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November 15-30, 2005

An Essential Book, by Victor Niederhoffer

The field of investments and speculation has now reached the point of all good sciences with the publication and diffusion of the great and essential investment book Trading and Exchanges:  Market Microstructure for Practitioners by Larry Harris. Along with Dimson, Marsh and Staunton's The Triumph of the Optimists, and perhaps a good book on valuation such as Aswath Damodaran's Investment Valuation, and a standard text on investments such as Sharpe, Alexander and Bailey's Investments, market participants now have available a foundation for practical and theoretical knowledge in this field that is equivalent to what they might expect in any of the other sciences such as biology, chemistry, engineering or physics.

Kuhn in The Structure of Scientific Revolutions discusses this halcyon state that every science must achieve, and points out that it leads to a rapid accretion of knowledge as investigators extend the accepted knowledge in many directions, fine-tune the theorems, and test and sharpen the hypotheses that form the basis. And what a horn of plenty Trading and Exchanges provides. Each chapter set my head reeling, giving me theoretical and practical insights, suggesting areas I must study to improve my game, and sparking research in related areas that could lead to greater profits.

The book is about how markets work from the bottom up, with emphasis on:

  1. The structure of trading
  2. The benefits of trade
  3. Speculators
  4. Liquidity suppliers
  5. Origins of liquidity and volatility
  6. Evaluation and prediction
  7. Market structures

There are 29 chapters in the book, each divided into a series of economic principles that provide a foundation for understanding the chapter: a series of stories about how the big boys and little boys profit and lose, the evolution of practical market solutions to facilitate the activity, and legal and efficiency issues that arise from the fray. I found in reading the stories after the economic principles that my whole trading life came back to me with deep resonances and overtones. I kept saying such things as "my goodness, if only I had known this, or hadn't let it happen to me!" or, "never again, the b##tards!"

Central to the book is the division of market participants into the following categories:

  1. Informed traders, who profit by bringing prices into line with where they should be
  2. News traders, who take announcements and evaluate them and hasten prices to their proper levels
  3. Dealers, who provide liquidity to other traders by buying and selling out of their often very expensive inventory, from their very extensive communications and research base
  4. Order anticipators, the parasites who frontrun and imitate the actions of those higher in the chain of information
  5. Bluffers, who disseminate false information not related to fundamentals to create transitory movements to the cost of all others
  6. Utilitarian traders, those who provide the energy that makes the system go round, including investors and borrowers who move money through time and hedgers who use the market to reduce the risk that price moves would have on their businesses
  7. Asset exchangers, who switch among instruments to create the optimum portfolio as the economic backdrop and their own conditions change
  8. Gamblers, who trade for entertainment

The book shows the impact of all the structures, rules, and trading procedures on each of those participants. A simple way to summarize one aspect of this division is that there are informed traders who know what they are doing and are going to profit no matter what, and futile traders who think they know what they are doing but serve to provide money and energy to the informed traders that make the system work. I had a similar division into producers, dealers, consumers and recyclers in Education of a Speculator.

However you slice it, you want to be trading with the futile traders, especially when they get lucky and think they are smarter than they are. The extensions of this rule to markets with upward or downward drift provides one of the best frameworks for profit for the sapient market participant.

Not explicitly mentioned in the book is that chartists and trend followers are mainly futile traders and that the idea that they can overcome the zero-sum aspects of the trading game by somehow taking money from informed traders and dealers is a theoretical and practical implausibility. Regrettably for me, some major brokerages seem to have realized this recently and are closing down such departments. But, fortunately for the continuation of the market, many funds devoted to such futile methods and the mystical belief that the past will be similar to the future, especially after a drawdown, are still going strong. I was unsure whether to compliment the author on his diplomacy, or chide him for his naiveté in not covering this natural extension of his work.

My favorite chapters in the book revolve around the exact mechanics of orders. Orders are of two different types: market and limit. They differ in their uncertainty of fulfillment, and the liquidity they provide. In a essential passage, Harris states "Traders who use limit orders grant trading options to the markets because they allow other traders to trade when they want to." He goes on to show that limit orders in general will be slightly more profitable than market orders, because it takes more time and expense to move them as the situation changes than the simple market order which provides liquidity. A typical table in the book describes some fine points in the types of orders. Although I wrote one of the first technical articles on the properties of orders and their effect on prices on the exchange, and have followed the field closely as a practitioner continuously and actively for 40 years, I found there were numerous areas of which I was completely ignorant and many others that I had to learn about quickly in order to perhaps better prosper.

One of the strengths of the book is the frequent use of games and sports to illuminate the decisions that market players should and do make. All of us can relate to such things as to how proper strategies and tactics in card games, sports and bargaining can help us attain our goals. Through Harris's lens and the foundation of economic principles and actual market practices in each field, you learn how and why to apply these to win in markets. Some of my favorite passages:

A comparison of bookies to dealers:

Most sports betting markets are quote driven markets in which books are dealers. The bookies try to maintain a balanced book. When bookies have balanced books, their only risk is that their losing clients will not pay up. Dealers minimize their credit risks by carefully screening their clients. They limit the credit that they extend to cover their potential losses. Ruthless bookies also minimize their credit losses by threatening the kneecaps of their deadbeat clients.

Investors and borrowers:

People often need to move money from one point in time to another. People face intertemporal cash flow timing problems when their incomes and expenses do no coincide. When their incomes are more than their expenses, they invest, to move money into the future, or they repay money they have borrowed in the past. When their incomes are less than their expenses, they borrow or they liquidate investments. People invest, borrow, liquidate, and repay to move money forward or backward through time.

Block traders play Concentration well:

Block traders play a game similar to the card game Concentration in which players take turns uncovering cards and attempting to match them. To match buyers to sellers, block traders must remember who was, who is, and who would be interested in trading hundreds of securities.

Harris has many beautiful discussions of why past performance is not indicative of future success. His 2 by 2 table of skill versus outcome with the lucky and successful being insufferable is at once deeply explanatory and hilarious, as are a hundred other tables and classifications in this 643 page book. Perhaps the main weakness in the book is that Harris seems unfamiliar with the niches that profitable market participants must gravitate to if they hope to overcome all the frictional costs that the market structure imposes. The key reason that many apparent anomalies exist is that they are lures to foment hope in the uninformed. Whatever works in one field or another, or with one technique or another, the Law of Everchanging Cycles insures will not continue in the future. Similar farsightedness is seen in the chapters on bubbles, and performance evaluation, with a 10 page introduction to t-tests, statistical power, and distribution theory. But regrettably this material leads up to misleading conclusions about the Sage. The real question is whether the Sage's message and skills will hope up in the future, now that the tax losses and angles and constant bearish messages have used up their wind.

But one or two defects in a book with literally more than a thousand good parts is only human. Trading and Exchanges is essential reading for all market participants. Anyone who takes an investments class, or has been, is, or will be a market participant should read it. It belongs in every library, every home, every economist's and lawyer's office, and should be required reading in every investments and finance class. Finally, the elementary and structural part of investments, from which everything else builds, has its masterpiece.

Joe Hughes Adds:

I don't know a trader worth his salt who doesn't wear several of those eight hats, or have the ability to don any of them on any given transaction. I would not consider them individual participants, but more of a position of strength or weakness to be considered prior to a transaction. For example:

Every good trader understands which one of these eight positions he is in prior to transacting. Akin to "if you don't know who the sucker is at the table, it's probably you."

Joe Gelman Mentions:

You might be interested to know that Thomas Petterfy, CEO of Interactive Brokers, sent copies of Harris's book to many (or all) of his customers as a gift. In a special inscription, he noted, as you have, that the caliber of the content made it a worthy read by all traders. Your review is certainly on the mark. But maybe you could elaborate on your statement, "The key reason that many apparent anomalies exist is that they are lures to foment hope in the uninformed."

Why NYC and Fairfield County Real Estate Prices Went Up, from George Zachar

Note the middle column of this table from the recently-released Bureau of Labor Statistics report COUNTY EMPLOYMENT AND WAGES, FIRST QUARTER 2005:

The Perfect Turkey, by John Bollinger

Been running this down for years; finally got it right this year.

Tuesday evening: Fresh 13 pound bird from Peking Poultry in Chinatown.

Wednesday afternoon: Brine the bird. Five gallon pail half full of cold water; half salt, half sugar, enough to float an egg. Very large handful fresh sage, half inside the bird half in the brine. Heavy plate on top to hold bird down. Place in cool place.

Late Wednesday night: Remove plate, invert bird, replace plate.

Early Thursday: Bird out of the brine, rinse and dry. Let stand a bit to dry skin. Rub with olive oil. Tuck wings under body, do not truss. The bird is ready for the smoker.

Smoker: Assemble electric water smoker, fill water pan with boiling water. Cut three hooks from a wire hanger to hang top grill 3 to 4 inches below where it would normally sit. Affix remote reading thermometer just above grill next to where bird will sit, but as far away from edges as possible. (Heat rises around edges in these type of smoker.)

Wood: Cut a fruitwood log in thirds against the grain and split with hatchet with the grain. I used almond wood this year. Pieces should eight or ten inches long by one inch by half inch. Place first stick on electric heating element so that it lays across several sections.

Smoking. Place the brined and oiled bird on the lowered grill and put dome top on smoker. Wrap smoker in heavy towels, cardboard boxes on some other good insulating material. You will not open the smoker until you are done. Turn on smoker and gradually increase temperature to 210 degrees and keep in there. The insulation should make it easy to keep the temperature within a few degrees of 210.

Maintenance: If the sun some out or goes away, the wind picks up etc., check the temperature and adjust as needed. Add a new stick of wood every hour, otherwise molest not! Do this for eight hours.

Half hour before dinner: Gather guests around smoker. Remove insulation, lift the domed lid. Be prepared for a loud and satisfying chorus of oohs and aahs. Remove bird to platter, tent with kitchen towels and let rest for half hour. Carve and bask in the goodness of it all. Overeat.

Psychoneuroendocrinology, from Andrea Ravano

The defect I hate most is prejudice and cliche. For its moral implications, of course, but also for economic if not philosophical reasons. But when I come across science reports such as the one below I ask myself if racists and prejudiced human beings aren't on the right side of the table! Of all the problems to solve in Italy, a study on passion and love? One wonders...

ROME (Reuters) - Your heartbeat accelerates, you have butterflies in the stomach, you feel euphoric and a bit silly. It's all part of falling passionately in love -- and scientists now tell us the feeling won't last more than a year. The powerful emotions that bowl over new lovers are triggered by a molecule known as nerve growth factor (NGF), according to Pavia University researchers. The Italian scientists found far higher levels of NGF in the blood of 58 people who had recently fallen madly in love than in that of a group of singles and people in long-term relationships. But after a year with the same lover, the quantity of the 'love molecule' in their blood had fallen to the same level as that of the other groups. The Italian researchers, publishing their study in the journal Psychoneuroendocrinology, said it was not clear how falling in love triggers higher levels of NGF, but the molecule clearly has an important role in the "social chemistry" between people at the start of a relationship.

Ask The Senator, a Continuing Series

Q: How do I determine where to place my protective stops?

A: I think there are two areas here: traders vs investors. For short-term trading, system traders such as I need to see the largest decline in trades that still made money, and set a stop accordingly (assuming sample size, etc., is adequate).

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

Ten Remarks About Prague, by Laurel Kenner

  1. Beauty. Prague is a medieval city of clock towers and spires along the River Moldau (Vltava nowadays), a gift for New World types seeking their roots.
  2. Humanism. In the 1300s, Charles IV went to Paris for the best university education the world had to offer. He came home speaking five languages, brought master architects from Paris and laid out hundreds of acres in an farsighted city plan that endures today. He brought scholars and thinkers and founded a major university. In 1968, the revolt against Communism began here.
  3. Intellectuals. Kafka and Freud among the most famous. Freud left early for Vienna; that was where the resources were. Kafka went there later in life, only to die of tuberculosis at age 41.
  4. The Golem. A cabalist in the Prague ghetto made a living servant out of clay, the stories go; The Golem is the name of a fascinating literary masterpiece by Meyerink.
  5. The eradication of the German language. German merchants were key economic players as far back as the 13th century, encouraged by Charles IV. As power shifted to Austria and its emperors became insufferable, no language but German was tolerated. In 1938, Germany again seized power, under Hitler. Today, not a trace of German remains, whether on street signs, in theaters or in bookstores. No Russian, either.
  6. The survival of the Czech language. Centuries of repression might have permanently crushed creativity in Czech, but the Czechs are remarkably determined. The National Theater, a real beauty, was built in the late 1800s with private funds and devoted from the beginning to Czech productions. Local people turn out in formal clothing for a Dvorak opera (subtitles in English). Doors are barred after the curtain rises. Czech writers, like Czech musicians, are prolific; the windows of Prague's many bookstores are full of books in Czech. It is a Slavic language, a relative of Russian, and completely impenetrable to the speaker of English or Latin-derived languages.
  7. Souvenir shops. Prague has at least an unrelieved mile of them, all filled with cheap "traditional" Czech glassware, marionettes, and garnet and amber jewelry -- all of exactly the same design and no doubt the same provenance. The guidebooks of five years ago still speak of elegant shops in the beautiful old arcades of Old Town. Those days are no more.
  8. Catholic statuary. Baroque saints and Christs and popes and Virgins are everywhere -- on balconies, on bridges, in the squares. Even John Hus, burned at the stake in the 1400s for challenging the church structure, has a statue (but it's Art Nouveau).
  9. The Cafe Slavia. In contrast to the "better", (i.e., expensive), restaurants, you can try this Art Deco cafe across from the National Theater, order plenty of good food and still barely manage to spend $20. Both locals and tourists frequent the place. The service is agreeable, and the pianist is much better than the painful C-players of American pop at the fancier joints.
  10. The Museum of Communism. Shares quarters in a casino upstairs from the McDonald's in Old Town. A video of the police attacking peaceful protesters in 1989, the last gasp of the Communist regime, brings tears to the eyes. At the end, there is an exhibit on Mikhail Gorbachev that memorializes his speech saying he would not use violence against reformers. I recall anew the man's greatness and place in history (and let us not forget Reagan).

