Robert H. Heath

Jeremy Siegel: Stocks for the Short Term

Jim Hawthorne -

You're right that the 1929 peak for the DJIA was not recovered until 1954.

Siegel's calculation includes reinvestment of dividends and is inflation-adjusted. As a consequence of the market decline in the the 1930's, dividends were meaningful. And of course, the first half of the 1930's were deflationary, so it is reasonable that on a inflation-adjusted basis, with dividends reinvested, an investor in 1929 would have been "back to even" by 1946.

Joe Nocera on Value at Risk: Not as Useless as Advertised, But...

Guldimann's paper is well worth reading and is a nice antidote to the "VaR Models Made Me Do It!" theme that pervades the Nocera article (which is also worth reading).

It should be noted that ANY incentive compensation system can and, with enough dollars at play, WILL be "gamed". The fact that traders consciously or unconsciously figured out that they could stuff risk into the fat tails without being charged for that risk is a new twist on an ancient practice.

Twenty-Two Years of Job Creation Wiped Out in a Single Day

"But the news that our economy lost 75,000 jobs
yesterday needs some context."

Here's some context from Alan Greenspan (writing in 2007, "The Age of Turbulence", p. 169-170)

"Out of nearly 150 million people employed in the workforce, 1 million leave their jobs each week. Some 600,000 quit voluntarily, while roughly 400,000 get laid off, often when their companies are acquired or downsized." (1)

So, in normal (non-recessionary) times 400,000 per week or 80,000 per workday get laid off. In this context, 75,000 layoffs all announced on the same Monday seems less shocking.

Obviously, we're in a recession; so the layoffs that occur at Caterpillar's headquarters are not being fully offset by hiring at another firm, or even by Caterpillar itself at another facility.

A NET loss of 75,000 jobs per day for a full year would indeed be devastating to our economy. But in our expansive and dynamic economy, it's apparently not that remarkable for 75,000 positions to be eliminated in a single day. But layoffs tend to be large-scale and widely publicized whereas job creation tends to occur one employee at a time without fanfare.

According to the Bureau of Labor Statistics, payroll employment (establishment survey, not seasonally adjusted) shrunk 3.0 million from the peak in November 2007 through December 2008. That comes to NET job losses of 230,000 per month, or about 11,538 per work-day. If 75,000 jobs were eliminated each work-day over this period, then more than 63,000 were created each work-day, most without so much as a press release, let alone an NYT article.

The real issue as you point out -- and journalists routinely overlook -- is the slowdown in job creation.


(1) Alan Greenspan's figure of 150 million employed was undoubtedly based on the household survey, which captures about 5 million additional workers, many self-employed, who are not included in the institutional survey. He was probably also rounding up.

Digital TV Providers Stand to Profit from Many New Subscribers

I think it is highly doubtful that cable and satellite TV providers will see a meaningful uptick in subscribers due to the analog cut-off.

Sure, some households like your parents will make the switch. But even without a $40 converter box subsidy; spending $50 to $100 on a DTV converter box from Best Buy is equivalent to one month's cable or satellite bill. It's pretty clear that over-the-air households don't care so much for the additional channels available on satellite and cable or they would've switched already. Non-subscriber households are generally more rural, more price-sensitive and less interested in 400 channels than cable or satellite households.

I will be surprised if significant numbers of these households sign up for the recurring monthly expense of a cable or satellite bill in these challenging economic times.

Sure, a small fraction of OTA households may be too rural -- or conversely too urban -- to get a reliable over-the-air digital signal so they must turn to satellite or cable if they want a signal at all. But as an investor I'm more concerned with existing subscribers (whose numbers dwarf non-subscribers) downgrading their services by canceling HBO or giving up the premium digital tier.

Like all subscription-based businesses, cable and satellite benefit from consumer inertia making them somewhat defensive in a recession, especially compared with more ad-dependent media companies.

But I would not bet on a big boost from the digital switchover.

Jeremy Siegel: Stocks for the Short Term

Thanks for the article, but I advise caution.

