Friday, April 18, 2014

A Test of Recycling

I've done the experiment suggested in this video.

For some things, there is no value in recycling. For others, there is good value. I recently upgraded from 15 year old appliances, and I had to dispose of them. I put an add on Craigslist for my dishwasher and microwave, offering them free to whomever would pick them. I had too many calls and emails to count. Unfortunately, nobody wanted the glass bottles and aluminum cans I offered.

Tuesday, April 15, 2014

Friday, April 11, 2014

Chillin with a Billionaire

The Rotary Club of Marietta was pleased to host Marietta Kiwanis for a joint meeting this week. We were very happy to have Home Depot Co-founder, Atlanta Falcons owner Arthur Blank as our speaker. You can read some of the details here, although he talked about much more.  It was a good time. Even Loxxii enjoyed the day.

Tuesday, April 8, 2014

Lost and Found in the Financial Waters

On March 8th, Malaysia Airlines flight #370 disappeared. To date, it has not been located. With only a vague sense of the plane’s last reported position, searchers face a seemingly impossible task to locate the lost airliner. This sad event is strangely similar to an incident which occurred almost 46 years ago. The outcome of that search was both interesting and pertinent to investors.

In May 1968, the US Navy nuclear submarine USS Scorpion was lost at sea. Since technology at the time was more primitive, the Navy knew the boat’s last reported location, but had very little idea of the boat’s final position. Traditional search efforts produced no new information. Dr. John Craven of the Navy’s Special Projects Division worked on the search. He compiled a list of possible scenarios for why the submarine was lost. He then asked an unusual team of experts from diverse backgrounds to theorize about the disappearance. Instead of asking these experts to brainstorm together, he asked each one to speculate on the likelihood of each scenario.  He placed a wager (a bottle of Chivas Regal) on each of several details: the boat’s course, it’s speed, the angle of descent when the submarine sank, etc. Although none of these bits of data were enough to reveal the boat’s location, Dr. Craven was able to use them to form a composite of the ship’s final descent. He used Bayesian probability theory to put all these diverse guesses together into what was essentially, the collective guess of his group of experts. Craven’s composite location was not a spot any one of the experts had picked. As James Surowiecki noted in his book TheWisdom of Crowds: “The final estimate was a genuinely collective judgment that the group as a whole had made, as opposed to representing the individual judgment of the smartest people in it. … Five months after the Scorpion disappeared, a navy ship found it. It was 220 yards from where Craven’s group had said it would be.”

Craven’s success hinged on four requirements for collective wisdom: diversity, independence, decentralization, and aggregation. Craven purposely selected participants with diverse skills and experiences. His group was not merely a who’s who of submarine experts. He ensured independence and decentralization by instructing the participants to work separately and for their own benefit (the chance to win the Chivas). Finally, Craven used mathematics, Bayes’ Theorem, to aggregate the independent analyses. These same four criteria are crucial to the wisdom of financial markets. When these conditions are met, markets are generally efficient. This is why indexing (at least the low cost variety) is generally a good way to allocate investments. However, when any of these conditions are absent, market efficiency breaks down. As financial advisors, we favor passive investments and other ways to capture the wisdom of the markets, while regularly monitoring markets for signs of a breakdown in what makes markets wise.

Financial markets are usually diverse, by default, as they contain participants from all different backgrounds.
Ironically, about the only real threat to diversity in the financial markets is the rise of index investing. To see this, consider the extreme where every investor is 100% indexed. This creates a total absence of diversity. Investors would essentially destroy market efficiency by pursuing it. Fortunately, this is not a significant threat. Active investing thrives in many forms, and among passive investors, specialization helps maintain diversity. Similarly, an extreme shift toward index investing would be the primary threat to breakdown decentralization. As it is, today’s biggest failures of centralization are in small company retirement plans. For cost and regulatory reasons, many companies offer employees very limited investment choices via their retirement plans. These top down decisions are limiting to investors. For this reason, it is generally best for investors in these restricted plans to stick with index options (if available) among the major assets classes. Modern financial markets have little risk of aggregation problems due to information technology and the widespread availability of financial market data.

