Monday, April 30, 2012

Is a Vote for Obama a Vote for Inequality?

Lies, damn lies, and statistics

Two truths provide endless entertainment.  First, we all should know politicians are masters of using statistics to distort the truth.  It’s fun to watch, but it’s sad that so many voters don’t see through it.  The fun is trying to determine which politicians are good liars and which are so stupid that they believe their own lies.  As voters, we have to decide whose lies are most destructive.  Personally, who is more destructive seems more important than who’s the bigger liar. 
Second, journalists can be equally entertaining when they have to deal with numbers.  It’s easier to forgive journalist.  By definition, their expertise is words not numbers.  When a politician dismisses the trillion dollar deficits of the current administration as nothing different from the hundred billion dollar deficits of the last administration, one can forgive journalists for not noting the dollars to dimes difference on order of magnitude.  So, regardless of whether one thinks the differences are justified, it is foolish to look to the media to help one assess the difference.    

However, as with politicians, one has to wonder whether it is ignorance or intent that distorts journalistic endeavors.  It does become annoying when one suspects a supposed reporter is editorializing. It’s a major failing of our journalism schools that they don’t teach the difference between the editorial pages and the news pages.
“All well-and-good” you say, but what does that have to do with whether a vote for Obama is a vote for income inequality.  Simple.  Let’s turn to “lies, damn lies, and statistics” as it is reported by journalists and used by politicians.  A recent example is an article entitled “Wage Divide Grows Wider” in the April 18, 2012 print WALL STREET JOURNAL or “Workers' Pay Divide Persists” online.
The article starts out saying “The gap between America's highest- and lowest-paid workers is widening.” It cites: “Labor Department figures released Tuesday show that between the end of the recession in mid-2009 and the first quarter of 2012, earnings of Americans at the top—meaning those who earned more than 90% of all workers—rose 7%, before adjusting for inflation. During the same period, wages of those at the bottom—meaning those who earned less than 90% of all workers—rose 2.5%.”  
“Mid-2009” on!  That is Obama’s show any way you look at it.  There wasn’t an opposition at the Federal level worth mentioning until the legislatures elected in 2010 were seated the following year.  Even then it was only one house of Congress.   So, based only on the data, Obama is promoting income inequality. 
Alas, the truth is that most class warfare rhetoric about income inequality is just noise made to appeal to a constituency.   Nothing illustrates that better than the fact that Obama has made the gap between top and bottom a theme of his re-election campaign. To quote his State of the Union: "We can either settle for a country where a shrinking number of people do really well, while a growing number of Americans barely get by, or we can restore an economy where everyone gets a fair shot."  Talk about hypocrisy.  Create inequality with a massive “stimulus,” then rail about it as if you would do something about it.  That’s the “lies.”
The article goes on to note: “That pay difference predates the global financial crisis: Between 2003 and 2007, wages grew 12.9% for high earners, compared with 8.4% for the lowest-paid 10% of workers.”  Those who keep score on a political basis might find it interesting that during the Bush recovery the bottom 10% did a better job of keeping up than during the Obama recovery.  The difference wasn’t small either. Under Bush the growth rate for the bottom 10% was about two thirds of that for the top 10%.  Under Obama it was one third.  The interesting thing is that since high incomes tend to grow faster during expansions, Obama’s failure to stimulate economic growth should have produced a convergence of income growth rates relative to the better economic performance under Bush.  That’s the “damn lies.”
But, it is just the beginning of “lies, damn lies, and statistics.” Why does the article ignore 2007 until mid-2009? The answer is because the writer isn't reporting meaningful data. Starting out with an agenda and finding data to support your conclusion is not quality reporting. Upper incomes are more volatile as in high beta wealth. By ignoring periods of recession the article turns the tendency of upper incomes to fluctuate most over the economic cycle into what looks like a trend.  That’s the “statistics.”
There are at least two unfortunate consequences of this game of “lies, damn lies, and statistics.” First, the game can be played while ignoring the volatility of incomes.  One suspects it is intentional. Politicians find it convenient to promote the notion of a plutocracy in order to support their class warfare substitute for serious thought.  Sort of a “keep ‘em stupid and in their place” approach.  
Reporters can avoid reporting information that would challenge peoples’ preconceptions.  Reporting news is much easier if the news isn’t unfamiliar.  Besides, avoiding things that are unfamiliar is easier for the mentally lazy. 
That it leads to stupid decisions is just an unfortunate side effect.   What if income gains for the poor and middle income groups can only occur when the upper income tail of the distribution goes up more?  (For the math geeks, what if the median, kurtosis and skew are all dependent of the same variables?  After all they are all a part of the same distribution).  It doesn’t decide any issues, but it’s worth knowing.
Second, we avoid addressing or even discussing the important issue of mobility and opportunity.  Scott Winship of the Brookings Institution is quoted in the same article as finding that “there aren't signs of weaker social mobility between the poor and the middle class over the past 60 years.” 
There is data relevant to mobility.  The best data is longitudinal data that tracks incomes of a large sample of people over time.  Follow up surveys and personal historical reconstructions have also been used to address the issue. My impression is we know mobility hasn’t changed a lot, but we are measuring with a yardstick.  That’s fine unless inches have major social implications.  What if inequality can only be reduced by eliminating mobility?  What if minor changes in mobility have major implications for the stability of a society?

