Tuesday, May 21, 2013

Morgan Stanley is not your friend

Not if you are their client. Not if they're underwriting an IPO you're purchasing. And certainly not if they're just trading on the other side of the market against you.

What, did you expect something else? Is this surprising to you?

Then I have bad news for you. You have no business picking your own shares to day trade in equity markets.

The Greek sent me this interesting Atlantic article about the debacle surrounding the Facebook IPO.

It's rather long, and I have mixed feelings about it, so let me give you the quick version.

Facebook had a big IPO coming up. As the date neared, they realised that revenue projections were going to be lower than expected, because more people were switching to (low ad revenue) mobile services than they'd forecast. They released a form with the SEC that buried this news while meeting technical disclosure requirements. Institutional investors figured this out from their brokers and banks. Joe public did not.

There's an interesting story here, but I found it hard to get through, because it started in the following manner:
Uma Swaminathan tuned the television set in the living room of her ranch style home in the suburbs of East Brunswick, N.J. to CNBC. It was 9:00 a.m. on May 18, 2012, a day the retired schoolteacher thought might make her rich. She logged onto her Vanguard brokerage account on her computer and placed an order for 5,000 shares of Facebook at $42 a share.
Like a bad movie, I already knew how the rest of this was going to play out from the first paragraph. The author clearly has sympathy with the lady in question, and invites the reader to as well.
With short hair, brown skin, and few wrinkles, Swaminathan looks much younger than her 68 years. She spent most of adult life as a suburban mom, making tofu for her daughter's friends at theater rehearsals, taking her three sons to soccer practice and Boy Scouts, and volunteering in the local community. She served a term as president of the Indian American Association of New Jersey.
My immediate responses are threefold:

1. These sound like admirable things to do.

2. A similarly glowing list could be compiled about just about anybody.

3. If this is story about financial markets, what about the above listed background made her think she was an ideal candidate to start trading actively?
Her interest in the stock market didn't develop until her husband died about 13 years ago. Her four children had already moved out to attend college or to pursue their careers. Swaminathan was left with her late husband's 401(k) retirement account, when she started dabbling in the market, investing in stable companies like Microsoft. Not long after, she began to follow the news coverage of initial public offerings (IPOs) -- when private companies enter the public market -- and came to know of the phenomenon known as the first day "pop." On the day that companies would debut on the stock market, the price would tend to shoot up before stabilizing. A year earlier, she watched as social networking site LinkedIn's stock price closed up 109 percent on its opening day.
Okay, we're going to hear a lot of sympathetic stuff later in the article. But let's just unpack some of these statements. Roll the tape again:
[She] came to know of the phenomenon known as the first day "pop." On the day that companies would debut on the stock market, the price would tend to shoot up before stabilizing.
So IPOs historically go up, on average (we'll come back to that phase in a second) on their first day. So what? Do you think that you're somehow owed a large first day return? For what? What did you do to earn them?

And in a question that might be viewed as immensely patronising, except for everything revealed by her subsequent actions: do you think that positive average returns are the same as uniformly positive returns?

Financial markets combine two distinct roles. There is a positive sum problem of real resource allocation - prices send signals about which companies should be able to expand their operations, and what the economy should produce more of. But there is also a zero sum problem of trading - if I buy and the share goes up, I make money relative to the alternative case if I hadn't bought. But the guy I bought it off loses money relative to if he hadn't sold.

So this woman might have made money. But who would have lost? Whose story is not being told here?

Most of the time, the company who sold it to her. The standard answer in the finance literature is that IPO underpricing is about companies getting ripped off by their unscrupulous advisors. So finally, the academics get their way, and Facebook is definitively not ripped off with its IPO price. So instead the story gets written about the woman who bought the Facebook shares and lost money. But that's inevitable - if someone makes money, someone else loses.

[Diversion: Academics have written hundreds of papers on the reason IPOs are "underpriced" because of the first day pop. But really, do you think CEOs look at stories about the 'biggest IPO flop ever' and think to themselves, 'Wow, that's what I want! That Zuckerberg guy managed to get absolute top dollar for his worthless shares!'. And if they don't, can you really blame them?]

But it's more than that - the woman wasn't buying shares in the IPO from Facebook, but in the open market. She was buying them off some other investor. Maybe she was buying them from Goldman. Maybe she was buying them from some other small investor who doesn't get an Atlantic story written about them. Who knows.