Siegel's graph indeed shows that US equities -- held for a sufficiently long time -- have delivered higher real returns than bonds, bills, gold or cash. That's utterly consistent with modern financial theory that says that investors demand (and historically have received) a higher expected return for bearing the higher risk of owning equities.

Siegel's work also suggests that one can diversify much of the short-term volatility of equity risk by holding equities for a sufficiently long time, much as one can diversify idiosyncratic equity risk by holding a portfolio of stocks rather than one or two names.

But keep in mind that a plot of an ordinary least squares regression line through a data series that follows a random walk will always exhibit apparent cases of “regression to the mean” over some time frequency. That’s in the nature of the math, and not necessarily indicative of a mean-reverting tendency of the process being analyzed. True, Siegel claims that US stock returns exhibit a mean-reverting tendency because the decline in the standard deviation of average annual terms over lengthening holding periods is lower than one would expect in a true random walk. But note that this phenomenon manifests itself when you consider holding periods of five years or longer. (1) As Siegel puts it “…[US] stocks… have never offered investors a negative real holding period return yield over periods of 17 years or more.” (2)

This is not to say that the chart is uninteresting. A plot of major US market indices shows long periods (18-25 years) of below- and above-trendline performance, which might be suggestive of changing investor tastes or demographic trends playing out on generational time-frames. But again, caution is in order here. If you have 200 years of data to evaluate 20-year trends, you have only ten independent data points.

As regards a short-term market call, your excerpted chart shows that the “regression to the mean” that followed the “oversold” market in 1974 took 20 years to regain the trendline. These facts and indeed Siegel’s advice against market-timing hardly seem consistent with a recommendation for a short-term trade, even one with a “nice cushion” of 750 on the S&P and a holding period all the way out to April.

Finally, I doubt any of this provides comfort to an investor who loaded up on Japanese equities in 1989 with the Nikkei Dow at 38,000. Unless Japanese stocks increase four- to five-fold this year, Japanese investors from 1989 are facing a twenty-year holding period with a significantly negative return.

(1) See Siegel, Stocks for the Long Run, 2nd edition; page 32, figure 2.4

(2) Ibid., at 26

Defending VAR - But You Still Need Common Sense

morph366 -

I'm not sure which part of Ms. Reyent's conclusion you disagree with. In her words:

"A financial model is never a complete representation
of what is going on in the markets and was never meant
to replace judgment as well as common sense."

In yours,

"Risk analysis should be a lot more about understanding
human emotions - fear, panic greed and peer pressure
- and quite a bit less about mathematics and Monte Carlo
simulations."

You seem to be in violent agreement on this point.

cr0bar -

Thanks for the response.

I encourage you to re-read the Nocera piece in the NYT as I just did. For me, the most interesting bit is the anecdote about Goldman Sachs losing money on their mortgage desk for 10 straight trading days. I'm quite sure that Goldman's risk models (including VAR) would characterize this as an outlier. So what did Goldman do? They apparently compared what was actually happening to their models' predictions and concluded:

1) the world had changed, or
2) the models might be mis-specified, or
3) they couldn't explain what was happening.

Either way, they decided to "get closer to home." That's what I call testing and re-testing the model. Goldman didn't distinguish itself by avoiding the use of risk models; it has come through the current crisis (relatively) unscathed precisely because of *how* it used them.

Regarding your other point, I think we are in agreement that taking no action with regard to a potential wager is risk-free (at least as regards that specific bet). But I don't think introducing the concept of "luck" -- by which you seem to mean a good outcome despite a foolish wager -- informs the debate. The issue I raise is how do you evaluate the risk/reward of an inherently uncertain bet *before* the outcome is known?

For my part, I prefer to have information -- conditioned by my beliefs about the relevance and validity of that information -- as opposed to willful ignorance. As I cannot peer into the future, the information I have is necessarily limited to past experience. So, in my view, using information about the past to make predictions about the future is rational. Willfully ignoring information is irrational.

When Taleb's valid observations about outliers get converted into prescriptions to ignore historical data, I wonder exactly how one is expected to follow this prescription.

