Valuation vs. Momentum Investing

Bill Spitz (who is known to the readers of this blog for his prescient calls in the past, As Risk Increases, Spreads Widen) has written another gem documenting the "manias" leading up to the current market.  Students will learn something about about two strategies for investing:  Valuation (long run) vs. Momentum (short run).  Here is the bottom line advice:

• There are widely accepted and time tested methods of forecasting returns on various asset classes. 
• While we work very hard at refining the inputs to the process, you should understand that they vary considerably over time rendering the forecasts subject to error. 
• These forecasts do actually have pretty good predictive value over 7-12 year time horizons but provide little or no insight into near term returns. 

Of course, everyone will want to know what he thinks of the current market, and here it is:

The Shiller P/E has risen from 13.3 to 32 since 2009. Note that the long term average is 17 although it is important to remember that it hit 44 during the Dot.Com bubble. An additional mitigant might be that the combination of strong earnings and a relatively flat stock market in 2018 has reduced the P/E somewhat based on current earnings. Most other asset classes are similarly expensive as compared to their historic norms. The Federal Reserve has made its intention clear to raise short term interest rates and we are already close to an inverted yield curve which has historically been an accurate predictor of recession. Finally, there is a great deal of noise on the political front with continuing discussion of Brexit, the prospect of trade conflicts, and active shouting matches with North Korea and Iran.

UPDATE FROM A VALUE INVESTOR:

...it’s actually easier, or at least more fun, to define growth and value by caricature of the kind of people who buy each type of stock. Growth investors wear nice suits, and are charming. They are by nature optimistic and typically do not read the footnotes, because, no one else does, right? If they go to a conference, they fly first class or in a private jet. Value investors are rumpled and not as much fun to talk to. They are overly analytical and obsessed with missing something in the footnotes. They fly coach. 

Are weaker property rights behind the fall of the RAND?

In the chart to the right, denoting prices over the past six years, we see a big increase in price of Pounds measured in RAND, indicating an increase in the demand for Pounds (people who want to sell RAND and buy Pounds).  It fell, but it is going up again.  

In general, markets prices give us signals, but they can be hard to interpret.  Here is one interpretation:

In a barrage of headlines that sparked chaos in FX algo markets, The South African government proclaimed proudly that it is opposed to illegal land grabs (sparking a rally in the rand) before humans realized that this is mere statement of fact and that the entire reason for this process is to 'legalize' land grabs through reform.

This interpretation should be familiar to anyone who has read chapter two, which talks about the incentive-aligning effects of property rights, which are behind the rise of modern China and Vietnam. But in South Africa, it looks as if they are being eroded.

Here is another interpretation:

LONDON, Aug 30 — Emerging currencies sold off sharply again today after Argentina’s peso suffered its biggest one-day decline since 2015 overnight, with Turkey’s lira, the South African rand and the Indian rupee all feeling the heat.

How much you need to save to become a millionaire in 15 years

Article from CNBC:

To become a millionaire in 15 years with no savings:

•  With a 4 percent rate of return: $4,063.55 per month 
•  With a 6 percent rate of return: $3,438.57 per month 
•  With an 8 percent rate of return: $2,889.85 per month 

 To become a millionaire in 15 years with $10,000 in savings:

•  With a 4 percent rate of return: $3,249.88 per month 
•  With a 6 percent rate of return: $2,638.21 per month 
•  With an 8 percent rate of return: $2,105.20 per month 

 To become a millionaire in 15 years with $20,000 in savings:

•  With a 4 percent rate of return: $2,436.21 per month 
•  With a 6 percent rate of return: $1,837.85 per month 
•  With an 8 percent rate of return: $1,320.54 per month 

 The average annualized total return for the S&P 500 index is more than 9 percent. So start saving!

