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July 2005 Posts

Dept. of Hubris, by Victor Niederhoffer

Fortune's article on ousted AIG CEO Hank Greenberg "Inside Hanks's Big Fall" outlines the guideposts of many an executive's path to doom:

  1. "All I want in life is an unfair advantage." (I note that Hank apparently likes tennis and often describes his situation in terms of foot faults.)
  2. A Morgan Stanley analyst summarizing her glowing report " What investors really want is for Hank to become immortal".
  3. "The problem of AIG was that G had built a company accountable to no one but himself. Spitzer's suit says that AIG's official books were altered on nothing more than handwritten sheets, with hundred of millions of dollars shifting from account to account."
  4. In response to a refusal by a trader to buy some AIG in the last 10 minutes of market trading because it was illegal, he told her he didn't care what the H the reason was. Like his counterpart at GE, G "was a bully of epic proportions."
  5. When the reckoning comes, excessive and unleavened love always leads to total warfare. For example: " G blasted his former company for refusing to let him collect his personal office possessions, including the medical records for his dog Snowball"

The observer from the grandstand like myself who doesn't know much about the insurance industry must agree with what many of G's defenders say: He never did anything for himself, but for the good of the company. "He was dedicated to the company," said E. Stempel, a former director. As Henry the K said " I can imagine an excess of perfectionism. I can imagine him going to the edge. But I cannot imagine that he would deliberately go over it."

It is ironic that "an improbable source" -- the company of his good friend the Sage of Nebraska -- seems to have gratuitously turned over documents that led to the end of Greenberg's career. Yet the problem at both the Sage's company and Greenberg's AIG seems clear. It's one I've seen a google of times in my career. An old lion or Cape buffalo, if you will, is no longer able to adapt to the flexible demands of leading a dynamic pack. He digs in deeper and deeper, sullenly lashing out at any who all who would thwart him in his single-minded ideas about what's good for the pack and the company. Eventually, the former young lions that he protected and nurtured turn on him with a vengeance for the good of the futurity.

Preconceptions About Distance, by Alex Castaldo

Last week we were expecting a package from New York City. I get a call from a man with a Chinese accent: "Delivery! I am here at the house, next to the mailbox." I explain to him that Chair's house is at a considerable distance from the mailbox, down a long driveway. He answers that he is at the correct mailbox, that he can see several houses, so why don't I just come out and meet him. I get frustrated and angry, unfairly so, because he is an immigrant who is new to this country, is working hard, but is just unfamiliar with the topography around here. I shout some more instructions down the phone and finally he drives to the house, which is not visible from the road.

This week we get a visit from an audit partner of a South African accounting firm. Her father was a white landowner. After lunch she announces she is going to go jogging on Chair's property. When she comes back and tells about the lake she saw, I realize she has gone to the nearby Valley Forge area, trespassing on several private properties and a nature preserve without realizing it.

Similar preconceptions affect all of us in our investments. How far a price can go, or what is a reasonable P/E, an outrageous interest rate, etc., is affected by our previous experience, just like our concept of how big a plot of land a person lives on depends on whether we were brought up in China, Connecticut or South Africa.

The Grandmaster responds:

On the subject of perceived distances chess makes an interesting model. For example there are a number of endgame studies in which the attempt to make a king travel along what is APPARENTLY the shortest distance to the required destination is an incorrect plan, and that in fact he can use a longer route to arrive at the same time (e.g. diagonal ones as opposed to horizontal or vertical).

I believe that markets contain similar anomalies, the movement of prices giving the IMPRESSION that there is a simple geometry to it all and that ideas we'd apply to the physical world would work there too. But when you come to look at the detail it turns out to be false.

George Zachar recalls:

I once stayed at the Newport RI summer home of a great^n grandchild of the Lippencott fortune.

It was by the water, across a narrow beach.

Driving across one of the local bridges, I saw dozens of people fishing, virtually shoulder- to-shoulder.

I turned to my friend and asked why they weren't casting from one of the scores of local beaches.

"They're private," I was told, after a very awkward silence.

Having grown up in New York City, I had no notion, none, that there could BE such a thing as a "private beach".

Spec lesson: It's very very hard to know what you DON'T know.

Mark Mahorney comments:

This reminds of something I was thinking about research recently. These dozens of people aren't fishing where the fish are. They are fishing where they can fish. If fish are there it is coincidental. But mostly fishermen just stand there. They get away from wives, tough jobs, whatever. Not really any different than sitting about a coffee shop, although the conversations are likely far less stimulating. But why does it look so pathetic?

The way most people fish is analogous to the way most people get market information and do research. People are influenced by the news that popular media think is important, or rather think that people think is important. And research is mostly limited to what is readily available at reasonable costs. For example, people have built indicators representing just about every possible permutation of price and volume, packaged them with data subscriber services, along with programmatic tools to eke out a few more permutations.

Value Line is great, but the retail versions of its services don't provide access to raw historical data and many fields are recalculated. If you want to do in-depth research into historical earnings data you have to step up to an institutional-level service.

Consequently, most people's research is concentrated without much regard to where the profits are. Back to the fishing analogy, no doubt people with fishing boats and fish finders catch more fish because they invest in being where the fish are. Finding fish amounts to an expensive hobby for most people, but it's akin to the professional vs. the amateur or the smart money vs. the retail investor. Most investors can't justify the expense of expanding their knowledge beyond what is readily available to the public.

Hence, hedge funds make a lot of sense from an efficiency standpoint. Bloomberg terminals, Value Line institutional services, tick data, niche data, specialized education and experience, etc... all amount to shared resources when assets are pooled.

Dick Sears Weekly Commentary: Power Failure

Lobagola Sighted in the Amazon

The Memoir, by Victor Niederhoffer

American Sucker by David Denby  is about loss of balance during the Nasdaq crash of 2000-2002, and how the hopes of a movie critic were raised and lowered. Also the breakup of his love affair with Sam Waksal of ImClone and Henry Blodget, the pathetic nature of his muddling with his family, the greed that led to loss of romantic ardor and financial stability as the market gyrated, the similarity between the decisions that a movie critic makes and those that an investor makes, the general limitations and persona of an average investor, successful in his own field, who is seduced by a desire for more power and perks, the strident voices of the envious and promoters who goaded him on, the interplay of chance and choice that sealed his fate, the asides drawing parallels with the conspicuous consumption of Thorstein Veblen, his independent development of the theory of reflexivity and feedback as it applies to the market, the weaknesses in his investment approach that guaranteed his ruin, the revitalizing power of real estate, his heroic Markmanesque spirit even at the end as he hopes for a killing in WIFI, is well worth reading as a rudder.

Victor adds:

Here is how Denby, a layman with no training in economics or investments, but a sincere desire to get rich writes about his discovery of the feedback between news and price action. " Suddenly a result causes the momentum to turn good or bad, takes on a life of its own, until extreme measures are needed to reverse it, and these new measures in turn become a danger, and on and on , forever and ever. In the market you never come to stable point. A given fact, Low employment, (he was writing during a period when bad employment was good for the stock prices, and is too lazy and ignorant to check out that relations change) determines a mood, which mood produces new facts, and these facts further enforce the mood. Causes emcee effects. which turn into new causes..". The Palindrome said it much worse. vic

Tom Larson contributes;

I'm trying to decide if Denby was a Hoodoo. He didn't really try to drag others into his delusion, although his family certainly suffered from his hubris. I suppose the thing to do would be to steer clear just in case his "bad luck is contagious" as Martin says in EdSpec. Reading it, you feel like you are watching a crash in slow motion--there is an air of inevitability to the tale. As pathetic as the story was, I think it took courage to tell it and hope that it was redemptive for him.

Notes from Abroad, by Shui Mitsuda

People in the Japanese market name things. A year or so ago Sony Shock due to low income report by Sony. This summer they invented Printer Shock due to lower earning reports from Epson and Canon. Oh, this made one me laugh. The stock price of Seiko Epson plunges while longs get accumulated, as usual...

What We Can Learn from Shells, by Victor Niederhoffer

Shells and mollusks have been around for 500 million years, and they are the second most numerous family of all in nature. The shell provides the protection and stability for relatively slow moving species and how it evolved and its function would seem to provide some guidelines for survival and success stories in markets and life.

The book Shells by Cheryl Claassen is very helpful in understanding the uses and abuses of shell research. Her passage on predation as a contest between prey and predator among shells makes you particularly skittish about the direct approach to investments. Shells change their colors, their size, their opening thickness and space, their curvature, their carried baggage, their depth, their shape and their speed, all to avoid being swallowed, enveloped, suffocated, trapped, drilled, thrown to the ground (the otter is a master at this), cut open, hammered, crushed, speared, poisoned, parasitized, nibbled or "killed by forced entry from non-human predators." They use all their senses to preclude dying as a meal for a day by escape, and over evolutionary time by developing the ideal mechanisms for such defense, a defense that Claassen emphasizes again and again is mainly against their natural predators such as birds and fish rather than humans.

The shell is mainly for protection, but also to prevent dehydration and the mollusks manipulate the shells by "strength, resistance to dissolution, thickness, projections, colorations, narrow apertures, hinge teeth and crenulations on margins and repair, often affixing stones, shells and other detritus to provide camouflage". Particularly clever are the many mollusks that arrange when ingested to close up tightly, thereafter emerging healthy and unscathed through the digestive tract of their predator weeks later.

I am always amazed, after reading something about how a slow moving species like the mollusk or a moth is able to use all types of deception, that anyone could believe that markets and the human actors within it don't make it equally hard to survive with a simple strategy of eating them "raw, squawking and fully feathered" as the great M.F.M. Osborne liked to say.

The two main kinds of structures for animals are the skeleton and the shell. The skeleton hangs the organs around an internal framework, and the shell puts them in a box. The skeleton is much more adaptable, but the shell provides rigidity and protection, a nice alternative. The most intelligent mollusks, the cephalopods, like the octopus and the squid, have given up their shells so that they can be more mobile and flexible. The companies that try to protect themselves with a rigid structure through regulations that preclude competition, or heavy non-reproducible fixed costs, like the mining companies, are like the shells. They can maintain it for so long, and certainly everything they do to create a fixed structure for protection is to be applauded. But I wonder if the companies that are more skeletal, such as eBay and Google, can maintain flexibility as well as providing a fixed barrier to entry and dehydration? May I mention MERC in this context, as having the best of both worlds

As an additional note, the boys in the office are generally averse to a wager because we don't like to gamble, but when we read that you can drop an abalone shell from a second floor window and it won't break, the gloves came off and many nickels changed hands. We dropped it and the oak floor chipped but not the abalone. The abalone has amazing strength, 3000 times stronger than the minerals it's made of. The secret is that it has a crystal formation called aragonite that lays down calcium carbonate between sheets of protein in a regular pattern. Another amazing example of how nature has a million designs that can teach us about engineering. They can also teach us about how to make a stock strong, and I hypothesize that the layering of ups and down in a path, with for example a 5-point move consisting of 25 points up and 20 points down, is much more resilient than a straight-up 5 points.

John Kuhn adds:

The mollusk is a fascinating class of animal; One thinks of the typical bivalve as the aquatic equivalent of the ungulate, attached to the rocks or sea floor feeding on plankton born by wave or gravity, in large "herds", not asking for much; the aquatic equivalent of the ungulate, or vis-a-vis the stock market perhaps the hordes of mutual or even index fund holders, along with small speculators. Don't move much, and those that do don't disturb much and barring catastrophe, on balance as a group live out their four score and ten with adequate nourishment.

But such reductionism falls before the daunting number of as many as possibly 70,000 different species. Some with thick shells, the giant clam for example, the abalone with so many minute layers its construction is being examined for potential military application in armor improvement; others who've left their shells far behind, the squid, the octopi. For the latter their only contact with shells is when they eat their mollusc relatives, the clams. One senses a happy feedback loop between octopuses' brains, for which they are notorious, and the variety of habitat which they can access. Like the perhaps mythic hedge-fund manager, they can "examine and eat more things."

As many molluscs as there are, they inhabit by necessity hugely varied habitats and niches. Limpets here, barnacles there; Sea and land slugs and snails in gardens, on rocks, in sand, on trees, stuck to boat bottoms. Some of the shell-less molluscs can change color seemingly at will for communication, perhaps for camouflage; others, the nudibranches for example, have evolved defenses seen in insects; "poisonous" coloring. And then, getting more directly to the point, there is the highly poisonous blue-ringed octopus. They're everywhere and range from benignant to deadly, grass and plankton eaters all the way to carnivores.

Like the ungulate, the most numerous types, the bivalves, are prey for many other species; and like the ungulate, even if a few are picked off by a passing whatever (bird, octopus, shark, lion, bear market, fraud, margin call) they survive and thrive via sheer numbers. If there's a market correlation, there must be a sufficient supply of, if i may mix metaphor, sheep that the market as a whole can continue to feed. But the environment must never be permitted to become so toxic or the numbers of predators so great as to threaten this dynamic balance. Nor must they be "shorn" in such huge numbers that they bring aridity and death to the ecosystem. (Which is not to deny that a certain class of pundit cannot make a lavish living by attempting to scare them all to death.)

I can't quite find the corollary for "too few" predators however. Yet, for example, the zebra snail is a serious environmental problem.

Some of these molluscs must eat really good food; the giant squid, characterized as a "giant eating and reproductive machine" reaches 75' in length. Like the stock market itself, many of its true attributes are either poorly researched or so far hidden from view.

Dr. Michael Ott adds:

The abalone is a great model. It is able to withstand impact of collision by diffusing the applied force across many random angles. This reminds me of a boxer who knows he is going to be hit, and turns with the punch to soften the blow.

The 'random' angles are set up by the overlaid layers of aragonite, each focused around a calcium atom. The placement of calcium atoms is seemingly random, but if their configuration was slightly altered, the shock absorbing property would disappear. Many minerals have a breaking point called a plane of cleavage. Mica is a well known example. You can smash a chunk of mica with a hammer, and nothing will happen. If you tap it along its plane of cleavage, it will neatly divide, with 2 flat, smooth faces where the mineral was formerly attached. Aragonite has no continuous plane, so the force is dissipated throughout the entirety.

I'm also reminded of the Japanese proverb posted on my website: the bamboo that bends is stronger than the oak that resists.

Research into biomimetics is fascinating. Angela Belcher at MIT and Marcela Bilek at the University of Sydney are experts in the field.

Sushil Kedia comments:

The logarithmic spiral structure so noticeable when one observes a lateral cross section of a shell is one which has enchanted the minds of mathematicians for many centuries, and bringing up any discussion of this here may also (un)fortunately take our minds to the golden ratio, Phi, Fibonacci numbers. I think it is possibly still worth the risk.

Possibly, the simplest way to construct a logarithmic spiral is to take any two dimensional polygonal shape, say P0 (P - zero) & expand it by a growth factor G to produce P1. Placing P1 adjacent to P0 the next transform is to apply the same growth factor G to P1 to obtain P2 and so on and so forth. The adjacent placements of the similar shapes so expanded and placed one after the other would produce in simpler visualization the logarithmic spiral. Though, there is mathematical beauty of a tantalizing degree present even in evaluating all the more complex formulas, which are available here.

Now, irrespective of whether this constant Growth factor G is phi or any other number one achieves a logarithmic spiral which would on its own find the relationships to phi, e, pi and so on and so forth. This simplification, clearly also fits with the path of least resistance when one gets down to the traditional valuation formula as embodied in the Discounted Cash Flow method. The entire Art as also the Science of valuation is about making calculated (gu)estimates of the Growth factor in the cash flow projections and an 'appropriate' rate of discounting. Companies, investment opportunities and securities that offer fundamental circumstances around them amenable to easier & more reliable estimates of earnings growth are known to Discounted Cash-Flowists to produce estimates of the risk factor or the discounting factor to be far lower than others. Value enhancement is a game of being consistent and being one whose future estimates are more believable if not more predictable. Even though, regulators world over require it to be mandatorily mentioned that past performance is no guarantee of the future, none can escape the demands of the theory of least effort.

So, while avoiding the potential controversies that may come up with Fibonacci, phi and fractals of wave principles one variation of learning that my mind is attracted to seek from the design of molluscs and the logarithmic spiral so dominantly visible in their configuration is consistency and predictability would invariably bring about a sense of beauty on its own and consistent with mathematical properties of beauty - phi, e, pi or any other measures. This last bit might, as Chair maintains needs be tested and could be another direction. For a thought coming aloud, since desire to seek perfection is anathema to human affairs and certainly in trading or investing and since a perfect growth estimate is Utopian [as it amounts to probability = certainty] might not one think of a way to compare earnings streams' projections of a large enough number of securities and work out suitable estimates that may endeavor to compare deviations from a perfectly consistent growth factor to assign ranks, comparative numbers and such similar measures to select securities more preferred than the evaluated universe for building portfolios. Diversification that aims to reduce risk, invariably reduces the possible opportunity. Soldiers who are scoring their battles on Sortino ratios would find concentrating risk and reward as meaningful possibly with this mindset of selecting stocks bottoms-up.

Conches, a particular type of shells that produce pure notes when air is blown through their axis with a consistent turbulence of flow do bring out elements of music that again are consistent with the stricter mathematical definitions of auditory beauty too. For this property alone, since times Vedic that had highly evolved to applying progressed Mathematics, till the present times in Indian Heritage blowing conches alone was the mightiest effort for initiation of war, religious ceremonies or any important adventure. So, might I say, consistency of past, present and future profitability again is nothing but purest music to ears.

Even the hawks (a symbolism for companies that have grown efficiently through gobbling prey) seem to be taking a flight path that is a logarithmic spiral, since their optimal path of vision is a constant growth factor as the predator zooms in on its prey.

The tropical cyclones (read: market catastrophes, possibly) too hurl forward in a path that is a logarithmic spiral multiplying forward their 'zone' with a constant growth factor.

Spider webs (read: manipulation & stock promotions, possibly) fan out in a logarithmic spiral, expanding each next radius from the vertex in a constant growth factor and one where the radius of influence is targeted to have geometric progressional properties.

Whirlpools (a margin call cascade, possibly) fans out again in a radius (the expanse of influence, possibly) that expands in a geometric progression producing yet again a mathematical taxonomy akin to a logarithmic spiral.

Wonder, if these may be non-fantasy-domained germinations of testable seeds of ideas. Measures of variations from constant growth factors that would relatively evaluate similar sets might bring one day to our fold comparatives of comparably similar situations in markets.