Repatriation and Stock Buybacks, from Prof. Gordon Haave

US companies had billions of dollars stuck overseas. The government allowed a one-time repatriation. Jim Willie is upset that they used much of that money to return capital to their mostly American shareholders rather than use it to invest in otherwise unwise capital projects.

So, three things could have happened:

  1. Money stuck overseas being useless.
  2. Money repatriated and returned to shareholders to be re-allocated across the capital markets to where it is most needed.
  3. Money repatriated and spend on capital projects that don't make economic sense in order to please Jim Willie.

Willie comments, "I don't mean to trivialize share buybacks, but to question whether this is the best use for that capital or if it's just the safest way to assuage stock holders." But in fact, the most important thing for the long term health of the economy, assuming a given tax, regulatory and legal environment, is that capital flows to where it is most needed. The corporations doing stock buybacks with this repatriated money have decided that they don't have a good internal use for the capital, and are instead returning it to shareholders. What do shareholders do with it? Shareholders re-allocate it to the sectors of the economy that need it most. This is a positive event in our free economy: the everchanging cycle of capital shifting from where it is idle to where it is most needed.

Kevin Eilian Adds:

The corporation does not "exist" - a corporation is simply a formal reflection of its private maximizing participants. Buybacks are still the most tax efficient way of delivering back to shareholders a return on their risk taking investment, (dividends are taxed at up to 15% after they are distributed - with a buyback, an investor does not suffer the 15% leakage since he/she can postpone asset sales). If you can't earn a return on such an investment, (or if the corporation is hamstrung as to the best, most tax efficient ways to deliver returns), as the chair has shown beautifully dozens and dozens of times, you strip away the incentive to invest, and hence, kill off economic growth. Why is this buyback issue even in dispute?

Slow News Day, from Alston Mabry

The New York Times must have had some space to fill, or maybe they're just trying to teach economics subliminally. Either way, the headline alone is irresistible:

Upbeat Signs Hold Cautions for the Future

By most measures, the economy appears to be doing fine. No, scratch that, it appears to be booming. But as always with the United States economy, it is not quite that simple.

For every encouraging sign, there is an explanation. Consumer confidence is bouncing back from what were arguably some of its worst readings in years. Gasoline prices - the national average is now $2.15, according to the Energy Information Administration - have fallen because higher prices held down demand and Gulf Coast supplies have been slowly restored.

At the Beginning and At the End, by Steve Ellison

What messages do markets send? Is there some level of redundancy in the messages?

Claude Shannon's 1948 article on entropy noted that the relative entropy of the English language is about 50%. This percentage means that about half the characters in English are redundant --"determined by the structure of the language" in Shannon's words, rather than adding meaning. For that reason, one can scramble some letters without diminishing readers' comprehension.

Language has evolved over millennia. Presumably 50% relative entropy is close to an ideal level, allowing listeners to understand despite losses in transmission that might occur because of noise or poor hearing. Minor mistakes do not usually change the meaning understood by the listener. With 100% relative entropy, a minor change or transmission loss would completely change the meaning every time.

Binary and Markets, by Dr. Kim Zussman

  1. Me vs. you
  2. Buy and hold vs. market timing
  3. Indexing vs. stock selection
  4. Asset allocation vs. wazoo leverage
  5. Sell winners vs. buy winners
  6. Buy losers vs. sell losers
  7. Buy pain vs. sell pain
  8. Buy blood in the streets vs. all streets are bloody
  9. Real money is made long term vs. not
  10. Trending is bad vs. trending is good
  11. Stocks go up long term vs. short life-spans
  12. Risk can be outsmarted vs. risk is always smarter
  13. Variance is bigger than you think vs. heroes don't worry (dead < live)
  14. If you're right you can kiss her vs. kiss off

Redundancy and Beauty, from Alston Mabry

Much of the redundancy of English spelling is beautiful. I like through much more than the utilitarian thru, and what about beauty itself?

Last Friday the S&P marked it's highest close since 1 June 2001 however if you calculate the minimal path for each day, i.e., the minimum of the absolute value in points of either C-O-H-L-C or C-O-L-H-C, and sum them, you can see that during the period 1 June 2001 - 25 November 2005, the S&P traversed 22,682 points to get back to where it started.

Redundant? Beautiful?

Saint Bruce: World Peacekeeper, from Rip Mackenzie

Following up to a piece about childhood heroes and Jim Sogi's oft-mentioned martial arts master, I have found an article about a Bruce Lee statue erected to keep the peace in a region where the mere concept has been a dream for longer than time can forget.

Two Conceptions of Communications, by Victor Niederhoffer

In Beethoven: His Spiritual Development, the author, J. W. N. Sullivan, describes a meeting with a beautiful girl, Elizabeth Brentano, the Immortal Beloved, where Beethoven says "Art is a means of communicating knowledge about reality. Music verily is the mediator between intellectual and sensuous life. Those who understand my music must be freed by it from all the miseries which the others drag about with themselves." This noble sentiment, inspired doubtless in the heat of the moment by his hope for Ms. Brentano's kind attentions, seems to me a good way to think about the beautiful figures traced by the charts of many technical analysts.

A contrasting view of markets is presented by Larry Harris in his book Trading and Exchanges, perhaps the second most valuable book about markets after the Triumphal Trio's work. He divides traders into "information traders" and "futile traders." The former try to buy low and sell high based on the superior information they encapsulate. The latter have no chance of ever winning, and the more you trade with them the greater your chances are. I often attempt to trade with these latter, especially those who sell low after a sustained move down in markets with an upward drift, be their trades based on a descending moving average, a breakout to the downside, a secular bear market, or their own hatred of the free markets economic system.

Harris labels a related third category of traders as "bluffers" who disseminate false information to make others change their bids and offers. Rumor mongers and touts would be included here, as well as those who provide part of the truth but not the whole truth, for example the blogger who reports that employment in Berks County, PA looks terrible, and the situation in China is bad, so that it would help his bearish position along. Dealers and speculators and investors must be very wary of someone planting information like this so that they don't go out of business. Harris believes that being a good poker player is excellent training for such, and I would add that patience and counting are other virtues that will help you withstand such a bluffer. He would probably recommend the books of Malmuth and Sklansky on gambling for the investor as an antidote, but I might recommend the works of Snedecor or Anderson or Galton.

Universal Geometry Part II, from Jim Sogi

If you compute the spread, (angle), and quadrance, (length) of the early October drop and current rally using Universal Geometry. S&P mini December.

The high of 10/3/05 (Julian 1)(x3), was 1239(y3). A3=(1,1239)
The low of 10/13/05 (Julian 10)(x2), was 1172(y2) A2=(10,1172)
The high of 11/25/05 (Julian 53), was 1235 A1=(53,1273)
y1=1273 x2=10

s = ((y1-y3)(x3-x2)-(y2-y3)(x3-x1)) ^2 */* ((x1-x3)^2+(y1-y3)^2)
s = 57600/97322
s ~ 3/5

Quadrance (distance squared) |A1A2| = ((x2-x1) ^2 + (y2-y1)^2) ^.5 = 68
 (81+4489) ^.5
Quadrance |A2A3| = ((x3-x2^2)+(y3-y2)^2) ^.5 = 101

The spread and quadrance can be used instead of polar coordinates or vectors for precise measurements using xy coordinates. These then can be quantified for predictive testing. The computations are simple algebra and fast, (for a computer).

Deep in the Heart of Texas, by James Tar

Rather than flying home to California for this past holiday weekend, I decided to spend it with a close college friend and his family in Dallas, Texas.

Dallas has always been in our nation's spotlight, whether it be a cheerleader or two, or a since-past hit TV show. Regardless, everything is big in Texas, from the cars Texans drive, the homes most live in, or the size of the debt on most personal balance sheets.

You see, Texas, and perhaps more so in Greater Dallas than anywhere else in the state or country, is the home of the $100,000 a year household income that lives with a multi-million dollar lifestyle. Everything here, from the Gucci shoes adorned on most feet to the top of the line Cadillacs, can be accumulated through convenient and easy financing. Any bear might stand up and cheer to such behavior and practice, but I am not one of them. Debt is OK, so long as payments can be made. I do not think things will slow down any time soon.

The growth in Dallas! Areas like Frisco and McKinney are expanding like wildfire. Thrifts are on every corner, in fabulous, state-of-the-art buildings. There is a SuperTarget every 10 miles or so, with a Wal-Mart just across the street. The parking lots are full, not empty as a bear might expect. Gasoline is about $2 a gallon.

When you walk in to any retail store here, you are welcomed by every person working there, with a Texas-sized smile. This makes it easier to spend, and the store is ready to send someone out to your car with your bags. Nowhere else in America can you find such a diverse range of restaurants offering choices of high quality product. The average server is quick to your table, pointing out all the good things on the menu and ready at your side. Other areas of our country would be wise to adopt Texas-style service.

I am not an economist, but I am certain there is a reason the Fed has not yet halted raising rates. Planned development here, according to several private business owners I spoke with, is not stopping anytime soon. Business credit default has diminished steadily in Greater Dallas over the last three years, according to a few local lenders. Though a bear may think otherwise, the boom in personal bankruptcy filings is due to the recent change in the law, rather than to current economic conditions.

Whether this is a pilot fish or not I do not know, but I am encouraged personally to say the least. Car washes featuring the $20 oil change are everywhere, and the lines are long.

Ask The Senator, a Continuing Series

Q: What's the outlook for New Orleans?

A: I'm five meters below sea level in Amsterdam today, where I mentioned to friends we sure could use their technology to shore up the Big Easy. They pointed out to me that in 1953 they had a similar disaster and since then have spent a little over $3 trillion on their water protection programs. I asked again. "Yes, over $3 trillion." Happy swimming!

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

Controlled Innovation, by GM Nigel Davies

There's a fine line to be drawn between sticking to the same variations and playing new lines. On the one hand the danger is that one might become stale and too predictable, on the other it takes time to become fully attuned to new types of position.

On the whole I think that 'controlled innovation' is probably the best route, changing something in your game with regularity but not everything at once.

Do Shareholders Pay CEOs to Misreport?, sent in by George Zachar

Katherine Guthrie, University of Michigan:

Tying CEO pay to firm value induces CEOs not only to work hard, but also to misreport firm performance. Shareholders should exploit such opportunistic behavior when they stand to benefit from misreporting. I empirically test this prediction around equity issuances, as artificially inflated stock prices allow shareholders to obtain external financing at lower cost. I find that (i) the likelihood of misreporting increases with equity issuances by more for CEOs in well-governed firms than CEOs in poorly-governed firms; and (ii) CEOs in well-governed firms also receive additional pay in the form of stock options during years with equity offerings, while CEOs in poorly-governed firms do not. My findings are consistent with the hypothesis that active shareholders pay CEOs to misreport around equity issuances.

Inordinate Round Numbers, from Jason Ruspini

There is an anecdotal tendency of prices to gravitate towards option strikes, especially near expiration, especially on high open-interest strikes. Is a fluid dynamics metaphor apt here? Is there a significant tendency for prices to "jump" between option strikes, which are like low-pressure areas?

I spied a Ouija board in a young lady's apartment yesterday and this got me to wondering if there has ever been a psychological study on the use of these games. Without a reason relating to market structure, aren't round number tendencies akin to naive "self-fulfilling" forms of TA: trendlines, Fib, Elliot, etc? Of course, profitability is an important arbiter.

Kim Zussman comments:

There is some evidence on this in the recent paper Stock Price Clustering on Option Expiration Dates, reviewed by Doc Castaldo, with the conclusion that the effect is small.

Jim Sogi adds:

The rounds are a result of the negotiation process.

We've all engaged in negotiations: buying a car, a kid's allowance. Bigger negotiations on business deals are more complex, but involve similar movement of prices. One of the goals in mediation and negotiation is to preserve 'movement' by both parties on some issue or other, normally price. The typical horse trade involves a high offer and a low bid and a bouncing process of movement towards some price between the two. When conducting negotiations it always seems so trivial to have to go through a tedious process when it is understood where the outcome will be, but for some human reason, the process cannot be short-circuited and the difference split at the first round.

