Inflection Point

This was the "it" term before green shoots. The 'ah but the change in the second derivative is changing positive. When discussing economics at a cocktail party hosted by my father, one of his mates blindly referred to the inflection point changing. I murmured approval and then asked him what he meant by it and quickly a pen was found and it was like high school all over again drawing sin graphs. I have supplied a graph below, its a gif so it moves.


When you are looking at it pay attention when the point nears the x-axis near 1.6. As the color of the tangent line changes from green to red to blue, the red is the inflection point. This also works as an analogy for the economy. When economists, talking heads and policy wonks parroted the inflection point mathematical jargon what they were saying was that the steepness of the decline was lessening and that we would approach bottom. Here is an example with the employment to population level.



So you can see that the wonks were correct, at about January the ratio stopped dropping as steeply. However, if you refer back to the graph above you can see that it would be no where near the nadir of the curve.

Then bad news in the guise of good news came from the labor report on the 11th. In truth it is good news, productivity jumped 6.4% annualized, 1.6% for the quarter, meanwhile labor costs fell -5.8% annualized or -1.45% for the quarter. Which, when employing deductive reasoning means that the employment ratio will grow slowly as companies squeeze more out of their labor. It follows then that they would then increase part-time workers to full time before finally bring aboard new hires.

All in all, it will be quite a long while before we hit the next inflection point.

Bounded Rationality piquing my interest

I was reading an article this weekend talking about the microfoundations of macroeconomic theories having series structural issues. The author maintained that uber-rational homo economics does not exist, and that people do not have perfect foresight, or even optimization skills. The author invoked bounded rationality. This led me to think about a book I haven't thought of in years, Max Bazerman's "Judgement in Managerial Decision Making." I recommend the book; it is very accessible. There are plenty of surveys and games that you can play with others to see just how limited our cognitive functions are, and it is, dare I say, fun.

Basically Bazerman theorizes that humans have two thinking states: the 1st is based on simple rules of thumb and allow you to make quick decisions. These rules are created by you either through your own experience or training. The second type of thinking is the rational version of deliberate debate, weighing the pros and cons of an action on several measures, such as: defining the problem, creating alternatives, weighing trade-offs. The reason humans have these two systems is that if we had to base every decision with the superior method of system two we would take a disproportionate amount of time choosing between different brands of Frosted Flakes.

Here is a quick example of what Bazerman terms an availability heuristic. You receive a newsletter in the mail and it states that the stock market will go up over the next 6 months. You ignore it. 6 months hence the market has gone up and you receive another letter that states that market will go down over the next half year. 6 months hence the market is down and you receive another letter stating that the market will go up. This time you consider the letter for awhile, maybe it sits on the coffee table for a week, but you still throw it away. 6 months go by and the market is up and you receive another letter stating that the market will go up again. This time you thoroughly read the letter and send your money into the broker who has been sending you the letter for two years. You never hear another word and lose 10,000 dollars. What happened?

Well imagine instead you are this deceptive broker. You have a list of 100,000 people. Every 6 months you send out the letter to everyone, except that only half get the market goes up letter. The other half get the market goes down letter. So in the first half only 50,000 are correct. Then 25,000. Then 12,500. Finally, the last letter 6,250. The broker gets 10,000 from each he walks away with 62,500,000 dollars. Not bad for two years work. This is also what people call survivorship bias, which happens in the mutual fund industry. Not that I am calling them crooks, but when you read stats like 90% of our funds have been up every year, well that is with the caveat that the poor performing funds are dead. Thus, no longer in the reported data.

Correlation on draft day?

