A Dash of Insight

Confidence, the Economy, and the Fed Balance Sheet

Poll reports show that President Obama's confidence ratings are falling.  This should not be a surprise, given the record positive levels at the time of the Inauguration.  Current polls show continued popularity for the man, but increasing skepticism about his policies.

For the economy and for investors, there are some specific issues that will play out over the summer.  We set these up in our "Summer Quiz."  Those who have good information and market savvy will score well on the quiz, and also profit in the markets.  We believe that this summer is a key time for investors.  As we reveal the answers, the significance will become crystal clear.

We will continue to reveal the answers and announce our prize winner at the conclusion of the article series.

Background

Economic growth is strongly related to confidence.  When CEO's get worried, as they did after the demise of Lehman last fall, they cut costs first and ask questions later.  Economic confidence is closely tied to employment, a topic we follow closely at "A Dash."  Employment indicators often lag actual economic progress when employers are quick to fire and slow to hire.

We do not all share a common interest.  It would be nice to think that all hope for an economic recovery, but that perspective is mistaken.  Here are some obvious exceptions.

Political Opponents

Perhaps in a perfect world there would be a few years in a political cycle where everyone in the country all pulled together.  It occasionally happens when there is a specific and imminent common enemy -- after 9-11 for example.  Most of the time private motives dominate over the public interest.

Partisan Politics

Quite frankly, there are many who hope for the economic recovery plans to fail.  There are strong partisan reasons.  The most important members of this group are running for office in 2010.  Their personal stake is huge.  There will be a constant barrage of partisan economic criticism.

Bearish Pundits, Commentators, and Fund Managers

There are many who stand to profit from a market decline.  The many bearish pundits have credibility and book royalties on the line.  The commentators have prestige, jobs, salary, and bonuses at stake.  Sometimes personal motives outweigh a national interest.

Some hedge fund managers have aggressively short positions.  Anyone paying attention knows that these positions are always supported by the Bearish Blogging Network (BBN) where there is direct or indirect compensation for supportive bloggers.

With so many providing so much negative commentary, it is easy to be led astray.  Let us consider a specific example.

The Fed Balance Sheet

A good way to begin is by removing the most obvious issue, question #4 from our quiz.  Information about the Fed balance sheet is readily available, specific, and timely.  Those taking a bearish viewpoint have emphasized the growth in the Fed balance sheet, including loans to various financial institutions.  The critics have suggested that this growth was part of the Obama Administration efforts and also that it puts taxpayers at risk.

Here is a recent report from Macroblog, one of our featured sites:

There are three key facts from this report:

1. The increase in the Fed balance sheet dates from the Lehman failure and the aggressive response, not from the start of the Obama Administration.
2. The overall size is declining slightly.
3. The distribution of assets has shifted from the riskier short-term lending to non-bank financials, moving to agency paper.

Conclusion

From a public policy perspective, the Fed has attempted to restore what we refer to as "normal lending".  The Fed recognized a market failure, where credit markets seized up.  This step is aggressive and temporary.

From an investment perspective it is crucial to understand the nature of the policy.  Some portray the balance sheet expansion as a "bailout" or an unlimited commitment.  This portrayal is calculated to frighten the individual investor.  It it not accurate.

Restoring confidence will be an uphill battle.  It begins with better understanding of the policy.

Full disclosure:  Our current posture, reported weekly, is bearish, reflecting market sentiment.  We see the bearish case as overstated, but realize the evidence will come one piece at a time.

We are working to find the catalysts for a changed perspective.

Dumb Comments on Energy Prices and Manipulation

There are so many silly assertions and so little time!

One of our missions at "A Dash" is to identify strong sources of information and analysis.  Even the most intelligent reader needs some expertise to make the key distinctions.  Let us consider some examples.

Oil Demand and Price

The Statement:  One of the CNBC talking heads repeatedly stated that oil prices fell by 80% but demand did not drop that much.  To her, this was evidence of an inaccurate market.  None of the many CNBC panelists contradicted her.

The Reality:  Introductory Econ classes start with how markets clear, showing a supply function (a curve) and a demand function (also a curve).  The markets clear at the intersection of the two curves.  A lecture or two later there is a discussion of elasticity -- how much demand (or supply) changes with a unit change in price.  There are examples of inelastic demand (insulin is a favorite) and more responsive demand.