So, Phi & Fibonacci may still not be the privilege of the El**o*t wavists alone. Molluscian phenomena come in so many shapes, colours, sizes and levels of deception in the markets too. Might a day be brought upon men of the markets when measuring deviations from beauty of perfect growth be quantifiable and the seekers of the magic of phi in prices dump the chimera for better, realizing the underlying constructs of 0.618 for what they are.

Notes from Abroad, from the Pen of Sushil Kedia

Forecasting particularly the weather which modern satellites and super-computer based algorithms of the meterological departments has often produced adverse incursions of huge intensities and far more frequently than the said algorithms and forecasting models would assume.

More than the missed call of a less than normal monsoon which the Met forecasted a couple of months ago and when Mumbai and its hinterland was slapped with a downpour in all of 2 and 1/2 hours that broke a 100 year record, the second miss and addition to mass panic that the Met ended up doing yet further that more serious rains are expected in the last day and the sky has befittingly remained silent and dry.

Modern city living, what with its promised over-sophistication ends up drawing a population to itself far in excess of what the infrastructure can handle at any stage of the advancing evolution at such moments of tension and strain on the system.

20 million people getting anxious, what with a 100 Television channels operative in India all simultaneously booming not just citywide, but nationwide a story of unfolding calamity exacerbated the simultaneous exits of people from offices, factories, schools etc. etc. The CROWD was setup not so much by the rains, but by the new found information booming Television Industry. So, the rains did pull the trigger out here in Mumbai in the last 48 hours, but I strongly suspect the credit for building the spiral of emotions and thus accentuating the human calamity more than the wrath of nature must be the crowning glory of none but the efficient media.

I thought of pulling this point up on the open list, getting some lesson out of the episode that may be applicable to most things in life and for most moments in the markets the information explosion machinery might in the name of adding efficient discounting of events be actually heightening the intensity of human response to it way much more.

A friend on the other side of the globe in the Americas, got troubled and made efforts to check if I & my family was ok. That is sufficient proof of media induced panic, concern, care, tension traveling to every nook and corner of our globe. Indeed, the hundreds of deaths, loss of property and complete breakdown of the system phone networks collapsing under the load that overshot estimated peak load, transportation grid in a complete deadlock, all economic units including those that would sell medical care, food, newspapers etc. etc. being subject to the same media induced exacerbated panic far beyond the intensity of the natural calamity.

Ken Smith writes about Bernard Mannes Baruch;

Bernard Mannes Baruch (August 19, 1870 - June 20, 1965) was an American financier, stock market and commodities speculator, statesman, and presidential adviser.

"In 1957 institutional research was welcomed by no less an authority than Bernard Baruch, who said: "The emergence of this new profession of disinterested and careful investment analysts, who have no allegiance and alliances and whose only job is to judge a security on its merits, is one of the most constructive and helpful developments of the last half-century" (David Dremen, 1977).

As Lack would say, "They don't get the joke." Well, maybe Lack would not say that, but I will.

First, the new profession was not disinterested. Second, then new profession was not careful. Third, the new profession did have allegiances. Fourth, the new profession did have alliances. Fifth, the new profession had a private agenda and was not without self-serving motivations. In fact the research reports were aimed at stimulating the purchase of financial instruments in which their superiors and associates had an interest in, for profitability, to be obtained by the firms they worked for, on humongous compensations schedules.

That's the joke.

The Department of Hubris Notes This Article Sent in by Jeff Rollert

DJ Plans For Proposed Tallest Skyscraper In US Unveiled (DJ)

CHICAGO (AP)--Noted architect Santiago Calatrava has officially unveiled his plans for a proposed 115-story high-rise in Chicago that would replace the Sears Tower as the tallest building in the country.

The two-thousand-foot-tall building would twist up toward the sky like a giant, silver birthday candle. It would go up along the city's lakefront near Navy Pier.

Calatrava presented his plans during a news conference Wednesday at the Museum of Contemporary Art. He says the proposed building would continue helping shape the downtown area as a place to both live and work.

Chicago developer Christopher Carley says the building would house a hotel and residential space. He says he needs to sell 40% of the building's residential units before he can break ground.

The building must also be approved by the city.

Comment from William Mitchell, Professor of Architecture, Media Arts and Sciences at M.I.T.


Yes, they will all have exactly the same problems of decreasing efficiency with height. The Chicago project will suffer from these problems a little less, since it is a residential rather than an office tower, which means lower density of occupancy and therefore less requirement for elevator space.

As far as I can tell, the reasons for building them are the the same as usual -- some combination of national or civic pride, the ego of the developer, and the perceived real estate marketing benefit (I'm doubtful that it's an actual benefit) of being able to offer "the tallest."

They may not be real projects, incidentally. People who need publicity, for one reason or another, have figured out that they can get it by announcing a project for yet another "world's tallest." Sometimes it's an effort to take the wind out of the sails of somebody else's project. It doesn't cost much to do, and the press usually takes the bait -- particularly if there is a famous architect involved. There are a lot of these announcements, and only a fraction of them come to fruition. I'll believe that the Chicago project is real, for example, when I see that the financing is firmly in place.

Building monster towers is clearly not a rational use of resources in a strict sense, but I don't really see it as culture rot. It's just another form of expression of pride by means of conspicuous consumption, and in some cases another way of separating fools from their money -- not the most commendable of pastimes, I suppose, but very human and time-honored ones.

George Zachar adds:

As a lifelong New Yorker and amateur architecture buff, I like really big buildings, if properly sited, and think folks who choose to live/work in such spaces are rationally allocating their resources.

The Time-Warner Center at Columbus Circle, for example, sits atop an enormous transit hub, and is an easy walk from the theatre district, midtown offices/shops/restaurants, Lincoln Center, Central Park, etc. It is a natural, comfortable home for what would be too big elsewhere.

Similarly, the banal but now missed World Trade Center towers were an easy walk from a large mass transit nexus in a neighborhood that by itself is the third largest office district in the nation.

Windows on the World, which topped the North Tower, was the highest grossing restaurant in the country at the time of its demise.

Yes, the Twin Towers had a rocky financial history, but given what's happened to real estate in the last few years, there's little doubt rents there would have risen alongside the rest of the city's commercial property.

Love of density is not a widespread attribute in the American public. The wild popularity of low-density suburban living, and its attendant car culture, attest to this fact.

But unquantifiable "returns to density" are apparent in the speed with which New York returned to better-then-normal after 9/11, and the rebirth of countless cities in history that had been devastated by war, plague, etc.

If private investors and occupants want to create and consume "world's tallest" structures, I can't come up with a reason to impede them.

William Mitchell replies:

There's nothing, per se, wrong with concentrations of urban density, like Manhattan and the Chicago Loop. In fact, as pointed out below, they have many advantages. But the crucial points are: (1) you don't have to go highrise to get high density -- London and Paris, for example, are very dense without a lot of towers, and (2) there is always an optimum height for towers, for the reasons that we have discussed, and going beyond that optimum height always produces inefficiencies. (Conversely, not building high enough on a valuable urban site wastes some of its potential.) As shrewd architects and developers know, the trick is to hit the sweet spot.

Pam Van Giessen adds:

Professor Mitchell is spot on. At the end of the press conference the developer mentioned that he would not be able to start building until the place is 50% leased. That's a lot of pre-leases that need to be sold. Further, this is not the first, second, or even third time that some developer has announced plans for the tallest building in Chicago. Since 1989 several developers have announced such yet none of the projects has yet been built. I won't even believe Trump Tower till the thing is totally done and they turn the lights on.

Apparently Professor Mitchell has seen the media regularly take the bait on these sorts of announcements before (probably the Chicago media!). My reaction to the announcement was "yeah, right," while shaking my head at the predictable media absurdities of a slow summer news day in the Second (but best!) city.

On a related note, George Zachar sends:

EUOBSERVER / BRUSSELS - Moscow is set to host Europe's tallest skyscraper after the Russian firm Mirax Group signed a contract with Chinese builders on Monday (25 July).

The investment creates a stark contrast with the EU's construction sector however, which is struggling to emerge from a 10-year long recession.

"Russia feels itself as the midpoint of Europe and Asia", one of the building's architects Sergei Tchoban told EUobserver. "The wish of Moscow is to be seen as a world class metropolis and financial centre and this statement must be projected outward"

Chinese Engineering Construction Corporation will erect the main part of the 85-storey, 340 metre tall Federation Complex at a cost of some 440 million in the heart of Moscow's financial district.

The building is due to open in April 2007, hosting a five-star Hyatt group hotel, luxury apartments, offices, shops and restaurants.


CHICAGO: A 224-storey pyramid shaped building, the tallest in the world, is being built at Katangi, near Indian city of Jabalpur in Madhya Pradesh state. The 2222-foot (677m) Center of India Tower scheduled for November 6, is being financed by Maharishi Mahesh Yogi (The Beatles' former spiritual leader), and will be his new world headquarters.

The Department of Numerology, (Professor Charles Pennington), applies itself to the S&P:

The S&P futures' last 6 closes were 1233, 1236, 1230, 1237, 1234, and 1235. 6 is 2 times 3, and the next-to-last digit of all six closes was 3. Even more uncanny, we are currently in the third millenium of the Common Era.

Anyway, the part about having at least 5 closes in a row with the next-to-last digit unchanged. This doesn't happen very often. It happened in June, I see, but the last time it happened before that was November 10, 2004.

Here is a listing of the occurrences since 2000. The columns are "next day S&P futures change in points", "date", and "unadjusted S&P futures close". It hasn't been pretty!

-14.7    8/29/2000    1518.3
-12.2    3/12/2002    1169.5
-4.5     1/15/2003    921
-11.5    4/8/2003     878.3
-21.8    5/16/2003    944.3
-6.6     9/8/2003     1029.1
-10.5    9/9/2003     1022.5
-11.4    10/16/2003   1049.2
-4.2     11/7/2003    1050.4
 6.9     12/5/2003    1060.8
-8.6     12/8/2003    1067.7
 0.8     7/12/2004    1113.4
-2.9     7/13/2004    1114.2
-7.9     7/14/2004    1111.3
 6.4     8/24/2004    1097.4
-14.4    9/21/2004    1127.3
 8.9     11/10/2004   1164.8

Victor Niederhoffer on Horror Movies and the Abelbufflecketts;

There is something terrible about the movie Lost in Translation that explains why markets have more than their usual 1.5 million % a century drift ahead of them imminently. The terrible thing about the movie is the hateful arrogance Bill Murray shows towards the Japanese and his utter contempt for them and the business system where they request him to do two or three takes of his one-minute Saitoro commercial to earn his $2 million fee. How importunate of them, he thinks, to politely ask him to put more emotion into his delivery than his usual deadpan style, now regrettably repeating itself in the equally demeaning and hateful, Broken Flowers where he truly is amazed that his son and step wife are put off by his lack of emotion, and is turned off by their banal views and lower brow middle class habits as compared to the sophisticated kinds of things that dead pan comedians like him find titillating.

But why do the Bill Murray's of this world get unanimous favorable reviews and command the mega bucks, the only comparables being the 90% of the other successful films that are horror shows. You see, the average American is completely insecure. They love the horror shows, they love the comedians who put them down, who make them feel insecure because they don't set up their jokes with an elaborate lead, because it enables them to play act their fears about their own self worth.

The same thing is at work with all the mumbo jumbo about how the American system is about to crumble, how the stock markets about to go to 5000 again, about the jobs we don't create, the terrible things we spend our money on like SUV's instead of saving for factories, the corruption of the financial reporting and business ethics as exemplified in the Enron story.

That's why the weekly financial columnist is the most revered man in American financial journalism, and why the sage is considered the world's greatest investor, with the greatest wisdom for the masses even though his stock hasn't gone up in 8 years, and he hasn't found one stock he likes that he might buy during this period except for the proverbial See's Candies that brokers sell him when they cant find anyone else to pay above book for these substitutes for the short line farm implement type companies and declining regional retailers he used to like to buy before Charlie taught him that you can just buy something good and hold forever, the second worst idea in the history of American business since there is so much change from year to year that you must always be dynamic in your investment portfolio.

In any case, as our insecurity mounts, as our desire to play act our insecurities rises, as manifested in the popularity of the horror shows, and the Bill Murray put downs, we become more prone to mumbo jumbo about the coming market Armageddon. The professors play their role in this by talking about the declining risk premium we can expect to see in the future, and the incredible unpredictable volatility and fractality and earthquakery black swan disasters, we can expect to find lurking in the future, thereby providing a backdrop for people to express their horror film insecurities by eating up the advice to avoid stocks. But of course, that's why the IPO's have returned 50% a year the last few years, and can be expected to set the bar for other returns as long as the horror films and the Bill Murray's and the Sages remain in the limelight.

What could be better for the poor specinvestors of this world who do not share this gloomy view?

Pam Van Giessen adds:

Hasn't it always been thus, particularly with Americans? As our lot improves, we keep looking/expecting the proverbial other (bad news) shoe to drop. Perhaps it's a war between the optimists and the pessimists. Pessimism seems to make for better (easier) theater/entertainment than optimism. Everyone knows Jaws; who even remembers Rooster Cogburn?

Perhaps Dr. Brett would have something interesting to say about the psychology of society on a larger scale?

A response from Kim Zussman

Another interpretation takes into account the common, but not universal, male middle (of what?) age burn-out. A younger Murray would likely have been excited and honored by his Japan visit, but the weight of his banal, financially successful life robs him of this pleasure. Until, of course, megatart Scarlett Johanssen inexplicably and situationally chemotaxes toward him. That'll wake 'em up (did me) toward life and even the Japanese.

Perhaps this is yet another example of Hollywood social opinioneering: We are sooo successful, sooo prosperous, soooo bored because we lack the soulful humanity of cultures like Japan. Or Russia, where the soul was invented.

Maybe such preoccupations with sybaritic sensationalism distracts from puerile capitalistic objectives, such as feeding and housing society? (Na-Zdarovya: the Russian toast which means "To your health")

Thomas Miller adds:

I think societies cycle between periods of optimism and pessimism, everchanging cycles, but man is basically optimistic or we wouldn't have survived this long. Investors also go through periods of optimism and pessimism, bull and bear markets, but as Triumph of the Optimists shows, the optimists win big over time.

Its important to identify the current mood of investors and follow the money. I think the optimists currently have the upper hand. People seem to say there are a lot of things to worry about, but it doesn't seem to be negatively affecting their investment habits as charts of the major indexes show. Aren't bull markets supposed to climb a wall of worry? As for current entertainment, the horror movies and others mentioned may do well, but I think the positive family movies from Pixar and Dreamworks do even better. I recall The Passion of the Christ did well, igniting something of a revival of Christianity around the world. I read that Hollywood, ever following the money, is set to make movies showing religion in a positive light. Not that long ago, many movies showed priests as psychotic devil worshipers, etc.

To paraphrase Sophie Tucker who once said, "I've been rich and I've been poor; and rich is better." - I've been optimistic and I've been pessimistic; optimistic is better.

Another song for the Spec Party. This song was composed by Ms. Lisa Borodkin, inspired by a karaoke performance of "Boots Are Made for Walkin'", originally sung by Nancy Sinatra:


You keep sayin  you got a short for me
And the market will tank, but confess
You been shortin  where you shoulda been longin
And now there ain't no egg left in your nest

Stocks are made for buyin
And that's just what I'll do
One of these days my stocks
Are gonna walk all over you

You keep bearin  where you oughta be bullin
100 years, and up 10 million percent
You keep dumpin  where you shoulda been pumpin
One day you'll be right, but you ain't been right yet

Repeat Chorus

You had a good week, so you gave me a teasin
And you keep sayin  that you'll never get burnt (HA!)
Well I know a bear who could be in for a squeezin
And he'll lose more than he's ever earnt

Repeat Chorus

Ready Stocks?  Start buyin'!

Top Athletes are Freaks, the famous 198: By James Lackey

Bobby Myers gets this fascinating first hand account of the famous 1980 fitness test in an interview with Brad Lackey.

Racer X: Okay, Brad, let s hear it from the horse s mouth, so to speak. From the top, what went down that day when all you guys went to the NSHI [National Sport Health Institute] and participated in this fitness test?

Brad: Cycle Magazine sponsored it, I believe, and they wanted to determine if motocross was really the second most demanding sport in the world behind soccer. So they picked seven or eight of the top riders and sent them to Southern California in Englewood in 1980. Their [Cycle s] original plan was to determine if a privateer didn't win races due to the equipment, or was it a lack of conditioning on the privateers part. So they selected about seven top racers and one privateer, who I believe was the top privateer, but I can t recall the guy s name. Chris somebody. I have the original article back home somewhere, and I'll send you a copy if you d like, Bobby.

Okay, Brad, sure. Anyway, it was Mike Bell, Danny Laporte, Jeff Ward, myself, Kent Howerton, and a couple other guys. I can t remember who it was, but anyway, the deal was, we went down there and we were going to show them what motocross racers were all about. This is the place where they test the top athletes from almost every sport.

Continued here

High priced and low priced S&P stocks in the second half of the year, by Charles Pennington

I thought I would take a look at how low and high priced stocks respectively have performed during the second half of the year.

Given below are the percentage returns over the 2nd half of the year for, respectively, portfolios of the "high" priced stocks in the S&P and of the "low" priced stocks in the S&P.

For the "high" price portfolio, we hold equal-weighted positions in each of the 50 highest priced S&P stocks, and for the "low" price portfolio, we hold the 50 lowest priced stocks (although we exclude stocks with prices less than $1 per share).

Here are the results:

 date       % rtrn HIGH prices    % rtrn LOW prices
 12/97           10                      16
 12/98           3                       -7
 12/99           8                       -7
 12/00           2                       -3
 12/01          -5                       -2
 12/02         -12                       8
 12/03          15                      40
 12/04          9                       10

 avg            3.8                      6.9
 std dev        8.8                      15.8
 t-score        1.2                      1.2

The low price stocks had a higher average return, although with higher volatility as well.

Although I won't report it in detail here, I did find that the low price stocks were much more volatile during the first half of the year than during the second half; the standard deviation for the returns in the first half of the year for the 97-04 period was 31%, much greater than the 15.8% given above for the second half of the year. Ironically the second half is the quieter one, despite the fears of October crashes.