Here are a few simple, low-stress ways to start investing:

• Sign up for your employer's 401(k) plan and take full advantage of any company match, which essentially gives you free money
• Contribute to a Roth IRA or traditional IRA, an individual retirement account that offers tax breaks
• Use micro-investing apps such as Acorns, which help you begin by investing small amounts of what it calls your "spare change." The app rounds up your purchases to the nearest dollar and automatically puts your coins to work
• Try other apps that aim to make investing simple
• Consider automated investing services known as robo-advisors that can help you out no matter how much you have in the bank
• Research low-cost index funds, which Warren Buffett recommends

Smart Parking Meters

One of my favorite areas of Fort Worth is getting smart parking meters. West 7th Street is quickly becoming quite the evening destination. However, once you are there, you may have to circle a bit to find a parking spot ... or park some distance away. A supply shortage means that the price is too low, especially in the evening. The city is implementing meters that will adjust price based on demand. In the longer run, more garages are also becoming available.

HT: Cindy

Econ talks that you can listen to in your car

Here are some Ted Talks I have blogged, and here are some otherpodcasts I have listened to (mostly those from Planet Money)

I would advise not trying to listen to my online lectures, as they are designed to be looked at on a computer.  (it was frustrating for me when I tried it as there are long pauses so a user can see the material). 

How high should the minimum wage be?

Why do college graduates earn more?

Bryan Caplan suggest that college diplomas don't increase your human capital (give you new job skills), but rather are "signals" that show you are willing to drop out of the labor force (so you think you are high enough quality) and have the discipline to finish a four-year degree. 

Is this moral hazard or adverse selection, and why did BCG get it wrong?

Moral hazard can look very similar to adverse selection.  For example, if you see Volvo's running through stop signs more frequently than other cars, you could infer one of two things:

• Moral Hazard:  the cost of running a stop sign is lower in a Volvo, so Volvo drivers run more stop signs; or
• Adverse Selection: bad drivers are more likely to buy Volvo's so they are more likely to run stop signs.  

In the blog post below, a BCG study compares Medicare Advantage plans to traditional fee-for-service Medicare:

• Single-year mortality rates fell from 6.8 percent in the traditional fee-for-service sample to 1.8 percent 
• Patients in the Medicare Advantage plans had shorter average stays in the hospital (about 19 percent shorter.)
• Patients in the managed plans were more likely to receive preventive care ...For example, diabetic patients in the fee-for-service sample had an average of 11.5 amputations per 1,000 patients; those in HMO plans with global capitation had only 0.3. 

and mistakenly infers moral hazard:

What distinguishes Medicare Advantage plans from traditional fee-for-service plans is the degree to which they use mechanisms designed to encourage the delivery of cost-effective quality care. Three critical mechanisms are financial incentives that are aligned with clinical best practices, a selective network of providers, and more active care management that emphasizes prevention to minimize expensive acute care.

 when the answer is likely adverse selection.  From colleague Larry Van Horn:

Those individuals who choose a Medicare Advantage (MA) plan are historically of a different risk profile (lower), and to the extent that results are case mix adjusted the severity of the MA population is overstated. In short, tough to make the case on the BCG study with which I am well aware.

Some popular blog posts on this topic:

• What happens when a company forgets about moral hazard and adverse selection?
• Why does it cost more to insure a Tesla?
• physician/patients are less likely to deliver by cesearean section
• Moral hazard vs. adverse selection:  President Trump
• More fun and on-topic blog posts.

How does health care differ from ``textbook'' industries?

The incentives are all screwed up:

• Most of it is purchased with Other Peoples' Money:  (Stossel Video)
• Incumbents can keep out new entrants (Managerial Econ blog post)
• Providers can create their own demand (Managerial Econ blog post)

Before going on a date, consult an economist.

Because they know how to develop intimacy.  Another experiment from the book Randomistas:

University students were randomly paired up.  Half the pairs were asked to make small talk, while the other half were given questions designed to build intimacy, such as "What does friendship mean to you?", "For what do you feel most grateful?", and "What one item would you save if your house was burning?".  The intimacy exercise worked so well that one pair of participants got married.

If this happens to you, we would point you to our most popular post ever, Consult an economist before buying a wedding dress.

