Day trade nation

Five years ago, trading stocks was the new national pastime. One would imagine that the severe market downturn of 2001-2002 extinguished the desire of gaining instant riches by playing the markets. Sounds reasonable, but it’s false: the passion for trading still rages throughout the land.

Just take a look at the data. According to data from the International Federation of Stock Exchanges, the number of equity trades in the U.S. (including the NYSE and Nasdaq) rose 310% between 2004 and 1999. To put this in perspective, in 1999 there were 1.6 equity trades per person in the U.S., a number that rose to 6 last year. In other developed nations, the avaerage number of trades per person is usually less than one.

It's also worth pointing out that the average value per trade fell dramatically: from 42,000 dollars to just over 10,000.

Now, event though the ease and low costs of online trading have surely led to a large increase in the number of individual investors actively involved in the markets, it is also possible that other trends, such as the explosion in hedge funds, have contributed to the huge increase in trading.

What is pretty certain is that much of this trading is wasteful. Any number of studies have shown that transaction costs are the nemesis of investors. The math is well-known: on average, individual investors will obtain gross returns equal to the market average (say, the return on the S&P 500), but trading costs push the net returns significantly lower. If memory serves me right, most will lose around two percentage points annually by trading too much.

Bulls in the china shop

That’s a very adequate metaphor for U.S. policy towards China, as described in the previous post. Apropos, here is Brad Setser’s take on this issue, a must read that lays out well the sheer complexity of China’s currency dilemma.

If you feel like you need to grasp the big picture, don’t miss Bill Gross’s (PIMCO's Grand Master of Bonds) very accessible description of the main issues facing the U.S. and the global economy.

The China factor

What a strange day in the markets. It certainly began badly: higher than expected wholesale inflation and lower than expected industrial production figures for April (as to these, weakness was concentrated in the automobile sector). Yet, in the end the broad indices managed to rise nearly 1%.

Most commentators stated that a Treasury Department report to Congress on exchange rates and trade saved the day. This report warned China that unless it takes steps soon to make its exchange rate more “flexible” (that is, let it rise), it would be branded as a “currency manipulator”, a designation that would give free rein to the Congressional demons of protectionism

So why is this good news? Well, the dopiest reporters argued that American stocks rose because these warnings would be heeded and American firms will eventually face less Chinese competition. Smarter hacks said that the positive reaction reflected a collective sigh of relief, since apparently some talking heads had expected the Treasury to accuse the Chinese of manipulation in this report.

I know, it doesn’t make much sense either. My guess is that stocks rose in sympathy with good earnings numbers from H P and Home Depot, among others.

As to the China factor, some experts argue that letting the yuan rise would be a good idea, since it’d be a necessary step for correcting the current unbalanced state of the world economy (Brad Setser is in this camp, broadly speaking). Other fear it will plunge China –and probably other East Asian economies--into a nasty Japanese-style deflationary spiral, with negative consequences for the world economy (Andy Xie of Morgan Stanley more or less supports this view).

In other words, no one really knows, but everyone agrees it will have a big impact. Oh, and by the way, is it really a good idea to push around the face-saving, prickly, Chinese who happen to finance a rather large chunk of government spending in the U.S.?

The absurdity of competitiveness

What is it about our love for ranking nations according to their “competitiveness”? To me, these lists, such as the one published by the Word Economic Forum (WEF), seem totally useless. Basically, the rankings are nearly identical to an ordered list of income per person. Which is rather tautological: the richer you are, the more competitive you are and vice versa. Duh.

Part of the problem, of course, is that “competitiveness” has many meanings, as this excellent article explains. Yet, even if we agreed upon on a specific definition, it is a flawed concept. John Kay tells it like it is:

Interest in national competitiveness is an extension of interest in the competitiveness of companies. Competitive businesses are able to offer goods or services more attractive than those of their rivals through lower costs or better products.

But the analogy between individual businesses and national economies doesn't quite hold.Companies that are not competitive disappear. Countries that are not competitive don't. These nations still need to import, and their exchange rate falls until they become competitive again. Every country that trades internationally is competitive in some areas - the things it exports - and uncompetitive in others - those it imports. This principle of comparative advantage has been a foundation of economic analysis for 200 years.

"Flying Salmon Sighted Over Washington"

Give the gals over at Tamara Wilson Public Relations a cigar for coming up with that headline for this prosaic press release.

Investors never learn

Thanks to Mahalanobis for providing a link to Burton Malkiel’s latest piece on market efficiency and fund investing. As always, he makes the compelling case that most people who invest in stocks should stick to boring-but-cheap index funds. Yet, as index-fund pioneer John Bogle points out here, their market share in the stock fund segment stands at less than 20%.

People are just as overconfident about picking winning funds as they are about selecting above-average stocks, with equally lousy results.

Alternative market recap: Oil beats Wal-Mart

I frequently chastise the financial press for trying to explain away the stock market’s random day-to-day fluctuations by latching to an eye-catching event that probably has little to do with what happened.

Today offers a great example. Stocks fell across the board, though the drop was unremarkable (about 1%). There were three important pieces of news: oil prices dropped sharply for the second day in a row amid reports of slower than expected demand growth and high inventories, U.S. retail sales rose strongly in April and Wal-Mart reported disappointing first quarter earnings, in addition to warning that this quarter’s results would also be weak due to high gas prices.

Reporters spun it this way: Falling oil prices in April helped boost retail sales much more than expected, yet these two pieces of good news were offset by Wal-Mart’s earnings miss and its fairly gloomy forecast for this quarter, not to be taken lightly coming from the world’s largest retailer.

However, why should Wal-Mart be so pessimistic given that oil prices are falling? Doesn’t less expensive energy help consumer spending? Needless to say, reporters got very confused (see this example of tortured logic). In the end, since stocks fell, they mostly blamed the largest and best-known target: Wal-Mart.

