Wade Armstrong: Negative Economic Predictor

Negative Economic Predictor

Posted Thursday September 13, 2007 in Business

I’m not much of an economist, but it’s starting to seem like I can predict recessions. Specifically, I start companies right before the economy goes in the toilet. I don’t know what I’m on to, but this is two times around the track now that this has happened. It’s a bit funny, but, if I’m clever, maybe I can figure out how to make money off of it.

Dot-com Bust 1999

I co-founded my first company back in the end of 1999, about a year before things really went sideways for dot-coms. It was a Web design company, and some of our clients went out of business in the bust as well. Revenues were slashed mightily, and the obvious question was: could we have predicted it? Well, we all knew the investment market for dot-coms was overheated and ridiculous. So, probably yes. But we went for it anyway.

Housing Bust 2007

And, to be frank, I knew the housing market was overheated when I started my current company back in November of last year. Heck, I knew things might be tough back in January 2006, when I started working on the concept. But I never expected things like Fed can’t stop recession or Worst August for home sales in 15 years or even Wave of bad news drives up oil prices. Could I have subconsciously decided to go for it right at the peak of the market?

Hedged?

Thanks to my Web design experience, I was conscious of the fact that the overall economy could have a substantial effect on my company’s potential for success. That’s one reason why I decided to initially target higher-income customers: wealthier consumers are less likely to change spending habits in a downturn.

Correlation is not Causation.

But, hedge or not, things look to be going south for the next few months. And I have to ask: could I have predicted it? Do I actually get in the game around downturns?

One explanation might be that rising markets give me the confidence to start a business. That’s not implausible, but I was conscious of that potential problem, so I tried not to concentrate on a rising market in my current venture.

Another is that, when the downturn starts to get bad, I start long-term projects, like getting my MBA. These projects keep me from starting a company for years, maybe missing the upswing and getting back only in time for things to start going south again.

Finally, the my entrepreneurial activity and the economy could be noncontingent. But that’s a boring explanation. I like it better when it’s spooky. So: how do I make money off of my uncanny ability?

Comments

If you actually could predict downturns, making money off it would be easy — buy things with negative betas. There are a variety of securities that do well when the market as a whole does badly.

Posted by: Auros | September 29, 2007 3:29 PM

Next time I start a company, I should make a negative bet on the economy in the next 18 months!

But aren’t those things with negative betas called “hedge funds”?

Posted by: juniorbird | September 29, 2007 5:41 PM

Nah, there are plenty of prosaic examples. Gold has a negative beta — when the market is falling, conservative people rush into gold. Makers of “inferior goods” (i.e. goods that people consume less of as income increases, and more of as income decreases — like ramen) do well in a down economy, so their stocks tend to have negative betas. I’m not sure whether gov’t bonds show up as negative beta against the stock market, but it would be reasonable if they did — “flight to liquidity” often means money going into bonds.

The practice of hedging on a large scale, which hedge funds were supposed to engage in (but mostly don’t anymore) would tend to involve holding some positions with negative betas, but the point of a hedge is to balance positions against each other, not necessarily to make any bet about the direction of the market as a whole. So you go long on the soda industry, while placing a hedging bet on corn syrup futures (because corn syrup is a key ingredient in soda). If corn syrup stays cheap, your bet on soda wins; if corn gets more expensive, your other bet wins. Keep elaborating this with various bets balanced against each other, and assume that even in a recession you won’t actually see a great-depression style total implosion, and you can turn a tidy profit. Until you run into the problem that “the market can remain irrational for longer than you can remain solvent.” (Past correlations turn out not to determine future results…)

Of course, if you’re leveraged to the tune of a trillion dollars, you can then make everybody else bail you out, because allowing you to just go under will cause your creditors to default on their debts. (Another cliche — when you owe the bank a thousand dollars, the bank owns you; when you owe the bank a million dollars, you own the bank.) LTCM was doing some more sophisticated things than simple hedging, mostly cross-currency bond arbitrage. But their downfall was largely about the market doing something irrational that their models said wasn’t “supposed to” happen.

Posted by: Auros | October 2, 2007 2:04 AM

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