The Death of Newspapers

Along the general vein of fretting over newly lost industries from cars to investment banking (Seriously, housing's gone, no one cares about 'renewable' garbage anymore, retail is gone, what exactly is the economy running on?), there has been a lot of talk about the decline of newspapers.  Generally, people tend to blame the Internet for everything and diss management for failing to take advantage of counterfactuals like starting their own Craigslist.  

Yes, the Internet is a really big deal, a fact which Google trends makes very clear to me.  But big brands, as Yglesias notes, are doing really well.  Magazines have done alright too.  It's the combination of the Internet plus all sorts of other stuff that are putting journalists out of business.  After all, virtually every newspaper now puts their content on the web.  They've realized that they're not in the business of selling paper, but rather of selling media content, which can happen in any medium.  

Online media distribution has very different economics though.  For one, you don't have the crazy diseconomies of scale which have supported cozy regional oligopolies.  If I'm on the web and searching for news, I might as well go to the best source of news, while in my hometown I might be limited to a few local papers (no, you don't want that mail subscription to the NYT).  The best online sources of content have generally done pretty well with respect to page views.  The strategy of many news teams, however, has been to respond to budget crises by cutting back writers, which pushes more people to other online sources, which hurts the budget more, which causes another death spiral of cuts... the WSJ and NYT, however, have kept up pretty good news teams and seen plenty of visits their way.  

But newspapers would still be fine if they were able to just move their customers online and still make similar ad revenue per customer.  They'd perhaps be better off since the cost of a newspaper is pretty close to the production cost.  The big problem is that Internet advertising is nowhere near as profitable as print advertising.  You behave very differently on the Internet than other media places, and advertisers don't really know how to deal with that.  They might fix this one day; the first TV ads were rip-offs of radio ads and no one paid them any attention.  Perhaps the defining characteristic of the Internet is the network structure of links and the quick diffusion between sites; it's not crazy to think that someday we'll want to click on those links, since we click on everything else we see without thinking about it too much.  Probably the best way to get there is to data-mine personal information to deliver links that look like things I click on all the time.  I click on the news stories at the top of my Gmail account, for instance.  People are going to lose a lot of privacy, hands will be wrung and the occasional sob story will hit Newsweek and people will be better off.  But right now Internet advertising is less profitable for newspapers by a substantial margin; it's not that they've lost customers so much as they've lost the profit/customer. 

The Internet also takes away a lot of the reason for their being a newspaper, which is after all a bundled product of various smorgasbord news items.  This used to be the most efficient way to deliver a mass of information to a person.  These days, people tend to use specialized sources--ESPN (or, even better, deadspin) for sports, gawker for entertainment, Slate for contrariness, blogs for opinion, and so on.  There are a handful of aggregators, and of course the best media brands with international coverage draw attention, but there's much less reason to use a mid-size town newspaper for this purpose.  There's maybe less serendipity of coming into wayward news events online, but really people use the internet for a lot of random stuff.  If historical evolution went from the internet to the newspaper, old hands would complain that young folk no longer get the educative experience of browsing Wikipedia.   

Some newspapers have responded by increasing specialized coverage to appeal to wider audiences, and letting reporters write blogs to create some personal information channels.  In the long-run, the Internet is a very un-democratic institution which makes everything follow a power law.  So a few blogs dominate, and many of these tend to be run out of big media institutions (and staffed by Ivy Leage grads...); the remaining big blogs are mostly legacies.  Again, the problem lies in monetizing all of these people.  It tends to be only possible with extremely rich people, which is probably why Murdoch decided to keep the WSJ behind a wall (while silently redesigning the site).  Yeah, that leaves you without ammo in the daily link barrage, but your proprietary blogs can still participate in that while you focus on profits.  

This has all been great for consumers.  Following the general trend of globalization--kill local options while increasing choices for everybody through trade--it's easier to get quality everything than every before.  Probably investigative reporting will take a big hit, since bloggers are better at shifting through things in the public domain rather than adding original reporting, but who really cares.  The top-quality newspapers will do very well, as will niche publications and anything that caters to rich people.  

The big unresolved problem in my mind is coming up with decent personalized aggregators.  Sites which take a person's given preferences to deliver things that 1) All their friends are reading 2) Appeal on the basis of 'you really should know this' 3) Provide some random flavor 4) Are similar to things you have read 5) Go beyond fetching stories to summarize ongoing debates 6) Provide "Internet criticism;" broad, meta-criticism of overarching trends and themes.  Of course, you'll be able to make this as personalized as desired, vote up/down on stories, send to friends, etc.   Google News doesn't really cut it--humans might need to get involved at some point.  Naked Capitalism is nice for some finance/economics stuff.  Newser is pretty interesting too, but there's a lot of room to get better.  Slate does some of this, and a service similar to Slate, but for everyone and user generated, recently went bankrupt. 

Basically I'm waiting for the point where I berate people for not reading/creating blogs like normal people and instead twittering or some nonsense.  