Friday, April 27, 2012

Can a Controversy Exist If Only a Referee Participates?

Truly a head scratcher

One would think a controversy would require some new disagreement between people besides the referee. Evidently not. Seems the JOBS Act has created a controversy without new contesting opinions. Let’s start with a little background. The WALL STREET JOURNAL reported on April 12, 2012 (“JOBS Act Jolts Firms to Action”) that “Two companies have submitted confidential plans for initial public offerings under the JOBS Act that was signed into law last week, an indication that some firms and their backers are moving quickly to capitalize on the controversial measure.”

What’s the controversy? As always, there are those who might buy and those who might sell. Is that the controversy? One has to hope not. That is a market. There are people who participate in new offerings and people who don’t. Is that the controversy? Hardly. That’s true of any market unless the government enacts a mandate that everyone participate. Beside, as we saw when the government tried to open up IPOs during the tech bubble and then restrict IPOs when their actions backfired, it is dangerous to try to manage market participation.

One of the absurdities of those who want to report a controversy is what they use to justify the notion. One provision of the JOBS Act is that certain companies can file draft registration statements for their IPOs on a confidential basis for review by the SEC staff. Before it had to be made public in an initial filing, usually made several months before an IPO is actually priced and completed. The JOBS Act allows qualifying companies to postpone public disclosure of such information until 21 days before they launch a series of "roadshow" meetings to sell the IPO to investors. Because such meetings usually take about 10 days, the result is that investors may only have a month to scrutinize disclosures instead of three months or longer. That time difference is the great controversy.

To support the contention that the two month difference is controversial they use the example of online coupon company Groupon Inc. Groupon revised the first quarterly financial results it reported as a public company. It discovered that executives failed to set aside enough money for customer refunds. The changes reduced fourth-quarter revenue and widened its loss.

Alas, you respond, “Don’t companies that have been public for decades have to revise financial results?” Yep! “Didn’t Groupon go public under the rules that existed before the JOBS Act.” Yep! You got me again. Fact is Groupon is totally irrelevant.

Will some people lose money investing in the IPOs made possible by the JOBS Act? For sure. Hopefully, that’s not controversial. It’s true of all investments. No matter how good an investment is, someone will figure out a way to lose money on it. Investing is risky. IPOs are particularly risky, and most investors should avoid them. No regulation can change that. They can have a roll in a diversified portfolio, but as has been argued in previous postings, angel investing is probably a better portfolio fit for many investors.

The JOBS Act shouldn’t be subjected to contrived controversy based on the referees’ aspirations for power. Startups are too important to be made the political football of power hungry regulators or their mouthpieces.

