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September 15-20, 2005

9/30/2005
Dick Sears: Weekly Technology Commentary

9/30/2005
Golden Eagle, by Bo Keeley

Hopped Mexican freights the past week with Mexican trampas and Honduran illegals who sneak in dirty droves across Central America and freight through Mexico to their dream of America freedom and dollars.

Twenty per train that we’ve been on. They descend ladders from grain car tops when the trains stop in pueblos, and fan to pound doors for water and food. Great people -- smart yet drawn with hunger, like the American Depression.

At a major rail junction in Surfacta, Mexico, we met the ostensible village idiot, a Honduran contact who greases the underground railroad. Then freighted with a new group through the spectacular Copper Canyon in the first car behind locos for heat, and nearly asphyxiated in 88 tunnels.

Arrived black and safely, Latin like me, in Chihuahua. We disembarked from a freight car bumper with four Hondurans on the fly to avoid yard security. Then Diesel and I beat a way alone to the border where, lacking coyotes two days ago, we were nabbed wading dead center in the Rio Grande into Texas by the Border Patrol. Illegal entry, certainly.

They detained us into the night as Diesel provided financial advice -- anything you can hold in your hand, senors -- the earth, gold, houses, because the bottom soon will fall out of this paper world . The patrol treated us cordially and with humor. At midnight, I couldn’t get Diesel off the phone with his newly wed, so after ample warning I left him in some dusty pueblo with a blanket. He’s not the first bold adventurer to die on the cross of a young wife. His mind will clear and he’ll be glad for the chance to strive with little wherewithal beyond brilliant faculties, like the other illegals.

According to Border Patrol, 30,000 a day try to take the American border and 60 percent succeed. The unsuccessful ones try again and again. I decided to go to Central America and work my way from the start along the underground route.

Yesterday I sat in Sonora canyon, in a dry streambed next to a golden eagle. Started 30 feet away, then gradually decreased the distance until we sat 10 feet apart. Dark brown body, with lighter brown head that was wetted from fishing a nearby pool. He stood about 18 inches but was slouched, probably digesting, and didn't rustle a feather. Long down-curved beak, and talons black and one-inch long. nictitating membrane. Blinked at me every couple minutes, and maybe he mused that he was the only golden in the world to sit 10 feet from a wingless biped in slippers.

The prelude to this:

I was walking a path up a canyon and met a gringo female birder peering thru binoculars up into a tree. Eyeing her buttocks, I asked, "what are you looking at?"  she said, "a ground creeper, but there's another bird up there." She swiveled with predator eyes and whispered, "There's a golden eagle in the dry streambed a hundred yards ahead on the left." I forgot her butt and replied, "that will be a treat," and crept down the path for the golden encounter. Who needs women?

9/30/2005
Nassim Taleb on Options

A- I believe that humans have a natural tendency to overestimate probabilities that are in the common discourse. We have plenty of evidence of that effect. In fact it can lead to a pathology of people paying more for terrorist insurance than plain insurance (which includes terrorism). And people pay almost the same for a lottery ticket, whether the odds are 1 in 1,000 or 1 in 1,000,000.

B - Strangely, I also believe that discussions of "crashes" should make not make one more worried (nobody was talking about the 1987 crash when it took place). By the same argument I would even agree about the decreased probability --crashes are less likely when people talk about them. However, I cannot make too strong an inference from that for option valuation, simply because of the small probability effect. By not too strong an inference I mean "avoid to buy these options" in the tails, not be exposed to them. Simply, a) the market is not a lottery with well-known properties and finite payoffs; b) the smallest error in valuation can lead to monstrous payoffs because of the severe, very severe nonlinearity in the tails; c) even if the past were relevant, we need disproportionately enormous data to estimate the tails outside of the Gaussian distribution; d) people who accept the Gaussian use it by central limit arguments; by CLT it does not work in the tails. There is a strong fallacy about CLT. Central limit is an asymptotic property and, tautologically, there are spots where you reach it faster than others (the center) -- convergence in the tails is slower (to the rate of log (log(observations))).

Furthermore, one may be right on the "probability" of a crash. The problem is that you may be slightly off on the magnitude of the move --ever so slightly wrong "exponentiates" in the tails. You may be accurate about the odds of a crash of 20 % --but you don't know if the crash is going to be 15or 25%. This second order effect is gigantic in the tails. Alas, we do not trade probabilities, but payoffs. Consider the convexity: a 10 sigma out of the money option can pay close to 20 years of time decay from a single crash. A 20 sigma will pay close to 5,000 years. A 40 sigma hundred of millions of years. In brief, the more remote the event, the less we know about its frequency --and the more we are likely to make an error on its magnitude which can be costly. Our knowledge degrades away from the at-the-money in a severely exponential way.

This is allowing me to make my point: I am not saying that the downside tails are cheap, only that we know absolutely nothing about them, nothing, even if we know their probability.

Steve Bal Responds:

Another board member mentioned a paper "Integrating Methodologists into Teams of Substantive Experts" by Rob Johnston that mentions experts outperform novices in explaining pattern recognition (after the fact). It is the process that one becomes a so called expert that ties him to previous beliefs and make it harder to consider new information/process. Experts may be losing as they focus on their favorite variable, the public takes in all information, noise, hype, rumors, tips etc.. and in the end that may just work out. Just like option buyers, experts (self proclaimed) may overestimate their skill and underestimate factors such as time decay.

Phil McDonnell Responds:

One of the concerns I have long held about behavioral psychology and its stillborn stepchild behavioral finance is the basic paradigm. In the usual "experiment" the psychologist lines up a small sample of subjects and offers them hypothetical gambling choices. None of the choices actually involve real money so the weighting function of how a "dollar" is valued is already defenestrated. The psychologist or his grad students interact with the self selected subjects leading to the possibility of further bias. These issues are real and can lead to many problems. However these are not my main concern.

The science of probability and statistics has a long and successful history. The basic ideas were laid down by Bernoulli and many others and are well accepted today. Most modern books follow the same basic precepts and almost invariably there is a discussion of a "fair" bet. I suppose there's a Federal regulation which requires it.

All of the psychologists who do these gambling preference studies assume that what all of the statisticians are saying is true. Specifically the assumption is that a fair bet is one which has an expectation of zero. So the experimenter assumes that he has the "right" answer and all of those silly subjects are acting irrationally. I assert that the irrational ones are the statisticians and psychologists.

If we consider a simple coin toss where heads you win a dollar and tails you lose a dollar we find the expectation is zero and so it is called a fair game. I claim it is foolish for anyone to play. The alternative is not to play, the expectation of not playing is also zero but there is no risk, which I would quantify as variance. So by playing we are assuming added risk for no additional reward. That is irrational. If we were to do that enough we would eventually have to worry about gambler's ruin. If we were to play the coin flipping game against an opponent who is much wealthier than we are it is much likelier than the poorer player will go broke first.

If the game is viewed as a succession of lifetime choices then it is really a compound interest problem not just a simple expectation / probability exercise. Then the minimum return a rational gambler should accept is a winning return which will make him whole for each loss in a compounding sense. This is the rational point of indifference. For a man with $100 if he bets a dollar and loses his wealth is now .99 (99/100) of what it was before. A win gives 1.01. But the correct way to value these outcomes in a succession of such gambles is as the natural logarithm of the wealth ratio outcomes as follows:

     ratio    ln(ratio)
win   1.01     +.00995
loss   .99     -.01005

The table clearly shows that log for the win outcome does not adequately compensate for the log of the loss outcome. Rational people should avoid these "fair" bets and leave them to the behavioral psychologists who presumably are lining up in droves to take them.

The correct winning payoff make this coin flip bet fair for a player with $100 and $1 loss is about $1.01 because the ln(101.01/100) = +.01005 which exactly offsets the -.01005 loss from the table above. This would be one possible way to adjust the game to one which a rational player would be indifferent. Note that the indifference payoff changes with wealth, bet size and probability unlike the usual "fair" bet in the books.