Two Songs to be Sung at the Spec Party by a Special Guest, written by Laurel Kenner

Old-Hearted Men

(to the tune of "Stouthearted Men" from "The New Moon"; music by Sigmund Romberg, original lyrics by Frank Mandel and Oscar Hammerstein)

Spare me from men
Who are old-hearted men
Who've been short ever since '82.
Who always call
For the market to fall
Who have always the same point of view
Shorting the dollar,
They don't like the dollar,
They don't like the market at all!

Spare me from old men
Who don't like high vol or low vol
Cynical old men,
Who don't like
Anything at all.


Spare me from men who like
P/Es of 10
And a price less than two-thirds of book
Men who can't find value fair anywhere
In the market wherever they look

Nothing for sale in the market appeals
When the trade deficit is so wide
Everything is wrong,
And never's the time to go long
Say old-hearted men
Who sing the old old-hearted song.

The Hedge Fund Song

(to the tune of "What Is a Man?")

There are so many, so many
Hedge funds to choose
Which one is the best hedge fund for me?
They all are long-and-short, as far as I can see
Seven thousands funds, one strategy.

There is no risk
None whatsoever
Win, lose or draw
They take my fees
I'll  prob'ly lose all my money
Something about it seems funny.

There is no risk
With a long-short fund
They charge me fees,
'cause they are so good.
Thank goodness I'm in a long-short fund!
They'll take my fees,
Fees upon fees,
I give it all to them!

Five percent
Quite a low commission
Four percent management fee
Plus one-fifth
Of my profits
One-third if they're good
Goodbye, goodbye gains!


What's a good fund?
Is it a black hole?
Taking more fees
'Till I'm bled dry?
Paying a bite to a fund of funds?
It's a good deal,
Really a steal,
The manager wins in the end.

Victor Niederhoffer on Momentum in Basketball and Markets

In his discussion of the four corners offense, Dean Smith, the hugely successful coach of North Carolina from 1961-1997, says he likes to introduce it when he's just reached the plus point after coming back from a big deficit.

Some might say that by slowing our pace we're cutting our own momentum, however, I believe that momentum often has an uncanny way of shifting once a team has come from behind. There is that tendency for that team that pulled ahead to breath an understandable sigh of relief. Also, the opponent's flow begins to surface with the realization that the lead must now be recaptured rather than merely protected.

Is this a general tendency of human nature, and is it reflected in markets? I have counted this in many different directions and find that Mr. Smith may have hit upon a universal truth.

J. T. adds:

Often in the NFL teams that develop leads or have overcome a lead with less than 5:00 min to go on the clock go into a "Prevent Defense" This is very similar to Mr. Smith's comments. It possibly might be a truth associated w/ the round number theory. Being an avid hiker in my teens, reaching an apex to a hill changes the hikers mental state and rhythm when hiking. Also paddling through rapids in the higher classes gives this too. Going from low chip count to higher chip count. The tension and release mentioned later last week is tied into this somehow as well.

Possible formula could be:

  1. You're behind
  2. You overcome
  3. Tension is released
  4. You take use of momentum change
  5. Change your game
  6. Mix up your strategy (defense/offense, strokes, paddles, steps)
  7. Keep momentum and opponent becomes confused and baffled

Jim Valvano former N.C. State Legendary coach being in the same conference as Dean Smith, and new on the job back in '80 had to come up with something to overcome UNC and UVA w/ 7'4" Ralph Sampson. His strategy eventually worked and led the Wolfpack to one of the most memorable finals over the heavily favored Univ. of Houston and the "five slamma jamma". Being in the Same conference with the Tarheels and the "four corners" Valvano knew that every touch of the ball was important and he would need to get as many touches as possible. With the other Team stalling, he simply told the troops "Foul 'Em Boys", foul 'em, foul 'em and keep fouling. MAKE THEM BEAT US FROM THE FREE THROW LINE. If they started making free throws then he changed back and called off the fouling. He in essence controlled the other teams Offense with his Defense (hard to do). This is a wonderful, beautiful, example of the law of ever-changing cycles.

Mr. Valvano had two quotes that I will never forget.

1) "I figured State being an Agricultural School, we could milk a lead"

2) "My father gave me the greatest gift a person could ever give another person, he believed in me."

Steve Ellison comments:

Some NFL teams practice with loud music blaring from speakers to prepare for a game inside a domed stadium. Tiger Woods' father habitually created distractions, such as dumping clubs out of the bag, while Tiger was shooting in order to develop the concentration Tiger would need to ignore distractions on the PGA tour. How can speculators practice to prepare for the market's deceptions and pressures?

Dick Sears Weekly Commentary:  Nothing Ventured, Nothing Gained

Posted on Letters to the Editor, an article sent in by Paul Elliot of Motley Fool about the tricky business of selling.

Tension and Release, by Victor Niederhoffer

You see the concept of tension and release everywhere in life: in music, literature, movies and TV, humor, yoga, massage, and s#x. Indeed, I reviewed 3.8 million Google articles on tension and release (definitely not a Googlewhack) to get a handle on it. A good general framework for it is that it's a statement of a theme, followed by a conflict with that theme, followed by a return to the theme.

It's easiest to see in the form of music with a major or minor chord, followed by a note that doesn't belong to that chord, followed by a return to the chord. This is the basis for many good schemes of composition and improvisation and in the literature it is agreed that Beethoven and Bach and Wagner, and Elvis, were the masters of this. Many references to "Rock Around the Clock" as the archetypal tension and release modern song.

One experiences tension and release most clearly when with one's significant other, and finds it in the buildup of tension that finally becomes explosive and leads to happiness. It's an experience I found most lacking during my experiences with losses in 1997 (as recounted by my detractors and would-be destroyers with great glee).

Yes, but does one experience it in markets? And is it useful and predictive? There are so many anecdotal examples that one could write a sonnet about it. The most recent was the British subway terrorist bombings which was the culmination of the buildup of tension about what would happen to the market the next time a heinous terrorist act occurred. Once the tension was released, well, the market rose a quick 7%, and worldwide wealth moved up a nice $4 trillion or so.

It also occurs when we wait for the employment number to be announced with great fears about the economy's inability to create jobs, of the kind that the sybarites and chronic bears would like to be more rampant. And it occurs as we wait for that round number, the magic 5000 in the Dow that the chronic bears look for or the magic 5000 in the Nasdaq that I look for as soon as the last bear, the last true believer in the Sageist financial columnist throws in the towel as happened in 1999 when the last short selling fund closed its doors.

But what about during the week? Is there a natural rhythm to the bars of the market with a weekly 5 quarter time. Well, one has to start somewhere, and what better way to spend a Sunday morning with the relief of a tense hypothesis vis some counting.

To be simple, I looked at the 5 daily closes in a week in the S&P futures and classified each week into 4 categories. Was Friday the highest or the lowest of the week. Or was it not an extreme. If it wasn't an extreme, I classified it into a non extreme + week or a non-extreme - week.

Thus, last week's closes: Mon. 1226, Tue. 1233, Wed. 1236, Thur. 1230, Fri. 1237. It's a high week. Friday is the high. The week ending 6-24: Mon. 1220, Tues. 1221, Wed. 1221, Thur. 1204, Fri. 1196. It's a low week with Friday the low.

If Friday weren't a high or low, then I classify it as based on the move in the week. Like the week ending 7-1 where Mon. 1196, Tues. 1206, Wed. 1203, Thur. 1196, Fri. 1200. It's a non extreme + week because Friday's close of 1200 was higher than the previous Friday's of 1196.

I looked as a start at the last year's data, a period during which the market rose from 1079 to 1237. I found that of the 50 weeks I considered 32 were extreme weeks with Friday ending at the low or high; and this seems high for randomness. After the 11 low weeks, I found an average rise of 1% the next week. After the high weeks, a rise of approx 0.4%. The 21 non-extreme weeks yielded a slight negative average.

The results look to be somewhat supportive of the idea that the release of tension is a somewhat euphoric event for markets as well as humans. Much further work would seem to be possible here, and I leave it as a market offering to the reader to do so.

I found the article by Bill Hammel on tension and release an excellent generator of hypotheses and aid to my understanding in this peregrination.

Fine Sweet Tea, by J. T.

I took my wife and kids this weekend to the Orange County Fair. Not the Orange County in California! This is the typical country fair in our part in the South. Livestock auction, pig races, egg toss, food and more food, bluegrass music, blue ribbons being passed out, and a lot of handholdin' going on. Great time if anyone ever wants to come South. It's held on James Madison's estate, Montpelier. Gorgeous trees, hedges in the middle of nowhere. Adjacent to the fairgrounds is a beautifully sculptured parcel of land with a dirt track in a class with Churchill Downs and Keeneland. The whitest rail fence you ever laid eyes on, with beautiful contrasting orange dirt all laid out in a bed of the greenest grass on earth. Really something to see, with no grandstands, seating, benches or chairs.

The BBQ was equally good, though the slaw was too finely cut. Shredded is far better on a sandwich than fine chopped slaw. I had a basket of ribbon fries doused in malt vinegar as well. I had never had ribbon fries before; they are made as if the potato were a continuous potato chip, paper thin. This of course was washed down with some fine sweet tea.

"One Wants to be an E-T-F", by Kim Zussman

One wants to be an E-T-F
That's what one wants to be
For if one were an E-T-F
Then one could ride for free

I'd form a little basket
And fill it full of stuff
For longing or for shorting
I wouldn't make it tough

They'd call me up with options
Or put me down with glee
And as I age with decay
I'd model with a tree

You'd want to use statistics
Since losing makes you rant
Numerical heuristics
Popper says you Kant

I want to be an E-T-F
That's what I want to be
For if I were an E-T-F
You'd trade me for a fee

'Briefly Speaking' by Victor Niederhoffer:

  1. Ernest Hemingway is one of the few writers besides O'Brian with a good feel for modern investments. He writes in 'Old Man of the Sea' that the best time to sail in the Caribbean is during the hurricane months. The old fisherman always knows when there's going to be a hurricane a few days in advance, from the sea. I wonder if the normal summer decline we've been exposed to the last eight years, a highly significant and consistent one of about 2.5% a month on average, is like the hurricanes. When it doesn't occur, that's when the fishing is best. But that hypothesis must be differentiated from the normal mumbo jumbo that the Expert and the Fractalist like to trot out, that if you missed x of the last 20 biggest rises, why then you'd be left worse off than catching the sweat off a rich man's back.
  2. What is it about Humphrey-Hawkins that makes the world such a perfect place for the chronic bears for one day, with the average declines showing a t-score of -3 over the last decade and with this year's mere 0.75% decline actually more favorable than the average. Could it be the vindication of the sell on the news hypothesis?
  3. The reaction to the devaluation of the yuan has been commented on qualitatively by many. As I don't follow Asian developments (have I mentioned in the last week the devastating blow they administered to me and my customers in 1997, much to the joy of my detractors?), I can only comment that the devaluation was apparently exactly what the administration had been encouraging and hoping for recently. Yet, worldwide wealth managed to drop by at least $400 billion when it happened. Is this an example of unintended consequences, or a normal reaction to an event that was relatively certain vis a vis its ultimate appearance but uncertain as to its timing? A classification of events into uncertainties based on timing and magnitude might be a good start for psychologists interested in studying investor behavior without undue promiscuity.

George Zachar responds:

As to Humphrey-Hawkins, I have long contended that Greenspan's non-dramatic presentations are inkblot tests of the psychology of marginal capital deployers. They see what their self-defined blinders permit them to see, and react accordingly. This is qualitative, yes, but does provide periodic gut-checks of how the crowd perceives things.

And as to the yuan, I believe you are over-stating the timing uncertainty. There was an unmistakable run of very specific press leaks last week, predicting a Chinese currency move no later than Jintao's September visit to the White House. The nature of the reval, OTOH, is still ambiguous, and the subject of much chin tugging. Snow yesterday admitted he didn't know what it all meant, and said he was dispatching a team of Treasury bureaucrats to the Middle Kingdom to figure it out. Yesterday we learned where weak hands had positions near stop-loss points, and not much else, I fear.

Notes from Abroad, from Laurel Kenner

I am having a adventure of the sort that is uplifting to all specs, such as learning about how the old Cape buffalos are kicked out of their herds by the young bucks and spend the rest of their lives solitary and "very mean; they charge anything," so like the Abelsons of our world.

We also saw a classic scene in which a wildebeest, which you may recall looks something like a Minotaur but with four skinny legs, lead a herd of indecisive zebras across the Mara River while a crocodile lay in wait. Yes, we watched the zebras hesitate and deliberate and agonize for almost two hours until the wild wildebeest started neighing and then charged across the river fearless. But the crocodile just swam away, not liking zebras, and perhaps he decided instead to wait for the main chance as the thousands of wildebeest make their way from Tanzania to eat the Kenyan red oat grass. It all reminded me so much of investors who wait until a wild beast gives the example and then all move en masse toward the good oat grass. I am traveling with a younger personage. Everyone thinks she is my daughter, or possibly my grand daughter . I had a splendid offer of a dowry for her, and naturally I accepted with many modifications. But in the end the suitor did not deliver so we proceeded on our way to Zanzibar.

By the way we stopped off at Carnivore, supposedly one of the world's top 50 restaurants, where they used to serve wild game, but there is none of that any more as the government has put an end to the zebra barbecue and other things. Nowadays the most exotic thing they serve is farm-grown crocodile and ostrich. The presentation is dramatic as the waiters bring big skewers from a round smoking barbecue pit in the center to the table and carve off slices on to your plate. But all in all it didn't measure up to Austin. And our driver informed us that since he went to college he cannot countenance eating any sort of game meat at all so apparently the indoctrination is thorough.

Investment Philosophy: A Cynic's Guide, by Deon Gouws

Deon Gouws is CEO of Sanlam Multi-Manager, based in London.

If you don't have great looks, you can certainly do with a decent pick-up line. This is not only true in the dating game, but also in many other walks of life.

Consider somebody in his late twenties, looking for his first "real" job; let's call him Mr Job Hunter. After scraping through his B.Com a few years ago, Mr Hunter decided to take time out, and back-packed around the world. His experience is limited to a few part-time stints as a shop assistant, bar manager, waiter and ski instructor in various exotic locations. Mr Hunter doesn't have a clue about investments, but he knows his way around Sao Paolo, and he makes a mean Martini. He also has some great photo albums.

Let's say that you met Mr Hunter on a plane. You are returning from an international conference on Stochastic Calculus for Discontinuous Processes in Finance; Mr Hunter is on his way back from swimming with dolphins in the Great Barrier Reef, and he has decided it is now time to settle down. Would you jump at the opportunity to offer him a job, sitting there with his long hair, torn jeans and the tattoo on his right shoulder?

Most people would agree that neither Mr Hunter, nor his curriculum vitae look very good from the perspective of the typical employer in the business world. So Mr Hunter does what anybody would do in his situation: he cuts his hair, he puts his best foot forward, and he dresses up his CV to the best of his ability; yes, he spends time on his pick-up line.

An employment consultant assists Mr Hunter. The selective disclosures do not focus on his surfing ability or his speed down the black slopes; instead his interests are listed as a "passion for financial services, and a desire to add value within a structured organisation". His part-time jobs are summarised as a "multi-skilled background, underlining the ability to adapt, and to work in a highly pressurised environment". The fact that he's looking for his first serious job at the age of nearly thirty, is described as "benefiting from maturity and self-knowledge". And it was his travels to the Andes, Lapland and the beaches of Fiji which gave him a "global perspective".

Mr Hunter interviews at a selection of investment houses and broking houses. He gets four job offers. He becomes an equity analyst in the industrial sector, has a few lucky breaks, and twelve months later he gets a 100% bonus. Within five years he exercises all his share options, resigns from the firm, and starts his own hedge fund. He retires at the age of 39 and becomes a ski instructor again.

Which brings me to Mega Alpha Investments, the firm that employed Mr Hunter in the first place. Mega Alpha focuses on the equities market, and if the truth be told, the two founder portfolio managers will buy any share which they believe will go up in value (and do so faster than the market, when times are bullish). They take tips from stockbrokers, they attend conferences, and sometimes they even read annual reports. Most of all they rely on their considerable experience and gut feel.

At the beginning of the company's life, they grew rapidly. They were on the right side of the bubble in the late nineties, performance was breath-taking, and times were good. Unfortunately the bubble burst, and Mega Alpha have now dropped to the bottom half of the ranking tables. Investment consultants have branded them as growth managers in a value market. Business has dried up.

At around the same time that Mega Alpha employs Mr Hunter, they also appoint a leading consultancy firm to help them in their marketing efforts. The consultants recommend that they work on a pick-up line; accordingly they assist Mega Alpha in formulating an investment philosophy. Curiously, the firm's founders have never thought about such a thing; this, in spite of the fact that they have managed to build a successful investment firm with a decent long-term track record.

Since it is true that the portfolio managers at Mega Alpha generally prefer to buy cheap shares rather than expensive ones, the consultants recommend that they open their philosophy with a statement in which they describe themselves as "value investors". Based on the inflated self-opinion of Mega Alpha's staff, most of whom always insist that they are right and the rest of the world is wrong, the consultants further insert a line in the investment philosophy stating that Mega Alpha believes that "investment markets are not totally efficient". Lastly, having interviewed Mr Hunter (the first analyst ever appointed by Mega Alpha), the consultants conclude that Mega Alpha believes in "detailed, bottom-up fundamental analysis"; this is duly inserted as the punchline to the investment philosophy.

Mega Alpha gets invited to a number of new business pitches. Unbeknown to them, all their competitors have similar-sounding investment philosophies. But they sign up some new clients anyway, as a number of trustee groups are convinced by their (newly formulated) research-based value approach within the framework of inefficient markets, and a presentation delivered with panache.

Soon after, Mr Hunter gets his first lucky break when he stumbles on a share in the healthcare sector. He bases his buy recommendation on an attractive price-to-book ratio. Six weeks later, the shares go up ten times after the company is awarded the rights to a new patent. Mega Alpha's clients enjoy spectacular performance.

At the time that Mr Hunter is wrestling over which sports car to buy with his first bonus cheque a few months later, the business development division of Mega Alpha can hardly cope with all the new business pitches. Which just goes to show that value investing probably works.

And so does having an investment philosophy which sounds convincing.