Wednesday, April 4, 2012

Predictions: Win Some, Lose Some.

So what if it’s not January.

The last posting, “Investing PART 15,” mentioned that volatility this year would be different from last year. The difference affects the return on the investment strategy discussed in that posting. The logic: One of the factors determining option prices is volatility. So far this year, volatility has been more like the second half of 2010 than 2011. Thus, it seems the prediction that volatility this year wouldn’t resemble 2011 has been borne out, and it has affected the return on the strategy. Nevertheless, the nickels are still there to be picked up.

My second fearless forecast looks more questionable. Logic would suggest that sometime this year financial economists should recognize that the concept of (and purported measure of) the risk-free rate of return is a joke. It seems logical since both the President and congressional leaders (of both parties) openly discussed defaulting on Treasuries. (Treasuries are the traditional definition of the risk-free rate of return). So, default risk is there. (If you think not, look at how the voluntary Greek rescheduling was structured. One has to be increditably naïve to think that the US government wouldn’t resort to the same sort of picking winners and losers. Just make it politically advantageous and it will happen).

Bernanke and other Fed official regularly debate when rates will rise. That will affect the price of existing bonds. So, interest rate risk is apparent. To argue there is no downgrade-risk is counter factual. The currency risk was highlighted earlier last year when we saw an international flap over the currency impact of Fed policy. In the April 1, 2010 posting on this blog, “Beware the risk-free return,” other risks were discussed.

Yet, financial economists persist in misinterpreting risk in order to defend the theoretical edifice they’ve built. This blog has often pointed out how that theoretical structure yields some very useful ideas that can be employed to increase return and reduce risk. However, keep in mind that the mathematics of the structure are often employed to fabricate a quantitative precision that just doesn’t exist in the real world of investing. More importantly than false precision, the edifice is misleading investors regarding risk.

To illustrate, the ECONOMIST (3/17-23/2012) had an article on the spread (i.e., difference in returns) between stocks and Treasuries (“Shares and shibboleths: How much should people get paid for investing in the stock-market?”). The spread is known as the equity risk premium. The article first discusses before the fact verses after the fact risk assessment. That investors are sometimes wrong isn’t a very enlightening explanation of the spread. Then the article provides the following very traditional definition:

“Another explanation for the high returns is a paradoxical one: that equities have become less risky.”
“The first step is to define the equity risk premium more exactly….break it down into the following components: the dividend yield, plus the real dividend growth rate, plus or minus any change in the price/dividend ratio (the inverse of the dividend yield), minus the real risk-free interest rate.”

This is all well and good EXCEPT that the conclusion that equity risk is the total explanation is wrong mathematically and factually.

Mathematically the spread is the difference. It is wrong to attribute a difference to the value of only one of the two numbers that generate the differences. The math is wrong if one focuses just on the risk in equities. One can’t solve a - b = c and d - e = f and c > f for a, b, d, or e. The equations say nothing about the relationship between a and d. Just assuming that b = e is a copout. The result is simply a restatement of the assumption.

Factually, 1) Treasuries have been downgraded from their almost default risk-free status. But, even when Treasuries where triple A, there was always some default risk. 2) Short maturities reduce but do not eliminate interest rate risk. 3) Especially since, as implied in the WALL STREET JOURNAL (3/26/2012) article entitled “Treasuries Pile Up With Dealers,” the assumption of perfect liquidity is violated. When dealers have to accumulate Treasuries beyond levels they require in order to maintain a liquid market, they are creating the illusion of liquidity by suppressing price discovery. The violation of the assumption of market liquidity should be the nail in the coffin of risk-free return nonsense. Risk-free without market liquidity that supports price discovery is a contradiction. As Spock would say, “that is illogical.”

In short, Treasuries have risk and a change in the level of that risk is an equally logical explanation for changes in the equity risk premium. Investors would be well served if financial economists would sacrifice their quantitative precision and actually address risk.