J. T. Holley Responds:

Interesting, because if you take the coin flip and propose to everyone in a room that every time it lands on heads you'll pay them 500k but every time it hits tails they'll pay you 100k, then ask all ready to play raise hands? Small percent raise hands because of the fear of having to pay the 100k. To me 5 to 1 on a 50/50 bet is very rational! The fear keeps them from crossing the line and pulling the trigger though.

Everyone focusing on this loss aversion I guess is what keeps the Mistress happy in a lot of ways and those meant to lose continue their ways till end.

I personally like to focus on the prize and not the loss. This is obviously part of Dr. Taleb thinking too. I think where we might differ is in that lots of small wins cumulating in a compounding effect going forward with drift makes more "empirical sense" to me, rather than lots of small losses with big pay-offs at a rather infrequent occurrences?

Dr. Zussman raised a good point. The middle exists and is the dominant force. It is a buttressing effect. The tails don't have to occur? What makes someone think that they have to occur and to what magnitude? Ironically for this lowbrow thinker it doesn't seem empirical. To think that I could find an edge that would be significant enough to trade based on small amounts of occurrences and be patient enough for those edges to come along after I have been beaten over and over seems almost fantasy or make-believe?

5 to 1 on a 50/50 bet would be nice in the markets sometimes.

Jonathan Mogil Responds:

I have not kept up on behavioral finance in many years but here are my thoughts. Yes it is irrational, or at least in the strictest sense as defined above, it is. I'm sure many on this list (and perhaps yourself) would agree that investors or people are not always rational. Look at the choices people face when heading up to the blackjack tables - close to even odds (assuming they know how to play). If I understand your theory correctly, one also heads up to the table to take more risk with an expected value of roughly zero. In the case of slots, E(x) is negative. However, this is a huge industry, so why? Ditto with lottery tickets where the expected value is substantially worse than what the casinos offer. My thoughts are that people gamble for the excitement, free drinks, entertainment etc. For many its just the hope or dream of being the one on the right side of the distribution. Without trying to quantify this phenomena, I would suggest that the same reasons in which people chose to gamble like this would explain why the coin toss experiment you mentioned might be closer to how people do act, despite violating conventional risk/reward analysis.

Alston Mabry Responds:

My friend Bill developed a gambling problem after he retired from his job as an accountant. Bill blew through a lot of money, occasionally going to Vegas, but mostly on lotto tickets and even -- the real slap in the face -- scratch-offs. I explained to him how scratch-offs work from the point of view of the people who print big batches of them, but it didn't make an impact.

The key dynamic in Bill's behavior was his ability to ignore the cost of playing and focus only on the big wins. He won Fantasy Five payouts in excess of $25k on five different occasions. But he ignored the fact that he was still way down. (You know how many tickets you have to buy to have a reasonable chance of winning five times? A lot. Boxes and boxes full.)

The industry propaganda is all aimed at this tendency to ignore losses, ignore the cost, and focus only on winning. Bill would get magazines explaining how to play slots (and I thought you just put the coin in and punched the button), how to bet at various table games, etc. And the magazines always had articles spotlighting recent big winners, with glossy photos of Tom and Barb from St Louis or wherever, and a story about how they won two mil at progressive.

The key strategy for the casinos and state governments is to keep the losses small and continuous, and keep the wins dramatic but rare. This combination keeps people playing. A skewed distribution.

The part of Bill's brain that gets stimulated by the anticipation of the "big win" dominates the part of his brain that is perfectly capable of understanding the mathematics. And the part that talks will endlessly spin stories to rationalize the whole situation.

So what about BF? Here's one summary statement from a major player: "Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational." (Barberis and Thaler 614 kb pdf).

Frankly, I don't think I've ever met a "fully rational agent", so the above statement seems rather tame to me. I would generalize it into this question: Why do people make bad decisions?

I think it's legitimate to criticize the "students tossing coins" kind of research precisely because the dynamic you're trying to study is the emotional response to risk, so if the risk is small and artificial, how relevant are the results? However, people like Odean take a different approach and study data from real traders in real markets.

But is everybody the same? Or will we have "trader analysis labs" where I will be able to spend a day playing games with my own money, hooked up to monitors and observed by evaluators, and at the end get a "risk response profile" that tells me how I should manage my personal trading activity based on my unconscious behavior patterns?

A strategy for dealing with risk and uncertainty is the use of training and discipline. Just yesterday I flipped past "Master and Commander" right at the scene when Aubrey, having decided to risk a fight with the superior French vessel, identifies an advantage his ship will need, a superior rate of fire, and then drills his gun crews until they achieve it.

Jean Paul Schmetz writes:

I recently heard Dan Gilbert of Harvard (Psychology) talking about his recent research (his "normal" research deals with happiness). Basically he analyzes the practical value of Bernoulli's gift (expected payout = sum of the products of probability of outcome x payout of outcome) when applied by normal human beings. Two interesting conclusions:

  1. The probability of events that have happened recently is systematically overestimated (i.e. investors who were active in 2000-2002 will overestimate the probability of such a market happening again) and;
  2. The short-term payouts will be overestimated vs. the long term payouts.

This basically means that humans are absolutely unable to practically use Bernoulli's gift. For example it could mean that investors (human beings) are underestimating the probability and payout size of a very large movement to the upside over the longer term (say the next two or three years) while overestimating the probability and (negative) payout of a large drop to the downside in the shorter term. Still in line with the Fed Funds model which is basically unchanged since last October (33% undervalued using my method -- due to an overly large risk premium on stocks probably due to the problems discovered by Gilbert) predicting a large move to the upside over the next 12-18 months

9/30/2005
Letter to the Editor Regarding Commodities from J. G.

Victor wrote:

One of the many reasons I believe commodity prices are likely to fall is that the demand for them is relatively inelastic, not rising or falling with income, and the risk of producing a commodity that has a stable demand is low, and thus competition is very high, and this brings the rate of return on investment to the risk-free rate. If the rate of return is close to the risk-free rate, and the quantity demanded doesn't change, how is the price going to go up, not even considering all the innovations and history that Julian Simon has documented as the cause of their chronic underperformance relative to equities? We have been referred to the work of Damodaran on this subject for a related capital asset argument and will report on it subsequently.

Here is a simplistic alternative hypothesis for why commodity futures prices (as distinct from commodity-producing company stock prices) may continue to rise, without relying on fancy economic models, projections of Chinese growth, etc:

I reckon that my family consumes approximately 2,600 gallons of gasoline and 2,000+ gallons of heating oil each year. We likewise consume more than 50 pounds of wheat, coffee, sugar, etc each year. Victor correctly observes that my demand need is relatively price inelastic. To the extent that I am a hedger, not a speculator, it is entirely rational that I should commit a portion of my net worth to owning a basket of fully-collateralized commodity index futures to lock-in my current standard of living. This is economically similar to owning one's home rather than renting by the month or by the year. (We all know what happens to real estate markets when individuals en masse decide to buy homes instead of rent apartments!) To the extent that institutions/individuals increasingly conclude that commodity prices can rise and stay high for uncomfortably long periods of time, it encourages yet more participants to view a basket of commodity futures as a store-of-wealth --NOT a speculative vehicle -- , and a bull market in commodity future prices can ensue without any underlying fundamental changes - simply a shift in psychology. [I'm not commenting on underlying fundamentals in this letter, of course.] Of course, for every buyer of a commodity future, there is a seller. And presumably commercial producers will respond to people/institutions pushing futures prices up with incremental production. Unfortunately, the time lags can be painfully long. While it can take a decade for a substantial mine or refinery to come on stream, individuals and institutions can purchase billions of dollars in long dated commodity futures with a single phone call. Also, because "my" purchasers are hedgers, not speculators, they are price indifferent, and may not sell as prices rise. Finally, as the spot price of energy, irrigation and farmland rises, the instantaneous profitability of agriculture declines, creating second-order (but shorter cycle) upward pressure on foodstuff prices. [Incidentally, past commodity bull markets have lasted between 10 and 15 years . which is consistent with the lag time of substantial incremental production and/or substitution!] A final motivation to own commodity index futures as a store-of-wealth is the fact that after-tax real returns on savings have been negative in the US for a very long time. Even an optimist accepts that CPI inflation is running around 2.5% and for a New York City taxpayer in the top income tax bracket, a riskless rate in excess of 5% is required to simply maintain purchasing power. Ironically, of course, a fully collaterized basket of commodities receives the riskless interest rate and gets preferential capital gains treatment, so rising rates doubly benefits this strategy of locking-in one's standard of living by owning commodities as well. To conclude, I am not suggesting that natural gas prices will continue to rise at an annualized 200%. Rather, I am pointing out that owning a basket of commodity futures can be perceived as a risk-reduction strategy, and if this view becomes widespread, then we could be at the cusp of a major investor preference change - perhaps reminiscent of 1958 in the stock/bond markets.