Virtual Trading, by Steve Ellison

My children, ages 12 and 10, are devoted to interactive online games such as Neopets and Runescape. These games have elaborate imaginary worlds. In Neopets, a player can earn units of an imaginary currency, Neopoints, by playing games. Using Neopoints, players can buy and sell imaginary items within the game. The items may rise or fall in value over time. Interestingly, the trading of items does not always remain virtual. Some items are sold on eBay for real money. As Edward Castronova explains in the Harvard Business Review:

Say one player needs a breastplate, but the game's developer has made this armor difficult to obtain within the virtual world. The player can go to an auction site, find someone selling a breastplate, and send that person a check for $50. Then the two meet online and simply click 'trade'. EBay category 1654, 'Internet Games', comprises thousands of auctions for digital gold pieces, daggers, ray guns, and robots--accounting for $30 million worth of business in the U.S. alone. In Asia, the real-cash virtual-item market exceeds $100 million annually.

Neopets itself was recently sold by its founders for $160 million to Viacom.

Phil McDonnell adds:

Some years ago my son was a big time player of online games. At one point he was ranked number one in the world on Microsoft Zone, a site which claimed to have over a million players. As a result a concerned Dad was able to see a great deal of the inside of online gaming.

This phenomenon of pay for success in gaming has been going on for at least 10 years by my reckoning. The idea is that successful gamers sell virtual items for real cash on eBay. Of course there is no way to know if the sellers are really gamers who acquired the desired item through skill. This, of course is tantamount to kiddie gambling with the winners cashing in their chips. But that's the good side, in my opinion.

The other side of the coin is the possibility that hackers or programmers from the company could be selling these items. In this case the items can be created at will with the wave of a virtual wand and sold for what the market will bear. Most kids will be none the wiser. An extreme version of this is that the companies themselves could sell the coveted virtual items to the kids as a way to cash in on the addiction to winning at any cost.

Another related phenomenon is in the online shoot 'em up genre. The name of the game there is hardware and connection speed. The most likely winner of any given game will be the one with the fastest CPU, fastest video card and the fastest online connection. As a result the addiction to winning has driven up the costs of the fastest CPU and video cards to as much as 100% above the next fastest model. Most of the high end has been driven by gamers trying to buy wins. All of this begs the question of how much skill is involved in a game where the player with the biggest bankroll (or Dad's credit card) wins.

Victor Niederhoffer on Actions and Reactions, an Autobiography of Roger Babson

The successful man is the one who had the chance and took it. -- Roger Babson

In reviewing the autobiography, "Actions and Reactions" by Roger Babson, one hears the song and lyrics of "Something Wonderful " by Rogers and Hammerstein.

"This is a man ... as long as you live
he'll do something wonderful,
He has a thousand dreams,
That won't come true
You know that he believes in them."

Among the dreams that Babson did make true were the founding of three colleges; Babson with more than 3200 students, Wooster, the first women's business college, and Utopia College, a utopian college in the 'center of gravity' of the US, (Eureka, Kansas). He was responsible for founding the first investment counseling firm which has grown into Babson Capital with some 100 billion under management, the founding and development of the first US financial statistics firms, including Standard and Poor's, Moodies, Babson Statistical services, and United Business Service, the writing of 47 books, and thousands of articles for Saturday Evening Post in its hayday. He was a public speaker extraordinaire, Presidential Candidate in 1940 (he placed 3rd), a trusted adviser and friend to men of genius including Steinmetz, Ford and Edison.

He was the founder of the Federal Home Loan Bank and related reconstruction type government interventionist organizations, inventor of a million adages including 25 carved in stone in Dogtown, Mass; major collector and popularizer of Newton's writings, the main forecaster of the 1929 crash, the successful entrepreneur who established and or promoted numerous businesses in financial services, health, safety , the visionary, one of the major investors of land in Orlando and Central Florida. And yes, this was a man who believed in anti-gravity, a man who was wrong about perpetual motion, a man who believed the problems of crime came from bad movies and radio, (which he tried to remedy with his own operation in each), a man who wrote all his books and articles outside for health, a man who conquered tuberculosis at the age of 25 and lived to be 93.

Most investors will turn to Babson for his development of the Babsonchart which is an attempt to apply Newton's third law of motion " For every action there is an equal and opposite re-action " to the market. Babson believed that a normal line of stock market movement could be developed and that areas above and below the normal line were equal. "We assumed that after a depression area, another period of prosperity would occur equal in area to the preceding area . We took cognizance of the shape of the areas, an area might be deep in intensity and short in duration or shallow in intensity and long in durations. In both cases, the square millimeters should be about equal. Furthermore, the ups and downs of each industry always bear a relation to the chart. One industry will reach its high point in the early part of an area of prosperity, and it's low point in the early part of depression. This is true of the stock market, a study of the stock line, bond line, and commodity line shows that there is a certain relationship between them. Remember however that the steeper the decline and the deeper the area, the shorted will be its duration and the more rapid will be its rebound, and vice versa. "

While Babson's theories on market movements are mumbo jumbo of the highest degree, they are suggestive of interesting statistical relations that should be tested. And the student with an inquiring mind, and a good inclination to counting could make much by sharpening and testing the ever changing nature of the interlocking relations in the variables considered by Babson. It is no wonder with false theories of fixed relations such as this that Babson was known as the prophet of doom in his day, much as Prechter is today, and that after predicting a constant depression from 1927 to 1929 he was laughed off as a chronic pessimist until he hit the bullseye with yet another early September 1929 prediction of a crash which he is remembered for today.

pictures and captions are excerpts from 'Actions and Reactions'

A much more valuable feature of the book is the panorama it provides of American business conditions in the 1890-1940 area . Along with Henry Clews book, 50 years in Wall Street, the student now has available a rather complete history of American business practices and history ,especially in the financial era. And yes, of course the main lesson is that conditions today are most similar to the way they were 100 years ago, and that the unraveling of the lessons of financial history is key to understanding today. Another lesson is that panics were as common as fires on the prairies in those days and almost all of Babson's friends, went under at one time or another thru overextension. In one of the most valuable parts of the book, Babson remarks that he keeps a copy of the complete issues of the Commercial and Financial Chronicle from 1870 to the present, and that whenever he wants to forecast the market, he finds what part of history the current most resembles, and then he looks thru the Chronicle to see what happened in those periods.

As a student of the market with his own independent research, who knows that cycles are always ever changing and that there are numerous random and unpredictable features of the market, I do not find Babson's theories on markets overly valuable, except as a spur to independent investigation. It would be interesting to quantify some of these theories on a prospective basis, trying to predict such things as the future distribution of prices, when a trend line is broken, based on the duration and depth of the previous moves. But what I found much more valuable from the bio were Babson's insights on business. Here are a few sample nuggets:

  1. Always buy a repeat products company as compared to an equipment company.
  2. Sell a company between the funeral of its founder and the installation of his son as the new CEO.
  3. Always ventilate your offices each day, make sure the air is fresh and moving, and work outside as much as possible.
  4. Use paper towels at all times, and wash your hands thoroughly.
  5. Analyze business cycles in terms of the health and happiness of the populace, their emotions, and the ratio of bonds issued at the end with rampant securitation of equity being the harbinger of imminent decline.

Roger Babson was a wonderful man and his book even when wrong will make you strong.



Is There a Doctor

Let's give the guy some credit for his strength of character not to walk out of the meetings he has to go to Capitol Hill and answer the questions asked by the total imbeciles who are in "public office".


Roger Babson, who believes in the possibility of an anti-gravity device and a perpetual motion machine, espouses a theory in his autobiography Actions and Reactionss that markets spend an equal area of time below a trend line and above. He feels this is an implication of Newton's laws of motion. But how to test such a view? By area, he means the integral or rectangular area of the time that a market is below a trend line, versus above.

The defects of his theory are like those of most trend line'ists in that the changes in trend can only be determined after the event has happened. I would propose to test his theory by looking at at the cumulative sum of the moves below a moving average versus the expected distribution of future moves once a movement above has occurred. Some consideration should be given to the slope of the movement as Babson believe that the greater the previous slope on one side, the longer the duration on the other side in the future.

Mr. Babson has theories on the proper use of paper towels, the avoidance of colds, the selection of proper mates, the efficacy of prayer, the values of repeat versus equipment businesses, and the use of buggy rides that are more in line with our normal métier.

John Bollingerr adds:

Mr. Babson is indeed an interesting figure; I have been meaning to get around to his autobiography for a decade or more. Specs may want to check out his Business Barometers for Anticipating Conditions, first edition 1909, I have the 23rd, 1933. There appears to have been an edition a year from 1909 onward. Of additional interest is Business Barometers for Profits--Security--Income. First published in 1940, I have the eighth edition, 1958. A highlight of the former work is a foldout table comparing nine stock-market panics from 1837 through 1930. There are also some "Babson Charts" that depict the early development of his ideas.

These older investing tomes are often interesting works that illuminate the analytical processes of our forebears. Many of the ideas represented are no longer applicable and many are used today in improved (?) form, but, most importantly, these older works can be a rich source of ideas for the inquiring Spec.

Notes from Abroad, by Roger Arnold

Japan has passed postal reform. Although it must now go through the upper house in August this should not be a problem. This is very important and I believe it will be considered historically akin to the election of Regan or Thatcher or the deregulation of the NYSE commission schedule; take your pick.

The passage of this reform is not simply indicative of the failure of their fiscal and monetary policies of the past 15 years. It is an indication that the echo boom generation in Japan is taking a politically dominant role. I have been watching for this for over 10 years now.

The Japanese post WWII baby boom began about two years earlier than in the US, for reasons I won't go into. But that makes the echo boomers, what the US would call Gen X, about two years older than the corresponding US generation. The leading edge is now in their early 40s, having been born between '62 and '75. They are now entering their peak income, spending and wealth accumulation years. This should be increasingly apparent through the next 10-15 years. Given this momentous deregulation, the dollar weighted outperformance of the Nikkei versus the SPX should continue for many years.

I do not believe the same applies to Europe even as their dollar weighted performance has been even better recently. Any faltering by the US economy in the near term should therefore be followed very closely by a falling dollar and acceleration of Japanese repatriation.

But this is where I get perplexed; i.e. Greenspan's conundrum. The Fed is intent on a 4-5% fed funds rate. Do the markets follow suit and adjust sovereign yields accordingly or do they abandon the monetary mantra and set a new course?

It is a heavy question for which I have no answers, but you'd better make sure you understand what is happening. It's heady stuff, and the last time the world was faced with this conundrum was when Nixon ended the gold standard. And a lot of people got that move wrong.

Finally, I increasingly find myself understanding the Sage's rationale for a multi decade dollar depreciation. Don't get me wrong: the Sage is an anti-social misfit and always will be. But there are logical reasons to expect a falling dollar/yen from here.

Gibbons Burke comments:

The market serves a valuable function in our economy not often talked about: It provides an efficient mechanism for transferring precious capital from those who are ill-equipped to steward its growth to those who are adept. A variety of market participants provide this service up and down the food chain. The financial markets are voluntary arrangements. No one is compelled to purchase a piece of trading software. No guns are involved in herding investors into seminars. Advisory letters are sent to those who willingly subscribe to them, and may be cancelled at will. Investors who avail themselves of these services without exercising due diligence and taking responsibility for their own actions are the true dangerous lot -- they are a danger to themselves. They blame others for their bad decisions and misfortunes; they delude themselves about the true nature of their problem, so the solution remains ever beyond their ken.

John Lamberg adds:

Tuesday AM. Phone rings. "Hello John!" "Yes?" "It's your friend Bob. Remember that investment letter I sent a few months ago?" "Why yes I do. It's the one that promised to make me a fortune. Worked great!" Pause. "I'm calling you today to offer you an opportunity to double your money in heating oil" Cutting "Bob" off, "Well, Bob it's 100 in the shade and I'm more in need of electricity for my air conditioner than heating oil. But I'll tell you what, take me off your list and I'll think about it for a second or two. Have a nice day Bob." End of call.

A Little Lobagola in the Naz? by Victor Niederhoffer

There is something beautiful about the movement back in Nasdaq 100 to exactly 1600, its first hit of the round number since the beginning of the year, and its fall to 1450 in conjunction with the leaked disappointing IBM earnings announcement circa April 14, and the surprising bullish one after the close of July 18. It has within it a tale of migration and return, rhythms related to the tax, weather and cycles of despondency and exuberance that could excite all the emotions.

Sushil Kedia reviews "Vedic Mathematics"

Vedic Mathematics by Bharati Krsna Tirthaji and V.S. Agrawala, is a very tiny yet potent compilation of the application of Sixteen Sutras from the Vedas. A Sutra when transliterated means a code or a formula. Vedas are the ancient body of knowledge from the Indus Valley Civilization. Because, the onerous task of scientific enquiry was also delegated by the society then to the spiritually absorbed sages, modern history has been misinterpreting in many instances the Vedas to be a body of spiritual-religious significance alone.

It is claimed that the Divine manifestation offered all that is to be known and can be known in the form of an all encompassing body of knowledge called Vedas. Without entering into the debate, it may suffice for our purposes here that a huge amount of research and deciphering work has been undertaken by several universities in America and Europe in the twentieth century and significant amounts of deep knowledge has been uncovered. Might we not agree that all knowledge is Divine in any case! It is claimed by many scholars researching the Vedas that the etymology of Vedic education was focusing more on building individuals who would become good at knowing than being merely good at learning!

The Vedic Tradition of imparting the said complete knowledge relied heavily on ways that would aim to make fuller use of the faculties of the brain and mind. Instead of recording reams of discussions and explanations on paper or other such recording device the Guru-disciple tradition trusted methods that would help develop perspective and intuitive application of deep principles helping facilitate lightning fast calculations and unbelievably compact communications making extra-ordinarily efficient uses of memory. In this very Vedic Tradition of handling knowledge a mnemonic code existed for handling large numbers as words and fairly evolved poetry. For an example, one may find that several of the devotional lyrics of the Vedic times are actually a poetic expression of numbers such as pi to 32 places of decimal when seen from this mnemonic code. So the ancients knew some good bit of mathematics.

This decoding of the mnemonic coding applied not only to numbers but also to bigger concepts is what has been facilitated in the twentieth century with the advanced universities of the West. The sixteen sutras have been interpreted to find immensely shortened procedures for calculations in our modern mathematics. With more evolved minds and more widely trained mathematical brains examining these sutras the concepts will over period I feel get applied to many more complex calculations becoming simplified and faster too.

Having explained the Vedic background and its tradition briefly as such, let me bring the attention of the list's mathematics aficionados to the specific samples of what may be accomplished on the study of this single book. Computing mundane transactions like the multiplication of a 10 digit number with another 10 digit number may become faster than punching the 20 digits and X and = sign inside a hand-held calculator! Yes, merely at the sight of the two numbers it may be possible to write down the answer from left to right!

Breaking down algebraic functions into partial fractions may not require expenditure of a couple of sheets of paper or a couple of minutes in solving a set of equations, but may become quite feasible to write the simplified partial fraction expressions at mere sight. A bit of practice with the new perspective obviously would help achieve the claim of 'at sight'.

The rhythm and very different rhymes embedded in numbers starts becoming more apparent to the mind on the study and practice of these techniques. Those amongst us who would like to encourage our kids to attack mathematics with both the left and the right brain would find the book very useful for this purpose too. I feel the biggest achievement of the techniques described in this book is to involve the two halves of the brain together! Early training that several kids received using the Vedic Mathematical techniques has helped them battle through some of the toughest competitive exams. like the IIT entrance also in India. There is a good chance the perspectives it can develop helps unleash the less or unutilized faculties of our brains.

The tall claims of "my method is best" are though a sore point in the text in several places, as can be expected from a devotionally oriented translator and may be ignored as the chaff in the wheat to get to the techniques. That's the only caveat along with a bit of complicated style of prose.

Dick Sears Weekly Commentary: Quiet Progress

A CXOAG review of "Momentum Profits and Non-Normality Risks", with comment from Thomas Miller

Why Momentum Investing Works?

In their July 2005 paper entitled "Momentum Profits and Non-Normality Risks", Ana-Maria Fuertes, Joelle Miffre and Wooi Hou Tan examine the distributions of returns for nine momentum investing strategies as they attempt to explain why the resultant portfolios outperform. Using monthly data spanning 2/73-8/04 for NYSE, AMEX and NASDAQ stocks and equally weighted portfolios, they find that:

All nine momentum strategies they examine show significant performance advantages for past winners over past losers (see chart below).

The standard deviations of the past winner portfolios is consistently just smaller than those for past losers, so reward-for-volatility risk does not explain the outperformance of past winners.

The distributions of winner returns consistently deviate more from normal than do loser returns, exhibiting a more negative skewness (the distribution curve tilts to the right) and kurtosis (flattened, with fat tails). Rewards for these distribution abnormalities may partially explain why momentum strategies work.

Momentum portfolios tend to follow the rhythms of the business cycle, incorporating more risk (higher beta and more negative skewness) during economic expansions than during recessions.

Efficient market theory still cannot explain fully the outperformance of momentum investing. Illiquidity and transaction costs may be part of the puzzle. The alternative view of behavioral economists, that momentum is a consequence of the market responding slowly to news, is still in play.

The following chart illustrates the annualized returns for all nine momentum strategies. The strategies devolve from two parameters: (1) the intervals of past performance used to rank stocks for momentum (R3 = last three months, R6 = last six months, R12 = last 12 months); and, (2) the holding periods for the portfolios tested (H3 = three months; H6 = six months, H12 = 12 months). All such portfolios generate considerably higher average returns for past winners than for past losers. Ranking based on a past performance period of 12 months and a holding period of three months produces the largest difference.

Link to article with chart

In summary, momentum investing works, and abnormalities in the distribution of returns for momentum-driven portfolios may partly explain why. A complete explanation of the success of momentum investing, however, remains elusive.

See also our blog entries of May 8 and January 10 regarding the momentum effect of inflows to (outflows from) outperforming (underperforming) mutual funds.

Thomas adds, 'I imagine that more work on this will be done by behavioral economists looking at investor psychology. As the train rolls toward higher prices, more and more investors become aware and want to get on board. This is not the same as the day trading momentum players of the late 90's, as "Ranking based on a past performance period of 12 months and a holding period of three months produces the largest difference." A lot more testing needs to be done, but the results cited in this paper are interesting.'

Invisible Strings by Yishen Kuik

I wonder what the invisible strings are that tie the different parts of the market together.

As an illustration, the S&P 500 (500 biggest companies), the S&P Midcap 400 (next 400 biggest companies) and the Russell 2000 (2000 biggest companies after the first 1000), taken together, more or less cover the top 2000 US companies by size.