The Death of Value Investing and Buy-And-Hold

Two strategies for dealing with investing that have held up over time are value investing and buying and holding.  Value Investors--exemplified by Buffett--buy things that are cheap and high quality (what is everyone else doing?), while the buy-and-hold people say it's useless to time the market or pick winners, and just buy some of everything whenever they can.  

Value Investing has a decent historical track record.  Cheap companies (many ways to measure this, just say their profits are large compared to the market valuation) do tend to perform well over time relative to the universe of picks.  The value mavens, and the field is growing, chalk this up to impatient markets.  

But the world of cheap stocks is cheap for a reason.  These companies are characterized by high leverage, are often cyclical, and have a high probability of going bankrupt.  Buying these companies is equivalent to taking on the risk that the entire economy won't crash, things will get better, and liquidity will flow again.  Which is completely fine; it's just that this risk premia delivers results exactly because of the low probability--perhaps even a probability so low you can't find it in historical data--that things may get really, really bad.  

I think we just saw one of those events.  If you look back at the track record of the value guys, they bought up cheap stuff earlier this decade and wound up doing pretty well.  That makes sense; the economy was in trouble some time ago, but liquidity, rising asset prices, and continued consumer spending propped up the levered, discretionary (cheap) portions of the market.  Then things crashed.  And then the value guys, if anything, were burned worse than most.  They mostly never saw how bad things could get--when your mindset is shaped by the Great Moderation and you think long-term, it's hard to--and so were pitching finance stocks, real estate, construction, even airlines, the whole way down.  It seems likely to me that, rather than being compensated for picking companies that were "psychologically" out of favor, value investors were instead compensated for bearing a "value" risk that paid off during the liquidity boom and hit a "black swan" as that funding died off and the risk embedded in low prices became evident.  

This is a very broad picture and doesn't capture everyone.  If Buffett read financial papers, he would no doubt refer to Piotroski's great paper, which shows that it's possible to discriminate between cheap stocks to find the ones with high quality.  He'd then argue that this the quality comonent matters as much as the cheap part.  I don't have much to say against that; the part of the paper I found most interesting was that within the class of poorly covered companies there are a few gems.  Still, with Buffett down as much as he is (and coming back through deals only he could get) the presence of accounting "quality" seems to cut out exactly when you need it.  

So maybe on a risk-adjusted basis, you can still find some good bargains.  Suppose that you can't.  What's the optimal strategy?  Many people resort to some sort of "buy and hold" idea, based on the historical trend that stocks go up about 10% a year.  Again, as with value investing, you have the problem that though there's a wealth of historical data, your true sample size is something much smaller because shifts in a few macroeconomic variables explain a lot of the changes in overall stock performance (and those variables are very historically contingent on all sorts of things).  Do we expect stocks to grow to infinity?  If the true risk-adjusted interest rate was really large, then a family could simply keep putting money away and grow arbitrarily rich.  Maybe this works for a few people but definitely not everybody.  Presumably embedded global political and economic risks crash wealth to zero every now and then.  Russian, Chinese, and German bonds were very popular about a century ago.  This is another way of saying that the equity premium, measuring the overperfomance of stocks relative to other investments, reflects actual risk which comes out at inopportune times.  

Another approach--interestingly, lining up with what Buffett has long said--is that stocks are like bonds.  That is, their returns are not distributed randomly, but can instead be reasonably predicted considering something like their dividends and price, much like how bonds are priced given their yield.  This makes sense from both a fundamental view--stocks are claims on the profits of a company--and an asset pricing view--the premium that investors are willing to pay for risk depends on broader circumstances.  Cochrane uses this to make the point that price volatility is not that big of a deal.  Another point is that--just as you don't go out and buy "bonds" regardless of the interest rate--you would do better to buy or sell in varying amounts depending on how cheap markets are overall.  Yeah, this is a lot similar to the value investing world.  But there are a few differences--one, you pick entire industries (or the market as a whole), not individual stocks.  Also, you don't depend on psychology for your returns, but rather on understanding risk premia at different times, for different asset classes.  You don't buy and hold "forever," but look at implied yield rates.

Here's what that would look like.  You take some stock of capital and divide it up into different asset types ("things"--real estate, commodities, materials, bonds--international equities by market cap, etc.) and you cycle money in and out of these asset types by judging aggregate valuation levels.  So you would have bought all sorts of equities (many emerging and small) several years ago, then commodities sometime in the last few years, then you would have shorted real estate, then equities (especially foreign), then commodites.  Any analysis you can do helps you make decisions.  Within asset types, you move out of expensive into cheap.  For all asset types, you buy quality.  Risk management is important; you hedge risks, including risks that assets start to move together, and volatility risk (out of the money puts).  

I realize I've just replicated a "hedge fund" but hopefully not all of them behave this way.  For one, a disturbingly large number of them turn out to be not that much into shorts.  The broader idea is that you don't claim any ability to "pick stocks," but rather you exploit different risk premia across different asset classes in a consistent manner.  As far as the individual asset components go, we may be in a world where the prices of many assets starts to link.  But even if you're playing only with one asset, timing long-short opportunities and remaining in quality should help you out.  