The point is, suppose she'd made money. Someone else sold too low immediately on the open. Would you feel equally sorry for them? Maybe if they'd gotten a glowing article written about how they volunteer at their local soup kitchen or whatever, but ordinarily, no, you wouldn't.

As the grievance studies professors are fond of saying - some narratives are privileged, and others are not.

Let's jump back to a statement at the beginning.
[O]n May 18, 2012, a day the retired schoolteacher thought might make her rich.
You thought you'd get rich trading IPO stocks as a retired schoolteacher.

The Greeks have a word for the feeling I experience reading those words, and it is catharsis.
She'd never placed such a big bet on just one stock, but she felt a personal connection to Facebook. She had been using the site to connect with family and friends since 2009, and almost everyone she knew had an account.
Facebook shares hit the market at an opening price of $38. Minutes later, Swaminathan's online order was executed, and the retired schoolteacher had just spent approximately half her life savings.
You put half your God damn life savings into a single stock? And an IPO stock at that? Are you out of your mind?

First of all, this shows that you have absolutely no idea about even the very basics of finance. Idiosyncratic risk? Diversification? Anyone? Anyone at all?

Second, it shows that you don't even understand the strategy you're implementing. IPO underpricing is a statement about average returns to a strategy of buying a ton of IPO stocks. It is not  a strategy for putting all your money into a single stock. If you are counting cards in blackjack, you want to place lots of bets over and over because the odds are in your favour. You do not want to put all your money on one hand. If you don't understand this, again, you don't understand the very basics of finance. 

I want you to remember this, reader. Because there's an entire article about how this is all JP Morgan's fault, and Vanguard's fault, and NASDAQ's fault, and FINRA's fault.

Madam, I submit to you the following - your belief that you would make tons of money by putting half your life savings into Facebook stock was not something you learned from JP Morgan, or Vanguard, or NASDAQ, or FINRA. It was not something you got from financial academia, or textbooks, or even moderately sophisticated blogs. I don't know where you got it. I suspect from naive extrapolation.

Don't get me wrong. There is another side to the story, one about investment banks giving selective advice to their favoured clients and the game being rigged against small investors. This is all true. But you don't need me to tell you that story - the whole article is about that. We can argue about what, if anything, should be done to fix this problem.

But to my mind, this is just a smokescreen. Why?

Because if you're putting half your life savings into a totally fair and not rigged IPO stock, there's a large chance that the story would still have the same ending. That's what happens when you take a huge bet on a single volatile asset. If I had to hazard a rough guess without looking at the actual data, I'd say it's a bit less than a 50% chance for a one-off bet, since IPO stocks do rise on average on the first day. But if you're doing this strategy multiple times, it starts becoming way more likely.

Financial markets are like a circular saw. You can use them to fashion a beautiful oak table if you know what you're doing.

You can use them to chop your own leg off if you don't.

You may think this is all rather harsh. Some poor woman still lost a ton of her life savings. Don't I feel sympathy for her?

Of course I do. It's a tragic story. She clearly had no idea what she was doing, and got fleeced by Wall Street.

As the great Theodore Dalrmpyle put it, people can both be figures of sympathy and also acknowledged as being significant architects of their own misfortune.

One can, in other words, be a victim, but also partly responsible. The two are not at all contradictory.

And this is worth mentioning, because this is not really a human interest story. It is, after all, a policy story. The author wants you to believe that this unfortunate woman's losses are primarily the fault of Wall Street Greed and Crony Capitalism.™ More taxes on crooked banks! More regulation!

The real problem here is the one that the author doesn't want to talk about - there are plenty of individuals investing in financial markets who have not the vaguest clue what they are doing, and a number of them are going to lose a lot of their life savings.

One way to deal with this is to load up on paternalism - only let sophisticated people with demonstrated knowledge trade. This might solve the problem. Then again, it might not. It would also come with a number of undesirable side effects.

The other way to deal with this is reflect on the sad and imperfect universe we live in, and the wisdom that the Gods of the Copybook Headings would have told us, much more in sorrow than in scorn:
"A fool and his money are soon parted."

