Daily Speculations

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The Daily Spec Archives

April 2005 Posts

[Note from the Webmistress: These archives memorialize some, but far from all, of the daily back-and-forth on www.dailyspeculations.com. Look for essays by contributors under their respective indexes, accessible from the Daily Spec home page.]

Hedging 101
Read the DailySpec Discussion of Options vs. Stops

Strange Doings in China

They say:

Mr. Krisrock: (1:245 a.m. EST): Peg was broken tonight during lunch hour...came back

Sushil Kedia: Revaluation hints dropped from China Securities Journal and a freak trade of $100K only traded below the peg "they" say due to "technical factors." A system problem if you want to be generous, a trial balloon if one wants to be cynical.

George Zachar: Mortgage market legend has it that all consummated trades at a "bad price" inevitably lead to markets moving to that price. The original erroneous trade itself is called a "Milstein," presumably in honor of the trader involved in the first such recorded transaction. So it appears we've had a Milstein in China.

Bering Sea Whaling Accident, from Yishen Kuik

Grist for sailors and students of the weather. Story about the first major whaling catastrophe in decades at a whaling village.

Excerpt from Anchorage Daily News story:

'But as the sun set late Tuesday evening, the wind switched direction and blew harder, with gusts later estimated at 35 knots. Waves grew to 8 feet, Slwooko said. Whitecaps formed and sprayed the whalers. In most years, a radio call would bring additional help, and on Wednesday several boats responded from the village, but others were forced to turn around, whalers said.

Whaling crews are used to harsh conditions, said longtime captain Wade Okhtokiyuk. But conditions in the Bering Sea have changed in recent years. There are more storms caused by low pressure zones, he said, and the sea ice is farther away, creating more room for waves to build.

"We never had big swells and rough seas this time of year," Okhtokiyuk said. "Now we're getting that more and more."

Professor Miller Continues His Adventures in Retailing with Part V: Office Superstores

Tour D'Argent, by Yishen Kuik

My wife was making reservations for good French restaurants in Paris and has been compiling recommendations for two and three Michelin star places.

I was shocked to find that the typical prices for these places ran to 300+ euros for dinner. In New York, there are a few places that run over $300, but these are the outliers. Most top restaurants have tasting menus offered between $100 and $180.

Why does such a phenomenon exist, I wonder?

Are Parisians that much wealthier than New Yorkers? Are there more wealthy Parisians than there are wealthy New Yorkers? Both are clearly not the case. Do Parisians love food 300% more than New Yorkers? Unlikely. Does labor cost 300% more in Paris? Possibly, but if price goes up, no matter the reason, quantity demanded must go down, and I should not be able to find dozens of such restaurants.

I don't know the answer for sure, but here is my guess: It is because the French have poor corporate governance.

Three kinds of people provide the repeat business at top restaurants: those who love food, those who have money and those who are on an expense account.

Perhaps the many very expensive restaurants in Paris can be explained by the possibility that those on expense accounts do not suffer much oversight of their expenditures, a condition consistent with the assumption of weak power that shareholders exert over the daily operations of a typical French company. This explanation is aided by the other curious phenomenon that some of these restaurants are closed on the weekend.


Dick Sears: Weekly Commentary: Glad To Be of Service

Ask the Chair

Q. Can anyone explain why I am constantly reading posts about possible entry points, buying times/conditions, number crunching stats as to undervalued situations, etc., when it has been absolutely clear to me that we are in the midst of a secular bear market? Mind you, this has nothing to do with personal sentiment or opinion; it is simply interpreting what I am seeing each and every day and trading accordingly. I am not a doomsday bear, nor do I have any biases; it is just amazing to me how many established professionals are still trying to buy buy buy at every possible juncture day to day. Does anyone who calls themselves a trader ever short overvalued stocks/markets/moves? How many rallies do you need to see fizzle into oblivion to prove what we are in the midst of? (Obviously, there are specific sectors and stocks that rise at specific times or under specific conditions and certain short term trading styles where you can be as bullish as you wish; I speak of the market condition in general.) Why have I been able to count on one hand the number of times I have read of any bearish play or overvalued situation? Doesn't this market call for at least some posts of a great short on some overvalued garbage? I am aware that everyone has their own style, but I find it incomprehensible as to why I continue to hear predominantly of bullishness. I'm open to your reasons.

A. A personage who is absolutely convinced that we are in the midst of a bear market inquires why he finds so little company on our list besides those obviously talking their book. The reason is that most people on this list have read  "Triumph of the Optimists" and "Practical Speculation," and both books emphasize the long-term 10%-a-year upward bias in all stock markets in all countries. That's the reason at a theoretical level. At a practical level, I would add, and this is just personal based on my observations of many years in the business, as well as exposure to almost all major hedge fund managers, including one who hates enterprise as much as Buffett -- yes, I would add that the reason we don't hear from those absolutely convinced that we are in the midst of a bear market is that they have been, are or will shortly be, broke, morally and financially, metaphorically speaking. Drinks on me.

U.S. Stocks in Euros, by Will Huggins

Not being American, I have an outside view of the US market and its moves relative to its exchange rate. Every time the dollar plunges (December 2004 for instance), the S&P rallies and everyone and their dog has a plethora of explanations as to why. In the first week of January, the dollar rallied and the market fell. Its been said here a couple of times that "it's the currency stupid". Well, I valued to S&P 500 in euros, using the opening in January 2003 as my base. Funny story emerges. After Iraq II, there was a genuine rally, everything else since seems to be a currency effect as the "Euro-base S&P 500" seems to hav been range trading between 870 and 930 since AUGUST OF 2003. The range seems to be tightening but monthly data resolution is sloppy.

What does that mean? FX is driving equities as the index components haven't really given anyone any reason to be genuinely optimistic about the future of their business (any more so than August 2003 anyways).

I wonder how long foreigners will keep holding while their US equities trade flat?

BTW, I used the opening prices of each month from free data sources. Surely someone can do better than this to verify or reject?

date       snp     usd/euro   snp in euros
Jan-03     909.03    0.9526    865.94
Feb-03     860.32    0.9290    799.24
Mar-03     834.81    0.9261    773.12
Apr-03     858.48    0.9153    785

Why I Love Baseball, by Tim Melvin

Letter to the Editor, The New York Times, by Donald Boudreaux

Like so many others, Catherine Mann and Katharina Pluck mistakenly assume that a trade deficit signifies trade imbalances ("When the Dollar Bill Comes Due," April 27). In truth, a trade deficit isn't real. It's an artifact of international-trade accounting which arbitrarily separates international transactions into two accounts, the current account and the capital account. Purchases and sales of goods and services are reckoned in the current account, while purchases and sales of assets are reckoned in the capital account.

If foreigners happen to buy relatively few U.S. goods and services and instead buy relatively many U.S. assets, the U.S. current account shows a deficit only because it excludes the offsetting foreign purchases of U.S. assets.

If trade accountants reckoned all international transactions (in goods, services, and assets) in a single account, no account would show a deficit and groundless fears about unsustainable imbalances would fade.

Donald J. Boudreaux
Chairman, Department of Economics
George Mason University
Fairfax, Virginia

Vive la Difference, by Bruno Ombreux

One good thing in France is investing in microcap stocks.

Historical studies show that the smallest capitalizations overperform dramatically. In the USA, this is explained away by commissions and bid-ask spreads. Well, this doesn't apply in France. Commissions are a percentage of money invested, not a flat fee per share. The book is order driven; there are no market-makers. Therefore you are as likely to get paid the bid-ask spread as to have to pay it.

Academics can't downplay microcap overperformance in such countries.

The Assistant Webmaster Interviews a Savvy Fed-Watcher

FW: Today Fed Governor Don Kohn, amid the usual "imbalances" talking points, laid out his (and highly likely Greenspan's) Cliff Notes overview of the economy.

AW: Does Greenspan use him as a mouthpiece? Why would a lowly Governor (as versus Greenspan himself) be "allowed" to shoot off his mouth like that?

FW: Kohn is a unique figure. He is AFAIK the only Fed staffer to ever be promoted directly to the Board. His prior job was as Greenspan's muse, and he was often referred to in Fed circles as Greenspan's alter ego. He's on the board to ensure continuity in/for the post-Greenspan Fed.

AW: Is he considered papabile when Greenspan retires?

FW: Excellent meme shift! It's not clear to me if the DC power structure would allow an insider to take the reins, just as a State Department careerist couldn't become Secretary of State. My bet would be an outsider for the top job, with Ferguson for continuity in the back office, and Kohn laboring to continue Greenspanism on the policy side.

Oil: An Exchange

Mr. Krisrock opines:

The four most respected oil geologists all think that a global peak in oil is a 2005 and 2007 event, just as it was in 1973 in America. You can't deny it didn't happen here.

Yishen Kuik responds:

Would it be fair to postulate the peak oil in America was the result of a substitution effect? It became cheaper to import foreign oil than to drill for the marginal barrel of WTI, and hence we saw Hubbert's peak in the 1970s. Local oil began to be substituted by foreign oil, hence the peak in local production.

However, on a global basis, there is no "foreign crude" to import. The substitutes are alternative forms of energy. One might debate how close/far we are to good substitutes, but until we get there, there won't be a global peak, just rising consumption and rising prices necessary to stimulate interest in digging the hard and expensive-to-reach reserves.

In fact, if oil prices rise high enough, it seems logical to assume that domestic US production might rise too, creating a second Hubbert peaklet on the right of the big peak.

Black and White, by GM Nigel Davies

Playing Black and White in chess are rather different things. With Black the players who do best tend to be counter-attackers who keep their positions flexible, with White the best results tend to be made by serve and volley players who go straight for the jugular.

It seems to me that this might have an application to trading - that there are times to be aggressive and take the ball on the half-volley and others when it's better to let it bounce to give yourself more time for the shot. Perhaps there is a way of knowing what kind of shot is more appropriate at a given time.

The Bounties of Enterprise, from Don Boudreaux

"Cleaned by Capitalism"

Editor, The Christian Science Monitor

Dear Editor:

Clay Bennett's Earth Day cartoon shows scissors (labeled White House) recklessly slicing through environmental statutes. Without here questioning the merits of the statutes or the reality of the slicing, I plead for protection of a most endangered resource: perspective. Pause for a moment to appreciate just how clean and safe our everyday environments are compared to those of our ancestors.

In fact, our everyday lives are more sanitary and healthier today than at any time in history.

James Sogi adds:

The cotton gin and steam power, and steam looms allowed the manufacture of clothes cheaply. Previously, weaving cloth took the better part of a year for a set of clothes making them prohibitively expensive. Often all but the richest had only one set of clothes. The advent of cheaper cloth allowed the use of clean under wear which prevented disease.

Life of William Dampier, A Book Review by Allen Gillespie

A Pirate of Exquisite Mind: Explorer, Naturalist, and Buccaneer: The Life of William Dampier is an excellent read. Dampier strikes me as a cross between a Captain Aubrey and the traveller who is bullish on commodities. The backcover reports that Dampier has more than 1000 entries in the Oxford English Dictionary including chopsticks, barbecue, and kumquat. The books also reports that his experiences were used by Swift and Defoe in their writing of Gulliver's Travels and Robinson Crusoe. Darwin called his books "a mine of information." The book has too many observations that might benefit a spec to list, and thus I simply give the book a thumbs up.

Delayed But Not Denied Liftoff, by Nancy Ying

More often than not, the market does its utmost trying to confuse investors by giving out conflicting signals. This is why when it's time to buy stocks, the market will try everything to prevent you from buying, and similarly when it's time to sell stocks the market will try everything to prevent you from selling. Eventually, however, the market has to reveal its true intention. Apparently the market did just that today.

Jeff Sasmor Trades by the Seat of His Pants

I have read many times about how the market is like one thing or another; the ocean, a mob, etc. Today I realized that I had unconsciously developed a unified theory that explains what the market is like and how to determine optimal buy and sell points. It's my theory, and it is mine. But I'll tell it to you (keep it a secret).

The stock market is like my pants. Yes, I know that sounds strange, but it's true. I have worn the same size pants (no, not the same pants) for over 10 years, so my theory is based on sound sample sizes - over 3600 data points.

When my pants get tight it's usually because the market is going down and I eat comfort food such as pretzels and ice cream. At some point my pants start to feel too tight and I stop eating so much. Invariably this causes the market to move up from a major low point. This occurred this week! So be advised! Get out those canes!

I have decided to start an email newsletter to report on this important indicator. For only $395 per year you'll get a monthly report with biweekly hotlines. It's called the Waist Report.

Alex Castaldo on the Philadelphia Manufacturing Survey

A friend of mine says that the strong number out today for the Philadelphia Manufacturing Survey shows that "both factories located in Philadelphia are doing very well".

The Assistant Webmaster adds: The Problem is Only "Temporary"

A 1939 state law - The Sterling Act - gave Philadelphia authority to impose the wage tax as a temporary measure to help cope financially with The Depression. Since then, its role has grown significantly. In Fiscal 2003, Philadelphia expected to collect 52% of all local tax revenues from the wage tax.

Bellwethers and O'Neil, by Allen Gillespie

The Chair has asked whether certain stocks have a special leadership role in the marketplace. He has looked at it from the vantage point of trees and IBM. I studied the moves of MSFT against the 1990s market and I have seen market weakness follow the demise of the speculative favorite of the day. I also cannot help but notice that Google's February high led the market by a month as has its March low.

Anecdotal Signs of a Market Bottom, by James Sogi

Back when phone calls were a nickel each President Calvin Coolidge and his advisor Herbert Hoover were out walking when the President asked Hoover if he could borrow a nickel to call his friend on the pay phone.

Hoover replied, "Here's a dime, call all of them."

Anyway, anecdotally, when telling all my friends, (both of them, haha), "Yeah, it's a good time to buy stocks when prices are down."

They looked at me with a look of revulsion and doubt and politely declined commenting, " Have you heard what they are saying on the news? Inflation! Trade deficit! Dollar dropping!"

"Hmmmm", I thought to myself.

Kim Zussman Offers Some Others:

  1. "Y" "W" (couldn't resist)
  2. Each week breaking new personal daily loss records.
  3. Someone I hardly know walks past saying "Short GM!" with a sardonic smile (perhaps a Daily Spec reader?)
  4. Sighted a bumper sticker which read "Gotta Trade". Which seemed so odd that I doubled back to find it really said "Gotta Ride" and was about the plight of Harley Davidson.
  5. Saw "Dust of Glory", which is not a documentary about life after vasectomy but the story of the Baja 1000 race and its cast of characters. This is a grueling, dangerous race with little reward beyond pride. A good inspirational for the motorsport afflicted featuring one family of racers repeating the mantra "Never give up".

As Does Hany Saad:

  1. The most prosperous of beggars at the subway stop with a penniless box for three days in a row
  2. An 18k gold Rolex President on eBay with 10 bids under $3000
  3. A very high profile personage on CNBC talking about commodities again after a six month absence
  4. Practical Speculation going down in rank, below 10000 on a 50 day moving average, after a very short lived recovery
  5. My wife suggesting that "maybe" we should start eating at home to save some money seven years after our first date

And Finally, a Few from Victor Niederhoffer:

  1. The number of letters to the editor calling me a moron tops three a day.
  2. My ulcers reach the heart.
  3. The head of my clearing firm apologizes for a previously scheduled visit and says "now, I hope I'm not going to hoodoo you."
  4. One of my daughters says I can have my money and some hotels back in Monopoly as she doesn't want to beat me.

Ask The Senator, a Continuing Series

Q: What do you think of "Hubbert's Peak"?

A: Anyone can scare you, yell fire, but that is not a solution and this world runs on solutions.

"Within 10 years we will be out of oil for practical purposes"

"I expect there will be little oil left to be used or found within the next 20 years"

"The worlds' oil reserves are now depleted"

Pretty strong statements.. They were issued in 1914, 1932 and 1973, then in 1978-82 we were told that by the turn of the century there would be no oil left.

Cassandras abound in this mock energy crisis; they have made an entire business out of scaring people and in the process selling the wrong-headed notions that less is best, of scarcity and that there is no future, or worse yet they should be the ones to control the future.

A mini version of this was/is the great water crisis in California, a state now awash in water after the Cassandras predicted the state would become a desert.

Run, don't walk away from these gloomy-minded scaremongers, or at least notice the opportunities that abound there.

Send queries for the Senator to senator<at>dailyspeculations<dot>com

Reverse Engineering, by James Sogi

1.Stephen Wolfram, in A New Kind of Science, sought to reverse engineer nature's complexity and reduce it to cellular automata, but admitted the difficulties. He demonstrated that simple rules allowed cellular automata to generate complex structures whose derivation, though simple, were difficult to determine and hypothesized that the same might be true of nature's complexity. David Kreps' lectures on Game Theory and Economic Modeling raised the same idea. Using game theory allows economists to attempt to reverse engineer complex economic relationships mathematically. He also admits the drawbacks of the endeavor. The Chair's statistical methods represent his effort at reverse engineering the markets. If Globex represented the entire market, reverse engineering might not be so difficult, but as Globex is but the shadow on the cave wall, the difficulties are apparent. Statistical methods and models, i.e. the tables, make certain assumptions about the market. Part of the engineering should measure the extent to which those assumptions accurately measure the observed data. Have the assumptions been tested? Is there a way to do so?

2. The market is said to be a discounting mechanism, but it may be thought of as a measure of utility. Utility is the subjective element in the measurement of risk in economic theory. However if we assume that the basic intrinsic value of business, commodities and credit remain constant, all that changes is people's perception of the utility of owning them. That change is measured by the price of stocks and credit. Its odd that when prices are lower, people (as in the public, i.e. my two friends) don't want to buy, as they perceive risk is higher as reflected in VIX, but when buying when prices are already high is even riskier. The perception of higher risk at lower prices seems to be a function of the news reporting sentiment rather than economics.

First-Quarter Earnings: So Far, Very Good, by Victor Niederhoffer

It is good to know that for the 147 companies in the S&P 500 that have reported first-quarter earnings so far, the average change in profits over the first quarter of 2004 is about 12%. For every company with profits below expectations, 3.8 reported positive surprises.

The actual earnings reported were 2.5% above forecasts.

The surprises were as follows:

But of course, that's not good enough these days. Nor is the 2.5 percentage point differential of predicted earnings yield over the bond yield. It is instructive to check such a differential with comparable figures and subsequent returns in the Fed Model work of Manchester Trading's Tom Downing and the  Spec Duo.

Of interest, too, is that for two years from the end of 3Q 2002 to the end of 1Q 2004, all the earnings seasons showed gains in the S&P. But starting at the end of 2Q 2004, the moves in the first 10 days of earnings seasons have been as follows:

Month (1st 10 days)% Chg in S&P 500
July 2004-3
Oct. 2004-2
Jan. 2005-2.5
April 2005-3

Hats off, the market mistress has found a new way of scaring the dickens out of the weak longs, before going up.

Recall that the S&P 500 was 950 in September 2002.

Lloyd Johannesen adds:

Are stocks priced fairly for a long term investor? The decline in real yields as evidenced by TIPS indicates that they are. Jeremy Siegel and other academics argue that the reciprocal of the P/E, or earnings yield, is a good estimate of the real expected return. 5-6% plus expected CPI of 2.8% indicates an expected return of 7.8% to 8.8% with no change in general P/E levels. This yields an equity risk premium of 3-3.5% over bonds currently. I think an expected return of treasuries plus twice the spread of investment grade debt to treasuries is logical for equities, and we are above that now. With a portfolio allocation to equities you are hedging against a further decline in real yields; if inflation and/or real yields increase you may lose more in equities in the short run, but probably not more than indicated by the ratio of expected returns.

George Zachar replies:

As to TIPS,

Real yields have declined globally, when you look at old-fashioned nominal debt versus any array of consistent inflation data. The glut of Asian savings has overwhelmed even the printing presses of the West. For now.

Supply and Demand, by Laurel Kenner

TrimTabs reports that 17 stock buybacks totaling a "whopping" $26 billion were announced over the last five trading days, bringing the total over the last 21 trading days to an "astonishing" $54 billion. Cash takeovers rumored to be in the works will further shrink the trading float of shares, TrimTabs said.

The effect of such supply shrinkages in the stock market would seem to be highly bullish. As far as we know, no study has been conducted on this. Such numbers beg for study.