I was building a data set for an upcoming football draft. What I am going to attempt to do is set up a draft heuristic that tells you what position you can go the most from by drafting it at any particular moment in the draft. So if QB's are a hot commodity this year, it tells you what performance remains on the draft board and whether you will have better performance from drafting a QB or a running back in your draft slot. So its essence is to instead of taking the best player on the draft board, which analyst will tell you to do because you can trade (of course this analysis ignores how hard it is to trade and what happens if you end up with 5 RB's, which depending on your gift of gab may not be the ideal foundation for making trade propositions,) instead shows you relative outperformance for each subset of positions. So if you can get a +5 over the median/mean QB but you can get a +7 RB you would or should take the RB. The analysis will also be helpful in making trades to complete your team.

However, when investigating the data set I came upon an unsettling set of numbers. Here is the first set in graph form.


So what I was seeing was tiers of players. You can see distinctly the upper echelon of players, then a another, then another, setting up a power law. A regression puts the R-squared at 72%. So then I wondered about the format in which a draft is set up. The normal way in which I have participated is a serpentine format that goes from 1 to 12 and then 12 to 1. So I ran those numbers below.

It definitely shows a two-tiered system of haves and have-nots with the first 5 draft positions able to parlay the superstars outperformance versus the mitigating lower second round draft pick. This leads me to believe that auction drafts, as many claim, have more fair outcomes than the serpentine method. Something to consider as draft season approaches. Good luck out there.

Same Store Sales Growth

Catchy title, eh?

I saw this chart in the Wall Street Journal Today and it really crystallized an idea in my head that I have held for a long while. So let me first start off by describing what same store sales are and why this chart is great, except I would have it do one additional calculation column.

There is not really a great definition, more of what it is not and then a nebulous gray area that remains is what it is. So here is my ad-hoc definition: A store that has been open for a year, then compares their month on month figures and this shows the same store sales growth or decay. So if I open a new Starbucks on July 1, 2008, I will not be able to do this analysis until the end of July 2009. If I open on the 15th of July the first month that I could do this comparison would be August '08 versus August '09.

What does it consist of? Well it is sales, which is another name for revenues, which are prices paid for merchandise times the number of items sold. So just two dimensions prices and volume.

If you followed the link you would see my chart is slightly different than the Journal's chart. See I broke the Same Store Sales growth into its two components so that it could be easier to decipher. Now we can see who dropped their prices to maintain their revenues and if anyone followed any other strategy.

So look at Aeropostle and BJ's. Two different strategies are afoot. BJ's kept their pricing the same and their volume suffered but they maintained positive growth. Aeropostle dropped their pricing by 7% but more than made up for it in pushing volume through.

Pricing is probably the more important story at thi spoint. It is almost a given that the US consumer will be tightening the belt until there are better economic winds blowing across the land. However, prices that fall portend deflation because it relies upon the consumers to spend. If consumers do not spend it is because they have less employment or are more cautious about the future (thus, saving more.)

I am going to follow up on this more at length and will probably grab these firms latest figures to do a quick DuPont analysis to see how these figures compare to their strategy.

Serial Correlation

So I am looking at the S&P500 index for the year. The index is currently up about 10% on the year. I am looking at my own investment portfolio and it is only up about 0.3%, should I be worried that I am losing my touch. Have I lost the alpha control on trading the index? No and no is the resounding reply.

Here is why.

What this two tables show is the return of the S&P and then below the return of the trading strategy. Then the following table tracks your investment dollar from the beginning of 2000 to the current date. So it shows that I have missed out on the rally from the March lows, but it also shows that I missed the carnage in 2000, 2001, 2002 and 2008. Meanwhile in bull years I lead in 4 out of the 5 years of the sample.

The main point is that one cannot be remiss if one misses out on the beginning of a market run. You must stick to your plan and trade your plan only. When you start deviating to "correct" your trades to what you are seeing in the market is when you will really start to lose money. That is why I like to look at this chart and know that my money grew 60% over the past 9 1/2 years and a buy and holder of the S&P 500 has lost 20%. It steadies my feet when I want to start buying options to lever and catch up.

King of the castle

This piece was submitted by Lune on Naked Capitalism's blog. I would recommend the whole article and tracking back to the original posting as well. Here is the most germane portion, the rest of the rhetoric just supports this thesis.

