings. I might just be saying, 'I want to fly'."

Max: "Elevators are pretty good places to pick your nose, but you shouldn't do it."

Upon learning what crab cakes really were Max said, "Crab cakes should be cupcakes shaped like little crabbies."

Max right now is jumping on the couch saying, "I love this night! It is like a birthday party!" Eva, watching MNF observed, "I just don't get some beer commercials. I like the one where he goes to the top of the mountain and pulls the beer out. I get that one."

Max: "Sometimes coaches look goofy."

Max: "Santa can't jump very high; he's a big dude."

Max is on a roll: "A giraffe could eat you." Me: "Well, no. Giraffes don't eat people." Max: "But if you had a leaf suit on they might."
Later: "Sometimes Santa comes into your house and looks around and if you have a bunch of toys he might only give you some and if you had a whole lot he'd leave you none."

Several from Max:
"Cows have to get the milk out of their skin or they will die."
"It is hard to pick your nose if it is sore but sometimes you have a big booger and if it is really big you need to wash your hands like ten times."
"If you didn't have a mouth you couldn't ask for candy if you were a little kid. That would be sad. "

Max: "Sometimes when you need to go pee-pee really bad someone talks to you and distracts you and you go pee-pee a little in your pants."

Max: "Papa, your neck looks like a turkey's."

Max: "It was easy for God to make aliens because they're so close to Heaven."

One of the byproducts of attending OU games is Max insisting we spend Sunday morning re-enacting the entire pregame in the backyard. I "get" to be the fans who have to stand up and clap and cheer at all the appropriate times. He is the players warming up, the announcer, the band, and the players running out of the locker room. The neighbors must love us.

[at the OU football game] Max: "What's a 'Hunnicutt'?" Me: "It means 'settling' and 'disappointment'."

At bath time.
Me: "I have to get your hair wet to wash your hair, Max."
Max: "NO! 'No' means no, daddy!"

Max: "Jesus has very good hearing."

Max's dream:
"A dinosaur was after me and 'Ah-Weece'. We hid under the table. He didn't kill us, but he zapped Mama."

Things I've learned this morning: Max, "In the world of donuts there are yeast donuts and cake donuts."

Max says, "Daddy doesn't wear a shirt when he mows - so neither am I"

Max gets Trick or Treat

Max was seriously concerned about his Sooners yesterday.

Wisdom from Max:
"A long time ago ghosts got into dinosaurs and thats why you don't see them any more."
"The beetles are the leaders of the bugs." Me: "Why?" Max: "Just because."

Max: "I'm a Wichita man. I'm from Wichita."
Homophone innocence.

"It's a glass of water." 100% his own idea and execution.

Max: "When you get old [elderly], you have to hear everything twice."

Max, "When I grow up, I want to be just like you, Daddy. Then I'll be able to go in the attic by myself." Apparently that is the measure of adulthood. He followed it with, "But I don't want to go into the attic." Quite the dilemma.

Max, "A magazine is a book you read when you go to the dentist."

[from Aunt Susie] A conversation between me and my 4yr old nephew:
Me: Max, I really like you
Max: I like me, too

Max reacts to eating a chocolate mouse

Max explained to me, "People call it a washcloth, but it's just a little towel."

April: "Max, please stop playing in the bathroom." Max, combing his hair: "I'm not playing, I'm being handsome."

April, "Max, is there anything you want from the store?"
Max, "Hmmm... Do they have gummies that look like bears?"
April, "When have you had Gummy Bears?"
With a confused look, Max, "Gummy Bears???"

Max just told me that Elmo was nice, but the dirty man was mean. I think he meant Oscar the Grouch.

Max's joke:
Max, "Mom, today at school I had a hand sandwich."
April, "No, you had a ham sandwich."
Max, "No, a hand sandwich. I ate it with my hand!"
"...I'm just kidding. It was peanut butter and jelly."

Max as the Flash (Flash wore an apron, right?)

Max was almost asleep when his eyes shot open with fear and regret as he worried, "I don't want Jesus to retire." Relax, he is not a prophet. Our priest, Father Boyer of St. Mark the Evangelist, is retiring tomorrow. Max is vague on what a priest is and completely unfamiliar with the concept of retirement.

Max plays Air Hockey

Mothers get accused of many things being their fault. This was a new one on April. Max: "Mommy! You broke my ideas."

Max says: "If God were not in the sky but was on the floor that would be cute because God is cool."

Not sure what this means. Max, "Let's pretend we don't have super powers."

Max to Elise: "I'm gonna squeeze the cutsy out of you." He said it in a sweet way, but it was still a little concerning.

Max's word of the day is 'sanitize': "Carrots are dirty. They have to be washed and sanitized."