Needles in Haystacks, by Victor Niederhoffer

It's always interesting to see how those with a view on the market are able to pick a needle out of a haystack to support their views. Perhaps the worst, systematic version of this comes around warnings season when the companies with the worst prospects warn and the market assumes that all subsequent news will be equivalent in prospects to the warnings.

This is an example of that same regression fallacy that pervades so much of economic and market thinking where the ephemeral component of a number is assumed to persist. First-year statistics students these days are asked to quantify the tendency for the batters in the top quarter of the batting average rankings in the first half to recede in the second half, and for those batters in the bottom quarter in the first half to gain in the second half. If only market people would read Stigler's articles on these tendencies, how much better the world of specinvestments would be.

In any case, the bears will be bombarding us with denigrations of the current earnings numbers and pointing to other weaknesses for sure. Here are four examples that crossed the desk today:

  1. Potential earthquake in Maine.
  2. Contention that some of the decline in jobless claims is due to seasonal factors.
  3. Qualcomm warning.
  4. Index of leading indicators falls 0.4%, giving grist to the bears despite being a melange of retrospective items negatively correlated with the future, one component of which is last month's stock market price.

Please understand, as our readers will doubtless point out, that we are privy to this same tendency to clutch at straws ourselves. When we're long, we don't like to emphasize the negatives. And we restrain ourselves from mounting the high horse over the world's Abelsons, whose obsessive tendency to focus on the negative puts them beyond the pale of all except certain institutions, when for one brief moment in time they're right.

Triumph of the Optimists, reviewed by a Southern Spec

If I have a Salami roll in front of me with a knife and cutting board and commence to cutting slices I will always have Salami that I am cutting. No matter if I end up with 100 slices or 10 they will all have the same Salami consistency and texture. No matter how many times I try to dissect the S&P that dag-gone 8-10% drift just seems to show up in some fashion, consistency and texture. You can't cut Salami and end up with Bologna can you? For the record I tend to make my slices by the day, month, quarter and year. My blade isn't sharp enough and hand isn't steady enough to cut those paper-thin intraday slices!

The Sage, Big Blue, Bears and Body Snatchers, from A. Fable

My son likes to have the Aesop's Fables read to him. He asks me what they mean, and this often brings to mind parallels in the market.

The Fox and The Crow

A crow was sitting on a branch of a tree with a piece of cheese in her beak when a fox observed her and set his wits to work to discover some way of getting the cheese. Coming and standing under the tree he looked up and said, "What a noble bird I see above me! Her beauty is without equal, the hue of her plumage exquisite. If only her voice is as sweet as her looks are fair, she ought without doubt to be queen of the birds." The crow was hugely flattered by this, and just to show the fox that she could sing she gave a loud caw. Down came the cheese, of course, and the fox, snatching it up, said, "You have a voice, madam, I see. What you want is wits."

My son asked, "What does that mean, Daddy?" I replied, "The fox had the wits to wait and patiently after those perched high stumble to vanity." For me, Buffett is the Black Crow. He has the cheese! He never speaks! He sits so high perched up on that branch, and oh, his plumage is so exquisite.

The other lesson I took away was that the market bears rarely get the cheese, but once it's in their mouths they can't hold on to it. They flap their wings (lips) ever so hard to reach that perch with cheese in mouth only to babble and give the bull foxes the opportunity to grab the cheese at lower levels once the cawing starts. Nigel's right: The headlines will be tainted and deceptively luring this weekend. Of course the aforementioned must be tested.

Aesop's fables are a darn good example of Darwinian thought! Another one that pays tribute to the market drift and the 1,500,000 million percent return over the last hundred or so years is the following. Substitute all hubristic bodysnatching ableprechtsonian types for the peacock!

The Peacock and the Crane

A peacock taunted a crane about the dullness of her plumage. "Look at my brilliant colors," said she, "and see how much finer they are than your poor feathers." "I am not denying," replied the crane, "that yours are far gayer than mine. But when it comes to flying I can soar into the clouds, whereas you are confined to the earth like any dunghill cock."

This one teaches that seeking "daily" profits from trading over and over against the much deeper pockets and the commissions, brokers bids, levels of "I get mine before you get yours" is a futile, futile dream. Less equals more

The Horse and the Groom

There was once a groom who used to spend long hours clipping and combing the horse of which he had charge, but who daily stole a portion of its allowance of oats, and sold it for his own profit. The horse gradually got into worse and worse condition, and at last cried to the groom, "If you really want me to look sleek and well, you must comb me less and feed me more."

ADD Does Not Add up to Success, by Vince Fulco

Brent Buckner makes a good point in a comment to an earlier post here. He points out, somewhat archly (I think), that:

"Willingness to undergo tedium may thus be a competitive advantage for active investors."

I agree. One of the things that separate some of the most successful people I know from the rest of us is that they are willing to spend an inordinate amount of time suffering through things that seem to make time slow to a crawl. For example, pouring through legal documents, doing cold-calling, reading lengthy financial filings, sitting in endless meetings about process, and so on.

Because among other things, there are people who game some people's inability to stomach boredom, from meetings to filings. For instance, they aim to get to the point in a meeting where the ADD crowd will literally agree to anything to end a meeting, and then they spring some complex request that they really want, knowing full well that the I-hate-being-bored gang will say no mas just to get out of the room and back to multi-tasking.

Of course, all of this puts me in mind of the wonderfully nihilistic passage in Joseph Heller's Catch-22 where Dunbar explains why he loves shooting skeet because it was such a mind-crushingly boring way to spend time:

Nebraska Chronicles: Two Valuable Things, by Victor Niederhoffer

I have read all the books about the Sage, and I have read all his bearish annual reports, with their implied sanctimonious message that he is so much more moral and prudent than you or I, and that a primitive society of abstinence and self sacrifice, for you, is to be preferred to our society of constantly increasing material well-being and personal liberty.

And I find that there are only two sensible and valuable things he has said (as he never talks in public about the importance of using tax losses and float from an insurance operation to buy stocks for the long term during a upward-sloping yield curve environment, and the importance of having very good friends and token ownership in the media, which are the actual sources of his success).

The first thing I find valuable is the message he delivered before the luxury boat trip he arranged for his fat cat influential friends and his surrogate son Bill, where Ben Graham was the invited guest . He said, "We are all here to hear Ben talk. No one else talk at all."  I always use this when introducing a distinguished invited guest to a dinner party.

The other useful thing is an extension of his Stoical idea that one should look at the market and not at the commentary. Along these lines, it is helpful to look at the "disaster" that is the fixed-income market. The bellwether long-term June bond trades at 114.12, a two-month high, 4% above where it was one month ago and within two points of its all-time high, and some 60-80 points above its level of the cardigan Carter era.

And also good is to look at the CRB index, now at 306, down from 316 a month ago, and about equal to where it was at the end of February.

The dollar is up about 5% on the year against the euro, with comparable damped gains against the others, to the cost of those who pyramided against it on the way down, and the humiliation of fellow quant grads from Harvard who were snatched by the Sage and talked about how the dollar stinks at Davos and other locales where the head Body Snatcher plied his trade.

More on the Sage, by Victor Niederhoffer

In describing the process described in the Wall Street Journal article about the sage where he apparently felt it prudent to point out an infraction in his good friend's activities to exemplify his own cooperation and honesty, always a noble virtue, I referred to it as a Lumumba shuffle.

However, what I meant to say was that it struck one as "Babangida Boogie". This is well known among NGO'S and is memorialized properly in George Ayittey's Africa in Chaos: A Comparative History as follows "...the posturing, tricks, and acrobatics are know as (The) Babingida Boogie": one step forward, three steps back, a side kick, and a flip to land on a fat ( mountainous) bank account. One day Nigeria's Finance Minister ---- talks of mass privatization. The next day( after the funds have been received ) privatization is merely an option to be considered by some government committee".

Beware the Slow Descent, by Victor Niederhoffer

Today's move in IBM marks the 14th consecutive daily decline. It's past the stage of guessing what the expectation is after such a run but one can frame the question: How likely is such a move to have occurred by chance? 

One can start with 14 declines in a row with 1/2 probability each as a 1 in 16384 shot. But there are so many more ways to look at this. Wiz suggested one. It's like a man with a good hand slow playing a position, keeping you in the pot after each small bet or check. Irv Redel would put it as a manifestation of the theory of least observable differences--- the frog that is put in cold water doesn't jump as the pot slowly comes to a boil (a theory which regrettably I've never tested for fear there will be no one available to take care of the kids after the session in the hotel). Thus when the market wants to keep you in, it goes down slow, but when it desperately wishes to get you out for a turnaround, then expect a convulsive heart-wrenching Beethovenian move.

I sold out of Pfizer on its cost-cutting bounce, but continuing the saga of individual stock mishaps in the Dear Vic letter, I put a good part of the proceeds into IBM the day before the foreshortened earnings announcement on April 14. I hope those I bought it from as well as those who sold the market down 10 S&P points in the 10 minutes before the announcement did not have to suffer undue uncertainty with their positions. Reminds me of all the inordinately high bids for puts I was presented with and accepted in the days before 9/11.

W    4/20/05 72.01      -3.47       -4.60     14521600
T    4/19/05 75.48      -1.17       -1.53      6715600
M    4/18/05 76.65       -.05       -0.07      9997400

F    4/15/05 76.70      -6.94       -8.30     18944100
T    4/14/05 83.64       -.93       -1.10      7293700
W    4/13/05 84.57      -1.18       -1.38      5787000
T    4/12/05 85.75       -.45       -0.52      6435200
M    4/11/05 86.20      -1.40       -1.60      6301600

F    4/ 8/05 87.60       -.84       -0.95      4147200
T    4/ 7/05 88.44       -.56       -0.63      4884300
W    4/ 6/05 89.00       -.57       -0.64      6174700
T    4/ 5/05 89.57       -.75       -0.83      3704600
M    4/ 4/05 90.32       -.12       -0.13      3015400

F    4/ 1/05 90.44       -.94       -1.03      4626600
T    3/31/05 91.38        .70         .77      5272200

Tim Hesselsweet adds:

Using renewal theory, the expected waiting time for the event, 14 consecutive failures, given that the probability of failure is 0.47 (adjusted for drift), can be found by: ET=(1+sum(.47^i))/.47^14 where i=1,2,..,13

Then the probability of observing the event at least once for five stocks over 1000 days is given by: 5[1-(1-1/ET)^1000)]=.07 which makes the probability close to 1 out of 15.

A much better way is to simulate in a manner that preserves the correlation structure of the data, but like most academic drivel this is of course worthless.

On Tuesday's Boston Scientific conference call:

Question: "Given that your stock price is sitting at a 52-week low, would senior management [who have sold some $200 million of stock over the last two years] consider using some of their own money to buy back shares?"

Answer:  "I don't care how cheap it is. I've got $6 options so buying at $30 is a bunch of bullsh-t."

Dan Grossman writes that this answer to a share buyback question was word-for-word, although a little more was said as well.

"I assume it was Jim Tobin, the CEO, but I couldn't tell for sure. Also on the call were the new COO (he wouldn't have $6 options), the General Counsel (doubt he would grab that question), the head of Investor Relations (ditto), and maybe someone else."

It was the last question of the conference call so you can easily hear it yourself.

Fashion and Facts, by Sushil Kedia

In line of thought with a recent post from the Chair about an invisible alms-giver and the degrees of moves in various markets which has opened some very exciting questions, one interesting phenomenon that is getting noticed is the short-term positive correlation between price moves in oil and equity indices.

Wonder if one of the possibilities is that the Almsgiver and his chosen rare few disciples knowing in advance that despondency is high when oil is higher and excitement is high when oil is lower and the smartest and the mightiest hands push for the bait when the fish would be hungriest. In a world besieged by trend-following where fashion takes on a more important role than facts, it is something that is happening for many months now.

Refinery Problems Help Crude Oil Prices? by Ross Miller

Back in the old days, when I used to take my dinosaur out for his walk, the wise old economists taught of something called "derived demand." For example, that component of crude oil demand that goes into refined product is not demanded directly; instead, its demand is derived from the demand for the refined product. Now if something creates a bottleneck in the refining process, supply of refined products will drop and so their price will increase. Similarly, the bottleneck will cause a drop in demand of the raw input (crude oil) and its price will decrease. Of course, in a manipulated market in which the participants (and certainly none of the financial journalists) do not know economics, it is possible for the price of the raw good to go up, but only temporarily.

Sushil Kedia comments:

A very logical explanation in which there are no apparent flaws.

Yet, the irresponsible press and manipulators are all operating inside economic realities of speculation.

Concepts of Giffen Goods and Veblen Effect do offer in many phases of speculative markets interesting perspectives on the economics of speculation which is quite different most of the time from the gentler 'economics'.

Expected Supply and Expected Demand or much more bluntly perceived supply and perceived demand, wherein with a rise in prices (trend-following hedge-fundists and other trend followers commit) the quantity demanded increases and with a fall in prices quantity supplied increases.

The utility function of speculation (purely financial speculation I am referring to here) is then dependent on the satisfaction derived from owning what is likely in vogue.

The psychosis operating in case of oil in recent times is disruption-in-supplies that ends up triggering a stampede of trend followers.

Undoubtedly, the event of refinery disruptions has in reality the effect as analysed by Mr. Miller, but the speculative crowd perceives this reality in its own way. The crowd often, and the market always is the master. Fundamental analysis could very well capture the logical and the learned computations of value, but the brute crowd force discovers prices in its own ways.

Purely looking at patterns (read relationships) of prices reflected either on a chart or in the more acceptable way of a table, I had advised my clients beginning early morning yesterday to shun the short term bearish view on oil and prepare for meeting a new high from where again a sustained fall taking it down into lower 40s is likely to emerge. But before that the risk of a new high is much greater to my methods.

Briefly Speaking, by Victor Niederhoffer

  1. During the last eight earnings seasons (from 8th - 30th of earnings month), the stock market was up an average of 0.6%. Why is the road better than the inn?
  2. Approximately 60% of companies beat the average quarterly forecast, 20% hit it and 20% miss it according to First Call. Thus, there is a chronic tendency to underestimate earnings among analysts, and companies tend to pull out the extra stops to beat them. Of what practical value is this.
  3. Why should news of a shortfall of 5 cents on IBM with the estimate for the rest of the year "in line with what you boys are thinking," according to IBM's treasurer, cause 13 declines in a row covering 18%?
  4. It would be the kind of symmetry that the market loves if the big decline were to start in conjunction with those who knew about IBM'S shortfall and stepped up earnings report in advance selling madly, and end with Intel reporting better-than-expected earnings as it usually does. Presumably Texas Instruments is not symmetrical enough.
  5. A Big League query. Given the market has been down three days in a row and the current day is up, what are the chances that the current change will be above five points? The answer is very surprisingly 4 to 1, but this is the kind of useless query that we encourage you never to make. Always look ahead not at the random probabilities of a previous event occurring.
  6. TrimTabs has been beating the bush saying that smart buyers like corporate buybacks and acquirers and dollar holders abroad are having a field day buying the Hades out of the market while hedge funds sell it to them with abandon regardless of the price. They hope that when the hedgies are forced to cover, there is not much carnage like occurred in oil and foreign exchange. Let us hope they maintain a proper humility and can walk the tightrope of making money on shorts that no one ever has before.
  7. The average move for the second day after tax day is surprising and well worth investigating with a pencil and envelope.
  8. For want of a nail a war was lost. But for the column that the Collab and I wrote on April 20, 2000 we all wouldn't be here and the world would be so much different. You see we were both out of work, and as our readers constantly reminded us for the next three years, 'How does a guy who blew up his fund and has no job come off writing a column telling people what to do? You can imagine the tightrope we walked with our editors when they received such missives regularly. But Jon Markman saw that column and said "it was the best column he ever read" and then he hired us. And if he hadn't, my goodness--- don't finish that sentence.

The Universe in Zeros and Ones, by Aerospace Analyst William Haynes

I've long cogitated on the significance of binary math and its application to computers. It seems to me that there is absolutely nothing that can not be totally defined by zeros and ones ... or more generally, by the presence or absence of a signal. Thus, rather than string theory, the fundamental "building blocks" of our continuum must be just that: presence or absence of a signal. The signal can be anything that can either exist or be absent. It has to be clear, unambiguous and detectible. Then the "big bang" would begin with the sudden existence of such a signal (sudden, because it either exists, or it doesn't... and there would not exist any means of measuring time anyway) and proceed toward the ever expanding proliferation of possible permutations and combinations of on/off, yes/no, ones and zeros to create the postulated resulting universe. What I've not really thought about is what the "rules" had to be for the appearance of the first "one" to result in initiation of all that followed.

Jim Sogi comments:

Dr. Haynes' epistemological comment touches on the nature of reality. The nature of things are manifested as yin and yang, or to humans as form in a dualistic existence defined in a binary manner. Things are perceived, defined and understood as what they are, or are not...the binary duality. The true nature of noumena is uncategorizable-- all is one without time or space. Such existence cannot be understood or defined by dualistic conceptualization. However, we do have direct internal experience with reality through our own awareness of mind in a manner not connected with sensory input.

Recommended Reading: Art Cooper's "Many Worlds" essay

Jeff Sasmor contributes:

In honor of the recent somewhat perplexing discussion about binary numbers:

1, 2, 4, 8,
Who do we appreciate?
16, 32, 64, 128,
A bit, a nybble, a byte.
data chunks that are just right.
Binary, octal, and hex,
They rule, and beat out all the rest.
Decimal has had its day,
out since Nixie tubes had their sway.

This is the car I will purchase when the market goes back up.

Light and Dark, by Ken Smith

Yin and Yang
Right and Wrong
Left and Right
Up and Down
Black and White
Zero and One
Friend and Foe
Light and Heavy
Win and Lose
Long and Short
Yetzer Hara and Yetzer Hatov

Sushil Kedia on Fractal Finance and Patterns of Mind:

I am merely attempting to put across the fog of thoughts up here so that it may be shredded finer in the pursuit of seeking clearer thinking. Please shred it with scissors of argument as sharp as available.

The excitement about fractal geometry (and for that matter each 'latest' tool of thought picked up in the evolution of knowledge) may actually be an unfolding leaf in the ever evolving perceptive process:

For example, in mid-school years we are taught that electrons move in orbits around a massively dense and compact nucleus. In later years, at the high school level we come across the Heisenberg's Uncertainty Principle wherein the position of an electron as well as its velocity cannot be both 'estimated' together beyond a degree of accuracy measured by the equation famous by Heisenberg's name. NOW, that is an example of how the SCIENTISTS before Heisenberg imagined, visualized and perceived a FRACTAL structure of electrons orbiting a nucleus in the same way as it is widely held that planets revolve around A SUN.

Now could it be possible since the best known definition of 'mind' as per Edward de Bono that "mind is a self-organizing pattern seeking system" that we the humans have got conditioned to expand our awareness and consciousness by comparing and by tautomerising our observations stretching from the macrocosm to the microcosm.

If that be the case, it could offer some plausible explanation for varying degrees of success in deciphering price moves (and many other things) using the TA oriented Elliott Waves and the Counting-oriented Fractal Geometry & Finance.

However, my basic question remains whether the entire process of amassing knowledge through design, experiment, observation, conclusion route is a case of developing fits to the observed data that continues to suffer from the presence of a mind that is a self-organizing pattern-seeking system.

The entrepreneur, the creative, the creators of situations in any field ranging from art to military pursuits have demonstrated across history that they do possess an edge out of such enterprise that is superior to edges gained merely from observed knowledge ranging from replication to reconnaissance.

In that sense, getting focused onto the markets that is more appropriate at our forum, how does this all compare to fighting 'circular trading', 'stock-promotions', CN*C TV channel etc., etc.

In other words, is there a counting based evaluation of approaches of creating market-situations (call it manipulation if you will please) vis-a-vis following the price in the market (do not call it trend following, if you will please) with an assumption and belief that the price reflects the collective wisdom of all possible participants.

If the experienced and counted answer is more inclined towards price being the king then it leads to the all-troubling query

Since, we seek returns over time and suffer adverse risk over time, the choices of all alternative endeavours in markets are to be evaluated at a rate of movement per unit of time. All calculations relating to what volatility is or could be or should be, what a trend is, what a random set of prices is, what an 'expected' and a 'likely' outcome is ARE ALL SUBJUGATED TO BE DEFINED differently for each individual participant in the market with their individual senses of time.