Never start a land war in Asia--or a price war!

The Washington Post reports that Fidelity seems to be starting a price war with Vanguard, by offering zero-fee mutual funds:

Fidelity’s zero-fee funds include a Total Market Index Fund, made up of 3,000 U.S. publicly held companies, and an International Index Fund, made up of several thousand companies in overseas markets. 

Ironically, Vanguard and Fidelity have been accused of reducing competition among the firms they both own, like those in the airline industry.  Apparently, however, they haven't figured out how to reduce competition among themselves.  If only they had read Chapter 15.

HT:  Mike V.

How to cut opiod prescriptions

First, make sure that clinicians know about patient overdoses! A randomized controlled trial involved 861 clinicians in San Diego:

About half of them served as the control. The other half received this letter: “This is a courtesy communication to inform you that your patient (Name, Date of Birth) died on (date). Prescription drug overdose was either the primary cause or contributed to the death.” ... The researchers hypothesized that the letter would reduce opioid prescriptions. To test that hypothesis, they compared the number of opioid prescriptions a few months before and a few months after the letter was sent. In the control group, prescriptions stayed pretty steady (actually they increased modestly). In the group of clinicians that received the letter, by contrast, prescriptions decreased significantly. And those clinicians were less likely to start new patients on opioids at all.

Incentives of Ride Sharing Drivers

Back in the old, old days, when you hopped into a cab at the airport and asked to go to your downtown hotel, the cabbie would start out and then usually ask something like, "Have you been to this city before?" If you did not know your way, he might take the long way to increase the miles and the fare. The WSJ is reporting that some ride-sharing drivers are now taking longer routes too. 

Passengers aren't on the hook for the higher fare because they pay a fixed upfront price based on the app's estimate of the ideal route. And while drivers are encouraged to go the most direct route, they can choose to ignore their digital navigators for a route that tacks on extra miles. The drivers' pay is determined by the actual trip's mileage and time, which can vary based on traffic conditions or diversions.

In the taxi example, I quiz students on how taxi companies fixed this 'long-haul' problem. The simple solution was to set the fare to a per mile rate plus a fixed fee. By driving the shortest route, cabbies could save time, pick up more passengers and thus more of these fixed fees. I love that there was a simple contractual change to address the moral hazard problem. In the ride-sharing context, the problem may be too inconsequential to fix.

An Uber spokesman said the company estimates longhauling occurs on less than 1% of trips in the U.S. 

Book recommendation: Randomistas

Fun book about the benefits of randomized controlled trials to evaluate medical treatments, social programs, and business practice.  For example, in 2003, CVS ran a randomized trial, stopping price promotions in 400 randomly selected stores. 

Three months later, the evidence was in.  By axing the promotions, CVS sold fewer products at higher prices [yes, demand curves do slope downwards!].  Across the 400 stores that ran the experiment, profits were up.  Not surprisingly, CVS soon put the change in place across all its 9000 stores.  A simple randomized trial likely increased the organizations annual profit by $50 million.

On Gary Loveman, an economist who left Harvard to run Harrah's, and who comes to Vanderbilt to speak, said three are three cardinal sins at Harrah's:

...you don't harass women, you don't steal and you've got to get a control group.

Article: "How health care killed my father"

Long, but good article from the Atlantic documenting the problems in an industry where consumers purchase care largely using "other peoples' money."

The average insured American and the average uninsured American spend very similar amounts of their own money on health care each year—$654 and $583, respectively. But they spend wildly different amounts of other people’s money—$3,809 and $1,103, respectively.

The author's solution (a Democrat), make consumers spend their own money, e.g., with $50,000 deductibles for insurance:

I believe if the government took on the goal of better supporting consumers—by bringing greater transparency and competition to the health-care industry, and by directly subsidizing those who can’t afford care—we’d find that consumers could buy much more of their care directly than we might initially think, and that over time we’d see better care and better service, at lower cost, as a result.

Trucking demand is procyclical!

