Henry M. Paulson: On the Brink: Inside the Race to Stop the Collapse of the Global Financial SystemA good study in ideology versus the reality of the financial crisis. This is a story that you will not get anywhere else, and it is worth reading.
Vitaliy N. Katsenelson: The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere (Little Books. Big Profits)An engaging and entertaining resource for understanding markets and picking stocks.
Mark D. Wolfinger: The Rookie's Guide to Options: The Beginner's Handbook of Trading Equity Options
Michael Lewis: The Big Short: Inside the Doomsday MachineA captivating story of the crisis, told from the perspective of the winners, but with lessons for all.
Barry Ritholtz: Bailout Nation, with New Post-Crisis Update: How Greed and Easy Money Corrupted Wall Street and Shook the World EconomyAn informative and entertaining account of the financial crisis. Almost anyone will find this stimulating and useful.
Leonard Mlodinow: The Drunkard's Walk: How Randomness Rules Our Lives (Vintage)Great insight for investors seeking to distinguish real indicators from random noise.
Kate Kelly: Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall StreetGood read, good info -- a building block for anyone trying to figure it out. What the heck happened!??
Michael Shermer: Why People Believe Weird Things: Pseudoscience, Superstition, and Other Confusions of Our Time
Graham T. Allison: Essence of Decision: Explaining the Cuban Missile Crisis (2nd Edition)A seminal work on decision-making.
Mancur Olson: The Logic of Collective Action: Public Goods and the Theory of Groups, Second printing with new preface and appendix (Harvard Economic Studies)
Andy Kessler: Wall Street Meat: My Narrow Escape from the Stock Market Grinder
Roger Lowenstein: When Genius Failed: The Rise and Fall of Long-Term Capital Management
Robert A. Caro: Master of the Senate: The Years of Lyndon Johnson, (Vintage)
Ken Uston: Million Dollar Blackjack
Edwin Lefèvre: Reminiscences of a Stock Operator (A Marketplace Book)
Neil Browne: Asking the Right Questions: A Guide to Critical Thinking (8th Edition)
Ralph Vince: Portfolio Management Formulas : Mathematical Trading Methods for the Futures, Options, and Stock Markets
Malcolm Gladwell: Blink: The Power of Thinking Without Thinking
Brett N. Steenbarger: Enhancing Trader Performance: Proven Strategies From the Cutting Edge of Trading Psychology (Wiley Trading)
Robert J. Shiller: Irrational Exuberance
Gene Epstein: Econospinning: How to Read Between the Lines When the Media Manipulate the Numbers
Edward R. Tufte: The Visual Display of Quantitative InformationThe authoritative work on the subject.
Murray Edelman: The Symbolic Uses of Politics
Gary Belsky: Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics
Laurence H. Meyer: A Term at the Fed : An Insider's View
James Altucher: Trade Like a Hedge Fund : 20 Successful Uncorrelated Strategies & Techniques to Winning Profits
Janet Lowe: Warren Buffett Speaks : Wit and Wisdom from the World's Greatest Investor
Nassim Nicholas Taleb: Fooled by Randomness : The Hidden Role of Chance in Life and in the Markets
William Poundstone: Fortune's Formula : The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
« Weighing the Week Ahead: Stick to the Facts | Main
Beware the bond pundits. They seem to have an agenda. It does not include profits for the average investor.
I am trying hard not to go into rant mode. Mrs. OldProf sternly instructed that I could not say "ignorant, clueless bozos." In this redacted version you get a milder story. Many widely-esteemed bond market pundits have a viewpoint that we regard as misguided, and costly to equity investors. Here is why.
The Background
Japanese investors -- government and individuals -- are major holders of US debt. The tragedy of the earthquake and tsunami will require cash for rebuilding. Some observers are highlighting this consideration and the implications for US debt. The conclusion of much of the punditry is that this will cause a collapse of the US bond market, followed by a collapse of equity markets.
The erroneous analysis of the bond market is the most blatant example of a major problem for investors. Even if you are intelligent, attentive, and focused, you will be led astray by what you see online.
Some issues require actual skill to analyze, and the Japan situation is a good example. Let us take a closer look.
The Typical Argument
Most of the talking heads on TV and the big-time blog writers cite the possible selling of US treasuries by the Japanese government and citizens as a major threat. I do not want to pick on any specific source -- there are so many candidates. The general argument is that the Japanese will be selling, China is no longer buying, and -- Woe is me! -- what will happen next? Since no one will be left to buy, the US bond market will collapse and equities will follow.
The general appeal of this argument comes from the "everyman" approach favored by most economic bloggers. This approach depends upon oversimplifying economics, transactions, and relationships.
Here are some simple facts:
This is a sad situation. I wish that universities would reward economists who ventured into the field of finance and investments, helping to highlight truth seeking. The upcoming Kauffman Foundation conference for economic bloggers may provide a forum for this topic.
How does this apply to Japan and the current bond market?
The Reality
The right way to analyze this problem would be to analyze the market microstructure to get a handle on demand. Supply is probably easier, since the normal trading is known and so are the Treasury auctions. The main point is that a serious analyst would use microeconomic principles to derive a demand curve. If the Japanese demand is reduced, that would shift the entire curve. Demand and supply curves would intersect at a somewhat different point, suggesting a different clearing price for US Treasuries. To do this properly requires some data and assumptions about the underlying demand and supply curves.
The analysis would include the following facts (some from a 2008 Fed paper on market microstructure):
A Simple Rule for Reading Economic Articles
Does the author understand that economics involves a distribution of demand and supply? That prices are determined at the margin? That small changes in price may imply great changes in quantity (or vice versa)?
To illustrate with the current example, the Japanese government, should it choose to sell bonds, cannot be treated like the owner of a piece of real estate -- all or nothing at a single price. The Japanese government (or citizens) will be willing to sell more bonds at a higher price, and might not sell any at a low price (choosing to raise funds in another way). The decision is a distribution, not a single, all-in transaction. It certainly does not happen at one point in time.
If you are reading an economic pundit who does not understand marginal pricing, just turn the page.
The market for US debt is deep and liquid. Small price changes draw many more bids from those using yield-based asset allocation models, a large part of the market.
I can't believe that so many clueless bozos mistaken analysts are so eagerly embraced by the media and readers. I guess nothing beats a good story.
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