9/30/2005
Lessons From Fly-Fishing the Upper Headwaters of the Missouri, by Tom Ryan

9/30/2005
Playing for Blood and Playing for Fun, by GM Nigel Davies

One of the main reasons a professional will beat an amateur is that the former is playing for blood whilst the latter is playing for fun. Often the latter doesn't even want to become too strong because he'd lose his peer group. So he plays gambits and tries to get into the pub before closing time, even if it means playing a few quick moves towards the end of the session.

So as much as I hate to disappoint behavioral psychologists, and indeed the Expert, amateurs in many fields (chess, investment, chasing women) are not necessarily acting irrationally in their pursuit of rating points, money or the extension of their genetic line. The are very rationally having fun!

It took me a long time to realize that people can have such frivolous value systems which don't make their percentage of victories a primary goal. But they do, and it's fortunate that they do. It would be very difficult to play for blood if everyone else were doing the same...

9/29/2005
Philadelphia Story, by Steve Wisdom

Random thoughts on BBQ & etc (in the spirit of my earlier Boston remarks) after spending a few days in Philadelphia, my (and lamentably Primal's) hometown, last week:

  1. Good (by Yankee standards) cheap BBQ at Tommy Gunns on South St. Lunch special: two generous pulled pork sandwiches for $5.50! It's BYOB so you have to hike a few blocks to find a proper sixpack of Dixie or Lone Star to accompany. And they took no offense to my dragging a table out to the sidewalk, so I could play flaneur (to use the Expert's term) although the cafes along Rittenhouse Square are a more appropriate venue.
  2. A family member had surgery at Pennsylvania Hospital, 8th and Spruce ("America's first hospital! Founded by Ben Franklin!"). It's run by the U of P. I was surprised by how friendly and efficient (dare I say, respectful of the paying customers) the hospital staff were. Is this a sea-change in health care? Are patients in short supply? Certainly a switch from my prior experience with a U of P hospital, a Saturday night 20 years ago when I chopped off the end of my finger while slicing cheese (with a Pythonesque scene ensuing, spraying blood everywhere, even had to scrub off the ceiling) and spent six hours, Third World style, in the crowded, noisy emergency room lobby waiting for care.
  3. Surprisingly no security (at least none obvious) around Independence Hall at 8th and Chestnut, arguably the most important building (symbolically) in North America. You'd suppose there'd be J#rsey barriers cutting off traffic in a multi-block perimeter. But no. The theory must be that al-Q doesn't bother with second-tier cities like Philadelphia.
  4. Skimming through the Sep '05 issue of Philadelphia Magazine, I see (though I had to read it twice before I believed it) that a "destination restaurant" has opened in Phoenixville, a crummy post-industrial town in the exurbs. Appears the town (appropriately, given its name) has been reborn as a cutesy downtown where tech-industry types from the Devon/King of Prussia area congregate. Creative destruction. Not too long ago, when someone said he was moving to Phoenixville (or Norristown, Pottstown, Coatesville et al) the proper reply was "I'm so sorry. I don't know what to say," much as if he were announcing the death of a close relative.
  5. In other dining news, Bookbinders has changed hands and the new owners have redone the Walnut St branch (a beautiful room now) and closed the 15th St branch. This is a Philadelphia "institution" but in recent year has been overpriced and mediocre (in the fashion of an upscale suburban restaurants), the sort of place (to paraphrase Dr Johnson) where one went not to eat, but rather "to have eaten".
  6. My sister lives in J#rsey, off Exit 2 of the Turnpike ("You live in J#rsey? What exit?") and even in this remote corner of the state she gets C#rzine in Sensurround. Billboards on the highway, autodialed phone calls, junk mailings, TV ads, etc. "Hey, I promise to vote for you, if you'll just leave me the heck alone." C#rzine is running for Gov, seemingly a step down for an august Senator, but it illustrates Albert Nock's principles: as Gov he'll have more money, power and perks to sprinkle on his buddies (literally, in the case of Gov Jim McGrievously). Oddly, considering the money he's spending on media, C#rzine needs $100 worth of grooming. His hair's too long; with the bald spot on top, he looks like Martin Luther. And he should either color his beard to match his hair, or just go natural on both. Get this man on Queer Eye for the Straight Gov!
  7. Society Hill, the southeastern corner of downtown Philadelphia, "would have been" one of America's loveliest historic districts, but in the 70's when Philadelphia (like NYC) bottomed out, cheap hideous condos/apartments were built on all the open lots, resulting in a gruesome mishmosh. Nowadays values have skyrocketed and the 18th century houses on Walnut/Chestnut/Spruce/Pine are being lovingly restored and expanded (largely by the vibrant gay community), but the damage is done. Good illustration of the principle that wealth is the key to historic preservation, not government regulations or master-plans.
  8. Motor-touring in the south J#rsey farm country with the top down, wind in my hair, country music on the radio, I heard this wonderful song, "Beer Goggles", and immediately thought of a certain Old Line spec:
He's on the dance floor yelling Freebird
Singing off pitch but he knows every word
Grabs him another girl he hold on tight
He don't see ugly
Through bloodshot eyes
He'll fall apart when he gets home
But right now his worries are gone
Cause life looks good, good, good
Billy's got his beer goggles on

9/29/2005
Briefly Speaking, by Victor Niederhoffer

  1. During the last four months, bonds have moved gradually back and forth from a low of 114.00 to 118.00 in a gentle ascent-descent-ascent and now descent that covered the same ground in five months that they liked to cover in one good volatile day in the 1980s when the bond vigilantes were masters of the universe. Such a reduction in volatility has many unforeseen consequences including such things as the heightened volatility in energy, through the law of conservation of volatility.
  2. Stocks have had five up days in a row, since Sept. 21, covering in total less than half a percent. This has to be the smallest such positive run of five in history. It gives one the feeling of having had the pleasure of escorting a most elegant and attractive other to five refined and noble cultural events without being invited in for a nightcap after the festivities. But such must be tested as to its impact on the market, not on romance, and similarities for expected moves after long runs of consecutive paint drying on a Arizona wall are surprisingly unrewarding to the chronics.
  3. The bulk of the conundra in economics, such as why diamonds sell for so much more than water, are explained by the concept of diminishing marginal utility. The concept also explains why risky stocks sell for less than stable ones. The marginal utility of buying a product is affected always by the availability of substitutes. Bonds are the main substitute for stocks, and their relative lack of attractiveness increases the marginal utility and derived demand that the public has for stocks. Changes in the attractiveness of substitutes and their affects must be tested in a predictive fashion so as not to descend into the labyrinth of promiscuity that surrounds all of behavioral finance.
  4. Convection currents explain most of the weather patterns we observe in our day-to-day forays with the wind and water. The essence of the phenomenon is how a source of energy like the sun causes the replacement and lifting of hot fluids instead of the more dense cold fluids that fall to the bottom. The movement of hot stocks to the top of the best performer list in a period, only to be replaced by the laggards in the ensemble of companies in the presence of constantly increasing income, wealth and changes in tastes has always reminded me of the changing winds and temperature from day to night in Brighton Beach on the Atlantic Ocean, where I grew up. Such regularities might well be applied to market phenomena ranging from sector rotation to the changing composition of the most-active, best performers, and new highs and lows in a year. One predicts it won't be long before the estimable Mr. Soji reveals to us how similar phenomena explain the prowess of the surfing champions and can be used to daytrade stocks with great aplomb.
  5. The European stocks continue to outperform their U.S. counterparts by a wide margin, with the normal indexes there such as Eurotop 300 up 18% year to date against a measly 0.5% for the US. Part of the differential is explained by the universal law of one return for all assets, perhaps best typified by the master investor Prince Al-Waleed of Saudi Arabia (the subject of a hagiographic Fortune interview of the type previously reserved for the magazine's biggest advertisers and the Sage of Nebraska), who sits on a portfolio that must directly or indirectly through his intimates approach the trillion-dollar mark. And part of the differential must be explained by the Vic-1997 effect: "Thanks for asking. Things are much better than they were in 1997, but then again they couldn't have fallen any lower than the nadir"). Yes, things were so bad in Europe that they couldn't have got any worse, as exemplified by the great desire of the Sage and other old lions to hold European assets rather than U.S. assets since the European trade balances were so much more green than ours. But ultimately one would predict a greater harmony and equalization of the returns of Europe versus the U.S., possibly caused by the equal conduction of return theorem.

