Investments as Time Machines?

You might be wondering what I have been up to, given the paucity of posts.

For one I have been working on research related to momentum trading with a couple of colleagues, that, alongside a class in applied computational economics have taken in a large chunk of my time.

I have been writing however, but since those posts are now published under Quantdary, it means that it has to go through the fun process we call review. I am currently working on a series of posts related to investment management, and the inspiration came from conversations with professors, investment managers and employees of financial institutions. My aim is to demystify the investment management process to the general population, with the hopes that they are informed enough to be able to ask the right questions so that they won’t be shoved into buying products that are ill-suited to their profile. Those that I have spoken with a hopeful that a culture change and a paradigm shift in the investment management business model towards an advise-based fees would be beneficial to investors. I share the same hope, and this is my little contribution towards that end.

The first part of the series can be read here.

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What I have been up to

Last semester was pretty heavy when it came to workload, I laboured away on my graduation thesis and got roped into a quantitative trading team. Very glad to have the thesis accepted, which means the coming semester consists entirely of course work.

Christmas was wonderful, and got 2 wonderful books to read. One book I got was Wine:From Grapes to Class by Priewe, and the other being Eric Silbin’s The Cello Suites. I had fun finishing Silbin’s Cello Suites, and it is wonderfully written and highlights Pablo Casals and Bach really well. Also thought it was a good strategy considering not much can be written about Bach given the dearth of biographical materials. The wine book is interesting, since I am trying to explore how people evaluate wine. As I always say in jest, if people would wine more and whine less, that would be grape.

What’s the gender gap in science?

Been overwhelmed lately, what with the series of Friday seminars and working on the graduating thesis on top of classes,assignments and extra-curriculars. Hence, I have not been able to update the blog for some time now.

I came across this essay on the New York Times examining the gender gap in science. You may observe that some of the views echo Sheryl Sandberg’s point about encouragement, and the data clearly mirrors her anecdote on how sometimes subconciously, women also view other women less favourably vis-a-vis an equally qualified men. Good thing to keep in mind, and to reflect in our daily interactions.

PSA for Netroots and Quantdary

1) Netroots is seeking more clients to help out this semester. Being a student-led social media consultation group, Netroots provide free advice and execution strategies to non-profit entities to help them achieve their social media goals. Today, these non-profits have succeeded in harnessing social media to achieve their goals, be it to enhance online visibility, enable online donation to supplement their fund-raising campaigns, augment their sponsorship pitch, communicate with their volunteers and supporters or reaching out to new audiences through their followers’ social media network.
P/S: Service not restricted to NGOs in Montreal or Canada. We have had experience helping out groups in South Africa, and will be helping a group from Malaysia for the first time this semester.

2. My data-driven newsletter Quantdary is recruiting successors, since I am graduating into unemployment in a year. Perks: training in programming, exposure to best practices in econometrics (no monkeys please), and of course, ability to convey technical information in an accessible manner.

Taper(ing) Talks

EDIT:I misrepresented the position of most analysts. They were referring to the qualitative easing part and not the entire QE part. My apologies,especially TD Economics since I linked their research. The latest FOMC meeting from July (FT link here) voiced concerns and disagreed on what to do with the threshold of unemployment, a view that I’d echoed in this post.

From my impression in forum discussions of analysts,forecasters and traders in the investment community, it seems like some are expecting the Fed to taper down its QE programme on September. This view is also echoed by TD Economics, and they argued that the removal of Fed Support has been priced in (10 year bond yield went up by 100 basis points), with about 10-20 basis point (0.1-0.2 %) to be priced in across the yield curve when “”tapering”  materialises, which is anticipated to occur in September.

Interestingly, the forecasted Federal Funds Rate is expected to remain at 0.25% through the end of 2014.
The forecast implicitly recognises that the following 3 conditions are expected to hold through 2014 then, which are enumerated by the Fed on scenarios that makes it appropriate to have a 0-0.25% Federal Funds Rate target:

  • the unemployment rate remains above 6.5 percent,

  • inflation between one and two years ahead is projected to be no more than 1/2 percentage point above the Committee’s 2 percent longer-run goal, and

  • longer-term inflation expectations continue to be well anchored.

