Sunday, May 5, 2019

Why Might Good News Make Stocks Go Down?

This runs the risk of being the most ill-timed post I've made since current recession risk is probably elevated. Don't take this as direct investment advice or as timely commentary on the current market. 

Consider a hypothetical couple planning for retirement and in the midst of that plan they are considering the upcoming year's vacation options. They can either have a staycation with peanut butter and jelly sandwiches and TV watching or a blowout Hawaiian vacation. 

As they consider which vacation they can afford, I arrive at their door having traveled from the future. Don't get caught up in the unrealistic assumption of time travel. The point is that I can credibly tell them the future looks very bright--perhaps I'm just Carnac the Magnificent. I tell them their investments will do well and times ahead are very good. How will they react? They go on the Hawaiian vacation. In other words they sell or forego savings (investments) and buy current consumption. 

The more technically accurate but less intuitive way of looking at it is the following. To get them to forgo enjoying the vacation now opting instead to save/invest, the market would need to pay them a higher rate of return (their discount rate, required rate of return, has increased). In order for current assets to have higher future returns, prices today must decline. Here is a fuller explanation from John Cochrane. His main point is that positive news can make market prices suddenly decline (if profit expectations stay the same but discount rates increase) but also negative news can make market prices suddenly decline (if profit expectations decline). 

If you find an unanswered question in this analysis, you are on to something. Good news can make the market decline but so can bad news. What exactly makes stock market prices suddenly go up? New, higher profit expectations could be the answer. Unfortunately, this is harder to come by than might be assumed. Remember, we are talking about long-term profit expectations. Those are tied to fundamental growth rates of ideas (innovation/productivity) and market size (population as well as density--a million people in a city are more productive than a million people spread sparsely over a large space). Moving that needle positive is much, much harder than negatively shocking it.

Saturday, May 4, 2019

Can Trump Be The Solution To Trump?

As faithful readers know, I have been ambivalent on the Trump presidency. From the beginning I thought there were reasons to be optimistic and pessimistic on it. Those are proving fairly prescient in some cases, gratefully off in others:
Optimistic - Shows why we should lose (and should have lost a long time ago) our reverent awe for the U.S. Presidency; prevents major government action/intervention/meddling on any number of issues by being a circus act writ large (his administration's priorities will be prestige and showmanship rather than policy accomplishment); forces a meaningful debate and action on limiting executive power (a little bit in tension with the previous prediction as this one mitigates a Trump administration that is actually trying to do something).
Pessimistic - Engages in major international war actions (beyond the high amount the each of his opponents would do anyway); sets back trade freedom and immigration substantially; creates strong racial, ethnic, nationalistic, and gender divides.
I have expanded on this upon Trump taking office and one-year in. Part of my analysis has been optimism that Trump will bring sanity to how we look upon the U.S. presidency.
  • Lost Respect for the Sanctity of the Office - yes this is a feature--let the scales fall from your eyes, the emperors have never been well dressed. But . . .
A recent episode of the always rewarding Something's Off with Andrew Heaton featured Rob Montz discussing his excellent Trump as Destiny: Why the Reality Show Presidency Was Inevitable. This is a great piece that I hope gets as much traction as possible. It resonates with me. I hope it does so for others.

We've gone from George Washington supposedly declining the offer to be king (even if this is apocryphal, the fact that it is part of the legend strongly implies we at least once held this to be a virtue) through John Kennedy embracing the image of being our king to genuine concern that Trump would take us up on the offer.

The course of history has been decidedly against my vision for the U.S. presidency. What makes me think I should be optimistic about Trump changing that? Indeed that is a question that troubles me. I'm not sure I have a good answer. The source of my optimism has been based largely on Trump as such an extreme example of the problem that those in Congress would find it their own interest to change course and the American people would see the office (not just the man who happens to be occupying it) as run amok. Unfortunately, our growing tribalism thwarts this on both sides--many or most Democrats don't allow themselves to see a connection between the office and this president and many or most Republicans don't allow themselves to admit there is a problem at all. Somehow we need to make fear of Trump lead to limitations on the presidency going forward.

I think Trump certainly could legitimately be impeached, and I would prefer this if it was at least neutral to the bigger hope that Trump will significantly erode presidential power and image. I fear it would not be constructive to that larger goal. Once he is out, the problem is "solved", and we are back to business as usual. Of course, we have that same problem in an election of a new president in 2020 or (more likely not until) 2024, but at least then there would not be the cleansing event that allows continued blindness to the bigger problem.

Here is my curve-ball solution: Get Trump to bring the limits we want. He can't make us think less of the office. We have to do that on our own if we are willing to take the red pill. But he can put into place strong limits on what his successors may do. Why would he do such a thing? Because he is vain and doesn't believe anyone else can be trusted with power. The best prospect of this might be as a 2024 election approaches and a Democratic victory looks imminent. Perhaps then a Republican-lead Congress brings strong legislation to Trump's desk and the lame duck sings a wonderful swan song.