So then what is TIME? Science has gone so far to the point of starting to treat Time as the fourth dimension, which to us humans is impossible to visualize (while some of us are able to imagine it). But for markets in particular and in attempting to understand time in the broader sense as well; any thoughts, links on the www, any referrals to research that helps understand time would help along a long way and some specs may kindly like to share their own discoveries, delights, disappointments in the pursuit of understanding time.

Kevin Bryant adds:

Elaborating on time, something I find infinitely interesting, not sure terribly useful in practical terms, is the idea that time travel is theoretically possible. Einstein's Theory of Relativity has long since been proven along these lines; for instance, atomic clocks aboard aircraft traveling at high speed. If you accept this fairly pedestrian notion of quantum physics, then it says, I believe, that everything that ever was and will be already "exists." Clairvoyance may not be as farfetched as many of us believe. Many a successful investor/entrepreneur has been said to have made bets based on overwhelming feelings/instincts. Not sure there've been any reliable tests here.

Perhaps even more mind-blowing, though, in opposition to the idea of predestination, is the theory that in the quantum world, all possibilities exist until an observer observes (perhaps this theory, the "Copenhagen interpretation" I believe, has been summarily disproved since I last read on it). The theory leads on to the idea of numerous, parallel existences. If this were the case, the powers of mind and intention, intention in particular (the focused mind) may have a greater impact on outcomes and the reality we experience than we are aware of.

Putting these ideas practically to work is another thing.

"A" comments:

Time travel isn't practically possible. If it were, then some enterprising individuals would have already travelled back in time and traded on future news. Prices would then essentially be flat. Since prices are far from flat, then clearly no one has has been able to travel back in time.

The above logic can be found in a sidebar of the book "Trading & Exchanges."

Yishen Kuik replies

I think the determining factor for this might be the ratio of the trading volume generated by time travelers versus the trading volume generated by non-time travelers.

One might argue that skilled traders who are able to discover reliable tradable patterns have something of a glimpse into the possible future and are thus already practicing a weak form of time traveling, ie predictions. As long as their trading volume is a small proportion of the normal trading volume, they can practice their craft and avoid too much induced disruption.

Someone out there might have a genuine time machine and the good sense to trade moderate size with it.

Joe Gelman adds:

Indeed, the fixers of horse races do precisely this. They don't bet so much as to make the return on the 'winner' so small as to be meaningless, just enough to take a respectable sum from the 'pool.' Rinse and repeat, it's a nice living. In fact, the notion of time travelers inhabiting the boardrooms of the major firms may explain the often bizarre patterns of the market more clearly than existing theories. As for the business of traders betting on 'feelings' -- ["Many a successful investor/entrepreneur has been said to have made bets based on overwhelming feelings/instincts"] -- well, I suspect many an ex-trader, now waiter, has also engaged in such behavior.

Market Zen, by Kevin Bryant

Perhaps trading/investment/speculation is not as difficult as we make it. I'm struck by the blindingly obvious fact that even the most active trader spends little of his/her time actually trading. the most critical moments are the periods of "non-doing" if I can borrow from the Zen Buddhist lexicon. In fact it never ceases to amaze how sometimes the best ideas come during moments of non-doing, unrelated to the conscious act of speculative practice.

There's a great trap in the labels: trader/investor/speculator it seems to me. In wearing these mantels we create a persona outside ourselves that demands affirmation and perhaps is often in opposition to profitable speculation. If we sit on a portfolio, call it a speculative position, for twenty years, are we traders/investors/speculators?

The act of continually pitting one's wits against the markets is one of the greatest chemical rushes going. there can even be a perverse attraction to the despair that comes during a rough patch. Omar Sharif, at one time a big gambler, used to talk with striking relish about his darkest hours, when he literally had just enough to buy a cup of coffee. after a particularly active trading period, I find the prospects of a quiet period, though it may be just what the doctor ordered, a strangely daunting prospect, psychedelic hues replaced by gray skies. Win or lose, while trading I feel closer to my primordial self, when visceral meetings with life and death were constant occurrences, when living by ones wits was expected and ordinary. i am struck by how even the smallest wager can elicit the same internal responses as one ten times the size. perhaps this in part explains today's gambling explosion. In America where life is supremely comfortable (in comparison to the rest of the world), there's desperate need to create drama. both suffering and joy bring us in touch with our humanness.

So in my relatively short existence wearing the investor hat, I recognize that the most important period of my investment life were the preceding forty two years, the period of "non-doing" that have informed my approach and choices today. My biggest risk I suspect will be in "doing", in forcing the action, drawing another toke from the pipe. The ideas are all around me -- do I have the patience, the restraint to let them mature on their own? How often have we looked back at major market turns and recognized the clarity of the signals (though perhaps not the precise timing), obfuscated by the noise and emotion of the moment?

James Lackey comments:

Trading is easy. Making money from the profits of buying and selling is what is difficult. Making a living from those speculations after paying taxes is even more difficult.

Lots of things are easy: having kids, getting married, playing games, being educated, being an apprentice.

That said the most difficult things are raising fine children, happy marriages, using an education to profit, being a master and teaching apprentices.

Finally, after a life's work to be a Man of La Mancha, to risk all reputation and riches for the "right thing," might be the most difficult trade of all.

'Damn crazy old man' are the coolest guys I have ever known. Non-doing Buddha, bull. We shall not regret the things we have done, we will regret those things we have not done. LACK

Hunter-Gatherer Society, by Philip J. McDonnell

There has long been a concept in psychology that men and women are different. The idea is that evolution has provided each gender with a fairly well defined role in the tribal society which presumably characterized most of the last 100,000 years or so. This theory goes by the common name hunter gatherer society. In this view of things women are the nurturers and stay close to camp. They gather berries and vegetables which are reasonably close by. The men are the hunters who roam about more freely in search of game. The skills, physique and mindset of each is suited to their role.

A friend of mine wrote her Ph.D. thesis on how this difference might affect the interest and effectiveness of men and women in different occupations. In particular one class which she studied was stock market traders. The skills and psychology which evolved over eons are not easily changed in the few thousand years for which civilization has existed.

A good hunter needs the ability and mindset to find a strategic location and remain hidden until the game come near. This requires both good tactical planning and a great deal of patience. The salient fact is that almost all of the game is much faster than humans and generally has better senses. The hunter who is unable to endure long hours of quiet waiting is one who craves action and the adrenalin pumping excitement of the chase. However such a hunter will soon starve. In the same fashion a hunter who hides upwind from the game will never see any up close. Quite literally his plan stinks. The game will catch his scent and avoid.

For a trader the requisite skills are very similar. The ability to think strategically and execute tactically is critical. The planning must be logically sound and free from flaws. To do this the best way is to do some counting with actual data. The best way to verify that your plan has ever worked is to back-test with real data. Failure to test may put you in the camp of the trader who starves.

Patience is critical to trading just as it is to hunting. A good trader will select his opportunities carefully. If none are available he is out. By contrast a trader who must always be "in the game" may be trading for all the wrong reasons. He is like the hunter who tries to run down the deer because he loves the thrill of the chase. His need for action is really a form of gambling and motivated by his need for entertainment. This kind of trader will soon starve because he is forced to accept many mediocre trades and the vig will soon eat up any profits he might have made. The patient speculator will wait for only the best trades and give them the time to develop. His patience will be rewarded with a higher average return because he is selecting only the best trades. In addition he will give less of his profits back in the form of vig. This trader will survive to hunt another day. It takes planning and patience to make a killing.

Laurel Kenner comments

I usually avoid gender discussions. I like being a woman, I think PC'ness is a joke, I know my personal limitations, and bottom line, "there's no percentage in it."

However, I am inspired today by a gift of Suze Orman's Financial Guidebook. (A spur to encourage me to write a better one.)

My point: It seems to me that the qualities Phil is describing are GATHERER abilities. Woman plant and wait. They have to find WHERE seeds and herbs grow, and they have to know WHEN to get them, and then they have to WAIT for them to be at the right stage of growth. They wait when they cook. Grinding acorns? Making baskets? Patience, patience, patience.

I'm not even saying that I personally possess any of the above attributes. But there is some similarity between the qualities needed for successful gathering and being able to wait till the market drops to buy and to hold on when the market goes against.


Lobster Anyone? Larry Williams Gets Shelled

I just took delivery of three lobsters, big ones, a total of nine lbs for $50.

Anyone have any great lobster dishes?

Mr. K responds:

Boil in white vinegar and pickling spices and then broil the lobsters ..that way they don't become too tough. Make a sauce of melted butter, horseradish and Lea and Perrins.

James Sogi responds:

Smother entire fresh lobster in way too much butter, wrap in heavy tin foil and seal tight. Throw in fire five min/lb or so. Seals in juice. Don't overcook.

A Hint from Rich Bubb:

If lobsters are still alive, before cooking them (via dropping them in boiling liquid), allow them to mellow out in a bath of cheap wine, so when they hit the hot water they won't tense up and make the meat tough.

How to Become a Rich Country, from Yishen Kuik

From Uncommonknowledge.org, Nobel Laureate Douglass North explains how the ability to conduct impersonal exchange in a country explains its wealth potential.

This brings to my mind the recent discussion on game theory - cooperative solutions bring superior results in the classic prisoners dilemma problem. Trading is a form of cooperation between a buyer and a seller. One might argue that the purpose of a good legal environment is to extend the number of trading partners one can have significantly beyond those with whom one has immediate acquaintance. The connectivity of each trading node is enlarged by law.

And if trade is, fundamentally, a cooperative effort by members of society to move goods and services or capital and risk swiftly along to their most suitable final destination, then the success or failure of economic development in countries might be attributable to the allocative efficiencies of their local markets, which are in turn the result of how much trade, or cooperation, takes place internally among their members.

Without the right legal framework, each members might be limited to trade within their local village, thereby balkanizing the cooperative efforts within the greater society to allocate resources. Conversely, phenomenon like eBay promote the cooperative effort within our society as people trade second hand goods, creating greater allocative efficiencies by freeing up raw materials and labor that would have otherwise gone into the production of more "brand new" consumer goods.

Inflows and Outflows, by Victor Niederhoffer

An interesting thing to study are the inflows and outflows to the market. Trim Tabs does a good job of looking at the money coming in from mutual funds, corporate buybacks, insider transactions, paychecks and so on.

A predicted inflow comes in on Fridays at ends of months, and a predicted outflow accompanied by a feeling of revulsion presumably comes around April 15.

Rudy Hauser keeps track of other predicted outflows vis-a-vis money leaving checking accounts, especially seasonally (e.g., before December)

Some anecdotal counting of S&P moves associated with these flows starts with April 15, 2000.

Date, day of week Move that week Move that day Move next day Move next week
4/14/00 (F) -11% -6% 4% 8%
4/15/02 (M) -2% -1% 2.5% 1%
4/15/04 (Th) -1% -0.5% 0.0 0.5%
4/15/99 (Th) -2% -1% -1% 3%

On other days of payment to the redistributors, there were no significant declines going back to the year 1990.

Ghost of Tax Day Past

Last Friday took the Spec Duo back to the dreadful events leading up to Tax Day 2000. We brushed the dust of the bound volumes of our columns for Worldly Investor and revisited April 15, 2000.

  1999 open high low close
m 4/12/99 1340.00 1372.50 1339.80 1372.00
tu 4/13/99 1369.00 1372.00 1353.00 1362.30
w 4/14/99 1367.00 1367.90 1334.50 1339.30
th 4/15/99 1343.00 1343.50 1315.50 1332.00
f 4/16/99 1333.00 1336.00 1318.00 1323.00
m 4/19/99 1333.00 1336.00 1318.00 1323.00
tu 4/20/99 1304.00 1318.00 1295.00 1315.00
w 4/21/99 1313.00 1355.00 1309.50 1351.70
th 4/22/99 1354.50 1369.90 1349.00 1369.10
  2000 open high low close
w 4/12/00 1518.50 1522.70 1475.00 1476.70
th 4/13/00 1486.00 1492.50 1452.00 1456.00
f 4/14/00 1435.50 1438.00 1348.00 1367.50
m 4/17/00 1367.50 1415.00 1359.00 1412.70
tu 4/18/00 1413.50 1454.00 1408.60 1452.70
w 4/19/00 1454.00 1459.50 1435.50 1440.30
t 4/20/00 1441.00 1448.00 1432.50 1447.20
m 4/24/00 1427.50 1441.00 1417.00 1437.00
  2002 open high low close
w 4/10/00 1120.00 1133.50 1119.00 1132.00
th 4/11/00 1127.50 1128.70 1103.20 1103.90
f 4/12/00 1108.20 1114.50 1103.90 1112.00
m 4/15/00 1115.00 1116.70 1100.30 1104.30
tu 4/16/00 1115.00 1131.00 1115.00 1129.70
w 4/17/00 1131.50 1134.40 1124.00 1127.90
th 4/18/00 1127.00 1132.00 1109.00 1123.00
f 4/19/00 1130.50 1130.50 1123.30 1126.70


Talk Like a Stock Market Operator

The newest additions to our glossary of 19th-century Wall Street terms, from Edward G. Riggs, "A Wall Street Vocabulary: A Simple Guide to the Technical Terms of Stock Speculation," Munsey's Magazine, Vol. X, No. 4 (January 1894)

To work up a stock far beyond its intrinsic worth by favorable stories, fictitious sales, or other cognate means.

A Break in the Market
Where stock is kept up by artificial means, and a money stringency or similar cause makes it difficult to carry the load, the attack of a bear clique or the actual inability of holders will produce a marked decline in values. The market "breaks" down.

A combination of operators controlling vast capital in order to expand or break down the market.

Gunning a Stock
To use every art to produce a break when it is known that a certain house is heavily supplied and would be unable to resist an attack.

Kite Flying
Expanding one's credit beyond his limits.

Milking the Street
The act of cliques or great operators who hold certain stocks so well in hand that they cause any fluctuations they please. By alternating lifting and depressing shares they take all the floating money in the market.

To "Sell Out" a Man
To sell down a stock which another is carrying so low that he is compelled to quit his hold and perhaps to fail.

Sick Market
When brokers very generally hesitate to buy. Usually consequent upon previous over-speculation.

Spilling Stock
When great quantities of a stock are thrown upon the market, sometimes from necessity, often in order to break the price.

Dick Sears: Weekly Commentary

An update on the Gilder Technology Index

Today, by Victor Niederhoffer

I am reminded of Oct. 28, 1997, and Sept. 21, 2001, and July 24, 2002, and similar previous declines.

Speaking of Multiple Hypotheses, by Kim Zussman

What very large cap stock appears on screen:
(bottom 15% 3-yr return)
(insider buying top 70%)
(liqidity ratio top70%)?

Hint: the usual inhabitants of this list are small cap bio or other tech, but this particular one is 16Bln and rhymes with "general odors".

In statistical studies we are supposed to isolate and evaluate all relative variables so that the null test can be stated as a falsifiable hypothesis. Studies of the pattern:

When I trade like an idiot on (t-1), return on (t) leads to inconclusive results. This is due to inadvertent inclusion of other hypotheses; on idiot days one may unknowingly also be an ignoramus. Or a fool, spaz, moron, dysfunctional, decerebrate,  or celibate.  And the problem is how to tell among the idiot days when one is conferred with other talents that would invisibly contribute to the results

Animal Spirits, by Phil McDonnell

A study I did recently showed that my trading profits increased five-fold on libidinous days as opposed to celibate days. Turning this information to good use remained problematic even after I had completed the study.

Finally I resolved to show the study to my wife. Since then the results have been most satisfactory.

NOTE!  It's Always Good To Reread the Maxims of Great Champions Especially When They Apply So Well to Speculating. Tom Wiswell has left behind a collection of such proverbs which has just been refreshed. Enjoy!

Why I Compose Backward, by Laurence Glazier

I've long been a fan of Covey's dictum "start with the end in mind," yet I suspect it was from a musician that I learned of the rehearsing technique of learning the final bar first ("bar" in England = "measure" in America). After mastering that most important bar, one then plays from the penultimate bar, then from the third to last, and so on. This ensures one knows the coda so well that the relevance of preceding motifs is realized when one works back to them.

Later, I began to compose from the right hand side. As with the rehearsing technique, but from the other side of the trade, I was able to ensure that each placed note would be relevant at a later time in the piece.

It felt congruent at one of my first trading seminars, when the lecturer said charts should be read from the right hand side, to view the most recent bars first.

Two years ago, visiting an island, I conceived an anthem with the rhythm of the sea, and the shape of the island's profile. However, whereas the four-part choral harmony was clear in my mind, working from left to right I could not make the conclusion satisfactory. On my current revisit, I have worked from the right hand side, with the end in mind, and at last it is all fitting together.

The Grandmaster adds:

It's quite common in chess also - we 'see' the kind of position we want and then try to figure out if we can get there.

Ten Commandments of Applied Econometrics, by Will Huggins

While studying for my (surprise, surprise) econometrics final next week, I stumbled across a piece sourced to Peter Kennedy of Simon Fraser University in British Columbia in reference to the subject line. Useful context for those asking statistical questions of market data.

  1. Thou shalt use common sense and economic theory.
  2. Thou shalt ask the right questions
  3. Thou shalt know the context (do not perform ignorant statistical analysis)
  4. Thou shalt inspect the data
  5. Thou shalt not worship complexity
  6. Thou shalt look long and hard at thy results
  7. Thou shalt beware the costs of data mining
  8. Thou shalt be willing to compromise (do not worship textbook prescriptions)
  9. Thou shalt not confuse statistical significance with substance (or "practical significance" if you will)
  10. Thou shalt confess in the presence of sensitivity (anticipate criticism)

Back to probit models and under-identified equations.

A Reader Writes:

I was delighted to come upon your site. It was quite by accident as I was searching for nutritional information. And since you so graciously solicit comments on the philosophy of barbecue I would like to contribute this fact which can also be viewed as an analogy:

The order in which ingredients burn away while on the grill (or during the process of metabolism) is as follows:

  1. Alcohol
  2. Sugar
  3. Meat (Protein - Muscle)
  4. Fat

Thank you for lending an ear,

Teri Keith
Great Falls, Montana

The Senator replies:

A Big Sky welcome to a fellow Montanan!

Martin Lindkvist comments:

This analogy might explain why it is sometimes very hard to do away with the fat in a company without ridding it of the good "nutrients".

Seen Along the Roadside, by George Zachar

When Spitzer calls
And Warren squeals
Hank's life is full of strife.
He called his lawyer
Then his flack
And gave $2 billion to his wife.
Burma Shave

Cane and Able

Vic was sighted at 4:15 pm yesterday leaving his stately home, leaning heavily on his cane as he walked south throughout the evening at a measured pace. An annual pilgrimage he takes during bad times on Wall Street in the three days before April 15th.

Fed Language Yo-Yo, from Alex Castaldo

March 22 (Fed Statement):

"Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident"

S&P fell 12 points

April 12 (Fed Minutes):

"Although the required amount of cumulative tightening may have increased, members noted that an accelerated pace of policy tightening did not appear necessary at this time"

S&P rallied 15 points

The Slithy Toves of the Market, by Jim Sogi


sevot yhtils eht dna ,gillirb sawT`
ebaw eht ni elbmig dna eryg diD
,sevogorob eht erew ysmim llA
.ebargtuo shtar emom eht dnA

She puzzled over this for some time, but at last a bright thought struck her. "Why, it's a Looking-glass book, of course! And if I hold it up to a glass, the words will all go the right way again."

This was the poem that Alice read. (Lewis Carroll, Through the Looking Glass)

A Looking-Glass Market

Looking at the understructure of June SP (mini) after the last 18-day Panic in a Pagoda and trying to make sense of the market, had a bright thought .... of Alice. Yes of course, it's a looking glass market, or also called by Magee a reverse head and shoulders, which will be defined as a drop of 25 points or more from open 18 days ago through close ten days ago, and thence a rise of 25 points in the next 7 days.

Since the Panic in the Pagoda (new name for the questioned head and shoulders pattern) was followed by a 35-point drop, a test of the reverse head and shoulders seemed appropriate, so when Chair asks, "Er, have you tested that?"

SP Big since 94 will show 118 such occurrences after which:

The following day
59% went down an average 2.8 points,
Std. Dev. 14.24 with significant distribution.

2 days after:
56% averaged 3.4 point drop SD=22, with significant distribution.
( we're at -10 circa 1184 now)

10 days after:
65% gained 11.7 point average, Std. Dev. 46.64
with a significant distribution shown below T=2.7 p=.007.
Which would be ~1209 in a week.