Yet, not only do the futures for the three separate markets move together, they tend to experience high volume together.

I find this odd because the liquidity in the three varies so greatly (daily volumes: ES $50b, ER2 $7b, EMD $1b) suggesting that very different players are playing in each pool. In addition, most creatures in the market stick to a certain capitalization size.

Looking at one-minute bars, I often notice jumps in volume simultaneously across all three. Why? What are the invisible strings that cause activity to pick up down the line from the biggest to the smallest companies?

'The Rails Sing Eh?', a two part 'beat' tale by Bo Keeley

The Summer and Jim Lorie, by Victor Niederhoffer

The summer is always a good time to philosophize about the warp and woof of markets and how I found my niche therein. My philosophy is much increased these days as it's the first time in recollection I've spent an evening or two without family, collaborator, or business partners. A particularly poignant starting point is that the market is at a 4 1/2 year high at the same time my 82 year old mentor Jim Lorie is at a low in his physical health.

But for Jim, I'd be in a completely different arena. He guided me through graduate school, arranged for my scholarship to continue, beat back all those who would not have allowed me to get my degree, provided for my financial well-being, got me my first job. I can hear him now saying "You left out that I carried you in our squash tournaments."

Even more important than the meals for a day he provided, which were essential to my survival then, were the meals for a lifetime he provided, setting me on a path for prosperity in the future, and providing a foundation for my current position. Most important were his studies that showed that in almost all periods of seven years or more with a reasonably diversified basket of 10 or more stocks, you were likely to end up with a 10 percent per year return. He supported this view with a complete enumeration of every NYSE stock's performance since 1926. And he attributed the return to the balance between the requirement that entrepreneurs needed to start good businesses, and the intrinsic rate of return from entrepreneurial effort.

It was hard to maintain that view during the 1970s when books and articles bubbled over with doomsday projections, and the misery index broke 20% a year. But Jim kept saying that there had been bad times before and there would be bad times again, but nothing had changed the balance. He served as the director of many funds, brokers, and companies during that period. And to them all, whenever they'd say such things as "we’re in a bear market; we have to lighten", Jim always had the same answer. "There's no such thing as a bear market except for one that's gone down a lot in the past, and that's the best time to buy". I provided a similar rudder for others through the "bear market of 2002" with my many hundreds of articles, and books, always espousing a buy and hold strategy and holding up to ridicule the Abelsons and Sages of the world who saw the end of the Dow as an immanency.

Another plank in Jim's philosophy was the importance of incentives. "Give a person a chance to make a profit and keep it, and the next thing you know there will be a benevolent circle of material and personal well being. Stay away from those areas where the system is rigged so that the only systematic way to allow incentives to work is through government intervention". I have found that extensions of that idea, as it relates to dollar investments or alternative investments, is a chief plank for any success I have had, and more important, for those occasions when I have been able to maintain the fruits of same.

The returns that Joe McNay achieved for Yale in the 1980s by following a strategy based on Jim's studies, i.e. bringing some $1 million into $100 million over a 20 year period by investing in growth stocks, proved Jim's wisdom. Jim's own performance during the almost 50 years I have known him, a period during which he has been fully invested on margin almost throughout, is certainly of the same order of magnitude as McNay's. Alas, Jim is not more than 100 percent invested at the present time, as he is battling a tough illness and needs all his energy to fight back.

Jim has been a mentor for many, and I represent the endless chain of such students and youngsters that Jim and his counterparts have set on the right path over the years. I strive to provide a similar bulwark to others out of a benevolent gratitude and my own self interest in making the world a better place for good people.

A natural outgrowth of such thinking is the importance for youngsters to surround themselves with the Jim Lories of the world who will guide them on a path that has success along the way.

Kim Zussman adds:

This paper by Prof. Lorie describes his research. His description of dealing with errors in data is daunting and suggests that today's "data at the fingertips" might not be all it seems.

Kim Zussman on Terrorism and Stocks

It makes sense that VXO (old VIX) crossed below 10 today. The last time this occurred was over 11 years ago, February 1994, which followed all-time low in December 1993. Tech was not to be outdone: VXN closed at new all-time low. No doubt expiry played a role, in conjunction with our Teflon economy. Teflon economies, like Ronald Reagan, don't worry about burnt swans sticking (nor fretting academics nor Jody Foster's bullets). According to NBER, late '93 was less than three years post '91 recession, whereas currently we are 3.6 years beyond the most recent contraction. In 1990 at the onset of Iraq I, oil peaked at $40 then dropped to $14 around the VXO minimum. In early 2003, Iraq II, oil peaked at $38 then rose to $60 around the current VXO minimum. Perhaps oil's price reflects the manufacturing cost of Teflon.

Victor Niederhoffer: Guaranteed to Happen

Many systemists of the contrarian volition like to hold a position against the trend until the first day of reversal. After a rise like the last six days in the U.S., from 1172 to 1232, (a not inconsiderable 5%), they wait -- yes, they wait, for a down day close-to-close.

Such a day occurred Friday. And with the majesty that the mistress of markets displays to her suitors, the market actually accomplished a half-point decline -- 1232.0 to 1231.5 -- so that if you acted on it at the close, you would pay 1231.75. And you would have received your quarter of 0.1% back out of the 5%... if you were able to act before the close. How guaranteed to happen, and how Darwinian* in its terribleness.

*See last sentence of  "The Struggle for Existence," Origin of Species

News Flash: Optimistic Headlines Rampant on Bloomberg!

Every week, I look at the headlines on Bloomberg and think I'm seeing a preview of the leading weekly financial columnist's pessimism. And every week, I feel like Willie Sutton on hearing of Thomson's homer, ready to turn myself in at the nearest police station.

The usual:

  1. Stocks May Fall Next Week on Interest-Rate Woes
  2. Fund Flows out of US Highest in 7 Quarters on Twin Deficit Fears
  3. Expensing of Stock Options May Lead to Decline in US Profit Growth
  4. Buffett Sees No Stocks to Buy in US, Increases Bet Against Dollar
  5. Semiconducter Orders at Lowest Rate of Advance in Five Quarters
  6. SEC Actions Against US Executives Overshadow Profit Optimism

But this week, why it was like a page out of Success magazine. The first five headlines today:

  1. GE Profit Rises 24%, Most in Six Quarters, on Industrial Orders
  2. US Productivity Gain Most in a Year; Consumer Confidence Rises
  3. P&G Wins EU Approval to Buy Gillette
  4. Stocks in US Rise on Economic Reports
  5. Asian Stocks Have Biggest Weekly Rise This Year

Amazing. And what a mistake it would be think that bullish enthusiasm might not last for more than a few days, especially during the time that bears normally make money: the summer doldrums.

Comment by Jack Tierney, President of the Old Speculators Assoc.:

All the potential big, bad events that overhung the market seem to have been reviewed and are now recast as "handle-able" . Haven't seen any figures but bear voices seem to be far more muted than I can recall in a long time.

The above is an observation I made on May 25. Since then, I have watched and read a significant amount of material. Admittedly little of it comes from Bloomberg but the sources are, nevertheless, many and varied. And where many of you are finding all this bearishness confuses me...because I can't find a fraction of the pessimism that some of you regularly wail about.

Unlike the purists, I DO watch CNBC - and even those they bring on who are supposedly bearish are so understated and unconvincing that one gets the impression they're faking it. The "Wall of Worry" no longer exists -- Ross Miller was right months ago when he stated this is "the bull that will not die." (Of course, it will eventually, but for the time being it appears immortal.)

There is one concern which the bulls are getting more vocal about. "All that money on the sidelines." It seems there's still a remnant of the benighted who refuse to relinquish their money to the Mistress of Markets. At one time I counted myself among their number. Now I ask myself,  "Why have I been so long for so long?" I'm not complaining about the returns, but  I would like to be a bear here.

While I can appreciate those who have no use for Abelson and his unrelenting pessimism, sharing a view with Kudlow and Cramer isn't exactly comforting. And while exposing Buffett as a fraud may provide a measure of pleasure, I get little comfort out of the resurrection, absolution, and re-ascension of Meeker, Cohen, Holland, and Battapaglia. It's not beyond possibility that these individuals cost investors more money than good old Bernie Ebbers...but unlike the others, Bernie will have no opportunity to be a repeat offender.

Today's markets remind me of the old westerns and the obligatory night time scene and dialogue: "It's quiet out there." "Yeah...toooo quiet."

Compression and Expansion, by Yishen Kuik

The relative value/arbitrage/market neutral funds generally try to buy cheap and sell rich, whether within an asset class or across asset classes, and hence one might broadly classify the sums of money that they control to be subjecting asset prices to a compression of range, the size of which is a function of slippage, commission and cost of capital.

The macro/trend following funds make bets on direction, and there is a herding aspect such that the group as a whole tends to have a significant net bias in one direction or the other. Thus the funds they control might be understood as pushing asset prices toward an expansion of range.

Would understanding these two forces of expansion and compression be useful tools to a speculator?

Travel Through Books, by Victor Niederhoffer

An excellent way to get a new perspective on the different ways of approaching specinvestments as well as the common humanity, biases, and predilections of poor people like us, and of disciplines used in every field is to read a good book.

During my recent two weeks visiting the Queen, and the casinos of Monte Carlo, I had occasion to read many such books, including The Demography of Corporations and Industries by Glenn Carroll and Michael Hannan. The range of topics considered in this book opens up a whole new way of looking at determinants of value, a much richer field than the tried and true and ever-changing relations to earnings and dividends. The landscape is all the sociopolitical effects of such population demography factors as birth, death, mobility, marriages, senescence, density, size and competition.

The chapters on density are particularly resonant as they show that companies formed in certain years tend to have similar S-shaped lifespans: growth at first, followed by senescence, with a renewed spurt of growth afterward.

Case studies in the telephone, auto and banking industries illustrate many of the points made. Tables include such subjects as the duration between the founding and death of firms in various industries; size distribution of good and bad companies; influence of competition on success depending on generalist or specialist strategy; and hazards of mortality based on age, size, and liability class. There is a strong negative relation between mortality and age.

The book includes a passing reference to Stigler's survivor method: "Classify the firms in an industry by size and calculate the share of output coming from each class over time. If the share of a given class falls, it is relatively inefficient. In general the more inefficient, the more rapidly shares fall."

Much attention and many independent lines of attack in the book illustrate the general phenomenon that "the strength of selection pressures at founding and the speed at which surviving companies illustrate failure-inducing routines explains the spells of success and failure that populations founded at different years face."

This book will get you thinking about a million areas related to performance of populations of companies that are out of the mainstream and worth serious study.

Relative Wealth by Kim Zussman

Contemplating whether there are differences in wealth between two individuals with identical financial assets but different:

  1. Ages
  2. Health status (self and family members)
  3. Financial autonomy of real and potential dependents
  4. Spending and thrift habits
  5. Country of residence (with differing degree of property rights)
  6. Expectations about life and realization of these expectations
  7. Happiness/actualization levels (genetic and environmental) and degree of engagement
  8. Number and magnitude of regrets
  9. Social/sexual/relationship satisfaction
  10. Assimilation into and enthusiasm about the current era (anti-nostalgia)
  11. Level of cognition, education, and continued love of knowledge

It is clear that, for equal wealth, a person 20 years younger is "richer" both from investment and consumption perspectives. The proof lies in asking how much an older person would pay to be young again.

This topic is difficult enough, but the begged question of how to speculate prudently in all aspects of wealth generation would seem important.

Clay-Court Tennis and Markets, by Victor Niederhoffer

Winners of the French Open (played on clay) are far different in ranking and style from those who win hard court and grass tournaments. The reason is that the balance between risk and reward is different. On clay, a player can't afford to go for outright winners, because every ball can be returned. Often, three or four good shots are necessary to win a point, versus one good shot on grass.

At a recent Wimbledon tournament, the finals never went beyond three strokes in a point on one side, versus 20 or 25 in a normal good French Open match. Thus a stroke which has only a 40% error rate would have a 22% chance of winning a point on clay, versus a 60% chance on grass. Moreover, a much higher arc over the net with much greater topspin and a much smaller chance of double faulting is necessary on clay versus grass.

Specinvesting seems to require similar changes in style. For a given market, going for a high-risk, high-return trade is appropriate after certain events, e.g., after a period of high volatility, or great swinging. For differences between markets, similar variations in the game might be played.

In retrospect, the currency and grain and metal markets seem to favor a higher risk strategy versus those with a long-term upward drift. Tactics appropriate for grass would seem to apply more to growth stocks, and tactics appropriate to clay would seem to apply more to value stocks. Around holidays and in other reduced trading volume environments such as those that often exist in the summer, a grass court strategy would apply.

All such seemingly sensible ideas of course must be tested and varied based on the Baconian theories.

James Humbert adds:

The effort of hitting a high-arching topspin ball on a clay court is immense and it isn't for glamour. It is intended so that the ball, after the bounce, goes higher and travels deeper to the back of the court. This creates some problems for the opponent. It will generally back the opponent close to or behind the baseline, making his position less offensive, and returning higher bouncing balls is generally more difficult, thus causing more unforced errors. I wouldn't care if I had to do a handstand and use my legs on the racquet if that meant I could back my opponent off of the court and put me into better position to win points.

The current problem with navigating the markets profitably is that traditional mixes of topspin and slice are not working. The prime money management law, risk/reward ratio, is being followed by every single player these days. "If you're looking to make 50 basis points, use 15-20 as your stop," is the common adaptation. Only in uncrowded instruments does this law to work consistently. Everything else is binary. You have to be willing to take on above-average drawdown for a symmetric, profitable return. And that drives the crowd in the tennis stadium, and your manager/coach, completely crazy.

Jonathan Hillman writes:

For a given market, going for a high risk, high return trade is appropriate after certain events, e.g. after a period of high volatility, or great swinging. For differences between markets, similar variations in the game might be played. In retrospect the currencies and grain and metal markets seem to favor a higher risk strategy versus those with a long term upward drift. Tactics appropriate for grass would seem to apply more to growth stocks and tactics appropriate to clay would seem to apply more to value stocks.  Around holidays, and in reduced trading volume environments such as those that often exist in the summer, a grass court strategy would apply."

This analogy reminds me of EdSpec 152-153 on open and closed positions, an inspirational passage on board games and the Palindrome's use of leverage, somewhat dissonant at points with the advice above. An apparent irony is that the fellow who more or less invented the game that works so well on grass, Jack Kramer, said of clay that it is the fairest surface. Why?  The player with the best strokes eventually wins. The apparent irony dissipates when one realizes that overcoming the tendency to calcify is the only rational response to a protean world.  Sometimes doing the same thing and expecting the same result is no less insane than expecting a different one!

James Humbert replies:

A serious tennis player doesn't vary his mental and physical effort from stroke to stroke.  Although a slice backhand looks like an easier stroke, the skilled, demanding players will put forth the same effort as they would a forehand taken on the rise.

Position sizing is not analogous to this maxim of stroke production in tennis. Tennis is played one stroke at a time, while portfolio management and trading requires making several strokes at once. Because I have been flying the friendly skies with maximum effort the last 7-8 days, I could not possibly put the same effort into other strokes. Believe me, if I had more arms, you can bet that I would be maxed up in every other stroke in my game. There is no sense in doing anything less.

Kim Zussman on ‘Creating Modern Capitalism’ edited by Thomas K McCraw 

The description of development and growth of Seven-Eleven Japan documents a systematic approach to franchisee incentive, market-sensing, distribution evolution, and point-of-sale information technology innovation.  Much of this textbook case-study results attribute to Toshifumi Suzuki, who started as a publication distributor but left at 31 to join retailer Masatoshi Ito.  Within 8-years, Suzuki became a director of Ito's company, and traveled extensively to the US. During these visits, he became interested in American "convenience stores", which violated Japanese cultural and governmental ideas about retailing but intrigued Suzuki. He went on to engineer a deal with Southland Corp to create and innovate Seven Eleven in Japan. The venture was so successful that it was able to help it's less efficient American father as he faltered. When asked about his biggest accomplishment, Suzuki replied, "I don't feel any sense of accomplishment. The world changes too much.  A marathon has its end, but the world does not stop."  Perhaps his attitude goes a long way toward explaining why those who have tasted success can never sate their hunger.

Ask The Senator, a Continuing Series

Q: In a recent column on MSN Money, the SuperModeler wrote "As we close the book on another dull first half of the year in the market, it's time to score another big win for StockScouter." What's your experience with it?

A: I have run StockScouter as a criteria for my Darlings of the Dow strategy and found it does not select winners, in the Darlings, as well as standard measures of value.

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

A Long Way Back, by Jim Sogi

The road line painter paints 16 miles of the center road line the first day. 12 miles the next day. Third day, 6 miles, 4th day only 3. The boss asks, " You started out so well, what happened?" Road painter says, "Hey, its a long way back to the bucket!"

Anyway. S&P mini open to close: 4 days ago 16 points, 3 days ago 12 points, 2 days ago 6 points, yesterday 3 points. Hey, Its a long way back to the bucket! You would be tired too, just like the market painting those long bars.

Using Color to Graphically Display Security Information, by Jim Sogi

All systems of color organization are located in three-space: described by hue, saturation, and value by red, green and blue components in video. Color's inherent multidimensional character can be used to convey additional information within the visual focus area at one time. Five dimensions can be captured with color and box placement. Using a boxplot, the location on the x-y axis gives information about absolute value, and the range over a time period for two dimensions. Text within the box plot can convey information such as absolute volume or bid ask values or rates of change. Color can be used to code the intensity or threshold amounts of hits at bid and the hits at bid can be classified by color value, say red, and the volume at certain thresholds can be coded by the intensity of the hue, darker and darker for high values. So at a glance the price, range, volume, amount of volume and ratio of bid strikes to ask strikes are instantly apparent. Other information can easily be coded, such rates of change, or statistical properties in previously determined ratios. It seems that options might use color to represent the levels of the different derivative moments in one location graphically. This removes screen clutter, confusion and stress in the decision making process and presents a cleaner presentation leading to better understanding.

The human visual system relies on color more than anything for making many visual distinctions and cues. A monochrome display is akin to watching black and white TV. Color is like the sneakers and the two guys and the tiger. The current graphical commercial packages with the same silly indicators are quite tired. The mishmash of screens, quotes, and indicators is confusing and misleading. Imagine, color violins or even different instrument shapes for different statistical properties. Why not tubas for prices under VWAP, or piccolos for prices above the 60 day breakout. The market is a symphony. Why limit the representation of all the information to black and white, and a single speaker and gray bars. So primitive and simplistic! There is no limit, just the imagination. Think how much better Dolby 5.1 surround sound is than the mono radio. What do you watch and hear every day? If you think this new graphical and sound capacity is a waste of time, please, continue to use your black and white bars.