The Conclusion:  It is not proportional or linear.  It is another case of pop economics intuition leading one astray.  Let us suppose that the oil market is near a tipping point.  A demand curve intersecting slightly above the production capacity leads to a price spike.  At a slightly lower point, producers may still want to generate some revenue.  It is all about the shape of the supply and demand curves.

Oil and Stock Correlation

The Statement:  An expert says that stocks are trading based upon oil.  There is a chart showing a correspondence between stock prices and energy prices.

The Reality:  The relationship between energy prices and stock prices is situationally dependent.  In general, high energy prices are a tax on the consumer.  There is no reason for higher oil prices to cause higher stock prices.

The Conclusion:  This is a classic case of a spurious relationship.  This is a technical statistics term meaning that Factor A (in this case perceptions about the economy) is driving the behavior of both Factors B and C.  The apparent relationship is not causal.  In addition, this would make sense only if stock traders thought that energy prices were a more accurate read of the economic prospects.

Rogue Trading and Energy Manipulation

The Statement:  There are some rogue energy traders who made drunken or mistaken trades.  These needed to be unwound.  This shows manipulation of the energy markets.

The Reality:  Mistakes are discovered and corrected.  It is not manipulation.

The Conclusion:  It has no lasting impact on prices, despite the media hype.

Speculation drives Energy Prices

The Statement:  Speculators have exacerbated price swings in energy.  Some government officials in several countries want to hold hearings and consider legislation to curb speculation.

The Reality:  Speculators are trying to make profits.  They add liquidity to the market, acting based upon many sources of information about all conditions.  Think "The Wisdom of Crowds."

The Conclusion:  There is very good evidence on this point, from some excellent sources.  Astute economist James Hamilton took a close look at this when energy prices spiked, and wrote as follows:

I personally do accept the view that the "paper oil" speculation has made a contribution in recent months to the increase in the price of physical oil. I believe that this speculation has resulted in a slight decrease in the quantity demanded that has required some modest supply reductions or accumulation of inventory by producers. But I expect that producers will find these changes not to be in their best interests as the demand adjustments become more prominent, at which point the price must return to that governed by the underlying physical fundamentals.

Ultimately, the price must be such that the quantity of physical oil demanded at that price is equal to the quantity of physical oil supplied. Any speculator who promises on paper to buy oil for more than the physical stuff is actually selling for will find themselves at that point with a big, fat paper loss.

Here is another take from noted investment advisor Dr. Stephen Leeb:

The real force at work behind last year’s run-up in prices, the subsequent decline and the rebound that has followed is the market’s invisible hand. In other words, good old fashioned supply and demand was the culprit. Unprecedented synchronized global growth between 2005 and early 2008 caused demand to soar, yet producers were unable to meet the call to increase production by anything more than a token amount.

Readers should check out his entire review of the history and his argument.  Government intervention to distort markets is the last thing we need.

Our Overall Take

There is an active market in conspiracies and manipulation.  It makes an ideal media story, whatever the reality.  Commentators also seem to have a bias toward the legitimacy of equity markets and against futures markets, often citing off-hours trading.  Perhaps those of us with more "Chicago" experience better appreciate the depth and liquidity of futures trading.

Those doing "pop economics" have a field day.  It takes careful analysis to sort out the reality.

Employment Situation Report Preview

Each month we ask the question, "What change in payroll employment would be consistent with other economic data from the same time period (the middle of the prior month)?

This is not a forecast, per se, since we do not posit any causal relationship among these variables.  They are all concomitant indicators of economic activity.  We use the four-week moving average of initial unemployment claims, the University of Michigan sentiment survey, and the ISM manufacturing report.  We carefully choose data from the correct time period.  Even though the ISM report was released today, the survey is obviously from earlier in the month.

None of these indicators have improved very much, so we continue our negative outlook on employment.  We were surprised last month when the job losses were less than we (and nearly everyone else) expected.  We are still looking for losses over 550K, much worse than the consensus loss of about 400 K.