Anyone who watches Congress go about its business will note a certain bipolar proclivity to its actions: it will snooze as important issues fester; then, at a seemingly random moment, it will wake up, and, after a frenzy of hearings, speeches, and negotiations, it will write and pass enormous bills faster than a harlequin ghost-writer on crack.

The public is therefore left cursing Congress for its laziness and inaction, then cursing it for its hasty decisions and rushed, poorly thought-out laws. There seems to be no in-between.

The reality is that getting a bill passed is somewhat akin to laying siege to a castle (the castle being Congress and the policy advocates being the marauders). A successful siege campaign in the Middle Ages could last years, and consisted of a slow grinding down of the inhabitants of the castle while building your siege weapons, training your forces, and probing the walls for weaknesses. Then, when a weakness was found (or created), all of a sudden, your forces would rush in, a huge, noisy battle would ensue, and very quickly, you'd either become the king of the castle, or be dead with your head proudly displayed on a pike.

For someone watching just the castle, it can appear like years of humdrum tedium interrupted by sudden, random chaos. The legislative process is a little like that (although being more civilized, we've replaced the pike with a symbolic skewering on the late night comedy shows).

History doesn't repeats it rhymes, correlations abound?

Just reading through Gluskin-Sheff's Chief Economist David Rosenberg musings on the market. The whole report is worth the read, you will have to register with the firm though.

The salient point, at least as far as this post is concerned is about how this latest burst in the S&P500 index is reminiscent of 2001 and 2002.

Then: Big 3 unleash 0% financing to bring about car sales. Annualized sales jump from 16.1 million units to 21.7 million units in just one month!

Now: Government let's Cash for Clunkers rip and car sales jump from a run rate of 9.2 million units to 11.2 million.

However, as Rosenberg points out this does little to build actual demand, while it seems that demand is increasing what occurs under the headline numbers is that sales are brought forward from the future. Say Consumer Bob was going to buy a car once he received his annual bump in salary in December. Now that the program is in force he would be wise to take the 4,500 the government was offering, plus what ever other rebates the manufacturers are offering to clear inventory for the new model year that begins in October. So his consumption from December is moved up. It did not create a new job and hence a new salaried person to purchase a car, or a recently minted 16 year old to stop riding the cheese wagon. So what happens once the demand is brought forward, it just leaves a lumpy distribution of sales.

Take this hypothetical say the new normal is for 12 million cars a year. So that is 1 million a month. With the new incentive structure fomented by the federalis instead of having a constant million a month, it instead
Jan- 1.0
Feb- 1.0
March- 1.0
May- 1.0
June- 1.0
July- 1.9
Aug- 1.6
Sept- 1.7
Oct- 0.4
Nov- 0.1
Dec- 0.3

So that all that ends up happening is that we have positive numbers now and then negative surprises later. So GDP looks good in the 3rd quarter but against all expectations worse in the 4th quarter. This leads to worry and the market falls again. But let's look and see what happened back in 2001/2

• 2001Q3: -1.1%
• 2001Q4: +1.4%
• 2002Q1: +3.5%
• 2002Q2: +2.1%
• 2002Q3: +2.0%
• 2002Q4: +0.1%

Just as it was written. The temporary boost then faded and the market lows were not reached until 2003. So will it happen again? Not sure, history doesn't repeat itself but America has placed itself into a very similar situation. Just a quick example, imagine that the government stimulus is akin to taking a child who just fell off his bike and attaching training wheels. Once the stimulus/training wheels comes off what happens, well the government and the Federal Reserve hopes that the economy/child will propel itself, but he may just end up in the hedge again.

I''l close with a direct quote from Rosenberg "The asset deflation, which included housing this time around, has been three times more intense (than 2001/2) and coupled with a broken-down credit market. It is vital as we go through this intermittent period of auto-related spending and output activity, to recall that similar period seven years ago and what we learned was that sustainability proved to be elusive."