Thursday, May 16, 2013

The sadness of things coming to an end

A breakup song that I would wager was not inspired by an actual breakup:
‘Go on now, go! Walk out the door!
Just turn around now, you’re not welcome anymore.
Weren’t you the one who tried to break me with desire,
Did you think I’d crumble? Did you think I’d lay down and die?’
A breakup song that would wager was:
‘The single saddest thing I ever heard you say,
Was on the day I told you I had to go away,
You said ‘Darling baby please, if you really mean to leave,
Can’t I just hold you a little while longer?’
It's not even my breakup, and it twists my heart to hear it.

Among the best things to recommend about a lifelong marriage is that one never needs to go through another breakup, at least until death do you part.

That must be an immensely relieving feeling.

Monday, May 13, 2013

Miscellaneous Joy

-Apparently someone took the Simpsons marketing scheme as a literal suggestion.

-So various IRS employees were apparently hassling conservative groups about their tax-exempt status. As part of the 'nothing to see here, move along' explanation, we got this classic from the IRS spokesweasel:
Lois G. Lerner, the IRS official who oversees tax-exempt groups, said the “absolutely inappropriate” actions by “front-line people” were not driven by partisan motives.
You don't say? Care to speculate what they were driven by then? Anything at all?

If a diplomat is a man sent abroad to lie for his country, a government PR spokesman is a man sent to the press meeting to lie for his federal funding.

Fosetti nails the real story here.

-Comedy gold from Reddit:

Wednesday, May 8, 2013

Hate Generalisations? You Probably Just Hate Statistics

One of the most oft-repeated nonsense claims by a certain type of low-wattage intellectual lefty is that one 'shouldn't generalise'. (For reasons that are worthy of a separate post', this seems to me to be reasonably correlated with people who also proudly announce that they 'don't judge').

Apparently, one of the Worst Things In The World you can do is to notice that information about the generality of a distribution may useful in predicting where a specific point in the distribution will lie.

For those people that don't like to 'generalise', I wonder what, if any, statistical measures they actually find interesting or legitimate.

What is an average, if not a statement that lets one generalise from a large number of data points to a concise summary property about all of the points combined? Or a standard deviation? Or a median?

The anti-generalisers tend to apply their argument ('assertion' is probably a better description) in two related ways, varying slightly in stupidity:

a) One should not summarise a range of data points into a general trend (e.g. 'On average, [Group X] commits murders at a higher rate than [Group Y]').

b) One should not use a general trend to form probabilistic inferences about a particular data point (e.g. 'Knowing statement a), if I also know that person A is in Group X, and person B is in Group Y, I should infer that person A has a higher probability of committing a murder than person B').

Version a) says you shouldn't notice trends in the world. Version b) says you shouldn't form inferences based on the trends you observe.

Both are bad in our hypothetical interlocutor's worldview, but I think version b) is what particularly drives them batty.

But unless you just hate Bayesian updating, the two statements flow from each other. b) is the logical consequence of a).

Now, this isn't a defence of every statement about the world that people make which cites claims a) and b). To a Bayesian, you have to update correctly.

You can have priors that are too wide, or too narrow.

You can make absurd mistakes that P(R|S) = P(S|R).

You can update too fast or too slowly based on new information.

And none of this has even begun to specify how you should treat the people you meet in life in response to such information.

None of my earlier statements are a defence of any of this. The first three are all incorrect applications of statistics. The last one is a question about manners, fairness, and how we should act towards our fellow man.

But there's nothing wrong with the statistical updating.

If your problem is with 'generalising', your problem is just some combination of 'the world we live in' and 'rationality'.

Suppose the example statements in a) and b) made you slightly uncomfortable. Let me ask you the following:

What groups X and Y did you have in mind when I spoke about the hypothetical murder trends example? Notice I didn't specify anything.

One possibility that you may be thinking I had in mind was that X = 'Blacks' and Y = 'Whites'. People don't tend to like talking about that one.

In actual fact, what I had in mind was X = 'Men' and Y = 'Women'. This one is not only uncontroversial, but it almost goes without saying.

As it turns out, both are true in the data.

Do inferences based on these two both make you equally uncomfortable? Somehow I doubt it.

And if they don't, you should be honest enough to admit that your problem is not actually with statistical updating, or 'generalisations'. It's just trying to launder some sociological or political concern through the action of browbeating the correct application of statistics.

So stop patronisingly sneering that something is a generalisation, and using that as an implied criticism of an argument or moral position. Otherwise zombie Pierre-Simon Laplace is going to come and beat yo' @$$ with a slide rule.