Remember when finding a stick could make you happy?

Max sings Taylor Swift

Advice from Max: "It would be really hard to put lava in a water balloon, so don't even try it."

[at Easter] Max found an egg with money in it and said, "I'm gonna get all this money, then I can go to college, then I'll be rich forever!"

From the Wisdom of Max: Did you know that cheese makes you stop dying? Farmers put medicine in cheese.

Me from behind a closed door: "It's me, Baby Elise."
Max: "No it's not."
Me: "Oh yeah, it is."
Max: "You don't sound like Elise."
Me: "I changed my voice, I'm Elise."
Max: "If you Elise, pee your pants."
Checkmate Max.

April to me: "We need to start watching on Netflix 'Breaking Bad'."
Max with a distraught look on his face: "Oh no, can we fix it!?"

What I heard from the other room:
Max: "Eat this."
Max: "It's yucky.... Don't eat it."
I did not investigate. Some things are better left unknown.
From April: The first thing that Max said to me this morning was "I went to the grocery store by myself and I had cheese". I asked him if it was a dream. He said "yes and papa was there and there was a shark".

April: "This is the coolest morning ever - we saw a fire truck testing its ladder and we saw a hot air balloon."
Max: "And we saw beautiful trees and a beautiful baby and a beautiful you."

Some of Max's more interesting questions of the day (he has many everyday):
"How do things not break?"
"How is your head attached to your shoulders?"
"How long cents does a kite cost?" (Pretty sure he meant how 'many' cents).

Monday, May 26, 2014

Three Points On Knowledge

1. Over Representation:

Think about when we offer our knowledge and opinions (and conjectures) on a particular topic for which we are not an expert--in other words, 99% of our daily dialogue. It would be interesting if the social norm would be to conclude by saying, "And that is the extent of my knowledge on this subject." Some people, of which I am one, are of the personality type that they feel compelled to share everything they know about a subject when discussing it. There is nothing wrong with this per se, but it can create the false illusion that we know more than we actually do--that there are even more gems left in the bag rather than that's all, folks!

I've been trying to make an effort to be more explicit about the limits of what I know, and I plan to work harder to that end.

2. "I Don't Know"

"I don't know"* is the almost always unacceptable response that is almost always the most correct answer. What happens after we die? There is but one correct answer scientifically speaking. You can believe one thing or another, but you do not know. 

IDK is nearly as applicable to all questions pre death. The complexity of our Universe, our economy, our own preferences leaves us generally in a state of darkness with just flickers of sporadic light. We should be more appreciative of this truth.

Yet humans have a universal thirst for certainty. Inquiring minds want to know. That is a good thing--it leads us to question and find answers and then question those answers to reveal deeper truths. I just wish we could be more honest about how true and virtuous the answer IDK is. If we were, it might minimize how thirst for certainty is also a bad thing. It is a big part of why we crave and succumb to authority. It is how con men can win over intelligent people. The investment community if full of people who refuse to say IDK. Politicians get roundly "defeated" in debates by even hinting at IDK. In business you might as well say "Fire me now".

Saying "I don't know" takes courage and wisdom, and so does acceptance of it as an answer.

3. Trust of Knowledge.

There are two extremes along the dimension of trust I am considering here. Those extremes are only trusting locals vs. locals are morons. I think people tend to fall toward one extreme or another, but they are not consistently at either end. Rather it varies topic to topic. The former extreme is driven by belief that only locals understand the circumstances whereas the latter is driven by knowing locals too well to know their flaws. Both reasoning are obviously faulty when at the extreme.

I see this thinking often in my profession, investment management. Some people are biased against a local firm managing their money preferring at least someone "smart" enough to be in Dallas or Chicago if not New York. Other people take the opposite approach and are very fearful of anyone from New York City! because "they will", of course, rob you blind.

Related (perhaps a bonus knowledge point): Margins of accepted error--how one's biases influence the margin of error one allows for cohorts who match versus cohorts who oppose one's views. Most ideas are bad ideas--impractical, plagued by substantially bad facts, and suffering from poor reasoning. Yet I think we cut our ideological brethren a lot of slack while being harshly critical of our opponents. We do something similar in business. If I trust locals, I give them a wider berth (and perhaps more financial leniency) than I do outsiders. If I think locals are fools, the hurdles I make them clear leave both of us poorer.

There are many ways we inconsistently apply margins of accepted error. Recognition and mitigation of these requires constant vigilance.

Keep thinking . . .

*There was a recent Freakonomics podcast on IDK. I thought it was good, not great. I hope the space they devote in their new book is a little more fulfilling.