Chair talked about use of sound in his book. Of course the sound of the TRS-80 was pretty bad. Think of the additional sound possibilities to add depth of information. the capacity of the human mind to absorb properly presented information is vast, if done correctly.

Jim Sogi on a different topic:

The weather report (www.prh.noaa.gov/hnl/pages/CWF.php)

called for strong  trade winds 15-35 knots, scattered showers and seas 6-10 feet, a normal Hawaiian day at sea. Flying over the channel between Oahu and Kauai the sea appears uniform with scattered white caps and with a steady wind blowing and scattered showers.  Upon arriving at the 56' Polynesian voyaging canoe Hokualakai and Hokulea, the crew prepare the canoes, tightened the wooden blocks fashioned in the style of the 18th century sailing ships which  hold the lines on the mast, and reefed down the sails. tinyurl.com/at3oa The captains discussed the possibility of delaying the departure to wait out the blustery conditions, but favored on time departure.  The plan was to head up wind for 20 miles and turn down to Leeward Oahu.  With a crew of 12 mature and experienced men sailing,  including an 82 year old former large vessel sea captain, and several men in their 60's, the double hulled sailing canoe, lashed strongly with  miles of line, no metal fasteners,   12- 5" wooden cross beams and sturdy sails,  headed across the rough ocean channel. tinyurl.com/cfhu2

Victor Niederhoffer: Four Variations on Rates of Return in Commodity-Type Businesses

  1. Advances in Behavioral Finance by Richard Thaler, Vol. 2 (published by the Russell Sage Foundation in 2005) seems to go beyond the usual academic tome in that it does not seem to be a direct solicitation for funds to invest in the author's existing or new fund or a way of cementing tenure. The 19 chapters in the book, ranging through arbitrage, stock returns, equity premia, overreactions, underreactions, investor behavior and corporate finance, are quite interesting on their own, and contain many original papers that apparently were not able to find their way into accepted and refereed academic journals.
  2. In Chapter 8, "Contrarian Investment, Extrapolation and Risk," by Josef Lakonishok, Andrei Shleifer and Robert Vishny, the authors conclude that "value strategies outperform glamour strategies by approximately 10 to 11 percent per year. Moreover, the superior performance of value stocks persists when we restrict our attention to the largest 50% or largest 20% by market capitalization." Such conclusions could only come out of an ivory tower. The results are based on retrospective Compustat data from April 1963 to April 1990. Biases upon biases are contained in such a study, starting with when the announced earnings data were assumed to be available. Why do such studies capture the popular imagination, when Value Line's prospective studies of similar strategies show return differentials at least as high in favor of glamour? Who is kidding whom?
  3. One of the reasonable things that investors used to be taught is that you can't make money by investing in a commodity-type business because competition is based on price. And the return drops to zero. This should be tested empirically, and a categorization of value companies should be based on product differentiation and ease of entry into the field.
  4. When I was in the merger business, I had many commodity-type businesses available for sale, and could never sell them for more than book value. The buyer always said, "If I wanted to buy such a business, why not go into it myself? And why should I pay more than cost, for a business that anyone can enter and thereby drive the rate of return to zero?" I have had tens of thousands of company-selling years in the merger business and this conclusion has never been upset. What is it about public companies that creates in the public mind the illusion that the return to a public company in a commodity business should be superior to the return of a privately held firm?

Mr. Ckin comments:

Even the purest of commodity businesses present opportunities for possible returns over the risk-free rate. 

Besides the economics of producing the end product, a company must be able to successfully market its goods in a unique way, such as investing in a brand name (Clorox bleach and Reynolds Wrap are virtually identical to the generic brands, but cost much more) or investing in a distribution scheme. The shareholder return of Alcoa was superior to its peers' over the past decade or so due to its prowess in anticipating price moves, and forward selling on futures markets, not because its aluminum was better, or even distinguishable, from anyone else's.

Moreover, arbitrage opportunities will probably exist in any oligopolistic market in which the participants/investors use different assumptions for risk-free rates of return. Why should we assume that Codelco, or RTZ, or Norilsk, or Phelps Dodge should all use the five-year US Treasury yield as a gauge of risk-free rates (as far as the Capital Asset Pricing Model is concerned)? Further, for metals and energy companies, wouldn't their reserve lives (duration, in fixed-income terms) have some bearing on the risk premium that an investor would pay for those assets?

Of course, the second point assumes that the CAPM is valid in the first place.

Allen Gillespie comments:

A company with continually falling earnings goes bankrupt. A company that fails to grow earnings is a bond. A company with rising earnings is experiencing growth. Thus even value managers rely on earnings growth.

The market cap increases of a few growth stocks is much greater than the assets under management of most firms. The problem, however, is that there is a serious index/benchmark construction issue that is not being addressed. Namely, the growth stocks frequently are not in the index, e.g. GOOG, which has added $50 billion to its market cap since the IPO, or YHOO, which got added on the top tick, or CME). To simply cut a large list of stocks in half and call one half value and the other growth based on price to book hardly measures anything, especially considering that the value of a stock is the discounted future cash flows. Marty Whitman has been successful buying bankruptcy recoveries, which is logical because after bankruptcy the future always has more potential value than the loss-producing past and Brown earns excess as a liquidity provider.

Where the growth funds went astray was in thinking the past would continue in the future. Moreover, in regards to Bill O'Neil, very few stocks really meet his criteria at a given time (generally 30-40) and his style has a market direction component which most mutual funds cannot implement. Furthermore, the stocks that have truly met the CANSLIM criteria the last few years include plenty of value stocks such as the homebuilders and oils.

Andrew West offers:

While I am sympathetic to your skepticism regarding LSV's "Contrarian Investment, Extrapolation and Risk," my perception was that it was their interpretation that was more in doubt than their raw numbers. That paper has been held up to peer review, and I have seen numerous subsequent papers written along the same vein, using different data sets in different countries. There are a large number of finance professors who could make a name for themselves by writing a paper disproving these conclusions by identifying biases or mistakes. Fama and French, who are generally unsympathetic to LSV's interpretations, still find value (or distressed) outperforming growth. Have the Value Line numbers been scrutinized by peers or followed up with out of sample studies?

Victor Niederhoffer responds:

Those problems you mention are true, but the survivorship problem itself is so great that any results of Lakonishok, Fama, or Dreman are totally worthless. And they are superseded by actual results in the '90s. That papers like this are accepted is guaranteed to happen, as detailed in Practical Speculation.

Jim Sogi explains:

One of the criteria in the valuation of businesses for gift and estate tax purposes is marketability. The existence of a large and liquid public securities market gives less of a discount to a minority share in a publicly traded businesses. Whereas a minority block of a privately owned business, whether commodity or not, is subject to various steep discounts for marketability, and additional minority problem of finding a buyer who wants to be under the thumb of the dead owner's son who knows nothing about managing a business, and the son's pushy wife and mother-in-law who know even less but are draining the profits for inflated salaries and perks. This is where the Sage may have gotten some of his returns, preying on the discount factor of distressed family businesses subject to estate taxes. Who exactly does a family turn to when grandpa's seaweed growing business needs to be sold? There is not much of a market, the salesmen take a steep commission, the valuation is always a question, and there is always some exigency involved, all adding up to a discount.

Kim Zussman adds:

Does not the observation of increasing prices for commodities (oil, gold, food) in times of fear prove there is a continuum, or axis of value, beginning with rudimentary supplies and ending with creative intellectual property that parallels Maslow's hierarchy? The assumption and hope that human society is evolving and progressing places value on the top range of the continuum. Zealots, Luddites and primitives value the bottom range and hope to force us to.

Alex Castaldo comments:

in the hallowed textbook "Principles of Corporate Finance" byBrealey and Myers on Page 84 the value of the firm is given as

            P0 = EPS1/r + PVGO

where EPS1 is the next earnings, r is the risk free rate and PVGO is the "present value of growth opportunities".  This shows that theoretically a firm with no growth opportunities is valued as a perpetuity: the annual earnings are discounted at the risk free rate.

Deeds that Won the Empire, by Nigel Davies

With the revelation that the London bombers were 'British citizens', I am opening Deeds That Won The Empire by Fitchett (Smith, Elder & Co, 1898). From the introduction:

The tales here told are written, not to glorify war but to nourish patriotism. They represent an effort to renew in popular memory the great traditions of the Imperial race to which we belong.
The history of the Empire of which we are subjects - the story of the struggles and sufferings by which it has been built up - is the best legacy which the past has bequeathed to us. but it is a treasure strangely neglected. The State makes primary education its anxious care, yet it does not make its own history a vital part of that eduction. There is a real danger that for the average youth the great names of the British story may become meaningless sounds, that his imagination will take no colour from the rich and deep tints of history. And what a pallid, cold-blooded citizenship this must produce!
War belongs, no doubt, to an imperfect stage of society; it has a side of pure brutality. But it is not all brutal. Wordsworth's daring line about "God's most perfect instrument" has a great truth behind it. What examples are to be found in the tales here retold, not merely of heroic daring, but of even finer qualities - of heroic fortitude; of loyalty to duty stronger than the love of life; of the temper which dreads dishonour more than it fears death; of the patriotism which makes love of the Fatherland a passion. These are the elements of robust citizenship. They represent some, at least, of the qualities by which the Empire, in a sterner time than ours, was won, and by which, in even these ease-loving days, it must be maintained.

Tiger Beat VALUE, by Charles Pennington

I know everyone is swamped with reading material, but I must recommend Tiger Beat VALUE, a magazine that I discovered recently at my local newsstand. Cover stories for the August issue:

Vince Humbert adds:

And don't forget this month's special supplement:

Victor Niederhoffer: An Interesting Discussion of Plant Problems

An interesting discussion of plant problems is contained in the excellent book Mathematics in Nature by John A. Adam. He points out that "plants face problems that humans have -- how to occupy space, receive sunlight, and interact with the environment in an optimal fashion". Thus, they have to make sure that they don’t interfere with each other too much. They solve this problem by in general by acting in a "most irrational" manner. In general this leads to a Fibonacci pattern where each number in a series, like leaf distance, or numbers of petals is the sum of the previous two. Markets also have a similar problem in not interfering with the sunlight of the public providing nourishment for the higher forms in the feeding chain and decomposers and thus, amazingly it might be possible for a Fibonacci-like solution to the consecutive ranges in markets, the relations of moves in one market to another (the oak leaves are generated 2/5 of a rev apart, 1/2 for elm, 3/8 for rose -all the numerators and denominators in these fractions are Fibonacci numbers)

I can't leave this subject without quoting this beautiful, resonant paragraph: "Nature, in its elegance and economy, often repeats certain forms and patterns...like the similarity between the spiral pattern in the heart of a daisy and the spiral of a seashell, or the resemblance between the branching pattern of a river and the branching pattern of a tree...ripples that flowing water leaves in the mud, the tracings of veins in an autumn leaf...the intricate cracking of tree bark...But underlying all the modifications and adaptations is a hidden unity. Nature invariably seeks to accomplish the most with the least- the tightest fit, the shortest path, the least energy expended. Once you begin to see these basic patterns, don’t be surprised if your view of the natural world undergoes a subtle shift." (from By Nature's Design by Pat Murphy. Yes, we see these patterns in markets--- but they have to be predicted.

Dr. Brett Steenbarger: The Morality of Trading

I recently decided to step down to a part-time role at my trading firm to make time to write my next book. One of the traders I had worked with graciously treated me to dinner to celebrate my year at Kingstree. This trader personally accounts for several percent of the daily trading volume in the Merc’s ES contract and has made millions of dollars (after all expenses) during each of the past several years.

Over dinner, he made an interesting statement. He indicated that he was proud of his trading success, but was looking for more. “I don’t produce anything,” he explained. Others, he said, produced books or provided beneficial services. All he created, he felt, were profits.

My philosophical hair began to crawl when he said this; his statement suggested that he had unconsciously accepted an altruistic standard of ethics. One’s value, such a standard implies, is measured by his or her “contribution to society”. By that standard, we should admire a philanthropist-heir, who distributes the money he never earned, more than a Robinson Crusoe, who by his intelligence and creativity thrives on a remote island. I’ve heard this standard espoused in other ways by traders who justify their activity by claiming that they contribute to liquidity in the marketplace -- once again seeking a sanction in the good provided to others.

Now here’s what’s interesting: Despite my trader’s evident angst, he had no intention whatsoever of giving up trading. Indeed, he indicated that trading alone gave him the sense of meaningful activity that he hadn’t found since his days as a boyhood athlete. This, I’m sure our Federal Reserve chair would say, poses a conundrum. Here he tells me that trading produces nothing of transcendent worth, and yet he finds it supremely meaningful. Why would someone find an empty activity meaningful?

Thomas Kuhn, the historian of science, offers a key insight in his book "The Essential Tension":

When reading the works of an important thinker, look first for the apparent absurdities in the text and ask yourself how a sensible person could have written them. When you find an answer…when those passages make sense, then you may find that more central passages, ones you previously thought you understood, have changed their meaning. (p. xii).

Kuhn’s observation is closely akin to Ayn Rand’s dictum that contradictions do not occur in nature. If you find a contradiction, check your premises; you’ll inevitably find that one of them is wrong. When an important thinker writes something absurd, the chances are good that the absurdity is a function of the reader’s frame of reference. Upon checking the premises of that frame of reference, you may discover meanings in the writer’s work that, to that point, had been unappreciated.

A psychologist’s restatement of this idea is that, when sane people say or do things that make no sense, the odds are good that their sense is different from yours. A while back I met a bemused foreign exchange student from Iceland who could not understand why Americans ask, “How are you?” and then don’t stick around for a reply. Clearly the meaning of what he heard was not the meaning intended.

So it is, I believe, with our successful trader. His doubts about his productivity reveal an altruistic standard of ethics. His actions, however, driving him to continue to trade well after his financial need for income has been met, suggest that another standard of ethics is lurking in the background.

Here again we turn to Rand and her published journals:

An animal cannot act against his instinct nor suspend it. He enjoys a safety man can never have—the invariable operation of his means of survival…A flea does not have the responsibility of remaining a flea. It can be nothing else…Man must remain man through his own choice. Nature guarantees him nothing, not even his own nature. Such is the penalty and the honor of being a rational creature (p. 254).

Later, she emphasizes:

The first, most earnest, most crucial question man asks of himself is: Am I right? An animal cannot conceive of such a question. Man cannot escape it. In one form or another, it rings through his whole life. It sets the leitmotif of his existence—the style of his soul (p. 254).

Happiness (as opposed to pleasure), I would argue, derives from the experienced sense of answering Rand’s question in the affirmative. Happiness is experiencing oneself as being right. Each of our activities -- relationships, productive work, athletic achievement, art -- is a potential mirror in which we experience ourselves. These mirrors either affirm for us that we are right or reflect an image that is cloudy or negative.

The ability to derive pleasure from action that affirms our right-ness as rational beings is evolutionarily adaptive. If we consistently experienced happiness by being wrong -- by acting in a manner contrary to the needs of our survival -- we would not be long for this earth. To the degree that we are hard-wired to respond to affirming mirrors in a positive way (a baby’s response to a mother’s smile; a child’s satisfaction in mastering a new skill; our joy in finding love), we operate with a biologically-based, implicit set of ethics that may well contradict those that we’ve learned over the years.

So it is with our trader. He knows darned well --and shows it in his actions -- that he is producing something more than profitable trades. He is producing the sense of rightness that powers his soul. The fact that he also contributes to liquidity, provides for the material comfort of his family, utilizes his wealth to invest and create jobs—all of this is secondary: a happy consequence of his acting upon his happiness. What is important is that to be happy is to be ethical, because true happiness derives from action in support of life itself. An unhappy person is not necessarily evil—life’s circumstances, from slavery to depression, can rob one of the options needed to “be right" -- but to be consistently and radiantly happy requires a will directed toward values. The markets tell us each day if we are right or if we are wrong Each day we, as traders, can live as human beings -- armed only with our rational faculties -- or abdicate that penalty and honor.

Success and happiness -- the conditions needed to thrive on this earth -- are reflections of the choices we make. What greater productivity can there be? What greater good?

GM Nigel Davies responds:

I really don't think that too much introspection is a good thing for a trader or indeed any competitor - these existential concerns smack of self indulgence and can be a big distraction. If people worry about the rightness of winning they should try losing for a change. Or maybe they've just got too much time on their hands and should try having kids.

Whenever I hear a colleague waxing lyrical about the meaning of things I feel an overwhelming temptation to tell him to 'snap out of it'. If anyone asks me why I do it I usually grin and say: I crush therefore I am. This does tend to have the desired result of stopping the conversation dead in its tracks.

Kim Zussman Responds:

This recalls Hemingway's post-climactic revulsion; the drive to posess knows no moral bounds but with ultimate achievement existential questions erupt.

Like the Cervical Apartments: You are a guest in the penthouse for 9-months then are violently evicted and banished from the building for many years. Then one day you timidly knock on doors at the ground floor hoping to get a shot at the elevator. Eventually persistence pays off but you can only climb the hot, sweaty staircase and the going is excrutiatingly slow and halting. After maximal effort and endurance, and years of effort, the penthouse is in reach. Then, ironically, the goal becomes less important than the quest. You gaze out at the shadowy city as the sun sets and wonder what it will be like to ride the elevator down one last time.

I have lost count of all the meetings I’ve had with successful market participants (mostly traders) who talk about their striving “to contribute” something of “lasting value,” “meaning,” etc. as if having a successful life and following one’s passions, whatever they may be, in and of itself were just not enough.  One of these days my bubble thought “so why don’t you hang it up and go join the Peace Corps” will come flying out of my mouth. <g> 

Pamela adds:

It seems as though man is prone to fall into a trap of either 1) feeling not worthy – our success is dumb luck and we aren’t really deserving of it therefore if we have an excess amount of cash, we should find someone or some enterprise more worthy of it; 2) dreaming for immortality – poets, painters, scientists go down in the history books but not those engaged in enterprise. Even Bono. 