Pitt Maner comments:

Vic's comments on convection currents, weather, and market rotations reminded me of a Christmas spent in Sweden in 1969 and my fascination with a cousin's lava lamp. Ah, to watch the lamp "magma" slowly being heated until a sustained succession of upwelling and downwelling molten, red blobs was attained was truly mesmerizing to a young kid. And now it turns out that these convection cells most likely are at work in the earth's mantle and account for the driving forces of plate tectonics, the resulting distribution of diamonds, gold and material resources on the earth's surface, and the wonderful, interplate "hot spot" that formed the Hawaiian Islands. Geopoetry in motion.

A quick surf of the internet further reveals that lava lamps are still made and have been employed by clever individuals as true, random number generators to produce data needed by scientists to model complex natural systems. Random numbers also are quite essential in keeping encrypted information secret. Overestimating randomness another one of those human traits (related to Dr. Taleb's observations) that has led to past problems employing the scientific method and keeping secrets secure.

Somehow the Chudhovsky brothers crunching pi on a home-built, "supercomputer" in a hot New York apartment come to mind. Will the infinite sequence of numbers comprising pi ever reach a series of predictable numbers?

9/29/2005
Dept. of Non-Predictive Studies*: Five Up Days, by Tom Downing

For Dow since 1900, sequences of five days up in a row have occurred 525 times. The average five-day move for these occurrences was 3.4%. The median four-day move for these occurrences was 3.5%. The smallest five-day move for these occurrences was 0.42% in February 1969.

Grouping into quintiles based on the move from C[t-5] to C[t]:

               t+1     t+5     t+10    t+20
-------------------------------------------
Q1:Lowest      0.12    0.10    0.39    0.34
Q2            -0.01    0.15    0.35    0.97
Q3:Mid         0.05    0.57    0.63    0.60
Q4             0.02    0.27    0.20    0.06
Q5:Highes      0.14    0.52    0.79    1.27

Unconditional  0.07    0.32    0.47    0.65

About 106 observations per quintile.

In the near term, there is a tendency for more extreme moves to be slightly bullish, while for the longer term (20 days), the tendency was for larger moves to be more bullish than smaller moves.

*Chief Minister, Prof. Charles Pennington

9/29/2005
Southern California Brush Fires Report, by Kim Zussman

A fall tradition here, are spurred by seasonal Santa Ana winds, dry, hot weather, and a fertile supply of those who seek to remediate the lower reaches of normal distributions using a box of matches.

As I write this there is ash raining down outside the office, which overnight thinly dusted cars and parking lots. Nearby communities have been evacuated and we are hosting some sleepy friends who were forced to flee in the early hours of morning. Having lived here for 40 years, today's condition does not seem particularly ominous since the winds have died down. However, that can change, and neither the fires nor their fathers are well contained.

It seems odd that mandatory evacuations have been called in many areas, since this been very rare over the years (in 1971 I stood on the roof of my parents home, hosing it down while the adjacent orange groves burned). Perhaps the political unraveling of New Orleans, as well as massive armies of trial lawyers, can expedite evolution of society.

Fire insurance is costly here, and probably a bad deal in the face of 40 standard deviation risks. One wonders if enterprising specs are canvassing the fire-adjacent neighborhoods with pricey supplemental insurance for sale.

9/29/2005
"When a Girl Goes Bad--Men Go Right After Her", by James Sogi

Like Mae West, the Mistress of the Market is good when she's bad. Take this year, the market is only up 5 points, less than 1/2 percent. To beat the market would only take making 5 points all year. A saving account or a CD outperforms the market. Buy and hold with dividends beats the market. Risk free bonds beat the market. When things seem ominous, people panicking, hurricanes, earthquakes, tsunamis, government screw ups, budget busting boondoggles, congressmen getting indicted, war, interest rates rising, oil up, the market starts doing some weird gyrations, like today, and yesterday, and last week, and last month, and in July -- panic du jour. The fluctuations of price allows some opportunity, and that is good. Yet prices are flat.

Is it not odd that all this happens when the year is flat, 1211-1216. The last five days closes virtually flat.

  • S+P Index

  • 9/22/2005 1214.62
  • 9/23/2005 1215.29
  • 9/26/2005 1215.63
  • 9/27/2005 1215.66
  • 9/28/2005 1216.89
  • 8/31/2005 1220.33
  •  

    9/28/2005
    The Real Reasons You're Working So Hard, An Article From Business Week Online:

    Honk if this sounds like you: While much of America is watching Jon Stewart, Letterman, or Leno, you're stumbling out the office door into a car-service Town Car or groping for the clicker to the BMW in the company parking lot. Once home, you slug down a beer or the last of a bottle of white wine on the door of the fridge, stuff some leftovers in your mouth, and collapse into bed beside your sleeping spouse. A half-dozen hours later, you crawl to the shower, throw on a clean shirt, pour some coffee down your throat, maybe drop a kid or two at school, and jump back on the frenetic work treadmill that you can't shut off.
    The good news -- if there is any, time-challenged amigo -- is that you are not alone. More than 31% of college-educated male workers are regularly logging 50 or more hours a week at work, up from 22% in 1980. Forty percent of American adults get less than seven hours of sleep on weekdays, reports the National Sleep Foundation, up from 31% in 2001. About 60% of us are sometimes or often rushed at mealtime, and one-third wolf down lunch at our desks, according to a survey by the American Dietetic Assn. To avoid wasting time, we're talking on our cell phones while rushing to work, answering e-mails during conference calls, waking up at 4 a.m. to call Europe, and generally multitasking our brains out.

    Martin Lindkvist responds:

    Honk! While I definitely see a lot of my own habits in this essay, I find that I am immensely more happy when I am working 60 hours a week with something I love, than 40 hours with something that I do not enjoy. So the trick must be to find an occupation which is one's calling, instead of calling the occupation one's having, fiend.

    9/28/2005
    Passive-Aggressive, by George Zachar

    Fannie Mae shrank its portfolio in August at an annual rate 27.1% by simply not replacing the mortgages that "liquidated" that month. Recall the doomsters' forecasting fire and brimstone if/when FNM had to liquidate its portfolio. In reality, just by standing still FNM is shrinking at a pace that's broadly in line with what the regulators demanded.

    09/28/2005
    GM Nigel Davies Shares a Recent Game

    This newly completed correspondence game played on Chessfriend is one of my best in any form of chess. And on this note I will be bowing out of correspondence chess.

