Yesterday I discussed how part of Apple’s success comes from the iTunes Store, where they unbundled the individual songs on an album. You can still purchase an album, but now you don’t have to. With individual songs costing 99 cents, piracy is less of an issue: most people feel they can afford the price.

Bundled products load unneeded products in with desired ones, simplifying the marketing and enabling the seller to earn a wider margin. But if the same goods or services can be delivered in an unbundled manner, they can be sold more efficiently. So what are some bundled products that we see?

You don’t have to look far—just think about the most inefficient services we receive. Health care and education are two services that bundle their products together, costing consumers more than they need to. With college, for example, you see fancy dorms, upscale food, and plush gym facilities tied together with core educational services. At many universities and colleges, tuition has risen dramatically even as country-club facilities have expanded.

But without shareholders and a bottom line, it’s up to states or alumni to hold schools accountable for wasteful spending. Ohio State has several golf courses and a private airstrip. Why would a public university need those, not to mention a climbing wall that can accommodate 10 students at a time?

But the market may have reached a tipping point. Tuition and debt are unsustainable for many, and no one wants to see their money wasted. If the core educational mission can be unbundled from other activities, college could cost a lot less.
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[display_podcast}Losing A Bundle

Many look at Apple and see a business that makes appealing, convenient consumer electronics. (Others see an information Hegemon bent on destroying individual liberty, but that’s another story.) But consumers are notoriously fickle and faddish about their gadgets. How does a gizmo company become the one of the largest corporations in the world in less than a decade, eclipsing oil giants and industrial powerhouses that took centuries to achieve their status?

Part of Apple’s success comes from unbundling prices. For years record companies included lousy songs along with hits on an album, forcing you to pay higher prices overall. By selling you single songs for a reasonable price Apple broke the pricing model that the recording industry had been using for 30 years, unleashing consumers from a practice that kept prices too high and encouraged piracy. In doing so, they profited as they unleashed a torrent of consumer demand.

Are there other services that bundle prices? Cable comes to mind. The cable companies charge $100 / month for 250 channels, when most people really only want a dozen or so. But like the old record companies, the cable companies seek to maintain their pricing model because it allows them to retain their profitability. But the times, they are a-changin’.

Video can be streamed quite easily via current technology, and if people can untether themselves from lousy cable-TV packages that tie them to 200 or so channels they never watch, watch them run. Apple TV through the iTunes Store has the potential to tap into another well of consumer frustration. My only question is what will Apple do with all the money they might make?
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Apple’s Core

There’s a cottage industry growing up around the question as to whether current unemployment is cyclical or structural. That is, whether it represents a short-term consumer-based pullback in aggregate demand, or whether it comes from a mismatch between labor skills and the kinds of jobs employers want to fill right now. With over 88 million people not in the labor force, it’s an important question.

It’s important because of the policy implications. If the downturn is cyclical, then all government has to do is jump-start the economy and the Great American Jobs Machine should come roaring back. But if the lack of jobs comes from structural issues then all the stimulus in the world won’t turn unemployed home-builders into software engineers.

For my money, I think this debate misses the point. The real story behind last month’s anemic jobs report was the disappearance of another 340 thousand workers from the labor force. Since the start of the recession the labor force participation rate has fallen from 67% to 64%. But that just continues a trend that began in 1998, when the participation rate hit 68%. During that time the number of people not in the labor force grew from 68 million to 88 million—an annual growth rate of over 2%. This is much faster than the overall economy.

So where have those workers gone? My guess is that a lot of them are on disability or have gone into early retirement. In 1995 the first baby-boomers turned 50; that age cohort will start to draw on retirement benefits. If jobs become hard-to-get, they just begin collecting Social Security sooner. But the number of people on disability has grown as well—by over two million since 2010—so much that now the SSDI fund is facing insolvency.

A fifth of Americans aren’t working, and a fifth of personal income is transfer payments. Structural or cyclical: How about both?
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Structure, Schmucture

When JP Morgan announced that they had lost $2 billion via mismanaged hedges, I wasn’t surprised. Yes, it’s a large number. But JP Morgan has a $2 trillion balance sheet and a $5 trillion swaps book—and they may be ¼ of the credit default market. After news surfaced a month ago of some of their trading positions, losses seemed inevitable, as smaller, more agile trading firms were able to position themselves against the outsized positions taken by the JP Morgan trader dubbed “The London Whale.”

The hedging strategy was “ineffective, poorly monitored, and poorly constructed” according to CEO Jaime Dimon. Dimon has now become the poster boy for hubris. A few short months ago he was dubbed the pinnacle of high finance and the King of Wall Street, bestriding the junction of Main Street, Wall Street, and Pennsylvania Avenue like a Colossus. Now he’s explaining to cub reporters why his sophisticated risk management team allowed a position to morph over time and get out of hand.

Trading losses happen. Usually they’re constrained by limits and common sense, although not always. I remember managing a foreign exchange desk some years ago. My traders had gone long dollars and the market went against us. My instinct was to cut our losses, but I deferred to the traders who had initiated the position. As I left for an evening event, I told them to close out the trade before they left for the night.