There tends to be an unspoken tendency towards equal incremental movements, as in an auction, as prices creep step by step towards the ultimate resolution. The start points and move jumps seem to be round numbers for ease of computation during times of heavy stress, with ten and five being the easiest computations. As more parties become involved, new information is coming in and therefore negotiations can become very complex. The markets are a negotiation process involving thousands of participants at any time. The path of prices can be seen following a negotiated process, with relatively equal size moves and the use of rounds. During negotiation, negotiations continue until one party does not move in the right direction and either stalls or reverses. Negotiations break down. This can be seen in a trending market, when parties no longer continue to move in ordered direction and the process breaks down resulting in ranging price paths.

Laurel and friend Bring Down the House in Vienna!

Vienna gala celebrants after Laurel Kenner's presentation of "A Musical Introduction to Speculation," hailed by many in attendance as "the best presentation they had ever attended."

Three New Stories from Bo Keely: Toes, Claws and Opportunities, The Winner Is, and New Faces and Old Aces.

Victor Niederhoffer Reviews 'Does Trend Following Work On Stocks?'

This paper, by Cole Wilcox and Eric Crittenden of Blackstar Funds, makes a worthy and thoughtful effort to answer the question of whether it's possible to devise a trend following method that works in stocks. Their method is to buy stocks at all time highs then they sell them after a 20% decline or so using the true range as a cut-off to sensitize. In order to do a valid study of such a phenomenon they have had to be careful to adjust properly for survival bias. They do this taking account of all NYSE, AMEX, and NASDAQ stocks listed and de-listed from 1983-2004.

Their results show that $1000 would have grown to some $30,000 during the period. Results for the years 2003 and 2004 of 55% return and 27% return are particularly impressive.

The defects of the study are that they do not show the statistical significance of their results. Small stocks performed much better than big stocks during the latter part of the period. It is not clear that buying the average stock in the category that they found the new highs from, and selling an average stock or a matched stock next to it in price would not have yielded very similar results. More to the point, I hypothesize that buying stocks that were 10% off their high, or at a new low, with similar inclusion criteria, would have come up with as good results. Finally, the inclusion of companies with lower than $250,000 daily trading volumes in the study makes the results unobtainable for those who would wish to implement it with reasonable new money.

While these are serious objections, they are of the armchair variety. We have tested similar strategies on big groups of stocks like the S&P500 and found it produces random results. That is just the point the researchers say, the small stocks are the ones that give the superior returns.

We must compliment the authors on a true attempt to find out the nitty-gritty of the market . Further work in the field by them and us will undoubtedly clarify the issues.

Eric Crittendon Replies:

I believe the following statement is in error:

"Finally, the inclusion of companies with lower than $250,000 daily trading volumes in the study makes the results unobtainable for those who would wish to implement it with reasonable new money."

The last paragraph of the paper goes into detail. Stocks with daily dollar volume that low would not have passed our filter.

The origin of this project was a data mining test on NASDAQ only stocks to find effective stops using a random entry method (that was back in 2001). We found several methods that were effective through various market cycles; all were derivatives of volatility, however. The stops we present in the paper are the most bland and easiest to understand. It is my nature to know what our "total wash out" risk (a.k.a. total portfolio risk) is and be comfortable with it. Without stops, and their aggregate remaining risk across all positions, I can't quantify this value. Under the assumptions in the paper we would have nearly realized this loss, being stopped out of almost 90% of our positions during the crash of 1987. I expect crashes to happen and wish to live through them. The entire system depends upon this reference point, total portfolio risk. It is calculated daily for existing and new (buy tomorrow) positions and becomes an independent variable input into a utility function that, in turn, specifies how much should be risked on each position. New positions are sized accordingly and existing positions are resized (both up and down) if they are out of alignment by a significant margin (determined by yet another utility function). The circular reference repeats every day. In this way we are able to honor every trade and control total portfolio risk. So, you can see my inability to provide portfolio performance results without the use of stops.

When restricted to the S&P 500 we found an inverse relationship between the tendency to have substantial and prolonged % moves and market capitalization. Intuitively this made sense to us as index members have already experienced the market cap growth necessary to get into the index. Also, index members tend to offer transparency that is communicated in real time by an army of analysts and research reports. Furthermore, their business models tend to be overly diversified relative to small/medium companies. Additionally, there is typically millions of dollars bid and millions asked just cents away from the prevailing price at any given time. It seems only an accounting scandal, speculative mania, or major market shock can provide the fuel for outlier moves. That being said, we don't discriminate against them; we are just happy that there are so many more small and mid-cap companies to buy.

Alston Mabry Adds:

The chart comparing their Trend System to the S&P over the period January '91 to January '95 reminds me of a chart comparing the VAY to the S&P over the same period. Most importantly, the bulk of the Trend System outperformance occurred in the period January '03 to January '05, during which the Trend System essentially doubled. The VAY essentially doubled in that same period, so one could make the case that Trend System results are hard to distinguish from the results of a randomly-selected, equal-weighted portfolio, or at least that the mean and standard deviation of the returns of such a portfolio should be the benchmark for the Trend System, rather than a cap-weighted index.

Old Hearted?, from the Assistant Webmaster

There's something disquieting about MSFT's adding a big $ greybeard, however esteemed and dignified, to its payroll. Reminiscent of ball clubs that pay $10m/year for superstar sluggers already a year or two or three past their peaks. Or investment banks that hire retired government poobahs for meaningless jobs, "Vice Chairman" or whatever. Meanwhile, GOOG takes care of business with 22 year old engineers you've never heard of.

Cray Says Co-Founder Burton Smith Will Leave to Join Microsoft

Nov. 25 (Bloomberg) -- Cray Inc., a supercomputer maker, said co-founder and chief scientist Burton Smith will leave Dec. 7 to join Microsoft Corp., the world's largest software maker.

Smith will also resign as a director, Seattle-based Cray said in a statement filed today with the U.S. Securities and Exchange Commission.

Microsoft is getting the principal architect of Cray's supercomputer system and the head of the company's Cascade project aimed at developing new supercomputers. Cray didn't say what Smith's title or duties will be at Redmond, Washington-based Microsoft.

Smith founded Tera Computer Co. in 1987 with partner James Rottsolk. They changed the company's name to Cray after buying Silicon Graphic Inc.'s Cray supercomputer unit in April 2000, according to Cray's Web site.

Drake's Fortune, reviewed by David Baccile

A couple of interesting lessons and maybe even a meal for life was in this book about Oscar Hartzell, the world's greatest confidence artist. Hartzell conned thousands in and around my neck of the woods, (Iowa, Minnesota, Missouri, IL), during the 1930s by convincing people to donate sums of money to settle the inheritance of Sir Francis Drake, one of the best known pirates and certainly most feared of the 16th century. In return for their donations, they would be in line to receive a share of the inheritance promised to be 1,000 times their investment, excuse me, donation. What was amazing about this story is that this con went on for more than 10 years with hundreds of loyal believers even after Hartzell was finally convicted. It is unknown how much money Hartzell was able take in but it is estimated to be over $1 million and probably over $2 million.

How can so many people be that gullible? The conned were, (are), inspired by the "dazzling hope of immediate wealth". There are no true victims of a con since there can not be a con without the 'victim's' desire to get something for nothing. The con man's will to deceive is matched and enabled by his suckers' urge to believe. Their relationship is co-dependent, and it's also symbiotic. Information and emotion travel both ways, from the con man to the sucker, from sucker to con man, living off each other, and the con man must have a strong will and a clear head if he's to remain untouched by the cupidity of his victims."

On impostors, "The impostor becomes temporarily convinced of the rightness of his assumed character in proportion to the amount of attention he is able to gain from it." Apparently 'temporarily' did not apply in Hartzell's case as he remained convinced in his character until his death in 1943.

One last item of interest, that is not really related to the subject of confidence artists, was a published essay written by John Maynard Keynes in 1930. I found it interesting in light of the US twin deficits. The title was "Economic Possibilities for Our Grandchildren". The power of compound interest over 300 years is such as to stagger the imagination. Every pound which Queen Elizabeth, (she backed Sir Francis Drake), invested in foreign trade has now become 100,000 pounds. It would be refreshing if our politicians could think more than 3 years ahead let alone 300.

The V word, from Dr. Kim Zussman

Study of idiosyncratic volatility shows a steady increase from 1950 to 2000, and a rapid decline since 2001. Analysis of similar I.V. spikes of the late 1920's and 1990's attributes it to low priced stock, (<$10), speculation by retail investors.

When it comes to market volatility investors seem to care more about it when sentiment is low than when it is high. Perhaps this is another way of understanding what happened to shorts in the late 1990's?

Tim Melvin Reviews The Little Book That Beats the Market by Joel Greenblatt

I had a chance to read this little gem yesterday. It's written in a very chatty style that could be understood by a bright nine year old. While I admit to being cheesed off at the author, Joel Greenblatt, for turning down my application to ValueInvestorsClub for the second time, with the completion of this book he has, in conjunction with his first book You Can Be a Stock Market Genius (hands-down winner of the "Great Book, Lousy Title" award) written what amounts to a PhD thesis in individual stock selection.

The book can be summed up very simply: Buy stocks with very high returns on capital that have high earnings yield.He offers the formulae and rationale, as well as historical results for this methodology, the necessity of sticking with the plan, and a few other gems, but the simple summary above is the heart and soul of the book. This philosophy of buying very good companies at very good prices is one that seems to elude most individual investors as they search for Nirvana out in mutual fund and managed account land. Most of them would be better off using the magic formulae in the book. Greenblatt even makes it easy by providing real-time lists of attractive stocks.

Easy to read, easy to understand: the book is a gem. Although it may seem simplistic to more experienced investors, it contains the recipe for long-term investment success. His first book covered what I call special situation value investing: such things as spinoffs, workouts, deep discounted stocks, light arbitrage. Taken together, the two books cover all you need to know to pick stocks over the long term.

Laurence Glazier Adds:

I saw this book advertised on a finance blog this morning. What I also need is the reverse: a way to find stocks likely to go languorously down, or at least unlikely to go up much. I like to place trades in pairs, a bull and a bear, and I find the bears harder to pick out. I suppose Greenblatt would reverse the criteria used in his book.

Vienna, by Laurel Kenner

To be in Vienna is..

Recommended reading: The Austrian Mind, An Intellectual and Social History 1848-1938, and Neurosis and Human Growth. Perfect companions in Freud's town.

Reply to an Earnest Spec, from Rod Fitzsimmons Frey

An earnest Spec writes: "I don't know who the 'economic fractalist' G. Lammert is, but for some reason Chaos theory seems to be a favorite resting spot for market babblery. That's probably because it lends itself so well to the techniques of propaganda." I reply:

  1. There are some very smart people looking at Chaos, opening numerous Transfer (appeal to authority) opportunities
  2. It's true - a stock chart does look like a coastline. A "plain-folks" appeal to the two-line lay explanation of chaos theory therefore works well.
  3. Since most readers (or more importantly, system buyers) won't make a serious or even cursory study of chaos theory, the technical vocabulary can be used for very effective Doublespeak
  4. The widespread coverage of chaos in popular science magazines allows hints of Bandwagon jumping
  5. Several technical aspects of chaos theory (fractals, attractors) have entered the common vocabulary, although, like other words with a specific use in science (quantum leap, bandwidth), users have little idea of the actual meaning. That opens the door for variants on Glittering Generalizations.

None of this means that chaos theory can't reveal anything about the markets: I don't know if it can or not. Certainly the invocation by the shysters who write books like Trading Chaos proves nothing one way or the other. I do suspect, however, that there'd be a lot more rich physicists if Chaos could tell us anything about the markets. And Mandelbrot would be playing tennis with S#ros.

The best, (Funniest? Most aggravating? Most pathetic?), example of this is the abovementioned book, which Victor and Laurel quoted in PracSpec as an example of transfer. Having spent a chapter explaining (wrongly) chaos theory and fractals, complete with a picture of a Mandelbrot set, they proceed to reveal their big "chaos-based" secret - a range/volume indicator.

"Comparing this to Einstein's formula e=mc^2, we can solve for the constant c^2 by transposing the m (mass): c^2=e/m = range/volume. In trading the mass would correspond to volume, and the energy would correspond to the price movement".

I assume "c" is the invariant amount of stupidity in the marketplace, but that's not made clear.

"I cannot overemphasize the value of this indicator. It is a more truthful measure of market action than any stochastic, RSI (Relative Strength Index) or other momentum indicator. Whatever you do, don't insult it by comparing it to someone's analysis or forecast. This is where the truth of the market is found".

That'll get you to level 1. Becoming a level 2 trader involves learning Elliot Waves with some fractal vocabulary thrown in. Level 5 is a state of all-awareness, complete oneness with the market:

"It is a higher form of order that becomes all-inclusive. There is no randomness. What we call random at Levels One through Three is really a catchall for our lack of insight and understanding."

To get to this level, where "you feel as though your are floating down a river that is providing you with any desire you name," you'll have to sign up for the Profitunity (™) Partnership Program (™).