A breakdown of independence is much more likely and more important for investors. As Surowiecki notes, independence is tough to come by for  social creatures. We learn from and often mimic each other, but the more we think the same things, the more likely we are to make the same mistakes.  Independence is important to decision making for two reasons. First, it helps prevent our mistakes from becoming correlated. Second, it makes it more likely new information will find its way into the marketplace. Putting these two concepts together means that when new, but poor or irrational information comes into the marketplace, it doesn’t make the crowd any dumber. 

There are two crucial cases where a lack of independence impacts financial markets.  The first impacts active money managers. As John Maynard Keynes noted, it’s better for one’s reputation to fail conventionally than to succeed unconventionally. Thus, active fund managers eager to protect their jobs often end up mimicking each other and the benchmarks they chase. This neutralizes any skill advantage they might have, and makes the overall market less efficient. In other words, active managers turn their funds into quasi index funds, but with higher costs. This ensures most managers will trail their benchmark index in most years. For investors, the appropriate counter to this problem is to seek truly independent managers whenever they deviate from indexing. Specialists with an absolute return mandate and an unconstrained investment policy are least likely to lack independence, as they carry little career risk for trailing an index. These managers won’t magically beat the market, but they can offer style diversification to an otherwise indexed portfolio, and help hedge client portfolios against conventional failure.

The second failure of independence occurs when this type of herding spreads from a small group and engulfs nearly all market participants. This is known as an information cascade, where people’s decisions are influenced, even made, by others. Stock market “bubbles” are examples of such cascades where investors mimic each other and chase returns without independent analysis. Consider the technology roller coaster of1997-2000. In 1997, sweeping tax changes were enacted. A significant cut in the capital gains tax was passed, along with significant reform of taxation on home sales. Additionally, the Roth IRA, a permanently tax-free savings account was created. These changes were enacted during a period of low interest rates and an expanding economy. The surging stock market was unsurprising given these conditions. As the economy grew and stocks soared, the demand for liquidity in the economy was not met by the Federal Reserve. Gold prices began to fall and deflation developed. This forced oil and energy prices to decline, further boosting most corporate profits. It also created reverse bracket creep, further improving after-tax returns. Much of the new capital was directed to the booming technology industry. With low interest rates and soaring stock prices, most of these new ventures were partly or completely equity funded. Due to the strong dollar and low capital gains taxes, employees preferred equity compensation over salaries. As deflation continued, heavily indebted companies were impacted, but the new, mostly debt free technology sector was unscathed. While the overall stock market advanced, technology stocks exploded higher, and the burgeoning financial media was right there to report on it every day. With financial television, an entire generation of investors was born overnight, and they immediately learned there was only one way to invest: buy technology.

All good things must end, usually at the hand of the Federal Reserve. By 2000, the Fed was concerned the economy was growing too rapidly. In their model, this must result in higher inflation, so the Fed announced a series of interest rate hikes. The economy slowed and technology stocks declined sharply from 2000-2003. Many rode technology stocks all the way down. Blinded by the trailing returns, they missed or ignored the change in Fed policy. During the entire roller coaster, the market contained diversity of opinion, but not much independence. Many investors warned of a pending correction, but few had the ability and capital to act on the contrarian view. Only a few hedge funds and contrarian managers did well in these three years, by avoiding technology and focusing on value elsewhere. However, it was a painful cycle for many.

For individual investors, a few techniques can help avoid these errors. Setting portfolio allocation parameters and regular rebalancing can limit the impact of individual asset or sector surges and crashes. Market indexes and passive investing are buy and hold strategies. There is a great amount of independence gained by simply rebalancing regularly. This amounts to basic diversification, and it works, as long as one has the discipline to abide by it. Additionally, investors can better notice new information by shifting their short-term attention away from market action. If one wants to monitor financial activity closely, it is better to study macroeconomic activity.  Much of the late 1990s technology boom was logical, and the market was wise to favor those stocks. The new information, which changed those conditions was macroeconomic in nature, easily missed by those chasing one– year or three-year returns.

Financial markets generally exhibit the wisdom of crowds. It’s not worthwhile for individuals to try to beat the crowd, but if one understands what makes the market wise, it’s possible to avoid being caught in a stampede.