  • [White "Davies, Nigel"]
  • [Black "Wilczek, Tadeusz"]
  • 1.d4 Nf6 2.c4 e6 3.g3 d5 4.Bg2 Bb4+ 5.Nd2 Nc6 6.Nf3 dxc4 7.O-O c3 8.Nc4 O-O 9.Qd3 cxb2 10.Bxb2 Be7 11.e4 b6 12.a3 Bb7 13.Rfe1 a5 14.Rad1 a4 15.d5 Na5 16.Ne3 Nb3 17.Qc2 Qc8 18.Bh3 Nc5 19.Ng5 Ne8 20.dxe6 fxe6 21.Nxe6 Nxe6 22.Qc4 Kf7 23.Nd5 b5 24.Qxb5 Ba6 25.Qa5 Be2 26.Bxe6+ Qxe6 27.Qxa8 Bxd1 28.Nxe7 Bb3 29.Nc6 Kg8 30.Nd4 Qc4 31.Qc6 Nd6 32.e5 Qxc6 33.Nxc6 Nc4 34.Bc1 Ra8 35.f4 Na5 36.Nxa5 Rxa5 37.f5 Rd5 38.Kf2 Rd1 39.g4 h5 40.h3 Rxe1 41.Kxe1 Kf7 42.Bg5 Ke8 43.e6 Bd5 44.Kf2 c5 45.Kg3 hxg4 46.hxg4 Kf8 47.Be3 c4 48.Bc5+ Kg8 49.Bb4 [Black resigns.; End date: 9/28/2005] 1-0

    9/28/2005
    Blanks Do Not Cost You Points, by Martin Lindkvist

    In The Rocket Review Revolution, Adam Robinson teaches students how to succeed at the SAT, at the same time that the speculator, as Chair has pointed out, can learn a lot about how to confront the questions that the market is asking at a specific moment in time. Robinson goes on to say that the student should answer all questions, because blanks do not cost points, and guessing does not hurt the score. In the markets however, I find the opposite is true. Not having a definitive statistical edge, and instead filling in a blank, will most certainly cost money in the long run. I have tested this in real time.

    Adam Robinson Replies:

    With respect, Martin mischaracterizes what I say about the SAT in The Rocket Review Revolution. I do not say that students should answer all the questions. There is a tradeoff between speed and accuracy, on the SAT as in so many other things. And the faster one answers questions, the more likely one is to make an error (think of typing). So, for each student, there is an optimal speed that maximizes the expected "return" on questions attempted. If that optimal speed does not permit the student to answer all the available questions in the allotted time, the student will be forced to leave blanks. What I did say was that if a student has attempted a question, he or she should answer it (since the time has already been spent). Time is the limiting factor on the SAT. (There are other important distinctions about the SAT versus market investing -- such as each question being worth the same amount -- that come into play on the periphery of this issue.)

    One crucial difference in the marketplace in that, unlike on the SAT, participants can choose their opportunities ("questions"). Since there are no "assigned" opportunities, the investor is free to leave as many of those opportunities "blank" as he wishes. Moreover, he can invest differing amounts depending on the expected returns (though students can do this with the time they invest per question, they cannot vary the point value of the question).

    So the investor, unlike the student, can choose which opportunities/speculations meet a certain minimum threshold (some minimum expected rate of return above the prevailing risk "free" rate), and, within that pool of investments, vary the amount invested (put at risk) depending on how much greater that investment's expected rate of return appears to be.

    GM Nigel Davies offers A Chess Angle:

    When you can't see a good plan, improve your worse placed piece. Unlike investors a chess player has to make a move, so his aim in such situations is to try not to do too much damage.

    Apportioning your thinking time so as to avoid time-trouble is a good technique that even very strong players might not have mastered (e.g. Viktor Korchnoi). And Bent Larsen also once quipped 'long think, wrong think' meaning that if one cogitates too long over a position, all sorts of weird and wonderful ideas enter ones head.

    A master plays fluently, with each of his moves having a purpose.

    9/28/2005
    The Rhythm of the Market, by James Sogi

    Appearing even more young and handsome than he is now, Chair appeared in the 1996 video with Dr. Schrade about music and the markets and it inspired some musical musings.

    Traditional African music embodied complex rhythmic structures with 32 or more bars of differing and evolving and resolving structure, but it lacked melody and harmony. European music contained complex harmonies and melodic elements, but the rhythmic elements were primitive. It was the cross pollination of the African rhythms and the European melodic structure in the old South gave us modern music with its complex rhythmic and melodic elements. Despite the importance of rhythm, oddly, there is no intellectual property in rhythm. A musician can rip off beat for beat the exact same rhythm as another song, as long as the melody is different. Intellectual legal property rights do not even recognize the existence of, the differentiation between, and the importance of rhythmic elements and structure.

    Chair's theory is that markets and charts share fundamental characteristics with musical structure embodying dissonance, resolution, tight ranges and soaring breakouts. However, the rhythmic element is just as important to a sense of music as harmony and melody. There are rhythmic elements embodied in markets whose beat must be understood, and measured. When playing music the musician counts the time, the time signatures, counts the rests, counts the beats and the notes, you have to be on time or its going to sound really bad. Some forms of syncopation are especially tricky to count right. Look at the counterpoint and retrograde action Chair highlighted in yesterdays and today's price action. Bach used a lot of music and music in reverse. The Beatles used it too.

    Just like a good musician, a good speculator should count out the rhythms. Let s look at the current top 500 hits on the S&P. From 9/12-9/20 there were 60 (30 minute) bars. Before there was a big change is the key or range, and after a big drop down. Its interesting how musicians call the time divisions on the music charts bars as well as speculators. We are now at bar 53 of the current verse or stanza. If the rhythm stays the same, the music might shift again at the same or similar time as the last stanzas as stanza tend to have the same length to be emotionally satisfying. It would be in keeping with the current rhythmic theme. There is nothing to prevent a change in time signatures. The Beatles would often use different time signatures in a single song with interesting effect. But count your rhythms and you won t be playing out of time with the markets. Unfortunately, some cats just got no rhythm, man.

    9/28/2005
    The Bear, by Pitt Maner

    On the eve of the Alabama-Florida football game in Tuscaloosa, featuring the Mike Shula-led Crimson Tide team versus Urban Meyer's Gators, veteran Southern football followers may hasten to recall the exploits of the great Alabama football coach Coach Paul "Bear" Bryant.

    Several books and movies have been done on Bryant, most notably "The Junction Boys" which covers first-year head coach Bryant at Texas A&M trying to turn around a losing program through the use of controversial, intense, brutally tough, pre-season practice sessions. The Bear was a fundamentalist and strong advocate of hard work, discipline, preparation, dedication, and "plain old desire".

    In an autobiographical work done before his death with John Underwood, entitled "Bear: The Hard Life and Good Times of Alabama's Coach Bryant", Coach Bryant gave his three rules for coaching:

    1. Surround yourself with people who can't live without football.
    2. Ge able to recognize winners. They come in all forms.
    3. Have a plan for everything.

    On his admiration for his college coach, Alabama coach Frank Thomas (a player under Rockne at Notre Dame) who in 1934 with Don Hutson and Bryant at ends completed an undefeated season with a Rose Bowl victory, the Bear said, "Where Coach Thomas was great was during a game, the way Dodd was. he could see things, adjust to things. Not many people can do that, even now." (ie. using modern techniques of replay, coaches in the press boxes, play analysis, etc.)

    The Bear certainly had a way with handling the multiple variables of winning college football: motivational psychology, game strategies based on pattern recognition, chain of command, improvement through coaching/practice, and adaptation to changing times (i.e. recruiting Alabama's first black players, employing the wishbone offense). And his quarterbacks did okay in the pros, too: Namath, Starr, Stabler, et al.

    9/27/2005
    A Letter to the Editor: On the Memes of Public Opinions, by George Zachar

    9/27/2005
    Briefly Speaking: Greenspan and the Real Estate Speculators, by Victor Niederhoffer

    1. Alan Greenspan's speech to the American Bankers Association today, in which he raised the specter of speculation's creating risk for the economy by undue reliance on unconventional mortgages and home appreciation, is based on a 51-page working paper he lead-authored with James Kennedy, "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences." The paper contains eight charts covering data for 15 years, and one table with 365 rows showing the various components of mortgage originations classified by sector, 1991-2005. There are numerous linear equations in the paper, and corrections for biases in the data, seasonal adjustments, and cross-sectional and longitudinal regressions. This is "Doctor" Greenspan's first paper since 1996 when he wrote "Motor Vehicle Stocks, Scrappage and Sales."