Globalization and the Future of Finance, from Jim Sogi

The WTO, IMF, Security Council, G7, Atomic Energy Board, South America's Andean Community of Nations (CAN) Free Trade of the Americas Agreement (FTAA), Nafta, EU and Mercusor all affect global financial markets. The flow of currencies and capital is critical now, even more than domestic metrics. The markets collective breath holding before the Fomc meeting and minutes seems misguided focus when more important information driving interest rates lies in the flow of capital from China, Saudi Arabia, Japan, Russia, Mexico, heating oil from Venezuela, manpower from Mexico, and other countries into bonds and real estate stocks and the banking systems of G7. Yet these are all but ignored or not readily available or understood. It appears that globalization itself being so new is not well understood by government strategists or financiers and could provide an edge. List members speak of global measures and their effects on the American economy. How might this be measured and quantified to render actionable predictions?

Some systems take a baskets of global etfs and currencies and choose among relative performers or relative performance of pairs. What anomalies hide in the global data? Where is the data available? Systems to pick domestic portfolios might be applied to a range of different types of globally available vehicles, or those might indicate effects in the US. Surely the flow of foreign capital effects bond yields and spreads as a demand factor mandated by the law of supply and demand. The demands of Russia, China and the weather there affect the prices of our commodities. Why focus on domestic metrics so fastidiously when a world of information is flowing our way.

Todd Colbeck Adds:

China just signed its first free trade agreement with a non-Asian country, Chile. This could have an impact on both commodity prices and the Chilean securities. There are 25 Chilean ADR's on the NYSE, and the ETF: Chile Fund (CH). CH has moved up sharply in recent days.

Regression to the Mean, from Mitchell Jones

Here is a Richard Russell comment that speaks your language:

Of course, the major "boogie man" on my mind boils down to one word -- overvaluation. It seems to me that aside from gold, almost everything is over-priced and just plain expensive. I'm a great believer in "regression to the mean," a phenomenon we haven't seen for a long while. And Gold help us if stocks, bonds, and real estate decide to regress to the mean price. We'd see monumental losses in almost every area of investing. The very thought of regression to the mean give me chills. But it happens. Sooner or later it always happens.

Scott Brooks Responds:

Regression to the mean? Define the "mean"!

There was a recent post on the site about the average return for the stock market over various periods of time being about 7% or so.

If I just use the Dow Jones as an example here's what I see: The Dow hit 1,000 in 1968, it then proceeded to go down until 1974. It then took the next 8 years (1982) to get back up to 1,000. In the '80's it skyrocketed and continued it's monumental rise up to nearly 12,000 in early 2000. Its now sitting at 10,900. If my math is correct, that's averages out to a 6.5% average return for the last 37 years. If we "regress to the mean" then the dow had better be around 16,300 by 2008 to make it back to its "mean" of 7%.

Regress to the mean? I'll take that kind of regression any day of the week. Especially when you consider that the Dow Jones Average does not even take into account dividends. Maybe your referring to the market being at basically the same level it was in '98 (pardon me for switching to the S&P). If it was to make up its 7& return it would have to skyrocket to get back to the 7% average in the near future (heck, it would have to skyrocket to get back up to its 7% average return by the next decade)

If my recollection of history is correct it seems that the markets have been, at best, bi-polar, behaving like a bad case of PMS, vacillating between Christmas Eve and living hell. Christmas Eve: The Roaring 20's, the 50's and 60's, the 80's and 90's. Living Hell: The first 15 - 20 years of the 20th century, The Great Depression, the 40's, the 70's and so far the new millennium.

Oh sure there are times that the market just held its own, and plodded happily along (the 50' and 60' might actual fall more in this category), but for the most part its been an "interesting" series of ups and downs.

How's gold done during that time frame compared to the market? Certainly not as well. However, gold can be an incredible investment, but, just like any stock you can name, it certainly isn't a long term hold (heck, is any investment something that you can hold and then forget about?).

Now I think a regression to the mean is something that I can use to make money and I use it on a regular basis. But I merely use it to time my buys and sells. I know many on this board are very suspect of technical analysis, but I have found the use of a 10 week trading band to be very useful for determining when to make entry and exit into the market. For instance, right now my research shows that we are at or near the top of the trading band. I have some stocks that I want to buy right now, but I'm going to wait for the market to pull back at least to the middle of the trading band before I pull the trigger on those trades.

Yes, using this methodology has cost me at times (waiting for a pull back that never came, or buying at what I thought was a bottom that kept going lower), but its made me far more money that its cost me. So I don't know what a regression to the mean would mean in the context of your discussion. Know what I mean?

Dr. Phil McDonnell Adds:

What the Dow Theory letter writer forgets with his regression to the mean theory is that the supply of money is fixed at any given time. To the extent that 2005 has been a good year for real estate it is only because the money came from somewhere else. Despite record corporate earnings and favorable stock to bond comparisons such as the Fed Model the stock market performance for the first eight months of the year was mediocre, at best. Money was preferentially flowing into real estate at the expense of stocks and other asset classes.

Now we have a new meme on the financial landscape. With appropriate hype and superfluous media repetition everyone now knows that the real estate bull market was and is a bubble. Couple that with the very real increase in financing costs as the Fed has pushed up short term rates and you have a correction in the real estate market. Statistics for the last two months show that real estate price increases are cooling substantially. If the money is no longer flowing into real estate it must be going into stocks and bonds. This sea change is a significant part of the dramatic rise in stocks in the last 45 days and the recent bond rally.

The regression to the mean phenomenon is real. However the key point overlooked by the Dow theorist is that the regression to the mean occurs at different parts of the cycle for different asset classes. When one class is losing favor the other is in ascension. Money removed from one asset class must inevitably be invested in some other class. It is an inescapable fact of economic life.

So we are left with a conundrum. Bonds had their run earlier in the cycle. The low interest rates of bonds helped fuel the real estate boom. Hard assets such as oil, metals and other commodities had their runs. What asset class is left? Inevitably stocks are about to have their day.

Victor Niederhoffer Suggests:

It might be helpful in discussing regression to the mean to consider its technical meaning which is very different from the way it has been bruited out on this list. This technical meaning is well covered in the book Statistics on the Table by Stephen Stigler and the references to his psychology paper covered there. In words, an observation at a given time, say of height consists of a part that is based on persistence and a part that is based on luck. The persistent part continues if you take another observations. The luck part doesn't. We expect those that are superior in height to continue their superiority into the next generation, but to have their superiority regress back to the mean directly according to the ratio of persistence to luck underlying the process. For two individuals compared at the same time, with identical degrees of persistence, we will note differences. The differences will cancel out in the next generation as the luck component evens out. That's part of the explanation of why the league leaders in the first half tend to show less superiority in the second half of the season. By measuring the means and variances and the co-variances of the distributions of individuals at two separate times, we can estimate how much of the differences are due to skill and luck. That's what a least squares regression equation estimates.

As it relates to markets, there is no reason to think that superior performance will be followed by inferior performance or vice versa. All it means is that the most superior performance between markets , will not tend to be as superior in the next period . For a given market, if we note an extremely good performance in one period, we would predict that it's performance will regress back to the mean in the next period, i.e. if it goes up 10% in one week, we don't expect it to go up 10% in the next week, but some lesser amount based on the amount of persistence and luck in the underlying process.

Much of what we see in markets has a large degree of luck in it. To the extent we think that the entire divergence from the norm is due to skill, we will tend to overestimate persistence. This is a fallacy often made in economic or psychological study of consecutive observations on individuals.

But nothing about the regression fallacy indicates that above average performance will be followed by below average performance, or that below average performance will be followed by above average performance. Quite the contrary, the regression effect shows that the degree of superiority will regress back to the mean ( in the case of heights of sons compared to parents, first observed and quantified by Galton, to the extent of 50% of the degree of superiority of the parents. For example if the mean height for the previous generation is 5 feet 6 inches and the parents are 6 feet, the kids would be expected to be on average 5 feet 9 inches ( without regard to drift upwards). The subject is best understood by working with the mathematical concepts involved which it's possible for the layman to do with a pencil and paper, possibly a random number table in hand, and a close study of the Stigler.

Thoughts on Meals, by Sushil Kedia

Seeing, Hearing, Touching, Smelling and Tasting : all the five primary senses must be satisfied and satiated for a successful culinary endeavour. Which other human activity necessarily is challenged each and every time with all our five senses together? I doubt if there is any (s#x included) where it is necessary to clear the tests of all of the senses simultaneously.

Potato wafers, to illustrate this point, have to be not only capable of producing the distinctive kkhrunch when pressed inside the mouth, but have to have their distinct aromas, flavours, textures and hold it to the reliable colour (shades of white). So, is true of every other bit of food we'd consume.

Extending beyond the primary senses, good restaurateurs thrive on the innate understanding of their business that eating is one regular human need with which possibly most have associated the largest numbers of emotions. Ambience, behaviour, benevolent attitude, lack of scarcity mentality..an endless list of associative emotions!

For all the recipes, for all the decorum, for all the poise and grace, for all the understanding of behaviour, for all the experiences of culinary chemistry a great chef takes care of all of the human senses and sensitivities. Despite and in spite of all the training a master chef "knows" the subtle variances and then having attained mastery seldom needs to measuring up the requirements of salt, spices, time to apply each process, presentation and handling feedback through the busy hours of the trade. It becomes second nature!

What is it that a great chef in grains in her / his system that one could become aware of and learn to apply in the pursuit of being a better trader? A million shades, a million nuances that help understand answers to this question keep popping out from my in-box day after day.

Among a large number of things I am thankful for, the meals that keep coming by each day, almost every hour, from DailySpeculations are particularly salubrious.

The sweet, sour, tangy, pungent, bitter, butterlicious, perfectly-roasted, well-brewed, invigorating, aphrodisiacal, sedative, habit-forming, mind-building and fulfilling meals from out here just load up to a non-replicable buffet.

Winner of the Contribution of the Month Award!

Exploring Fama-French in R, from an Objectivist Researcher

Visualizing the difference between traditional CAPM and the Fama French Three-Factor Model in estimating cost of capital., using R.

While I agree with Mr. Niederhoffer that the Fama-French 3-factor model has its flaws and limitations, my explorations suggest that whatever its faults, it typically provides a better return explanation than the even more commonly utilized CAPM for estimating a company's cost of equity. This may assume, however, many things Mr. Niederhoffer rejects, such as the viability of the SMB and HML factors that French provides. And keep in mind that a model that explains past returns does not necessarily explain future returns. (I personally don't think that size (SMB) is particularly significant retrospectively, and may be irrelevant going forward.) Similarly, if enough people take up Fama-French's model, this may (and may already have) eliminate any chance of future exceptional returns out of the HML (value) factor, which in any case is not constant over time. And even if HML is not a good factor for identifying value and is not a future-return generator, it probably is a decent proxy for identifying intangible, knowledge-based asset exposures, versus tangible, book-value oriented asset exposures. And it is interesting to observe that utilizing the FF-model, one can determine that BRK-A most likely deserves a higher cost of equity (required rate of return) from investors than the CAPM suggests, because the CAPM under measures BRK's market Beta and ignores the company's exposure to the HML (value, distress, tangible-asset-heavy) factor.

I recently wrote a function for R that estimates cost of capital using both standard CAPM and the Fama-French 3-factor model, and allows one to see the impact of the different models (which are simply regressions) for a given stock. (For a non-technical discussion of the standard CAPM and Fama-French models, see:

Womack, Kent L. and Zhang, Ying NMI1, "Understanding Risk and Return, the CAPM, and the Fama-French Three-Factor Model".

I believe this exercise provides the following benefits:

  1. The Fama-French model usually provides a statistically superior explanation of past return for companies. Using a more accurate model should allow for a better estimate of likely future returns, and provide a more accurate insight to the level and sources of investor risk perceptions for a given company ( e.g. provide a more accurate cost of capital estimate in a DCF model).
  2. The function we wrote allows one to visualize to what degree the model fits reality (e.g. a vague, dispersed cloud suggests a weak fit, a tight band suggests a tight fit) and observe whether outliers significantly effect risk estimates.
  3. The Fama-French model allows for the disaggregation of risk factors. Some believe, for example, that market beta is a true risk, while size and value betas are sources of return. If this is one's belief, one could actively seek companies with loadings on these factors, excluding SMB and HML betas from one's COE calculations (while still retaining the benefit of a more accurate market beta calculation provided by the Fama-French model).
  4. Even if one believes there is no risk premium or discount related to SMB or HML, these factors appear to provide informational content and often appear to provide significant context in a regression. One may also explore the time-varying nature of the market, SMB, and HML factor coefficients. (In my limited explorations, SMB and HML factor betas sometimes appear to be more stable over time than market betas.)

Continued here ...

