New pricing data come out on the housing market today and on a month over month (May to June) basis it was positive.  This was true for the previous period (April to May) as well.  The increase was not overwhelming but reasonably strong, but it is hard to get to excited when the latent supply (additional foreclosures, under water homes,.). 

What I found interesting was the breadth of the rise.  Nearly all the sub components rose as well even place where the foreclosure situation is a mess.  (What does this tell you about that factor as a driver?….)

A friend asked a question related to the degree to which I though this was driven by the first time buyer tax credit and what would happen to demand when that went away.  Without doing too much investigation my response was if it is all first time home buyers (which I can’t find the data but I’m told that they are heavy participants) then the ‘homeowner’ pool is getting bigger.  This is because people who were not in the owner category shifted to it and the seller will likely look for another house  (stay in the owner category).  Although I expect this ‘owner’ group stickiness to be less true than is normal because of the compositions of sales (ala foreclosures). 

That said the home price index is incredible correlated with mortgage credit and where that goes I expect housing prices to go; so did the tax credit matter, sure for someone somewhere; did it fix the housing market?  no, the credit markets really broke the housing market and are now trying to put it back together, we will all see if they succeed.

In my view one of the most important component of alpha generation (financial gambling) is weighting.  How large to make your bets.  Interestingly this is not often discussed in the class room or the board room.  Valuation, timing, and strategy are discussed but when was the last time someone asked you what the geo-metric mean maximizing weight of your strategy was (if ever)?  [An interesting side discussion is, 'is the reasons it is one of the most important components of alpha generation because it is discussed so little'].  Also the formal designs of weighting are much less developed (or maybe it better to say much more complicated; even when it is a single strategy weight and not a strategy in the context of a portfolio) than valuation.  But for the under use and difficulties that the sizing of bets entails it makes financial gambling much much easier than ‘life gambling’.

Consider that for a financial gamble you can scale it to your confidence, without (for most of us) having any impact on the market.  In short the way you scale the bet doesn’t impact the way the bet turns out.  On the other hand in life you can’t just scale the bets to confidence because how you scale the bets (which in this case I mean the effort/commitment that you put into an activity) changes the outcome significantly.  Consider the realm of foreign policy if you think  a foreign excursion (pays off 10:1) is worthwhile even given it only 20% chance of success.  A PM (portfolio manager) would put on a weighted bet based on the payout but the statesman would have to calculate the weight that he was willing to commit (and at the same time) consider what they would be doing to the chances for success.  A more challenging problem.

One purpose of floating exchange rates is to help global imbalances resolve themselves (at a basic level if you are running a trade surplus then your currencies should rally (purchasing power becomes greater, other regions become more competitive, and hopefully at some point the surplus (savers) country will spend their funds…so that they debtor country doesn’t explode)).   But currencies have a large number of other influences on them (the most significant of which is capital flows), so does it work just this way.  We’ll here’s a chart that tries to tell when currencies are doing the job of resolving global imbalances (when the blue line is positive it is ‘working’).

The charts shows the 12 mth moving average of the slope of an OLS (regression…read ‘a line drawn through points’) on the real exchange rate against the current account balance.  If you are running a surplus then your currency ’should’ go up (this would mean that a positive slope suggest that the currency markets are working’).  The blue line is the sum of countries current accounts as a % of local GDP…this is supposed to get a the size of global imbalances.  So what you’d like to see it the red line (the imbalances line) close(r) to zero but to the extent that it is not one would hope that the blue line would become go higher.

Admittedly this is way too complicated for what it is trying to do and it has problems in that it is dealing with a change (in the currency) and a level, sort of, in the current account balance.  The results are some what sensitive to the period that is chosen for the currency change.  (if you are interested I’ve chosen 24 month changes).  All that said I still think it is an interesting picture….why?

Because it shows that global imbalances blew up after 97/98 when the currencies stopped ‘working’, getting more in balance as currencies ‘worked’ between 00-03, and then expanding again when currencies stopped working again.  (Although given that the world has significant non-floating currencies, its not fair to blame it all on ‘non-economic’ markets)…

The CBO put out its Long Term Budget projection a while back but the cover it worth pondering.  Both scenarios it has evaluated are non workable.  At lease they are being honest…let hope we can tackle our fiscal problems before they tackle us. 

Another interest note is that the recent spike in debt % of GDP matches (or reasonably closely) up with (with respect to change and velocity of change) WWI, the GD, and (only the first year) of WWII. 

A nearly daily complaint I have about financial media is that they don’t get into the detail about the data.  They simply report the headline.  For example about a month ago Bloomberg lead with the following…..

“June 26 (Bloomberg) — Consumer spending rose for the first time in three months in May as incomes jumped by the most in a year, a sign that government efforts to revive the economy may be starting to pay off.”

It was all due to a one of tax credit. 