Since our analysis is based upon the final data, after all revisions, the ultimate accuracy may not be known until next year!  That is when final benchmark revisions are done.  Also, the sampling error (90% confidence interval) alone on the payroll survey is more than +/-100K jobs.

Other Predictions

In addition to the consensus forecasts, there are various predictions using proprietary data.  These are all interesting.

TrimTabs uses data from income tax deposits of salaried employees.  They expect job losses of 472,000.

ADP uses data from their payroll administration business, information that no one else has.  They have attempted to gear their results to the "official" government report.  They forecast a loss of 473,000 jobs, amazingly close to TrimTabs.

New entrant Wanted Technologies uses an algorithm reflecting online job ads.  They have a startling forecast:  a loss of "only" 260,000 jobs.  Furthermore, they made their call on June 19th.  And why not?  That was the right time frame to match the payroll survey, and their online job data is more readily available in real time.

Conclusions

Our own prediction of the jobs report has no special inputs -- just the analysis of concurrent economic data.  We are surprised to be the most bearish of the group.  As noted, the error band is wide.  The market will react wildly without regard to the sampling error or other issues.

We do have a few predictions that we can make with more confidence:

• Whatever the job loss, the unemployment rate will move higher.  The demographic factors at work require job gains of at least 150,000 (and probably more) just to maintain current unemployment levels.  The unemployment rate is an important social and political indicator, but it will lag in reflecting an economic change.
• The assembled punditry will state, whatever the number, that it should have been worse because the government is incorrectly projecting job creation. 
• If the result is really good, the rumor mill will start, as it did last month.  When the market spiked on a better-than-expected report for May, the rumors quickly circulated that it was an error -- a government worker had a "fat finger."  Those circulating this rumor (and those believing it) have absolutely no concept about how government reports are assembled, how many people are involved, and how many check points there are.

It just shows that if you want to be short going into this report, you can have confidence that the Bearish Blogging Network (TM OldProf) will have your back.  They will take advantage of the blogosphere to spin at high speed.  The official sources have to wait for a news conference or an interview to reply.  This is plenty of time to cover your shorts.

It is an attractive trade for any hedge fund manager.  Take last month as an example.  You could come in short and be an instant winner on a bad number.  If the report was positive,  you sell more on the spike (averaging up in price).  You then cash in on the silly "fat finger" rumor and the expected monthly spin on the birth/death adjustment.

How Can this Work?

It is amazing.  Take a roomful of traders.  Ask them whether government or a trading desk is more efficient.  We know what they would say.  Trading desks can execute baskets with a keystroke.  There are "fat finger" examples and also stories about interns sitting on keyboards.

Does anyone really think that a very complicated government report is generated in the same way?  Well the silly story was good enough to move the market last month.

A Crib Sheet for Government Data

Most sources -- even big-time media types -- provide no guidance about sources of information from the federal government.  There is a a useful advantage in knowing more.

We realize that there are many who reject any government information.  Here at "A Dash" we believe that this is an extreme viewpoint, and provides an opportunity for a trading advantage.

In particular, we distinguish between reporting data and offering projections.  Those rejecting the data reports are just fighting the mainstream interpretations accepted by nearly all economists and by the mutual fund managers.  Projections are quite different.  They come from different sources, and the results vary.

A Reader's Guide

Here are some typical examples of government information.  Our reaction varies dramatically and so should yours.

The Bureau of Labor Statistics (BLS).  This is a non-partisan agency.  The key professionals have tenure and earn respect from peers and supervisors by doing a good job.  A new President cannot fire them nor significantly affect their pay.  From their perspective, Presidents come and go but their work goes on.  They try to do a good job, and we think that they generally succeed.  The methods are subject to great debate before acceptance.  Once accepted, they are followed in a rather mechanical fashion.  Those suggesting that these reports are subject to partisan politics are just wrong.  They simply do not understand how government works.

The Office of Management and Budget is under the control of the current Administration, so it is partisan.  This does not mean that forecasts and comments are wrong, but consumers must consider the source.  At this time it means that forecasts reflect the Obama perspective.  Any forecasts should be carefully tested against outside sources.  For an illustration of how OMB can be slanted to a particular perspective, we recommend the Reagan era example of David Stockman.  In an interview he admitted a clear bias in forecasts and was "taken to the woodshed" by the President after he spilled the beans.  We are not suggesting that Obama is "cooking the books" with current forecasts, but we view them with appropriate skepticism, testing against other sources.  We plan to write much more about forecasts from the Administration.

