Finance I (Remedial) (Why Oh Why Can't We Have a Better Press Corps?)

A special Barrons edition.

Tyler Cowen did a bad thing in recommending Econospinning, by Gene Epstein:

Marginal Revolution: Econospinning: Imagine lengthy polemics against the use of numbers in the work of Paul Krugman (most of all), the Op-Ed page of The Wall Street Journal, Brad DeLong, Steve Levitt, and Barbara Ehrenreich, among others. Except the vehicle isn't the blogosphere, it is a book! This one is guaranteed to ruffle feathers...

I open the book at random and get page 143. The heading halfway down the page is "The Employment Report and the Bond Market." The text is:

...there is evidence that the employment report misinforms the bond market.... Once the [nonfarm payroll] number is announced at 8:30 AM [on the first Friday of each month], bond prices can react accordingly. But do they react the right way? The recent run-up in short term interest rates does not inspire confidence.

From June 30, 2004, to March 28, 2006, the Federal Reserve hiked the interest rate... 15 times in a row. The yield on the two-year Treasury note rose in response, from 2.64% on July 2, 2004... to 4.89% by April 2, 2006.... 22 employment reports [were] released over this period. How much credit can they be given for alerting the bond market to this 225 basis point rise in the two-year interest rate? No credit can be given at all....

[On] the 22 trading days on which these employment reports were released... the yield rose 11 times, fell in 9, and was flat the other two times...

Idiot. Fool. Must... calm down. Must... adjust medication doses. Must... remain calm. Must... explain things simply and clearly. Ah. I can feel the neurotransmitter balances change. That's better.

Ahem!:

Gene Epstein, Economics Editor of Barrons, believes that the monthly "employment report misinforms the bond market" because during the period from mid-2004 to mid-2006 that the Federal Reserve was in a tightening cycle[1]--and thus that bond yields were rising--bond yields did not exhibit substantial jumps in the immediate aftermath of the release of the monthly employment report. Instead, about half the time bond yields jumped. About half the time bond yields fell.

But suppose that bond yields had jumped, regularly, on the day the employment report was released. What then? Then there would have been a lot of free money to be made: sell bonds the day before the employment report is released, buy them back after the release, and so make your fortune.

That kind of thing doesn't happen. Financial markets may not get asset prices right all the time, but they are very good at eliminating easy opportunities to make lots of money via simple trading strategies. Systematic, arbitragible moves in asset prices in one direction only (or predominantly) in response to the monthly flow of economic data simply do not happen, whether or not the statistic released is informative and useful.

The monthly employment reports from 2004 to 2006 did not provide signals that short- and medium-term bond yields were on a rising trend--everyone trading knew that. The monthly employment reports provided signals as to whether employment was rising faster than previously expected--in which case bond yields would rise because that meant the Federal Reserve would be likely to raise the federal funds rate faster than previously expected--or slower than previously expected--in which case bond yields would fall because that meant the Federal Reserve would be likely to raise the federal funds rate slower than previously expected.

You don't have to be a fundamentalist believer in efficient markets to know the following proposition:

About half the time the monthly employment report will be stronger than expected, and bond yields will rise; about half the time the monthly employment report will be weaker than expected, and bond yields will fall.

But it appears that you do have to be a lot smarter than and know more about Wall Street than the Economics Editor of Barrons.

Comments

[Robert Waldmann]

No doubt upset at being classified with idiots like Krugman and Levitt you fall into self contradiction. You claim that the reaction is on average zero because things jump only in response to surprises. You claim your neurotransmitters jumped when you discovered that a journalist who is accepted as an authority on economics is a totally clueless idiot. Am I to infer that you still find this surprising ?

[That a journalist accepted as an authority on finance is clueless about the first-order implications of "arbitrage opportunities are rare" is not a surprise. That Tyler Cowen would recommend a book authored by one of the clueless is a surprise--and is what caused the need for additional neurotransmitter alteration.]

Or that the efficient Brad's neurotransmitters hypothesis is even more faulty than the efficient markets hypothesis.

By the way, congrats for getting on a list of 5 with Kruman and Levitt. As to the other 2, well as the efficient opinion makers hypothesis implies, an idiot who calls others idiots is right about half the time.

[howard]

as a regular reader of barron's, i generally find epstein a very thoughtful analyst in the short-run (i.e., if you want to know what's interesting about a particular jobs report of what have you, epstein does a good job of telling you), and a waste of time on the big picture, so this review doesn't surprise me in the least....

[walt tucker]

As an exchange member and "local" trader who frequently trades with ex-wrestlers, football stars and some hard working people who have varying degrees of order flow reading ability, I can share a valid but perhaps insufficient and anthropomorphic characterization of the futures markets:
They reflect economic fundamentals about 20 % of the time and screw the maximum number of traders the rest of the time.

[jon]

Um, I can't see anywhere where Cowen actually recommended the book, other than to say it would "ruffle feathers". Based on the above post, perhaps he was more on the money than he is being given credit for.