      Commentators immediately indicated that this heroic effort demonstrated the seriousness of his concerns about the current real estate situation. However, I immediately think of the old lions who have lost their virility and snarl at the coalitions of young lions who are taking over their place in the pride. I also think of Cyril Burt gallantly escorting Barbara Jensen to the Underground at the age of 84. And I think of Keats who, in the poem "Endymion," has his fallen hero pine for the long-ago days when he could romance the damsels. And one thinks of what Caroline Baum calls the MacGuffins that the "Doctor" would always pull out for his Humphrey Hawkins testimony (the Employment Cost Index et al.) to serve the equally false purpose of showing a man attuned to every detail of manufacturing activity that could go awry and affect the economy aversely, a state of mind that led to his "irrational exuberance" speech, which planted the seeds for the Nasdaq crash dance.

      There's something so appropriate about his previous paper's being about motor vehicle scrappage, and this paper's being so transparently the work of his younger co-author, so old-hearted and grasping at the same time, and yet so pathetic.

    2. Today's moves in the markets were the exact opposite of the August 29 moves in conjunction with Hurricane Katrina, when oil opened up 5% on the day at $70 a barrel and ended down 3% from there at $68 a barrel, and the S&P opened at 1195, down 1%, and ended at 1215, up 1%. Today, oil opened down 2% and ended up 2% and the S&P opened up 1%, moved to down 1/2% and closed about unchanged. But that's guaranteed to happen, as in both cases the public was behind the form, and those large, well-funded entities who took the opposite of the public's trade were able gain an overplus that according to the traditions of caneology they deposited in stately real estate sound as a rock to await the proper time for the canes to come out when the next squall occurs.
    3. A tabulation by my colleague Mr. Duncan Coker of the 2005 returns of the 20 biggest markets around the world shows the U.S. to be third-worst of all, ahead only of Taiwan and China. The median appreciation of all 20 is about 12%. How long can the differential between the equity rate of return of 6% and the long-term bond return of 4% (see our work on the Fed Model) be gainsaid? I must tip the hat to the chronic bears who remember the salad days of 2000-2002 and still promulgate the view that stocks are far overvalued in terms of P/Es, bringing back terrible memories of 1929 and how the Crash really got bad in 1932 when the Dow moved back down to 50, a level which doubtless would be in the cards now, were it not for the nefarious work of the Plunge Protection Team.
    4. One of the many reasons I believe commodity prices are likely to fall is that the demand for them is relatively inelastic, not rising or falling with income, and the risk of producing a commodity that has a stable demand is low, and thus competition is very high, and this brings the rate of return on investment to the risk-free rate. If the rate of return is close to the risk-free rate, and the quantity demanded doesn't change, how is the price going to go up, not even considering all the innovations and history that Julian Simon has documented as the cause of their chronic underperformance relative to equities? We have been referred to the work of Damodaran on this subject for a related capital asset argument and will report on it subsequently.

    Steve Bal adds:

    The demand for commodities may be inelastic but since they are traded in US funds and there is currently deep liquidity combined with modest speculation in oil, gold, lumber, this may be enough to keep prices at current levels or higher. As Keynes said, market irrationality can remain longer than most can remain solvent. Further there have been rotational moves between gold and oil for top place leading to excitement about commodities (leave it to the media to get investors' attention). I have developed a quantitative model of my expectations of the CRB Index.

    9/27/2005
    Boom and Bust, by Pam Van Giessen

    The baby boomers are entering the next phase of their lives (I understand they are about to turn 60 this month) and are shocked to find that even though they can dress like 30 year olds and listen to youthful music, they ain't 30 anymore.

    In addition to suggesting a healthful diet and cutting back on the carbs (particularly those found in breads, munchies, and processed sweet foods), increased exercise is quite beneficial, and green tea helps some people (Stash Tea Moroccan Mint Green is my personal favorite). Also, men have a tendency toward dehydration so be mindful of your fluid intake.

    Finally, as we age we need less long stretches of sleep but more frequent rests. In other words, if your body needs a nap and you are eating right, appropriately hydrated, and getting good exercise, then you probably need a power nap, and there's certainly nothing wrong with taking one (or taking a nice walk). We are programmed from a young age to work like demons for long stretches when the reality is that very few of us are constitutionally capable of it. Remember, when we were children we had recess!

    9/27/2005
    The Monte Carlo Method, by James Sogi

    Curiosity about Chair's and the Expert's use of and reference to Monte Carlo techniques prompted study of Paul Glasserman's Monte Carlo Methods in Financial Engineering. Monte Carlo is based on the analogy between probability and volume. The mathematics of measure formalizes the intuitive notion of probability associating an event with a set of outcomes and defining the probability of the event to be its volume or measure relative to that of a universe of possible outcomes. Monte Carlo uses this identity in reverse, calculating the volume of a set by interpreting the volume as a probability. The law of large numbers results in the estimates converging to the correct value. Financial assets price are the expected value and computation of the value as an integral often results in infinite or large numbers. Monte Carlo simulates stochastic paths and seeks the fastest convergence in formulating the problems and may present more competitive valuation methods.

    The risk inherent in observed fat tails must be balanced against the need to derive precise probabilities using a normal curve but leaves unaccounted for risk inherent in use of normal distributions. The theorists fit the fat tails randomly and retrospectively to alternate distributions, and there does not seem to be a good set of tools to properly measure the relationship of samples to the population and leaves an inability to predict probabilities. Monte Carlo appears to be useful when volatility measures can be factored in accounting for observed risk from the back door so to speak. Monte Carlo is useful for path dependent prices, and might be helpful in the stop/option/risk/size issue.

    Glasserman notes that the normal distribution has shortcomings as a model of changes in market prices virtually in all markets, the distribution of observed price changes displays a higher peak and heavier tails than can be captured with a normal distribution. Choosing a description of market data thus entails a compromise between realism and tractability. Imagine my happy surprise to read that the Student t Distribution, my personal favorite, has a distribution with fatter tails, as demonstrated by the graph of its log densities. The student t distribution is a mixture of normals, giving rise to the idea of a mechanism for generating a richer class of distributions by combining two normals with other random variables and allowing for a distribution with fatter tails, but with fixed distribution characteristics to compare with the samples of occurrences being tested, sort of a super custom student t distribution fitted to observations and factoring in occasional big changes.

    Another interesting avenue for multivariate analysis factoring in heavy tails is the t-Copula which is also discussed in Rene Carmona's Statistical Analysis of Financial Data in S Plus which has code for some really nice 3D charts. This is something that will be useful when looking at the bond/equity relationship.

    9/27/2005
    Franklin's Kite, from John Lamberg

    Interesting site: Theater of Electricity

    Franklins Kite: The question often arises whether or not Franklin actually did this experiment, and the answer is we do not know for sure. One thing, however, is certain: if he did do an experiment like this, he did not do it the way it is often shown. That is, he didn't tie a key to the kite string, fly it in a thunderstorm, and wait for it to be struck by lightning! Such an experiment would be very dramatic -- and quite fatal.

    There is one other effect that we demonstrate using our kite, but it is too faint to photograph easily. It is called Saint Elmo's Fire, or, to scientists, corona. It shows up as a faint purple glow around the edges of the kite, and would have been seen in the rigging and masts by sailors on the old wooden sailing ships.

    To the sailors, who named it after their patron saint, it was a sign of protection, but you can see in this picture how little it protects the kite! In fact it is a sign of great danger. So how did the sailors get it wrong?

    The reason is probably that all sailors in thunderstorms saw coronas, but only those whose ships were not struck and destroyed made it back to tell anyone about it!

    9/26/2005
    Thoughts on Trading and Chess, by GM Nigel Davies

    Trading is similar to chess in that the stronger players have superior pattern recognition capabilities and a means of deciding which of these is/are important.

    Trading differs from chess in that the number of points scored for each win or loss can vary.

    Playing White is known to be a slight advantage in a chess game and most openings result in what's known as a 'normal White advantage' (White takes around 55% of the points at GM level). Markets also have a 'normal White advantage' because traders must pay various costs (brokerage fees, slippage and just time) for the right to do business.

    Chess players usually get to play White and Black in alternate games but from a cost point of view the trader is always playing Black. Yet he can attempt to mitigate these costs by waiting for scenarios which he believes offer him prospects of an advantage. Chess players only have a partial influence in the positions they end up with because they have only half the input in terms of moves.

    Trading differs from chess in that the 'board' is infinite and highly prone to random events. But perhaps this difference is not as great as is commonly perceived; although chess has all the pieces clearly on view, our limitations vis a vis forward calculation make the future effectively unknowable.

