Tuesday, July 29, 2014

Nobody's Ever Been Smarter Than the Law of Supply and Demand

Peter Abraham's lead story in the Globe sports section this morning was that the Red Sox were looking seriously into trading Jon Lester because the team simply would not match or come close to matching the contract Lester believes could be his as a free agent come November.
Right underneath it, a second story, also by Abraham, reported that the Blue Jays nipped the Sox last night by a score of 14-1, mercilessly thrashing Sox starter Clay Buchholz and wanna-be starter Felix Doubront in the process.

This striking juxtaposition should win whoever was layout editor a Pulitzer nomination in the Commentary category. It used no words to make the most salient point possible about Lester's future, namely, that if it's not going to be in Boston, the Sox' near-term future is dimmer than December twilight.

The idea that Lester is headed elsewhere was hardly news in itself, although Abraham advanced the story by a considerable distance. The lefty's employment status has been a subject of discussion since spring training, a discussion that's become louder and louder as the Sox' 2014 chances have become more and more purely mathematical.

And every time the topic has arisen in my own mind (not that often, really), it has reinforced my awestruck wonder at one of the oldest mysteries of sports. What is it about games that cause the wildly successful and astute businessmen who own teams to forget the first principles of their previous businesses?

John Henry's game is finance. He must be very good at it. A very few people have made millions from dumb luck, but billions always require skill. Yet the Red Sox' treatment of Lester is a rejection of concepts of finance so elementary even I understand them.

Principle the first: There's no such thing as yield without risk. Those seeking higher returns, be they wins or dollars, must accept a higher possibility of losses.

Long-term contracts for starting pitchers are a riskier proposition than just about any derivative security you could name. The risk of lost seasons and tens of millions of bucks due to injury alone is frightening. The risk that according to reports that Sox are balking at in Lester's case, that a free agent pitcher's performance will decline due to age in the back end of a contract is in actuarial terms closer to a cinch.

But no baseball asset class offers a higher yield than superior starting pitching. It offers the closest thing the game offers to a guarantee that a team will be competitive in a game no matter what else happens.  So if a franchise expects to be a consistent winner, it has to have it. This is why Jon Lester will join the ranks of the One Percent by Christmas.

Stocks are riskier than bonds. But as Henry knows better than his home telephone number, if a portfolio is to grow, it should hold more stocks than bonds, because otherwise the rate of return won't cut the mustard. Missed gains are almost as much of a loss as are real losses.

It's even worse in baseball. Most of the time, an overly risk-averse financial portfolio won't lose money. A roster portfolio which avoids the risks of expensive starting pitching is close to a dead cert to be dead in the standings before the All-Star break, unless it has succeeded in acquiring and nurturing a flock of starters too young for free agency or has had unbelievable luck with journeyman vets turning in career seasons. Either of those events are longer shots than any bet Wall Street has to offer.

So if the Sox don't retain Lester's services, they will have to replace them or get worse. (in both finance and sports, things can always get worse). This is liable to cost as much or more in money, not to mention lost time, than just ponying up the going rate for a starter who is conveniently on hand.

Finance Principle the Second applicable to Lester's situation is a quotation attributed to countless persons. "The market can stay irrational longer than you can stay solvent." In baseball, substitute the phrase "above .500" for solvent.  The contracts being given superior starting pitchers these days are indeed irrational as a matter of cold accounting. Some of what Clayton Kershaw is scheduled to make will become dead money, a pure loss on the books of the Los Angeles Dodgers. Wins on the days Kershaw pitches, however, go into the NL West standings right now. The tickets sold because of the Dodgers' place in said standings go into the books immediately, not in 2020.

Markets are often irrational. But they're often rational, too. The trick is determining which is which. Baseball history suggests that no matter the cost of starting pitching, it's an investment a team can't afford to pass up. Google is a very expensive stock. Doesn't mean it's a bad buy.

The price of quality free agent pitchers has never been higher than it is today. Coincidentally, neither has the overall price of stocks.

I'm going to assume Henry still buys the occasional stock.


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