Don't Know Much...

Two big, unanswerable questions are:

1. What is consciousness?

2. Is randomness is an essential feature of nature? Or, is it merely an expression of our lack of knowledge? 

The first question, about consciousness, boils down to asking how unthinking matter can think.

What I mean by the second, which is about randomness, is this. When, for example, we lay odds that it will rain 30 days from now, do the odds reflect our lack of knowledge about what is already destined to happen? Or, rather, is the future weather not known yet even "in the mind of God," so to speak?

Given that we don't have a solution to either of those two, essential questions, how well-grounded can any of our knowledge of other things be? Obviously, I mean philosophically. (As a practical matter, I am not too worried that my chair is about to collapse through the floor.)

The most useful thing I have read about consciousness comes from Erwin Schrodinger, the physicist. Trying, I think, to get us comfortable with the idea that we will never figure out what consciousness is, he likens consciousness to, essentially, a camera that can take pictures of anything around it, but not of itself. (Even with a mirror, you cannot get a picture of the chamber inside, where the action is.) But being unable to see the inside of the camera is a pretty small price to pay for all the great things you can do with it, so, we should just enjoy using it, and stop complaining about the one thing it cannot render. Put a bit differently: to be able to look at matter, you have to write yourself (your mind) out of the picture.

Consciousness-as-camera may be either Schrodinger's metaphor, or my own attempt to summarize what he was saying in other ways. I can't recall (and do not have time to research it). The insight is his, however, not mine. There are passages of this kind in his book, Science and Humanism, which I recommend, and would take with me to a desert island. I also recommend the Entitled Opinions episode on Schrodinger, which you can find elsewhere online.

[Edited 10/30/12.]

The U.S. Stock Market

Good piece by Brett Arends in The Wall Street Journal about the expensiveness of U.S. stocks, on average, as measured by Tobin's q and the 10-year P/E. Link is here (I think it will work without registration). Ignore his piece's headline, which I am sure an editor wrote.

The piece Arends wrote is not dissimilar to a post I put up last week.

[Edited 10/22/12.]

Arbitraging the Political Futures Markets

A nice post by Paul Solman, economics reporter for the PBS NewsHour, and all-around good human being, on how to arbitrage the political futures markets.

One thing I really like are the warnings at the top of the piece from Doug Dachille. Dachille used to trade for JP Morgan. He does a good job of laying out the risks that arbitrage of this kind entails, such as basis risk and counterparty risk. One might decide to run these knowingly, but they cannot be ignored. There is much of intellectual interest here, but, being of like mind with Dachille here, I present this as a window into an interesting market rather than as a recommendation for a trade.

Are Profit Margins Too Wide?

This piece in the NYT from the weekend contrasts two views of the U.S. stock market. In one corner is Yale professor Robert Shiller, who says that the market is valued meaningfully higher than it normally would be, i.e., higher than it should be. In the other, Wharton professor Jeremy Siegel, saying that it is fairly valued.

These guys are both smart. Who's right? Probably Shiller has the better argument; the market is high.

As the NYT piece suggests, it is hard to resolve the argument using only the Shiller 10-year P/E (also known as the cyclically-adjusted price-to-earnings ratio or "CAPE"). The market looks high on Shiller's number, but it looks fairly valued based on a trailing 12-month P/E ratio. Plausibly, this is because the two recessions of the past decade have made average 10-year earnings figure too low. I mean, that's the argument the bulls make. On its face, it seems like it might be right.

The bears, in Shiller's camp, argue that the current earnings number is above trend, and at risk of reverting. In the end, that seems to be the stronger case. Shiller's 10-year P/E number looks about right, even with the recessionary earnings in as part of the history. I think the easiest way to get a sense of this is to use the "q" ratio from Andrew Smithers (Tobin's q, basically) that I blogged about yesterday. When you click through to the data in yesterday's post, be sure to look at how very well correlated q and "CAPE" are over time. The fact that they say the same thing is a pretty decent indicator that the "high market, high profit margin" camp, represented by Shiller, has the stronger argument.

As Bob Arnott says in the same NYT piece, there are other bits of evidence that help Shiller's case, like the fact that wages as a share of GDP are depressed. But I think you may find that using the q chart I linked to yesterday is a particularly intuitive way to see it.

Shiller opines in the linked article that stocks are high, but not crazily high. Long-term returns from these levels will have to be lower than they have been historically.

[Edited 10/16/12 and 10/17/12.]

Andrew Smithers, on U.S. Stock Market Valuation

Andrew Smithers does thoughtful work on the Shiller 10-year P/E ratio, and Tobin's q.

Here is his (bearish) view on U.S. stock market valuation, as of a little bit earlier this year.

Beware the "Central Bank Put" Bubble

Good piece (registration required) by Mohamed El-Erian in the FT.

A few choice sentences:

Central banks are neck deep in extreme policy experimentation mode, and getting inadequate support from other government entities. The longer this persists, the higher the risk that policy benefits will be offset by collateral damage and unintended consequences; and the greater the political heat on central banks. If the critical hand-off to fundamentals does not materialise, the reaction of markets will not be pleasant.

Insider's Account of the AIG-Goldman Swaps

Very interesting article about the housing-related swaps that essentially cratered AIG back in 2008, and nearly cratered the world.

The author is an anonymous bond trader from Goldman Sachs, with an insider's perspective on these transactions. Goldman was AIG's counterparty.