    So the chess player, like the trader, is still 'placing bets' based on his knowledge, calculations and experience, at least in many positions. I should point out that in some technical positions a good chess player does 'know' what is happening and can operate with a degree of certainty which is way above what the markets ever offer.

    The ever changing cycles of public betting are only found in quite an artificial form in chess play. Chess players should in theory be able to discover the 'truth' about certain positions once and for all. But the fact that their analysis is almost always incomplete/flawed means that cycles and fashions do exist. Many variations/positions get rightly/wrongly castigated as being bad and then rightly/wrongly rehabilitated.

    And the public is usually one or two steps behind the form...

    9/25/2005
    Polar Coordinates, by Docs V. Niederhoffer and A. Castaldo

    A squall, a diversion, a relation, polar coordinates. The decline in stocks last week, the greatest in six months, led me to go beyond listening to the usual divertissement of the Schultz-Ebler transcription of the "Blue Danube Waltz" to the study of complex variables and polar coordinates. Polar coordinates are a way of representing a point in terms of its distance from the origin and the counterclockwise angle that the point makes with the x axis of the origin, an alternative to the usual graphing method. There are 2pi radians in a complete revolution. So 90 degree is 1/2 pi.

    Radians are ideal for measuring the angles between two key variables such as bonds and stocks during big declines as well as other times. Some big down weeks in stocks, along with the change that week in bonds and the change in stocks the next week, follow.

    With the kind assistance of Mr. Doc Castaldo, we have computed the angles measured in radians of all the concurrent moves in bonds and stocks, and tabled them along with the move in the S&P next week.

    We studied all declines of 20 or more for stocks in a week.

    Wk ending    SP move Bond move   Angle  Magnitude SP move next week
    09/23/2005   -21.8   0.40625     -0.49    46.1   
    06/24/2005   -24.7   2.125       -0.12   213.9     4.3
    04/15/2005   -40.0   2.21875     -0.18   225.5    13.6
    03/11/2005   -23.3  -2.34375     -3.04   235.5   -14.6
    01/07/2005   -27.4  -0.40625     -2.55    49.0    -2.5
    08/06/2004   -37.5   2.625       -0.14   265.2     2.6
    04/30/2004   -33.4  -0.375       -2.41    50.2   -10.6
    03/12/2004   -38.6   0.71875     -0.49    81.6   -10.8
    09/26/2003   -38.4   2.0         -0.19   203.7    34.0
    03/28/2003   -30.3   2.03125     -0.15   205.4    15.6
    02/07/2003   -24.2   0.84375     -0.28    87.8     6.5
    01/24/2003   -42.8   1.3125      -0.32   138.1    -5.6
    01/17/2003   -23.4   2.03125     -0.11   204.5   -42.8
    12/27/2002   -24.9   1.875       -0.13   189.1    38.1
    12/13/2002   -26.5   0.8125      -0.32    85.5    10.2
    12/06/2002   -22.2   1.28125     -0.17   130.0   -26.5
    09/20/2002   -49.0   0.625       -0.66    79.4   -16.9
    09/06/2002   -21.6   0.9375      -0.23    96.2    -3.4
    08/30/2002   -24.9   0.9375      -0.26    97.0   -21.6
    07/19/2002   -73.3  -0.09375     -1.70    73.9     9.7
    07/12/2002   -73.7   2.59375     -0.28   269.6   -73.3
    06/07/2002   -39.2  -0.34375     -2.29    52.1   -19.4
    05/24/2002   -22.8   1.34375     -0.17   136.3   -14.9
    04/26/2002   -54.7   1.65625     -0.32   174.4     1.0
    04/05/2002   -23.8   2.4375      -0.10   244.9   -13.4
    02/08/2002   -26.9   0.53125     -0.47    59.5     8.3
    01/11/2002   -27.5   3.25        -0.08   326.2   -18.7

    Angles in radians, measured from bond axis (x-axis)

    Comments:

    One finds no systematic relations between the radian measure of the bond stock move in the big stock decline weeks, and the subsequent week during the previous three years. However, there is a clear tendency for the lower magnitudes of stock bond moves to be associated with rises in stocks the next week. It is interesting to note in this regard that the magnitude of the bond stock move in the week ending 9/23 was the second smallest of all 25 considered.

    Charles Kin comments:

    Do you really want a world with "radial technical analysts?"

    Actually, the development of price patterns generated radially throughout a particular time period could allow visualizations of patterns that would never be noticed on Cartesian coordinates. It could work spherically as well. Consider a representation of intraday security prices represented parametrically with a reference to time. The chart would start in the center with time=0. Each new tick could be described with a price and with accumulated volume (or perhaps on-balance-volume). Radius would expand at a constant rate throughout the day. One would need to develop a simple function to convert those variables into radians.

    Others are also looking at new graphical representations of prices, I see. Bloomberg for instance has a new display that looks for (abnormal?) skewness in a chain of option prices.

    Kim Zussman comments:

    One aspect of this would be to think of the unit circle with vector radius. At time zero, the vector points right and angle is zero. After time t, SPY and TNX (10 yr yield) have moved, and the difference between their moves determines the angle the vector makes with the X-axis. The conversion from % difference to angle units would seem arbitrary, but maybe there is something to thinking about divergence (convergence) between stock and bond returns as an angle with predictive value over many occurrences.

    I looked at SPY, and this week's drop was not as big in % as many others mentioned (I am not sure why you look at points but assume this scales because you test futures). However for 2-weeks, the decline was over 2%. And interestingly, TNX (which moves inversely to bond price) went up in recent 2 and 3-weeks.

    Looking at weekly returns for SPY and TNX since 1/96, week's return after SPY lost>2% the prior 2-weeks, and TNX was higher than 3-weeks ago:

    AVG     1.009827998 (+1%)
    SDEV    0.026421589
    COUNT            33
    Z       2.136796096

    Of course none of this takes into account "weather" effects such as Fed week tightening (Mr Cohn got it wrong this week) and unusual hurricane frequency in the face of rising oil prices.

    Jim Sogi queries:

    Doc showed the polar table with two subsequent weeks that would have caused some consternation at any level of leverage and ruin at over 10x the following week.

    1/17/2003   -23.4   203.1        -7   204.4   -42.8
    7/12/2002   -73.7   259.4       -16   269.7   -73.3

    Is there some filter or some model that can help avoid these two events that would normally be expected to occur again with a probability of concern to the practitioner of the speculative arts?

    Charles Kin rejoins with:

    On the subject of using graphical representations of price action to quantify behavior and expected future behavior, I consulted J. Dennis Lawrence's work entitled "A Catalog of Special Plane Curves." Mr. Lawrence (can't find any indication that he has an advanced degree) defines the concept of a curve as superset of arcs that may be represented parametrically with respect to time, are continuous, and are twice differentiable.

    Let's say that a chartist is seeking to determine whether or not useful information is contained within a series of prices, independent of any other variable or external market. The first question might be: "Is there a trend?" The answer is contained within the first derivative of the chart line. If over a particular interval of time the tangent line remains either positive or negative, without crossing zero, then the answer is YES, a trend exists.

    The next question perhaps ought to be: "Is the trend, if there is one, accelerating?" This answer would be contained in the second derivative. If this number is diminishing in magnitude, then one might be led to believe that an inflection point or cusp might be near, signaling a possible trend reversal.

    I suppose one could examine the third derivative of the price chart line to determine jaggedness, which might give some indication of historic volatility, but before going so far, it is important to keep in mind that in order for our exercise to have meaning, every point on the chart within our time interval must be continuous. If there are any nodes, gaps, or points for which there is no tangent, then we can no longer use our preconceived notions about geometry to judge whether or not a trend reversal is taking place. Essentially, all price points subsequent to that discontinuity will be defined by a new price function whenever there is a discontinuity in our price chart.

    Perhaps, to the dismay of technical analysts, this is a start of a mathematical definition of an "ever changing cycle." Or perhaps its time to take my cinnamon pill.