Unlikely? Probably about as likely as Kim Kardashian and Kanye West getting Trump to enact criminal justice reform.

Help Me Find a Difference

What is the logical difference in the following statements. In other words, why should I agree with some but not all or disagree with some but not all? 

To my children’s teachers: I really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To my garbage manI really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To my dentist: I really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To my favorite restaurant’s cooking and waitstaff: I really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To my favorite college team’s athletes: I really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To my favorite college team’s coaches: I really appreciate the service you provide, but your pay should be limited to a figure well below the result of the competitive market.

To tease this out explicitly - being consistent would require either market-based wages for coaches and athletes or highly-restricted wages for both. Perhaps Dabo Swinney should make as much (and only as much) as the lowest-paid college football coach.

Also, arguments about the "competitive market" being an unrealistic ideal compared the "real world" are not relevant for the point I am making here. Yes, there are all kinds of problems with wages being less than optimal from an idealized competitive market perspective. So one could easily use this same implied argument to rally against the state's monopolistic control of education, cronyistic contracts for municipal sanitation, medical and other occupational licensing laws, minimum wages, etc.

Saturday, April 13, 2019

An Analogy For Cliff Asness

The great Cliff Asness recently wrote a piece about the difficulty in explaining a market-neutral portfolio at an intuitive level. The problem is more fundamental than explaining the performance--as troubling as that can be. It is also a problem just helping people understand what they own. Here is my attempt to help him out.

Consider a bunch of guys in a basketball gym. Suppose I was an investor in their performance. First just think about all of them simply shooting baskets like in a warm up before a game. If I could “invest” by paying $1 each time one of my chosen players shot and making a return of $2 each time one of my chosen players made a basket, I would want to pick the best shooters and avoid the worst. I would be making money based on their shooting accuracy. At the extreme I would want to pick Stephen Curry and Lebron James (pick a couple of darling stocks and go all in with them). However, this is hard to do because the star performers are not that obvious—this is after all just a bunch of strangers in a basketball gym not a bunch of strangers plus a couple of NBA all stars. More likely I would need select quite a few players based on some metrics for selection and “invest” in their shooting percentage (build a long portfolio of many stocks). 

That analogizes to the typical portfolio. But what if instead I deliberately chose two teams from the group of guys and had them play a game. My investment's return would then be determined by which team wins and by how much. I gain more as my team wins by more points and I lose more as my team loses by more points. Now my ability to pick the teams (stacking the talent in my team) is the deciding factor of my success and I am essentially long the team I own and short the opponent. From the standpoint of each individuals' shooting percentage (the first approach that analogized a long stock portfolio) my long/short investment isn't highly intuitive, but when viewed as a group against a group it probably is.

Saturday, March 23, 2019

The Big Five - Choose Your Battles Wisely

Here is the low-hanging fruit of public policy. 90% solutions (improvements) on these issues are several orders of magnitude more important than 99% solutions on a thousand others. They are in no particular order (alphabetical):
  • Drug Prohibition (end it--allow adults to make their own choices)
  • Education (privatize it--give the government an ever-smaller role)
  • Immigration (open it up--allow people to freely move and freely interact with other people)
  • Taxation (simplify and redirect it--efficiently tax the use of resources not the creation of resources)
  • War (move away from it--make postures less bellicose and violence less of an option). 
Everything else at this point is details. They are interesting details, yes. For example, the recent interesting, generally important, but marginally insignificant issue of the legality of blackmail. [note: I side with Robin Hanson, but I am sympathetic to and willing to live with the counter case.]

How should you vote? I would suggest an equal weighting of these Big Five policy stances as the guiding framework. While this recommendation is a prescription to be a few/select-issue voter, that should be considered a feature not a bug. Similarly straight-party voting isn't necessarily morally or intellectually inferior to a strategy of "voting the person not the party". By what criteria is a candidate-by-candidate voter deciding? Why should they believe they are properly weighting the issues, correctly identifying the stance on the issues, and accurately evaluating each candidate's position and expected actions on the issues? Using a few benchmark issues as the litmus test keeps the focus properly on that which meaningfully matters and gives the best hope the rationally ignorant voter is making a good decision.

More importantly, how should you advocate (much more bang for the buck)? Let's say solutions are just as simple as awareness (I know it is not, but it is a useful analogy). Spend about 95% one's advocacy efforts roughly evenly on the Big Five: ending the drug war, privatizing education, opening immigration, reforming taxation, and reducing war. The remaining 5% goes for everything else. My own behavior has not adhered to this framework, but since I am just now formally defining this, I grant myself pardon. Will I follow this going forward? All I can do is try.

Sunday, March 10, 2019

I Know Why Dracula Is So Rich

Before we can understand why Dracula is so rich, we need to understand why investments make money at all. Why isn't the current price simply the sum of all future returns? Well, because future returns are uncertain. A business venture might be profitable. Money lent might be returned. And the investor might be around (alive and well as today) to collect when the future return is available. Hence, an investor needs to be compensated for the risk that the investment will not generate a return and for the risk the investor cannot use the invested funds as well in the future as today.