Website from a trucking company documents the effects of a pro-cyclical increase in demand for trucking:

Well into the third quarter of 2018, the trucking industry continues to experience the highest demand and yet tightest capacity for freight services in recent memory. Unemployment is low, falling to 3.9 percent in June. The national GDP is growing—4.1 percent in the second quarter. The housing market is booming; the demand for homes—both new and lived-in—far outnumbers the supply, so prices are often too high for buyers, according to NPR.

• large and small trucking companies alike saw both revenue and profits grow
• carriers will likely continue to seek rate increases in order to compete in the tightest driver recruiting market in decades.
• June was the 15th straight month in which prices increased on an annual basis in trucking’s spot market. 
• "We believe that this is the strongest normalized percentage level of truckload pricing achieved since deregulation (normalized meaning except for extreme periods of recovery from recession)."
• Some carriers are using most of these rate increases to pay professional drivers more to attract them to their fleets—and to retain the drivers they already have. 
• By the end of 2018, Klemp predicts pay will have increased 12 to 15 percent, a significant bump but still not enough to make up for the 16 to 19 percent shortfall of driver wages when adjusted for inflation. 

For affordable housing, move away from the coasts

This map plots the ratio of an average house to average income:

And as the Brooking article notes, and as I've noted, the lack of affordability in places like California can often be blamed on state and local government measures designed to limit the construction and diversification of housing. Zoning laws and other regulatory barriers to new housing production have decimated housing affordability of housing in many coastal cities.

Cities like San Francisco and Seattle have essentially become playgrounds for the wealthy in which existing homeowners fight tooth and nail any attempt to allow sizable amounts of new housing construction. They do this, they tell us, to preserve "the character of the neighborhood." But what they're really doing is using government regulations to drive up the prices on their own real estate, while driving lower-income people further and further out into the periphery. Oh sure, these Progressive guardians of the local "quality of life" might allow a handful of subsidized housing units to be built. After all, somebody has to make your cappuccino or do your dry cleaning. But the overall effect is to ensure few people can afford to move in.

The costs of obesity

From NY Times:

This economic burden hits low-income and otherwise disadvantaged populations the hardest, exacerbating income and wealth inequality. With insulin now costing up to $900 a month, a diagnosis of diabetes can mean financial ruin for a low-wage worker, especially if it results in uncompensated sick days or underemployment. And as disposable income declines, so too does the ability to afford a nutritious diet, creating a vicious cycle of poverty and diet-related disease.
...
 The total impact of obesity and its related complications on the United States’ economic output has been estimated at between 4 and 8 percent of gross domestic product. Even on the lower end, that’s comparable to the 2018 defense budget ($643 billion) and Medicare ($588 billion).

REPOST: Kidney Hold-up

Its seems that, back in 2012, a woman was fired by her boss soon after she donated her kidney to her boss ... because she was taking too long recuperating from the donation.

“I feel very betrayed. This has been a very hurtful and horrible experience for me. She just took this gift and put it on the ground and kicked it.’’

It seems she was hired, or rehired, so as to obtain access to her kidney. She had an implicit expectation that she would have continued employment post-donation. But after the operation, the decision was sunk and created a holdup opportunity.

Of course, she sued and apparently she lost. This may not have happened if selling a kidney were legal and she could have contracted for compensation. A market would likely have other benefits as it moves assets (kidneys) from low values uses (essentially "spare parts" in healthy bodies) to higher valued uses (bodies with nonfunctional kidneys).

REPOST: Do environmentalists cause pollution?

Carbon credits, designed as a payment to companies who reduce pollution, instead have the opposite effect. 

So since 2005 the 19 plants receiving the waste gas payments have profited handsomely from an unlikely business: churning out more harmful coolant gas so they can be paid to destroy its waste byproduct. The high output keeps the prices of the coolant gas irresistibly low, discouraging air-conditioning companies from switching to less-damaging alternative gases. That means, critics say, that United Nations subsidies intended to improve the environment are instead creating their own damage.

