Thursday, August 3, 2017

AUGUST 2017 DESERT OF THE REAL ECONOMICS NEWLSETTER



HAD WE BUT WORLD ENOUGH, AND TIME 

HAD WE BUT WORLD ENOUGH, AND TIME. ([i])

It is beyond cliché to say, “Time is Money”. But it usually is and that is why the oft-cited aphorism survives. This Newsletter will look at some options basics, as that is all the Authors are trading. This post will look at the “time value” component of options and how the limited life of an option affects the value of an option. But first let’s talk a bit about where we are at in the markets.

The Dow has broken 22,000 and the S&P and NSDQ are also at record levels.  And The S&P 500 hasn't suffered a downturn of 5% or more since June 26, 2016. And the VIX, a key volatility index, is coming in at record lows. So effectively this market is driven to higher and higher returns on low volume.  Everyone assumes a pull back is coming. But when? August, September, and October are typically weaker months for the market.

THE EXPIRATION CYCLE OF OPTIONS

As we know, options are contracts to buy or sell a specific security at a specific price on or before a specific date. The expiration cycles of options are standardized. The three cycles are:

1. January, April, July and October. (JAJO).
2. February, May, August and November. (FMAN).
3. March, June, September and December. (MJSD).

Options expire on the third Saturday of the month. The last time to execute an option is at close of the Options exchange on the Friday before. After the option expires, the option is worthless. So in addition to considering the type and strike price of the option, we must also consider the time until the option expires.

TIME VALUE AND INTRINSIC VALUE

Options have two types of values: Time Value and Intrinsic Value. We will do a little review on the concept of “in the money”, “at the money” and “out of the money”, and then montage into the concept of time value.

Options can be “in the money”, “at the money”, or “out of the money”. To illustrate, we will use Call examples for the bloatware company MonopolySoft (MPST). MPST is currently trading for $25 per share. We are interested in the April 16 Calls.

We believe that MonopolySoft will rise in price when its 2015 earnings report is issued in late January or early February. We believe that it will rise to $30. So we go to the MonopolySoft options montage in our online brokerage site. There are three April 16 Calls we are considering:

1. Call with a Strike Price of $23. The premium for this Call is $3. This call is in the money by $2. ($25 (stock price) -$23 (strike price)= $2.)
2. Call with a Strike Price of $25. The premium for this Call is $1.00. This Call is at the money because the stock price equals the strike price.
3. Call with Strike Price of $27. The premium for this Call is $.33. This call is out of the money because the strike price is higher than the stock price.

TIME VALUE AND INTRINSIC VALUE CALCULATION

Intrinsic value is the amount that the option is in the money. If it is a Call, it is the amount by which the stock price exceeds the strike price. If it is a Put, it is the amount by which the strike price exceeds the stock price. Stated another way, the intrinsic value is the amount we could make on the option if we exercised it. If we exercised the Call with the $23 Strike Price we could buy MPST at $23, sell it at the market price of $25, and make $2. This $2 profit is drawn from the option’s intrinsic value.

We could do that and earn the intrinsic value of the Call of $2. But if we did exercise we would still lose $1. Remember, we paid a premium of $3. So if we sell it for $2, we would lose a dollar. It is this $1 difference between the intrinsic value and the premium we paid that is the time value of the Call.

TIME (AT LEAST FOR NOW) IS ON OUR SIDE

The April 16 MPST Calls will expire on April 15th (Hmm, what a coincidence). They must be exercised no later that Friday, April 14th. So if we buy an April 16 Call it has almost 5 months until expiration. A lot can happen in that those five months, and that is to our advantage. There is an aphorism in Options trading that says: “Give yourself enough time to be right”. Many things can go right in the five-month life-span of the April 16 Call to cause MPST stock to go up in price. And if MPST goes up in price, our Call will go up in value. And even if MPST slips in price tomorrow, we still have nearly five months for the stock to turn around.

So with nearly five months to go in the April 16 Call, time is on our side. Let’s put a number to the time value of this April 16 MPST $23 Call:

$25 Stock Price - $23 Strike Price = $2 Intrinsic Value.

But since the Premium cost us $3 and the Intrinsic Value is $2, the Call has a Time Value of $1:

$3 Call Premium - $2 Intrinsic Value = $1 Time Value. So the Time Value is the cost, or value of the premium that exceeds its Intrinsic Value.

But what would happen if we have a Call that has no intrinsic value? Like a call that is at the money or out of the money? The entire value of these calls is composed of time value. We will look at this issue and the affect of option values as they approach expiration in another post or newsletter.

And yonder all before us lie[ii] The Desert of the Real.

For fun and for your literary enrichment.

To His Coy Mistress

by
Andrew Marvell

Had we but world enough, and time,
This coyness, Lady, were no crime.
We would sit down and think which way
To walk and pass our long love's day.
Thou by the Indian Ganges' side
Shouldst rubies find: I by the tide
Of Humber would complain. I would
Love you ten years before the Flood,
And you should, if you please, refuse
Till the conversion of the Jews.
My vegetable love should grow
Vaster than empires, and more slow;
An hundred years should go to praise
Thine eyes and on thy forehead gaze;
Two hundred to adore each breast;
But thirty thousand to the rest;
An age at least to every part,
And the last age should show your heart;
For, Lady, you deserve this state,
Nor would I love at lower rate.
But at my back I always hear
Time's wingèd chariot hurrying near;
And yonder all before us lie
Deserts of vast eternity.
Thy beauty shall no more be found,
Nor, in thy marble vault, shall sound
My echoing song: then worms shall try
That long preserved virginity,
And your quaint honour turn to dust,
And into ashes all my lust:
The grave's a fine and private place,
But none, I think, do there embrace.

Now therefore, while the youthful hue
Sits on thy skin like morning dew,
And while thy willing soul transpires
At every pore with instant fires,
Now let us sport us while we may,
And now, like amorous birds of prey,
Rather at once our time devour
Than languish in his slow-chapt power.
Let us roll all our strength and all
Our sweetness up into one ball,
And tear our pleasures with rough strife
Thorough the iron gates of life:
Thus, though we cannot make our sun
Stand still, yet we will make him run.


[i] Marvell, Andrew, “To his Coy Mistress”. Some readers may have read this poem in high school or college literature classes. All though some of the phraseology is dated, the message is universal. And the Author Rob does not even wear a watch.
[ii] “To his Coy Mistress”.







Wednesday, July 26, 2017

DANGER, WILL ROBINSON!*


Danger, Will Robinson! is a classic line from the 1960s space-opera “Lost in Space.” Originally a traditional science fiction show following a pioneering space family, the show became the Dr. Smith, Will Robinson and Robot fantasy adventure. Replete with human-sized vegetables, space hippies, and intergalactic bikers.

The Robot, whose purpose was to perform tasks for the family Robinson, and to defend them, often said “Danger, Will Robinson” when menace threatened Will and Dr. Smith. Will and the Robot were dedicated adventurers. Dr. Smith, by contract, was a malingering foil to the robot and maligned the mechanical monstrosity in malicious and contra-mellifluous terms. Uh, uh, er something.

One cannot swing a dead carnivore without hitting an article about the future of work being usurped by robots and Artificial Intelligence. The Author has addressed it several times. In “By the Pricking of my Thumbs,Something Wicked this Way Comes,”  the author addressed the risk to the future of work. Or more precisely, the lack of work thereof. And what the low information unemployed illiterates say, the problem "ain't the Chinese or the 'Mezcuns. The Author wrote in the earlier post:
         
    At every small town dive bar and VFW, it is the Chinese and the “mezcuns,” that’s “uh taken our jawbs.” Sorry cuz, there must be something funny in the AM Radio you listen to. It’s automation. Its here, and it is big. And hungry.

In the last decade or so, Mexico and China combined took about 1.7 million American manufacturing jobs. Sounds like a big number and it is:

That might sound high. But consider that last year alone, the U.S. added more jobs than those losses combined (1.7 million). Other research shows robots eat up a much bigger portion of the job-loss pie.

One study by two Ball State University professors found that between 2000 and 2010, about 87% of the manufacturing job losses stemmed from factories becoming more efficient. The chief driver of more efficiency in factories: automation and better technology. The other 13% of job losses were due to trade. [1].

NOBODY BUT CHEAP POLITICAL PANDERERS WIN TRADE WARS. AND THERE SHOULD BE LITTLE SYMPATHY FOR THE CEMENT HEADS THAT BELIEVE THEM.

In “Why the Robots Will Win the Coming Trade Wars,”, Patrick Watson, a colleague of John Mauldin of Mauldin Economics,  lays it out bluntly:

The first step to surviving a war is knowing which side you are on. But in a trade war, that’s not always easy…
But one group is sure to win in a trade war because demand for their services will skyrocket.

Who are these lucky people?

They aren’t people at all. They’re robots.

Watson concludes with the obvious:

This isn’t a new development. Intense competition is already forcing automation, but new trade restrictions will 
add further urgency.

DESPITE OUR MOST DESPERATE EFFORTS, AUTOMATION PROVIDES NO EFFICIENCIES IN THE DESERT OF THE REAL!

*”Danger, Will Robinson,” is also the name of a rock band from Northwest Indiana.









Saturday, July 22, 2017

AMERICA FIRST? OR AMERICA, WELL, YOU KNOW AMERICA...*


While the nation watches congress and the president vie for the title of the least capable and least productive, a policy is developing in the White House to plunge the developed world into a trade war. A trade war that might sound good in Pittsburgh, but will benefit Paris more than Peoria.  

As reported on June 30th in Axios,  trump, against the advice of nearly all of the cabinet, made it clear that he intends to impose tariffs on steel and other imports. Tariffs as high as 20% and which may cover aluminum, semiconductors, paper, and appliances like washing machines.[1]

TRADE WARS ARE CIRCULAR FIRING SQUADS. (COULDN’T WE PUT A SPECIAL SOMEONE IN THE CENTER?)

The ostensible target of this folly of a feud is China. But this trade war will affect American allies such as the UK, Canada, Mexico, Germany and Japan.  Retribution and recrimination will start the vicious cycle. And Chinese steel is not even on the trade radar. [2] America’s largest steel importer is Canada, followed by Brazil, South Korea, Mexico, Turkey, Japan, Russia, Germany, Taiwan and Vietnam.  China is not even one of the top 10 steel importers. So why China?  We will leave that to the readers

WELL, IF YOU ASK ME, UH, WE’RE PROTECTING THE WRONG WORKERS [2}

Dan Pearson of the Cato Institute is quoted in the Mauldin article. Pearson states:

“[c]lamping down on steel imports threatens considerably many more jobs than “protecting” the steel industry from foreign competition can save. As Dan Pearson of the Cato Institute noted recently: “Steel mills employ 140,000 workers. Manufacturers that use steel as an input 6.5 million, 46 times more.” Steel mills’ $36 billion of productivity in 2015 represented just 0.2 percent of US GDP, Pearson explains that the economic value contributed by US firms that use steel was 29 times larger.”

The Mauldin article also recounts the 2002 steel tariffs imposed by George W. Bush. The Bush tariffs caused the loss of approximately 200,000 jobs in industries that rely on imported steel.  Fifty-three percent of these losses occurred in ten states, seven of which went for trump in the last election. 

Trump made explicit “promises” to blue collar voters to “bring back (our[3]) jobs. If the plan is to bring back a few thousand in the dying coal industry and the diminished steel industry, while hundreds of thousands of other Americans lose their employment in ill advised trade wars, it is a promise that will ring vacant and hollow in 2020.

IF JEREMY BENTHAM HAD A COMPUTER, HE WOULD READ THE DESERT OF THE REAL!

*The Authors intend this website to be family friendly, if not a family contentious, discursive space. 


[1] A tariff on appliances is kind of ironic, since appliances are mostly made of steel. When the tariffs’ jack up the price of steel, American appliances will cost more. Who is the genius that sewer spawned that idea?
[2] Although the Authors abhor racism, prejudice and bigotry, there is an artful and mordant quote from the 1988 Vietnam War classic that captures the racism, bigotry and manifest ignorance in much of the white working class.  When asked a question in a media interview of his unit, Animal Mother states: ”Well, if you ask me, uh, we’re shooting the wrong Gooks.”
[3] As if a job is anyone’s, unless she has invested capital in a business that employers her.  “Our jobs” is a fraught statement in a world where countries compete against each other and attempt to gain competitive advantage. But it sure echoes in empty heads.

Wednesday, July 19, 2017

ALL’S FAIR IN LOATHE AND WAR…


As readers know, the Author Rob follows John Mauldin’s “Frontline.” Mauldin’s newsletters are entertaining and informational.  And the newsletter contains great discussion of interest rates and interest rate directions. 

Mauldin has an associate that writes a letter called “Connect the Dots.” His name is Patrick Watson. This week he addressed the impending trump trade war.  Since trump cannot man up to Kim Jong-Un, trump wants to pick a little war that he can actually declare. But a war no one that knows much of anything wants. A war where the losers will be the ones that trump said he would look out for.  His twitter reading multitudes.

FIRST STEEL. THEN WHISKEY?

An anachronism from the Cold War, a relic as bankrupt and counter-productive as the Electoral College, gives the a president a large loophole to ignore trade agreements if the president determines that they “harm US national security.”  The law has been in place since 1962.

The claim that steel imports “harm US nation security” is not creditable.  China has been dumping steel in the US and Europe.  From CNN in May of this year:

The European Commission has announced new anti-dumping duties on pipes and tubes made from steel and iron in China, its latest attempt to stop the flow of cheap metal from the country. 

The duties of 29% to 55% were imposed after an investigation found that Chinese firms were dumping steel into Europe at unusually low prices that hurt local competitors. 

But steel dumping does not harm “US Security.” The military industrial complex is not putting steel wanted ads on billboards or posting on Craigslist.  Measured negotiations and an international approach can more effectively address the matter than firing off a trade war to generate activity and satisfy a few sycophants.

Trade wars are like dance parties. When the music is playing, countries have to dance. The trade war will not be limited to the US and China.  The European Union is already drawing the lines in the sand:

[European Union] officials have begun assembling a list of US goods including whiskey, orange juice and dairy products to target for retaliation over Donald Trump’s plans to invoke national security concerns to limit steel imports.

European Commission president Jean Claude Juncker told the Financial Times, “Our mood is increasingly combative.”

The good news is that the trade war will end. The bad news will be how much damage will be done to keep one campaign promise out of a hundred, and a very ill advised promise at that. Damage many thousands of American businesses for a handful of steel mills.  

How the market will react is a hot subject of discussion.  

WE WILL HOLD THE DISCUSSION FOR ANOTHER DAY IN THE DESERT OF THE REAL.




Friday, July 14, 2017

FULL EMPLOYMENT AND LAGGING WAGES...WHY THE DISCONNECT?



The Author Rob remembers reading some letters responding to a blog article that lamented that despite the high demand for legal services, lawyers would not lower their costs to meet the demand.

One guy wrote in with something like “Supply meet Demand.”

The Author Rob did not respond, but anyone that has studied microeconomics should know that supply and demand usually meet at one point, ceteris paribus ,if at all.  There is mega demand for new Corvettes at $10,000. There is an unlimited supply of nurses at $100 per hour.  Simple economics that the guy probably forgot to consider. No harm, no foul.

WHY ARE PAYCHECKS FROZEN IN PLACE?

 Wages have only increased 2.5 % in the last 12 months. Yet there are help-wanted signs on every marquee. It turns out there are a lot of reasons why wages are lagging despite the result that would  be expected. There are several of them and looking them is illustrative of principles that extend across the graph.

1.     1. We got Long Memories. Wages have lagged for so long that workers, who remember the ugly days of the Great Recession, are reticent to ask for too much, even in these good times. And employers, so long used to pounding down wages for employees that were grateful for any job, have combined to create a negative feedback loop, or a vicious cycle.

In an article entitled “Why can’t Employees get Raises?” by Daniel Gross, “This amounts to a mutually reinforcing feedback loop. Companies are psychologically and emotionally geared not to raise wages as a matter of course. And many people who work are reluctant to aggressively ask for higher wages, or to quit and seek a better opportunity.”  

2.    2. Employers Want More Proof.  Despite the good economics numbers, there are doubts among employers and economists. The economic agenda of trump is stalled and political uncertainty is the touch word.

 “This is an unprecedented level of political uncertainty,’ said William E. Spriggs, chief economist for the A.F.L.-C.I.O. “That is creating a drag on the economy.’

“Juanita Duggan, chief executive of the National Federation of Independent Businesses, said, ‘Small-business owners seem to be in a holding pattern while they wait to see what Congress will do with taxes and health care.”

3.     What goes Up does not Always Come Down.  The reason that wages are rising slowly, if at all, may also reflect a certain type of wage “stickiness.”  Wage stickiness, or nominal rigidity*, posits that workers are very resistant to cuts in wages. Thus wages are nonelastic and employees will resign before taking wage cuts. So the converse may be true on the employer side. Raising wages without confirmation of a more robust economy leaves an employer that is suddenly overstaffed when business conditions drop with high labor costs. 

These are just some thoughts on the issue. But the Authors see the shades of tight labor markets most everywhere. On store signs that should be advertising sandwich and milk shake prices, there is “Help Wanted” in bold and desperate letters. 

*Wow, but could my bros Beavis and Butt-Head have some fun with the term "nominal rigidity."

VERY LITTLE IS STICKY IN THE DESERT OF THE REAL. THINGS RUN LIKE THEY ARE BUILT ON RAILS.

Sunday, July 9, 2017

JULY 2017 DESERT OF THE REAL ECONOMICS INVESTMENT NEWSLETTER

 Welcome to the Desert of the Real.[1] This newsletter is free of charge and directed to anyone who wants better investment results.

The Only Thing Inevitable is the Author’ s Use of the Trite Aphorism: “The Only Things that are Inevitable are Death and Taxes?”

Only one subject will figure prominently in this newsletter. The topic will be the Roth IRA and how to employ it effectively in your retirement planning. 



To begin the discussion, lets take a look the limits for Traditional and Roth IRA contributions. 

They are set out below:



20172016
Roth IRA Contribution Limit$5,500$5,500
Roth IRA Contribution Limit if 50 or over$6,500$6,500
Traditional IRA Contribution Limit$5,500$5,500
Traditional IRA Contribution Limit if 50 or over$6,500$6,500



Roth IRA Income Limits (for single filers)Phase-out starts at $118,000; ineligible at $133,000Phase-out starts at $117,000; ineligible at $132,000
Roth IRA Income Limits (for married filing jointly and qualifying widow(er) filers)Phase-out starts at $186,000; ineligible at $196,000Phase-out starts at $184,000; ineligible at $194,000



Before we take up the Roth IRA, let’s do a review of the Traditional IRA. A Traditional IRA, around since the 1970s, allows an income earner to put money into a tax-deferred account.   

Subject to certain restrictions, the IRA account holder then has his adjusted gross income reduced by the amount of his IRA contribution. Basically, the Traditional IRA contribution goes in tax-free. The returns on the IRA account grow tax-free until the account holder withdraws funds from the account. When she withdraws funds, the withdrawals are then taxed at her ordinary income tax rate.

A Traditional IRA holder cannot, subject to certain exceptions, make withdrawals prior to age 59-1/2 without paying a 10% penalt y. A Traditional IRA holder must begin withdrawals at age 70-1/2. Further, the beneficiary of the IRA, upon the account holder’s death, must begin to make withdrawals. In short, a Traditional IRA holder defers, but does not eliminate taxes on the account returns. Sounds good so far, so what’s the catch?

Here are the catches. The intervening years between the 1970s and today have seen huge changes in the tax code that have reduced the anticipated benefits of the Traditional IRA. Also, a key assumption that underlay the rationale for the Traditional IRA was apparently incorrect. Let’s take a look at what went wrong:

1. Tax Bracket Compression. When the IRA law was enacted, individual tax rates were higher Marginal rates could be very high[3]. And there were numerous tax brackets. If you were in a high tax bracket before retirement, you could generally assume you would fall into a lower tax bracket after retirement and pay lower taxes on your IRA withdrawals. Your Traditional IRA would not eliminate taxes, but it would reduce them.

Congress, in the intervening years, has cut top rates and reduced the number of tax brackets. There are now six federal tax brackets,  And if you listen to Donald Trump and the republican house and senate, the rates will be further compressed and lowered to three.  And reduce exemptions and deductions. Of course this White House and Congress have been spectactuarly ineffective at moving any legislation through. So let's not hold our collective breath.


And as tax rates compress, there are less tax savings available for your traditional IRA withdrawals. And if the flat-tax advocates get their way, there would be no bracket reductions to lower your IRA withdrawals.[4] But of course the flat-tax advocates are about as effective as flat-earth advocates as advancing their position.

2. What Cut in Retirement Income? In the 1970s it was generally assumed that nearly all Americans would have reduced income in retirement. Few Americans had amassed large retirement savings. Most folks relied on Social Security and a pension. Although the data is somewhat scant, economists are finding that retirees with Traditional IRAs are not taking substantial cuts in income in at least their first few years of retirement. This could be a confluence of two factors.  One is the result of tax bracket compression set out in 1, above. The other factor could be that individuals who took advantage of Traditional IRAs and are now retiring are high-net worth individuals that initially saw the value of Traditional IRAs in the 1970s and 1980s.

And it should additionally be considered that people who began investing in the late 1970s and early 1980s rode the strongest Secular Bull Market in history to unprecedented gains. When it rains, says the versatile aphorism, it pours.

If there are so many things wrong with the Traditional IRA, what is right with the Roth IRA?

The Author is Temporarily out of Alliterative Allusions and Terrific Tropes

The first and foremost advantage of the Roth IRA is that the proceeds are tax-free. All of the returns will be tax-free. The account holder’s contributions are after-tax, so there is not upfront savings. But the long-term benefit far outweighs up-front taxability. The only other concern with the Roth IRA is that high-income individuals cannot take advantage of a ROTH. These limitations are set out above.


Some Examples: (Important Note. These figures are a few years old, but the divergence still holds up.)

Josh and Jenna White are 35 years old. They plan to retire at 35, so they have 30 years until retirement. They do not have a pension plan at work. They can either contribute $8,000 to a Traditional IRA or $8,000 to a Roth IRA. We will assume that when they retire they will be in the 25% tax bracket. If they take a lump-sum distribution when they retire the lump-sum amount will push them into the 35% tax bracket. We will also assume they will get an 8% annualized return.

When Josh and Jenna retire, their IRA balance, Roth or Traditional, will be:

$264, 711 If they have a Traditional IRA and take out the entire lump sum, the amount, after taxes at the 35% rate is:

$172, 062. If they withdraw an equal amount of the proceeds over ten years, taxed at 25%, their annual withdrawal will be: $19, 853 per year.

Here is where the Roth IRA advantage becomes clear. If Josh and Jenna have a Roth, there are no taxes. They keep the ENTIRE $264, 711.

Tim and Trina Brown are 30 years old. They plan to retire at 70, so they have 40 years until retirement. They have 401(k) plans at their work and each employer matches 401(k) contributions up to 3%. They currently contribute $10,000 to their 401(k)s. Should Tim and Trina max out their 401(k) contributions? Or should they contribute to their 401(k)s only to the extent of the company match and put the rest into a Roth IRA? (The gentle readers should already know the answer, but here comes that math.)

If Tim and Trina continue putting $10,000 into their 401(k)s, they will have $296, 839, as a lump-sum (after tax) 401(k) withdrawal. If they take the proceeds over 10 years, they will get $34,251 per year.

However, if Tim and Trina limit their 401(k) contributions to only the company-matching amount, they will retire with $379,041. If they take it out over 10 years, they will get $38,817 per year. (These amounts include the taxes on the taxable 401(k) proceeds.)

$82,202! That is the difference. 27% more than the 401(k) strategy. Put another way, 2.4 more years of income than the 401(k) strategy. A simple strategy that anyone can take advantage of.



Here is a link to a site that that will demonstrate the financial difference between contributions to a Roth IRA and a Traditional IRA. https://www.moneyunder30.com/best-investment-accounts

 And if a 401(k) participant takes advantage of the company-match amount, and then reaches the Roth limit, he can still put more funds in his 401(k) up to his 401(k) limit. It is a great strategy

The Author Has Just Shown You The Elephant[5]

The purpose of this newsletter is to dispense financial and investment advice, to help readers understand the investment and financial environment we face, and to entertain. Nothing the Author has said to date about Secular and Cyclical markets, interest rates, high price/earnings ratios, sector and market relative strength is as important as the foregoing discussion of the Roth IRA, the Traditional IRA, and the 401(k) max strategy. No investment strategy can even approach the wealth building effect that the proper deployment of these strategies can deliver. By using good tax avoidance strategies, you get a 25-35% return out of the gate.

[1] The title of this Newsletter, “Welcome to the Desert of the Real”, comes from the 1998 film “The Matrix”. The world in the Matrix is a Simulacrum, a computer–generated illusion. It only “looks” and “feels” like the late 20th century. Instead, human beings are enslaved in tanks of fluid, wired to the Matrix. Also, readers steeped in post-structuralist philosophy may recognize the title as a paraphrase of a quote in Jean Baudrilliard’s 1981 book, “Simulacra and Simulacrum”.
[3] Tax deductions were more generous, however.
[4]A concern of Roth IRA holders is that the federal government may decide at some point in the future to tax Roth IRA withdrawals, limit the amount of Roth IRA withdrawals that are tax-exempt, or phase-out the exemption for high-income earners. This seems unlikely given the original promise of the Roth IRA that the proceeds be tax-free and the political power of retirees making Roth IRA withdrawals.
However, by non-direct means, the federal government has “raised” the taxes on traditional IRA withdrawals by compressing the tax brackets. And the trend toward tax bracket compression will probably continue under the pretense of “tax simplification”.
“Tax simplification” is a Washington canard, a glittering generality that has no meaning outside of a politician’s lexicon of trickery, or “Chumpery”. Chumpery (no relation to champerty) is when a politician addresses a hot-button issue with no intent (or real ability) to actually do anything about the issue. Prominent examples of Chumpery would include “Balanced Budget Amendment”, “Term Limits”, Flag Burning Amendment”, “Defense of Marriage Amendment”, or “Health Care Reform”. From the foregoing one could conclude that anytime a politician proposes something that would require a Constitutional amendment they are automatically engaging in Chumpery.
[5] “Seeing the Elephant” was a 19th century term for seeing or doing something unique or valuable. However, Civil War soldiers would also say that new men who first experienced combat "saw the Elephant."


STOCK UPDATE

The Quantum Multiplier Portfolio is short on stocks. A handful of stocks   Here are the long stock holdings:


                        Current Price July 7, 2017                  Annualized Gain
FDX                            218.51                                     48.5%
AMAT                         43.54                                      22.25%
CE                               96.14                                       9.54%

Nearly all of the Author's activity has been options, and most of that with short positions. The returns have been stellar. But this site provides only general advice and cannot recommend individual positions for specific situations. 

DESERT OF THE REAL ECONOMICS IS A MEMBER OF THE FEIGHTNER CONSULTING LLC FAMILY OF COMPANIES AND IS ALSO AN ASSUMED BUSINESS NAME OF FEIGHTNER CONSULTING LLC. (DAMNED LAWYERS ALWAYS WANT SOMETHING OUT OUT OF US.)



 

Saturday, July 1, 2017

WINNING TRADES AREN’T EVERYTHING. NO REALLY. THEY ARE NOT. BUT THEY MUST BE LOTS OF THINGS.


Much has been written about the psychology of trading, the need to stick with your system, and all of the biases and logical faults of humans as traders. Nearly all of us were born with them, at least nearly all of us that weren’t born as our ancient ancestors, Hunter-Gatherers. There are still a few groups of hunter-gatherers that choose to live more like hunter-gatherers and less like their encroaching neighbors. There are even a few hunter-gatherer bands in the Amazon jungle that have had little to no contact with the outside world. Brazil takes strong measures to assure that these hunter-gatherers are not place in contact with outside peoples.

SO WHAT IS THE AUTHOR YAKKING ABOUT THIS TIME?

Many things have been studied and written about human behavior and economics behavior. Numerous studies have been conducted on these phenomena. They have been with humans at least since the Neolithic Revolution in 8,000 BCE, the time when property rights developed. Many hunter-gatherers do not have strong concepts of ownership and property.  They are communal peoples with strong bonds within the group. Much of what they needed and used was available in abundance in their natural environment. 

ENOUGH WITH PALEOLITHIC PROPERTY.

Certain economic biases have crept into modern humans over the millennia. Especially when we consider intangible (stocks, bonds, bank accounts, financial instruments) property along tangible property such as real estate and goods.  Some have a strong bias toward tangible property.  They like land, cash, goods that they can hold onto. Every so often an event occurs where large pools of intangible wealth is lost.  Especially before financial stabilizers were put in place in the wake of the Great Depression.  And in the 17th, 18th, and 19th centuries, economies, especially the US economy, swung between panics and prosperity.

But even as the nature of wealth changed from tangible to intangible, industrial to intellectual, brains to bazillion bytes, certain biases recurred and where identified.

“IF WE DON’T SELL TOO MANY OF THESE, WE JUST MIGHT BREAK EVEN.” GROUCH MARX.

Some common investment biases are:

1.     "Loss aversion." Losses bite more than equivalent gains. In their 1979 paper published in Econometrica, Kahneman and Tversky found the median coefficient of loss aversion to be about 2.25, i.e., losses bite about 2.25 times more than equivalent gains. Simply put, humans will put 2.25 as much “energy” into avoiding a loss than making an equivalent gain.

2.     “Sunk Cost Effect.” This effect is a major problem for most of us some of the time and some of us most of the time. This effect causes us to make inefficient and irrational decisions to continue losing money on an asset or a decision. Let’s say you have 15yo used car. Its book value is $1500. You know you need a new car but are holding off buying one. The car is well maintained and all necessary repairs have been made.

The clutch goes out. It costs $700. You decide to put a new clutch in it. Now you have a car worth $1500 that has just had $700 put into it. (I suppose you can guess what comes next.) The head gasket blows and will cost you $800. And the mechanic tells you that the hoses are old and should be replaced. And steering control rods are going out.

At what point do you stop throwing money at it? This effect has a similar effect on losing investments. At what point does an investor sell the losing investment and cut her losses? Do you follow your system and the rules that are designed to manage the risk-reward parameters? Or do you cheat down the stop loss sell order? Or do you decide to wait for a couple more days?

3.     "Conditional expected utility" is a form of reasoning where the individual has an illusion of control and calculates the probabilities of external events and hence their utility as a function of their own action, even when they have no causal ability to affect those external events. This is a strange one. Some people think that their favorite team would have won the game if they had been home to watch the game. For investors, it is sitting in front of CNBC or Bloomberg news and watching the Chyron ticker.

We of course logically know that we have no control over such events. It could slightly skew our decision making, but its probably more of a time-waster than a cognitive disaster zone.

4.     Recency Bias,” or the “Party Effect.  Here is a great description of this pernicious bias:

These 4 guests experienced entirely different rate of return outcomes and view their portfolios and thus the stock market completely different. All 4 are correct. All 4 are right and yet they couldn’t possibly have more divergent outcomes. If they don’t have a complete picture of the stock market, like the elephant, they can get themselves in trouble. The difference between the best performing portfolio that is up 12.28% and the worst performing portfolio that is down 21.53% is an astounding 33.81%. Is this too obvious? You may say, of course they have different outcomes, they started at different times but that is not the point. The point is that stock market investing will always produce different outcomes. One guest started at the worst time possible. Another guest started at the best possible time. How they look at the past determines how they see the present. Most importantly, it will determine how they will act going forward. 

The Party Effect simply states that stock market participants evaluate their portfolio performance based on their perspective and their perspective only. They do not see the market as it is but as they are. Without an expert understanding of how the stock market works, this leads to incorrect conclusions “time again that people have variable risk profiles. BF demonstrates that fear is a stronger emotion than greed. This means that in our simple 4 guest example, Guests 3 and 4 are more likely to exit the stock market at just the wrong time since their recent, thus Recency Bias, experience is one of losing money. It means that Guest 1 and 2 are more likely to stay invested, thus catching the next wave up that is likely to follow. All 4 have intellectual access to the events of the last 30 months. All 4 can educate themselves on the stock market. However, their particular situation is so biased by recent events that the facts are unimportant. They behave irrationally.  

This effect is especially damaging to investors, especially new investors, hunch-and-tip investors, and investors that have unreasonable risk-reward expectations. 

There are more of these biases, but the Author Rob thought he would take on a few. 
He is reading an investment classic,  “The Way of the Turtle” by Curtis Faith[1]. Faith and a few others were selected by legendary investors Richard Dennis and William Eckhardt to trade using a defined methodology. The methodology was a Donchian trend following system. It was in a sense a test of the proposition that trading was a skill that could be taught. The novice investors were given accounts and turned loose.  The students that followed the system did well. The investors that allowed psychological biases to effect their trading did not do as well. 

The book has been out for more than 15 years and is available at the library or cheap online. The methodology discussion is pedestrian, but tidbits are well worth the read.
July’s Monthly Desert of the Real Economics Newsletter will be out in the second week of this month. Contact Julie or me with any questions, ideas or grudges you are holding.

AS CURTIS FAITH’S DESCENT INTO INSANITY AND PETTY CRIMINALITY MORDANTLY DEMONSTRATES, PAST RESULTS ARE NO GUARANTEE OF FUTURE PERFORMANCE IN THE DESERT OF THE REAL. OR MOST OTHER PLACES.


[1] Alas, Faith’s life has not lived up to his once-promoting start. He reportedly defrauded investors in various managed future schemes. He was convicted and jailed for various charges and has reportedly promoted schemes that fall on the far end of believable.  Mr. Faith had reportedly been working on a buyout of Apple and Disney on behalf of the workers and management as part of a deal where he was going to license all his new computer architecture in an open-source manner in a closed IP pool that artists and programmers all over the world were invited to join. Apple and Disney and Tesla Motors were to be the first acquisitions of a new private Faith-Family office with a very long-term outlook.”  https://dropdredd.wordpress.com/2015/06/01/where-in-the-world-is-curtis-michael-faith/