How surprised I was to get a phone call at 5:30 that morning informing me that they had stayed the night and the loss had quadrupled! My decision then was clear: close out half the position now, and half later. My point is that all trades can go wrong, and large trades can go very wrong. Traders often justify their positions with mental gymnastics—after all, my traders never went home, so they followed my instructions, right?

Dimon has to reassess his limits, but also reassess JP Morgan’s strategy. They’ve been successful because they managed risk better than most. But that reputation is over. With Washington regulators closing in and the vultures circling, Morgan’s fortress balance sheet turns out to have a breach. They need to fix it.
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Swapping Stories

Mark Twain famously noted that history doesn’t repeat itself, but it often rhymes. That is, there are broad themes that tend to reoccur, often generationally. Investors often forget or ignore the past, so they have a habit of giving in to their emotions and believing the stories that get peddled by fear-mongers or hope-machines, extrapolating past trends and ignoring the likelihood of regression to the mean.

We won’t see another tech bubble again anytime soon: no online grocer is going to sell at 200 times earnings. But there’s sure to be another cycle, another bubble, and another crisis somewhere. There will be another time when people overpay for exciting investment ideas because their future appears boundless. Then, when the bubble bursts and fortunes are lost, there will be another time when people can only imagine further declines.

Recently a couple of professors published an article entitled, “Why Stocks are Riskier Than You Think.” They remind us that stocks are always risky. As a result, the longer you hold stocks, the better your chances of getting wiped out by some unforeseen disaster. But the longer you do anything the more likely it is that something bad will happening. The question isn’t whether something bad can happen, but the likelihood of loss overall, considering good times as well as bad.

This kind of pain extrapolation is what drives markets higher. When people see no upside to the future, there is no optimism to evaporate from stock prices, and when the world doesn’t end stock prices melt up. That’s why a 30-year bull run followed the Business Week issue on “The Death of Equities.”

The irony is that the extrapolator thinks he’s respecting history when he’s repeating it. Martin Luther wrote that if he knew the world was ending tomorrow, he’d still plant a tree today. Luther was wise. Investors should be, too.
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The Death of Investing?

An old saying says that I’d rather be lucky than good. In investments, that seems to go without saying. After all, the investment world seems a mystery to most people, with obscure terms like beta and residuals, and advisors sporting strange credentials and letters after their names. Above all floats the specter of total loss, where investors fear to get help because of the risk an advisor may turn out to be like Bernie Madoff, and make off with their hard-earned cash.

But investment isn’t about luck. Famously, the Wall Street Journal ran a dart-throwing contest where they had some pros pick stocks and compared their six-month performance with random selections. After 142 contests, it turns out that the experts beat a dartboard 60% of the time. But this could have happened for any number of reasons—the experts could have chosen riskier stocks, the publicity of the experts’ picks could have affected the stock price, and so on. And it says nothing about whether those stocks were appropriate for various investors.

Because investors have varying goals: some need more income; some want their money to grow; some are trying to keep it safe; still others need to structure their finances to reduce their tax burden. There are as many different investment goals as there are investors. The most important skill any investor can bring to the markets is not the knowledge of obscure Greek terms and accounting tricks, but understanding him or herself: what are their hopes and fears, what are their income and liquidity needs; what kind of legal and ethical framework they want to use.

Self-knowledge is the first step towards successful investing. It’s been said that if you don’t know where you’re going, any road will take you there. But any road won’t get you where you need to go.
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Investing in Yourself

That’s the question as we approach the “fiscal cliff” of January 1, 2013, when the automatic spending cuts of the deficit compromise and the tax hikes associated with the expiration of George W. Bush’s tax plan kick in. Certainly with 5 million jobs still missing and GDP running at 2%, it’s hard to say that the economy is strong. Proponents of the stimulus say it would have been worse without it; skeptics point to the additional trillions of debt we’re saddled with, and there’s not much productive discussion in between.

It’s true that government spending can boost the economy in the short run, but the long-run effect depends on how the money is spent. If the government crowds out a private actor and does something that the private sector was already doing, then no additional growth will result. But if the government does something that only government can do, and it makes a permanent change that private actors can access—then that’s spending with a purpose.

The poster-child for productive stimulus spending is infrastructure improvement like the interstate highway system. Only the government is capable of compelling the land sales necessary to put in an efficient transportation system. This is a huge help for the general economy, but the highways have already been built. Are there other opportunities like this out there?

Candidate A for increased Federal spending would be the “Chicago Bottleneck.” That’s the portion of rail line that goes through Chicago from around the country. Chicago is the nation’s most important rail hub, serving six of seven national lines. A quarter of all freight traffic goes through Chicago. And rail transportation is growing dramatically. It will likely double in the next 20 years.

But it can take days for freight trains to get across the city—days of lost productivity, days of wasted fuel and increased pollution. The crossings and switching stations are antique and desperately need upgrading. And improving them will permanently improve the performance of the rest of the economy. It’s a big job, and one that government is well suited for. Best of all, it’s the kind of temporary, self-limiting stimulus that could jump-start economic growth and then get out of the way as the private sector picks up.

This is the kind of short-term spending that can improve the economy’s long-term performance. It would lower transportation costs and reduce energy use. Fixing the Chicago Bottleneck could help fix our economy.
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Stimulus You Can Believe In