Sunday, May 25, 2014

Highly Linkable

Two short videos lead us off. Work is a means not an ends. The world we live in is wonderful; be happy.

I want to go to there.

I want to go to then.

Tradesports is back, baby. Can't keep a good man down for long it seems.

I'd like for us to think hard for a moment about hard-boiled eggs. Next, please quit trying to make me feel guilty about foie gras.

Turning now to the item du jure in economics: Thomas Piketty's "Capital in the Twenty-First Century". There will be more soon, much more (including something about how, oops eeps, looks like his data may have had spreadsheet issues). For now just a few points with which I heartily agree: Landsburg says income inequality is something to celebrate. Cass Sunstein takes an Alfred E. Neuman approach to the issues Piketty raises (note, I do NOT heartily agree with the FDR conclusion at the bottom of the piece). But let me recast Sunstein's argument a little more clearly.

For those who reflexively agree with Piketty’s worldview, a question.

In which world would you rather live:

  1. A world (starting from where we are today) in which the rich however defined (e.g., top 5%, top 1%, top .01%) see their wealth grow at 5% per year while the rest of society sees its wealth grow at 2% per year, or
  2. A world (starting from where we are today) in which everyone sees their wealth grow at 1% per year?

How you answer this question says a lot about how personal envy ranks for you versus your love for others. I am not saying this is the choice we face. I am saying if it were, which would you choose?

Russ Roberts offers a great, short lesson in economics specifically regarding GDP and government expenditure. A snippet:
Here's the fallacy. Suppose I want to know your income for the year. I ask you and you tell me you made $50,000 in salary. Another way I can get to that number is to add up everything you spent money on--food, rent, clothing, entertainment, savings and so on. As long as I count everything, I get to the same number, $50,000.
Suppose I find out you spent $5000 on entertainment. It would be very wrong to say that without that spending, your income would only have been $45,000.
Read and understand this post from Scott Sumner, and you will have a better grasp on current monetary macroeconomics than quite a large portion of the economics-commentary professional class.

Climate Alert! A really small change might happen to the Earth in 100 years. So, panic now? No.

Scott Lincicome at Cato discusses two trade policies that make domestic gasoline prices higher than they would otherwise be.

Here is a sports-statistics lesson applicable and important in a wide range of fields from medicine to business: "...the complexity of a stat should not be its selling point. If a stat tells you something, but you can't act on it, it's no good." read the whole thing.

Not good at investing? Blame your caveman ancestors. Hint: Your problem is you don't and are not built to understand risk well.

Information technology and networks are all busted (HT: Barry Ritholtz). Have a nice day . . . for the record, I'm not as jaded and pessimistic as this piece, but I think there is much truth here.

Thursday, May 22, 2014

This Post Is Brought To You By The Number 3

My friend George has a theory. It is a sound theory with which it is hard to argue. He says the right number of kids is two. Two makes sense, he says. Two kids makes a foursome: great for golf, easy to seat at a restaurant, comfortable to ride in the car, etc.  Two kids means it is easy for them to have their own rooms. Easy to park their cars in the driveway as they get older. 

His kids are now grown and off on their own. I think he is happy as well he should be with the choice he and his wife made. I can find no argument to make with his points. While there is evidence and argument to say he might have been happier if had crossed one more bridge, I have to agree it has worked out well for him and his family. 

All I can say is this (after the jump):

Sunday, May 11, 2014

Adding Value to Investment Management

I've clumsily touched on this before.

I believe active investment management (e.g., being a stock picker who is aiming to outperform the market) is actually just a proxy for risk exposure--dialing up or down one's exposure to market risk. Consider the market price discovery process as a game whereby success is rewarded, poor performance is punished, and market knowledge increases even if average participant knowledge and skill does not.

For example, consider people betting on football games. The bets placed are on which team will win and by how many points in a given matchup. As people make their guesses over the course of many games and over time, the good guessers are rewarded with more resources while the bad guessers are punished encouraging or forcing them to exit the market. The average guess is the market price, the best estimate of future results. The market's knowledge increases along two dimensions: as more people make guesses, more information is incorporated into the price; additionally, as results come in, the better guessers dominate the guessing. This is a simple illustration of the wisdom of crowds. Yet as a new participant starts making guesses, there is no way to know what his guesses will look like or if they will be more accurate than the average guess. Paradoxically, these new guesses will very likely be less accurate than the market's estimates but their addition to the market will add to the market's accuracy. How does this paradox hold?

Imagine the market estimate is for OU to beat Texas by 10 points. A new bettor comes into the market betting that OU will beat Texas by 17 points. Let's assume that subsequently the market estimate adjusts to OU will beat Texas by 11 points. OU then does beat Texas by 12 points. The market was more accurate than the new guesser, but the new guesser improved the market's accuracy. I contend the specifics of this example are a good representation of new information incorporated into the market. It didn't have to be that the new guesser was less accurate and still accretive to the market estimate. To be clear that is my argument.