Some years ago a colleague harassed me for my charitable giving to dog organizations such as shelters, search & rescue, and health studies and research.  The point was made that I should be giving money to people, not animals.  So I stopped giving money to my favorite pet causes and started giving to people groups.  But I felt horrible (when, supposedly, such giving would actually make me feel better).  But it was as though I were taking out someone else’s trash.  This giving was not out of love or passion but someone else’s sense of duty.  It was the weirdest feeling for me – to feel bad about giving to people.  One day I couldn’t stand it any longer and reversed course and went back to my pet causes.  Ever since I’ve felt great about my charitable contributions because they were no longer charitable contributions in that I am giving money to something I love.  It’s as good as buying a new pair of shoes or going out to a nice dinner.  I love dogs; they are my passion.  Why shouldn’t I do what I can for that passion?  And who is anyone else to say that my passion is not worthy?  It is who I am.  We are all our best when we follow our true passion and the world is thusly enriched.  What is frustrating is having to fight collectivist societal views on this.  It’s great that Michael Steinhardt’s passion is Israel.  It’s not a charity for him but a true passion that I imagine he would support whether he had $100 or $1 billion.  It’s not about him; it’s about the Jewish peoples and the state of Israel.  And that’s the thing – when people follow their true passions they do step out of themselves into something larger whether they mean to or not.  I also believe that when people follow their passion they automatically act ethically in all they do because they work to protect that which they love.

Brett says:

Very nice!  In our respective posts, you and I have neatly captured the difference between Rand and Nietzsche.
Introspection during competition is probably like introspection during sex: a hindrance to both experience and performance.  That is very different from the reflection that accompanies the healthy development of competitive careers and romantic relationships.  A good example would be successful companies: in their day-to-day mode, they are all about execution and crushing the competition.  When new challenges and opportunities arise, however, they are quick to address the big questions of "Is this our core mission?"; "Are we on the right track?"  The problem is not asking the questions, but answering them in a mode that divorces correct responses from rational self interest.

Ten-Gallon Hat, by the Dude

Anthony Holden's 1990 classic Big Deal includes conversations with Amarillo Slim, one of the all-time best coffee-housing (talks a lot at the table) professional poker players. Slim waxes poetic on many topics, but this is the best elucidation I've seen of why one should strive to quantify opinions about the markets:

People everywhere assume that anyone from Texas in a ten-gallon hat is not only a billionaire, buy an easy mark. That's just fine with me, because that's the impression I'm trying to give. The approach puts those dudes in the category of guessers, and guessers are losers. That's my meat, to make the other guy guess.

Alex Castaldo: An Imaginary Conversation With the Palindrome

Palindrome: Hi!

Alex: Hi! What do you think of the market?

Palindrome: As you probably noticed, during the last two days the prevailing hypothesis underlying the market has been decisively refuted.

Alex: Hypothesis refuted? You are referring to Karl Popper's description of the scientific method...

Palindrome: Yes, science proceeds by making hypotheses, then experiments are carried out to try to refute the hypotheses.

Alex: I read "The Alchemy of Finance" but it wasn't very clear to me...

[Editor's note: The Palindrome himself said the sections concerning Popper and reflexivity were a little fuzzy to him, too -- like the thesis he gave up writing when he realized he didn't understand it. When the Palindrome emerges from the monastery he promised to retire to in the event of a Bush victory, perhaps he'll clarify these issues.]

Palindrome: Well, I am not, and I don't claim to be, a professional writer.  But I have discovered in my investment activities that financial markets operate on a principle that is somehow akin to the scientific method.  Making an investment decision is like formulating a scientific hypothesis and submitting it to a practical test. The main difference is that the hypothesis that underlies an investment decision is intended to make money and not to establish a universally valid generalization. Both activities involve significant risk, and success brings a corresponding reward, monetary in one case, scientific in the other. Taking this view, it is possible to see financial markets as a laboratory for testing hypotheses, albeit not strictly scientific ones.

Alex: And the hypothesis that has just been refuted is what?

Palindrome: In the event of a major Al-Qaeda attack in a Western capital, the market would have a terrible down day; down maybe 20, 30 S&P points.

Alex: And the market was way down at 5am when the attack was announced.

Palindrome: Yes, but it began to recover soon after that and actually ended the day up. And it has been running ever since. This is not what was expected.

Alex: What does it mean for the future?

Palindrome: A phase that began after September 11 is now over. This was a phase in which the market was afraid of a repetition of the events of September 11 on a similar or larger scale. That hypothesis, that significant terrorism would cause a very big market decline, has now been refuted.

Alex: If the market used to worry about terrorism and now no longer does, then that would seem to be extremely bullish!

Palindrome: You are beginning to sound like Victor! [Laughs]. Actually that is the simplest interpretation, but not necessarily the most correct one. When a hypothesis fails we have to formulate another to take its place. Other problems may come to the fore.

Alex: So from now on the market will be driven by something else, maybe the dollar, or maybe something else. What do you think?

Palindrome: Well, you'll have to do your own homework on that!

Alex: At least I know now that I should have bought in the early hours of Thursday, as my friend Lack did.

Palindrome: I would look at it the other way around: the people who sold at 5am are kicking themselves for doing so, and they will be more cautious in the future. That opportunity may not come back, to have futures down that much on a terrorism scare, or in any case it will be rare.

Alex: I see. Another one of your theories that I never understood is ...

Palindrome: Sorry, we can talk about it some other time, I have to get to the airport now. Bye!

Alex: Bye!

Laurel Kenner: Three Vignettes in the American Spirit

If you've ever wondered where that 1.5 million percent-a-century return comes from...

  1. I have often peered into the window of a Park Avenue store that sells exquisitely designed shoes, but I've never gone in. Until today. I saw a sign in the window: "60% Off Everything: Store Closing July 30." I went in and bought a little something. "Why is the store closing?" I asked. "The owner wants to retire," the saleswoman said. "She is 98."
  2. I stop by to see Angela Lam, an importer of fine Chinese antiques. She shows me a pair of 100,000-year-old mammoth tusks carved with a flourish of fierce dogs. We chat about our lives. I ask if she has children. Yes, she says. Her 17-year-old daughter has already been accepted at Columbia Medical School. "You must be so proud," I said, gazing at the passion in the mother's eyes. "She must be really smart." "Yes, very smart. She studies all the time. The only time she watches TV is after an exam. Sometimes I get up at night and her light is still on." "I'm sure you had everything to do with it." "No, she wants to study. She told me, 'I want to give you money, Mom.'"
  3. I walk back to my apartment. The Eastern European superintendent is stationed at the steps, acting as a hawker for a small girl and boy selling lemonade in the courtyard. Fifty cents a cup. I buy two cups. "Are you making a profit?" I ask. "No," said the little boy. "I'm just making money for myself." "That's a profit!" I laughed. "It is?" "Yes." I could have carried that lesson a little further. But I decided to let him stay on the first rung for awhile.

Kim Zussman: Sunday Literature

Many economic volatility measures are in long-term decline. A study published in December 2004 by Diego Comin and Sunil Mulani found that aggregate volatility of sales decreases while firm-level vol. of sales increases. Comin, author of another recent study, also contends that R&D spending is a small contributor to GDP growth.

A third study, by Fangjian Fu, looks at idiosyncratic risk. "The evidence in my paper supports Merton's predictions. I find that individual stocks that are expected to have higher idiosyncratic risk earn higher returns, and after controlling for the effects of idiosyncratic risk, larger firms tend to earn higher returns than small firms."

If it's too hard to understand stocks, perhaps this real estate bubble-talk at Wharton won't be helpful.

Update from Victor Niederhoffer: Decision-Making Under Certainty

There is no field in the world where decision-making under uncertainty is so retrograde as in medicine. Many treatment options are only available for use after hundreds of millions of dollars of research lasting more than 15 years. Countless innovators stay out of the field because economic incentives are lacking. Numerous treatments, e.g., cancer-preventing molecules such as statins, can be used only sub rosa because it would cost billions of dollars and dozens of years to do a proper double-blind prospective study of side effects that would have any reasonable power, say 95%, that differences of a few percentage points might occur.

Strangely, in our own field, there is something even worse. That's the strain that says because prices do not conform to a normal distribution, catastrophes are much more likely to occur than a typical observer might believe, and that normal statistical methods, normal decision-making under uncertainty, normal speculating in providing volatility insurance, are all doomed to failure.

Two quacks, one of whom I met 43 years ago at Harvard, are prominent in this modality, and the world of investment ideas is in their thrall. They are revered with the same awe as the prophets of pessimism, the Sage, the Palindrome, the weekly financial columnist who has never been bullish, and the other zombie cultists.

Because I am always trying to stay up on the latest in decision-making under uncertainty rather than advising all others to avoid risk by going to a horror movie, buying Treasury bills, or retiring to a monastery, I make it a point to go to the best college bookstores in whatever city I visit. In Britain, my usual rounds include Foyles, Blackwell's, and the Oxford and Cambridge bookstores. On a recent trip I bought a highly recommended book on the statistical synthesis of evidence, Meta Analysis by the Confidence Profile Method by David Eddy, Vic Hasselblad and Ross Shachter.

The book deals with problems where there are:

  1. Multiple pieces of evidence (macro and micro predictors)
  2. Different experimental designs (e.g., a one-year study and a one-month study with different outcomes)
  3. Different measures of effect (a Sharpe or a percentage of variation caught)
  4. Biases to internal validity (e.g., survival bias)
  5. Biases to experimental validity (e.g., the periods before and after 9/11)
  6. Indirect evidence (the Sage has a war chest of $40 billion through buying deadbeats and clever manipulation of their deferred losses)
  7. Mixed comparisons (one study looks at P/Es relative to the mid-market and another at stocks in the Dow)
  8. Gaps in experimental evidence (no study ever uses completely prospective data for seasonality).

Good self teaching techniques are included.

While there would not be any immediate gain in profitability for stock market investors by learning or studying these techniques, the reader will be able to develop a frame of mind that is much better attuned to proper decision-making in this all too uncertain world.

Kim Zussman comments:

I see meta-analysis used from time to time in periodontal and other medical literature to kluge together data from several similar studies. Seems like a way to strengthen statistical power, increasing number of subjects/outcomes/years of study necessitated by long periods and expense needed to see results in human trials.

The traditional way is studies on animals, who react quicker and can be treated differently than humans. Of course power is reduced by inter-species differences, and promising therapies are often marched up the evolutionary ladder and bridged to human studies. But then you might miss things, like COX-2 cardiac effects, due to few subject-years. The effects of lawyers should create more interest in meta-analysis.

I don't see how this pertains to markets since there is no shortage of historic data, and no need to combine prior trials. But perhaps there are parallel uncertainties:

Even though market tails might not contain deceptions, don't distributions evolve, along with the related post-mortems given by the media? 3/11/04 Madrid bombings == negative because of discovery that Al Queda not vanquished. 7/7/05 London bombings == positive because (investors learned from 3/11; Tony Blair's equanimity; US not hit yet; etc.).

Maybe instead of a method for combining studies we need a way to predict immutable patterns, versus ones that 8,000 hedge funds beat with their levers.

Dr. Janice Humbert responds:

Many trained in allopathic medicine are unaware of unconventional (off-list) treatment modalities. Part of the reason for this is that the study of medicine has become so involved and complicated that it is all they can do to learn even a small part of what they are supposed to learn.

On the other hand, there are many medical doctors who truly are aware and in tune with so-called complementary and alternative treatments, including off-list and many other modalities. Why do they not use them and why do they appear to turn a deaf ear to the pleas of the many patients who come to them with newspaper clippings, magazine stories, Internet printouts, etc?

One only has to understand that doctors are in fear. Fear of the patients who can turn on them in a nanosecond if something does not go as planned, fear of the malpractice attorneys who are beyond predatory and, perhaps greatest of all, fear of the State Medial Boards. These Boards can bring a physician to humiliating task, take disciplinary action, write letters of concern, revoke licenses, put doctors into the National Data Bank as bad doctors, and destroy the reputation and standing of an individual who has spent his entire life devoted to the study and practice of medicine.

In some cases, such as boundary infractions with patients, recidivistic substance abuse and just plain bad medicine, these Boards serve a useful function and are essential to keeping the public safe. However, in recent years, the scope of the Boards has extended into almost every aspect of medical practice. Doctors, already emasculated by the archaic health care system in the U.S., the HMO's, PPO's etc., who are now called providers rather than physicians, are simply afraid to do anything, or to move outside the boundaries of classical allopathic medicine. Just as in the markets, physicians are often motivated by fear and greed, and fear is the most powerful underlying emotion.

For those who care to go beyond allopathy, there are many alternatives: homeopathy, naturopathy, osteopathy, etc. These groups are also governed by regulatory boards, thus subject to some of the same restrictions as allopaths, but there is a broader sweep to what is allowed in the interest of serving and protecting the public. Nonetheless, these practices are also subject to the same vicissitudes which afflict classical allopathy.

In any case, the medical system in the U.S. is hideously broken and is a tragedy. Everyone suffers, patients and physicians alike. I have no solution, except to continue to do what I have done for the past 20 years: give myself 100% to my patients and engage in relentless communication with them about what I am doing and why. Even then, I have felt their wrath and the wrath of the regulators, and, it is unpleasant.

Nonetheless, I and many of my beleaguered colleagues keep on keeping on because that is the best we can do and we don't know any other way.

Kim Zussman: End and Begin


An older (and relatively younger all the time) gentleman was recently diagnosed with AML (acute myelogenous leukemia) and myleodysplasia (pre-leukemic condition where marrow cells are not maturing properly and not enough functional cells are reaching bloodstream). AML is bad enough, however the combination with myelodysplasia makes known chemotherapies extremely risky. He was told that chemo would likely kill not only cancer cells but also necessary precursors for immune and coagulation function. The odds are roughly equivalent for lifespan counted in months whether treated or untreated, and evidently blood stem-cell transplant is not an option.

A gentleman with quiet strength and equanimity in the moment maximum trial.

Someone familiar with this asked, "Why wasn't it diagnosed sooner? Can he sue his HMO for not ordering tests earlier? Why didn't he go in when he first felt sick?"

These questions are recognizable attempts to find remedy and amelioration amidst capriciously disordered inequity.

"Who would get the settlement even if he wins (posthumously)?" I responded. "His children", she said. Well, that ought to fix it...

His current plan is to locate and enroll in a drug study. Where investors wait anxiously for signs of efficacy or safety in human trials. And a pop.

Well, that is a contribution...


In the early '80s, there was a TV documentary about a poor older Jewish man from Ukraine. In lingering memory runs a clip of him strumming a guitar and singing in Yiddish about "Nachus".

Nachus. Like terms from erudite cultures, it does not translate directly to English. But nachus means "pride from your children".

His primitive tune was unintelligible to the unintelligent, but the soulful consecration of his life's efforts was unmistakable in any language. Or in any species.

Anyone relating to such extractions might, while in NYC, consider a visit to the Ellis Island Museum, which has been restored accurately to 1900 conditions. There are photographs of (mostly) eastern European immigrants from steerage compartments, escaping various pogroms and cleansings for promised shores. There are images of Yiddish plays and newspapers which may be from the old country or the new country; it doesn't matter. If you see this and look at Lady Liberty, still welcoming, with dry eyes, then you are dry. Because whatever your ancestry, it is about us and about you.

Dick Sears: Weekly Commentary

I'm writing to you from my computer room, on the third floor of a Victorian villa, overlooking the broad sweep of the Hudson River.

The Hudson is an estuary, which means the current flows in both directions. It is tidal as far north as Troy, 150 miles upriver from Manhattan. They say a log (or, I suppose, a wooden horse) launched in Troy takes a year to reach Wall Street. Twice each day it drifts down 12 miles, but then the current reverses, and it gives back all but a quarter mile of what it had gained. But in time it reaches the sea.

The ebbs and flows of the stock market are quite similar, though considerably less predictable, alas. Nevertheless the market's flotsam (that's us) does eventually get somewhere. The thing to remember is that historically common stocks produce a return of over a million percent per century, as my friend Victor Niederhoffer is so fond of citing. That wouldn't happen unless there was a strong, reliable current under the market.

It's true that the market has been meandering in recent years. Such periods are inevitable. But it seems to me that at last we may have rounded this bend in the river, and that the market's natural current may now once again prevail. The market's buoyant resiliency this week suggests that may be the case. Read more>>>

Victor Niederhoffer: Final Consonance

The low in S&P futures yesterday was 1186 in the New York session and 1172 in the overnight session, respectively the lowest prices reached since May 18 and May 17. Such a final consonance, or release of tension, reminds me of Rossini who could not get out of bed until a dominant seventh resolved into a major fourth. It is in keeping with my theory that such releases of tension are quite sanguine. The moves yesterday were also:

All these points must be tested of course.

Martin Skuggig asks:

Speaking of release of tension, yesterday I had much wanted a cane as the index of my choice declined 4% on my leveraged long position, and I desperately hit the buy button to try to scrape up some more contracts at a point which later proved to be quite close to the low of the day. Of course, all such tries were useless and instead there was a much interesting wait for the market to find its feet again. At what now is almost is a full Lobagola the question arises: Lobagola, and then what? What is the most usual outcome of the stampede back to where we were, a la Lobagola? A continuation, or will the balloon burst?

Victor Niederhoffer responds:

The only intelligent thing a former cotton trader and current fund-of-fundist ever said is that once it goes back to where it originally killed you, it goes much further. But this must be tested. And it is unfortunate that you were not able to buy at the lows. The derivatives expert, in the only sensible thing he's ever said to me, once told me that in the depths of despair if I ever tried to put more fuel on the fire, my broker would rise up like a viper from a bottle and strike and suppress.

Another Market-Based Solution: Bikini Discount, from George Zachar

SEOUL (AFP) - A local government campaign to attract more bathers to a South Korean beach resort by offering incentives to swimmers wearing bikinis has upset women's rights activists.
Ahead of the peak summer bathing season, Buan County administration southwest of Seoul renamed its Byeonsan Beach Bikini Beach and promised wearers of skimpy swimsuits a 10-percent discount on bills for hotels, meals and beach equipment rentals.
"Show off your beauty and get a 10-percent discount."

