Welcome to the Blue Money Report

"While the amount of long-term shareholder wealth lost due to late trading is large in absolute dollar terms, it is small relative to that lost to market timing. It is also probably smaller than the impact of excess trading due to incentives created by soft dollars and smaller than the cost to investors of choosing high-expense-ratio index funds.

"But charging a high expense ratio for an index fund, overtrading to earn soft dollars, and even allowing market timing are not illegal, whereas allowing late trading is. ..."

That little pearl of wisdom comes from Eric Zitzewitz, the oft quoted professor from the Stanford School of Business and the man who has supplied the ammo to the New York Attorney General's office in pursuit of a poorly executed hidden agenda. Of course that hidden agenda, brought to light by Zitzewitz in an October 2002 report about market timing basically resurrected an old problem that has cost millions of of potential profits for investors. The actual dollar amount is only an estimate but the popular number being batted around is 1.4% of lost performance. If that is the case, the real loss to investors is more in the neighborhood of $20 billion. Zitzewitz on the other hand puts that number at a much higher level after looking at the problem in a random sample (10-15%) of all the funds in the industry. His research points to a loss for shareholders of 5% for international funds and 0.6 basis points in U.S. equity funds.

Now we all agree that market timing is bad for the industry. Spitzer described it as a bet on a horse after the race has been completed. Zitzewitz suggests that it is more "like betting on a horse race after the first quarter mile, really." But what it is and why do we think its bad?

Over the last couple of days, the markets have rallied (once again). While that is always good, it is an opportunity waiting to happen for those engaged in market timing or what the technical people like to call arbitrage. The markets that trade while we sleep will rally behind any strong U.S. effort by the markets.

So these investors pile into certain funds, mostly those that exclude us in the game. When they do, they increase the fund's cash positions while subtracting any potential gains for the existing shareholders. Overnight trading from these moves are costing you profit as you sleep. The fund industry is supposed to set their net asset value (NAV) at the close of business. But these market timers are jumping in at the last minute taking advantage of what is called stale pricing.

Simple solutions are available to deter these types of trades and some funds have adopted them voluntarily. One of the solutions would be to close the fund to new assets after a certain time or impose fines and fees or both as the Vanguard Group has done for its index and international funds.

So what about this asymmetrical investing? It seems, that even though this issue is a deterrent to returns and has been in existence for over two decades, investors are piling into funds at record levels. This could mean either one of two things. The first is that investors are willing to sacrifice a small amount of return for the chance to be there when the fund posts double digit returns. The second is that they use the system themselves moving in and out of funds in 401(k) plans. Neither idea would warrant any discouragement from fund companies. Especially if it seems that the investor doesn't care.

Graham Tanaka was bouncing around the airwaves recently promoting his new book and the silly argument that productivity can be calculated according to the latest GDP. His 120% notion or as he explains it, 1% of increased productivity equals a 1.2% increase in GDP or 120% increase over nothing is a little risky of an assumption. The methodology used is at the heart of what many should begin to look at as a false recovery.

Tanaka, who seems like a very nice gentleman and noted economist as well is telling us that if inflation stays low, fiscal stimulus stays brisk and accommodative, and technology continues to increase at the same pace as it is currently occurring, this will force the cost of technology down while increasing productivity. The end result of all of that progress will be profits and prosperity for decades to come. Maybe, maybe not. If the current GDP numbers are any indication, technology had very little to do with it.

Last quarter was the result of more than just lower prices for technology - as yet in any real demand. It was rebates and tax cuts, a one time occurrence that primed the economic pumps, as well as still cheap refinance money and credit. This helped consumer drive their share of the market.

But productivity comes from business investing and that is still not quite there. That is largely because, no matter how business tries to calculate Mr. Tanaka's equation, a company must assume that the statistics published by the Bureau of Labor Statistics are accurate. And they seem to not want to believe those numbers.

The BLS has the ability to keep inflation low as they incorporate what the Europeans call quality changes into their calculations. These quality changes, the assumption that quality changes will drive down prices as new products are introduced. For instance, computers are a million times faster than the first one built fifty years ago. If the BLS were to quantify such an assumption, these computers would be worthless. The cost of that first computer was a million dollars. Considering how fast they have gotten and how many are sold in the U.S. each year (10 million), this would mean that the quality of the technology has increased 1 trillion dollars while at the same time lowering the price to, you guessed, it... nothing.

So what will drive the asymmetrical investor during this time of false recovery much like the test result labeled, false positive. They will understand the technology will still involve risks and those risks aren't coming from research, it will come in pricing risks as the only way they will be able to show a profit is to charge enough to get one. That won't come with deflationary pricing no matter how hot the technology is. Quality changes are not what business is looking to drive productivity. They have yet to fully utilize the capacity and innovation bought during the last expansion. The price tag for innovation will continue to climb and productivity will need bodies to get that done. Bodies that are not working just yet.

Those bodies are coming soon to a factory and productivity mill near you. Really. Mr. Snow said so and added that they will be accompanied by weaker dollar and cooperative Chinese economy which is poised to outpace the U.S. significantly by the year 2050. His optimism is catching and I would love to believe that what he is saying is actually what will be happening.

The Chinese, already in the midst of production boom designed to be deflationary have seen the future and they like what they see. Still prohibiting direct foreign investment, putting money to work in China can be problematic to the individual investor but not insurmountable. Government sponsored groups act as go-betweens in the process, which keep the Chinese hand firmly on the wheel. No amount of talking will get that to change Mr. Snow.