The decimal point is 1 digit to the right of the |

-10 | 3
-8 | 33
-6 | 120
-4 | 7644375531
-2 | 975552966541
-0 | 9765221109876
0 | 123334455667789902334567789
2 | 0222245578889900123577899
4 | 01267801468
6 | 014468
8 | 006
10 | 76
12 | 8
14 | 2
16 | 3

"The Red Queen shook her head. "You may call it 'nonsense' if you like," she said, "but I've heard nonsense, compared with which that would be as sensible as a dictionary!'" (Those who know about running in place will certainly recognize the quote.)

$100 Oil, by Robert Mahan

Of course the laws of supply and demand are still in effect, but I think the notion of $100 oil in the near future (3-5 years) is not so absurd. Mainly, one should consider the considerable amount of time it takes to increase supply: it takes years from initial exploration to production--- & working in the exploration side of the business, I can testify that oil companies are not yet spending much on exploration, despite massive commodity price increases. Also: consider that major oil deposits are becoming harder & harder to find: the majors are still choosing to make acquisitions to boost reserves rather than explore. Furthermore, since most of the cheap to find and get at oil has already been found and gotten at, extracting oil from tar sands, exploring hard to image sub-salt, and going into super deep water only becomes worth doing when the price of oil is much, much dearer than the mean of the past 20 years. Also: hydrocarbons differ from most every other commodity in that they are unreplenishable. This means that technological advances don't necessarily decrease costs. Already, the supermajors want to drill to super-deep depths, but the drilling technology isn't there to handle the temperatures at those depths. Probably eventually it will be, but when it is the oil companies will pay dearly for it-and that cost will manifest itself in the commodity price.

A Challenge to the Triumphal Trio from Kevin Bryant

Averages, like generalizations, can be a huge trap. A 100- or 200-year market history doesn't account for points of entry and exit. I would even argue that it's somewhat nonsensical to talk about historical stock market returns as proof since one was unable to invest in market indexes until relatively recently -- stock selection was still a key requirement. I won't explore at great detail here; however, the fact that indexing is now such a major market factor today has caused underlying market fundamentals to change. To borrow from quantum physics, the fact of observation has affected the outcome of the experiment.

I would suggest that most investors (now it's my turn to generalize) are active, and most critical investment years are not much longer than 10 maybe 20 years. this assumption partly reflects the notion that risk doesn't take on visceral meaning for most investors until their perceived earnings power begins to plateau or diminish, which probably occurs somewhere between 40 and 50 years of age. This also presumes that most people do not come into large inheritances and that it is not until the last third of their life that they have a portfolio of meaningful size, relative to their overall net worth and income (it would be wonderful if anyone has hard data in this area).

If you accept this line of thought, clearly, if you "read old books on the markets," the decades of your stock market participation are crucial (if you were 100% invested in equities).

I would make another, perhaps bold assertion that the market corrections of 1987 and 2000 were significantly more calamitous than that of 1929 because of the broadness and depth of market participation. The difference and saving grace in more recent history was Fed policy which was decidedly less accommodative during the Depression (of course, we were still on the gold standard). But does that mean markets are less risky? Greenspan is perhaps unparalleled in his political and persuasive powers as a Fed chairman. Is it possible that a different chairman would have taken a different approach? The fact that we appear so reliant on the decisions and utterances of one man for the direction of our markets doesn't give me a warm and fuzzy feeling. I would guess that volatility will pick up considerably as we approach his retirement in 2006 and perhaps continue well into the next chairman's tenure. it will be interesting to watch.

Finally, I have been bothered for many years by the creeping sentiment of the herd (putting aside the data supporting this sentiment), particularly before 2000, that equities represent, by far, the best return over the long term and the notion that investing is much like going to the grocery store; mutual funds are really no different than CDs but with a higher return. And because of diversification risk is de minimus. That sense of safety, even to this day, can only mean a great misallocation of capital in my opinion. It ignores the contractual aspects of equity, i.e., that there is no "promise to pay" and that it stands last in line behind creditors. An earnings yield of 4.5% on equities versus a yield of 4.1% on 5-year Treasuries just doesn't reflect this basic distinction of risk in my opinion. "Sure things" can't help but become crowded trades. Fear, hope, and greed guarantee this result.

I'll end this with a quote from Jesse Livermore:

Nothing ever changes in the market. The only thing that changes are the players, and the new players have no financial memory of the previous major cycles -- like the panic of 1907 or the crash of 1929 -- because they have not experienced them. It may be new to the speculator, but it's not new to the market.

Briefly Speaking: Behind the Form, by Victor Niederhoffer

1. The market awaits the minutes of the Fed meeting of March 22 with bated breath to see how hawkish they were on inflation. Since March 16, and March 22 , the CRB index has gone down 6% and 3% respectively. Talk about the public's being behind the form.

2. The market is down today additionally on a record trade deficit of 61 billion compared to a 59 billion estimate and concomitant weakness of the dollar. But the dollar is actually up about 3/4 percent on the news. Reminds me of all the times that market went down on fixed income rate hikes when interest rates actually went down.

3. I reflect on tax payment week of April 2000 when the market dropped 160 points. That's S&P points. Many other years were grotesque also to a non-random extent. Reminder of who owns most of our lives.

4. Interdisciplinary studies often give most insight to a field as they bring up universal factors and fresh perspectives. The book Regression Methods in Biostatistics by Vittinghoff et al, Springer, 2005, I find helpful.  Nice discussion of exploratory techniques for physicians including the LOWESS Smooth and survival statistics, the most neglected useful method for our field.

Daily Speculations Forum: Racing and the Market

The aerodynamics of car racing and bicycle racing are well studied, with the optimum position of cars in a line depending on vertical and horizontal drag. and other factors. Apparently being second in a car race right behind the leader is much more of a wining position than first. I wonder how important such considerations are in human racing in such things as sprints and marathons and relays. I often remark that it is much more bullish for a stock late in the day vis-a-vis the rest of the day if it's just down a little as compared to just up a little (and of course this must be tested over and over again). One wonders also whether the position of a company within an industry in weekly, or monthly performance, shows similar aerodynamic properties and whether this changes with the wind and the past (I look around three times)  "trend." -- Victor Niederhoffer

Russell Sears comments:

A few thoughts on this with perhaps some speculative avenues to pursue.

First, drafting is much more important into a head wind. When the going is tough, nobody wants to be the leader. The largest pack I have ever been in was at the start of Chicago Marathon during a windy day. Even the women were running with the guys. But several mile through once the corner was turned so the wind was at your back the pack thinned immediately. The favorites separated from the crowd.

Late in a race, the wind has much more effect on you as your strength and fight is often gone.

Perhaps some similar effect occurs in the stages of business, e.g., groundbreaking biotech and alternative energy stocks versus mature companies.

Second, leading a chase pack has an adrenaline rush and is heady stuff. Timing this adrenaline rush is very much like giving a diabetic sugar, full tilt until they crash and burn.

But taking the lead from someone can be very demoralizing. My strategy is to take the lead after the hill or after the wind, when doubt is highest. Often a reputation, a name, can be very intimidating. Passing Bill Rodgers or Frank Shorter was very hard when I was just starting, even though their careers were starting to wane and mine was taking off. But once I passed, it gave me newfound energy to ensure I beat them. The idea is to create a mental gap, not just a physical one. The GE-Exxon duel comes to mind. Perhaps sector duels also have this effect.

Watch for the "crash and burn effect" once the battle has clearly been won/lost.

Once the "gap" is created, often both competitors fall off their dueling pace. This itself can cause havoc as your cardiovascular system, which was in equilibrium, slows and lactic acid starts to pool. Slowing the pace due to increased wind drag can also causes havoc because your leg turnover slows, The way the blood returns to the heart is largely through leg motion. Pooling sets in as this motion slow. the Answer is to take smaller steps keep the turnover at a high pace. Unused capital and cash pools comes to mind.

This effect is usually greatest for the person passed, as they often give up. The leader has a newfound motive to try harder. This is especially true of a marathon. The worst thing, and surest way to miss your goal time, or finishing place is to look at the watch and calculate that you can coast in. Anyone who tries to let up a minute in pace will end up giving two or three minutes.

Older leadership wanting to coast in till retirement come to mind. Not all older leadership of course fits this. One example would be the first-generation business with the patriarch ailing but unwilling to cede control.

Drafting is best for longer races. In shorter races such as a mile, being second with a great draft leaves you vulnerable to being boxed in. The third placed guy will work with the first place guy to at least overtake you. In the market, perhaps this corresponds to too many close contenders, leave them battling among themselves.

Taller people fare worse in the wind, as the length of the winds leverage has increase, with your feet being the fulcrum. In the market, you can see volatility's effect on high beta stocks.

Finally, big packs cause a lot of elbows to be thrown and heels to be clipped. There are even shoving matches. Which is why our heavily favored team did not make it to Cross Country nationals, as punches were thrown at our second-best runner. Which brings to mind certain companies being investigated for their earnings and premium smoothing behavior: Unsportsmanlike conduct can shift everything.

Jim Lackey comments:

Drafting with motorcycles in the Grand Prix circuit has separate danger issues of their own. Craig raced and will discuss a street-bike-racer losing traction in front of you under high braking. Those boys run at over 180 mph.

In motocross drafting is very dangerous. The rear tire throws up rocks, clay, sand debris into your face. My first encounter, my cousin and I were training, racing 80cc motocross bikes when we were 11 years old. A rock came off my cousin rear tire and we were 5th gear pinned down the back strait away at over 60-mph. I remember this as clear as day-today, I tipped my head, like a tip of a cap. The rock took off the top of my helmet. A huge chunk of fiberglass was carved out, ruined a Bell Moto-III helmet.

Next, is racing in the mud. We must draft or run in single file due to ruts in the clay. There is usually 3 good lines or paths to race on the track in good conditions. In a mud race, either you run through massive puddles or you play follow the ruts, where everyone ran and you can achieve traction. On a jump, airborne you take you hand off the bars and tear off a lens off your goggles to see.

I remember getting hit so hard in my chest protector, a plastic gladiator type chest gear, the mud cakes hit me so hard it was a complete "knock the wind out of me" situation. Crashing falling flat on your back is the worst. You have the wind knocked out of you every time. You cant move, you feel like you are going to die, you cant breathe.

That is what scares the Hades out of guys racing and riding dirt bikes, crashing. That is the same as trading, fear of losses, money management, placing stop loss orders. However, anyone that has ever won a trophy loves to win. Sure we never like to lose, yet we are good sportsman. What we hate is not winning.

I am having flashbacks to racing pro class. trading the S&P futures is like racing any type of professional class. If you are not "on it" psyched, trained by a scientific tested program, and a bit lucky you have no shot what so ever at making the main event, the money round or being very profitable overall. Being a pro, paying for your races or making just enough to maintain the class is not a business, not winning, not profiting is losing.

Of course the top pros all went through these losing or not profitable times in their career. Certainly that is what separates the AA pros vs. the A pro riders is the fact the never gave up. The worked through their injuries and never took the easy way out, a salaried job for a brother in law.

I just saw an interview with a drummer in an alternative rock band. He tattooed himself from head to toe. They asked him about the art and why he chose the tattoos. I was about to drop the report when this caught my eye. The point of the tattoos was so that he could never be employable at a regular job. His idea was he was forced to either become a great rock and roll drummer or much worse, so when the chips were down his alternatives were worse than the alternative music scene.

I never really wondered why guys left Vic's trading and went on their own to do other things. I always just assumed these guys were smart and knew thy had connections and would be successful in life. I figured they just didn't have the passion for trading. The ones that left, and stated their own firms a direct copy of Vic's programs I guess were just pure hubris. They figured that sooner or later they were smart enough to figure out what Vic taught them on their own. I gather that as no real "thank yous" were offered and some offense was taken.

Then of course there is the old Mr-e experiment when he he calls Ivy boys stupid and they grenade in place. It is funny to me and a few of my friends. Our claim to fame is we have blown up more racing engines, relationships with women and cars (2 close loves) than we can count. In short we are wrong so often that it is quite simple to accept in our trading.

To draft a guy that knows how to profit off the markets is easier said than done. Dale Earnhardt died trying to help his team mate win the Daytona race years ago. he was just trying to help the poor bastard get his first big win, his team mate and would share in the profits.

I get the biggest kick when people tell me I would be broke if Vic didn't bail me out. There are many reasons I laugh. One, I have admitted that 57 times right here on the list. Second many kicked Vic when he was down in 97 and again in 2002 and I was right there. There is no one in the world happier than me to see Vic succeed. He deserves it for his life's work, that is profitable. especially after so many used him to market their own sham businesses.

Yet, the markets are one of the most competitive games in the world. I had a BMX buddy ask me the other day about trading Forex. I said oh no way. Forex, futures on the S&P options is like racing AA pro class. Nazz futures are the A pro ranks with big cap or S&P 100 stocks. Vet pro or expert class is Midcap and all other stocks. Small caps, penny stocks is the rookie class. I asked him what class do you want to race?

Craig comments:

Okay well I wouldn't consider myself an expert on this subject I have done my share of time at/on the racetrack with a superbike so at Lack's request will throw in my two cents.

Would seem to me that the major difference from the cars to the bikes is that a "bump" from another car coming off the draft into the turn or at any point won't put them on the ground, and one thing you try to avoid in motorcycle racing is the inevitable "road testing" of your leathers. All it takes for you to go down is for you to be focusing on the man in front of you too much and for him to go down, if you are watching someone go off the track at high speed then you better prepare for the fact that when you take your attention from him you will most likely be in the position of going down yourself, a great example of the old axiom, "you go where you look", the easiest solution to this is to never watch a falling rider which I would say is akin to "don't focus too much on the current price of the market, while you're in that trade", be aware but not fixated.

So drafting with bikes is certainly most common down the longer straights and often you see more of a dispersal going into the turns, this is where I go off on the tangent, bikes have a bit more room to adjust their lines through the turns so you will quickly see that most riders approach their line based on what they consider their strengths and weaknesses (sounds just like approaching a trade doesn't it?). A rider's line is basically his plan for going through a turn, for example, a rider that likes to use the maximum amount of lean angle typically designs his lines to use lean angle to his advantage so his line often is tight to the inside of the turn, while in contrast a rider who does not prefer to use all of the ground clearance available will likely have a line that limits his maximum lean time, so he will finish steering as soon as possible, straighten the bike and move from the turn as vertically as he can. So riders, much like traders will design their turns (trades) around the strong points they believe they have.

Now to watch the best of the best in MOTO GP is truly a beautiful thing, the current list of greats that are racing now would include, Valentino Rossi, Sete Gibernau, Loris Capirossi, Troy Bayliss just for a few that often battle up front. All speculators should indeed watch a GP race and consider the number of strategies involved to truly appreciate all that is happening since they do make it appear effortless and fluid. Rossi is the current master in my opinion, when he's not in the lead he's merely stalking the man in his way, examining their lines and braking habits while staying a foot or two off their rear tire, it does not take him long to recognize where the rider in front of him will begin braking and what their line through the turn will likely be and once he has that info , he simply waits for the proper time/turn to overtake them. If he knows where you begin braking in turn x, and he also knows that he go deeper in that turn before he needs to brake, then likely he'll late brake them and the next thing they see is his rear wheel, then it's a matter of can they keep up and do the same right back to him. This world is full of trading analogies, much as the everyday life of each speculator, one must simply open their eyes so that they may see.

Don Van comments:

Craig I agree with all your points and can add some that may apply to trading. I raced open wheel single seater formula cars until 1994.

It is certainly true any rubbing can be dangerous for bikes however it was equally dangerous with open wheel racers if not done with extreme care and with someone you could trust with your life. A wheel to wheel rub was OK but getting a wheel inside another usually led to disaster and end over end multi car crashes. I was involved in many mostly on starts and into turn one.

There are many subtle and specific techniques to drafting besides the obvious of the hole in the air advantage. It starts with knowing your competition and who you can work with to take max advantage. In each race I always knew who was my competition for the win usually 3-5 drivers in the field the rest were of no concern. In any race the idea is to eliminate as much as the competition as you can quickly. After a successful start and making it through turn one intact I always looked to see who I was running with, if it was someone as fast as me we would attempt to "hook up" and "work together" to separate from the rest of the front pack. Two or more drivers working together can go much faster then a group that is fighting it out under braking at each turn.

The best technique is to use the "leap frog" strategy which simply means on the longest straight you take turns passing each other to take advantage of the draft and never pass under braking which only slows you down. The end result if executed correctly is an insurmountable lead on the rest of the field that increases lap after lap leaving the race in the hands of only 2-3 drivers with a few laps to go. The ideal situation is to be left with only 2, you want to be the #2 car on the final lap, make your pass on the long straight utilizing the draft and come out of that last turn in the lead. Of course with about 3 laps to go the #1 car is thinking the same thing and trying to sucker you in to taking the lead. It is important on that final lap not to make the pass too soon and risk a re-pass into the final turn, best to drop back prior to the turn before the long straight so you can take the turn at max speed but not end up directly behind the lead car and be forced to take the pass too early on the straight. Experience, patience, confidence, discipline all become important in this final move. Many drivers will choke in this situation where one move is for all the marbles no second chances.

I have been in these situations many times as #1,2 or 3 and it is possible to win in any position but different techniques are used in each case much of it depends on the action-reaction of the other drivers, lots of feints, mind games, jockeying going on in that last lap. If in the #2 or #3 position observation of the driver ahead is also important, is he checking his mirrors, getting tired, sloppy, sliding the car, missing brake points, wide in the turns, missing down shifts these are all signs you may be able to pressure him into a mistake that he can't recover from, in racing all it takes is a few 10ths of a second advantage on the last lap to win without doing anything at all.

George Zachar comments:

Anecdotally, when Trump was solicited to propose a plan for New York harbor's governor's island, he reportedly said that the "first guy" investing in such a scheme "always goes broke. I want to be the second guy." In most other modern property ventures I am familiar with, first is best. In capital markets underwriting, where reverse engineering is rampant, it often pays to invest in distribution, letting the other guy pay for the research and development. MSFT shows that both quality and seniority can take second place to marketing/distribution. The value of "place in line" is likely in flux across industries and time.

Charles Pennington comments:

Oddly enough, not only does the car in second place benefit from "drafting" the car in front of him, but also the car in front benefits from the car behind. (I learned this from a big NASCAR fan. Apparently it's very well known among fans. Yet I don't have a simple picture of how the physics works. Here's a website that discusses this: "The lead car benefits from a drop in air resistance that comes when the slight vacuum at its rear wheels is filled.")

So by analogy maybe all the stocks in a leading sector will benefit.

Tom Marks comments:

The NASCAR drafting phenomenon might have applications for interpersonal relationships as well. If a young man is interested in marriage, his chances are probably improved if he starts dating a woman who just broke up with a long-term boyfriend, sort of a dating drafting phenomenon with the initial suitor breaking the nubile's coquettish resistance to commitment. Studies would probably bear this out. (The anecdotal evidence certainly does.)

This, of course, raises the possibility of strategic drafting wherein a guy purposely introduces a charming yet caddish friend to a desirable woman knowing full well that eventually the thing will blow up, whereupon the calculating swain then swoops in with more sensitivity than a Dr. Phil show and walks off with the prize.

The whole human mating ritual is just a cotillion with wolves.

Janice Dorn comments:

And did the second mouse get the cheese or not?

So there were these two flies, flyin' around above a lake. And the one fly says to the other fly, "Ya see that lake? I'm gonna drop down onto the surface of that lake." And the second fly asks, "Well why ya gonna do that?" And the first fly says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow pretty fierce and it's gonna blow us all around, and I'm gonna drop down onto the surface of the lake to get out of the wind." And the second fly says, "Well that's a good idea."

Well there were these two trout, swimmin' in the lake. And the one trout says to the other trout, "Ya see dem two flies? I'm gonna get me one-a-dem flies!" And the second trout says, "Well how ya gonna do that?" And the first trout says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water. And that's when I'm gonna swim on up and get me one-a-dem flies." And the second trout says, "Well that's a good idea."

Well there were these two bears, walkin' through the woods. And the one bear says to the other bear, "Ya see dem two trout? I'm gonna get me one-a-dem trout!" And the second bear says, "Well how ya gonna do that?" And the first bear says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies, and that's when I'm gonna reach in the water and grab me one-a-dem trout!" And the second bear says, "Well that's a good idea."

