Here is the idea. Instead of privatizing Social Security, we could have the US Government start up its own Mutual Fund using part of the Social Security Trust Fund. The Mutual Fund would take advantage of its economies of scale and target a 6% control of the predicted Total Market Valuation of the NYSE. It would circumvent its potential for corruption by basing its investments on a conservative investing strategy implicit in a simple algorithm that would only require 27 weeks of publicly available NYSE data. Almost everything would be based on simple but reliable statistics that could be verified by others. The goal would be to save Social Security, improve on the return to people's savings therein, and to stabilize the NYSE and attract more long term investment in it.
An example of the reliable statistics used is the total predicted NYSE market valuation. It would be based on the sum of the predicted total market valuations for all of its stocks that have been in the stock market for at least 27 weeks. The predicted valuation for each stock would be based on the median trends of their valuations from the previous 27 weeks. These predicted values would then be used as weights in the investment decisions and a simple panel-data regression that would be used to decide the weekly holdings of the mutual fund.
The secret to the algorithm, what would make it a conservative investing strategy, would be that all the stocks in the stock market would be valued on the basis of their weekly log-returns, the log of 1 plus the percentage weekly return in value for a stock. 26 weeks of data would be used in a simple mean regression to predict the next week's log-return for each stock. The weekly log-return would have several advantages over the weekly return for the evaluation of stocks. It would fit with what has been shown to be human nature in Prospect Theory. People tend to be more averse towards losses in wealth than gains in wealth. The log-return would weight losses more than gains and mute the importance of larger gains while increasing the importance of large losses in value. To illustrate this:a 20% loss would have a log-return of -.097, a 10% loss would have a log-return of -.046, a 10% increase would have a log-return of .041, a 20% increase would have a log return of .079. This measure of value would reward stable stocks and penalize unstable stocks.
The fund would then each week invest two-thirds of its funds, based on the target of maintaining a 6% control of the predicted total stock market valuation, in buying long in the top 20% of the stocks (weighted by their predicted total market valuations) and the remaining one-third would be used to sell short(making money for the fund off of a decline in stock value) in the bottom 5% of the stocks. This would reflect a chastened optimism that would hedge well against a worst case scenario of a general decline in the stock market value. The higher concentration in the selling short would be to compensate for their higher volatility. The specific holdings of each company in both groups of stocks(the ones the mutual fund would buy long on or sell short on) for each week would be based on a standardized value of their predicted weekly log-return.
This sort of strategy could easily be tested using historical stock market data, including the 1987 stock market crash, or even the Great Depression. Although the Mutual fund would likely perform better due to its considerable market power. I am convinced that if it targeted 6% control of the NYSE that it would save Social Security and provide more stability for the US Stock Market. It would maybe force out some of the more volatile stocks, discourage stockbrokers from trying to time the market, and reward long-term investment strategies like that of Warren Buffet and Berkshire Hathaway. I also think that the overall reduced volatility of the market would then attract more capital away from hedges like bonds so that it can be allocated more productively.
If this issue were paired with requiring companies to list compensation under employee option plans as a direct business expense, it would make a decent rallying point this fall for economically progressive candidates, perhaps especially in Conneticut.
dlw