Which raises an interesting question from my end, is this really talks on the tapering of Quantitative Easing(expanding the money supply) or Qualitative Easing (tilting the Fed’s Open Market purchases towards risky assets? ).

In the beginning, the change in Federal Funds Target Rate to influence short term rate is becoming less potent as we approach the zero bound (what is the difference between 0 and 0.25%?), and so instead of swapping reserves for short-term treasuries, the Fed had to experiment by swapping short-term Treasuries for long-term treasuries to make long-term borrowing cheaper (Operation Twist), before expanding into purchasing Mortgage Backed Securities to support housing prices (let’s just call this Qualitative Easing, since these assets are riskier. I did not make this term up, it was referred to this by a Macro Prof in an exam I wrote.) So how do we reconcile these forecast figures with the exit condition of the Fed? The only logically consistent view is that the taper talks are on the withdrawal from Qualitative Easing programmes and Operation-Twist like programmes. If one wants to argue that Quantitative Easing is heading towards its end, the .25% Federal Funds forecast cannot be justified. (Unless it’s your birthday, then you can both have the cake and eat it, but that day is not today!)

Aside: Nobody really talks about the Repo market anymore eh? Except the good folks at FT’s alphablog. I recommend following those posts and comments on the Repo market discussions.

Today,I’d like to focus my attention on discussions on the first condition, the unemployment rate. This is an issue that fascinates me, primarily because I am entering my senior year with an Arts degree and have been over the course of the summer, regaled with woes of the unemployed by friends who have graduated.

In all seriousness though, I think this is one of the most widely discussed yet poorly examined variable by the press. In fact, discussions on unemployment had annoyed the Fed that a tool is specifically designed to help people track the Fed’s assessment of conditions on the labour market. If you are interested in unemployment 101, Jodi Beggs has a good post on it at About.com.

Before I began my study on unemployment I’d thought that unemployment during the recession is driven by mass firing, that is, an increased inflow into unemployment. I was also under the impression that prolonged recession and persistent unemployment is caused by increased layoffs. I was wrong. While mass-firing (inflow into unemployment) does go up when a negative shock hits the economy, it is actually the outflow (difficulty in finding jobs) from unemployment that makes a recession prolonged and unemployment rate persistently high. Have a look at the graph I took from Sahin and Patterson’s post from the New York Fed’s blog.

Inflow and Outflow

Moreover, I think most of the unemployment rate discussions have also missed a crucial dynamic factor -the flow from non-participation to the labour force (although I think the Fed is very concerned with the development of this factor, since it was stressed that the current unemployment rate “understates” the health of the labour market.). Let me put it this way, when the survey is conducted and you say that you have given up finding a job, you are technically not considered to be part of the labour force, and so you don’t enter into the unemployment statistic.

So what deadline should we set? I don’t know. What I know it shouldn’t mechanically follow the 6.5% threshold, since ignorance of the flow from non-participation to the labour force and underemployment risks the removal of support as the economy is recovering. A strict adherence to the threshold without context is akin to patting yourself on the shoulder for bailing out water on a sinking boat without addressing the leak.

I wonder if anyone is working on modelling agent’s decision to enter and drop out of the labour force, and whether there are empirical studies that show how they react to the vacancy yield etc?

Gossip Corner:

1. John Taylor is still selling the Taylor Rule.

2. Stephen Williamson tries to make sense of the “announcement effect” and is skeptical of the QE accomplishments.

Just to drive discussion on Williamson’s post. If we think of the interest rate as being driven by short term real interest rate (IS-LM intersection, or return on capital) + Expected Inflation + Term Premium, wouldn’t the figure sort of make sense? i.e. recovering economy drives up real interest rates, while expected inflation remains same or decreased, and term premium increases because of withdrawal from Qualitative Easing. Then qualitatively, the yield movements do make sense.

Cross-Asset Correlation Heatmap as of end of June 2013

I have just gotten round to churning out the next batch of correlation heatmaps, since I was very occupied over the course of the academic year, especially in the Winter Semester. Anyway, here are the high resolution heatmaps, and I will conclude this post with some of my observations.

m011012to281212 labelled

m311212to290313 labelled

m010413to280613 labelled

The increased correlation of treasuries and equities is stark, especially in Q2 2013. The developments and reasons for this is baffling (to me at least).