Well there were these two hunters, huntin' in the woods. And the one hunter says to the other hunter, "Ya seem dem two bears? I'm gonna bag me one-a-dem bears!" And the second hunter says, "Well how ya gonna do that?" And the first hunter says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout, and that's when I'm gonna lower my rifle and bag me one-a-dem bears!" And the second hunter says, "Well that's a good idea."

Well there were these two mice, scurryin' through the woods. And the one mouse says to the other mouse, "Ya seen dem two hunters? I'm gonna get me one-a-dem hunter's cheese sandwiches!" And the second mouse says, "Well how you gonna do that?" And the first mouse says, "Well ya see that storm? It's a brewin'. And when that storm hits, the wind's gonna blow and the flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout and the hunters are gonna lower their rifles to bag the bears and when they do they're gonna drop their cheese sandwiches, and that's when I'm gonna scurry on out and grab me one-a-dem cheese sandwiches!" And the second mouse says, "Well that's a good idea."

Well there were these two cats, stalkin' through the woods. And the one cat says to the other cat, "Ya see dem two mice? I'm gonna catch me one-a-dem mice!" And the second cat says, "Well how ya gonna do that?" And the first cat says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and the flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout and the hunters are gonna lower their rifles to bag the bears and when they do they're gonna drop their cheese sandwiches and the mice are gonna scurry out to grab the cheese sandwiches, and that's when I'm pounce and catch me one-a-dem mice!" And the second cat says, "Well that's a good idea."

Well you know that storm, that's been a-brewin'? It hit. And it hit BIG. And the wind blew and the flies dropped down onto the surface of the water and the trout swam up to get the flies and the bears reached into the water to grab the trout and the hunters lowered their rifles to bag the bears and they dropped their cheese sandwiches and the mice scurried out to get the cheese sandwiches and the cat jumped out to pounce on the mouse.

James Sogi comments:

Dr. Pennngton's NASCAR article refers to game theory. Chair mentioned game theory being an exception to foraging theory. A few other posts recently have referred to game theory.

Game Theory was invented by physicist John von Neumann. Von Neumann and Morgenstern wrote the Theory of Games and Economic Behavior. Game theory says that the true source of uncertainty lies in the intentions of others and represents a dramatic break from prior efforts such as Galton, Bernoulli and Laplace, to incorporate mathematics into decision making. Almost every decision is based on a series of negotiations, but unlike poker and chess, there is seldom a winner. Alan Blinder, former Fed Vice chair, wrote in a 1982 paper that the likely outcome between politicians and the Fed would be tight monetary policy and expansionary fiscal policy, similar to what we have now. It is the result of what is known as the Nash Equilibrium, named after John Nash where the outcome is less than optimal for each side, but stable. This a a typical result of mediation, where neither party feels that the result is favorable.

A controversial aspect of game theory applied to economics is that the participant can get the most winnings if he behaves rationally. The winnings can be increased if the other participants do not act rationally. An example of irrational behavior in an auction such as the stock market is the "winner's curse" where the buyers dog-pile in at the top of the market and over pay. See Bernstein, "Against the Gods."

Have any here pursued game theory applied to speculation? Seems like an interesting avenue to pursue. Perhaps some of you might have some good recommended reading on its applicability to the market.

What is Game Theory? by David K. Levine, Department of Economics,UCLA  

"Game Theory," by Fudenberg and Tirole, is the textbook on game theory.

Adi Schnytzer comments:

The best texts I've ever seen (and those recommending them are indeed experts) are Binmore's relatively modern text and the old but essential primer by Luce and Raiffa. Generalizations about game theory are very dangerous. It is a very complex field and thus far has proved more useful as a theoretical tool than a practical one, although U.S. intelligence did use it in WW2 to win some naval battles in the Pacific.

Mr. B comments:

I studied game theory last month. This was just out of curiosity. I didn't
intend to apply it to speculation. That's a good thing, because after
studying it, my feeling is that it is largely useless for everything
including speculation.

It is based on extremely strong assumptions on the rationality and
information of players. For instance, it is assumed that each player knows
everything about the game and about the other players, except their
decisions. Games are solved in one iteration, even those looking
deceptively sequential. That is, there is no "hard right edge". Also, games
are too simple to describe most real world situations.

Not surprisingly, when game theory is tested on real people, they often
don't behave as predicted by the theory. Moreover, game theory can't even
be used to advise on how people should behave, because many of its
solutions are sub-optimal or even lose/lose.

I fail to see what's the big deal about Nash equilibria, which are often
presented as the cornerstone of the theory. They suffer from the same
defects as the rest of the theory. I think Nash got everybody excited
because of his interesting personality, and of his first use of the fixed
point theorem.

This being said, I would still recommend learning game theory, because it
provides a new way to think about some situations. It fosters questions,
and as Vic keeps saying, it is most important to ask the right questions.

I can even think of some applications, limited to simple speculative games,
like two big players in an illiquid market. In this case, I don't expect to
make money with game theory only, but I expect game theory to help me
analyse the game. Let's say we are two players in an illiquid stock and we
want to get out. We can either use a market order or put a limit order. The
game payoffs are the respective slippages:

                 market           limit

market      -3,-3              -2,-4
limit           -4,-2               0,0

Even in this simple game, you need to have beliefs about the other player.
Is he totally random and as likely to chose both strategies? Or is he a
panicker and 90% likely to trade at market?
Game theory won't tell you what to do, but it fosters questions and the
realisation that you are trading your beliefs.

Adi Schnytzer responds:

With all due respect, maybe a month of study isn't quite enough to sort the field out! That said, I think your bottom line is right. The assumptions are extremely tough, although the recent literature does permit relaxation of the assumption that we know everything (ie the utility functions) of all the other players. In particular, there are games of incomplete information (eg insiders v outsiders) and those in which one player has doubts about the rationality of another (eg trembling hand games) and so on. Finally, there are multi-stage games which do not reduce automatically to one-shot affairs, but then it must be assumed that decisions made by players in the early stage(s) of the game can be made to stick in later stages.

In other words, you can renege on a contract, for instance. The greatness of Nash equilibrium lies elsewhere. In the standard theory of the firm or consumer, it is assumed that the firm or consumer can take decisions based on either full information vis a vis the environment or with some element of uncertainty. So the firms maximizes profit in the former case and expected profit in the latter. Game theory allows the theorist to take account of competitors explicitly rather than pretending they don't exist. And in a world of oligopolies that is critical. Of course it was Cournot who first used Nash equilibrium (in the C19!) when he analyzed duopoly and allowed one firm to take account somehow at least of the second firm's output decision. If I wish to model the behavior of a car manufacturer, I'm going to get closer to the truth with some form of Nash equilibrium than neoclassical optimization models.

Yishen Kuik comments:

I see game theory in action everyday whenever I walk by the Holland Tunnel entrance at 6th and Grand.

Cars on Grand want to go straight into the Tunnel.
Cars on 6th want to turn left into the Tunnel.

Fearing a long wait, each driver on 6th lines up bumper to bumper within the junction box when the lights are green, forming a curved wall 3 deep in cars. When the lights turn red, the wall of cars remains in the box, blocking access to the Tunnel by the now furious drivers coming from Grand, who retaliate by lining up bumper to bumper waiting to cut into the cars from 6th. The cars from Grand form another wall of cars sealing off 6th avenue, including those on the rightmost lanes who just want to get uptown.

Everyone loses and has a longer wait. If everyone simply stayed out of the junction box, there would be better flow on the roads, leading to higher utilization and lower wait times.

Seems like a textbook illustration of prisoners dilemma and the strategic benefits of cooperation.

Russel Sears comments:

Not that I know much about game theory, but I remember playing a board game called "Masterpiece". The rules were simple you each had so much money, and bet on paintings once you won the bid then you drew from shuffled but, uniform distribution stack of values (starting at $50,000, $100,000, $150,000 ... $1,000,000). The object was to end with the most total value.

First playing with my brother and then latter neighbors played this regularly summer of 5 grade. Not that I knew much about stats then, but at first I had a tremendous advantage as I found the average value was $525,000 and I even did a little crude Bayesian adjustment if I won the bid an saw the value.

Again I was at first playing one opponent. my brother. I had a tremendous counting edge. But soon my counting edge was gone. As he soon learned through trial and error and seeing my limits. And perhaps not with as much precision learned to adjust his bid if he drew a few great or rotten values in a row. We then even learned to read off each other adjustments how great or poor opponents value was.

When my neighbors joined us, however, I was startled how the game changed. It took me a while to figure it out, why I was losing. When my neighbors and my brother where not bidding "rationally" but winning more. With more competition, you had to take risk and get lucky. If you bid "rationally" you might end up with the highest total average "return" for your "investments" on all the combined games but you had fewer "wins". The math of standard dev. and optimization and game theory was well beyond my 5th grade mind. But the lessons were there. I was focusing on "the curse of the winning bid" they were focusing on the flip side, not often mentioned to investors, "no guts, no glory"

What's this have to do with investing. Two ideas.

Simple, there is a conflict between objectives of individual investors and investment managers. When the individual is playing against the sole competitor, the market. He does not care about "winning" individual hands or period. He wants the highest combined total. The investment manager however, wants bragging rights he wants to win business, they do window dressing, they take gambles like MS Strategy Lab as the game winds down, and they inflate risk to catch up if results are behind.

Further, I learned if one player was turning conservative, after winning a few bid he had a great return. and vice versa. If participants were still bidding high taking large risk they probably all had a mediocre hand. The competition amongst funds to "hit a home run" at every at bat. Fueled the volatility in the late 90's and even early 2000's . Once the focus turned to "long term results" the vols. died, and After 2003 more than the usual funds beating the S&P, and Dow, the lower Volatility in the market this year seems to follow. They (the managers) have more confidence in their hands. In short read their hands by the risk they are willing to take. Vice versa, the risk adjust to their confidence in their hands.


Seasonal Poetry from Jeff Sasmor

Spring blooms
I was whole
My cup runneth over
Cup now half empty
Alternative Minimum Tax

Quote of the Day, from Victor Niederhoffer

"An executive board of one hundred of the ablest men in the world could not possibly determine the direction which production should take without the index afforded by prices in the merchandise and stock markets. But through the stock market it is determined almost automatically, with as much nicety as anything can be determined which depends upon human judgment, where further production is needed. Upon that market is concentrated, in a sense, the judgment of every human being in the world having any interest in production either as consumer or producer -- not only of those who deal in stocks and securities, but those also who are directly concerned in the industries and interests which these securities represent. That delicate register of values, that sensitive governor of production, that accurate barometer of the people's needs, could not be replaced by any process that any State socialist has devised or suggested." Wall Street and the Country, by Charles Conant, 1904.

Thus, 40 years before Mises and 20 years before Hayek, the author makes the case for the impossibility of socialist calculation without a price system.

Prof. Ross Miller Resumes Regular Commentary

Visit his site to find out why he's 80% certain that oil has topped. (Hint: Goldman's Super Spike call was on the last day of the quarter -- isn't that convenient?)

Alliteration Alert, from a Southern Gentleman

"It is possible that there is useful information in word usage in communications. For example, increased frequency of terms like "higher oil" could indicate excessive fear and imminent reversal of oil price."

I hate to bring up "bad pennies," but I will remind everyone LOUDLY that whenever alliteration is used in descriptions, run, run for cover! I can't believe I didn't catch it sooner, but timed so perfectly with Goldman's $105a-barrel oil, the alliterative words SUPER SPIKE came out and oil has been movin' down since. Some might remember from days gone by the Patents for Profit guy on this list. Those words that did me in, along with with Enron: "Powerful Power Producer." Ugh, I am going to start countin' alliteration and its deviant ways.

Review by Alex Castaldo

The Stock Market's Reaction to Unemployment News, by J.H. Boyd, J. Hu and R. Jagannathan, Journal of Finance, April 2005, p 649.

Fear in the Stock Market, from Mark Mahorney

I'm prone to generalizations. That always offends some people. So be it. Taleb's worst case scenario, Buffett's sharecroppers, peak oil theorists, permabears, market cons, deficit watchers, long wavers, and extreme gold bugs all have one thing in common. They all profit when bad things happen, expect it, and too often want it. They scare people out of their money.

Over the past century U.S. equities have continuously become LESS risky. Read old books on the markets and it will be incredibly obvious how much safer the markets have become.

Letter to the Wall Street Journal Editor

Dear Editor:

Thanks for exposing the deceitfulness of those seeking to protect U.S. textile producers from foreign competition ( "Textile Disruption," April 11). Of course, like all protectionists they incessantly yell jobs, jobs, jobs! as if the goal of economic activity is to make work.

This jobs mantra reminds me of the Chinese official who showed a visiting American economist a dam being built by workers using shovels. Why not use bulldozers? the economist asked. You d build the dam faster and with far fewer workers. Oh, but think of the unemployment that would cause, the official answered. I m sorry, I misunderstood you, replied the economist. I thought your goal is to build a dam; I didn't realize that you're showing me a make-work project. In this case, then, you should ditch the shovels and instead use spoons.

Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

Bubbles, by Mark Mahorney

People chase high returns wherever they are. Always have, always will. Sometimes this leads to bubbles, sudden decline in interest and price collapse. But really, though no one ever sees it this way, bubbles can be formed on the short or long side and a short squeeze could be viewed as the bursting of a short bubble. Excessive demand for shorting followed by a sudden shift in expectations for the underlying security or contract, or in the expectation of how other speculators will perceive the value of the underlying security, the latter often having more to do with price in the short run where excessive speculation occurs, and supply and demand dictating the long run.

I believe that the growth in interest in the commodities and futures markets is due to both the uncertainty in equities and the growth in the gambling market. I believe that the interest in online gaming is spilling over into the markets as another alternative or substitute for gambling. That gaming is creating a new breed of speculator, making these markets a very dangerous place for amateur investors and really everyone. These markets are acting just like stocks were in the mid to late 90s when I was one of those crazed stock gamblers.

But there will always be speculators seeking out the wildest volatility. Hence the interest in buying the stocks of Chinese communist government owned utilities and manufacturers. I would include the gold bugs in this category of speculators, but for different reasons. They are not a very rational bunch and not quick to run scared even in the face of a sudden interest in the dollar (several major financial institutions have shifted to a bullish stance on the dollar in the past week or so), because they believe so resolutely in their 'end of civilization' scenario.

Buffett seems to be in this camp with his comments in his annual report about Americans soon becoming share croppers to the rest of the world and shorting the dollar to the tune of $22 billion.

 Read the whole post

Dick Sears: Weekly Commentary

An update on the Gilder Technology Index

Eliot Genuflects Before the Owner of The Buffalo News

Jim Sogi Extends the Discussion on Foraging Theory

Foraging Theory and Optimal Investment Decision

Following up on Chair's fascinating insights and reference to Houston and McNamara, Model of Adaptive Behavior we find that foraging theory seeks to model the optimum strategy for the organism to maximize its reproductive value (V). The theory is based on the organism's 'state'. A strategy is a decision making framework which under foraging theory is based on the state of the organism. The approach differs from the cost benefit analysis in that it does not focus solely on consequences of a decision, but assumes that a decision is based on the state of an organism. The organism's state (x) can be its size. A big fish is less likely to be killed by a predator than small fish, but its energy expenditure will be greater to make the kill and that will affect its decisions and behavior. other states might be its energy reserves or age. States can change with time (t). There is interaction between the organism's actions which affects its state and affects its V and probability for survival. The model also accounts for a random variables and in the dynamic programming model introduces probability factors.

Optimal Decisions

The formula seeks to determine the optimal choice of action at time (t) by H(x;t;u) where(u) is the action taken. Thus the optimal action (u) is defined by the one with the highest (H) value. Danger of predation affects foraging behavior. When an animal eats it gains energy that enhance future reproduction, but in looking for food, it may be killed by a predator and not reproduce. The optimization formula solves the animal's best choice to succeed. There is the obvious trade off between energy and time. This is the efficiency and lost opportunity analysis. Say the rate of foraging is y, the optimal H will be when the energy used (e) begets the greatest energy gain (h) such that e/h > y.

Optimal Investment Decisions

This decision making model can be applied to investing. Forgive the mathematical challenges and allow me a qualitative approach. A curious by product of McNamara's model is the optimization or curve fitting problem that also plagues market back testers. An animal arrives at an optimum strategy that works in a given environment but when the environment changes through either random or causal effects, the animal's optimum strategy is no longer effective and it dies off unless it can change its strategy.

A typical losing investment strategy in the seminars is to look at the risk/reward ratio as the criteria to make a trade and set a stop loss and target. This is the cost benefit analysis. Foraging theory suggests a better approach. A risk reward approach has little room other than a subjective setting of a mechanical target and fixed stop loss subject to random factors that may or may not be appropriate for the investment climate or that investor at the time of the investment decision. Foraging theory looks to the state of the market and or investor, the efficiency of the trade and the probability of success as the optimal decision making formula.

The goal (H) will be the portfolio annual rate of return, as that is the purpose of speculation. The (h) will be the amount of profit (energy gain) per trade and t will be time in the market. The authors use dynamic programming which introduces a probability factor p, which we will call the speculators' expected probability of success on a statistical basis. The statistical analysis gives us a prospective expectation which might be (h) or equivalent to energy gain expected. The state might be the speculators portfolio size, return expectation, or things such as return needed for college or retirement.

Foraging analysis would then look to determine whether or not to take a trade and the amount to risk based on the probability of success, the expected return, the size of the portfolio, and the need of the speculator to make a certain return. Added factors would be the length of time to stay in the trade, and the optimum time of exit for profit and risk, ie trade efficiency. Is the position sitting there doing nothing when other opportunities are lost. Is the position making bank at a good rate with high efficiency? Is the probability high to justify pressing? To determine the optimal exit, has the position reached its probable expectation of profit? Has the environment changed that no longer gives a probable expectation of continued success? Has the foraging cleaned out the easy food in the area reducing efficiency? ( As in a huge up bar). Has the fund achieved its target rate of return and might the added risks of continued foraging not be justified by further risks. (The end of the quarter conundrum) Like this March when the end of the quarter oddly ended near the low, and the profits followed in the next quarter to the chagrin of the managers reporting quarterly.

The benefits of foraging theory as applied by intelligent speculators allows changing strategies that take into consideration current states to avoid extinction in changing environments suffered by fixed system back testing slow moving foragers. Many thanks to the Chair for such innovative and creative insights to the market.

You Can Beta the Ranch on This One, by Tim Hesselsweet

"In equities this would mean something along the lines of shorting a low beta stock and buying a high beta stock when you think the high beta stock is about to make a move up (could also be vice versa)." Kendrick Brown

Here's a fun experiment for the next time you visit a college campus: find a group of PhD students and suggest x is going up because of y, then watch as they scurry to isolate exposure to y. A corollary to KB's idea above would be to use the relationship between high and low beta to identify periods when you expect the high beta will outperform, then buy the high beta and don't worry about reducing your expected profit as well as doubling your transaction costs by shorting the low beta security.

Briefly Speaking, by Victor Niederhoffer

1. It seems that 99% of the professionals in the investment business have forgotten that higher prices lead to lower demand in the short term, and a increasing quantity supplied at each price in the long term .This is covered in most courses on microeconomics (my favorite book on the subject being Heyne's "The Economic Way of Thinking") except those taught by the communitarians at the Massachusetts-based schools. Failure to understand this phenomenon and the related idea that incentives matter has been the chief source of long-term loss that I've seem in speculation in markets. Most recently I saw massive same in the grains, and I expect to see it in the oils and commodity-based funds.

2. The autobiography of Mark Twain has some nice comparisons of prices expressed in dollars per pound and bushel in 1840 and 1900 for commodities in Missouri and Connecticut, and they support our previous calculations based on CRB date, and case studies based on street life in London that stocks have gone up in all relevant periods since the industrial revolution by about 100 times per century as much as commodities. What a opportunity for speculation that those investing in hot commodities disagree with these conclusions and don't read such books.

3 A certain famous former money manager from Fidelity has always struck me as one of those ignoramuses proud of the fact that he's never read a book and was raised in the school of hard knocks with insights about equal to those of the Beardstown Ladies. Recently in Fortune he stated he's made a fortune by buying companies when they move from crappy to less crappy. It has that ring of brawling, foul-speaking, Red-Soxian semidrunken in-your-faceness so typical of his pronouncements -- but the query, "Uh, have you tested that?" would seem apropos and the answers might be interesting.