I am positing that uncertainty is the single (the one and only) source of financial investment return above the time-value of money (TVM). Assuming we all have an identical time preference, which we do not, the time-value of money can be summarized as a single discount rate, an annual compound interest rate. Let's set the discount rate to 3% whereby $100 today is equal to $103 in one year, $106.09 in two years, and 1.03^n into perpetuity. To any degree that there is uncertainty about collecting the future investment, one would require a premium to the discount rate--an increase in it to compensate for risk (e.g., 3% becomes, say, 5%, which would be 3% for TVM plus 2% for risk). I realize "discount" is counterintuitive, but understand that it simply means discounting a future amount to be equal to a value in present terms. 

One way to get rich is to have a discount rate (a time-value of money) less than 3%—like say 2%. Then getting someone to pay you 3% in one year’s time is like getting paid almost 1.5 year’s interest in a single year since you only require 2%. It wouldn’t take much leverage (or much time) to make this a very real and very big get-rich-quick (or eventually) plan. 

Another way to get rich is to have less uncertainty about the future--the mythical crystal ball. Even if it is cloudy, it plus what everyone else (the market) knows is better than only what everyone else knows. 

This dawned on me when I was listening to Jason Wiser's retelling of Bram Stoker's Dracula (Dracula: The Night King (part 3 of 3), specifically about the 35:21 mark). Because he is an immortal monster, Dracula can simply wait out any temporary problems--go to sleep for forty years as those who hunt him age and die. Now, think about Dracula's time preference for money or anything else. He plays the loooong game. He doesn't need to consume now and can let his wealth work for him quite easily--decade-long naps allow for very deferred consumption. Relative to mortals, he has a very, very low discount rate because his time horizon is astronomically longer and uncertainty from his perspective is much, much lower. 

What are the implications for us in the non-fictional, mortal universe? Tyler Cowen's Stubborn Attachments wrestles with this concept (confession: I have not read it yet, but I have purchased it, intend to read it, and have listened to approximately 3.79 trillion podcasts of him discussing it). As I understand it, he argues for a discount rate of 0% thereby valuing the future as equal to the present. In such a framework at the individual level you would not be paid a premium for deferring consumption. However, I believe he is proposing this at the societal level and more as a framework for policy making. A conclusion this leads to is generally favoring growth as the primary goal/aspiration for social policy.

What about implications for investors? Individuals are not immortal; so unless you are planning a trip to Transylvanian, you better continue to demand compensation for deferred consumption (TVM) and some premium for risk being taken.

What about endowments and foundations? I would propose they are not nearly as much like Dracula as they would like to be--in the time horizon and uncertainty dimensions. I won't at this time accuse them of having other Dracula-like qualities (fodder for a future "shots fired" post perhaps). These entities have current and continual demands for withdrawals. An X% annual spending policy and a collection of interested parties with very different perspectives strongly challenges any argument for a lower discount rate. The foundation as a concept may theoretically have an infinite time horizon, but its donors, beneficiaries (both current and near-future ones), and employees do not. At the very least it will be difficult for them to think and act as if there is an infinite time horizon when they should (deferring consumption in tough times) and rather easy for them to do so when they shouldn't (assuming future growth will solve all current shortcomings). 

Lastly, what about governments? Well, should they really expect to be around into perpetuity? How many can reasonably expect this? So far at least technically the success stories number zero. (Perhaps another future post expanding on this question and applying to foundations as well.) I will grant that governments in a practical sense to a degree (magnitude matters) can assume very long time horizons borrowing against the future. It will work just fine until it doesn't. Given enough splinters (growth-hampering regulations, inflation, entitlement promises, etc.) you'll eventually have a wooden stake. Governments may aspire to be Dracula (see below), but they face many, many obstacles in getting there. 

This brings us to a Partial List of why governments are like vampires:
  1. The light of day is toxic to their way of behaving.
  2. Taxes = blood.
  3. They can seduce with their promises.
  4. They create captured minions whose self interest becomes subservient and aligned to the master's.
  5. We trust them blindly at our peril.
  6. They are incapable of looking themselves in the mirror.

Wednesday, February 27, 2019

Ranking College Football Programs - 1970-2018

It is about time that I updated my previous work on ranking college football programs.

Recalling the methodology from before, I am attempting to answer who's better, who's best. I am limiting the data set to my generation (1970 through 2018) because it happens to coincide with what I believe is the modern era of college football. To rank the teams I use average margin of victory. Opinions could differ, but who are you to criticize? Join together with your like-minded brethren to create your own list. Just be objective rather than try to fool us again with some anyway, anyhow, anywhere to make your team come out on top.

The results are below and the spreadsheet with the full analysis is here.

Since 1970:

Since 1998 (BCS and College Football Playoff era):

Since 2014 (College Football Playoff era):