The problem can easily be understood using marginal analysis: pollution credits increase the marginal benefit of producing the harmful coolant. This increases supply, which reduces the price, which encourages more coolant consumption.

When the developed world (UN & EU) threatened to cut off the pollution credits, China and India threatened to release the gas into the atmosphere.  This is an interesting bargaining ploy that works only if the developed world cares more about the pollution than India and China.   

REPOST: Get rich slowly, the power of patience

Patience makes you rich.  I tell this to my kids, my students, and anyone else who will listen.

The theory is simple.  If you have a low discount rate, it means that the future is almost as valuable as the present.  For example, a "patient" person with a discount rate of 5% is willing to invest $100 if she can earn $105 in one year, a relatively low threshold for investing.  In contrast, an "impatient" person with a discount rate of, e.g., 30% is willing to invest only in much more lucrative investments, i.e., those earning at least 30%. 

The difference between the two is that the patient person will make more investments (those with a return between 5% and 30%) which will make the patient person rich.  Patient people invest more in education, smoke less, exercise, and watch their weight.  These activities all demonstrate a concern with the future, at the expense of the present. 

 Here is some new evidence:

Patience boosts wealth by much more than marriage or religion. Respondents with discount rates more than one standard deviation above the average of the sample had 29% less net wealth, a loss of around $130,000. More impatient people—similarly controlling for religion, income, race, sex, optimism and education—were more likely to smoke, drink excessively, and miss out on their flu shots and medical examinations.

The title of this blog post is stolen from colleague Bill Spitz's terrific book

Larry on Healthcare/incentives/Amazon

Colleague Larry Van Horn is a gem!  When you listen to his interview, pay attention to the economic principles: how bigger deductibles, which make consumers spend their own money on health care, change incentives and firm strategy.

Can inequality cure poverty?

Former student Quinn Connolly's book review of Steven Pinker does not put it that way, but:

According to Pinker, this “confusion of inequality with poverty comes straight out of the lump-sum fallacy—the mindset in which wealth is a finite resource.” Helpfully, Pinker reminds us how the Enlightenment revolutionized our understanding of economics. First, by teaching us that wealth is created; and second, by showing that we can make more of it.

Can Economics teach us how to live?

Former student Quinn Connolly translates Jordan Peterson’s Rules for Life into economics:

•  Signaling, “Stand up straight with your shoulders back.”
•  Moral hazard. Rule No. 2 is “Treat yourself like someone you are responsible for helping.” 
• Asymmetric information. Rule No. 9 is “Assume that the person you are listening to might know something you don’t.”
• Short-termism. ...shortsighted thinking can be used to justify absolutely anything and therefore “breeds nothing good.”
• Future Value.  “Pursue what is meaningful, not what is expedient.” 

Judge Leon (ATT/Time Warner) Should Have Read Chapter 16

If he had, the U.S. Dept of Justice might not have appealed Judge Leon's decision, arguing that he ignored the economics of bargaining.

The DOJ brief relies almost entirely on economics to make its case that when a vertically integrated content provider like ATT/Time Warner fails to reach agreement with a rival distributor, like Comcast or Charter, some consumers will shift to ATT's distribution (DirectTV).  This gives a merged Time Warner a better alternative which will allow it to capture a bigger share of the proverbial profit pie.

The ideas of Chapter 16,

The alternatives to agreement determine the terms of agreement

is reflected in the appellate brief:

It is fundamental to the economics of bargaining that a party derives leverage from having the ability to walk away, even if it never actually does so. If Time Warner truly could not walk away and the MVPDs knew that, it would have no leverage at all. 

All of this matters, because economics is what gives coherence to antitrust enforcement:

“To abandon economic theory is to abandon the possibility of a rational antitrust law.” Robert H. Bork, The Antitrust Paradox 117 (1978). That is what the district court has done, and why its ruling constitutes error. 

Optimal Stopping: How long should you search for a mate?

Computer scientists say that 25% of your time should be spent searching before you make an offer (propose) if you have a 50% chance of being rejected, then make an offer to the next person who exceeds the maximum of the first 25%.