The Change Function Revisited

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The current economic crisis has turned a lot of common wisdom about recessions on its head. Hence, I wanted to make a short list of these ideas. Despite the ideas’ faults, many are still followed to the detriment of those who follow them. I know that I won’t be able to list everything; so if you have some more points to add to the list, please send them over.

1. Hide from a recession in school – Unless one is getting a doctorate, this strategy has completely failed. Anyone entering a Master’s degree in 2008 or 2009 should be done with the degree by now. Unfortunately, in the meantime, the employment situation has not improved.

In some ways, the situation for the students could actually be worse than prior to acquiring the degree. These students are now unemployed with huge loans. If this recession continues into 2012 and 2013, even the PhDs will lose on this strategy.

2. Don’t hire overqualified workers – This is pretty standard recession advice for companies. Sure, the overqualified person might be great for the job and a good deal for the moment, but as soon as the economy recovers, the employee will leave the company. And the company is left holding the bag without an employee in a more competitive job market. It’s a bad deal.

However, in this recession, the companies that hired overqualified workers scored big. The job market hasn’t recovered at all. Furthermore, it takes unemployed workers about six months on average to find a job. If one hires an overqualified employee, they likely wouldn’t be able to locate a better job searching part-time for a whole year or more. This has been a great time to get some amazing workers on the cheap.

3. Bet on the next boom – Many investors had a textbook version of a recession in their mind. There’s a crash followed by yet another roaring boom. Sure, stocks recovered from their lows, but there’s no raging boom taking place now. A bunch of folks are holding bank stocks ready for a leveraged play on the economy, but the banks are doing nothing but collecting dust.

This view has kept many investors away from gold as they still believe in an oversimplified version of the business cycle. As soon as the economy recovers, supposedly gold should collapse. Well, where’s that recovery?

4. Fiscal and monetary stimulus creates jobs – In my opinion, never has the United States government spent so much money and created so few jobs. The stimulus didn’t even put a dent in the unemployment rate, and even the president has admitted that those shovel-ready jobs weren’t so shovel-ready after all. Some have called this crisis the failure of capitalism, but with these sorts of results, big government abysmally failed even more so.

5. The effects of monetary policy are relatively quick – Admittedly, this took many free-market types by surprise. The Fed printed tons of money, and it has taken inflation nearly three years to show its ugly face. Many were expecting hyperinflation as early as 2008. Even the textbooks cited two years as the time frame for monetary policy to filter through to the economy. In this case, it’s taking much longer.

6. Wait out the real estate market – This one is pretty self-explanatory. No, house prices don’t always go higher, but many still hold on to this hope.

Well, that’s it for my list. I know that I’ve missed some things; so be sure to send in your thoughts. Next, Chris Wood will discuss the trigger point for a successful technology. Then, Dan Steinhart will inform us about “Black Friday” of the online poker world.

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The Change Function Revisited

By Chris Wood

In last week’s Daily Dispatch, Alex Daley hit on a concept germane to technology investing that deserves some additional commentary.

To quote from the article, The Coming Biometrics Onslaught:

When we think of technology, we often dream of the whiz-bang new capabilities it has brought to our lives, from ATMs to DVRs to smartphones. For a technology to go mainstream, first and foremost it generally has to also reduce someone’s “pain” – whether that be saving businesses money, or allowing an individual to conveniently catch his or her favorite program.

Ultimately, it usually comes down to the end-user of a piece of technology, who has to like the outcome before it will really catch on in a big way. Just because banks would prefer to save money with ATMs doesn’t mean customers will prefer them over live tellers. But put them in places where one can’t put a bank – like convenience stores and malls – and suddenly they are beneficial to both parties. That’s a recipe for widespread proliferation.

The concept Alex hits on in the quote above is one of the first tools we in the technology division use to initially assess potential tech investment opportunities – the “change function.”

Originally described by technology guru Pip Coburn in his book, The Change Function: Why Some Technologies Take Off and Others Crash and Burn, the change function is all about addressing the thoroughly disproven maxim of “build it and they will come.” It’s an approach to creating and evaluating technology from a user’s (particularly end-user) perspective rather than focusing solely on Grove-style 10x disruptive change and Moore’s Law, the supplier-centric approaches of the past.

The essence of the change function is that users will only change their habits when the pain of their current situation is greater than their perceived pain of adopting a possible solution.

Consider, as Coburn does in his book, lessons of the personal computer. The first PC was built in 1964. Moore’s Law was a necessary condition to bring the price down to a low-enough level for a market to develop. But responsible for the huge growth in the PC market was the graphical user interface (GUI), which lowered people’s perceived pain of adoption enough to fuel the rapid market expansion and sales in the late 1980s and 1990s. Thanks to the GUI, the technology of the PC was now available to the masses without the pain of having to learn how to write code to adopt it. As Coburn said, “The GUI was the sufficient condition that made a cool technology less scary to Earthlings and therefore more accessible.”