I'd have to backtest this with a more systematic approach.  May or may not "beat the market" but should get some returns while being explicit about the risk.  

I don't know why I'm so stupid as to write up every potentially profitable idea I have.  Hopefully no one reads this.  

Speaking of Tail Risks

What are the odds of an "unknown unknown" event pushing the price oil up a lot higher or lower?  If Bush decides to take down Iran before the new administration moves in, terrorists attack any number of oil bottlenecks, Venezuela or Russia or Nigeria implode, Central Asian pipelines get hit, Iran uses asymmetrical warfare in the Persian Gulf, or, alternatively, large economies shut down, Iraq decides to start pumping out a lot of oil.  Production-wise, on one hand you have large oil fields rapidly reaching the peak of their capacities, while the oil spike really sparked a lot of marginal producers to start projects.  I can see the short-term shocks going in either direction, and I could see the long-term price of oil moving lower (more substitutes, more production from marginal suppliers) or higher (fall in price of oil kills of new investments, so ageing fields don't get replaced).  To me, that suggests high price volatility of oil in either direction is a real possibility.  So go out and buy some out of the money derivatives?  

Things I Was Wrong About

To be honest, I never really expected a financial meltdown of this scale.  Sure, the housing meltdown was inevitable and subprime losses were particularly bad.  But I never envisioned that amplification effects could magnify asset losses through catastrophic deleveraging.  At this point, there have been problems in virtually every sector in finance--from real estate based paper to derivatives, brokerage firms, insurance, interbank lending, corporate lending, money markets.  The next wave will presumably come from hedge fund and private equity withdrawals.  These problems have spread far beyond Wall Street.  Decoupling is dead, as every major economic zone is facing worse conditions.  The Baltic Exchange Dry Index, a measure of shipping, is considerably down.  

The legacy of letting Lehman die is pretty mixed.  As the WSJ reports, Lehman's demise really kicked off the cash crunch.  (By the way, has anyone else noticed that they redesigned the site and are ungating more of their content?  If this is Murdoch's doing, I'm all for him.)  The fact that money market funds owned Lehman bonds contributed to their drop in Net Asset Value below par--kicking in redemptions and a Federal bailout.  Still, while it doesn't look like people took events that seriously after Bear Sterns--including Lehman, which was tardy in finding a buyer--Lehman's fall was enough to ensure a round of bank consolidations and recapitalization.  

And, of course, we are not at a bottom, though I did pick up quite a bit of stuff right around the short-term bottom that we saw.  It'd like to imagine that absent Congress not approving the bailout, we would have seen the worst, but I'm no counterfactual historian.  In any case, trying to time or predict macro events in the economy is as hard as predicting the weather.  No one worries about selling at the exact highest price, so why worry about that when buying?

All that said, I remain optimistic--cautiously exuberant, if you will--about the future.  The "fundamentals" of economic strength are doing well; growth in BRIC and frontier markets is going on a breakneck pace, developed countries remain filled with capital and educated workers, and global flows in capital and ideas remain fluid.  Meanwhile, equities have seen something like an eight year price slump combined with a third-off haircut.  It's always the end of the world when you're facing the full brunt of the crisis, and it's those people who are able to stomach buying into panic that make out like bandits.  

The Easterlin Paradox

One of the many reasons people dislike economists is this idea that they favor growing the pie rather than redistribution.  The resulting wealth inequality is a problem for some people, who argue that relative income is a bigger deal and equality is a moral value.  Many of these people choose to earn less money than they could.    

There's a good deal of truth to this.  Clearly people tend to compare themselves to a reference group.  But I've always been skeptical of this theory, because it doesn't seem to explain migration.  

As far as I'm aware, most people move accross or within countries in order to make more money, even if their relative standing drops substantially.  The reverse movement--people trading up in relative income but lower in absolute income--seems rarer.  Many people move to poorer countries, but such moves often increase opportunity or consumption.  It's always possible that people retain their peer group at home as a reference group.  But if reference groups are relatively fixed, a wealth-maximizing theory will yield better predictions of behavior.  

And now you have some evidence against this theory in the form of happiness surveys.  Sure, the whole happiness studies field is a little wooly, but numbers are awesome.  Kahneman, that radical right-winger, argues that income differences explain differences in reported happiness.  A more comprehensive study from some smart people at Wharton makes the same point with the same survey.  Some 90% of people with incomes over $250,000 count themselves very happy; something only 42% of people with incomes under $30,000 feel.  That group would not be happier if transplanted into a poorer country.  

It's easy to say that money doesn't make people happy, but development changes countries in all sorts of ways.  There are moral changes encouraging fellow-feeling, less discrimination, and the general spread of progressive values.  It's worth pointing out that liberals champion these values, while decrying the process by which they spread through society, and conservatives support the process, while harboring sentiments incongruent with the realization of an affluent society.