First, FOMC minutes released suggests that in spite of “taper talks”, slamming down the break is far from being concrete. In fact, as the FT reports, the minutes send largely mixed signals. While unemployment rate and the 2% inflation target are part of the key conditions that guides policy decisions, Fed officials also warned that they could intervene if market reaction jeapordises the achievement of these goals.

Second, the increased correlation of treasuries and equities is confusing for me. On one hand, the fact that CBs are confident enough to withdraw the QE programmes would suggest that the economy is recovering, that should be good news. But then, stock markets reacted to that by moving down, thus causing the fall in both Treasuries and Equities, a development that wasn’t confined to the USA.

On further note, it is expected that bond prices will tumble, and this is a view that is emphasised by a fancy passive investment firm who presented in one of the classes I took over the Winter. In their view, bonds are over-priced. But an increase in risk-free rates will make the expected returns of equities fall(for stocks with Beta greater than 1), making them more expensive, but would perhaps reduce volatility, which is good for risk-averse investors.

So what to look out for? Here’s my list:
1) Labour Market Conditions – I hardly hear discussions on “tightness” of the labour market, with the views emphasised in labour economics. Have we looked at the vacancy yield? (Vacancy/unemployment rate). When this improves, one of the QE tapering conditions would have been fulfilled.

2) Composition of the Treasury Yield. Pay attention to the short term interest rates (intersection of IS-LM for you Keynesians), expected inflation (proxy with “Breakeven Inflation” by subtracting yield of Treasuries with Inflation Protected Treasuries of same maturity) and the interest “term-premium.” Withdrawal of Fed support should drive up the term premium that were kept low, and a recovery would also imply higher return on capital (IS-LM) intersection.

3) What is the outlook of the economic environment? The IMF just slashed world GDP growth forecast; China’s GDP growth seems likely to contract what with the clamp down on banking liquidity, export-import data gleaned so far in China suggests a slowdown; the Euro Area seems to be segmented by core and peripheral markets, with heavy focus on Portugal recently and  talks on risks of bond “restructuring.” Don’t think ECB will follow the Fed too much, since the Euro Area are faces its own unique problem, and the PIIGS issues would not be too dependent on development in the US economy. Overall, the heuristic here is bad economic environment are bad news for equities. So withdrawal of Fed support, ceteris paribus, would make equities more expensive.If earnings outlook is bleak, then it follows the equities will take a tumble.

Edited on 20th July 2013 to make heatmaps “clickable.”
On 29th July to clarify a misleading and ambiguous sentence. 

 

Book Recommendation: Lean In by Sheryl Sandberg

Update: A friend shared this NYT profile of formerly high-powered women who dropped out of the workforce to be a full-time mother (with volunteer work at the children’s school and the community of course).

While shopping for a gift for a close friend whom I often discuss feminist issues with, I came across Lean In. I first heard of Sheryl Sandberg from a Ted Talk in which she discussed why there is a paucity of women leaders.

Lean In Cover

In the introduction of the book the author acknowledged that while institutional settings are important, her goal was to focus on the individual level instead, since it allowed the author to build from her experience and observations. Most of the anecdotes and recollections lends credence to observations in the sociological literature, especially those that examines gender roles and how it limits  the advancement of women in their career.

Throughout the book, the author recounts interactions which she thinks gender roles have inhibited career advancement, and prescribes solutions such as “sitting at the table” (which is a way of saying having one’s presence felt), and “don’t leave until you have to leave.” In offering advice on how to maneuver the public-private life distinction, which had traditionally delegated a lot of caretaking/familial responsibilities to women, the author encourages men to play a more active role in the household, and advocates egalitarian arrangements in household chores. Moreover, men are acquainted with the role they can play as colleagues in the workplace  in removing the disadvantage that restricts the choice women can make in their careers – restrictions that are due to the incongruity of the gender role that women are conditioned to assume, and the occupational role which rewards “professionals” rid of familial responsibilities(or those who are good at offloading them, typically to the spouse).

It is the latter, I think, that serves as an imposing glass ceiling in the career advancement of women. It is not so much an issue of women participation in the workforce, women have  made up a huge fraction of the workforce since the post-war era. Rather, the issue lies in the choice that women have had to make when it comes to their career in navigating precariously in their dual roles, firstly as caregivers and “nurturers” and secondly as the committed modern “professional.”