4. A beautiful article in Fortune reveals the inside working of the 7 a.m. Saturday meetings at Wal-Mart's Bentonville headquarters, and their related Thursday and Friday meetings and merchandising meetings, and the 15-minute change-of-shift meetings at each of the company's stores. In this manner, information from all regions flows up to headquarters about what's selling and what displays are working and what the customers are doing, and often within 10 minutes they have fine-tuned their marketing from catfish to poker chip throughout the operation. There's no doubt that their motto, "The Customer Is King," has been very much responsible for their success and almost every other great retailer's success. The question of how to run a good meeting, and what feedback connections are ideal for same throughout an operation seems a very apt one for all entities.

Variations on the 10 Plagues, by the Chairman

1. According to Exodus 7-11, the Lord released 10 plagues on the Egyptians to induce them to release the Jewish people from slavery: blood, frogs, gnats, flies, cattle disease, boils, hail, locusts, darkness and the slaying of firstborn sons. As alluded to in a letter to Vic, I bought some Pfizer in November 2004, and the deluge of bad news, disasters, calamities, collapses and disappointments visited upon that company brings to mind the 10 plagues that Jewish people get to reenact, sometimes with "experiential dramatic elements," in their Passover Services.

2. Here are some of the plagues visited upon Henry "Hank" A. McKinnell, Jr., PhD, chairman and CEO of Pfizer, and other stockholders such as myself since I bought it. On April 8, it was announced that Moody's is considering lowering Pfizer's perfect credit rating on long-term debt. On April 7, the FDA asked Pfizer to recall Bextra, a $1 billion painkiller. On April 6, Pfizer announced that its GAAP earnings in 2005 were going to be about half those of 2004, while sales would be flat. The company called 2005 "a transition year." Before that, a hailstorm of tort actions and invitations to class-action suits related to Celebrex...studies showing the painkiller increased heart-attack risk...third-party copayer studies showing members who didn't use Celebrex were healthier than those who used it...brilliant arguments by the lawyers challenging Pfizer's Lipitor patent that left the outcome too close to call...a call for the drug's withdrawal issued by the Citizens Public Interest Group, and the news that they had been successful in 9 of 11 previous such actions...calls and hearings by Congress to reduce Medicare costs by bulk purchasing a la the Canadians...the coming patent expirations in the next four years on drugs generating 40% of sales...the indicia of darkness by the announcement that Pfizer's sales force has in general five sales reps calling on each doctor with exactly the same product but will reduce that to three. Why, never since my foray into the Thai stock market have I been visited by such darkness.

3. Yes, but with all these disasters, isn't Pfizer a good buy? I found 200,000 references to disaster NYSE including a disaster of the day on Google. To bring it down to manageable size, Mr. Dude from this office and I studied the performance of all companies that received Wells notice since the end of 2002. Recall that a Wells notice is a formality to notify the company that the staff is considering a recommendation for a civil action alleging violations of laws. There were 37 such companies on this distressed list, and they included Imclone, Gateway and AIG. The results: too late the phalarope in the game for profit. The returns are -0.06% in the next year with a 95% confidence interval going up to + and - 8%.

4. News comes down the pike that Robert Olstein, formerly of the Quality of Earnings Report, is a master at making money from stocks that have collapsed. His Financial Alert fund has shown some superior performance since its inception a few years ago. Olstein's theories seem sound as a nut, and there are many anecdotes reported in a the Bloomberg story on him that leads one to believe that his knowledge of accounting gimmicks and strengths is far superior to mine. His year-end 2004 holding include such well-known stocks plagued by troubles or graced with virtues surrounded in darkness such as Tyco, Interpublic, Del Monte Foods, American Greetings, Payless ShoeSource, Williams, Gray Television, Tommy Hilfiger, Hasbro and Tupperware.

But apparently it's not surefire. The Professor reports that in each of the last three years, the performance of his fund has not beaten the equally weighted S&P, albeit this is a rather stiff hurdle. (To be continued)

[Note from the WebMeistress: The Chair owns none of the securities mentioned above, including Pfizer.]

Sandpipers, by Mark Mahorney

When a predator approaches the ground nest of a sandpiper, the shorebird will feign injury, acting convincingly as if it has broken its wing while luring the predator away from the well-camouflaged nest. I have seen them do this. Anyone not knowing the truth of its deception would surely be fooled. However, if you know the charade then you know there must be a nest nearby.

Did the peccant insurance company's attorneys get in before the subpoenas and comb through documents, only to present a single binder on a strange but not necessarily problematic transaction involving two offshore entities, to lure investigators away from more serious problems in the home offices?

With Apologies to Gary Snyder, by Tom Ryan

to love

love hard, playing, fighting
rough and rowdy love rassling
she bestows, she betrays

kissing pounding laughing

up between old growth dow
twin ipos rise and flutter

the old food
the new food

all tangled in a flood of blinking lights

deluge starts daily at 8

Forensic Trading, by Jim Sogi

The Usual Suspects

"To be a forensic scientist requires the appropriate integration of basic human emotions with basic rational enterprise, what the ancient Greeks called "reason". Their term did not carry the unfortunate contemporary connotation of mere mechanical calculation. Forensic science, as science, demands cognitive skills, but more, it demands reason in the ancient Greek sense -- it demands of us a rational soul, with emotive and cognitive elements operating in harmony." Forensic Science, James and Nordby. Many top speculators such as our own Senator have a group of usual suspects to follow for regular market leads. How can these elusive profits be captured? It takes a lot of footwork, sturdy boots and long hours.

Signature or profile

Forensic scientists seek a criminal's signature or profile, which are the unusual and distinguishing features of evidence or identification of certain characteristics belonging to a certain criminal. The market has its usual suspects with characteristic signatures. When they show up with their characteristic signatures, the alert speculator lays a trap hoping to capture some profits from the unsuspecting suspects.


Many crime investigations fail to adequately study the victim. A good speculator will investigate market victims carefully. A good example of this in the market is the study of victims of failed trades on breakout/reversals. See for example the 20-day reversals or other breakout failures. Doc rock also has certain market victims under investigation. Investigate victims of failing momentum. See the failed range breakouts this past year or even this last Friday and Monday and Tuesdays failures. Who are the victims of these losing trades? How can the perpetrators of this be investigated and captured? What are their habits? Who are the predators stalking them? When will the market's modus operandi change and victimize the faders?

There is a suspicious circumstance under investigation. Where were you on the night of March 15-16 between 1201 and 1199. (June mini SP) Anyone with information leading to the arrest and conviction of the those responsible for this will receive valuable recognition. Will the perp return to the scene? What are his tendencies. Has he returned in the past. How soon? Will he linger or go further. To make things difficult, my investigation of the case files show that there has never been a gap down over 4 pts unfilled for over 16 days since 1994 in SP big. Very unusual and mysterious. Add to the mystery the solar penumbra, the round numba penumbra and the dead Pope and you get the Mystery of the Papal Penumbra.

Losing money in the markets is a crime. Let's do our best to fight losses and take out our magnifying glasses and examine the evidence carefully.

Letter to the Editor, from Don Boudreaux

Believing the Yuan to be undervalued, Congress is threatening to raise tariffs unless the Chinese government takes action (Congress Again Says It May Act to Counter China s Yuan Policy, April 8). Sounds like straight talk from no-nonsense public servants. It isn't.

If Charles Schumer and other Congressional protectionists spoke plainly, they would say: By buying dollars with Yuan, the Chinese government taxes its citizens to subsidize Americans consumption. This policy is wrong, not so much because it hurts the Chinese people but because it upsets certain American producers whose support is crucial to our plans for re-election. If Beijing doesn't raise the Yuan s value, we'll reciprocate by hurting our citizens with higher tariffs. And as long as Beijing keeps putting the screws to ordinary Chinese, we in Washington solemnly promise to put the screws to ordinary Americans.

Sincerely, Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

From the Dan Neil Piece That Got GM to Pull Its Ads from the LA Times, from George Zachar:

GM is a morass of a business case...The company's multiplicity of divisions and models is turning into a circular firing squad. How can four nearly identical minivans — one each for Pontiac, Buick, Chevrolet and Saturn — be anything but a waste of resources? Ditto the Four Horsemen of Suburbia, the Buick Rainier, Chevrolet TrailBlazer, GMC Envoy and Saab 9-7X. How does the Pontiac Montana minivan square with Pontiac as the "Excitement" division? Why, exactly, is GMC on this Earth?
For a company so utterly devoted to each of its 11 brands — counting offshore badges such as Opel, Holden, Vauxhall — the overarching strategy seems to be to flatten the distinctiveness out of all of them in the name of global efficiencies. Take Saab, poor Saab. The new 9-3s will be built in Russelsheim, Germany, alongside Opel Vectras. The 9-2X is a badge-engineered Subaru WRX. The 9-7X is a Chevy Trailblazer built in the Nordic enclave of Moraine, Ohio.

The Elephants Return, from Steve Wisdom

For more on Lobagolas, click here.

Google Hits, from Yishen Kuik

The message seems to be consistent ...

"the dollar will weaken" 2050
"the dollar will strengthen" 598
"the dollar should weaken" 184
"the dollar should strengthen" 115

"the euro will weaken" 143
"the euro will strengthen" 403
"the euro should weaken" 22
"the euro should strengthen" 39

"the yen will weaken" 205
"the yen will strengthen" 229
"the yen should weaken" 49
"the yen should strengthen" 32

"gold will weaken" 13
"gold will strengthen" 29
"gold should weaken" 10
"gold should strengthen" 12

HPQ Haiku, by George Zachar


Rock star CEOs
have no shame. Welch to HP:
Give Carly more time?

She destroyed HP.
So why is Carly's last fan
famed Neutron Jack Welch?

Tis hard to fathom
What binds tarnished CEOs.
Both crave jets and jewels?

Marriage number three.
Huge compensation scandal.
His book's called "Winning"?

Deception, as Practiced by Howard Hughes, by Yishen Kuik

Prompted by the Scorsese film, I picked up Barlett & Steele's biography of Howard Hughes. I choose this book because it seemed well researched and the two authors are Pulitzer Prize winners.

The book covers many topics, but I thought I'd point out one as pertinent to the list.

Barlett and Steele have done a great job in documenting Howard Hughes's use of deception in business:

There are many more examples of Howard Hughes's tactical business maneuvers in the book, which I would recommend.

Life as a Short, Life as a Long, by Nigel Davies

Being long or short stock indices summons up quite different emotions. When I'm short I can't escape the feeling that sooner or later I'm done for, and it reminds me of the inevitability of death. Being long, on the other hand is life affirming, the gradual rise in stocks over the years being a testimony to civilization and our part in it. Sooner or later you feel you're on the winning side (leverage questions temporarily aside!).

Do other members have similar feelings? And can peoples bullish or bearishness be traced to aspects of their personality, the justification for how they 'feel' being created thereafter.

Robert Mahan replies:

I started out as a bear. Then again I started out in the late 90's and believed that the so called "irrational exuberance" was really irrational exuberance.

I'm a cynical person by nature. I don't believe in G-d, believe that Capitalism is not only not ideal but in fact the worst of all possible economic schemes ever invented by man with the exception of all the other ones, believe that Western Civilization will probably decline from its current peak, and that life is more or less meaningless and that luck plays a much bigger role in it than most on this forum would confess.

Yet I'm 100% long stocks, particularly high-risk tech stocks. Why? Call it a hedge. If I make money I win; if I lose my fortune - I get to play the justified cynic. Call it win-win if you want. Or maybe I just believe in the future of a word I'm not a great big fan of. So call it a hedge. Call it Pascal's wager.

Another Spec comments:

Perhaps it is a matter of personal preference. My preference is that if I ever wake up one day feeling as if being net long is a "testament to civilization and my part in it," then the first thing I will do is liquidate every long position I own. But I know that will never happen. I wake up early, but I am not a morning person.

Janice Dorn counsels:

I respect every person's feelings, as they represent the truth of that individual. However, if being long or short a position impacts significantly on the quality and philosophy of one's life, it may be appropriate to re-evaluate the reason/s one chooses to trade the markets.

Department of Misconceptions

A reader wrote me today saying that interest rates are artificially low, and that as they adjust, P/E's can only fall.

If I had a buck for every time someone wrote to me that the reason that stocks are too high is that interest rates are about to rise drastically, I'd be a wealthy man. The main problem with this is that it doesn't take into account that long-term rates are an average of expected future rates.

The second major problem with it is that no field in the world has more experts and more arbitrage in it, and the chances that the layman can at the margin have superior insights as to the future direction than the current levels implied in the term structure is like being able to shoot a basket from the opposite foul line.

A related fallacy, one similar to the idea that the dollar is in a swoon, is that interest rates are in the midst of a relentless rise. Indeed, they're near a 20-day low, and long-term rates are comfortably below where they were at the beginning of year. -- Victor Niederhoffer

Bar Charts on Steroids, by Jim Sogi

The adoption of Arabic numerals in the over Roman numerals at the start of the first millennium enabled rapid advances in mathematical theory and the ability to do computations such as addition, multiplication and long division numerically rather than the computation using pebbles. In fact the word calculate derives from calculus, the Latin word for pebble which had been the only way to compute. Basically it was finger counting. The distinguishing feature of the Arabic system (in addition to the "0") was the spacial place holding representations of the numerals to the left of the decimal which allows understanding of the phrase,"I made 7 figures" .

We take this so for granted now, but this concept can be extended. For example, the stem and leaf plot shows numbers, but nothing more than their arrangement conveys added dimensions of information on the statistical distribution. With color monitors the use of color give added information to words and bars that was impossible with pen and black ink or monochrome monitors. The simple price bar can convey more information with the use of color to represent an up bar or down bar, or shades of color to represent volume or statistical deviation or other information. See Tuft.

The bar or point and figure chart can be even further amplified by not only using color but by putting data in the bar levels together with color, and can show useful information at a glance by virtue of their arrangement. Rather than use just x's and 0's in a point and figure chart, complex data can be scripted into the chart. Most packages use color on the quote boards for up and down and change to show at a glance in an analog manner the state of the market without having to do the mental computations necessary with digital information, but why not arrange the numbers on the screen to convey information? What does it take to get an edge at the start of the second millennium? Same then as now--you just need to run a little faster than the next guy.

Click Fraud, from Art Cooper

In view of the Chair's admiration for the art of the con, he may be interested in this WSJ article, which describes 'Click Fraud,' the practice of driving up a rival's internet advertising costs by clicking on his web ads with no intention of doing bona fide business.

See our Buyback Study Update


Q: Dear Vic,

I have had a series of misadventures in buying common stocks over a lifetime that is almost too sad and disastrous to think about, let alone write about., but you seem to be an accepting and sapient sort, so maybe you can help me.

In a nutshell, I've lost more money in more ways in stocks than seems conceivable. Let's start eight years ago, when I gave up on U.S. equities (something that has happened about 10 times in my life, each time after disastrous losses). A friend told me that he had made 100-fold by buying a Thai construction company, and then I read that the emerging tigers were bigger and growing five times as fast as Europe and I knew that an Arab sheik had just made a fortune by buying Citibank when it went to 8 on the theory that big banks always turn around -- they have to. So I bought Krung Thai Bank at 50 after it had dropped from 200.You see, not only did it have the "guaranteed to turn around" good thing, but the Thai government itself owned 90% of it. So it was doubly -- nay, quadruply -- less likely to continue to swoon.

Oh my gosh. I got forced to sell out at 5 and that precipitated a contagious string of events that brought me to the knees if not the belly up.

Next thing after giving up, I gave my money to a biotech genius who had turned 50 cents into a million dollars. He turned a few million into about $50,000 for me in such stocks as  gene company whose main product was a cure for lupus that led to exactly the same proportion of deaths and recurrences as the disease itself. Finally, a friend asked me what evidence I had that he had actually turned 50 cents into a million since he had to borrow money from me to fly from Florida to Michigan to attend a biotech conference.

We laughed a little about this and I turned my stocks over to a great expert, a man who combined his stolidity as a great weight-lifter and engineer with a dash of imaginative futurism that only the scientific young could possess. His specialty was the tech stocks, especially the tried and true like Sun and Lucent and Cisco that were paying dividends and once had been as high as Krung Thai and were sure to bounce. I lost about 80% on 7 figures before the master mind pulled the plug and went to another firm to trade futures with the techniques I taught him instead of individual stocks.

Before that, there had been an interlude where a physicist in my employ used specially designed electromicroscopy techniques to buy stocks that had runs of longest losing days among peers -- a system which, tested over 20 years, had not only worked every year, but had turned a dollar into $10,000. On paper. The only problem was that when we tried it in actuality, it turned my seven figures into five.

After a series of misadventures with such things as stocks recommended by friends who had Russian portals valued at 1/100 the comparable Yahoos and Googles in the US, ready to be underwritten at 20 times my purchase price, all of which went down by 95% in the year after I bought them, I went back in myself. I worked out a system of buying biotechs applying for new drugs when the insiders were buying . It couldn't lose, because the insiders knew exactly what was going on with the regulatory  process, and no way would they buy if they didn't know that the FDA was going to grant them approval for a blockbuster. On paper, this system made 75%-100% a year. Unfortunately, when we tried it, it lost 50% a year before we threw in the towel.

Next, I figured I would buy distressed things that had spillover declines from unrelated disaster stories in companies that really did have problems. Sort of like buying Allstate when AIG has trouble. But I chose to buy Pfizer when Merck announced that it was pulling Vioxx.. I bought Pfizer at 30, down from 35 a few days before and 50 the year before. Not only did I know that Pfizer's product Celebrex had nothing in common with Vioxx, but I also as a statistician could tell that the excess heart diseases that the Cox 2's apparently caused were mere statistical artifacts caused by faulty adjustments for multiple comparisons, and that these drugs had many benefits infinitely greater than the 1 or 2 percentage point-a-year extra heart attack risk that the data-mined, propagandistic studies falsely pointed to.

Well, it was like a deluge. I got visited with every affliction of the Big Pharma industry. First another study was dusted off that implicated Celebrex, next I had to face declining government and insurer payments for products, next patents that were expiring, next a challenge to its main product that the experts all said was about 50-50 to succeed, next a study by a co-payer that said they shouldn't have to pay for the product because it didn't work in their group, then television programs every minute urging viewers to join the class action suit for redress, next news that the product under question had less than half the prescriptions written for it than previously.

Finally, when they announced that their sales and earnings were going to be down drastically this year but that they were going to spend $5 billion to save $8 billion over the next four years, and that they were going to reduce the number of sales reps calling on doctors with exactly the same product to three, I threw up my hands and took a 10% loss, on the one day it seemed to have risen since I bought it six months ago.

Well, Vic, I could go on. but I think you get the drift. The rest of the story is too sad to tell. What in the name of Joe should I do? I feel like Willie Sutton, that ardent Dodgers fan, who shortly after escaping from prison was listening to the 1951 playoff game with the Giants. And when he heard, "I don't believe it! I don't believe it! I don't believe it! The Giants win the pennant! The Giants win the pennant! The Giants win the pennant!" about Bobby Thomson's homer, he just wanted to go right over to police headquarters and turn himself in.

Please tell me what to do.

-- Vic

A: Go down to police headquarters without wasting any time and turn yourself in! -- Daily Speculations

A: Go surfing. -- Jim Sogi

A: He should turn his screen upside down. -- "Bruno"

A: I've tried turning the screen upside down - it doesn't work. -- Philip J. McDonnell

A: Confess all to your dog. Then take him out for a run or walk. The stress release of the exercise will clear your head of yesterdays wounds. Sharing the joy of running with a dog will teach you to live for the moment. And with increased blood flow to the brain you might get some creative ideas for tomorrows battles.-- Russell Sears

A: Tell your "friend" there is always hope. Story in Traders monthly magazine about Chinese trader who lost money consistently for 20 years and now gets $180,000 for 1 DAY seminar on his methods because he allegedly is up last couple of years. Your friend could make pretty decent living off seminars and wouldn't even have to trade. -- Thomas Miller

The Grandmaster on Learning from the Greeks

A much recommended method of improving your chess is to find a 'hero', a player whose style/ personality /achievements most appeals to you, and then model your own play on his. I think this makes some sense, though I'm not sure it should be applied too mechanically. I believe that players only reach their peak when they discover their own unique voice.