The Congressional Budget Office is a source deserving respect.  We call this a bipartisan source, since it must earn and keep the respect of Congress, no matter which party is in power. Initiated in 1975 under the leadership of Alice Rivlin and later Rudolph Penner, the CBO analyses earned the respect of both parties in Congress.  Any young professional wanting to do objective policy analysis should see the CBO as a dream job.  In the current policy debates the CBO is responsible for evaluating every proposal.  This is especially crucial to the health care initiatives and the Congressional agreements concerning PAYGO, where there must be a revenue offset for new initiatives.  Here is a great current example.

Summary

The mainstream media does not explain these differences nor reflect them in reports.  A CNBC anchor recently kept referring to the CBO as the CBOE (an options exchange).  A top source at TheStreet.com recently attributed a CBO analysis to the GAO, even using the "old name" for the GAO.

They just don't get it.  The big-time sources do not distinguish between various government sources.  They do not provide any background or context.  They do not grasp the distinctions.

You can do better!  You can start by printing out this article and using it as a handy reference.

Summer of '09 -- A Crucial Time for the Investor

Investors face some important decisions.  For those approaching retirement it is a crucial time.

There is plenty of advice.  The television commercials, blogs, and email messages include a variety of appeals:

• Those telling you to buy an annuity to lock in your income, marketing to the fear of market losses, and perhaps playing down the death by a thousand cuts from inflation.
• Those telling you that you can do better than your financial advisor.  Go on your own!  You have a "feel" for the market.
• Those advising gold.  Everything is about to go wrong, so you need to have hard assets.
• Those offering speculative gains.  Here are some stock ideas that are "home-run" ideas, where you can triple your money in a couple of months.  Often these are penny stocks.

Any of these strategies could be right --- as a part of an overall plan.  For those with adequate resources for retirement, a defensive posture might be correct.  Some investors might be willing to learn what they need to know and execute with discipline.  Inflation protection will play a role at some point.  Some speculative ideas will work, but most will not.

It is a minefield.  You need a plan.  Here is a nice article asking a key question about when you should plan to retire.

You also need to know how to interpret data and modify the plan as the evidence changes.  Many of the sources of information are selling something -- annuities, brokerage services, gold, or complex structured products that play upon investor fear.  In a typically excellent article, David Merkel writes as follows:

I have three bits of advice for readers.  First, don’t buy any financial instruments tht you don’t understand well. This especially applies when the party selling them to you has options that they can exercise against you.  Wall Street excels at products that give with the right hand and take with the left, so beware structured products sold to retail investors.

Read the entire article for some additional helpful advice.

Our Approach

Every investor has a different problem and requires a specific plan.  All face the same challenge, but individual needs, goals, and risk tolerance vary widely.

We must interpret a recession that does not fit the prior molds very well.  The causes were complex with many interactions.  The attempted solutions are also complex.  It is not a cookie cutter where we can say it will all play out like some prior year.

Many make predictions with great confidence, often drawing more from their political opinions than economic evidence.

At "A Dash" we are seeking objective economic indicators with proven value.  No one knows how it will all play out, so it is a week-by-week process.  The answer will come from a combination of interpreting economic data in a dispassionate manner and recognizing the effect of public policy initiatives.

The Investor Challenge

Any investor navigating the minefield must do three things, all major themes at "A Dash":

1. Overcome the psychological pull identified in the behavior finance literature.  These are the reasons that most investors significantly lag market averages.
2. Monitor economic data in an objective fashion, getting past both the "green shoots" crowd and those who always find the worst take on any information.
3. Put politics aside, figuring out how to make investment returns no matter which party is in power.

In an effort to help investors with these points we suggested a little quiz.  Apparently we did not present the problem effectively, since our fine editors at Seeking Alpha did not see the significance of the questions.  We know from our classroom days that everyone hates quizzes, especially when they do not know the answers!