Everchanging Cycles, from George Zachar

One sees them all about: men who do not know that yesterday is past, and who woke up this morning with their last year's ideas. There is a subtle danger in a man's thinking that he is "fixed" for life. It indicates that the next jolt of the wheel of progress is going to fling him off.
-- Henry Ford

Large Caps, by Victor Niederhoffer

It is instructive to look at the returns of the companies that constitute the S&P 500, versus the Index itself. At year end 1999, the Index closed at 1469, versus 1261 today, a decline of 14.2%. Yet, of the 500 companies currently in the Index, 313 are above their 1999 year end level, 158 are below, and 29 weren't publicly traded in 1999. The index itself has a current market cap of $11.6 trillion, a P/E of 18.5, and a dividend yield of 1.8%. Fifteen companies account for more than 1% each of the Index, a cut-off value of $11.6 billion market cap:

Company         % Of Index  5 Year Annualized Return                          
Altria                 1.3             21.1                                             
AIG                    1.6             -1.0                                              
Bank of America        1.6             10.8                                            
Chevron                1.2              5.3                                                
Citigroup              2.2              3.9                                                 
Exxon                  3.3              6.8                                               
GE                     3.3             -5.8                                                
Intel                  1.4             -7.9                                                
IBM                    1.2             -3.5                                               
Johnson and Johnson    1.6              4.9                                                
JP Morgan              1.2             -5.2                                              
Microsoft              2.3            -11.6                                                 
Pfizer                 1.4             -6.5                                                
Proctor and Gamble     1.7              1.0                                                 
Wal-Mart               1.1             -5.5

Just seven of the 15 companies had positive returns over the five years, versus 66% of the total that had positive returns. The average return for these 15 companies was -1% a year versus an average of 9% a year for an average stock.

From this I conclude:

  1. There is much retrospective bias in the returns for the companies now in the index versus the original companies.
  2. The small companies did much better than the larger companies.
  3. The growth companies performed much better than the value companies. This must be checked with properly adjusted prospective data.
  4. There is a tendency for big companies to have names that begin with letters earlier in the alphabet than average. just 1, Wal-Mart, is in the bottom third of the alphabet.
  5. No industry dominates the results for good companies.
  6. The technology companies did not fare well during this period, which encompassed the NASDAQ crash.

Big Brother Bernanke, from George Zachar

The only dissenter on Bernanke's nomination thus far has been Kentucky Senator (and former baseball star) Jim Bunning, whose q&a with Greenspan's heir apparent included this nugget:

"The Federal Reserve will not withhold the M3 data from the public; rather, it will no longer collect and assemble that information."

All students of rhetoric will instantly recognize this as classic Orwellian "doublethink":

"to be conscious of complete truthfulness while telling carefully constructed lies"

Priceless Wisdom in Nine Words, from Jay Pasch

"Becoming successful is a matter of losing not winning." -- Mr. E.

Victor Niederhoffer Replies:

Let us test all priceless wisdom so we don't fall into the trap that 999 out of 1000 investors do by thinking that books like Reminiscences and The Intelligent Investor contain useful information. In fact, their advice would insure that investors lose so much more money than they have any right to lose, and would hasten the descent into oblivion, psychosis, degeneracy and suicide that so riddled the aforementioned authors and their ilk.

On the Senator's Bookshelf: State of Fear

State of Fear on global warming by the prolific Michael Crichton is a must-read. It's a novel but packed with more charts than an Elliot Waver has, and great data on the myth of the hullabaloo about the planet's warming up.

Amazingly, while reading the Herald Tribune here in Madrid this morning, I noticed a story with the exact same lies and distortions as a "save the planet" group uses in a press release in his novel! The article here had the some bogus information on the planet's warming up 0.6 degrees in the last 100 years (it's actually been 0.3) and that malaria will become rampant (it hasn't), on and on, same bogus rhetoric.

Predicting Evolution, from Nigel Davies

Seems like an interesting area vis a vis markets. Once pockets of predictability are discovered, markets must change. But can we anticipate the likely direction of the change?

"Fighting bacteria with antibiotics has always been done the same way," says Hall. "We make a drug and after a while, the bugs adapt to it, so we give them a variant of the drug. But if we can predict how they're going to get around our treatments, we can work out a way to make that route impossible for them. We can cut them off at the pass."
"It's an arms race," says Hall. "One of the things that came out of this experiment is that there's a new drug, called cefepime, that is lethal to many bacteria and looks to be a promising antibiotic. But, we found mutations in the TEM-1 gene that allowed bacteria to hydrolyze cefepime, and we think there is a very good chance that this capability will arise in nature soon."

Kim Zussman adds

This is a changing cycle problem:

  1. Major flu epidemics have moderated in severity/frequency like many other infectious diseases. This is the result of discoveries of Pasteur, Lister, Koch that disease is caused by transmissible organisms, which in turn led to development of drugs and hygiene which inhibits their growth and spread.
  2. Reagents which inhibit infectious agents select for resistant forms, and disease cannot be permanently eradicated (except on Mars where there is no atmosphere or life, and the UV levels at the surface sterilize better than an autoclave).
  3. New Listers will arrive (even off-list) to attack evolved adversaries, and the battle goes on.
  4. All of the above for the same reasons that no market system exists which shifts all wealth to its discoverer: evolution.

The Long and Short of the Yield Curve, from George Zachar

This Fed Chair transition will be the first one with a liquid, specific, Fed Funds futures market keeping score. This is the current state of play:

Nov05   4.000s
Dec05   4.160s
Jan06   4.270s
Feb06   4.450s
Mar06   4.475s
Apr06   4.580s
May06   4.600s
Jun06   4.615s
Jul06   4.615s
Aug06   4.615s
Sep06   4.615s
Oct06   4.610s
Nov06   4.605s

Recall that each figure represents the market forecast of the average funds rate for the stated month. Greenspan's final meeting will be 1/31/06, so the 18bp spread between the Jan and Feb contracts indicates an 18/25 or 72% probability of a 25bp hike then. Bernanke's projected trajectory, down to half a bp, is keyed to the rest of 2006's meetings:

Jan 31
Mar 28
May 10
Jun 29
Aug 08
Sep 20
Oct 24
Dec 12

A Bayesian Book Review, by Jason Schroeder

I strongly recommend Phil Gregory's Bayesian Logical Data Analysis for the Physical Sciences

This book clearly presents concepts and develops methods. As Bayesians treat decision theory, model selection and parameter estimation as the same problem, the book is about parameter estimation! The book shows the developments of the methods and the usefulness of the machinery by removing (and demonstrating) simplifying assumptions made when fitting models and data.

This book is not an apologia of the Bayesian world view. The author and myself treat this book as a companion to E.T. Jaynes Probability Theory

As a reminder to the curious, Bayesian Probability Theory is not a kind of statistics, it is an extension to and enhancement of Logic. It is a system of thought.

End of Year Momentum, by Victor Niederhoffer

As the end of year approaches, it is conventional wisdom that the winning stocks are kept but the losers are sold for tax and window-dressing purposes. If so, the companies that are doing the best near the end of the year might be expected to perform inordinately well toward the end of the year, and the companies that are doing the worst might be expected to perform poorly. Thus, a cumulative November barometer for individual stocks might be posited. Or in baseball terms, the teams that are winning as of the end of November, perform better than the teams that are losing as of the end of November.

But it must be tested. I performed a hand-study of the phenomenon for the last five years:

Performance of Companies Last Month of the Year
Year      S&P  10 Best Companies  10 Worst Companies 
                    as of Nov 30        as of Nov 30
2000       -1                +22                 -14                        
2001       +1                 +6                  -2                      
2002       -5                 -2                  -5                     
2003       +5                 -3                 +11       
2004       +3                  0                 +12                      
Average     0                 +5                   0

There is some evidence that in recent years the worst have done better and in the old days the best did better. Because this is a study on the current S&P 500 universe, the superior performance of the worst companies during recent years, with double-digit gains in 2004 in AMCC, FRX, WPI, NOVL, and CIEN, and in 2003 for Q, KG and LMT, might be due to survivor bias, in the sense that if they were truly bad in both periods of the year, they might have vanished into oblivion or into the Midcap index.

However, the hand-study does underline how regimes change. During the beginning years, it was clear shooting to buy the momentum winners and hold on. During the recent years the reverse. All told, a suggestive and cautionary study, grist for the Minister of Non-Predictive Studies and a worthy caution to academics and practitioners who lump years and companies of all price classes together willy-nilly, assuming independence of the observations in a year, and not taking into account survivor bias.

Queens Off the FOMC Board?, from George Zachar

One definition of the transition from middle to end game in chess is when the queens leave the board. The Nov. 1 FOMC minutes hint we may now be down to rooks and pawns:

Policy setting would need to be increasingly sensitive to incoming economic data. Some members cautioned that risks of going too far with the tightening process could also eventually emerge.

That's the passage that has the debt geeks breathing hard right now. The rest of the minutes is the usual two-handed economists' overview of the macro data.

Symbolic Thinking, from Rod Fitzsimmons Frey

As a new father, I've found interest in studies of child development. In the August 2005 Scientific American, Judy DeLoache describes the development in children of symbolic thinking. The introductory experiment showed to children a small model of a full-sized room: the experimenter used the model to demonstrate to the child where a toy or treat was hidden in the room. Released into the real room, three-year-olds had no trouble finding the toy. Two-and-a-half year olds, on the other hand, failed utterly.

Apparently, examples abound, including children trying to stuff their feet into photographs of shoes, or biting into paintings of apples. By the time a child reaches four or five their symbolic thinking has developed sufficiently that such amusing mistakes disappear.

Or do they? An illustrative example concerned three-year-olds given a riding car to play with. At some point the riding car is secretly replaced with a small model car, a foot long. The child is then observed trying to stuff his foot into the diminutive toy. He was riding in it just a few minutes ago! The reaction of children to their failure to enter the car was either anger at the car, or avoidance: they walked away.

This is directly analogous to my, and I suspect others', reaction to Bacon's ever-changing cycles. What worked last month stops working: the rational reaction is to determine what has changed and what the current appropriate behaviour is. The more common reaction is to rage against the market, the broker, and the universe; or to walk away from the table in disgust. I suspect that we don't actually "complete" our development of symbolic thinking by four years old. We simply grow enough of it to avoid embarrassing and frustrating everyday experiences. More sophisticated examples of morphing models still have us stuffing our foot into the photographed Adidas. Every time the market world isn't behaving as it should, we should picture the child climbing into the Tonka toy and ask ourselves, "what's changed?"

Reminiscences of an Auto Industry Dropout, by Rob Fotheringham

The question of the value of GM triggered a few memories of a past life in Detroit. Several years ago I worked in finance at one the Big Three. Conventional wisdom held that GM was expected to have the most labor disputes as they built 70% of the content of their vehicles in-house, versus Ford's 50% and Chrysler's 30%. Non-UAW suppliers were able to provide parts much less expensively than their unionized counterparts. The dirty little secret, though, that executives went to great lengths to protect, was the utter failure of the company's car platforms (I would imagine similar stories can be told of the other two). I mean car as opposed to trucks. In one year, the company's truck business had an $8 billion profit while the car business lost $4 billion for a net profit of $4 billion. That same year the company had a small profit on one car line, and a reasonable profit on another, while every other car platform lost money. One midsized platform lost over a billion dollars by itself. Press and analyst statements seemed very carefully crafted to create the impression that cars were profitable, just not quite as profitable as the truck lines.

Retrospective apologies rambled throughout the organization to justify the perpetual trouncing by the Japanese, including reminders of federal mandates that required the sale of higher mpg autos with low mpg trucks to reach the necessary average mpg figures, or providing a low-priced, entry-level offering to hoodwink first-time buyers into a lifetime of brand loyalty. But the insiders knew the truth: none of the losses had been planned. The executives at the top had become so far removed from the experience of being a consumer that their chances of guessing what a real person wanted in a car waned with each year they spent inside the belly of the beast. Executives are granted a luxury car of their choice that is fueled and detailed every day when they pull into the world headquarters parking lot.

Mary Walton's book Car provides a fascinating example of how executive egos overruled consumer-oriented, straight-thinking design engineers in one of many steps that undermined Ford's flagship Taurus platform. Bill Ford's recent appearance as his company's spokesman re-emphasizes the unwavering clan of boss-worship still alive and well in Detroit (any adman worth his salt knows the "CEO as pitchman" routine is a fallback when the idea well runs dry). Organisms are born, live, and die. Companies do the same. Detroit is a decaying octogenarian, stubbornly fixed in its ways, with its best days long gone, whose spoiled children (the UAW) will appreciate them only once they're gone.


Gold, from Andrea Ravano

Historically, movements in the price of gold have been inversely correlated to the value of the US$. But currently the US$ and gold are charging ahead seemingly at the same pace. The usual rumors of hedgers building up sizable long positions are circulating, as well as central bank buying. I will not speculate here on the value of these analyses, but I will refer to the probability that either one of the two positions is wrong. Are we witnessing the formation of a new cycle or are we facing the same old strong-dollar weak-gold pattern and thus should be brave and do something about it? I am a bit skeptical about gold's strength, but wouldn't like to be contrarian just to enable some long hedgie to make a killing off my bright idea..