I've never consciously looked for a model, but in chess I discovered Lasker early on and still gain insights from his games and thinking. I also discovered Botvinnik quite early and then Leonid Stein, though I have to say that I also studied the games collections of Larsen, Keres, Tal, Rubinstein, Capablanca, Tartakover, Alekhine, Spassky, Petrosian, Fischer, Kasparov and others. I also learned much from John Littlewood during my teenage years, later on from my friend Lev Psakhis and gained insights applicable to chess from many other people who are expert in unrelated spheres.

Whilst I am deeply grateful to them all I also know that you have to do it your own way. You can't learn from your own mistakes if all you do is play other peoples' moves.

P/E Ratios and the Scientific Method, by Kevin Bryant

I recently read The Education of a Speculator which I thoroughly enjoyed and am halfway through Practical Speculation which I find equally engrossing. More than any conclusions drawn therein, I have profited (figuratively at the moment!) from the germs of ideas that have me thinking about the essence of things in the markets.

I am a relatively recent, full-time investor/trader/speculator (the label means little to me except when asked among "respectable" company) after twenty years in a traditional commercial banking environment. With this in mind, I write with some trepidation: how does my two years of active investment experience give me a basis for questioning any of your well researched and tested findings? Nevertheless, your own skepticism about the conclusions of experts I take as an invitation to challenge some of your views.

In your second book you state that P/E ratios have little predictive value. While I won't quibble with your data, is it possible that your analysis is too narrow in scope and therefore inconclusive in itself. You highlight the problems with sample size which I heartily accept. However, what may be your own personal bias gets in the way of offering the converse case. While the sample size may not allow one to draw definitive conclusions about a correlation to returns, it is no less supportive of findings suggesting that there is no correlation. There may indeed be a correlation but we may not know for another couple of centuries. The comparability of the data is no less problematic, an issue you touch on, particularly when going back twenty or thirty years.

I believe (as I practice) that none of these indicators are particularly bankable in isolation. It seems only common sense (at the risk of falling into the "plain folks" trap) that one must consider an array of indicators, factors, questions of which P/E ratios are one, albeit a particularly useful one in my opinion. It would be more useful to construct a test combining at least two or three factors, e.g., P/E's with real interest rates and dividend yields, or with the inflation rate and oil prices, or with the prior five years earnings growth, etc. Unfortunately, not being so much of the "counting" bent I am not able to offer any of my own data here.

At the risk of sounding pedantic, a high P/E multiple (higher than the historical mean) is suggestive of two things, either future earnings will rise more quickly than the relative rise in prices or future prices will fall more quickly than relative declines in earnings. Given the caution you emphasize with respect to the reliability of earnings calculations, I am not concerned with relatively small dispersions from the mean but am especially interested in significant dispersions - where I believe we are currently. I also make the "leap" in this case that multiples are significantly higher than they appear for a couple of reasons.

Short term stock prices have taken on an importance over the last twenty to thirty years that has fueled increased creativity around financial reporting. What happened at the financial institution I was employed by was a phenomena at work throughout industry, an attempt to "align management and employees with shareholders". You refer to this interesting notion of "memes". This alignment meme has created today's inordinate focus on quarterly results and short term share prices and, even with regulators' and lawmakers' efforts to the contrary, the elaborate efforts at financial engineering and earnings management. Admittedly, I have no statistical backing for this conclusion, it is purely based on my own experience in pouring through financial statements over the last twenty years and on supplementary reading and discourse.

Secondly, and more quantifiable is the altered mix of the S&P 500 over the last decade which now has a much greater reliance on financial activities. Roughly one quarter of S&P earnings are derived from financial companies, indicative of another issue or problem depending upon your point of view. Stripping those companies out of the index takes multiples closer to 30x.

Putting my present leanings to the side, the main point is, high P/E's should, importantly, cause one to ask the question "why". From there one may come to the conclusion that the environment for earnings growth is good and therefore that multiples will "self-correct". Alternatively, one may decide the opposite, that earnings prospects are not so good and so prices will come down.

Reflecting on the larger backdrop of the usefulness of the scientific method with respect to financial markets, revisiting the problem of sample size is useful. Stock market history, particularly modern stock market history, is woefully small when compared to the course of commercial or economic activity. Focusing on the last 100 years of stock market activity reminds me of the movie "The Village" where the villagers live in a kind of preserve, not aware that there is a much larger world outside living according to different rules and standards. As you know, much of the modern day stock market, since the Depression, has operated during a period of enormous economic expansion, arguably as much a product of monetary policy expansion as to technological innovation. While one need not accept the notion of Kondratieff cycles, it would seem prudent to acknowledge that there are long term cycles of economic expansion and contraction which one hundred years of stock market history barely accounts for. Therefore despite your best efforts to quantify stock market experience you are at constant folly I should think of groping the tail of the elephant and declaring it a snake.

The risk management techniques of major financial institutions is wonderfully instructive. Granted, I assume methods have improved somewhat since I left that world, but I can remember the methods for determining likely default rates as well as VAR analysis. Usually data points were collected over a period not exceeding 10 years, which could provide a statistically relevant sample size, but failed miserably to account for the full range of experience. As Benoit Mandelbrot points out very well in The Misbehavior of Markets, "Shit Happens," and with more frequency than traditional statistical analysis might suggest.

The so-called "Thought Experiment" seems to me more useful as a scientific method with respect to the markets than quantitative analysis, though the latter is no doubt be useful. So returning to P/E's, quantitative analysis highlights the fact that P/E's are presently higher than the mean. This then leads me to a more important question, the thought experiment: How long would investors be willing to buy stocks at prices which would require, roughly, twenty years or more to return their original capital? Not long in my view.

Greenspan--Not So Slick, by Jonathan Mogil

I usually refrain from comments on the maestro on this board as many more intelligent people on monetary policy than myself. However, his comments on oil and gas yesterday were a farce.

Can't he realize the problem with high energy prices would be better fixed by sticking to what he is supposed to do? The low rate environment is more to blame and fixing it will do a lot more than letting the contango futures markets adjust prices. Yes, the build from the curve might reduce some spec frenzy but not really getting at the underlying issues. 54pc of oil is consumed in the form of gasoline, 10pc heating oil. When you add jet fuel you are up to 70pc. All consumer driven. At the end of the day people only have so much to spend. Auto costs consist of more than gasoline. Low lease payments have offset this pain. The year-on-year declines in SUV is just the start but more needs to be done. If he wants to curb energy prices he should stick with his original job.

A Reader Writes:

I have not spoken to a single person today who feels confident about the market. The cherry is a fellow who retired at 30 because his investment portfolio far exceeded his pay as an engineer at Rockwell. He is currently 75 years old, and told me today that he is going into cash because 37 of his 40 positions are down for the month, and he thinks the market will go lower.

Maybe I've drunk the Daily Speculations Kool-aid, but to me things just don't look so bad, so I've been buying down here. It's days like this that can make the difference between a hero or a degenerate gambler.

The Bad Old Days, by James Sogi

Quit complaining. Things are generally pretty good now. The economy is good. Interest rates are low. The war is winding down. Taxes are low. Business is good. Jobs are up, pay is up, unemployment is down. The US is the King of the Hill. Asia and Europe are all doing well. Democracy is breaking out. Capitalism is spreading. Stocks are a month and 4% off their all time historical highs. What's to complain about?

It really sucked back in the 60's and 70's. Kids (like me) had to practice hiding under desks to prepare for the atomic bomb. The nuclear threat was real. The country was torn with racial strife, and there were riots in the streets. The Vietnam war was tearing the country apart and ruining its finances. 1000 kids a month were dying. Europe and Japan had barely recovered from the World War II. Chinese and Cambodians were bing killed by the 10's of millions in the Communist scourges. The President resigned. New York City was bankrupt and garbage lined the streets ten feet deep. We had to watch Gilligan's Island and the Monkees on TV. the personal computer hadn't been invented. Give me a break.

Fed fund rates were over 10%.

MonthFed Funds

Taxes were up to 70%.


And you complain about now?

Pitching in the Pinch, by Victor Niederhoffer

In every game there comes a time when everything hangs on a thread, where the difference between success and failure is a mosquito's eyelash, where the scales are evenly balanced, where what Martie Riesman call "the critical point" occurs, the opponent is at maximal strength, and that little extra, Christy Mathewson's "Pitch in the Pinch," the one you always keep in reserve, carries the day.

That time occurs in the market every day, and the commentators always miss it. I always miss it also because the only news I read is from the National Enquirer and that's a weekly, available at supermarket, that very frankly is not mainly directly concerned with the market. But today, voila, there it was when Elliot Spitzer said a civil resolution of his accounting probe was " achievable." It occurred at 1:30 p.m. with stocks at a year-to-date -- nay, a four-month -- low ----and the S&P rallied a fast 6 points in one half hour and then another 4 shortly thereafter as AIG jumped 6% in 2 minutes on the news.

Christy would have been long and doubtless other greats among us sensed the pinch, knew the knuckleballer was coming, and covered their shorts right at the bottom.

Ajax was in front, but Odysseus was running so close behind that his feet were hitting Ajax's tracks before the dust could settle back into them. All the Achaians were cheering his effort to win, shouting for him to pour it on. When they were in the stretch, Odysseus said a silent prayer to the gray-eyed Athena, "Hear me Goddess; be kind to me, and come with extra strength for my feet." Athena heard him and lightened his limbs, feet and arms. As they were making their final spring for the prize, Ajax slipped and fell. So Odysseus took away the mixing bowl, because he finished first. Ajax stood spitting out dung and said, "That goddess tripped me, that goddess who has always stood by Odysseus and cared for him like a mother." They all roared with laughter at him. And Antilochos came to take the prize for last place and grinned as he spoke to the Argives, "Friends, you all know well the truth of what I say, that still the gods continue to favor the older men. Look here, Ajax is older than I, if only by a little, but Odysseus is out of another age and truly one of the ancients. But his old age, is, as they say, a lusty one." -- Stephen G. Miller, Ancient Greek Athletics (New Haven: Yale University, 2004)

Book Recommendation from Victor Niederhoffer: Elements of Forecasting, by Francis Diebold

Truly about forecasting, from a regression standpoint, but just covers the elements of regression that are clearly related to forecasting. Recommends the program Eviews as the best for forecasting, and their sample output includes much better information for forecasting including the Akaike and Schwarz criteria , and s.e of regression forecast, and Durbin Watson that many programs are missing. Chapters include graphics, modeling, seasonality, cycles, moving average and autoregressive moving average models, forecasting cycles, using regressions for forecasts, combining forecasts, and arima forecasting and smoothing, and as lagniappe, volatiity forecasting. 432 beautiful pages.

The Definition of Counting, by Philip J. McDonnell

One thing which has been missing from our recent discussion is a definition of counting. Undoubtedly we all think we know what it means but sometimes it is helpful to critically examine our own ignorance. It seems the markets are continually trying to teach us that lesson.


Counting is a scientific process whereby numeric or classified data is used to test a predictive hypothesis for statistical significance in order to gain a mathematical advantage in the market.


Essential to the above definition is the language of statistical hypothesis testing and the use of the scientific process. The hypothesis must be well defined and falsifiable. Opinions and vague visual interpretations are anathema to Counting. Usually in such circumstances the countist will seek to use the raw numbers or classification data in lieu of charts or methods which require subjective interpretation.

Classified data is also quite useful in counting and can include such events as "the CFO just left", 3 or more insiders bought, today is Tuesday, the market was up (+) or down (-) yesterday. The data which can be analyzed under the Counting rubric can be quite broad, need not be numeric and is not limited to price, volume, open interest or traditional accounting data.

Simple hypotheses are preferred in Counting because each time we add a condition we reduce the size of the sample available to test for significance. However more complex patterns are allowed. An example of a pattern event might be "two weeks with lower lows while a Republican is in office". One possible way to test such a pattern would be to classify the data into all cases where the event is true versus all cases where it is not true. Then the statistical test might be to test whether there is a difference in the means between the two cases or a difference in the proportions which are up for the two cases. Any valid statistical test can be used to test for significance.

Hunting the Elusive Altruism in the Stock Market, by Victor Niederhoffer

On a recent visit to the South African savannah, I was confronted with an example of reciprocal altruism when my daughter Katie yelled to me just as a dominant baboon prepared to attack me from behind in order to seize the ice cream cone I carried.

She thereby increased the danger to herself, but knew that out of gratitude I would warn her or share resources with her to put her out of danger.

The value of altruism was first suggested by Darwin to explain the social behavior of ants and bees, and was then quantified by Bill Hamilton. His famous formula is that altruism will occur when:

R X B > C

where R is the proportion of genes the donor share with the recipient;

B is the increased expectation for number of children that the recipient will produce; and

C is the reduced expectation for number of children that the donor will have.

This leads to such predictions as that a individual should sacrifice himself to save two siblings, two children, four grandchildren or eight cousins. It explains such things as why prairie dogs will stand up to warn their sisters even when a badger is more likely to attach them because of their increased visibility, why ground squirrels give alarm calls when a predator is sighted, why vampire bats will feed their children, and why bee-eating birds will stay in the nest to help with feeding instead of breeding on their own.

The question immediately emerges as to whether certain markets provide altruistic warning signals about great danger to other markets. To study this I looked at the last 16 daily warning signals of silver where silver went down 10 cents or more in a day and looked at the performance of the S&P the next day as follows.

Silver Signals

DateBig Silver DeclineNext Day Move in S&P

Conclusion: There seems to be no inordinate degree of altruism in silver toward the stock market, and indeed an unpublished study shows that silver is relatively spiteful toward oil.

Dr. Brett Steenbarger comments:

[Vic wrote:The question immediately emerges as to whether certain markets provide altruistic warning signals about great danger to other markets.] Fascinating question. Might it benefit the gene pool if the weakest of the species sacrificed themselves for the propagation of the strongest? Or if the capture of the slow and the lame alerts the swift and able, who attempt their escape?

The banking stocks persistently trade at the bid, while the oil stocks move size at the offer -- resources shift from one niche to another in the face of rising rates. Just as the NASDAQ makes new lows, the large S&P traders lift their offers...a few seconds pass...and buyers enter the fray.

Market technicians and fundamentalists remain faithful to their telescopes, altruistically benefiting those who study the teeming life and Darwinian struggles beneath the microscope.

Rudy Hauser comments:

The question is how a gene favoring reciprocal altruism would develop. Even if it benefits a group that has it, the question is why it would survive and spread long enough to get to that point.

The genetic benefit to kin is there even if it is not reciprocal, which explains paternal love. We find siblings compete for parental attention but tend to unite against outside dangers, which makes perfect sense when one looks at the relative genetic benefits in each case. But before verbal communication developed older siblings would know who their younger siblings were but the opposite would not be true. By engaging in altruism for toward those who engaged in such acts for you, younger siblings would be benefiting the genes they shared with their older siblings.

It is easy to see how this could have led to reciprocal altruism toward non-close kin in the group. Along with behavior designed to become and/or ally with the group leader so as to gain a better share of food, etc., one soon had behavior that would lead not only to reciprocal altruism but also to political alliances and economic exchanges.

With regard to altruism, there would be a benefit to appearing to be altruistic to encourage altruistic behavior of others toward oneself while actually cheating. This in turn would lead to the evolution toward strong emotional reactions toward those caught cheating. After reading about this in "The Moral Animal: Why We Are the Way We Are: The New Science of Evolutionary Psychology" by Robert Wright, I have also seen some more recent articles on experiments that have demonstrated the latter behavior patterns.

Attic Treasures, by Nigel Davies

On another trip to the attic I found the following first sentence in the introduction to 'Trading Systems and Methods.' Though this feels rather like telling Prince Charles that a pig farmer from Yorkshire was his father:

Quantitative methods for evaluating price movement and making trading decisions have become a dominant part of market analysis. At one time, the only acceptable manner of trading was by understanding the factors that make prices move, and determining the extent or potential of future movement. The market now supports dozens of major funds and managed programs, which account for a sizable part of futures market open interest and operate primarily by decisions based on 'technical analysis'.....
In many ways, there is no conflict between fundamental and technical analysis....

Briefly Speaking: The Dollar, by Victor Niederhoffer

How many in the media, public or trading community know what is the movement of the Dollar since the close of year against Euro, Yen, or GBP. About up 5%, 6% and 2% respectively. And since year end 2003, about -2%, 1%, and -5%.

What is significance of this disparity between actuality and realization?

Tim Hewson responds:

With regard to Chairs query below, the number of hits on google news for the last month for the search "weak dollar"= 2,280 hits; for "strong dollar"= 365

As for its significance, I should be the last person to ask, but perhaps it can be viewed as the consensus being behind the curve, with the market shaking the tree to dislodge some of those loose apples.

We're an Individual, Aren't We? by the Grandmaster

I was once comparing notes with a chess colleague on what distinguished a player with 'potential'. Basically we figured that in your face smart alecs without too much respect were much more likely to become strong chess players than nice guys, part of the reasoning being that they looked for the flaw in our moves whilst the nice guys believed us.

This thought makes me wonder if there isn't a deeper level to trend following than using past prices to extrapolate future action, and one which may lead us to being place on the wrong foot even though we believe we are coppering the public play with 'anti-trend' strategies. It emanates from the idea that society prefers people that fit in rather than those who ask questions. That can be any society, even one composed of people who are by and large quite individual.

In my proposed anti-trend strategy of fading King Murphy's 5/20 crossover with a 10 point stop loss, I joked at the end that 'disturbingly this hasn't been losing too much money of late'. But actually this wasn't a joke.

Recently we have seen the publication of books such as the much praised (here, but not by me) 'Trade Like a Hedge Fund'. I've also seen countertrend strategies touted in many other places too, for example Larry Connors 'How Markets Really Work'. With more and more people are competing for these trades I wonder if they are not fading any kind of move ever earlier and 'bottling up' what the market 'wants to do' into a narrow range. But what happens when the market is done with being bottled up?

Because of this I have to say that the hairs on the back of my neck are on end whenever I see huge agreement here about 'trend following' being bad. I would also like to refer everyone to the March 05 edition of 'The Technical Analysis of Stocks and Commodities' which suggests that a 'stochastic oscillator' is not overbought above 80. This indicates an approach to trading (reversalist, but not on selling stock strength) which is highly analogous to some of the strategies countists are using.

Oh yes, and has anyone been trading the famous 'first of month' bullishness this year?

We're an individual, aren't we?

They Laughed When I Sat Down to Hedge, by Kim Zussman

In Barron's and WSJ appear ads for firms to help start up your new hedge fund (already there are 8,000 and counting). Notice also that more mutual funds (eg Hussman, Heebner) are using options and shorting.

It seems this relates to the dynamics of changing cycles compounded by ever smarter, faster money. When a past pattern breaks down a few times, the question arises was this within expectations (insert fat tails and swans here) or has the pattern died? However there is risk of paying large tuition before gathering enough data to learn whether the cycle has ended.

Academics like to call short-term traders "noise traders," but as our attendance here attests there are conductors who can winnow symphonies from cacophony. The rest of us can be proud providing Mr. Dude's* liquidity.

*Note from the Webmeistress: Michael "The Dude" Pomada is the latest addition to the Chairman's trading office. He is a Southern California boy.

Heart and Risk, by James Sogi

We compute probabilities and statistical distributions. We compute risk, yet inherent in the risk formula is its basis as a decision-making tool, making the human an integral part of the equation. Risk is the probabilities combined with time to make a decision. Where is the human element in our mathematical formulae and scientific market testing?

Many bodily functions such as heart rate, breathing, anxiety, muscle ache are sub cortical and are not presented clearly to the conscious mind. Have you had a vague discomfort, but when massaged out, felt the sharp pain of a pinched or tight back muscle of which the conscious mind was not specifically aware. Have you exited a trade not because the market topped out but just because of anxiety over the position? Of course you have.

As an experiment in line with recent posts on wiring traders, I put my Polar S725 cycle/heart monitor on while trading. The idea is to count or quantize the human element. The heart rate monitor stayed the same through trade entry and when my position was entered and drew down, but as the position went profitable, the heart rate went up. This is good information to have presented in hard numbers next to the trading screen while trading as it is for sports training while cycling or running. For sports the heart information provides a better workout with scientifically determined levels that can be recorded. For trading it might help avoid making stupid decisions.

