Swans, Mind Games, and Curve Balls

Excellent piece by James Montier on the mortgage crisis, with a short primer on behavioral finance:

… it is wholly wrong to characterize what happened to the US economy and markets as a black swan. To do so is, in fact, an abdication of responsibility. If these extraordinary events were totally unpredictable, then there would have been nothing we could have done to prevent them.

The events of 2003–2008 were not black swans at all. They were “predictable surprises.” The term was first coined by Michael Watkins and Max Bazerman. A predictable surprise also has three characteristics: (1) At least some people are aware of the problem; (2) The problem intensifies over time, and (3) Eventually the problem explodes into a crisis, much to the “shock” of decision-makers. As Bazerman says: “The nature of predictable surprises [is that] while uncertainty surrounds the details of the impending disaster, there is little uncertainty that a large disaster awaits.” 

What evidence do I have that the current mess was a predictable surprise? The New York Times ran a fascinating article in mid-December 2007. This noted that, seven years earlier, Edward Gramlich, a governor of the Federal Reserve, had warned that a fast-growing new breed of lenders was luring many households into risky mortgages they couldn’t afford. The article also cited the Herculean efforts of Sheila C. Bair, a senior Treasury official, to persuade sub-prime lenders to adopt a code of practice and to let external monitors verify whether they were complying with these standards…

So the big question is this: What prevented us from reacting to the predictable surprise? I can think of five major psychological hurdles that hampered us in this regard.

Montier goes on to list five innate hurdles identified by behavioralists:

1. Over optimism
2. Illusion of control
3. Self serving bias – reacting to and interpreting information in ways that support what we already believe
4. Myopia or “hyperbolic discounting”
5. Inattentional blindness

The article covers these innate human behaviors in a quick and easily comprehensible fashion — highly recommended. In fact, learning to identify and manage these innate hurdles in ourselves can help us to become not only better investors, but better family members, co-workers, citizens, and voters.

—

Here’s a fascinating item related to “innate hurdles” — scientists argue that the “break” that we perceive in a pitcher’s curve ball, and the “rise” in a fastball, are illusions.

“What?!?” the baseball junkie might ask.  Yep. Check it out.

If you’re familiar with our Links page, you may have noticed our link to the BrainConnection.com library. We’re utterly fascinated by the biological reality (and puzzles) of human perception. It’s not nearly as uniform and objective as we like to think, nor is the physical world as distinct and external as we tend to believe. And that raises a lot of questions, some of them even more uncomfortable (but still fascinating!) as the curve ball question is for many baseball fans:

Batters throughout Major League Baseball may be struggling with an optical illusion when they try to hit a curveball.

Scientists suggest in new research that curveballs don’t actually break near home plate — it just appears that way as a hitter switches modes of seeing.

The break, which appears to be a sudden change from the ball’s curved path, may come from the way the human eye shifts between central and peripheral vision, according to the research, released yesterday by the journal PLoS One. The scientists explained the “rise” in a fastball the same way.

The work is the first to explain the break and rise as illusions, according to the authors. Previous explanations include the idea that the hitter underestimates a ball’s speed, said Zhong-Lin Lu, a neuroscientist at the University of Southern California in Los Angeles.

“The brain is tricked,” Lu said in a telephone interview.

He and his group used a flash animation of a descending circle with a moving shadow that mimicked spin. When five observers stared directly at the circle, it fell straight, and when they focused their vision on something else, the ball appeared to move to the side of the screen. That’s because the brain couldn’t process both the spin and the vertical motion, Lu said.

The researchers used the observers’ reports to figure out the size of the break. If the eye is off the curveball by about 10 degrees, the size of the break is about a foot, Lu said.

A fastball “rises” for the same reason, even though in reality, the ball is dropping, he said.

The researchers aren’t saying that a curve ball doesn’t curve (“Magnus force” is what physicists use to explain the arcing trajectory of a pitch). They are simply pointing out that some of the perceived movement in a curve ball (and all or most of the perceived rise in a fastball) are optical illusions.

So the traditional interpretation that curve balls had a sharp break, or that fast balls rose, were largely illusory; definitely an example of self-serving bias and inattentional blindness. Meanwhile, hitters who learned not to be fooled by their innate biological hurdles should have performed well relative to their ability.

Likewise, awarerness of biases and beliefs, and attentively seeking novel information that can challenge or refine those beliefs, can serve investors well.

Obama Budget & 4Q09 GDP

We were feeling a little smug about Friday morning’s GDP print, given our argument in 2H09 that growth prospects were probably being under estimated. At 5.7%, it wasn’t quite the six handle that we thought we might see, but barring any significant downward revisions, it was closer than most expected, and nominal GDP did indeed have a six handle.

Interestingly, headline government spending added little to the quarter’s numbers, so there will be an interesting debate over how much of a role ‘fiscal demand’ is playing, but we’re cautious about that for a few reasons. First, the slower pace at which private inventories were liquidated was a large contributor to GDP, but sustainable private sector growth and employment are unlikely as long as inventory building remains anemic.  Second, federal spending was down due to a lower defense spend, while non-defense spending was up 8% versus 7% in 3Q09, so it’s hard to argue there was no fiscal component. Third, it ignores the possibility of lag effects between public sector spending or deficits and subsequent private sector activity. And if we’re right that fiscal expenditures are still playing a role, the GDP data could imply a very healthy multiplier, a possibility sketched out in this recent academic paper.

This leads us to the Obama budget released today, which will be a real tooth gnashing, garment rending piece of work to many. But it looks pretty good to us at first glance (see the criteria on page six of this Idle Speculator), far better than recent rhetoric led us to expect. The deficit is forecast to be a record $1.56T in 2010 and to remain above $1T in 2011, and it’s beginning to appear that Obama is “triangulating” on fiscal austerity measures, or at least on the time frame over which deficit reduction will occur (though it’s not clear how PAYGO fits into this).

The President’s budget will be tough for some to swallow, but as we’ve pointed out elsewhere, the belief that government is always and everywhere the problem, or that it cannot contribute to real economic growth, is based on a massive underlying assumption: that the private sector is always and everywhere able to grow. It’s not hard to reduce that position to an absurd one, e.g., if a natural or biological calamity were to severely impact private sector potential, a government with a monopoly over money creation could pick up some or perhaps all of the slack.

Reality is far more complicated of course, but since demographic ratios came to our attention, it seems patently clear that private sector potential can vary wildly over multi decade periods, especially in economies where a steep fall in childhood mortality occurred at some point in history. Japan is the most recent example of a two decade downswing in potential output, and its policymakers mistakenly approached the problem as a cyclical rather than a secular one. The U.S. and other western nations are roughly ten years behind Japan in demographic terms, so there’s still roughly a decade of slow, no, or even negative growth ahead of us, barring an active public sector (note: “active” can include tax cuts). As we wrote last November:

We’re familiar with the major [economic] catechisms; we’re just not sure that the evidence supports any one of them over another. Structural economic conditions can and do change — age structure is just one example of how this can come about — and different conditions may call for different approaches.

There are several economic measures that, when viewed over the last two decades, support our assessment that demographics are playing a powerful role in the performance of the U.S. economy (and by extension, these measures tend to undermine arguments against Republican budget profligacy in the 2000s). For example:

The year over year decline in state and local income tax revenue has never been so precipitous, and it has become far more volatile since demographic ratios first turned negative in the late 1990s;

The trend in real private inventories has also been declining since the late 1990s; and 

Equipment and software investment has been in a similar downtrend since the late 1990s.

Admittedly, we’re just eyeballing graphs here and speculating on whether they correspond well to more robust empirical analyses. But we’re fairly confident in our speculation, and this has led us to accept that we are in a Keynesian moment, or more accurately, two Keynesian decades with a Minskian moment in the middle. In such an environment, where private sector expectations are pessimistic, the optimal response is for the public sector to pick up the slack in consumption, investment, and intermediation, within the constraints set by inflation expectations (granted, inflation is a messier issue in a world where the USD is the global reserve currency, and based on a first cut view of today’s budget, we believe our tradable goods inflation thesis is back in play).

The Obama budget appears to pick up a healthy measure of private sector slack, and should thus be favorable overall for employment, asset prices, and economic output. The inflation issue will be far more slippery: on the one hand, a well designed federal budget gives the Fed more room to tighten, as private sector expectations improve; on the other, fiscal direction is uncertain, especially beyond 2011, and prone to shocks, so central banks will have to be rather nimble (more nimble than they were in 2003-05 and 2008) to avoid taking an overly easy or tight approach to policy.

Obama’s proposed tax increases on high income households will cause some resentment, but it’s hard to see how the income disparity pendulum could keep swinging on its current arc. The administration might also believe that higher tax rates on higher incomes will be supportive of state and municipal debt financing. We’d feel better about it if there were an accompanying reinvention of the corporate tax code, as we believe that would have some positive second and third order effects on lower and middle class incomes; first order effects could be achieved by instituting a payroll tax holiday as Warren Mosler has suggested.

Unfortunately, we place a zero probability on corporate tax reform happening any time soon (the budget calls for increasing taxes on certain sectors of the economy), and a near zero probability on a long payroll tax holiday. Despite that, the President’s budget does brighten the economic outlook a bit for 2H2010 and 2011, and the possiblity of a double dip might have been pushed back to 2012 or 2013 (which clearly calls the semantics of ”double dip” into question).

URLs:

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

http://faculty.wcas.northwestern.edu/~yona/research/Multiplier-version12.pdf 

http://www.whitehouse.gov/omb/blog/10/02/01/Introducing-the-2011-Budget/

http://symmetrycapital.net/idlespeculation/20100112.pdf

http://symmetrycapital.net/idlespeculation/20091109.pdf

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=ASLPITAX&s[1][transformation]=pc1

http://research.stlouisfed.org/fred2/graph/?s[1][id]=CBIC1

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=NRIPDC96&s[1][transformation]=pc1

http://en.wikipedia.org/wiki/Minsky_moment

http://moslereconomics.com/2010/01/28/tea-party-plan-for-dems-cut-to-the-front-with-tax-cuts/

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and earns a commission on sales generated through links from our website. At the time of writing, the firm, its principals, and its clients did not own any securities mentioned, or any securities issued by entities mentioned.

Obama’s Approval Polarization: Man or Country?

Gallup has an interesting data point showing that President Obama’s “approval polarization” is the highest on record, going back to the Eisenhower administration:

A few thoughts spring to mind.

First, it’s the kind of thing that sounds “bad” at first blush. But is it? The top four polarization ratings belong to Obama, Clinton, W Bush, and Reagan. Is that bad company, as compared to a Johnson, Ford, or Carter?

Second, it appears that there may be a time trend at work in the data. If approval polarization has increased since 1980, then Obama’s approval gap might be more attributable to the U.S. political climate than to the man himself (there are plenty of factors that would lend support to such an argument). And note that of the last five presidencies, the one with the lowest first year polarization was the only one that ended after a single term. Admittedly, that last point’s a stretch, given the small sample size and the fact that the 1992 election occurred in the fourth year of GHWB’s presidency.  But it still supports that argument that this poll finding is more complicated than a first glance might imply.

On the ”sounds bad at first blush” phenomenon — my favorite is this line parroted by some cloudy headed thinkers: ”We’re the only species that drinks the milk of another species.” First, it would be nice to have a biologist confirm that nothing similar occurs in the animal kingdom, as symbioses are everywhere, and humans just happen to have the capacity (thumbs, brains, technological innovation) to do it exceptionally well. But second and most important, we’re also the only species that wears shoes, or belts, or underwear, or any other article of clothing (leather or hemp, you decide), drives cars, writes greeting cards, makes phone calls, worships formally, produces electricity, brews coffee, invents movements like veganism, writes and reads weblogs, pierces ears and other body parts, develops organizations like PETA, plays informal and organized sports, demonstrates outside corporations and furriers, goes to college, reads magazines, goes to concerts, buys housewares, hang glides, tells time, uses cell phones, base jumps, etc.  The list is awfully long. So being the only species that “does something” doesn’t mean that that something is necessarily bad. Likewise, it’s not possible to say that Obama’s polarized approval ratings are “good” or “bad” without deeper analysis.

URLs:

http://www.gallup.com/poll/125345/Obama-Approval-Polarized-First-Year-President.aspx

Monkey Economics

I love this kind of stuff, but (because??) it’s terrible news for homo economicus; not kind to ‘Cartesian dualism’ either:

…when [researchers] trained a low-ranking monkey to open the container [of apples], just as any technical college advertisement will tell you, the new skills translated into a higher income. Roughly an hour after she’d open the container for everyone, she was getting groomed a lot more, as much as a high-ranking monkey, and she no longer had to do hardly any grooming herself. But that was not the most spectacular finding.Dr. NOE: So what then did, is we got a second low-ranking female, trained her to open a second container with apples in it, and then we saw that the value of the first provider dropped, more or less, to the half of what she had before. So now we had a competition between two animals. Both of them could provide this good, these apples, and so the value of the first one dropped down again. And of the second one who was very low at the beginning of the experiment, she went up. And they ended up both in the middle, so to speak.

BLUMBERG: So when there was a monkey monopoly on the skill, the monkeys paid one price. But when it became a duopoly, the price fell to an equilibrium point, about half of what it had been. And this all happened despite the fact that we’re talking about monkeys here. Monkeys can’t do math.

Dr. NOE: Animals that cannot form binding contracts, animals that cannot talk about what they want to do or cannot offer verbally or anything – they nevertheless are quite accurate in adapting their behavior to what the market gives them.

BLUMBERG: Dr. Noe says that monkeys arrive at these economic outcomes not through sitting down and negotiation, but through feeling and emotion. Monkeys develop positive associations toward a container-opening member of the society, and they just want to groom her. But once another monkey can open the container, the skill isn’t as unique, the positive feelings diminish, and grooming goes down. It’s the law of supply and demand played out along the neurohormonal pathways that deal with emotion in the monkey brain.

Dr. Noe wonders how much of human economics operates along similar lines. As he puts it, even on the stock market, people might play more with their bellies than with their brains.

Ya think???

URLs:

http://www.npr.org/templates/story/story.php?storyId=114068638

http://en.wikipedia.org/wiki/Homo_economicus

http://en.wikipedia.org/wiki/Dualism_(philosophy_of_mind)

H1N1 Update

AP is reporting that “some people who aren’t at high risk for swine flu complications got the much-in-demand vaccine…healthy adults or senior citizens instead of kids, pregnant women and people with health problems.”

Should that be cause for alarm? On the one hand, public health officials and members of at-risk populations should be proactive about getting the vaccine, and others should be supportive of those efforts. But on the other, the greater the number of vaccine administrations, the lower the risk of H1N1 to the rest of the population, including at-risk groups. As the article reports:

One of the doctors who helped draw up guidelines for vaccine priority groups also isn’t surprised at how things are unfolding.

The government’s vaccine advisory panel “did not expect vaccine police to be set up around the country,” said Dr. William Schaffner, a flu specialist at Vanderbilt University Medical Center, who is on the panel.

If vaccine demand is low in some locations, it makes sense for non-priority groups to get it instead of wasting the supply.

“I don’t consider it a problem,” said Schaffner. “I consider it more of a problem if vaccine is left unused.”

That seems to make sense. Also, flu trends being reported by the CDC are scary enough this year that we can understand people’s temptation to avoid chivalrous conduct. Based on the latest data released for Week 41, which ended October 17th:

• Just about all of the reported and tested flu cases this season appear to be H1N1 (“swine flu”).
• The proportion of deaths relative to the number of hospitalizations has run between roughly 3% and 8%. Granted, this is a hospitalization-fatality rate, not a case-fatality rate. But imagine you have a severe enough case to enter the hospital, and have a 5% chance of not returning home. And while the proportion of deaths appears to be trending down since late August, the number of hospitalizations is up over 500%, so a lower percentage of fatalities out of a much larger number of hospitalizations provides little comfort — for example, the number of deaths in week 41 was up more than 200% over week 35.
• The number of flu deaths per week has been increasing exponentially since 2006, and to paraphrase George Soros, it’s gone ‘parabolic’ this year. There were 1.5 deaths per week in 2006-07, 1.7 in 2007-08, and 2.23 in 2008-09, while the current run rate for 2009-10 is 7.6! [We divided by fifty two because the flu didn't take its normal seasonal break this summer; the actual number of deaths per week during flu seasons would be higher than those figures.]
• According to this chart of expected versus actual cumulative hospitalizations and deaths, it’s not apparent that any age groups are at higher risk  than any others. In fact, one could argue that the 18-49 group should be at the front of the line! As we pointed out previously, this mimics the ‘W shaped’ global influenza pandemic of 1918 that killed many, many millions of people, and a far greater number of healthy adults than a typical influenza virus.

H1N1 is not only scary enough at the moment to excuse some people elbowing their way to the front of the line for the vaccine. You can actually make a sound argument, based on historical evidence and current data, that healthy twenty to forty year olds should be included in the target population for the vaccine. Perhaps that’s one reason why the CDC is not up in arms about the lack of ‘vaccine police’.

URLs:

http://news.yahoo.com/s/ap/20091030/ap_on_he_me/us_med_swine_flu_vaccine_cheaters

http://www.cdc.gov/flu/weekly/

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/AHDR41.htm

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/IPD41.htm

http://www.cdc.gov/flu/weekly/weeklyarchives2009-2010/EIP41.htm

http://www.cdc.gov/ncidod/eid/vol12no01/05-0979-G2.htm

http://www.cdc.gov/ncidod/eid/vol12no01/05-0979.htm

http://www.amazon.com/gp/product/0971542821?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=0971542821

PLEASE NOTE: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Symmetry Capital Management, LLC is an Amazon.com associate, and may earn a percentage of any sales generated by clicking through to the Amazon.com website from links on our website.

Wall Street Stuff

Barron’s cover story this weekend urges Fed Chairman Ben Bernanke to stop punishing savers and raise the Fed’s target overnight interest rate. To support their case, they use an array of market indicators, including the US Dollar index and the USD price of gold, arguing that “big investors have come to see the dollar, commodities and stocks as one-way bets.” A dramatically titled sidebar of charts (‘The Perils of Easy Money’) is provided, but beyond the rising price of gold, there’s nothing in them that offers primae facie evidence of either easy money or impending inflation.  Yes, the USD has declined almost 15% from its peak, but at current levels it is simply back to where it was at the end of 2007 and beginning of 2008. And while the S&P 500 has had a breath taking run off of its March 09 lows, it’s still roughly 20% below its peak.

What’s more, there’s little about the real U.S. economy that argues for higher nominal interest rates, and inflation (and deflation) can only arise from a misalignment of the financial system with the real economy. There’s still a considerable amount of private sector debt to be worked out in the coming years and decades; excessive household consumption has run its course; and U.S. demographics do not imply a high or rising ‘natural‘ rate of interest in the decade ahead. In fact, based on that latter point, we can sympathize (out of context) with Milton Friedman’s 1965 claim that “we are all Keynesians now”, as research into population demographics and their effects on economic output and asset pricing has produced some powerful (if tentative) insights. At the present time, the U.S. is simply not at a point where, demographically speaking or policy-wise, a low nominal rate of interest on overnight reserves is likely to produce rising asset prices or “excess demand” for goods and services in the same way that it did in the late 1970s. And for that reason, increasing investment in public goods, as many of today’s policymakers advocate, might be a good idea. It might even be inevitable, judging by the experience of Japan, a country ten years ahead of us on the demographic curve. At the very least, we can hope it will be done well (Art Laffer penned a supply side refutation back in May but did not address his underlying assumptions of perfect competition for — and full employment of — real resources).

The real problem with a low Fed Funds target, as we have pointed out previously, is that the USD is still the world’s primary reserve currency. Thus, while a low Funds rate might be appropriate for the U.S. economy, it can have inflationary consequences in parts of the world that have higher expected growth rates (the reverse can also happen, as it did in the 1990s – while a high funds rate and a strong dollar seemed appropriate for the U.S. economy, they wreaked deflationary havoc on much of the world). Rising prices for goods that are globally traded, and thus subject to the Law of One Price, will feed back into domestic U.S. price levels, providing a noticeable whiff of stagflation, much as gold, precious metals, and other commodities are doing now.  The global pressures caused by an easy Fed are also going to cause plenty of political consternation and some financial dislocation abroad, as recent salvos from global trading partners over the USD attest to. But we don’t expect broader inflationary pressures to unfold in the U.S. for quite some time, nor do we expect Congress to even entertain the possibility of revisiting Humphrey Hawkins; which means, in our view, that the Fed will remain easy for some time, probably well into 2010. In the meantime, should the USD continue its current trajectory, we might see some coordinated global interventions, as we did with the Plaza and Louvre Accords in the mid-1980s. But in those episodes, national treasury departments played the lead roles, not central banks.

There are also a couple of Investment News articles that illuminate some of the beefs we have with our industry. The first one is on a Morningstar study that found that over half of all mutual fund managers have no money in their own funds. There are some legitimate reasons why a percentage of mutual fund managers would not own shares of their own fund — but that percentage should be waaaaay below 51%. That’s bad enough, but what really stuck in our craw was the speculation that some fund managers might have their money in separately managed accounts that follow a similar strategy as their mutual fund, as they tend to offer lower expenses (they also offer greater transparency, potential tax advantages, and opportunities for customization). If we ran our Opportunistic Portfolio as a mutual fund, our firm’s principals and employees would own it as a mutual fund, period. As it is, we only offer it as a separately managed account, because that is a more advantageous approach for most investors, and because technology has made it possible for us to offer separate accounts to all of our clients (it’s also a heck of a lot cheaper than forming a mutual fund). I know this stuff goes right over most of our clients’ heads when we try to explain it. Suffice to say, we’re trying to do right by them, and by our industry, on each and every day, and we appreciate stories like this one as they lend support to a key piece of our competitive strategy.

The second article is somewhat innocuous, but offers a glimpse into the prevalence of momentum trading in our business, and the general fascination with market momentum. It quotes a large cap manager at ING as saying that ”There does seem to be something unorthodox about [current equity market behavior], but you ignore it at your own peril.” That’s not an objectionable statement, but the article’s headline was a bit stronger: “Market rebound may be illogical, but ‘ignore it at your own peril,’ manage of $1.7B warns”. Surely a similar thought occurred to each of the 20,000 bison shepherded off of Vore over the eons:

[The site hosting that image is pretty neat - you can read a history of bison and horses on the Great Plains while authentic cowboy/saloon music plays in the background.]

Our beef with momentum investing is that it rationalizes away everything but herd direction. If a manager buys momentum because the underlying investment thesis makes sense, there’s nothing wrong with that. But buying momentum for its own sake is the height of glamor boy laziness and stupidity. There’s too much of it in our business, and it contributes precious little to the economies and societies we operate in.

[The 'glamor boy' link will be nostalgic for anyone who was watching MTV in the late 1980s. While it's hard to take Corey Glover's claims of ferocity seriously while he's wearing a spandex suit and a marching band jacket, it's still a great song.]

URLs:

http://online.barrons.com/article/SB125573856421291217.html?mod=rss_barrons_this_week_magazine

http://s.wsj.net/public/resources/documents/BA-EasyMoney091019.pdf

http://www.frbsf.org/publications/economics/letter/2003/el2003-32.html

http://www.time.com/time/printout/0,8816,842353,00.html

http://economics.uwo.ca/econref/WorkingPapers/researchreports/wp2009/wp2009_2.pdf

http://frank.mtsu.edu/~berc/tnbiz/stimulus/laffer.pdf

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20091019/FREE/910199975/1094/INDaily01

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20091019/FREE/910199982/1094/INDaily01

http://www.wyomingtalesandtrails.com/buffalojump.jpg

http://www.youtube.com/watch?v=7XRpuhc9dgU

http://www.wyomingtalesandtrails.com/bison.html

Swine Flu’s “Very Sobering Statistics”

The AP is reporting that government officials are concerned about the virulence exhibited by swine flu to this point:

The swine flu is causing an unprecedented amount of illness for this early in the fall, with the deaths of 11 more children reported in the past week. And less vaccine than expected will be ready by month’s end, federal health officials said Friday.

Of the 86 children who have died since the new swine flu arose last spring, 43 deaths have been reported in September and early October alone, the Centers for Disease Control and Prevention reported. That’s a startling number because in some past winters, the CDC has counted 40 or 50 child deaths for the entire flu season — and no one knows how long this swine flu outbreak will last.

“These are very sobering statistics,” said the CDC’s Dr. Anne Schuchat.

Also disconcerting is that “about half of the child deaths reported since Sept. 1 have been teenagers.” The 1918 global flu pandemic caused so much devastation because of how it affected healthy adults, as opposed to the very young and the elderly. An interesting discussion of current flu epidemiology can be found here, and it amplifies the CDC’s “very sobering” assessment. For example, note in the second graphic that the 5-17, 18-49, and 50-64 year age groups are already at or above their expected hospitalization rates, and we’re only at the beginning of flu season.

The probability of a severe, 1918 style impact is unknown, with best guesses ranging from negligible to 20% to ‘know way of knowing’. But quantifiable or not, it’s an ongoing risk that deserves attention.

P.S. An interesting 2008 paper from Virology Journal was linked in the comments section of the Science Links article. It sets forth an interesting hypothesis that declining Vitamin D synthesis, due to decreased exposure to sunlight, is a significant factor in susceptibility to influenza, and thus its seasonality. The experimental evidence from humans is minimal (n = 104), but what there is seems pretty tantalizing. NOTE: We are not dispensing nutritional advice! If you’re interested in the idea of Vitamin D supplementation, we strongly suggest you seek out a qualified clinical nutritionist. Vitamin D toxicity is nothing to mess with.

P.P.S. This paper is truly mind blowing — the remarkable rise in deaths from coronary heart disease (CHD) in the mid-20th century might have been associated with exposure to the 1918 influenza: “…the data suggest that the 1918 influenza pandemic and the subsequent epidemics up to 1957 might have played a determinant role in the epidemic of CHD mortality registered in the 20th century.” If true, it raises the possibility that a staggering amount of resources invested over 50+ years in analyzing, screening, and treating other factors believed to be associated with CHD mortality might have been put to better use. Yikes!

URLs:

http://news.yahoo.com/s/ap/20091016/ap_on_he_me/us_med_swine_flu

http://en.wikipedia.org/wiki/1918_flu_pandemic

http://www.iayork.com/Images/2008/9-22-08/1918FluMortalityCDC.png

http://scienceblogs.com/effectmeasure/2009/10/why_the_epidemiology_of_swine.php#more

http://www.continuitycentral.com/news02524.htm

http://www.virologyj.com/content/pdf/1743-422X-5-29.pdf

http://en.wikipedia.org/wiki/Vitamin_D#Overdose

http://www.scielo.br/pdf/csp/v18n3/9286.pdf

Dog Kisses, Wolf Vomit, and Investing

Our quote of the day is taken from a Time article about cutting edge research into canine cognition and behavior:

“If we happened to spit up whatever we just ate, I don’t think our dogs would be upset at all.”

The gist of the quote is found in the following passage:

The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection.

Believe it or not, this example is relevant to investing, finance, economics, politics, and pretty much every other human endeavor, as it nicely illustrates the gaps that can exist between beliefs, perceptions, and reality. When we interact with a dog, we can’t prevent ourselves from thinking human thoughts, thoughts that are also deeply embedded in our biological and cultural backgrounds. That means that for most of us, when another person kisses us excitedly about the face and mouth, they are demonstrating the affection they feel for us (though sometimes it’s other emotions, as Fredo Corleone could attest). And in most cases, that’s probably what the other person is thinking too. But apparently that might not have any resemblance to what a dog is thinking when it “kisses” you. Nonetheless, we tend to believe it is a “kiss”, primarily because receiving affection, real or perceived, makes us feel good. But it’s an interpretation that is probably not well grounded in reality.

In the investing world, decisions and behaviors are not always grounded in a solid assessment of reality either. For example, while it might have felt better to sell risky assets in February or March of this year and be done with it, the reality is that it would have imposed a severe performance cost (to this point, anyways). Likewise, it feels good to own assets that are in popular demand, like homes from 2003-2006, tech stocks from 1998-2000, and so on. The overwhelming use of “momentum” indicators in the investing business indicates that the majority of professional investors are prone to the same kinds of mistakes. While the continuing prevalence of herding behavior in financial markets might be comforting to individual members of the herd at most times, it’s almost certain to cause episodes of significant harm.

Studies of successful investors and traders have found that while they experience the same emotions and discomfort as every other person dealing with risk and uncertainty, they have developed skills that allow them to manage emotions with reason and discipline. Specifically, they have a firm grasp of the fact that they are involved in a probabilistic endeavor that may not turn out well in every case, and they apply consistent decision making processes, even when it would feel better to run the other way. While you may never need to develop the ice water veins of a successful trader, or the steely nerves of a contrarian investor,  there are a couple of old adages that, because they are well grounded in reality, should help all investors avoid excessive reliance on emotion when making financial decisions:

What goes up must (eventually) come down.

Don’t put all your eggs in one basket.

Of course, in the world of human-canine relations, it probably won’t cause any harm to believe that a dog kiss is, well, just a kiss. It sure beats the alternative!

URLs:

http://www.time.com/time/magazine/article/0,9171,1921614,00.html?xid=yahoo-feat

http://www.youtube.com/watch?v=FcFlp6kl508&feature=player_embedded

DISCLAIMER: Symmetry Capital Management, LLC is a Pennsylvania registered investment advisor. The foregoing is not a solicitation to buy or sell any security, or a recommendation to engage in any particular investment strategy.

The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”The first rule for scientists studying dogs is, Don’t trust your hunches. Just because a dog looks as if it can count or understand words doesn’t mean it can. “We say to owners, Look, you may have intuitions about your dog that are valuable,” says Hauser. “But they might be wrong.” See TIME’s video “The New Frugality: Doggie Day Care.”

Take for instance the kiss a dog gives you when you come home. It looks like love, but it could also be hunger. Wolves also lick one another’s mouths, particularly when one wolf returns to the pack. They can use their sense of taste and smell to see if the returnee has caught some prey on its journey. If it did, the licking often prompts it to vomit up some of that kill for the other members of the pack to share. The kiss dogs give us probably evolved from this inspection. “If we happened to spit up whatever we just ate,” says Horowitz, “I don’t think our dogs would be upset at all.”

Lomborg: The Climate-Industrial Complex

An important op-ed in the WSJ today from Bjorn Lomborg, a European social scientist despised by many (unfortunately) for his sobriety on climate change policy. He cleverly sees a broad parallel between current impetus on climate change and the “military-industrial complex” that arose during the Cold War. As President Eisenhower famously warned, that relationship created a “disastrous potential of misplaced power,” and required an “alert and knowledgeable citizenry” to keep it in check. In Lomborg’s piece, you’ll see many of the concerns we’ve raised regarding the momentum behind climate change policy, with some supporting anecdotes:

• Political agency risk  
• Profiteering and rent seeking
• Enron as the poster child of “regulatory business”

Lomborg also cites research that questions the all to frequent “green collar jobs” mantra. As we’ve pointed out, the important question is what the net effect on employment is (green collar jobs created less other collar jobs lost). He concludes, ”[T]he partnership among self-interested businesses, grandstanding politicians and alarmist campaigners is an unholy alliance.” 

Of course, Lomborg is probably well aware that his arguments will do little to sway true believers on either side of the issue. In fact, it’s likely to have the opposite effect, as research into political beliefs demonstrates:

…when partisans face threatening information, not only are they likely to “reason” to emotionally biased conclusions, but we can trace their neural footprints as they do it.

When confronted with potentially troubling political information, a network of neurons becomes active that produces distress…

The brain registers the conflict between data and desire and begins to search for ways to turn off the spigot of unpleasant emotion…

Not only did the brain manage to shut down distress through faulty reasoning, but it did so quickly… The neural circuits charged with regulation of emotional states seemed to recruit beliefs that eliminated the distress and conflict partisans had experienced when they confronted unpleasant realities. And this all seemed to happen with little involvement of the neural circuits normally involved in reasoning.

…Once partisans had found a way to reason to false conclusions, not only did neural circuits involved in negative emotions turn off, but circuits involved in positive emotions turned on. The partisan brain didn’t seem satisfied in just feeling better. It worked overtime to feel good, activating reward circuits that give partisans a jolt of positive reinforcement for their biased reasoning.

Here’s a challenge to climate skeptics reading (and writing!) this post – try to avoid the partisan rationalization trap! Is climate change worth worrying about? You bet. In fact, what we like about Lomborg is his centrism and sobriety. Yes, he’s a reviled scourge of climate change proponents, and a comforting presence to skeptics and deniers. But if the latter read him more carefully, he would probably be loved by no one – which makes him all the more compelling, in our view.

URLs:

http://online.wsj.com/article/SB124286145192740987.html

http://www.bbc.co.uk/blogs/newsnight/2007/08/the_political_brain_by_drew_westen.html

http://www.youtube.com/watch?v=8y06NSBBRtY

Tyson: Defending Obamanomics

UC Berkeley economist Laura D’Andrea Tyson penned an interesting op-ed for the WSJ today, arguing that President Obama’s stimulus plan and budget will have positive economic and social impacts. Some of her claims are wait-and-see economic projections, others offer some helpful detail and historic perspective, and a few are, in our opinion, open to vigorous debate. Key excerpts include the following:

The president’s budget is progressive and ambitious. It will not, however, explode the size of government as some critics warn. If the economy recovers as projected, over the next decade taxes as a share of GDP at around 19% will be lower than they were during the second half of the 1990s, government spending as a share of GDP at around 22.5% will be about where it was under Reagan, and nondefense discretionary spending at around 3.6% of GDP will fall to its lowest level since that data was first collected in 1962.

This is Tyson’s essential argument, and it’s important to read/hear. She notes that the projections are subject to some uncertainty: “The real risk lies in the possibility that the economy’s recovery starts later and is much weaker than the economic assumptions in the budget.” However, we think the underlying objectives are the ones to pay attention to. In our view, people on the political left and right tend to expect far too much good from their own policy preferences than warranted, and far too much harm from their opponents’. And right now, too many folks on the right are gnashing teeth, rending garments, and calling for the end of the world as we know it. We’ve been saying for some time that investors should brace themselves for public policy shifts that will lower most financial asset values at the margin, perhaps substantially. But it’s also important to keep in mind that (1) there’s nothing in Obama’s plans that spells doom or outright collapse (in fact they contain some worthy economic objectives) and (2) our political system tends to be very responsive to costly policy errors, at least compared to most current and historical alternatives.

President Obama’s budget will restore the top two marginal tax rates to their 1990s levels of 36% and 39.6% for individuals earning more than $200,000 and couples earning more than $250,000. These changes will affect only the top 3% of taxpayers, the group that has enjoyed the largest gains in income and wealth over the last decade. In addition, for these taxpayers the tax rate on capital gains will increase to 20%, the lowest rate in the 1990s and the rate President Bush proposed in 2001, and the tax rate on dividends will increase to 20%, a rate lower than the rate of the 1990s and nearly 40% lower than that proposed by President Bush in 2001.

Good policy context, and there have been some stubborn problems with the U.S. income distribution over the last few decades, which we believe is an important factor in the Democratic party’s return to power. In another passage, she also clarified the change in treatment of charitable deductions, which will be deducted at a maximum rate of 28%; that’s not as dire as some commentators have described. However, we have to keep a few counter points in mind. First, in the U.S., there is a relatively high rate of movement between tax brackets; the people being taxed more heavily in coming years may not be the people who benefited from rising incomes at the top over recent decades. Second, taxing the beneficiaries more heavily is not the only solution to improving the income distribution; for example, the inflation tax on savings, and most importantly, our relatively high marginal tax rates on corporate income (as demonstrated by David and Christina Romer, colleagues of Tyson’s at Berkeley) are compelling alternatives that might confer greater long term benefits to society as a whole. In fact, there was some thin but tantalizing data following the 2003 tax cuts that indicated income improvements among lower wage earners; unfortunately, the relevant measures expired before any firm conclusions could be drawn, but the 2003-2006 period might prove to be a fruitful area for research into taxes and income distribution. Tyson also waves away the impact on small businesses, arguing that only 3% of them would be subject to a higher rate; perhaps, but it still imposes a marginal cost during a time of deep economic recession and uncertainty, and it also worsens the relative distortions between personal and corporate income taxes. Third, the federal government must be very careful not to cross that unknown threshold where human capital begins to emigrate from the U.S., something that has happened in states like California and Illinois in recent years. As a country, we may be nowhere near that point yet, but we are closer than we were in 2008. And if we are reckless enough to cross it, the long term consequences would be depressing.

Reducing the nation’s dependence on foreign oil and cutting carbon emissions are also priorities, supported by overwhelming scientific evidence on the risks and costs of climate change.

This is the point we would take vigorous exception to; in fact, it’s almost reflexive any time we hear the phrase “overwhelming scientific evidence.” If we had a dollar for every time that phrase has been misapplied in the history of humankind, we could retire and write these missives for our own amusement. Good science acknowledges that uncertainty looms large in any model, however the evidence may look at any point in time. Human beings have been diligently modeling climate change and anthropogenic warming – an exceedingly complex and chaotic system of interactions – for less than thirty years. Our knowledge of many important contributing factors is just as young or younger, and for yet to be discovered factors, it’s nonexistent. As Benoit Mandelbrot wrote in Fractals and Scaling in Finance, “it is prudent to fear that ‘what we know’ is not necessarily the last word.”

Despite our heretical skepticism, we think that cleaner energy technologies are extremely desirable, and we fully acknowledge the risk that the current models prove to be accurate. Anthropogenic climate change and its consequences could be as serious as the critics say, or worse, and limiting CO2 emissions might indeed be an effective means of limiting the damage. Scientist James Hansen’s and others’ warnings of an irreversible ‘tipping point’ should not be dismissed out of hand either.

But the climate change movement reminds us very much of other movements once based on “overwhelming scientific evidence”. For example, it was believed for a time, by some otherwise intelligent people, that autism was primarily caused by cold and emotionally distant mothering! A more credible and persistent one is the connection between diet (saturated fat and/or cholesterol) and Coronary Heart Disease (CHD). The consensus built upon “overwhelming scientific evidence” has been subjected to an increasing number of attacks in recent decades, as evidence accumulates that limiting the ingestion of cholesterol and/or saturated fat to lower the risk of CHD in populations is highly questionable:

“[In the Framingham Massachusetts study,] the more saturated fat one ate, the more cholesterol one ate, the more calories one ate, the lower people’s serum cholesterol…we found that the people who ate the most cholesterol, ate the most saturated fat, ate the most calories weighed the least and were the most physically active.” Dr William Castelli 1992 (link).

Dr. Clare Hasler noted in a 2000 Journal of the American College of Nutrition article, “it is now known that there is little if any connection between dietary cholesterol and blood cholesterol levels.”

According to Dr. Uffe Ravnskov, “observations strongly suggest that high cholesterol is only a risk marker, a factor that is secondary to the real cause of coronary heart disease. It is just as logical to lower cholesterol to prevent a heart attack, as to lower an elevated body temperature to combat an underlying infection or cancer.” He has also aggregated substantial evidence that calls the association of saturated fat intake and CHD into question.

In recent years, regulatory bodies like the FDA have paid increasing attention to the role of trans fatty acids in the diet, and by many measures, they are at least as harmful, perhaps much moreso, than saturated fats were once believed to be. In short, the once “overwhelming scientific evidence” that saturated fat and/or cholesterol in the diet raise the risk of CHD in a population has turned out to be  little more than the well-publicized-theorizing (or opinions) of some scientists (or activists) based on preliminary but incomplete findings, supported by economic beneficiaries, such as pharmaceutical companies. This is not to say that CHD management therapies, including dietary modification and drugs, are worthless; they are surely helpful for some individuals. But the diet-CHD hypothesis for entire populations, after decades of widespread acceptance, has been shown to be quite shaky.

There are countless other examples, from many fields of life, that “overwhelming scientific evidence” is often extremely plastic, and that “consensus” is often oversold (the SMON episode in Japan is a powerful example). Our sense is that the anthropogenic global warming movement has many of the features of such movements, and if true, the costs of pursuing this particular piece of change could far outweigh the realized benefits. And as long as we profess to care about future generations of citizens and taxpayers, not to mention understanding and solving the problem at hand, we should be explicitly mindful of this risk.

Another important concern relates to cap and trade as a means of limiting carbon emissions – the so-called “market based” approach. This sets up a public-private system that allows privileged entities to extract significant economic rents. According to Tyson, the Obama Administration claims that 80% of the initial auction revenues from a cap and trade system “will be used to finance a refundable tax credit of up to $400 for individuals and up to $800 for families.” There are severe agency risks in a cap and trade system, far more than a straight carbon tax, and its planned implementation strikingly contradicts, for example, the decision made by Treasury and Congress to end the use of private debt collectors by the IRS.

———————————–

Epilogue: We have a serious beef with some of the global warming related thinking and marketing being peddled these days. One of the most irritating examples comes from our local cable company – it’s an ad with children ranging from perhaps three to twelve years old, warning their parents about impending ecological collapse – as if the planet itself needs us to save it! This idea is so inane that it borders on insane. The planet will be absolutely fine, with or without us, presumably until our solar system collapses. As Professor Valerius Geist noted in his book Whitetail Tracks:

The type of landscapes we take for granted as “natural” are actually an article of human intervention caused by human elimination of megaherbivores…

The huge, tree-crunching giants [are] gone, a profound departure from normal landscape ecology…Kill the big plant-eaters and continents sprout forests…That was the new setting, the new ecological stage, for a new beginning for life on Earth…Fires replaced giant herbivores as devourers of trees…Life adores opportunity. It simply will not rest!

In other words, life on planet earth is capable of adapting to many different climates. Thus, the whole global warming movement, for the most part, is not about the planet, but about us! It is propelled by our evolved capacity to think about the future, to worry about our place in it, and perhaps by cultural and institutional backgrounds that encourage us to embrace personal guilt and responsibility. This should not lessen the material concerns raised by the global warming hypothesis, of course. But it should at least start to demolish the old “Mother Earth needs our help” myth as the  mindless bunch of nonsense that it is.

Geist’s observations also tie back into anthropogenic global warming, as the past existence of megafauna would argue that the earth’s climate has been much warmer in past epochs, perhaps warmer than the worst climate models currently predict. Imagine a world of giant herbivores toppling flora of any size, crunching, munching, and ingesting massive amounts of plant material, fermenting them in specialized digestive systems with multi chambered stomachs, and acting as giant fertilizing machines spreading seed-laden dung far and wide. The “greenhouse gas” emissions of such processes would have been massive, and a hot, tropical planet would have been the norm. Looked at in that light, it’s unreasonable to argue, for example, that large, stable polar ice caps represent some normal state of affairs in the natural history of the planet’s climate. Rather, their contraction represents a threat to our species’ and some other species’ status quos. But the planet will get along swimmingly with or without humans, polar bears, arctic seals, or the many other species at risk from a significantly warmer climate, many of whom exploited niches created by past shifts in climate. As Geist observes, life adores opportunity and will not rest – no new niche will go unfilled.

Again, to be clear, climate change is a possibility with potentially severe ecological consequences for human beings and other species. But it’s important to contemplate it in the broadest context possible, and with a clear understanding of our motivations for doing so. We will also point out that given the complexity and significance of the subject, the highest probability of optimal policy outcomes is likely to be conferred by referenda. However, there are few causes whose champions and true believers would agree to subject them to such a process, much less abide by an “undesirable” outcome (Bjorn Lomborg’s Copenhagen Consensus Center is a notable exception to these typical human behaviors). Hence the rush to implement programs – based, of course, on “overwhelming scientific evidence”.

URLs:

http://online.wsj.com/article/SB123655553728965955.html

http://homodiet.netfirms.com/otherssay/chd/heart_disease1.htm

http://www.jacn.org/cgi/reprint/19/suppl_5/499S

http://www.ravnskov.nu/cholesterol.htm

http://www.webcpa.com/ar
ticle.cfm?ARTICLEID=30927

http://www.palaeos.com/Mesozoic/Mesozoic.htm

http://www.copenhagenconsensus.com/Default.aspx?ID=319

http://www.nytimes.com/2004/06/05/arts/50-billion-question-world-where-to-begin.html