Thus, the market price is a random walk (we can't predict the direction or magnitude of the next change in price) with a drift--a drift towards greater accuracy. Active managers are attempting to be smarter than the market. However, the market is pretty darn smart, like +99% smart--meaning that is how close the market generally gets to accuracy (being as accurate as one could be at a given point in time). How confident are we these managers can add to that and why would we think they could, over time, across hundreds of securities at any one point in time? Even if there is a persistent flow of "dumb money" flowing in to the system, why should these managers be in any position to consistently pluck it off? It is very doubtful they would be, and if they were, why is the dumb money so willing to put itself in such a position? We can tell stories here to hypothesize about why, but inherently there is a tension between those stories and the underlying market process that makes those stories necessary--if the market is getting smarter, then the new money must be getting dumber to allow for smart money to be smart (i.e., smarter than the market). But then how can the market be getting smarter???

Active management is risky arbitrage at best. Here is what I mean: imagine I see that the price of rice in Japan is $550 per ton while the price in the U.S. is only $450 per ton and total shipping costs average about $50 per ton. A riskless arbitrage would be if I could instantly buy rice in the U.S. market and sell rice in the Japanese market at the prevailing prices less the shipping cost. Let's say I explore that option but find it is not available. The next best thing is to physically buy rice in the U.S., rent a ship, steam over to Japan, sell the rice . . . then . . . profit. Turns out when I get there they won't let me sell it. Or they will let me sell it but only with a hefty $100 per ton tariff charge. Oh, and the ship might sink before I get there. What I have engaged in is a risky arbitrage. My ignorance of Japanese tariffs or my bad fortune on the high seas means my attempts to beat the market on pricing rice were in vain.

I was operating somewhat in the dark in my rice arbitrage, and more knowledge would have been helpful. Alas, overwhelmingly most knowledge is hidden. Market participants, even the brilliant ones, can never be certain they even have the sign on the price discrepancy right. To wit from our analogy, the price of rice in Japan might be LOWER than the world price once all opportunity costs including risk are considered.

This puts active management in a new light. It isn't an attempt to deliver above-market returns. It is an attempt to deliver more risky or less risky market performance--it could be either case depending on the manager. Modern portfolio theory simplifies the world and says investors achieve this by borrowing or lending at the risk-free rate and then increasing or decreasing respectively their exposure to THE market portfolio. Perhaps active management is a real-world facilitator to achieve these ends.

Saturday, May 10, 2014

Highly Linkable

Last Saturday, May 3rd, saw the passing of a giant in economics, Gary Becker. Becker was one of the first economists I got a regular exposure to via his column in BusinessWeek. I immediately found an intellectual home in his economic wisdom. David Henderson memorializes Becker here. Russ Roberts remembers him here. Cass Sunstein reflects here.

Assuming the standard arbitrary delineation of the economy into parts, there is perhaps now a new "largest" one.

Josh Barro puzzles over why anyone would want to be a homeowner. Steven Landsburg offers a good critique of Barro and a valuable overview of the issues involved. Megan McArdle counters to a slight degree. With a nod to Arnold Kling, there are major problems with leveraged homeownership as the primary middle-class asset: owning an asset that by its nature is depreciating--try as you might to fight the tide via HOAs and monitoring city council meetings, at the end of the day you're planting flowers as the local factory closes. King Canute could relate as the former actions are immaterial relative to the latter, exogenous, effects. And the latter doesn't have to be a local economic shock like a major employer leaving town. That is just a stand in for depreciation in general. There are two forms of depreciation: wear and tear and out dating. As you perfect taking care of the former, you risk maximizing the latter. At some point you have completely rebuilt an outdated house or you have chosen an expensive way and place to build a house brand new--an interesting spin on the Ship of Theseus paradox.

On a related personal note, I have two friends about to realize a big dose of depreciation in similar ways. One is going to nearly fully replace his heat/air system and the other is going to fully replace both sides of his two-unit heat/air system. The first is looking at about $5,000 in cost while the second will see about $13,000 in cost. All that just to get back to even so to speak--nothing different to show for the huge purchases.

Caplan is playing matchmaker between Western Civ and Open Borders.

Jeffrey Tucker says P2P will prove to be a death blow to the state.

Questioning the conventional wisdom in two examples: (1) saturated fat does not or at least may not cause heart disease, and (2) race perhaps is genetic and is not a social construct.

Humanity has officially jumped the shark. Of course, we knew Las Vegas would be in on it.