Defending VAR - But You Still Need Common Sense

From cr0bar:

"This is a black and white issue, if the models are wrong
they are wrong, not a little bit right."

With all due respect, this assertion has a nice rhetorical ring, but no substance whatsoever except for the nihilist.

A VAR model, like any other model, is an *intentional* simplification of the real world it attempts to describe. We already have the real world, in all its elaborate and bewildering complexity, so we build models that are simplified abstractions to further our understanding. If a model that is "a little bit right" is therefore "wrong" by your lights, then all models are (intentionally) wrong, your position is nihilistic and this debate is pointless.

A sophisticated user of a mathematical model -- whether for risk management, weather prediction, or discovering underlying causes of diseases -- attempts to understand the models strengths and weaknesses (by comparing its predictions to the real world) and takes both into account when drawing conclusions.

It is undoubtedly true that senior bank executives took false comfort from various risk analytics and allowed their firms to take on far too much leverage with disastrous consequences. But false comfort and excessive leverage are not the fault of the models any more than flood damage is *caused* by the model that produces your local weather report.

I assume you occasionally consult the weather report before deciding how to dress in the mornings and whether to carry an umbrella? And you are probably grateful that airlines check the weather before flying even though weather reports are notoriously unreliable and frequently wrong. If so, you are living proof that one can receive probabilistic information and act on it with something resembling free will.

Also, "[sometimes]... no information is better than bad information" really makes no sense without a predicate assumption about how one uses that information and a corollary about the consequences. What matters is what one does with information (or the lack of it). If you mean, "Possessing bad information, believing it without reservation and acting upon it with adverse consequences is worse than having no information, not acting and therefore not suffering the consequences”, I suppose that's trivially true, but only because I've stipulated that the outcome was negative. That's what logicians call "begging the question".

It’s equally true that “Sometimes bad information is better than no information.” If you received a hot tip that Steve Jobs suffered a heart attack, immediately shorted AAPL, closed out your position at a profit and subsequently discovered the rumor was false, you’ve still profited from the “bad” information. In fact, someone in possession of good information that Steve Jobs had NOT suffered a heart attack might have lost money betting the other way. So, I suppose it’s also true that bad information is *sometimes* better than good information, depending on the outcome.

If “bad” information can be worse or better than good information, how are we to decide which bad information we should accept or reject ex ante?

I’d build a model, make some predictions and test the predictions against real-world outcomes.

The Problem of Media Economics: Value Equations Have Radically Changed

* "To me, these two incidents represent media value equations
* that have radically changed. It seems that most media companies
* still haven’t figured out how to adapt to or even understand the
* changes to the fundamental exchange of value in media."

* "Some of that stems from a failure to understand legacy media
* economics."

I think media companies understand very well the "changes to the fundamental exchange of value in media." And they almost certainly understand their legacy economics. What is widely misunderstood (outside the large media companies) is that the legacy value of a particular unit of "content" -- "Becoming Jane", for example -- is largely determined by high tightly the content owner can control its distribution.

In all likelihood, your inability to rent "Becoming Jane" online is a result of Disney's agreement to provide DIsney/Buena Vista releases exclusively on Starz for a prescribed period of time. (For more information, although not much, since " the terms of the settlement preclude any public comment." see www.multichannel.com/a...)

This agreement supplies Starz with a steady stream of movie titles and Disney with the ability to pre-sell a multi-year release slate to a premium cable movie channel. Back in the day before Amazon, Netflix, Roku, Vudu, TiVo, etc. these exclusive deals served to create islands of value for Disney, Starz and your cable or satellite TV provider. Today, these exclusive deals largely serve to frustrate consumers who expect to find all content readily available on-demand for rent or purchase.

There is a lot of infrastructure being supported by legacy video distribution channels, including your local multiplex, local retailers who sell DVDs, your Blockbuster store and the premium movie channels to which you might subscribe. Hollywood will not (and in some cases cannot) unwind this thicket of distribution channels and release windows and their associated infrastructure overnight. There are legal, economic and infrastructural obstacles, but overall is the fear of exchanging "digital pennies for analog dollars" in Jeff Zucker's memorable phrase.