Perhaps we should have stated it more strongly.  Anyone who cannot do well on the quiz, and we strongly believe most would fail, will be out of touch with the economy and the market over the next few months.  They will also make psychological mistakes that will lead to failure.

We were alarmed that our smart neighbors had so many ideas -- most of them wrong -- and were all acting decisively on their opinions.

Over the next two weeks we will reveal the answers to the questions -- each of which was carefully chosen to reflect an important issue.

We could have just written an article about "The Eight Big Mistakes You are about to Make."

Our experience in education tells us that people learn more when they try to answer a question themselves before getting the answer.  It is a tried-and-true technique.  We urge readers to take a look at the quiz and make some private notes of the answers, even if they do not choose to enter the contest.  Official entries for our prize will close on Thursday.

As we explain each answer, the significance of the questions will become clear.

And finally, while our focus is on the individual investor, most of the concepts are equally important for traders.

How to Make Money on Barney Frank

Barney Frank, (D Mass), the Chair of the House Financial Services Committee, is a polarizing figure.

He is the bête noire of the conservative punditry.  Whenever he does or says anything, there will be a chorus of objections from those who disagree with his politics or his lifestyle.

Over at Zero Hedge, one of the several "Tyler Durdens" managed to work in a couple of offensive remarks in a very brief post.  (We're not repeating them.  It will be interesting to see if the Seeking Alpha editorial team publishes this one!)

The issue?  CNBC scored one of their "First on CNBC Interviews" by getting Rep. Frank on Squawk Box right before the hearing on executive pay.  It all started OK, but then Mark Haines started to weave from straight questions into a discussion of his own opinion.  He often does this, and his viewers like it.  With a rookie on the show, it can be devastating.  With Barney Frank, who showed very little tolerance for this.  In fact, he seemed pretty testy about the questioning.  For CNBC, it just meant that they lost the interview.

You can see it yourself right here:

Why Listen to Barney Frank?

Barney Frank is one of the most polarizing figures in Congress, at least to a national audience.  His constituents think he is great, and he has a very safe seat.  (This means that those who believe that he took various actions for small campaign contributions do not understand the political process).

As a funny-sounding, very liberal, and openly gay member of Congress, Frank is an easy target.  He is no stranger to controversy, providing more ammunition to right wingers and gay bashers.

Our question is the same, practical, relentless one we have been offering for some months:

Do you want to make a political statement, or would you rather make money?

The blog writers who want some boo-yah's from their audience bash away on Barney.  While avoiding explicit criticism of Frank, Mark Haines probably scored points with his own audience by offering his personal viewpoint on executive compensation and shareholder influence.

The Attitude of the Smart Investor

Let us suppose for a moment that you do not agree with Rep. Frank's politics.  Here are a few facts:

• He is one of the most powerful people in Congress, at the epicenter of various decisions on financial regulation;
• He is (perhaps) the smartest person in Congress, according to a poll of Congressional staffers.  (If you do not see this, then maybe you need to review your personal biases.  He regularly runs rings around interviewers, as he was doing with CNBC this morning.)
• He has been accepted by the Street and the GOP (Hat Tip Charles Kirk).

Here is what Crains New York has to say:

Just about everyone in banking wants to be Barney Frank's friend nowadays......

Mr. Frank ambles around the halls of Congress in the type of pin-striped suit familiar to any banker—although his untucked shirt betrays any notion that he might be one. Yet financial executives credit him with reining in his fellow Democrats' angriest impulses about how to handle Wall Street. He can charm Republicans, too: Last month, he was the only congressman ranked among the “most partisan” and the “most bipartisan” in a survey of members by The Hill newspaper.

“He finds a way to negotiate,” says Scott Talbot, senior vice president of government affairs at the Financial Services Roundtable.

Of course, it also behooves bankers to play nice with Mr. Frank. Asked if bankers have come to grips with new realities, he tartly answers: “I think they understand a new set of regulations is coming. And it's better to sit down and get it right than get it wrong.”

You really need to read the entire article to understand how serious financial executives view Frank.

The Simple Question

So it is a pretty simple question.  When you are watching CNBC do you want to hear the viewpoint of one of the most powerful Congressional leaders, or do you want to hear opinions from Mark Haines?