Where Do Probabilities Come From? by James Sogi

The frequentist believes the numbers come from experiments. If the probability is 0.1, if infinite samples were taken, 0.1 is the fraction that would be observed. The objectivist believes that the probabilities are a real aspect of the universe, not just a description of the observer's belief. Physicists are objectivists. Subjectivists believe probabilities reflect the agent's belief. The frequentist ultimately ends up being a subjectivist in order to act in the real world.

From uncertainty can come certainty through the scientific method. It is tempting to use fixed patterns . The danger of the fixed system is to try fit the observation to the system, which may, or may not be appropriate. The mind sees patterns where none exist - this is the danger of subjectivism. The old fixed system may miss a new element in the current situation that may be overlooked when the fixed system is set in the mind. This is where when the new cycles come in, use of fixed systems may miss new elements. This is the danger of objectivism. Life is historical, something is always different. What is new? What will the effect be? What is the historical curve, the new trend, the break from the old? These are critical questions to ask. This is the same problem as the black swan and the problem of induction. We simply cannot know the future except dimly reflected by extrapolating the past. Those that do not know history, that do not observe, are condemned to repeat it.

Dave Whitesel Replies:

I would posit that history contains the secrets of forward demand precisely because of our need to part with it. Now that surmise does not mean we are always successful in said pursuit, it simply means that in free market economies history provides the clues as to forward actions of entrepreneurs seeking solutions.

Entrepreneurs can be way ahead of the systems they exist within, timing is critical, but history is the entrepreneurs starting point. By way of example, automobile economy has extensive cause and effect issues which extrapolate onto our present, providing entrepreneurs with the guidance they need for action.

Without knowledge of history the entrepreneur loses connection to forward demand, as opportunity to correct the problems cast off as effects. Inertia, is another obstacle, the entrepreneur must face, inertia layers additional risk on his endeavor, as systems interested in preserving the status quo might be formidable enemies of entrepreneurial action.

Inertia breaks down; if cause is real. Inertia is a masquerade designed to preserve vested interests, its a state of intransigence built with a high coefficient of fiction. Forward demand persists, its telegraphing need by the greater cosmic conscious, a state of mind which the sensitive entrepreneur cannot ignore.

Forward demand is the entrepreneurs edge, the knowing of that which the past has given unto them, whose minds seek the promise of satisfaction of human need, progress and potential.

History itself is a commodity of the present, its in the now that we decide what to do next.

Rod Fitzsimmons Frey adds

To the list I would add numerologists, who may be a subset of objectivists, although they are not empiricist. A numerologist believes that numbers come from a real aspect of the universe; but the numbers are not a reflection, hint or indication of that aspect: they are the aspect. The numbers are what is real, and the universe we see and experience is a shadow of the number, not vice-versa.

Smart numerologists include Plato, Socrates if he's real, and Nietzsche. Dim numerologists include followers of Elliot waves and Fibonacci retracements.

New Financial Data Service? from Mr. Ckin

Do all the answers lie in this soothing device, the Ambient Orb stock market monitor.

Time magazine describes: "The Ambient Orb may look like a crystal ball on acid, but it's really more of a giant mood ring--plugged straight into the fluctuations of the stock market..."

Properly calibrated, I could save a fortune on expensive data feeds.

Prices and Greed: Don Boudreaux writes to WSJ

Re "Pump it Up," (Editorial, Nov. 22): I, too, have noticed that the price of gasoline sold at the station I normally use has fallen 40 percent from its high in early September.

My heart is warmed by this decline in oil-industry greed - although I'm distressed by the obvious increase in consumer greed revealed by these sharply lower prices.

Briefly Speaking, by Victor Niederhoffer

The Fama-French model is the main academic model accepted by portfolio managers and the public that relates return to company characteristics. The key variables supposed to predict return are small size, high book to price, and systematic risk. Thus, it's guaranteed to lead the investor down the pike of oblivion to the home of losing so much much more than they have to. The main defect of the work is that it uses retrospective, irreproducible data from Compustat. Another weakness is data mining, searching for a million variables that impact, and finding a few from a cross section that worked in particular year.

But these critiques are variants of Dr. Zachar's "your own man says it's so" (having come back from Austria today where the custom is to call everyone and his wife Dr., George will excuse me), And the real critiques run so much deeper, including the fact that a prospective study of such factors would show that investment in growth stocks has led to wealth about 100 times greater than investment in value stocks over the last 30 years.

While Jim Lorie was alive, he always asked me not to be too harsh on Dr. Fama, despite the personal animus that Fama bore for Jim, because Fama was a man of varied scholarly interests. But now that Jim is dead, I can't refrain any longer from pointing out the myriad defects of the Fama-French study, including the fact that an enumeration of the companies involved would show that low priced, unbuyable companies account for the main part of even the irreproducible retrospective aspect of the work, and that the principle of ever-changing cycles shows that whenever investors get on the value bandwagon, it is likely to lead to prospectively below-market returns, as well as the economic arguments that show that value investing, with its eschewal of companies that have high returns on capital, consigns you to the commodity-type investments that Charlie had to browbeat the Sage out of before the tax credits ran out.

Enforce the 55mph Speed Limit?, from Dan Grossman

I am surprised sensible people would sign on to such a killjoy, unhealthy view. Modern cars and trucks and Interstates are designed for 65 or 70 mph. Driving at 45 or 55 would lead to many more accidents through longer trips, leading to far more tired drivers, not to mention the intense boredom of driving too slowly.

Trips on Interstates are often hours, not a few minutes, and differences in speed mean large differences in trip time, resulting in tremendous additional costs to individuals, truck transport and society in general. Honest studies of the 55mph Interstate experiment of some years ago reported no significant decrease in accidents per miles driven.

Victor Niederhoffer Reviews Fewer

The book Fewer by Ben Wattenberg has lessons for all investors and observers of human trends. The main point of the book is that all countries are expected in the next 50 years to lose population and age. The key variable he uses to support the argument is the fertility rate, the number of children born to women throughout their child bearing age of 18-44. If it falls below 2.1, then we expect the population to decline and age, because the number of men and women who ultimately must die, adjusted for death before 18, would surpass the births. There have been some shocking falls in the fertility rate over the past 50 years, typified by Europe and Japan at 1.7 in 1950, down to1.35 now, and lesser developed countries moving from 6.2 in 1950, down to 2.9. Surprisingly, the only Western country with a fertility rate above 2.0 is the US, due to the high fertility of the immigrants.

The book has chapters on the implications of this phenomenon for business, the environment and geopolitics, the implications for aging of the populations, and a review of the main reasons for the declines. The chapter on business is written from the standpoint of the layman with no investment or economics background. The main point he makes is that larger population means larger sales, and this is something that all businesses should keep in the forefront, especially in the location of their retail stores. He boldly states that because of the graying of the population "cruise lines, cardiology, geriatric care, reverse mortgages, health care and cemeteries receive a boost. On the other hand, orthodontists and youth clothing retailers lose out".

The chapter on Aging entitled The Graybie Boom traces the demographic impact on aging of declining birth rates and increased longevity. In a typical chart, he shows that the proportion aged 65+ in Europe will go from 15% in 2000 to 28% in 2050.The main cause of this is declining fertility rather than increased life expectancy. The author concludes that this will put much pressure on health care costs and on pension systems such as our Social Security System. To his credit, the author balances the usual doomsday scenario of the declining worker/pensioner ratio, by the hope of technological and scientific progress and economic productivity. "What workers may lose in pension and health benefits they may gain by growing richer in the private sector. Indeed they may well come out ahead. Remember that the basic idea is to provide for its citizens, not balance the books."

The explanations for the decline in the fertility rate are the weakest part of the book because Wattenberg doesn't fit it into an economic model. He lists contraception, urbanization, education, availability of work for women, abortion, divorce, homosexuality, and the rising age of marriage as the key factors. He doesn't relate it to the opportunity cost of having children, which rises with income as well, or the direct cost of having children versus their contribution to revenue, as most economists would.

The author makes reference to the work of Julian Simon in deploring the fact that there may be one fewer Picasso or Einstein or women who invents a cure for cancer in the world, but does not consider the question of whether an individual birth adds or subtracts from world prosperity and happiness. Indeed, the book is largely a hodge-podge of disparate facts, often without sources or balance, and references to UN studies. It's a mix of conservative, liberal, and libertarian thought about the deplorable conditions and outcomes that had led to the decline in fertility, as well as a paean to the Bush doctrine of spreading American values of liberty, democracy, rule of law, and ability to control one's own wealth, throughout the world, without any model or framework to tie it together.

Nevertheless there are numerous excellent, thought provoking passages. Here's a favorite: "Think about your friend, Amanda, the woman in the ad agency who delayed having children, then delayed further because she was getting a good promotion. Think about your friends Chris and Jennifer, who have been divorced, once, twice, or more, thus reducing the fertility rate. It's easy to see the demographic problems in Europe, but it's happening in America too. We may see a lonelier world. Will friends become like family?" There will be no grandchildren, siblings or cousins to allay the misanthropic tendencies of these lonelies.

Fewer provides an excellent overview of demographic factors that every thoughtful investor should consider in planning for the future.

Dr. Kim Zussman Responds:

Such demographic sea-changes were of concern in choosing a specialty 25 years ago. Periodontics seemed favorable in this regard, in that the boomers were getting older and people were becoming more interested in saving their teeth.

Fast-forward to the present, with great demand for periodontal treatment and implant replacement. However, who could have anticipated the economic laws which would shape this evolution?  I should have taken econ!

Patients generally fear going to the periodontist because they may need surgery. Dentists generally fear referring patients to periodontists because they may lose patients. The vacuum of this disequilibrium was filled by pharmaceutical companies, which developed locally applied antibiotics with some evidence of efficacy (which, along with variable evidence on surgery, is enough to defend a malpractice case) and marketed heavily to dentists. Hence GP's could keep/treat their perio patients, and patients could happily avoid referral.

However, like all areas, quality counts (or in speculating, counting is quality). Patients (i.e., customers) are smart enough to properly weigh the value of services, and most periodontists are extremely busy.

Such forecasts are important for teens preparing for college and the related narrowing of options. Seems the writing is on the wall for many fields where cheap/smart labor can be imported, and it is very difficult to predict the best jobs 20 years out. So we aim for the best diversified education possible, with the goal to learn how to learn, and hope this will facilitate adaptability for survival and prosperity in the future.

Russell Sears Responds:

One demographic trend which is only somewhat examined by economists is how will we be governed with "Fewer".

Sure they all touch the obvious, Social Security and Medicare. But Governments seem to assume expansion and don't function too well without it. The old adage, "Bureaucracies never contract", rings true.

I believe this will have some profound impacts. The politicians and lawyers always eat even before the brokers.

Getting caught on the wrong end of this trend causes not just hunger pains, but often you are the meal.

I have yet to see a economic demographic discussion on the necessity of shrinking governmental powers as the population shrinks. The governments that get this wrong doom their countries.

Ain't No Stopping Us Out, by David Wren-Hardin

I've played with stop orders, and probably even advocated them. But on further thought, I don't think a simple stop does anything. My analogy is to molecular motors and Brownian motion. The base idea was to construct a molecular ratchet. As the molecule randomly bounced along, it had a well, and it was easier to bounce out of one side than the other. For a while, the thing ticks along in one direction. But every so often comes a big bump, and it jumps out of the high side of the well, and loses all progress. Random walks will get you every time.

Georgia Institute of Technology physicist Ronald Fox discusses how a molecular ratchet might be used in cells to transport molecules along microtubules. The difference is it uses ATP to constrain the ratchet. ATP is the cell's energy source. So one could strain the metaphor and perhaps say that by expending "energy" to move your stops, dynamically reallocate them, etc, one could ratchet one's P&L ever upward. But in my opinion, in trading, energy equals money, and I think the laws of conservation of energy come uncomfortably close to applying to trading too.

