Allison's ode the second moment


Hello,

Welcome to the 27th issue of Allison’s Ode to the Second Moment, a newsletter that literally—and seriously—gets to the bottom of the college wage premium.

Looking for the college wage premium in all the wrong places

Few investments are sure in life, one that comes closest is a college degree. In most industries, college graduates are paid more. This college premium increased over the years because technology tends to favor educated workers, though why this is true is not clear.

Could it be that college teaches skills that help graduates thrive in a dynamic economy? Could it be pure signaling? Perhaps college doesn’t teach students useful skills at all, but the people who go to college are demonstrating to potential employers that they are smarter and more able to work well because they managed to graduate. In that case, a college degree doesn’t increase anyone’s intrinsic value as much as it signals to employers that graduates are smart, disciplined, and well-socialized people.

The knot to disentangle is how much of the college premium is signaling and how much it rewards real skills. A new study offers some insights from an unexpected source: sex workers. Apparently sex work pays an 11 to 13% premium to more educated providers. I’d guess this has nothing to do with signaling, as sex workers don’t normally advertise their education credentials.

Perhaps college does offer skills that helps someone run a business by cultivating a regular client base and by imparting more “soft skills.” Maybe the people who go to college already have those skills, either way the sex trade offers clues into why a college degree pays off so much.

Robots are coming for jobs on Wall Street, too

To date, sex work is not a job likely to be out-sourced to technology—but no one ever knows what’s next.

Pity the stock-pickers. First, everyone found the passive investing religion. More people invested in index funds and eschewed active management. Overall, passive funds are still a small share of a growing market, but their share is growing, and they may continue to syphon assets away from active managers.

Just when it couldn’t get much worse, it turns out algorithms might be better at finding alpha (if it exists) than human stock pickers. The job outlook worsens for active, human managers. Better keep your wealth liquid.

I like algorithms; I build them myself. Odds are they will reduce demand for humans in asset management. However, like most technologies, I am skeptical they will totally replace people. They will probably just make the market more competitive and require more skills. After all, algorithms are built by humans and that means they are subject to the same biases and market assumptions we are.

We are often slow to recognize a structural change in markets. Algorithms might be even slower if they must be rewritten in order to profit off a new market ecosystem. You might say I am wrong, as an algorithm is better at recognizing the new market and turning a quick profit, but that requires the algorithm’s author to imagine everything that might ever happen to markets in the future. Humans, especially quants, aren’t normally so imaginative.

I am guessing that means there is always room for a sharp and nimble human mind. It just has to be better than before.

Efficient markets never say die

Though, to be honest….I am not sure if humans or machines were ever good at stock-picking.

Take the current market environment. It seems that since the election everyone has been waiting for the next shoe to drop. But the stock market kept going up while the world was full of uncertainty. It appears markets are counting on better regulations and tax reforms. But what if they don’t pan out?

Does that mean a crash is inevitable? There were rumblings of the long-awaited correction last week. Alternatively, some argue the stock market doesn’t reflect heightened political risk. Perhaps earnings justify current stock prices.

Sadly, it is impossible to know. That’s the tricky thing about bubbles. It is nearly impossible to know if you are in a bubble until after the fact. An eight-year bull market may seem primed for a fall—but it’s not necessarily a bubble, which is technically a fast run-up of stock prices. As evidence, stock prices increased at a fairly steady pace over the past eight years.

A lot of maybes: Maybe stocks will crash next week, maybe next year, maybe they’ll just fall slightly, maybe they’ll keep rising, or maybe they’ll stumble and then recover. Good luck figuring it out; odds are you’ll lose money if you try to time it, even if you have the world’s best algorithm.

Redefining risk

I know that’s scant comfort for people about to retire. They’ve spent their lives saving and have this big (hopefully) pile of money. The value of that pile will determine how well they live in retirement. If the stock market is up, they’ll enjoy tenderloin every night for dinner. If the market is down, they are first in line for the early bird special at Denny’s. When you have no other source of income, except Social Security, market swings become a very big deal. I think it’s messed up we put too much risk on people during one of their more vulnerable stages of life.

This is why I am pleased this Wall Street Journal article shifts the conversation away from retirement wealth to how to turn that wealth into stable income. Though the story doesn’t mention the rate at which someone could turn wealth to income is another source of risk, and a non-trivial one. Annuity prices vary with interest rates. These low rates mean income safety is a lot more expensive than it was 15 years ago.

But it’s a start. The more we talk about income, the better. It’s our best shot at better, low-cost products that help retirees deal with risk. Who knows? Maybe the market for tontines will even make a comeback.

Until next time, Pension Geeks!

Allison