[anne]

Walt Tucker:

'As an exchange member and "local" trader who frequently trades with ex-wrestlers, football stars and some hard working people who have varying degrees of order flow reading ability, I can share a valid but perhaps insufficient and anthropomorphic characterization of the futures markets:
They reflect economic fundamentals about 20 % of the time and screw the maximum number of traders the rest of the time.'

Precisely, and important to keep firmly in mind.

[Tyler Cowen]

My "review" was intended to summarize the book, which I think it did. I hadn't worked through any of the examples when I wrote it, in fact I still haven't, but I did peruse the pages.

[spencer]

Betting on a monthly economic release is a "suckers" bet created by the brokerage houses to create volume . they do not care if you bet the over or under. they depend on volume, and that is all the bets on the economic data do -- create volume.

At first glance you should see this as an even bet -- the over or under has a 50% chance of being right in any given month. But this ignores the house take through commissions, etc..

Can anyone show me that it is possible to consistently out guess the consensus and make money by betting on monthly economic releases.

[Gene Epstein]

When Brad DeLong makes a negative judgment of a book, he is quite capable of doing it fairly and honestly. As a case in point, read his sympathetic but highly critical judgment of New York Times reporter Louis Uchitelle’s recent book on layoffs (“Americans Idle,” New York Times Book Review, Apr 2, 2006, p. 20.).

But in his own sweeping dismissal of my book (“Tyler Cowen,” he writes, “did a bad thing in recommending Econospinning”—italics mine), he falls far short of his own standard. Just for starters, I needn’t tell him that a reviewer of a book should always make due acknowledgment when he himself is mentioned critically in that book. Better still, he might explain why the criticisms made of his views—on which he is surely a uniquely qualified expert--are either correct or incorrect. Could DeLong really not have noticed that his own name is listed in the index of my book, with more than one page reference? His over-heated language alone (“Idiot. Fool”) makes me doubt his claim that he opened “at random” to page 143; I get the impression he felt provoked. But if he did not notice, then I can only tell him he ought to read the series of chapters that include critical mention of him. They are important chapters, principally on the way New York Times columnist Paul Krugman—and from a very different perspective, the Wall Street Journal editorial board—grossly misrepresented the labor data.

Instead, DeLong condemns my book as “bad” by dealing “at random” with just a single topic covered in three of its pages that is only loosely related to the central theme of the book. All the important topics to which Tyler Cowen alludes, are ignored. In fact, if DeLong only read my discussion more carefully, he would see that I did not commit the naïve error he attributes to me--which would indeed be an odd slip for a veteran of a market-oriented weekly like Barron’s. For a full response to his criticism, I refer interested readers to my own blog—econospinning.com—dedicated to keeping a log on reactions to my book it should be up and running by this Friday, August 25th.

Since DeLong has proved himself quite capable of generating light rather than heat when even strong disagreements arise, I hope he adheres to that standard in any future exchanges between us.

-Gene Epstein

[mickslam]

Brad-

You are excellent. Keep up the great blogging - lately you've been drawing the heavy hitters. I read Tylers stuff and your stuff all the time, and I am big fans of both you, him, and the other marginal guy, Alex.

Keep up the commenting on others blogs. Its one of the best developments I've seen in a while.

[Jon Fernquest]

"Brad - You are excellent. Keep up the great blogging - Keep up the commenting on others blogs. Its one of the best developments I've seen in a while."

Yes, yes! Barrons? Isn't that a rag devoted to investment advice?

I think it's great that you and Mankiw are giving mainstream Macroeconomics a public voice. Academics usually have so many other pressures on them, that they defer from this role. It's great that leading figures are taking this on, on a daily basis makes it even more useful.

[jerry]

Hi Gene, I heard your segment on On The Media. I admit that I was casually listening to it while debugging code. I am sure I didn't pay enough attention to it.

http://onthemedia.org/stream/ram.py?file=otm/otm082506f.mp3

The discussion on PK starts at: 3:57 with Bob Garfield starting off: "... you devote most of your book to taking on individual targets, notably Paul Krugman of the New York Times...."

I found it enlightening that you refer to Paul Krugman only as a journalist, and never as a Ph.D economist, never as an economist with a university teaching position, and never discuss his reputation as being due to his economics work, but rather to his position at the New York Times. ("Our most important economic journalist due to his position at the New York Times" (4:50))

Why did you spin OTM listeners with your suggestion that Levitt, Krugman, and many of the others you write about are primarily journalists and not Ph.D economists with teaching positions?

Shame! One might think you were spinning. One might think the "larger lesson" is that in fact you are a liar, "the larger mission" is that you have a conscious, though hidden agenda.

Perhaps you would say that your references to Krugman as journalist and not as economist are insignificant noise and you didn't want to take the sizzle out of your sales.

Paul Krugman's response is at 7:30.