Actually, today’s performance can be explained quite easily. The energy sector represents arount 10% of the S&P 500 and today it fell around 4% on average. This alone explains about half the drop. Most of the rest can be accounted by the retreat in financial sector stocks (around 1% today, but they make up more than 20% of the S&P 500), probably attributable to recent market jitters concerning hedge funds

And Wal-Mart? Yes, it’s big and its announcement didn’t help. But keep in mind that the consumer staples sector --which has a similar weight compared to the energy sector--to which it belongs actually fell only 0.5% today according to S&P’s data, much less than the market as a whole.

In any case, one shouldn’t read too much into one day’s figures. Stocks fluctuate for any number of reasons day after day. But if you do keep track of these things, always check broad sector trends, which are always more representative than extrapolations based on the performance of one or two stocks. Standard & Poor’s provides these figures on a daily basis.

Organized labor is dead, long live organized labor!

What do today’s failing firms, such as GM, Ford, UAL and Delta have in common? Mainly, they’ve been unable to adapt to changing market conditions, unlike their more nimble rivals (Toyota in autos, Southwest in air travel).

This brings me to another shared trait: these firms are bastions of union power. While no one can deny that they’ve been badly managed for a very long time, organized labor has also played a big role in their demise. It forced the firms them to employ too many workers, stick to obsolete and rigid work practices, concede excessive long-term benefits in the good times and made it very difficult to close unprofitable operations (plants, routes, etc.). Last but not least, management and labor spend so much time bickering about issues like pensions that the firms’ main business is neglected.

Needless to say, their successful rivals are mainly non-unionized or face pliant Japanese-style labor organizations.

When these ships sink, as they surely will (at least in their present form), organized labor’s long decline will be nearly complete. Sure, it’ll hang on for a while in the economy’s non-competitive corners, such as government, but in the private sector it’ll be basically extinct.

Like the medieval guilds that preceded them, unions were well-suited to a certain environment: growing, regulated economies where production was increasingly carried out in workplaces with rigidly defined repetitive processes. Obviously, this no longer describes our world, where repetitive labor is increasingly automated, changing tastes and conditions require flexibility and competition is ever-increasing.

As always, most workers do have an interest in banding together to negotiate better terms for themselves, so the question now is not whether unions will be replaced but what will substitute them.

My guess is that a new type of labor organization will come along, one that provides services to the individual worker, rather than the firm or industry unions we know today. These new unions will provide many things that neither the market nor the government do well, such as training, job search assistance, unemployment insurance, career change services, legal advice, infant care, etc. Firms will be left alone to do what they will, but they’ll have to meet minimum standards and comply with contractual obligations with regard to workers. Otherwise, they’ll face strong legal action and the new unions will be able to pressure firms by withholding qualified labor.

These new organizations will provide benefits to society as a whole. They’ll make it easier to retrain and reemploy workers displaced by changing tastes and international competition, thus reducing resistance to socially beneficial policies such as free trade. In addition, they could help workers take advantage of existing but underused benefits, such as tax-free retirement accounts. They could even play a positive role in matters such as corporate governance and health care (giving their members better bargaining power vis a vis providers).

Well, only time will tell. But at least my utopian future unions sound like a an attractive alternative to the Teamsters and their like.

The economist as freak

Recently, Bryan Caplan of Econolog mused about why people tend to dislike and ignore economists. In the end, he argued that dismal scientists should forget about being nice. Instead, they should be blunt, telling people how things really work as explained by the principles of classical economics. Call it the Larry Summers approach.

Mr. Caplan is right about how ecomists are perceived. Nonetheless, he simply misses the point. People mistrust economists because, unlike them, they don't constantly look at the world through the prism of maximization (at least conciously). This post by Caplan nicely illustrates this point:

I wear shorts about 10 months per year, and I live near Washington DC.
Judging from the number of funny looks I get, and the number of times perfect
strangers stare at me and ask "Aren't you cold?," my behavior is puzzling at
best.

The silly explanation is that I'm from California. But that should
make me more sensitive to cold, not less! The real answer, naturally, is that
wearing shorts in the winter is good economics.

The simplest economic comback to the unwanted queries would be "Of course I'm not cold. I do own long pants. By revealed preference, if I were cold I wouldn't be wearing shorts."

But that's not quite right. The truth is, I sometimes am uncomfortably cold as a result of my
attire. So what gives?

The answer is that if I dressed more warmly, I would be more comfortable during the few minutes that I am outside (maybe 30 minutes per day), but less comfortable during the many hours that I am inside. It's cold outside, but warm inside, so I maximize my expected utility over the course of
the day.

Would you like to have a drink or hang out with someone who thinks like this? How about having him for a roommate or a son-in-law? I wouldn't, and I'm an economist

Dept. of Unknowable Unknows

In finance, as in life, totally unexpected (and mostly unwelcome) events rudely impose themselves on our peaceful life for no good reason. As Donald Rumsfeld memorably stated, they’re the unknown unknowns. It doesn’t matter if you’re very smart, alert, careful and cautious; every once in a while they’ll whack you.

That’s exactly what must be going through the minds of Deutsche Bank’s shareholders today, as this report explains:

LONDON (MarketWatch) -- Deutsche Bank tumbled 2.9% in Frankfurt amid unsubstantiated talk the bank is the prime broker of a hedge fund that's under duress. A London-based spokeswoman wasn't immediately available to comment.

Hopefully, this rumor will prove to be unfounded. But one day, probably in the not so distant future, another Long Term Capital-like accident will once again threaten to bring down many famous names (incidentally, read what LTC’s wonder boys are up to currently).