Monday, April 7, 2014


1. High Frequency Trading (HFT) is not bad, nor should it be banned. It is a direct result of competition, and it helps make our markets efficient. As KD notes, it helps, not hurts, the little guy.

2. The difference between law and legislation is significant. As Don notes, Law does not require Legislation for its creation or enforcement. A great example is jumping ahead in a line. Here's the law on joke stealing, without legislation. Here, the baseball version.

3. April Fools. I found two noteworthy entries. One takes a tongue in cheek look at Westerners' fascination with all things Eastern. Another pokes fun at the omniscience of regulators.

4. It is both thrilling and humbling to see someone you know do something well. Loxxi continues to shine.

5. I'm neutral on unions. In a voluntary situation, I'd support any decision workers make to coordinate. I think in reality, most unions are like most bureaucracies: wasteful to most, extremely beneficial to the elite few. I'm intrigued by the idea of college athletes forming unions, as the NCAA seems to be a pretty clear cartel. Maybe unions are what are necessary to bring some accountability to the NCAA. However, let's be honest. College athletes get a very good deal. If they are exploited, please, throw me in that brier patch.

6. It's for Charity, so fuck you copper.

Saturday, April 5, 2014

Let's Make Subsidies History, not History Subsidies

Dear Editors,

I hereby nominate Marietta Councilman Stuart Fleming as this month's man on the margin. A crucial concept in economics is that all change takes place on the margin. For a camel hauling ten thousand straws, it may take only one additional straw to break the camel's back. Last month, Councilman Fleming grossly misjudged the marginal impact of highlighting boarded, blighted properties. However, his recent effort to evaluate how the city subsidizes entities such as the history museum is potentially revolutionary. Not only is the subsidy for the museum significant, but historical tourism is a primary focus of the city's economic development program.

In debating Councilman Fleming's question, the City Council really has two issues to consider. First, should the city be subsidizing tourism (or any economic activity) in general? Is it a valid function of government to take from one group of citizens (property owners and taxpayers) to give to other groups (business owners). Conservatives tend to prefer a limited role for government and favor the emergent growth resulting from allowing taxpayers to make their own decisions on how to spend their dollars. Liberals tend to prefer a broader role for government and favor taking dollars from taxpayers to be spent more appropriately by government officials. Historically, Marietta has taken the liberal route when it comes to economic development. Perhaps Councilman Fleming will be the marginal vote to change that approach?

Second, only if the answer to the above is yes, should the city then consider the best ways to subsidize economic activity. Which subsidies do the most good for the least amount of harm? How does the subsidy for the history museum measure on an absolute value, and relative to the city's other options? On this point, the issues unique to museums are considerable. Most incorrectly assume a museum's customers are the viewers of the art or artifacts, when in reality, the true customers are the donors. Museums exist to provide legacy benefits (as well as tax, networking, and social goods) to donors. The current museum subsidy assumption is that the museum will be a marginal factor for visitors deciding to come to Marietta. In reality, visitors make those decision on other factors, and those who do visit may partake in the museums because they are here for other reasons. The serious fans of history are willing to spend significant resources to consume their hobby. However, they often do so in the private marketplace. Instead of spending time and money to travel and stare at a wall, they spend time and money to purchase artifacts for their own collections. In short, the beneficiaries of the city's subsidies to the history museum are local donors. This may be a valid use of public funds, but it is an ineffective way to achieve economic development.


Russ Wood

Eat more Chicken, at Popeyes?

I like Chik-fil-A. They have good food, and free wi-fi.
But they block my favorite blog out of ignorance.


I'll test the Popey's wifi and see if a switch is in order.

Monday, March 31, 2014

To Me, and To You

In Case You Missed It

Good stuff from the past week.

1. A rare victory for common sense: Drone Edition.

2. Social Justice. Nice phrase, but what does it mean

3. Because your president does not understand economics, you are now banned from selling your old chess set, or used piano, across state lines. I shit you not

4. There's a new way to access some of the best poker content on the internet. Just in time for the WSOP.

5. Here's yet another way the government bailout of General Motors was harmful to the public.

6. Kid Dynamite returns to Vegas. Part 1. Part 2.

7. This is cool. Literally.

8. DFW on grammar.

9.  Biofuels are evil, according to the UN.

10. It really is better to give than to receive.