I think the folks at Disney understand that you can either watch "Becoming Jane" or something else or nothing at all on Saturday night. What keeps them up at night is the impact on all those other distribution channels when your expectation of going online and instantly renting the title from the cheapest provider becomes a reality.

Similarly, I think newspapers fully understand what online news and classifieds are doing to the newsPAPER business. But it's not as simple as saying "let's just reduce the cost of a subscription by the cost of the newsprint and supply the paper exclusively online." In the good old days, the only way to get your morning dose of in-depth international news was the newspaper. And it came bundled with local news, TV listings and classified ads, which you paid for even if you didn't care about the local news that day, or used TV guide to decide what to watch on TV, and weren't currently in the market for a used car or new job. Bundling content you really want with content you want less passionately is a time-honored way of optimizing revenue and allowed the newspaper to provide a paper product that satisfied the various and shifting needs of a large community of diverse readers. It also conveniently supports the press room, printing plant, truck-drivers, newsstands and paper-carriers who make up the distribution chain. Finally, the resource commitment and the attractive marginal economics led to oligopoly or monopoly market structures in many cities. For these reasons, I recall a time when Warren Buffet himself thought newspapers were one of the world's greatest businesses.

A consumer's ability to disaggregate news sources -- international news from nyt.com, local news on sfgate.com, classifieds on craig's list -- unravels the local newspaper's bundling strategy. And the shift to online consumption undermines the physical and human infrastructure involved in the delivery of the paper product, leaving the local newspaper with stranded costs.

Again, I think the newspaper companies understand this phenomenon all too well. The challenge is how to surrender the surplus economics associated with bundling content and physical delivery before an obvious economic model based on unbundled, digital delivery has emerged to cover the costs of newsgathering.

So while it's undoubtedly true that many major media companies are struggling to ADAPT to "new" media economics, I believe most of them fully understand the issues. And the fundamental issue is that much of "content" economics have historically been related to effective restrictions on the channels of distribution. "New" media economics may be simply be synonymous with "lower" media economics. Like most businesses, media companies and their shareholders will struggle to cope with lowered expectations.

Reports of Equities' Death Are Greatly Exaggerated

There is a "huge flaw in the logic" of ANY argument that attempts to assess the cheap (or expensive) nature of stocks based solely on how far they have fallen (or risen) in the recent past.

The presumption, for example, that stocks are cheap at current levels because they've fallen so far so fast requires one to simultaneously hold the views that the market is inefficient now, but was efficient at some time in the recent past. Said differently, the argument is equivalent to saying "..the market had it right when the S&P was at 1300, but at 800 the market is acting irrationally."

The NYT article makes a valid point when it observes that many equities are essentially flat from 1998 through 2008. If the author had wanted to pile on, he might have mentioned that the Nikkei will have to rise around 30,000 points or 375% in 2009 to finish 2009 flat with its peak 20 years ago.

TV Networks Weathering the Storm

I found the NYT article to be anything but optimistic for the broadcast networks.

Yes, declining audiences overall mean that there is scarcity value associated with those shows that still deliver, which has sustained some pricing power. And pre-selling inventory in the upfront (as in any business) means current economic conditions will have a lagged effect on broadcast ad sales. But the fundamental trends for broadcast networks and their local affiliates are anything but bright.

The networks are in the business of selling people's attention. And they face more competition for people's attention than at any time since the the commercialization of the technology a half century ago. Moreover, they industry operates with cost structures, guild rules and operating practices largely established under conditions of benign regulated oligopoly.

Finally, most of the regulatory, geographic and distribution structure of the industry is predicated on over-the-air transmission of local content (basically news) that is largely irrelevant to the 85% of the market that subscribes to cable or satellite services.... or relies on the internet for news.

How much longer will local news ("four alarm fire on Pine Street, film at 11:00") support this outdated business model?