Do you want to read some politically oriented bashing of Barney, or would you like to make money?

Investors should be agnostic with respect to politics and to life style.  Those who insist on injecting politics as part of their analysis are facing (at least) four tough years of investing.

There are investment stories that will work.  It does not matter if you agree with Frank, or Pelosi, or Obama.  As long as we can predict what they will do, we can find an edge.  Even though we absolutely hate government control of business, we have found winning investments this year.

How?

Be practical, not political.

The Most Important Stat: Bloggers versus Experts

Market pundits always try to explain modest changes in the broad averages.  Today their stories are all wrong.

Today, the most important statistic came from Jack Hough at Smart Money

The Story

Hough did a piece on the credibility of government statistics.  It is a nice job compared to most prior discussions.  He provides a viewpoint on each of the key issues, citing arguments from the BLS and the principal conspiracy theorist.

It would be interesting for investors to read the entire article and also to read the supporting documents from the conspiracy guy and the BLS.

Almost no one will do this, since they are too lazy to do any real work.  We are now addressing to the handful of people still thinking and reading.

Of the few who try, most will not be able to evaluate the arguments, since it requires some understanding of data analysis to reach a real conclusion.

It is possible for someone to sell snake oil and the reader will not know the difference.

Basically, it comes down to how people feel about government.  Most students enter college -- we know, we taught them -- with a negative bias.  They see movies.  They make the mistake of thinking of Congress -- 535 people with different motives, coalitions, and partnerships, as if it were a rational unitary actor. Simple and facile interpretations can be persuasive.

The Data

As observers of the investment scene, we have documented a long-term process of dis-information.  To our amazement, the story was even worse. 

The data show that 85% of readers do not believe government data.  Wow!

This is an astounding result.  We knew that the big-time blogs were unduly influential.  We knew that the mainstream media sources accorded undue recognition to the extremists.  We also knew that every time we discussed government data in a positive light, we got hate mail -- both aggressive and plenty of it.

We are still astonished.  Normally the highest people in socio-economic-status (SES) also have a higher score on questions related to Confidence in Government.

But it is  an online poll -- tracking an audience known to be unrepresentative, wealthy and conservative. Does this matter?  What interests us here is that the unrepresentative sample  is so far out of touch with reality.

To Summarize

The data are complex.  We believe that any of the Internet pundits (name your candidate) or the conspiracy guy would be beaten like a drum if engaged in a fair fight with someone from the BLS or another suitable representative.

BEATEN LIKE A DRUM.  Any media source wanting to try this could do it.

We cannot cover this in one article, but it is an open challenge to government critics.  Any time, any place.

Investor Implications

Many individual investors are attempting to monitor economic developments.  There is a choice in data sources.

You can take information from one of two sources:

The first source consists of career professionals whose salary and benefits have no relationship to politics.  They develop methods and write articles for peer-reviewed journals. Their career chances depend upon professional performance as evaluated by others in the field.  You already pay millions of dollars for this information.

The second source has a profit motive.  None of the assertions are reviewed by peers or published.  Everything plays upon emotions and pre-conceptions.  There is plenty of support from bloggers who share these motives.

To us the choice seems obvious.  When we learn that nearly everyone disagrees, it makes the trade even more attractive.

The Importance of "Being Right"

A few days ago, Abnormal Returns raised the interesting question of whether it is more important to be right or to make money.  The article cited past work, correctly noted that one could be dollar positive while losing in most cases, and showed behavioral finance literature on the concept of sticking with a thesis, even when it is losing.

This was a great article.  As a front-line investment manager, we know that it is a crucial factor in the thinking of many individual investors, the people we are trying to help.

As an aside, we congratulate Tadas on his new business relationship, and wish him the greatest success.  He has provided an extremely valuable service to investors and deserves some recognition and compensation.

An important bonus from his new approach is that we can now hope to get more such articles -- provocative questions, actually stimulating the rest of us to think and to respond.

The Merkel Response

Another of our featured sites, The Aleph Blog, took a different perspective.  Here is how David Merkel responded:

I’m going to take the other side of this one. This is a bear/choppy market argument. During a sustained bull market, being right makes lots of money.