“Personal current transfer receipts increased $162.6 billion in May, compared with an increase of $59.1 billion in April.  The American Recovery and Reinvestment Act of 2009 provides for one-time payments of $250 to eligible individuals receiving social security, supplemental security income, veterans benefits, and railroad retirement benefits. These benefits boosted the level of personal current transfer receipts by $157.6 billions at an annual rate in May. “

http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm

but once in a while they get something close….

like with the Reuters storythat job hunters take summer off…although they needed an explanation of why 247,000 people lost their jobs and the unemployment rate went down from 9.5% to 9.4%.  At least they didn’t simply report a drop in unemployment.  That said, saying that this is driven by the unemployed taking a vacationing is some what deceiving.  The labor force dropped by 422k which could be true (and likely is to a degree) that the unemployed are discourage but it is more likely a statistical fluke and that the labor force will jump up next month….which they will then attribute to coming off summer break.

What makes someone feel wealthy?  Is it the amount of money or is it the change in the money they have (the amount they have today vs. the amount they had yesterday)?  From my experience and observation of human beings it is almost always that latter.  People are happy when things are improving even if the status is still bad (poor people are happy when they become less poor) while the people are upset if things get worse even if things are still very good (rich are upset if they lose money but are still rich).   Although everyone is slightly different and the self reflexive historian may be an exemption I think this generally holds.  If the change is more important than the level (remember we’ve just experience a large negative wealth shock), which change is the one that matters?  Is it a draw down or level relative to last high, is it 12mth change, is is 3 mth change or something else?  This matters because once that change period has passed after a collapse then activity will resume based on the incremental (or next) change.  Of course it is not one single change and it is not all about the change the level matter greatly in the long run (and I think it impact the sensitivity to the change).  Anyway interesting stuff.  The IMF put out a wealth by country chart that gives an interesting picture.  I was surprised that the level was relatively similar across the countries although the asset composition was quite different.

I wanted to leave a link to Paul Krugman’s post that references the cycle charts.  Now to be fair he criticized the WSJ not the package itself so I may be stretching for a critic.  The Eichengreen-O’Rourke work is very good and require some fairly heavy data lifting (I’ve trekked around to a couple libraries and haven’t been able to find a good set of League of Nations Monthly Statistic Bulletins) but they are doing draw down chart not cycle charts so by there nature the downturns will be more in-line.  Each methodology is valid but they have different purposed, I prefer cycles for thinking about the economic relationship but draw-down are not a bad way to look at a collapse. 

As an aside: For my select few diligent reader I’m sorry about the weak and infrequent posts of late.  I’ve been given the honor of being a dear friends executor so I’ve been spending all free moments trying to school myself on some legal details.  I’ll be back up and ranting soon enough.

There is a ‘classic’ joke about two economist walking across the campus quad.  They see a 20 dollar bill on the ground and one goes to pick it up and the second prof, stops the first by saying, ‘markets are efficient, if the $20 dollar were on the ground it would already be gone.’  So the first stops and leaves the money there. 

Now I think that the joke is a little harsh toward academics.  Yes sometimes they seem to model for the sake of modeling and want reality to conform to their models instead of the other way around but they do so at their own risk (the better ones try to account for these things and when they don’t they do so explicitly to show the core elements cleanly).  The point of the joke is that the economist fail to recognize the friction in the efficient market or put another way someone has to make the markets efficient (they have to actually pick up the bill). 

What made me think of this was I was looking at an asset and was struck by an unusual event.  The bid (what someone was willing to pay for the asset) was higher than what someone was willing to sell it for.   

Now I don’t know many of the technical details of how various exchanged manage matching across their books but its it important to remember these types of details – even if it, which more often than not may make sense, via a humbling process in the model.

As time passes each age sees themselves (for the most part) on the cutting edge of …fill in the blank.  Whether they are or are not is in many ways debate-able but to be on the cutting edge often requires complications.  Some recent conversations have surrounded the idea of keeping complexity out of certain areas.  How should that choice be thought about? 

Consider that Leonardo Da Vinci stuggled with the concept zero.  Although its still may be a struggle when your going through algrebra in primary school it no longer pushes the great minds of our time.  My point is the because something is complicated doesn’t mean that it should be scraped.

I would suggest considering the following question, ‘does the construction, that happens to seem complicated, have value or is its value derived from the complication itself?’  What do I mean.  For example sales people will use complication to obfuscate the truth while remaining ‘honest’ in order to close a sale.  I was reading something recently where a CMO market participant was quoted as saying, “We think (they try) to obfuscate the risk associated with each one of these tranches. We think it is a kind of deliberate thing on the part of the dealer community to make it very difficult to understand the (securities)” 

I was surprising to see that the quote was from 1993.  If the ‘CMO market participant’ is right and the complication is for the sake of obfuscation then the complication is not (net) valuable.  This makes one reflect, bond basket products have been complicated for a long time, but they haven’t always blown up.  Does complication lead to blow up?  No.  Does complication make blow up more likely? Yes.  Does complication have value? Maybe.  So should these bond baskets continue?  They will need to show that the risk/reward to increased complication is better than it has proven to be so far.

Update Cycle Chart book is here: