Random Musings on Markets 2019: Two Musings to Paradise*

This week, our not-weekly look at strange financial news brings you volfefe, the perils of model inputs, California’s struggles with the law of unintended consequences, lessons from video-game hyperdeflation, yet another look at Libra and creative capitalists profiting by launching veggies. We hope you enjoy the read!

Volfefe

Monday, analysts over at a big New York bank that rhymes with FlayPea Shorgan unveiled a new index which they dubbed Volfefe—a play on President Donald Trump’s puzzling and mysterious “covfefe” tweet from May 2017. This gauge is an effort to measure the impact of Trump tweets on bond market volatility—hence, the name. It is a portmanteau mashing together covfefe and volatility.

Now this is pretty clearly an example of an investment bank doing what an investment bank does: They find hot trends and try selling into them. Many, many, many investors think Trump’s tweets are hugely important to market direction, with pundits spilling oodles of pixels on the subject. Such attention can mean big profits for investment bankers if they can find a way to capitalize. Hence, we initially figured the Volfefe Index would soon spawn an array of long and short Volfefe exchange-traded funds (ETFs) targeting traders who bizarrely think they can forecast  what and when Trump is going to tweet before he does so. Maybe even leveraged Volfefe ETFs for those doubly or triply convinced they can trade on tweets! If not for bonds, then somebody would surely craft them for stocks.

That was our initial theory. But we are now questioning it, considering the following snippet from The Wall Street Journal:

“Analysts at [FlayPea Shorgan] tracked 4,000 tweets by Mr. Trump since 2018 and found 146 moved markets. ...”

Err … that’s fewer than 4%.

Further, as the article went on to document, analysts from another big bank picked up the gauntlet and applied it to stocks, finding that the difference between days when Trump is very actively tweeting and when he isn’t amounts to a rounding error:

“Returns for the 90^th [when Trump is tweet-heavy] and 10^th percentile [when he’s relatively silent on social media] were just -0.09% and 0.05%, respectively.”

That is a very inconvenient finding if you think trading on tweets is a good idea, one that doesn’t support creating ETFs on Volfefe or its potential offshoots, in our view. That, of course, doesn’t mean investment bankers won’t do it. After all, in that business (like politics), popularity and stories are equally, if not more, important than actual results.

Juuuuuuuuuuuuuuuuust a Bit Outside

Forbes got into a wee bit of hot water with the masses this week, taking flak for a list of the 100 “most creative and successful business minds of today” that included … 99 dudes and one lady. It seems self-evident that any list of the 100 most innovative business leaders, which this purported to represent, should be juuuuuuuuuuuust a bit more balanced than this—not because we are into quotas, but because we are alive and paying attention to the world. Forbes apologized and then blamed its methodology, so of course we looked at said methodology, and we agree there is a problem! But the problem isn’t that the model is misogynistic. Rather, said model doesn’t have a snowball’s chance of capturing most actual innovators.

While the gender non-balance is the first clue that the model is faulty, the second clue is the company the lone innovative woman ran: Ross Stores. Now, we love discount shopping! And we aren’t snobby enough to believe only Tech companies, and not retailers, can innovate. But if a decades-old bargain basement wonderland is one of the leading lights of innovation, then that is a sign you are perhaps not looking in the correct pool of companies.

Indeed, Forbes’ model was fishing in the wrong pond. Specifically, the pond containing only “CEOs with greater than $10 billion in market value”—in other words, big publicly traded companies. That excludes, you know, startups. Those companies that happen to be most innovative, with visionary founders leading the charge. Founders like Emma Yang, Melonee Wise, Claire Tomkins or any other of the dozens of female startup whizzes profiled in Forbes earlier this year. It also excludes non-Tech impresarios of private companies, like Sara Blakely. We know there is always a lot of unfounded hype in the startup universe, but there is also a lot of actual newness and free-thinking. A model that ignores these and has only publicly traded companies—many of which return piles of cash to shareholders because they don’t have a ton going on in the way of innovation—stretches credulity.

Anyway, we aren’t doing this to pick on Forbes. Rather, to illustrate a point: A model is only as good as its inputs. Keep that in mind next time you read about some wonderful back-tested, model-driven investment strategy.

The Law of Unintended Consequences Strikes Again

Last year, California’s state legislature passed a bill forcing city councils to stop pandering to NIMBY homeowners by blocking housing developments on the various absurd grounds they have used to do so for decades. It was an attempt to ease a severe housing shortage in areas of the state where new jobs have lapped new housing units about six times over. As long as they met basic permitting requirements, developers would be able to build apartments and condos to their hearts' content, boosting supply and lowering rents. There was much singing and rejoicing.

Now, however, state legislators are trying to unwittingly chase housing developers out of the state by passing statewide rent control. Rent control is one of those things that sounds really good—and is really good for the beneficiaries—but creates vastly more losers than winners in the long term. By reducing the potential return on constructing apartments, it discourages developers. The few projects they do decide to undertake tend to be of the luxury variety, where returns are highest. The incentives to build functional, cheaper units for everyday people disappear, especially with other state and local laws compounding building costs and mandating a certain percentage of below-market-rate units. As a result, housing supply tends to stall—and when longtime tenants move out, landlords jack up rent for the next tenant, making housing more expensive than it would otherwise be.

Look, we suppose lawmakers are attempting to solve problems here—good intentions.^[i] But we also don’t think it is a coincidence that the three most inefficient and expensive markets—housing, health care and education—are the ones where politicians have monkeyed the most.

So, we offer this up to investors as a lesson in the law of unintended consequences. Assessing policy risk for stocks is impossible if you can’t think three, four or nine steps after the immediate, most easily seen consequences. The examples we use here all fall under the non-market-related category of sociology, but they at least demonstrate this crucial logic.

Exhibit A: minimum wage increases. The immediate, seen benefit is higher wages. Great! But those raise costs for businesses, creating new incentives. When Mountain View jacked its minimum wage up to $15.65 per hour, the local Burger King closed, erasing jobs. In Oregon, grocery stores responded by opting for more automation. Now unions are pushing for a referendum to cap self-checkout kiosks. If that were to pass, we suspect it would only spur an exponential rise in online grocery delivery services—making Webvan potentially the most forward-thinking company in modern history.

Exhibit B: California’s old Prop 13, which capped property taxes at 1% of the property’s cash value, indexed the assessed value to inflation rather than local market values, and prohibited reassessments unless the property was sold or the owners did some construction. That benefited California homeowners tremendously! But it distorted the market by creating a huge disincentive for homeowners to sell, especially retirees who might otherwise have downsized. A family who bought their three-bedroom rancher in Sunnyvale in the 1980s probably paid around $300,000. Today, assuming a 30-year mortgage, they have paid it off and have an annual property tax bill of maybe $6,000, give or take. To downsize and get a condo where the HOA takes care of basic maintenance needs, they could sell their home for over $2 million, which is fantastic for them, but a condo would cost about $1.5 million and more than double their property tax base—and add HOA fees on top of that. As a result, many retirees just sit tight, limiting the supply of existing homes for sale and driving housing costs even higher. When they pass away, their children will frequently rent the home out, enjoying the low tax base as well as the easy $6,000 or more in monthly rental income. If Prop 13 went away, housing supply would probably increase, particularly in the “starter home” category of un-remodeled cottages.

Take another California bill that passed this week, which purports to require Lyft and Uber to designate their drivers as employees instead of contractors. Absent legal workarounds, which the companies have hinted at, this will probably diminish the pool of drivers at any given time and, we suspect, accelerate both companies’ transitions to self-driving fleets. In the meantime, the many drivers who simply like to pick up extra cash and meet new people by giving a couple of rides in their spare time will lose out.

No policy is perfect—all create winners and losers while trying to solve problems. For investors considering national legislation that could affect vast swaths of the economy, the question is always: Will this create more losers than winners, and are markets aware of this? The answer can create an investing edge.

Meanwhile, in More Fun News #NotAnAd

Back when we were kids, before streaming was a verb, videogames were an expensive treat. There were generally two ways to obtain them. One, put them on your holiday wishlist and stay on your very best behavior. Two, do every last paid odd job your parents would give you, from pulling weeds to cleaning toilets, and save your meager earnings for a year or more until you had the $250 for an original Nintendo (or $199 if you didn’t need the version that came with Duck Hunt), $199 for a Super Nintendo or $189 for a Sega Genesis.^[ii] Then you would feverishly play whichever game came with the console until you had saved $69.95 for a new one. If you were lucky, your parents would rent a game for you now and then to ease the wait for a new purchase. The idea of a personal videogame library with multiple systems and multiple games was a pipe dream.

Today, thanks to the twin forces of capitalism and intellectual property rights, it is no longer a pipe dream—it is reality. Later this month, Sega will hop on the mini retro console bandwagon and release a mini Genesis with 42 games pre-installed. If you bought the console and every game on their initial release, this would cost $3,126.90. In today’s dollars, that would be $6,469.93. But Sega is selling the whole kit and caboodle for $79.99—a 98.8% discount. They can do this because the marginal cost of repackaging old software, for which they still own the publishing rights, is basically zero. Meanwhile, thanks to Moore’s Law, the console’s hardware is exponentially more powerful—and cheaper—than it was 30 years ago. The publishers’ profit motives and margins are all of our gains. Plus, along with a surge protector and HDMI splitter, they enable Elisabeth to plug six consoles into her TV without breaking the bank.

Now, if only California lawmakers would let the same capitalist system that obliterated videogame costs and scarcity obliterate housing scarcity.

Centralizing Libra?

We swear that one of these days we will stop writing about cryptocurrencies, especially Facebook’s not-yet-actually-a-thing cryptocurrency, Libra. But policymakers keep on saying things—weird things—about it, which then compels us to tell you about them.

Anyway, the latest installment in the seemingly never-ending story that is “Policymaker stokes weird fear over Libra” featured French Finance Minister Bruno Le Maire criticizing Libra as a potential source of financial instability and calling for regulators to put the kibosh on it. None of that is very weird,^[iii] but this, in our view, is: He went on to call for creation of a “public digital currency” by governments, noting that he had already spoken to outgoing ECB head Mario Draghi and incoming ECB head Christine Lagarde about it.

For those of you who don’t recall the original appeal of Bitcoin (et al), it was largely this: High-tech currency with limited supply exists on newfangled accounting registry that puts it outside the reach of governments and central banks, preventing them from debasing it. This is why many folks with a libertarian bent were attracted to the notion. Perhaps that is why Facebook chose the name Libra for its not-yet-a cryptocurrency. Beyond being an astrological sign, it is very close to liber, Latin for free. That is also the root of liberty, which is the basis for libertarian.^[iv] We can’t be sure, but it would be good marketing.

Anyway, if the ECB, French Finance Ministry and IMF are involved in managing and crafting this public crypto-asset, all that italicized text seems moot. Bizarre!^[v] It also means central bankers would be creating a currency to rival their existing ones, which we didn’t really think the European Monetary Union’s charter would allow them to do. We would love to pick Draghi’s brain on this and ask him if he sees an e-euro as a threat to, you know, the euro. But we doubt we are going to have the chance.

Capitalism: Alive and Well in the Heartland

This week, The Wall Street Journal featured a fascinating tale of creative farmers conjuring solutions to weak commodity prices (think: corn, apples). It seems some of them have decided the solution is to fire the crops out of a cannon. Literally. For a fee.

Todd, who went to college in Delaware, theorizes these fine folks are mimicking an annual competition that used to be held in the state^[vi] called Punkin’ Chunkin’. Punkin’ Chunkin’ is an annual post-Halloween competition, in which folks design air-powered cannons to see who can launch pumpkins the furthest. Folks pay to watch it, with the proceeds going to charity. (Visit www.punkinchunkin.com for more.)

Imitation is, of course, the highest form of flattery. Good business too! You see, it seems a lot of people are willing to pay to shoot corn, apples and more at targets and relish in the satisfying “splat.” The Journal notes that corn is presently selling for roughly $4 per bushel presently. Low. But one Iowan farmer noted he charges $2 to fire four ears—roughly $100 a bushel! Bullish! Still others are firing inedible apples and other produce, monetizing what would otherwise be waste.

Then there are the suppliers. The cannons themselves retail for roughly $6,000. Not chump change! But it is a one-time cost, an up-front investment in launching veggies that reaps rewards year after year. Anyway, this just highlights two of the things we love about capitalism. One, there aren’t limits to folks’ creativity in search of profits and problem solving. Two, you never know what will work until you try. So kudos to you, good farmers. You may fire when ready.

Have a great weekend!

*This title is an intentional deviation from our typical pattern to honor 1980s legend Eddie Money, who lost his fight with cancer Friday morning. RIP Eddie.