This experiment showed me where my trading weakness lies: in extending profits to what the market offers rather than what my beating heart demands. Friday, when the position went positive, the heart rate went up. Rather than trade my heart, I made the heart rate go down by relaxing and held the position till the market said, "Get out," rather than listen to the little devil whispering in my ear, "Get out, before you lose your profits...Get out right away with your few measly points."

The Sources of Tr**d F*!!**ing Profits, by Alex Castaldo

A sagacious observer of T.F. wrote: the returns to trendfollowing are [...] similar to the returns of other risky assets. The presumption then is that there is some risk premium being earned for the activity, a shorthand of which could be the observation that hedgers are not permitted to lower their risk for free. [...] trendfollowing does not work in stocks since everyone in the stock market has the same profile - profit maximizer. What is required is a happy loser in a market with fat tails due to inelasticity - e.g. hedgers.

This idea that the profits of Tr**d F**!!**wers come from hedgers is plausible and interesting, but let us examine it more closely.

Consider Crude Oil. The price rises, then falls back a little, then rises again, making a new high. At this point the Tr**d F**!!**wers (the Donchian boys) come in long. By assumption, they will make money on average, and their profits will come from the short hedgers, like Exxon corporation selling their crude in the futures market. That s OK with Exxon, they are willing to pay for this price protection.

The problem [and this has been the downfall of all academic theories of futures based on hedging starting with Keynes] is that consumers of the commodity also hedge, and in the opposite direction, buying futures to protect themselves against a price rise. No one knows which is more important at any time (i.e. who has to pay to lower their risk). WHAT EVIDENCE DO WE HAVE THAT IN THE ABOVE SITUATION THE PRODUCERS (short hedgers) ARE THE ONES WITH A GREATER NEED TO HEDGE?

A good lawyer, like Mr. Sogi, could make the following argument for the other side:

At the present time, if the price of oil goes down $5 Exxon corporation will have good profits, if oil goes up $5 EXXON will have unbelievably good profits. If the price of oil goes up $5 Delta Airlines ( a consumer) will probably go bankrupt, if it goes down $5 they will probably squeak through with lousy profits. WHO HAS THE GREATER INCENTIVE TO HEDGE AT THIS TIME? When prices are higher than the consensus of a few months or a year ago it is the consumers who have their back against the wall. They are the ones on their knees praying please, please, don t let the price go up further ; they are the ones who would be willing to pay a price to hedge themselves (what Mr. Wiz calls a G.M.T.F.O. trade, with a negative expectation). Yet your theory says that in this situation it is the producers who pay to hedge. Delta Airlines, coming in on the same side as the Donchs, would be paid to hedge. It doesn't make sense. I rest my case.

In my opinion the source of T.F. profits lies elsewhere.

David Baccile Reviews "The Chinese Century" by Oded Shenkar

In a word, I found the short book (175 pgs) to be frustrating. It was my first attempt to try to understand the role China will play, its strengths and weaknesses, and I was hoping to gather some real data. I guess Wharton School Publishing isn't too interested in numbers, hard data or philosophical insights from (Chinese) insiders.

The Chinese Century began with an argument as to why this wasn't another "Japan Inc." type of book, as several authors penned works in the '80s that Japan would dominate the world and that Japanese management styles had to be copied. The author repeated the same generalizations all thought the book and was clearly biased in his presentation of the argument. He quickly dismissed conclusions by the McKinsey Global Institute and Alan Greenspan on the impact of trade on U.S. employment while giving significant print to positions of the Economic Policy Institute which is, he admits, a liberal think tank.

The author's points can be summarized as; China is in a better position than Japan because China's population is large enough to allow a shift from low-tech manufacturing to a combination of high and low tech....he argues that Japan ran out of labor and so Japan could no longer provide cheap labor for low tech. China forces foreign companies/investors to perform R&D in China...this speeds the transition from low tech to high tech.

What's missing? Any discussion on the state of the banking system. Yes, the country has accumulated large dollar reserves; how are banks doing, though? How will the country survive the transition and deal with fast growth?

The author dedicates significant time to the issue of piracy. To say that piracy and patent infringement is rampant in China is an understatement, according to the author. Yet, the author does not seem to see this as a negative. I must admit to being pretty frustrated that US companies willingly partner with China when they know they will be cheated and ripped off. There are statistics that music companies get no sales in China because bootlegs and pirated products are so rampant.

There was also no discussion of issues related to property rights. Perhaps naively, I believe that no country can be successful in the long run without ensuring property rights.

There was no discussion about internal Chinese politics, nothing about public sentiment and no talk of the monetary system. How anyone can write a book titled "The Chinese Century" without covering these topics is beyond me.

I must say that I agree China is a real global force making a huge impact on economies and politics. The fact that the Chinese will spend more on their military in 10 or 15 years concerns me.  While I think China is a power, I do think they have structural disadvantages which over time will show themselves. I want to learn more, so if you have any suggested readings please send a note to .

The Rashomon Market, by James Sogi

Akira Kurosawa's 1950 classic Rashomon set in feudal Japan is about an incident in a forest recounted by 4 different participants in a court inquiry. Each tells the tale from their perspective reflecting their needs, their agendas, their feelings and relationships, resulting in the stories about the same "facts" being completely different. Each has something to hide which leads to prevarication by all of them. The issue is whether the prevarication is the result of intrinsic evil or justifiable personal circumstance. The acting is over the top, and the movie is a must see.

A similar tale is told everyday in the market. Each market participant has different needs, agendas, histories perceptions, and sees the market completely differently. As with the three blind men examining the elephant, the bear saw Friday's drop as a great vindication of his view and recovery of his position; the Bull saw the the action as a short pullback to add to or enter a long position. The day trader saw the morning gap up as a great short set up, and the long saw the gap as a great exit from Wednesday's trade.

This is one of the difficulties our market debates ; each one of us has such different perspectives that though we are examining the same elephant, one sees a snake, one a wall. Each has a reason to prevaricate or interpret what we say to influence the tribunal. No one is right or wrong but human nature is subjective and thus leads to the creation of the market whereby both buyer and seller feel that they've been enriched.

Pope John Paul II, RIP, by Laurel Kenner

I see my own late father in the photographs of the pope: serious eyes, open smile, tough Polish face, big hands that worked with stones and wrote poetry, hearty energy for skiing, running, working. 

I'm not a woman of faith, but I admired John Paul. He made me proud of my Polish ancestry. And he tried within his framework to "see things as they are," my personal idée fixe. The first non-Italian pope in 455 years and the first Slavic pope ever, he was an outsider who rose to the occasion.  The pope genuinely liked people and forsook the traditional papal "we" in favor of "I." He unhesitatingly confronted the powerful in their lairs. He also forgave the man who shot him, and apologized for the horrors perpetrated by the church over the millennia. When he went back to Communist Poland as pope, he touched off the Solidarity freedom movement as people were emboldened by his example and decided to no longer be ruled by fear. Perestroika followed, the Iron Curtain came down, history was made.

John Paul's pronouncements on economics represent good intentions rather than prescriptions that would truly improve people's standards of living. Yet the survivor of Communism had some sharp insights. The following is a passage from a 1987 encyclical, "On Social Concern":

It should be noted that in today's world, among other rights, the right of economic initiative is often suppressed. Yet it is a right which is important not only for the individual but also for the common good. Experience shows us that the denial of this right, or its limitation in the name of an alleged 'equality' of everyone in society, diminishes, or in practice absolutely destroys the spirit of initiative, that is to say the creative subjectivity of the citizen. As a consequence, there arises, not so much a true equality as a 'leveling down.' In the place of creative initiative there appears passivity, dependence and submission to the bureaucratic apparatus which, as the only 'ordering' and 'decision-making' body if not also the 'owner' of the entire totality of goods and the means of production, puts everyone in a position of almost absolute dependence."

Ayn Rand could hardly have said it better.

The pope went on to draw a parallel between dependence on the state and "the traditional dependence of the worker-proletarian in capitalism." He also spoke of the dangers of the individual quest for profits. Here I part ways with him, as the rhetoric is old-fashioned Marxism.

Vic, whom I regard with much bias as the most articulate living advocate of freedom, says capitalism is a moral system because people have the right to their own life and to the fruits of their labor. Life is not to be lived for others not state, not church. The freedom to seek and maintain individual profits is what allows people to be benevolent and to widen the circle of happiness and productivity and achievement and invention.

Pope John Paul was said to have been a formidable debater. I almost regret not being a believer, for I would dearly enjoy hearing a Pope-Chair debate -- and now it would be possible only in the Other World.

E-Mail Exchange Between Two Members of the new Financial Elite, Reprinted from the Financial Times of April 1

Alan Lewis is managing director of Sthenos Capital, a London hedge fund manager that closed its funds at the end of 2004. Daniel Loeb is chief executive of Third Point, a US hedge fund manager. Mudlark has confirmed that the e-mail exchange below - reproduced verbatim apart from minor style changes - is genuine and took place this week.

From: Alan Lewis To: Daniel Loeb March 22 2005

Daniel, thanks for calling earlier today. Enclosed is my CV for your review. I look forward to following up with you when you have more time. Best regards, Alan.

From: Daniel Loeb To: Alan Lewis March 28 2005

What are your three best current European ideas?

From: Alan Lewis To: Daniel Loeb March 28 2005

Daniel, I am sorry but it does not interest me to move forward in this way. If you wish to have a proper discussion about what you are looking to accomplish in Europe, and see how I might fit in, fine. Lesson one of dealing in Europe: business is not conducted in the same informal manner as in the US. Best regards, Alan.

From: Daniel Loeb To: Alan Lewis March 28 2005

One idea would suffice.

We are an aggressive performance-oriented fund looking for blood-thirsty competitive individuals, who show initiative and drive, to make outstanding investments.

This is why I have built Third Point into a $3bn (£1.6bn) fund with average net returns of 30 per cent over 10 years. We find most Brits are a bit set in their ways and prefer to knock back a pint at the pub and go shooting on weekends rather than work hard. Lifestyle choices are important and knowing one's limitations with respect to dealing in a competitive environment is too. That is Lesson one at my shop. It is good that we learnt about this incompatibility early in the process and I wish you all the best in your career in traditional fund management.

From: Alan Lewis To: Daniel Loeb March 28 2005

Daniel, I guess your reputation is proven correct. I have not been in traditional fund management for more than 11 years. I did not achieve the success I have by knocking back a pint, as you say. I am aggressive, and I do love this business.

I am half American and half French, and having spent more than half my life on this side of the pond I think I know a little something about how one conducts business in the UK and Europe.

There are many opportunities in the UK and Europe, shareholder regard is only beginning to be accepted and understood. However, if you come here and handle it in the same brash way you have in the US, I guarantee you will fail. Things are done differently here. Yes, place in society still matters, where one went to school etc. It will take tact and patience (traits you obviously do not have) to succeed in this arena. Good luck! Alan.

From: Daniel Loeb To: Alan Lewis March 28 2005

Well, you will have plenty of time to discuss your "place in society" with the other fellows at the club. I love the idea of a French/English unemployed guy, whose fund just blew up, telling me that I am going to fail.

At Third Point, like the financial markets in general, "one's place in society" does not matter at all. We are a bunch of scrappy guys from diverse backgrounds (Jewish Muslim, Hindu etc) who enjoy outwitting pompous asses, like yourself, in financial markets globally.

Your "inexplicable insouciance" and disrespect is fascinating; It must be a French/English aristocratic thing. I will be following your "career" with great interest.

I have copied Patrick so that he can introduce you to people who might be a better fit. There must be an insurance company or mutual fund out there for you. Dan Loeb.

From: Alan Lewis To: Daniel Loeb March 28 2005


From: Daniel Loeb To: Alan Lewis March 28 2005


Ethanol and the Mathematics of Energy

Roger Arnold drew our attention to a University of California-Berkeley study entitled, "Ethanol Production Consumes Six Units of Energy to Produce Just One."  A "Science Daily" article on the study said:

In 2004, approximately 3.57 billion gallons of ethanol were used as a gas additive in the United States, according to the Renewable Fuels Association (RFA). During the February State of the Union address, President George Bush urged Congress to pass an energy bill that would pump up the amount to 5 billion gallons by 2012. UC Berkeley geoengineering professor Tad W. Patzek thinks that's a very bad idea. Ethanol is produced by fermenting renewable crops like corn or sugarcane. It may sound green, Patzek says, but that's because many scientists are not looking at the whole picture. According to his research, more fossil energy is used to produce ethanol than the energy contained within it.

To which Jim Sogi replied: The question is not the amount of energy, it is the cost and availability and ease of use of the energy source. Scientists often miss the economic aspects.

There is lot of free industrial waste heat available for re use. Put the ethanol plant next to the steel mill/air conditioners/garbage dump/sewer treatment plant/, and siphon off some heat for distillation. You only need 173 degrees F to distill alcohol. That's not much. We also have geothermal for a heat source that makes 20% of the island's electric. On Oahu they have a garbage to energy electric plant that burns garbage and makes some percentage of Oahu's electric. I used solar heat and burned scrap wood and bagasse to heat the mash like the old moonshiners for my ethanol for fuel project.

P.S. When in college in Oregon sealed wood stoves worked great. One or two pieces of wood lasted all night.

And Yishen Kuik directs us to Cornell University professor David Pimentel's finding that ethanol is uneconomical.  

The Chairman: Briefly Speaking

We today inaugurate a new feature, "Briefly Speaking," in honor of all CEOs who were not "briefed" beforehand in conjunction with any activities that subsequently were investigated by authorities.

"Briefly Speaking" is based on the following quote The Oracle of Omaha "was not briefed on how the transactions were to be structured".

Briefly speaking, the WSJ article on Greenberg's last tumultuous days should have appeared in a Harold Robbins novel. Some excerpts:

He called and yelled at several directors.
He had his own elevator guarded by his own security detail, his living room adjoining his office and private chandeliered dining room.
At monthly management meetings, he was served hot tea in a china cup by his butler (while other execs sat around in coats and ties without refreshment).
"That would be stupid!" he said when asked if the board should lessen the conflict between AIG and related entities essentially controlled by Mr. Greenberg
"You couldn't even spell the word insurance," Greenberg, calling from a speaker phone aboard his boat in Florida, told a group of outside AIG directors assembled in their attorney's office to discuss subpoenas from the SEC and the New York State Attorney General. The group included a former secretary of defense, a former U.S. ambassador and a Harvard economics professor.
"Let's go home now," he replied after an awkward silence to a board toast on March 15 to a "great, great friend, the man who made AIG what it is today."

Goodness knows, I will never allow my own staff to serve me lunch ahead of any others.

-- Victor Niederhoffer

Briefly Speaking: Monster Oil, by Victor Niederhoffer

It's guaranteed to happen that on the last day of a quarter a brokerage house will disseminate a model that shows that one of their major holdings is imminently due for a 100% increase in price. Also, that the model will be generated by an agrarian reform-loving mathematician who does not understand the first theorem of economics:

The higher the price, the greater the incentive for increased supply and the greater the incentive for reduced consumption.

The brokerage house model should be understood in terms of Ben Green's Horse Trading rather than considered a legitimate economic exercise.

Briefly, the attention given to the nice Monster numbers reminds me of a truly proper exercise in "forecasting " undertaken by the great Paul DeRosa. He polled the 10 major banks, to get their deposits, then put them thru a Bureau of Labor Statistics census adjustment seasonal program to come up with an estimate. How beautiful. So good that he had to stop it, as the edge was embarrassing.

But because of these adjustments, and the unholy politicking going into the employment number release (do they want people to control their own retirement, or do they want the government to decide, not that the relatively non-government administration has been elected), it is shameful to use a series like Monster to predict employment since the random components are paramount, whatever one part of the numerator may be estimated to be.

Dept. of Free Enterprise Thoughts

George Zachar forwards this article from Celeste Biever at the NewScientist news service:

Modern humans may have driven Neanderthals to extinction 30,000 years ago because Homo sapiens unlocked the secrets of free trade... Trading would have allowed the division of labor, freeing up skilled individuals, such as hunters, to focus on the tasks they are best at. Others, perhaps making tools or clothes or gathering food, would give the hunters resources in return for meat....

Jim Sogi comments:

What is a trade? It is a deal in which both parties to the deal feel richer at the moment it is complete. This must be true or the trade would not have occurred unless each side felt they would be enriched by consummation. This is the basis of commerce and was a big evolutionary advance over the physical subjugation by the taker over his victim that characterizes animal and pre-commercial human and Neanderthal life.

Opinions and Actions, by the Grandmaster

One of the most interesting things I ever heard said about a great player was how GM Sosonko once described Anatoly Karpov. I don't have the exact reference at hand, but it was to the effect that Karpov never discusses who is better, he just plays another move. Now Karpov knows very well who is better or worse in a position, but for him this is secondary to the actions he must take.

Since seeing this I have noticed that weaker players always want an opinion whereas the stronger ones change like the breeze and focus on action. In dynamic games the advantage often swings back and forth, and this calls for flexibility rather than opinions.

The Housing Situation, by Kevin Eilan

Networks planning two new reality TV shows on real estate - (New York Mag)...

"No Business Like Shvo Business"

For years, the standard profile of a real-estate agent was an SUV-driving suburban matron, or, like Richard Ford's Frank Bascombe in Independence Day, a burnt-out divorcé looking for a fresh start selling split-levels in New Jersey. It was often a place where one ended up, rather than began. In New York, at least, that's changing. Fueled by record-high housing values, a wave of speculative development, and a radically constricted supply of residential units, real estate has become not only the city's most lucrative investment, but its ever-grander obsession.

This is a city, after all, where an Elliman agent recently parked her car in front of an open lot in Chelsea and sold five $1 million condos from the backseat by showing buyers the site through a hole in the fence. Whether the popularity of The Apprentice has anything to do with its setting in the real-estate industry, the networks aren't taking any chances: Both ABC and NBC have real-estate series in the pipeline the imaginatively titled Hot Properties and Hot Property, respectively. (Shvo says he was approached by one of the big-four networks to star in his own reality show, but passed to devote his time to his company.)

Risk, by Kim Zussman

The tenet that investors are compensated for risk derives from the gambling where one risks loss in hope of gain. The essential difference between investment and gambling is the degree to which gamblers believe they have an edge when they don't. Right?

Like gambling, speculating entails risk that delays present certain gratification to an uncertain future. This imbalance is impractical for those with more yesterdays than tomorrows and commensurate inability to resurrect from ruin.

Life resembles art and markets mimic nature. All manner of calculation, cogitation, preparation, and exercise are met irregularly with the unanticipated tiger*. Deft brushstrokes ironically rendered fuzzy, spatters poignant. Apollinaire to Picasso; gaga with data.

Composer John Cage wrote, "My father was an inventor. He was able to find solutions for problems of various kinds, in the fields of electrical engineering, medicine, submarine travel, seeing through fog, and travel in space without the use of fuel. He told me that if someone says "can't" that shows you what to do. He also told me that my mother was always right even when she was wrong" (XY genius).

Viktor Frankl teaches that the doors of happiness open outward, and beyond this happiness in a competitive world necessitates risk. Choices of education, career, spouse, investments entail risk of stagnation, boredom, inactualization, poverty, organic atrophy, and intellectual starvation. Evolution is a gamble, but less so if one knows their own strengths and weakness. Successful inventors and speculators exploit their gifts in identifying important questions and using their ingenuity to predict rare solutions. Beyond intellect there is prerequisite steadfastness in the presence of pain, which dramatically thins the herd of the commonly linked reasoning and sensitivity types.

*King Con

The King invites young men of the kingdom to compete for the hand of his daughter. To the gathered crowd of suitors he explains the task: "First you must open one of the 10 doors of this room -- one of which holds a tiger! And I guarantee that you will not be killed by an anticipated tiger." The crowd thins and finally only one young man wearing spectacles is left.

"Why you?" exclaims the king.

"Watch this!" says the young man. He points successively at each door and says "I don't anticipate a tiger here." After repeating this for all 10 doors, he says, "Since I do not anticipate a tiger behind any door, any will do, as you have no tiger!" Gallantly he opens Door 7 and is immediately sliced in two by a giant Siberian White.

"WHAT!" shrieks the princess. "Madchen, he was a schmuck." said the king. "He didn't anticipate a tiger behind the door, so he was not killed by an anticipated tiger. He was killed by an unanticipated tiger."

"OK daddy, I see. Maybe instead of marrying I can do as you did and attend law school."