With Real Estate, This Time it Really is Different by Peter Schiff, Euro Pacific Capital Inc., Summarized by Ari Siegel

Aside from the Great Depression, national real estate prices have never declined in any year. Most industry professionals are predicting that real estate prices have peaked, but will still increase modestly, or at worse dip slightly. However, the Mr. Schiff predicts a bubble burst with a very hard landing. He states some background and several reasons to support his conclusions:

  1. Historically, real estate has increased no faster than inflation. Recent price increases are unprecedented.
  2. Real estate bubble began at tail end of 1990s stock market bubble; not a coincidence that mania flowed smoothly from one market to another.
  3. Irresponsible actions by Federal Reserve, Federal Govt., Wall Street and mortgage industry were cause for the continuation of this bubble.
  4. Fed's dropping rates to unprecedented levels was inconsistent with the nation's low level of savings. It fueled the mortgage refinancing binge that resulted in an artificially lower cost of home ownership.
  5. After 9/11 and tech bubble burst, Bush did not want a painful, but necessary, recession on his watch. Increased spending and irresponsible tax cuts, particularly exempting first $500K profits from home sales from tax, caused the appearance of a healthier economy.
  6. Fannie Mae and Freddie Mac began to insure increasingly risky mortgages; subsequently securitization of these riskier mortgages increased. Moral hazard inherent in separating lenders from actual home owners resulted in irresponsible lending to non-creditworthy borrowers.
  7. Wall Street perpetuated the securitization of billions of dollars of mortgage loans to non-creditworthy borrowers.
  8. During the bubble, the Mortgage Industry has removed several traditional checks on the mortgage process: 20% down payment, full documentation and proof of income, payment of principal from day one as part of mortgage loan, fixed rate mortgages, reasonable debt/income ratios. In short, interest-only loans to non-creditworthy buyers have fueled the bubble and set it up for a hard crash.
  9. The Mortgage Tax Deduction (not new, but more important under artificially inflated price conditions) allows homeowners increasingly large deductions as housing prices go up. As with all government subsidies, the price of the underlying product/commodity actually rises. For example, because of guaranteed student loans, universities can charge impossibly high tuition. In real estate, realtors and mortgage lenders benefit through higher commissions/fees on inflated home prices, more transactions, and larger mortgage balances.
  10. The ATM effect: homeowners use artificially high prices and low barriers to refinancing to extract cash from their homes, sometimes in order to speculate by buying second and third homes. The mortgage lenders are able to securitize such refinancing loans and pawn them off onto the public market. There is no reason for mortgage lenders to apply the traditional checks-and-balances on providing loans, because their risk has lessened. In fact, pressure to meet heightened earnings expectations has all but forced publicly-owned mortgage lenders to chase after any and all loans.
  11. Appraisals. A good example of this mania is found in the new relationship between lenders and appraisers. Traditionally, lenders wanted a true value on a home because they were concerned that they be adequately collateralized. However, the new breed of mortgage originators are only concerned with funding the loans, and only hire appraisers that will validate higher sale prices. The appraisals understand who pays them, and are pressured to appraise high, a fact which further inflates the housing bubble.
  12. Homebuyers have bought into the idea of homes as sources of income. Thus they are incentivized to take out more debt, and increase consumer spending, which drives house prices up, which induces more spending. Why reduce spending when one's $500K home is expected to increase in value $100K/year for the forseeable future? In fact, why not buy another income-producing home? This temporary boost to consumer spending has revitalized the economy, increasing employment, incomes, housing demand and home prices, enabling additional cash-out refinancing, and thus perpetuating the cycle.

Mr. Schiff concludes that the current conditions driving the bubble with subside. Interest rates and inflation will rise, forcing a resumption of savings as home equity fades, leading to suppressed consumer spending, recession, job losses, and lower housing demand. Supply of unsold homes will continue to rise, and a reintroduction of higher down payments and tighter lending standards will reduce the number of buyers. Primary residences that have been squeezed dry of equity, and speculative second and third homes, will be dumped onto the market as owners struggle to meet increasing payment demands. As the aforementioned trends reverse, prices must fall rapidly to bring the market back into equilibrium.

Thanks to Mitchell Jones for bringing this article to my attention.

Trading from McDonald's, from GM Nigel Davies

(from the Ocean Plaza McDonald's, Southport, UK, 11.31 GMT)

Whilst not exactly Viennese cafes, McDonald's UK are leaders with their wireless internet connections. This makes trading from McDonald's rather easy, and there's good inexpensive cappuccino too.

Rather than go stir crazy indoors, I figure I might make this a regular feature of the Grandmasterly day.

Real Fun, by Dr. Kim Zussman

NYU's Jeffrey Wurgler and others have studied the relationship between the IPO market and stock prices. It makes sense that companies would attempt financing by going public when stock prices have been rising strongly. But do IPOs predict stocks?

Wurgler's site contains data on yearly IPO count from 1962, which was imported and used to further evaluate IPOs and SP500 (using Yahoo historic yearly (December) closes, adjusted for dividends).

First a "normalized" variable was constructed from yearly IPO count: simply the (this year)/(last year) ratio from 1962-present (chgIPO). This was regressed against annual SP500 returns as follows:

1. Last year's stock return vs. this years chgIPO:

Slope X Variable 1
Coefficients 0.059
Standard Error 0.028
t Stat 2.15
P-value 0.038

As anticipated, year/year up (down) markets make for increased (decreased) IPOs, and the relationship was significant.

2. Last year's chgIPO vs. this year's stock return:

Slope X Variable 1
Coefficients -0.056
Standard Error 0.029
t Stat -1.94
P-value 0.060

Here last year's change in IPO had negative correlation with this year's stock returns (increasing IPOs predict decreasing SP500), though the regression only approaches significance.

Since the period in question included both high and low inflation, it seemed worthwhile to check whether adjusting SP500 for inflation would have an effect. CPI data is available from US Bureau of Labor Statistics, and has all items for urban consumers (which seems to be what Professor Shiller used). Using the set 82-84=100, 100/CPI was calculated for each year and the product( SP500 annual close)*(100/CPI) = "real" SP500 close.*

Now checking last year's chgIPO vs. this year's real SP500 returns:

Slope X Variable 1
Coefficients -0.06
Standard Error 0.028
t Stat -2.14
P-value 0.039

This result is similar to the same test against nominal stock returns, however now becoming statistically significant. The equation is:

this year's SP500 real return = 1.112 - 0.0608*(last yr chgIPO)

For 2004, chgIPO was 2.98, which gives a predicted real return for 2005 of 0.931 (-7%), which is off but not that far fetched if 2005 inflation is fairly large. (The equation for nominal SP500 returns predicts -1.4% for 2005)

*It seems moot which year CPI data sets value=100 as long as all years adjusted by a ratio. In this case, use of 100/CPI as multiplier had the effect of adjusting SP500 price to 1984 dollars, which is again moot when calculating year/year returns. Due to inflation, real close is higher in the early years and lower in the later years. Mean SP500 return 62-04 was nominal 8.06% and real 3.62% . Data available here.

The Most Dangerous Man on Wall Street, by Joe Hughes

T'was several lifetimes ago, as I have died many a financial death since: I was befriended by an amour's father. He was a very kind, generous and humane man. From a modest background, he had escaped farm life in the Midwest; worked hard; fortune smiled upon him. And at one point was the Chairman of the NASD. His daughter was of nuptial age and he was eager to get to know this new young buck of a trader taking up with his baby. We shared many a meal in some of San Francisco's finer establishments where one would find the city's financial gurus and "in the knows."

At the time, I was a twenty-something fixed income trader, street-hardened in a guttersnipe sort of way. It was early on in our lunch set, that this demi-denizen of Wall Street, some 30 years my senior, decided to check my intellect and savvy.

"So who's the most dangerous man on Wall Street?," he parried between bites of petrale.

"That's easy," I replied in my typical shoot-from-the-hip style. And honestly, I don't remember who I put forth, Ace Greenberg, Lew Glucksman, Sam Zell; could've been any one of fifty or so superstars. It didn't matter. I was wrong.

"The guy sitting in the corner, scratching his nuts, with kids to feed and a mortgage payment." Continue Reading...

Breathing and the Clinical Pathology of the Market Ecosystem, by Sushil Kedia

Do plants and trees also breath? Oh they do, but only inhaling CO2 which the food consuming species exhale and complementing each other flora exhale O2 which the fauna inhale. Flora by design has been endowed with an ability to produce food and the fauna by design endowed with agility and the bliss to consume the food.

Now, focusing onto the more pertinent breathing of the food consumers and examining the process more closely one finds that Haemoglobin molecules that are the carriers of O2 from the lungs also carry back the CO2 from the various cells. The transportation molecules are taking them back and forth from the pulmonary cavity to each and every mitochondrion (those basic units that produce energy in each and every cell) and back. So, that possibly explains why the heart rate goes up when one is running instead of walking at one's usual pace. Not only the requirement for Oxygen is increased but also the production of CO2 that needs to be expelled out rises too proportionately.

A has a useful graphic here explains nicely and one can not fail to notice that nature too is operating a vig in favour of the food consumers in this paradigm at least. Fauna throw out air with a CO2 content that increases from 0.4% to 4% (3.6% rise by volume) while O2 content changes from 21 to 17 (taking away 4%)! So, might I say that Cash is the Oxygen everyone who hangs out in the markets needs. By that assumption the analogous stature for Stock is that of Carbon di Oxide. Trees take CO2 or stock and produce fruits (wealth) and O2 (cash). Does that then sound similar to the public at large (and their well appointed survivorship bias blessed dedicated bull mutual funds) are akin to the trees and the professional speculators the more progressed specie on the food chain?

Now, by this analogy it would be clear that a chase to acquire more and more oxygen will produce a sub-optimal configuration and a chase to acquire more and more stock would result in that too albeit in a different way. As much as choking can threaten life, oxygen poisoning could do that as well. Oxygen levels falling below an optimal point in the blood configuration as well as CO2 falling below an optimal point are both bad.

Taking a slight aside at this point, before we return to a clinical pathology of the markets' ecosystem there is a synchronisation that keeps in balance the O2 or CO2 consumption/production in the broader ecosystem. At nights, trees are not consuming CO2 and are not producing O2. The animals too are gradually reducing the level of 'work' they do and the O2/CO2 cycle does go to its lowest activity levels in the deep of the night. So what is changing? It is the stream of photons that which varies and the system adapts itself. So, assuming the flow of information akin to the flow of photons can one hypothesize that an experimental market on a security without any history where the experimental traders are not in touch with anyone and trading all on their own on the bids and offers thrown at each other (through electronic screens) and the desperate efforts that they would make at deciphering patterns and relationships so generated from such prices would eventually hurt all / most of the traders bringing trading in such an experimental market to a grinding halt! If until tested numbers are found from an actual experiment like that one is inclined to believe that the flow of information is the source of all the energising of the markets then for the time being lets assume information = photons.

When the pros are working hard -- running (on borrowed cash/ leverage), shaking the trees (off wealth), jumping up to pick fruits etc. etc. the ecosystem is witness to a faster consumption of oxygen. The trees however will not start consuming CO2 in a rising proportion of the oxygen being absorbed away since the rate of photosynthesis is dependent upon the quantity of photons being absorbed.

In a closed system of monitoring this phenomenon a noticeable difference should then come by that would surely indicate varying fauna activity levels. But, a closed system is akin to the models of conventional Economics.

Now, within inside the pros side of this ecosystem a faster heart-rate would be indicated by the number of ticks in a particular time-frame.

Oxygen poisoning (a professional deep-sea diver friend from the Navy informed me happens when haemoglobins get all loaded with oxygen which is not being unloaded at the mitochondrions that do not need it yet and hence CO2 is unable to get out of the cellular microcosm since the carriers are all loaded) would be akin to prices jumping up layers in the long term drift. The heart-rate does not rise but collapses in such a situation (No. of ticks per unit of time or of price).

Choking, when O2 is not / lot less available and Haemoglobins are being paced up by the heart to carry whatever little they can grab to the Mitochondrions, then Volume rises denoting the rise in the rate of movement of the haemoglobin molecules. But this momentary surge in the pulse rate too collapses as mitochondrions dwindle in the energy release.

So, in judging the O2/CO2 absorption-release cycles between the flora and the fauna would analogous studies between the relationship of total volume to number of ticks over any time frame prove of any predictive value?

It would be useful to hear from other specs if they have conducted / evaluated studies of volume -vs - no. of ticks over a specific time-frame that might be checking the pulse rate and the blood glucose levels of the markets.

General Motors Health Crisis, by Prof. Gordon Haave

I'm teaching an econ class where my students are working on a team assignment: valuing General Motors. So let's take Occam's Razor to GM to distill the probability of bankruptcy and/or the value of GM shares.

What would you pay for the following cash flows? $15 billion in cash, it is yours. $3 billion in industrial and consumer finance earnings. Then we have the obligation to invest a $90 billion pool of assets. This pool must earn 9%. If it earns more, you keep the difference. If it earns less, you have to make up the difference. The problem is that there are restrictions on how you can invest this pool. Probably 1/3 must be fixed income. Of the equity portion, you are probably topped out at 1/4 international. While you can probably do some hedge funds, it would be on a broad scale where your performance is not likely to be greater than the average fund-of-fund's.

So what would you pay for these cash flows? The market says $13 billion.

Charles Humbert Adds:

This exercise shows the limitations of using multi-stage discount cash flow models to assess the value of the equity residual for long-lived assets like GM. Even very modest changes in the assumptions for future sustainable pension returns versus the growth of post-employment obligations can cause huge variations in the pension liability for the company. Given that the company, like many other of the "big uglies," are likely to have murky accounting for OPEB (other post-employment benefits, mainly healthcare), I don't see how yesterday's proposed legislation will help matters much. Perhaps the Senate is looking for a mechanism to defer some of the expected future burden onto the Pension Benefit Guaranty Corp.

Since "Detroit" has become little more than a group of pension funds that make cars, I'd think it would make economic sense to vacate their industry completely. Maybe they could go invest in HMOs or homebuilding or energy...

Prof. Haave Replies:

The model is very, very simple, the kind of thing I think about in the car, as opposed to in front of a spreadsheet.