Summer Interns 2005

Victor Niederhoffer reviews Why Do Absolute Returns Predict Volatility So Well by Lars Forsberg and Eric Ghysels 

This paper concludes that absolute variation is a much better predictor of future variation in returns for stocks and also shows more persistence. A 20 year period encompassing all intervals from 30 minutes to two weeks is considered.  The superior properties of absolute variation relative to standard deviation depend on its sampling distribution's being a function of the squares of returns rather than the fourth powers of returns, and on the absolute returns' invariance with respect to jumps in the process. In sample and out of sample data confirm these conclusions. The paper confirms the lack of ill wisdom of the emphasis I've placed on absolute variations for the last 30 years, with particular reference to the percentage of variation caught with an indicator, and the successive reductions in absolute variations that adding additional variables to a model versus the total variation about the mean creates. A discussion of how to compute R2 with absolute variation for commonly used predictors will be imminent.

Why Capitalism Rocks, Part XXII, by George Zachar

July 8 (Bloomberg) -- Home Depot Inc. and Lowe's Cos., the two largest home-improvement retailers, are sending hundreds of trucks of plywood, generators and flashlights to the Southeast as Hurricane Dennis moves closer to the U.S. The trucks will be positioned in states from Florida to Texas, waiting to see where the hurricane strikes before moving to stores in those damaged areas to unload supplies. The hurricane, which hit Cuba today with 150 mph winds, may strike anywhere from the Florida Keys to Galveston, Texas, by the weekend, according to the National Hurricane Center. `It's a logistics juggling act,' Home Depot spokesman Don Harrison said. `You stage the resupply trucks as close to ground zero as you possibly can and yet keep them out of harm's way.'

No unaccountable bureaucrats or confiscation or political favoritism or coercion, just self-interested people foreseeing ways to meet the needs of others.

Surely a Coincidence, by Charles Pennington

British Pound, New York closing prices:

   21-Jun-05   1.83
   22-Jun-05   1.82
   23-Jun-05   1.82
   24-Jun-05   1.82
   27-Jun-05   1.83
   28-Jun-05   1.81
   29-Jun-05   1.81
   30-Jun-05   1.79
    1-Jul-05   1.77
    4-Jul-05   1.76
    5-Jul-05   1.76
    6-Jul-05   1.75
    7-Jul-05   1.74
    8-Jul-05   1.73

Someone pushed the Pound down eight cents over the seven days ending the day before the terror attacks. Surely a coincidence.

Important Alert, from Victor Niederhoffer

There is a new way of preparing tomato that I sampled at La Chèvre d’Or in Eze, France that involves covering a beef tomato with a dressing of anise, garlic and olive oil and then injecting it with an infusion of herbs that is apparently used in a handful of modern French restaurants. The first taste is like a glow of roses, and then the feeling of release like the fresh air after a rainstorm or just in time at climax. Totally awesome and worthwhile.

Briefly Speaking, by Victor Niederhoffer

There have been far too many creations and releases of tension in the markets, recently and over time, to be consistent with randomness. Such a quantification could provide a meal for a lifetime for someone with a good musical or romantic mind. I discussed such a program with Laurence Glazier in England with particular reference to the Euro at 120, the SP with two more zeroes at the end, and oil a few octaves below at $60.

Jim Sogi adds:

A few more rounds: NDX 1500, Bonds 4%, Silver $7.

I suggest an alternate theory, for the sake of argument, that might explain the creation/release of tension. The system is coming to equilibrium after a period of long disequilibrium like Indian sitar music with its droning undertones and interweaving lines. Ambient, drone zone. In astronomy, a star finally reaches equilibrium, in some cases as a black hole that sucks in all volatility around it. The theory is that the Fed has succeeded in creating equilibrium, their admitted goal. The growth scenario will give way to a steady state. A beaker with Brownian motion will eventually reach a state of equilibrium in the absence of a new input. Stock action has been compared to Brownian motion, and the anomalies within the stochastic movement have been quantifiable and caused by structural elements of the market system. Look at the comets, the wanderers, who after millions of years, eventually return, always in orbit, until they dissipate, brought to mind by Deep Impact. Look at our planets revolving around and round, the stars in the galaxies. Newton was able to quantify it by considering their circular repetitive aspects rather than an independent outside unique force controlling the motion. This is not to say we won't have 40-60% swings, but the idea is the revolution is of the cyclical variety, not the Big Bang variety, which never made much sense to me. The global economy is after all basically a closed system and that is the driver of our markets.

Solidarity, by George Zachar

I printed out a nice, colour Union Jack image and taped it facing outward on my office window...

Night School: Lecture Series by the Ayatollah of Lobogola, by Jim Sogi

Seems that today there were many lessons in U. of S&P night school relating to:

  1. Use of stops per prior discussion on adverse excursions and distributions of returns
  2. Gaps and subsequent return
  3. Effect of news
  4. Changing cycles of diurnal predation and feeding
  5. Philosophy of Dr. of Caneology
  6. Penumbral mumbrological effects
  7. Lecture series by the Ayatollah of Lobogola
  8. Use of theatrics and deception

A Good Day to Die, by Ken Smith

In the film Little Big Man Dustin Hoffman hears his Indian friend ask him to accompany him to a hill where a funeral pyre has been set up. The procedure is to lie on the structure until death occurs then friends and relatives set the pyre afire and perform a ritual, sending the spirit off to his happy hunting grounds.

The Old Indian said, "It's a good day to die." The sky was blue, the weather warm, butterflies in the air, birds singing, ground squirrels mating. The Old Man settles himself on the unlit pyre.

I've always thought the Old Man's attitude was positive, a perfect model of positive expectancy in the face of seeming darkness. Today is an example of when the Old Indian's attitude needs to be adopted.

Pugnacious, by the Dude

While traveling over the weekend I happened across some words of wisdom from renowned poker player and 1973 WSOP champ Pug Pearson, and found some of his thoughts applicable to the markets:

You've got to remember that in poker there are more winners than losers. At least at the higher levels. I'd say there was a ratio of 20:1. But losers are great suppliers. One loser supplies a lot of winners. And the better the player, the bigger the cut. That's what they call the great pyramid of gamblin'. Sharks at the top, then the rounders, the minnows, and at the bottom the fish - the suckers, the suppliers. Scavengers and suppliers, just like in life.
It's a funny thing - gamblin'. It's like running a grocery store. You buy and you sell. You pay the going rate for cards and you try to sell 'em for more than you paid.
A gambler's ace is his ability to think clearly under stress. That's very important, because, you see, fear is the basis of all mankind.
The real thing to know is that folks will stand to lose more than they will to win. That's the most important percentage there is. I mean, if they lose, they're willin' to lose everything. If they win, they're usually satisfied to win enough to pay for dinner and a show. The best gamblers know that.
Losing is like smoking. It's habit-forming, believe me. Some of the players at this table couldn't beat Tom Thumb at nothin'. But loss is inevitable. The question is how much you control it. A winner is first and foremost a controller. That's why in life, I'm just a little better than even, and an odds-on favorite to stay that way.

When it Rains it Pours, by J. T. Holley

In my little patch of heaven in Richmond it hasn't rained for 16 consecutive days. Leaves were drying out on trees; temperatures averaged mid to high 90's. Ponds and lakes noticeably subsiding. Well-diggers taking out ads in the paper. People with short tempers swattin' flies and mosquitos on humid downtrodden days. Then bam, smack, pow. Tornados touchin' down, powerful downpours, hurricanes around the corner.

Darn if the markets don't look that way when glancing over data sometimes.

16 days doesn't seem that long after it starts pounding rain. Quickly you forget about those dry hot days and start focusing on the tree bending over on your house or the creek rising up to the porch. From one outlier to the other.

Tom Ryan Reviews The Geometry Of Crashes - A Measure Of The Dynamics Of Stock Market Crises by Tanya Araujo and Francisco Louca

In this paper the authors look at individual stock returns in the S&P and for a specific time interval they calculate the return differences between all of the stocks and use that to build a 2D matrix. They then go on to calculate the eigenvalues and use that as a means to analyze the uniformity of market movements, apparently irrespective of beta. Unsurprisingly, market movements are most uniform during crashes. An interesting method which tries to quantify the extent to which the market is acting uniformly.

There are also some comparisons to random movements and some introductory material on sectors, which can be analyzed the same way. For unknown reasons they used 16-day returns. The highest values 1971-present:

  1. October 1987
  2. October 1989
  3. October 1997
  4. October 1998
  5. April 1999
  6. Dec.2000/Jan.2001
  7. April 2001
  8. September 2001

Zeuthen on Benoni Structures, by Nigel Davies

Besides ZOOM 001 (Zero Hour to the Operation of Opening Models), Steffen Zeuthen compiled two works on Benoni Structures:

Modern Benoni, a huge 400 pages before you even get to the illustrative games (these are not numbered) categorized according to:

Wing Benoni, subcategorized according to:

You will search in vain for any other such clear categorizations of positions by other chess authors. All of Zeuthen's books are out of print (implying sales were poor) and I seem to be the only GM who admires his contribution to chess literature, with the possible exception of his co-author on Zoom, Bent Larsen.

Surfing, by Steve Ellison

While vacationing in San Diego, my kids and I decided to take a surfing lesson. There were five-foot waves breaking about 100 yards out, but smaller waves got closer to shore before breaking. My kids were able to ride the smaller waves, but I had to go farther out because the smaller waves did not transfer sufficient energy to accelerate my mass much.

For non-surfers who might want greater insight into any discussions of the sport, here are the rudiments. I was told to paddle hard toward shore as the wave I wanted to ride approached. I would go slowly at first (only as fast as I could swim), but then the wave crest would arrive and speed up my board dramatically. When my velocity became great enough, I could grip the sides of the board (the rails) and with a single motion jump from a prone position to a kneeling position. Then I could try to get up on my feet in a sideways crouch, carefully balanced in the center from a left-right perspective, but entirely on the back half of the board. I actually succeeded at doing so a few times, and it was quite a thrill.

No doubt there are many, many things about this sport that I do not understand, but I made several observations. It helps to be in good physical condition. For one who works at a desk for 50 weeks a year, the constant swimming and wading into oncoming waves constituted a very strenuous workout.

Economy of movement is important. It would be very wasteful to paddle away from shore, only to be knocked back to where one started by an incoming wave. My teacher told me to push the front end of the board down at the moment of contact with an incoming wave.

Wave sequences are unpredictable. My daughter was underwater at one point after falling off the board. Sensing a wave crest pass over her head, she came up for air into what she thought would be the trough. She got a lungful of water as a second wave came in only a few feet behind the first.

Overall, it was a great experience, and I reread Jim Sogi's surfing posts with greater understanding as a result.

A Housing "A Ha" Moment, by Nigel Davies

This IMF essay on housing booms looks like food for thought . The suggestion is that:

  1. 40% of them end in busts, a higher percentage than stock market booms.
  2. There is much international synchronization.
  3. 'A bust in equity or housing prices has clear spillover effects on the other asset class.... The equity price reaction after a housing price collapse was more virulent, in terms of both magnitude and the speed of the fall.'

Pam Van Giessen adds:

Some of the "housing bubble" talk, on both sides of the political divide, strikes me as pretty elitist. Yes, there is crazy flipping going on in some areas and some of those folks will make a bundle and some of them will lose. Such is speculation. But there also exist a lot of people who are finally getting an opportunity to stop piddling away rent money and actually own something that maybe will increase in value and they will be able to trade up.

The Assistant Webmaster replies:

Stop piddling away rent, but start piddling away carrying-costs. I was in South J#rsey last weekend, in Avalon/ Stone Harbor. These were sleepy beach towns in my childhood, but have been Hamptonized in the past 10 years. Prices have doubled in 2- 3 years, and are up an order of magnitude since the early 90's. A nice beach-block house (not waterfront) is $4m; a similar bay-block house (with 1/4 mile schlep to the beach) is $2m. In Avalon, a waterfront "estate" (a knock-down) possibly (but not certainly) divisible into three building lots, is listed at $7.2m. Of course there are quality improvements yada yada since the olden days, but in general, prices are "Wow!"

Guesstimated "income statement", for the modest 1200 ft2 house we rented for $2000/week:

Home value        1,200,000

Revenue                      Assumptions
Rental income        20,000  Summer of 10wks X $2000 per
Expenses                     Assumptions
Mortgage interest    66,000  Jumbo 30yr, 5.5%, X 1.2m
Property tax         24,000  High J#rsey taxes, 2%'ish of value, X 1.2m
Realtor skim          2,000  10% of rental income
Property management   4,000  By owner, imputing 80hrs/yr X $50 per
Insurance             2,000  Rentals are expensive to insure
Misc                  2,000  Beach tags etc. etc.

All these numbers are arguable but CEFGW. The gist is, the owner is getting $20k, and his "cost of goods sold" is $100k. So the rental income covers only 20% of costs. I'm not a "bubble" believer, but "Wow!"

The Dismal Science, by Kim Zussman

The dismal science is becoming an increasingly popular major, ostensibly driven by salary concepts.

Some of us are old enough to remember a time when such pro-establismentarianism was uncool (then it was social work or biology with emphasis on environmentalism), but now Freakonomics is in.

20 years ago it was computer science and engineering. I know a retired aerospace engineer from MIT who had been inspired by Sputnik and the space race as a boy.

Biology used to be either for health-professions or teachers but now there is biotech.

Major waves would seem to be lagging indicators of the difficult choices facing young people. Cyclical decision-making in face of uncertainty.

Bodyguard of Lies, from Gibbons Burke

John Walker of Fourmilab reviews Les mensonges de la Seconde Guerre mondiale (Lies of the Second World War). Paris: Perrin, 2004. ISBN 2-262-01949-5:

"In wartime," said Winston Churchill, "truth is so precious that she should always be attended by a bodyguard of lies." This book examines lies, big and small, variously motivated, made by the principal combatants in World War II, from the fabricated attack on a German radio station used as a pretext to launch the invasion of Poland which ignited the conflict, to conspiracy theories about the Yalta conference which sketched the map of postwar Europe as the war drew to a close. The nature of the lies addressed in the various chapters differs greatly--some are propaganda addressed to other countries, others intended to deceive domestic populations; some are strategic disinformation, while still others are delusions readily accepted by audiences who preferred them to the facts. Although most chapters end with a paragraph which sets the stage for the next, each is essentially a stand-alone essay which can be read on its own, and the book can be browsed in any order. The author is either (take your pick) scrupulous in his attention to historical accuracy or, (if you prefer) almost entirely in agreement with my own viewpoint on these matters. There is no "big message", philosophical or otherwise, here, nor any partisan agenda--this is simply a catalogue of deception in wartime based on well-documented historical examples which, translated into the context of current events, can aid in critical analysis of conventional wisdom and mass stampede media coverage of present-day conflicts.

Models of the Stars, by Victor Niederhoffer

A query comes in regarding the methods used by star quants; whatever the methods are, I'm sure that any success is not due to the complexity involved. With successive models, it's essential to calculate the standard error of the estimate from the simplest model, i.e. to take the average error, adjusted for squares if you wish, but preferably just using the absolute errors about the mean. Once you have that average and total error, then fit the more complicated model. How much have the errors been reduced? By comparing the ratio of the reduction to the original error with an F-test, you can measure both the significance and magnitude of the improvement. Such a procedure will generally show that the simple variables used, i.e. the main effects, account for an order of magnitude more impact than the additional variables added. The significance of the initial variable will also be considerably greater. As for predictability, which is so much more important, see Bacon, and see Stigler's Statistics on the Table, especially the regression paper. Whatever mumbo the star quants purport to use, it isn’t complexity that gives them the edge, but more likely the niche, such as after-hours trading.

Briefly Speaking, by Victor Niederhoffer

1. There is a sense of febrile unrest in Europe, driven by indicia of hopelessness such as declining populations, rising unemployment, costs far and above the value of their currencies in dollars or hours worked for goods, rising crime, incredible congestion on roads even with congestion charges, a move for national identity cards to preclude emigration, taxes above 100%, and growth rates well below inflation. Who would choose to live there or start a business there unless there were Draconian restrictions enforced by the kind of world state apparatus that the Sage and the Palindrome prefer?

2. Chain Reactions by Adam Hart Davis talks about all the vertical and horizontal links between sciences in England from the time of Francis Bacon in the 16th Century to the present. It is highly educational to see how scientific societies and friendships combined with philosophic businessmen. Mentoring and friendships based on business lead in a direct line to so much of our personal material well-being. Particularly important have been the Lunar Society, the Royal Society, and the amateur scientists' experiments for practical and scientific advancement.

Balance, by GM Nigel Davies

Chess features a subtle interplay among different elements. Part of the trick in playing well is finding the point of balance among these elements and then combining them in the decision making process:

Given the complexity of this multi-layered thinking, how easy it then becomes to deceive yourself over the true nature of a position. Especially pernicious is to have an edge at one point of the game (or even believe you had an edge) and then pursue the ghost of this advantage when it no longer exists.

Another Meme Dies, by George Zachar

One thread wafting around the bullish-on-bonds camp lately has been "the Fed never tightens when ISM goes below 50" meme. The bizarre nature of the current interest rate cycle, and the declining share of economic activity associated with ISM/manufacturing never entered into the equation.

Now, with ISM itself stubbornly refusing to dip toward/below 50 (just reported 53.8 +2.4), casual debt longs who held through yesterday's Fed meeting, are throwing in the towel, bringing the 10 year yield back up to a 4 handle.

Every seasonally-adjusted component of the ISM report was up, BTW, except "new export orders".

Busking, by Shui Mitsuda

From day one, back in 1995, I have been using charts for trades.

The Senator taught me the dangers, as well as benefits, of using charts along with fundamentals and other indicators, most of which are commonly available now but I did not pay much attention to them back then. He certainly added greatly to my depth of knowledge and I admire very much his decades of intensive and persistent observation of markets, at details that I had never imagined looking at in the past.

I don't trade based on charts alone. I treat fundamentals just as preciously as charts. But I would certainly be lost if I did not use charts.

I used to do busking in London, playing music and selling audio tapes. I needed to see the crowd to know when to change my selection of audio tapes and when to pull back or even when to stop playing music. To me charts are similar to that observation of crowds. If we had purely loved our music and kept on playing while ignoring the crowd's reaction, we would not have been able to buy dinner out of busking.

A Greenwich Hedgefundist Surfs the Web

I often track down the current/former academic sites of principals at high performance hedge funds. It often leads to some great, if dated, material.

Happened to come across David Magerman's site. He's the head of production for Rentec and a former student at Stanford. He has an easily digestible Postscript-format 19 page primer on probability notation, titled Everything You Ever Wanted to Know About Probability But Were Afraid to Ask, that will be old hat for math gurus but is still a good launchpad.