I find the idea of “caretakers” and “nurturers” being the natural domain of women to be arcane and ludicrous. As the author pointed out, what was ingrained by invoking biological evolution, such as our propensity to favour fatty and sugary food(a remnant of a period where food was scarce) can be disciplined and adapted to our modern context, where we have a surfeit of (bad) food. Similarly, it does not stand to reason how child rearing should be exclusively a role reserved for women, for men can and should play their part. If anything, technology like breast pumps override biological constraints and enables men to share in the care taking of children.

As opposed to men, women seem to face an additional criterion in the evaluation metric of a modern professional, which is tied to the gender role expected of a wife and a mother. The common phrase evoked is “you just can’t have it all.” This brings to mind the derision that was showered on Marissa Myers, the CEO of Yahoo! who promised to work well into induction, and was reported to have worked from the hospital after giving birth. In balancing career and familial responsibilities, women risk being morally judged for the weighting schemes that were chosen. Tilt too much towards one’s career, and one is invariably labeled as a bad mother who sacrifices the well-being of the children for her career. Tilt too much towards one’s family, and one is presumed to be “not committed” to one’s career. What discussions on this issue often fail to recognise is the confounding extrapolation of one’s thought process from a chosen action because of individual preferences; or because an identification with a group and is subject to systematic social and political happenstance (A did this because it makes sense to A as an individual; or A did this because A belongs in the group of vowels in the universe of alphabets).

It is unfair, immoral even to decry that women who chose to be stay at home mothers (which is noble and taxing) to have betrayed the feminist movement. After all,I do not think the feminist movement is meant to subsume an individual’s utility maximising choice over the ideal view of the modern women. However, when women are forced to make a choice in her career because the environment is designed for a modern committed (read:single individuals, or those who could offload family commitment) professional, this becomes an issue of social justice.

This view is best illustrated by a chapter in SuperFreakonomics, where the authors cited a paper about the gender pay gap. I do not have a copy at hand with me at the moment, but from my recollection it was argued that once you control for the finance courses taken by a group of MBA holders, the wage gap attributed to gender differences disappears. (Technically this is an IV regression, where you use the “finance” related course as an individual variable, presumably after checking for the exclusion restriction, and then run your second stage OLS). Moreover, it is noted that women tend to prefer the less-compensated “in-house” job. The intuition would be that since men disproportionately specialise in Finance, they wound up taking the better compensated jobs. Beyond this effect, there is no gender related effects.

What such an assessment ignores is what constraints women to systematically avoid Finance related courses, and also to choose “in-house” positions. Might sociologists offer better explanations, in that this is a result of the balancing act of conforming to gender roles and the constraints that only women exclusively face? Moreover in terms of the econometrics, IVs require one to swear by their model and convince readers that the model is fully specified. Not only is finite sample bias an issue, weak instruments exaggerates the bias, and a healthy skeptic should seriously entertain the possibility that the cited point estimates are blemished by weak instruments.

Having enumerated what I think are good advice both for women and men (who want to play a role as colleagues and partners), I think the question to Ms Sandberg inevitably escalates to the institutional level. I heard that Yahoo! is renovating its office to allow their CEO to bring her child to work, but I wonder if the facility extends to other employees? I have also heard being able to hire a nanny or have access to child-care in the work place would solve the issue, and again, is the option economically feasible to the average worker? Now, the title of the book “Lean-In” is partially in reference to the invitation for men to join in the efforts to correct one of the most entrenched social justice issue we face, and it is also an extension to those who set the tone of their organisations to do their part.

How then do new entrants to the labour force make known that this an important issue in the work place? One of the suggestions in the book is that in negotiating, women should phrase this issue collectively, using “we” instead of “I.” Yet, the issue has not been discussed from the perspective of men (even though they are encouraged to be more active in the family and to “lean-in”). I do hope the book is getting attention and a committed enthusiasm from those who are in a position to set the tone and culture of an organisation. Entrants to the labour force would find it slightly embarassing to express themselves, especially since they have yet to have found their partners. (Readers of the book will identify a similar setting in a book, when a single colleague was pre-optimising and deciding their career path in anticipation of having a child, even though the individual has yet to have found a partner at that point!).