When I choose stocks, I do all that I can to have the odds tipped in my favor — industry analysis, earnings quality analysis, valuation analysis, balance sheet analysis, free cash flow use, and even a review of the anomalies like momentum, volatility, balance sheet growth, etc.

It’s not perfect, but I typically have 70% winners, and my winners are larger than my losers. Being right helps make money… does anyone doubt that? But hubris destroys.

Does that mean I give up my risk control disciplines? No. I get things wrong, and when I am wrong, I cut my losses. Every 20% move down requires a review — if the thesis is intact, I buy enough to rebalance. If not, I sell.

Also, my methods continually improve my portfolio, selling things with less potential to buy things with greater potential.

Our Take

There was a lively response to the original article, with many good ideas.  It is a timely and complicated subject.

We often approach questions like this by stepping away from the instant question, looking at extreme examples from our own experience.  Let us take companies that are about to go bankrupt.

Experts know that the common stocks in these companies generally go to zero.  The common has no value, since the bankruptcy forms NewCo and the bondholders get equity.

This is very difficult to explain to investors.  The sentiment of the market often is focused on the general business of the company -- often with good potential -- rather than the economic fundamentals of the stock.

We have had several cases where investors wanted to buy a penny stock, about to go into bankruptcy.  We warned that the stock was worthless.

In several of these cases, all high volatility situations, the stock doubled after our advice.  Eventually , it went to zero.

Did we give poor advice?  Our experience and knowledge -- an understanding of the process -- was correct.  Anyone following the advice would have eventually been proven right.  Meanwhile, major gains were missed.

Could anyone predict that the stock of a bankrupt company would double, say from 75 cents to a dollar fifty?  Perhaps, but that is not our method.

The story of being right versus winning is far more complicated.  The emphasis on last year -- a single point in history -- has a special significance since the results were so dramatic.

We plan to revisit that question.  For now we wish to highlight a single point:

What is the long run?

A casino has a small edge, but makes money because there are many relevant bets.  It is more difficult for the individual investor.  The edge might be significant, but the occasions for testing it are smaller in number.  When does one see the "long run?"

Put another way, how many major financial crises have there been?  What constitutes a good record?

There is an obvious advantage to methods that get quickly into the long run.  Is there a way for the individual investor to participate in this approach, controlling risk, while getting good returns?

More examples and discussion to come.....

Street Fighters: Good Information and Good Fun

Kate Kelly's book, Street Fighters:   The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street,  now on our recommended reading list, is a great source of information and fun to read.  It is well-sourced, authoritative, and always interesting.

Does it provide, through a look at Bear, the answers to our financial crisis?  We think not, but that is part of the fun.  The reader can collect information -- raw data -- with real confidence.  There will be many accounts of the financial crisis.  Anyone seeking a complete understanding should consult many sources.

The Approach

Street Fighters tells an engaging tale focused upon how a mighty firm was reduced to rubble in three days.  You know the ending before you start reading, but it is no less engaging.  The author has a nice sense of the characters and has done extensive research into backgrounds.  We not only learn about the major players, we learn what everyone else thought about them.

Such an approach is open to challenge.  Kelly provides footnotes for sources, and acknowledges disagreement.  It is convincing support  for her narrative.

The Result

The reader is treated to a view from several perspectives.  It is an insider's take on the politics within an investment bank.  There is genuine conflict over risk and which products to feature. Even the most jaded reader may have some sympathy for a wealthy guy who spent a lifetime building up his company and his position, only to lose it all in a few days.  This is "inside baseball" at its best.

The story is dramatic and well-told.

Assorted Insights

The reader has raw data to draw conclusions on several interesting points.  Here are some that stood out for us.  Yours might be different.  Please consider the following:

• Significance of CNBC.  David Faber had a story about firms not trading with Bear.  It was big news, but it was later denied by those in question.  The damage was already done.   The issue is how much information one needs to go with a story like this, when the story itself can affect the outcome.  Should Faber have verified more completely before going with this story?  Would it have made a difference?
• Significance of Kelly and the WSJ.  Many readers will already be familiar with the three-part series in the Wall Street Journal.  In the book, Kelly asserts that the series itself -- criticizing Cayne's leadership -- had an impact within the firm.
• Hank Paulson's Role.  Paulson is portrayed as dictating a punishingly low stock price for Bear.  Historians will combine this information with additional information, includeing his reversal on the use of TARP funds, the decision to force TARP on all of the major banks, and other similar decisions.  From our perspective as public policy experts, this is an extraordinary and arbitrary use of powers.  It is on a scale that is without precedent for a Treasury Secretary.
• The Fed Role.  The decision of the Fed to expand lending to include investment banks, only two days after the Bear failure, was extremely arbitrary with respect to timing.  We should all be concerned when public officials make decisions about which firms (and which investors) live or die, and do so without clear rationale.  Bear was allowed to die while others were saved.

Conclusions

Kelly's conclusion is that Ace Greenberg built a firm on some principles and Jimmy Cayne violated those and lost it all.  We are not convinced.

We can now see what happened to many other firms.  It would not have mattered if Bear's leverage and risk had been a little less.  Kelly is probably right in suggesting that Bear was an unloved firm on the Street, and therefore first to be challenged.

It was beyond her scope to consider other causes, although there is a paragraph or two on the trading in Bear stock.  This was something we watched daily on our trading screen.  Those betting against the firm could trade in the thin Credit Default Swaps market (CDS), buy puts (where premiums exploded in issues that were far out of the money), short the stock, pull your hedge fund accounts, and spread rumors.

These events were all taking place.  The sequence of causation will never be determined.  What we do know is that any business depending upon confidence and credit can be destroyed in three days. Those aiding the destruction can make millions as it happens.   If that is a verdict on a business model, the entire banking industry is in question.

Final Take

The book is fun to read and has plenty of raw data with authoritative sources.  You should read it, and combine what you learn with other information.  The story of the 2008 crisis is complicated.  We look forward to reviewing other books on the subject.

Dubious Indicators: Continuing Jobless Claims

Here at "A Dash" we have a continuing commitment to finding important economic indicators.  This means throwing out misleading information and finding indicators that help investors.  We are going to examine some "broken measures."  This analysis will not be biased.  We are going to throw out some indicators that skew bearish, and some that skew bullish.

Continuing Claims -- A Dubious Indicator

There is a new indicator on the economic front -- continuing jobless claims.  Pundits of a bearish persuasion are rejecting the recent stabilization (even improvement?) in initial claims.  They prefer to cite the hockey stick rise in continuing claims.  Here is an example, but we do not mean to pick on any single source.  You can find the chart anywhere on the Bearish Blogging Network, but we are picking it up from a more balanced source, Bill Luby.  Please read his discussion to get the context.  We just want to show the excellent chart.

The chart is alarming to all who see it -- another "worst in history" presentation.  Should we believe it?

The Problem

The key point is that this is not an apples-to-apples comparison.  Jobless benefits have been extended twice (at least for most states), so recent data are not strictly comparable with past periods.

There are some who believe that extending jobless benefits reduces the incentive to look for work.  While we do not endorse that viewpoint, there is an obvious "break" in the time series.  We cannot compare periods where jobless benefits have different time periods and expect to get meaningful results.

 BLS Data

The BLS provides a different approach, available in the table below.  Anyone who looks at the actual data will see the facts, as follows:

• The number of people experiencing 27 or more weeks of unemployment has increased dramatically in the past year, from 1.4 million to 3.7 million.  It is a bad employment situation, as we have frequently reported.
• The mean duration of unemployment has increased from 18.3 weeks to 21.4 weeks, a serious increase.
• The median duration of unemployment has increased from 11.0 weeks to 12.5 weeks.

This is a very negative picture, but not as bad as the popular chart suggests.

Download Duration of unemployment

Our Take

We remain very concerned about job losses, the employment rate, the rate of marginally attached workers, and other indicators.

Having said this, the four-week average of initial claims is an important indicator in our employment models.  It has stabilized in recent weeks.  Most observers do not pay any attention to actual data about new job creation, which is running at a rate of over two million per month or so.

Briefly put, we all know the employment picture is bad.  It is important to look to indicators that are comparable across time periods.  There is new employment.  Some people are finding jobs, although the rate is still poor.

The continuing claims chart is not helpful in this regard.  It should not get much attention.