Given the restrictions, I would be hard pressed to justify a long-term expectation of greater than 7% earnings on the asset pool. This means, if everything stays the same, the value of GM is wildly negative, which leads to a few thoughts:

George Zachar Remarks:

The critical variables in valuing GM are all on the liability side. The market cannot know the size, composition or payment schedule of of GM's liabilities. Its vaunted "cash position" can vanish with a Delphi headline.

Between the unions (whose stupidity cannot be overstated), management (see note on unions, above), and the courts all shadow boxing here, there's no way the sharp pencil crowd can intelligently set a value range the firm.

The asset prices we can see (debt, CDSs, equities and their options) represent guesses and hopes, not "value". I admire and applaud the work done to use visible metrics to value GM, but I fear it is wasted energy, given the scale of unseen unknowns.

An Article Review by Alex Castaldo

"Why do absolute returns predict volatility so well?" by L. Forsberg and E. Ghysels, Aug 2004

The problem studied is the prediction of volatility of S&P500 for the next 1 day, 1 week, 2, 3 and 4 weeks using intraday data (specifically 5-minute returns). After a theoretical and empirical analysis of several alternatives, the authors come to the following conclusions:

  1. As dependent variable it is best to use ln(RV) i.e. the log of the Realized Variance. This outperforms both the RV itself as well as sqrt(RV) i.e. the volatility. This idea of using a logarithmic transformation had been suggested before. The authors show that even if one is ultimately interested in volatility, it is advantageous to run the regression in terms of logs, make the forecast and then transform back to a vol.
  2. As independent variables it is best not to use RV or a transformation thereof and instead use RAV or Realized Absolute Values. Recall that RV over a period (such as 1 day) is the sum of the squared returns over the subperiods (i.e. 5 minutes). RAV on the other hand is the sum of absolute values of the returns. The RAV are better behaved statistically (less sampling error) and more appropriate to use when the stochastic process for prices includes jumps, the authors show. This result is somewhat counterintuitive: since we are trying to predict RV, it would seem appropriate to use past RV's on the right side of the equation as well, but the authors show otherwise.
  3. A reasonable specification is the so-called HAR (Heterogenous autoregressive) model of Corsi (2003): ln(RV_future) = b0 + bd*RAV_today +bw*RAV_week + bm*RAV_four_weeks, where the coefficients b0, bd, bw, bm are estimated by regression. The three independent variables are the RAV's of today, of the past week (5 trading days) and the last month (actually the last 20 trading days, for simplicity). This model gave good results in an out-of-sample test (the model was estimated for 1985 to 2001 and tested from January 2, 2002 to October 29, 2003). It was superior to, or comparable to, any other model the authors tried.

Pwnership, by the Assistant Webmaster

As the Sony malware story has blossomed over the past week, I've been thinking in more general terms about pwnership.

According to media reports, the "patch" released by Sony is worse than the original malware. So now there will be a universe of lusers affected by the malware (i.e., those who didn't tumble to "something's wrong here" when their Sony CD told them it wouldn't work in ordinary media-player software, and/or believed that their anti-virus/anti-malware tools would "catch" something like this) and a larger universe (by orders of magnitude?) who are confused and try to install the "patch" because they once played a Sony CD on their computers (in a nice parallel to the chain-emails that circulated in the early days of the WWW, "Be careful!! New computer virus!! Will erase your hard drive!!")

Why do people get pwned? How could anyone, no matter how luserly, wind up with a PC pwned by Sony? The short answers:

In the analogous case of terrorism, recall how the Israelis were wise to shoebomber Richard Reid (true, they missed his shoebomb, but they were "awake" enough to grill him at length before he boarded). Contrast US airline security, which was (and I believe, still is) pwned by the terrorists. The government "screeners" lackadaisically examine the X-ray monitor, relying on the technology as a replacement for really "seeing". "What's in this guy's heart and mind?" is the key, not what (you think) is in his luggage.

Similarly, I have zero (yes, 0) speeding tickets in 25 years of driving. Why? Because I use my eyes/ears/brain. I'm always asking myself, "If I were a state trooper, where would I plant my car on this stretch of highway?" Contrast a fund manager I know (let's call him "Uncle") who once got three (yes, 3) tickets on a single drive from NY to Vermont. He was totally pwned by the police, despite his state-of-the-art radar detector He wasn't "seeing", and he relied on technology.

The extension to the markets "writes itself": reliance on Black-Scholes/Li/whatever models..

Jim Sogi Adds:

We read the papers, but do we see what is happening? We read the GPS but do we know where we are and what is going on around us? We read the statistics, but do we know what the risk and situation are? Are we about to get pwned by the market? We have antivirus, but are we safe from hackers and social engineers and cons? We have governments and politicians, but are they to be believed? We have accountants, the SEC, lawyers, insurance, but are we protected? Ever see a tourist walking down the street blind to what is going on around him? Ever see the Emperor's new clothes? Ever see the drunk talking to the pretty girls, thinking he is charming, funny and can dance?

We need vision. Unless we are seeing and understanding, we are going to get pwned. It's what you don't even see that flattens you. Then you are pwned.

DWG, from Chris Humbert

Having installed Valentines in my cars, I remain ticket-free after many years. They are not foolproof, though. I was pulled over two weeks ago for doing 60 in a 35 mph zone. When the officer returned to my car and told me he was only issuing a warning, I was amazed. Until, that is, the followup questions of a somewhat personal nature led me to the belief that the true source of my reprieve was the rainbow flag decal near my license plate. That is the second time such a thing has happened to me in the last two years. Only in the SF Bay Area, I guess.

The Rasputin Effect, by Peter Grieve

There is a phenomenon which often occurs in formerly successful companies which are now in difficult times. It is named after Rasputin, the mad monk to whom the Russian royal family turned for advice in their time of troubles. When prevailing conditions are unfavorable, and companies are in trouble, and management has make misjudgment after misjudgment, they often turn to a radical, untested, faddish business philosophy for relief. The new idea will fix everything, make decisions easy, and secure everyone's jobs. This effect is seen in other competitive areas as well. In the late 1990s the aerospace companies with which I was involved adopted corporate credos, six-sigma production, and specification-based intra-corporate interaction (I don't remember the exact name of this last idiocy, but it involved writing down exactly and quantitatively everything that you expected from other people in the company). Of course all of these companies went down like tenpins soon after. If there was a way of tracking this sort of thing (by using the customer lists of faddish consultants?), and distinguishing it from normal innovation, perhaps it could be an indicator of imminent demise.

The Elephants Trample the Oil Market

Dept. of Dendrology, from Dr. Kim Zussman

Christine Nilsson (1843-1921) was one of the greatest opera stars of all time. Christine married twice. Her first husband was a banker, August Rouzaud, who didn't enjoy watching his wife on stage in Paris. She could sing wherever she wanted, but not in Paris. During that time Christine appeared a lot in London and on tours. August Rouzaud eventually became mentally ill and was put in an asylum, where he used to climb the trees in the garden believing that he was a rising stock-market. Following his death, Christine remarried the Spanish Count di Casa Miranda.

Nothwithstanding trees, I rather prefer lying flat on the ground like a risk-free asset with nowhere to fall. Feels good on the back, too!

Universal Geometry, by Jim Sogi

It should be possible to rigorously test technical indicators to see if they are in fact informative and predictive. The million dollar question presented over the last three weeks is the extent of the current rally. This additional information is helpful as some of the quantitative statistical readings don't always give the exact entry price or exit. This is an exercise to utilize Wildberger's Universal Geometry and its appropriate use of Cartesian coordinates.

Take for illustration the simple basic upper channel TA line. Take a basic line from two retrospective chart tops (20 day highs might be an alternative). Start point A1 8/3/05 (Julian 1), 1254.50, the high swing close. The Cartesian xy coordinate is (1,1254.50).

Next point A2 9/9/05 (Julian 26) 1248.50, the next high swing close, and draw downward sloping line A1A2. Cartesian coordinate is (26,1248.50).

After A1A2, during the next month, the question became how high would the price go on this swing? When is the best time to sell the position: 1200, 1225, 1238, 1240 or 1254? In the line from the prior tops?

Does the line intersect point A3 on 11/11/05, close of 1138, the next swing high? Julian day 70 is 11/11/05. Coordinate is (70,1138). Using Universal Geometry compute whether A1A2A3 are collinear.

Take the Universal Geometry reflection calculation a la Wildberger from the xy coordinates using Julian date and price. The hypothesis is that price follows a linear regression path and upon reversal follows its reflection upon the same angle of incidence. This is another way of saying the that the rate of price rise equals the rate of decline. This allows computation by simple algebra of the coordinates that will intersect line A1A2, and the exact times and prices needed to satisfy the conditions for testing.

Add the hypothesis that the angle of reflection will equal the angle of incidence then we also have a time and date to predict the next top, and the path to get there. This should be testable, unlike old chart lines, by defining the retrospective tops, and testing whether price went to the line, but did not exceed the line, and then dropped thereafter. If significant, then test it out of sample. The use of coordinates and Universal Geometry allows rigorous definitions not previously possible.

The Palindrome Bats 1000, from George Zachar

Top Hedge Funds Giving to Politicians, Parties in 2005
Nov. 15 (Bloomberg) --

Fund                    Party Percentage Amount Raised
Elliott Associates        99% Republican      $229,250
S#ros Fund Management    100% Democratic       $91,932
Citadel Investment Group  55% Republican       $91,283
Renaissance Technologies  92% Democratic       $89,650
Cerberus Capital Mgmt     94% Republican       $63,700
Tudor Investment Corp.    87% Republican       $63,000
D.E. Shaw                 95% Democratic       $57,000
Baupost Group            100% Democratic       $53,099
Och-Ziff Capital Mgmt     88% Democratic       $42,700
Wellington Management     83% Republican       $40,000
Canyon Capital            97% Democratic       $32,300
Top 50 Hedge Funds        54% Democratic    $1,092,420

Noteworthy that there's no "fig leaf" pretense of tossing a nickel the other way..

Dan Grossman Wonders:

Any significant difference in performance depending on whether hedge funds are primarily Dem or Rep contributors?

Sushil Kedia Remarks:

A rumor went around some of the Asian dealing rooms today that S#ros is stopping out of his USD positions, as an explanation of the rare move of two days in a row of gold galloping higher while the USD continued to rise. As most Asian equity indices spent most of the day in a dull existence, before roaring to life at the London opening with Europe trading higher, the gossips kept busy talking about the very quotable book of S#ros.

Thought for the Day, from Brian Haag

It is the very essence of prices that they are the offshoot of the actions of individuals and groups of individuals acting on their own behalf. The catallactic concept of exchange ratios and prices precludes anything that is the effect of actions of a central authority, of people resorting to violence and threats in the name of society or the state or of an armed pressure group. In declaring that it is not the business of the government to determine prices, we do not step beyond the borders of logical thinking. A government can no more determine prices than a goose can lay hen's eggs.
-- Ludwig von Mises

Chakra Con, from Ken Humbert

When I was 20, I was in a single cell on the bottom tier of a wing in the prison at Lompoc, California. A cement building, steel door with small observation window, but I could view the outside grounds through a small, barred window in my cell.

This was the perfect environment for the practice of Yoga meditation and Yoga physical exercises. I found a book on the subject in the prison library. This was a godsend in that now I had something to do with the endless hours of lockup.

My cell had a simple storage area for three pairs of socks, three pairs of shorts, three pairs of t-shirts, spare shirt, spare pair of pants. There was a private sink and a toilet. The bed did have a mattress over a steel frame. In short a parsimonious situation. Ideal for limiting the scope of the horizon, the field of extraneous stimulations.

My yoga practice continued for several weeks without much advancement in chakras.

Yet the moment did come when I arrived at a place never before experienced. My self was suddenly at a point where I feared to go any further; I was advancing past the heart chakra and into a realm of mystery which backed me off from going any further, as in "fools go where wise men fear to tread."

Nevertheless, getting that close to that mystery was enough to advance me to a level which most humans never attain. I never went back to that spot - before I die perhaps I will venture there again.

Bernanke Soundbite Analysis, by George Zachar

Bored, unflappable, disciplined enough to stay on message, effortlessly pulled the "correct" data points and relationships out of his memory to rebut/validate arguments. No unforced errors, no gaffes. He was trying hard not to make news.

From his prepared text:

I will be strictly independent of all political influences and will be guided solely by the Federal Reserve's mandate from Congress and by the public interest.
Monetary policy is most effective when it is as coherent, consistent, and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.
I view the explicit statement of a long-run inflation objective as fully consistent with the Federal Reserve's current policy approach, including its appropriate emphasis on the role of judgment and flexibility in policymaking.

In my next life as a professor of rhetoric, I'll assign the above passages to my students, and ask them to tease out as many internal contradictions as they can.

As to the other side of the table, the members of The Most Exclusive Club In The World, also known as The World's Greatest Deliberative Body (that's the US Senate), largely posed high-school level questions, while citing the New York Times three times, and hack lefty Washington Post columnist E. J. Dionne once.

There are obvious conclusions that can be drawn about the Senators' intelligence and the seriousness with which they take their jobs.

The only folks with the slightest evidence of comprehension of the subject matter are Shelby, Sarbanes and Bennett. The rest of the lot would be challenged by a small town school board budget.