The takeaway here from a technology investor’s standpoint is that it’s a good idea to initially assess new technologies through the lens of the change function. Rather than just considering how disruptive a new technology is or how relatively cheap it’s likely to become in the next few years, first try to determine whether it solves a problem for end-users and whether the pain of not having the new technology outweighs the total perceived pain of adopting it. This will put you on firm footing to dig deeper and allow you to screen for potential technology investment opportunities more readily.

[Did you know that technology has become the single largest sector of the American economy? Even so, investing wisely in tech stocks isn't easy. Put the expertise of Casey Research to work for you, with a risk-free, three-month trial subscription to Casey Extraordinary TechnologyDetails here.]

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The Government’s Poker Face

By Dan Steinhart, Junior Analyst

Recently, debate in Congress over the legalization of online poker has been heating up. The clamor is a direct result of April 15, 2011, dubbed “Black Friday” in the poker community.

On this date, the FBI shut down the three largest online poker sites, seized their assets, and charged the founders with felonies. Charges included bank fraud, money laundering, and violations of the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006.

UIGEA was attached at the last second to the non-controversial (and widely perceived as essential) SAFE Port Act after several previous attempts to outlaw online gambling failed to pass. Online gambling has technically been illegal since the passage of UIGEA, but until Black Friday, enforcement had generally been lax.

Poker is the most popular form of Internet gambling by far, so the reverberations throughout its community have been the largest. It is also the only form of gambling that can legitimately be considered more a game of skill than of chance, a key difference being emphasized by advocates of legalization.

We here at Casey Research generally believe that all voluntary interactions between adults should be legal, provided they don’t violate another’s rights. Gambling certainly falls under this category, but let’s give the feds the benefit of the doubt and examine the evidence.

The odds in any form of gambling can be boiled down to the house edge, or the advantage the house has over the player. For example: the house edge in Blackjack, when played with proper strategy, is 0.8%. So for every $100 you “invest” in the game, you’d expect $99.20 back. Poker differs in that it’s played against other competitors rather than the house, so the house edge is in the form of a “rake,” or cut of the pot, which is typically around 5%.

Obviously, this is a raw deal for the patrons. With the exception of poker players, all gamblers are guaranteed to lose over the long run. Even poker is a zero-sum game, with the vast majority of the crowd losing money. Given these facts, it’s conceivable that Congress just wants to prevent us from squandering our wealth.

Of course, the government itself offers gambling in the form of lotteries. If our benevolent Big Brother really wants to protect us from the usurious advantages of online casinos, its own gambling systems should at least offer better odds. Do they?

(Click on image to enlarge)

Not exactly. In fact, it’s tough to overstate just how horrible state lottery odds really are. Your odds are 7,500% better playing craps than buying the average state lottery ticket.

We can draw many conclusions from this data, but two stand out the most. First of all, the free market provides overwhelmingly superior and cheaper gambling entertainment than does the government. No surprise there, as this principle applies to every product and service under the sun.

Second, the government’s professed intention of saving us from ourselves is clearly a guise. In reality, the feds don’t like when their own cut is diminished, so they attempt to eliminate or assimilate competition. As is usually the case, Washington is self-interested and is using force to enhance its own growth.

To drive the point home, the bill currently circulating through Congress would require online gambling sites to impose a 28% withholding tax on all winnings, an additional 2% federal tax would be levied on the gambling sites, and individual states would have the option of imposing another 6% tax. To top it off, the sites would be required to collect each player’s personal information, such as address and Social Security Number, and provide it to the government.

And don’t try to deduct gambling losses on your tax return. You can only deduct losses up to the amount of your winnings, which is the IRS’s roundabout of saying the losses are not deductible.

So for all you online poker aficionados out there, we sympathize. You’ll likely get your game back, but not without paying Uncle Sam his protection money your fair share.

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Additional Links and Reads

The Changing Shape of Unemployment (Council on Foreign Relations)

This link from the CFR, a favorite target of conspiracy theorists, has a good chart on unemployment. (And please don’t send any crazy CFR conspiracy theory e-mails.) Essentially, the chart shows unemployment during recessions changing from a sharp V-shape to a U-shape starting in the 1990s. Unemployment is no longer a sharp drop with an equally sharp return to employment. At the current rate, the CFR estimates employment returning to normal by 2016.

Trichet’s ‘Strong Vigilance’ Comment Signals ECB to Raise Rates Next Week (Bloomberg)

Unless something goes horribly wrong in Greece between now and Thursday next week, Trichet will almost certainly raise rates to 1.5% from 1.25%. The divergence with U.S. rates will become a growing problem for Bernanke. It’s one thing to keep rates low when everyone else is doing the same thing. But if the euro gets too far ahead, the dollar will feel the hurt.

Is Fat Tails Insurance Worthless? (ZeroHedge)

ZeroHedge has a nice discussion on hedging against low-probability events. Is it really worth it? Furthermore, is it really a low probability event if everyone is doing it? The conclusion is similar to our suggestion in The Casey Report: hold lots of cash. It’s difficult to perfectly hedge against the market, but being liquid during a major downturn is a great way to take advantage of disaster.

That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor

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avatarDoug Casey - Casey's Daily Dispatch posted Tuesday, June 28th, 2011.

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