    Philip J. McDonnell responds:

    Mr. Kin writes:

    "..it is important to keep in mind that in order for our exercise to have meaning, every point on the chart within our time interval must be continuous. If there are any nodes, gaps, or points for which there is no tangent, then we can no longer use our preconceived notions."

    M.F.M. Osborne once observed that markets are not continuous functions and that treating them as such is dangerous business. In fact markets trade in discrete jumps. Osborne suggested that rather than graphing prices as rising or falling lines from price point to price point we should instead show the charts as step functions or even point clouds. If a stock trades at 50 ideally we should show it as a point (isolated dot) in price and time. If the next trade is at 51 that is a new dot. There were no trades in between so why should we fabricate a line in between when in fact nothing happened.

    When viewed as a point cloud it is clear that the price function is everywhere discontinuous and everywhere non-differentiable at all higher derivatives. Fundamentally markets are a discrete process where price is discovered one trade at a time. Thus the essential machinery of calculus and analysis, such as convergence to a limit may be on very flawed theoretical ground.

    Mr. Kin also suggested:

    "The next question perhaps ought to be: "Is the trend, if there is one, accelerating?" This answer would be contained in the second derivative. If this number is diminishing in magnitude, then one might be led to believe that an inflection point or cusp might be near, signaling a possible trend reversal."

    I tested for the existence of trends in the s&p using correlations over time frames from 1 day to 12 months and generally found a preponderance of negative correlations. This should be interpreted as trends are anti-persistent in the market.

    I also tested the 2000+ stocks which trade options for evidence of trends using standard CAPM alpha and beta regression model. Using alpha as the beta adjusted metric for past trend the study found that as a group the top alpha stocks each month were anti-persistent. The CAPM model was also adjusted to account for curvature by adding a quadratic term. Again the results clearly showed that the top curvature stocks each month under performed and were strongly anti-persistent. The study performed about 250,000 regressions for each of the 250,000 stock months covered.

    9/25/2005
    Rational Trig and Markets, by Doc Alex Castaldo

    Last week the Bloomberg newswire carried the surprising announcement that Australian mathematician Norman Wildberger has developed a new form of trigonometry that does not use sines, cosines, etc., but can nevertheless solve all trigonometric problems (and do it better, he claims, than the classical trigonometry invented 3,000 years ago). Called Rational Trigonometry, Wildberger's invention does not even use distance and angle, but replaces them with two new notions: "quadrance" and "spread" (see below).

    I was skeptical, to say the least, but after reading the first chapter of his book, I see nothing obviously wrong or nonsensical in what he is saying. Here is a brief summary.

    Kim Zussman responds:

    To which I would add the following conjectures:

    1. Reward results from taking risk, and risk is not real if it can be eliminated.
    2. Intelligent study improves reward/risk but cannot eliminate risk without eliminating reward.

    And questions:

    1. If the returns generating distribution is perfectly knowable, what is the risk?
    2. Assuming equal intelligence and access to intelligence, are the most successful generals in battle more or less likely to risk defeat?
    3. Do all accountings of great generals, and great heroes in general, suffer from survivorship bias?

    9/26/2005
    Larry Williams: Cervantes and Don Quixote Must Have Been Traders...

    The following quotation sure rings true of me:

    He knew more about reverses than verses.

    9/24/2005
    I've Got a Little List, by Victor Niederhoffer

    Someone's going to consider the influence of vivid events on investor overreactions and point out that after any disaster, all investors act like anything with a 1-in-a-million probability of similarity to the old event is going to have exactly the same impact. Witness all those still waiting for a replay of Oct. 19, 1987, or the hedge fund managers still waiting for 1929 to return because speculation was very big then and is big now, or the idiots who wait for the spread on short-term versus long-term rates to approach 2% again.

    I got a little list, and on it will be the reaction of insurance companies to the next hurricane after a big one hits (See the Bloomberg story below), or the reaction of oil after it goes up big on a previous natural disaster. On it will be the weekly financial columnist who's always been bearish since he started in 1964 and the sagacious conglomerateur from Nebraska who started by easing out his partners from the bankrupt textile manufacturer that my equally sagacious friend (who owns the shares from Day 1 because his father-in-law was the company's labor lawyer) says the Sage bought for $750,000 with a $75 million tax loss carryforward.

    Vivid events are the one aspect of the promiscuous psychological biases of behavioral finance that wishy-washy academics like to point to that really do provide opportunity for investors. People overestimate the probability of recurrence of something very vivid and easy to remember. Of course, instead of quantifying what vivid events are and finding opportunities to profit, psychologists are more likely nowadays to tell you how it is so much better not to stereotype a minority group by retrieving the one time you got mugged from its ready presence in your memory.

    Hurricane Rita, Sparing Dense Cities, May Cost Insurers Less Than Expected
    By Jesse Westbrook and Bradley Keoun -- Sept. 24 (Bloomberg) -- Hurricane Rita may cost insurers including Allstate Corp. and St. Paul Travelers Cos. $2.5 billion to $6 billion, less than some of last year's storms in Florida. Estimates are low for a storm of Rita's intensity because its strongest winds hit the sparsely populated western coast of Louisiana, two storm modelers said. Eqecat Inc. projected $3 billion to $6 billion, and AIR Worldwide Corp. estimated $2.5 billion to $5 billion. At $6 billion, Rita would cost as little as a third of what some analysts had expected and a fraction of the $40 billion to $60 billion estimated for Katrina, probably the most expensive disaster in the industry's history. 'This is more of a normal-type storm,' said Bob Hartwig, chief economist of the Insurance Information Institute, an industry group in New York.

    Alston Mabry Responds:

    Hindsight is so convincing that one almost inevitably fights the last war. The classic example is the Maginot line.

    It is often thought that the Germans had superior military technology, tanks and aircraft in particular, in 1940 when they took France in six weeks, and in 1941 when they staged a phenomenal advance into the Soviet Union. However, the French and British had tanks and aircraft equal or superior to the Wehrmacht and Luftwaffe, and were not inferior in numbers either. The Soviets likewise had a much larger army, a very large air force, very good tanks, and continued to advance armor technology throughout the war and produce some of the best tanks in the world.

    The Germans were not superior in technology or manpower, but in thought and application. While the allied powers were afraid of fighting the last war, men like Guderian and von Manstein were fighting the next. Ironically, the Germans had learned much about armored warfare from men like Mikhail Tukhachevsky whom Stalin executed in 1937, along with other talented Red Army officers.

    9/25/2005
    A Little List, Lyrics by V. Niederhoffer and L. Kenner

    (To the Tune of "As Some Day It May Happen," from The Mikado by Gilbert & Sullivan)
    As now is a good time to finally clean up this town
     We've got a little list
     We've got a little list
     Of charlatans and pessimists who should be underground
     Who never would be missed
     Who never would be missed.
    
     There's the foolish blusterers who never have a losing trade
     And all the brokerage analysts who never say "downgrade"
     And the pessimistic guru who lost hope in '65
     And the floor broker who says your order never did arrive.
    
     Chorus:
     We've got 'em on the list, We’ve got 'em on the list; and
     And they'll none of them be missed
     And they'll none of them be missed.
    
     There's the billionaire complaining taxes really are too low
     And the tout who likes to write about his own portfolio
     The journalists who publish charts with lots of colored lines
     And the bear who's always seeing a new kind of danger sign.
    
     Then the people selling systems that with just a tweak or two
     Would clearly beat the hedge fund guys with hardly a snafu
     And the worshippers of Buffett who show up in Omaha
     To pay homage to the miser whom the media holds in awe
    
     Chorus:
     We’ve got 'em on the list, we've got 'em on the list; and
     And they'll none of them be missed
     And they'll none of them be missed.
    
     And the personal finance writers who take chapters to explain
     Everything that's obvious or not much of a strain
     The purveyors of newsletters of technical analysis
     They'd none of them be missed
     They'd none of them be missed.
    
     And whosoever will, with sophistry resist
     Their well deserved inclusion on this soon forgotten list,
     Shall banished be to lower realms where artful sinners dwell.
     And join their brethren howling, from the seventh circle of Hell.
     But it really doesn't matter whom you put upon the list
     For they’d none of 'em be missed
     They’d none of them be missed.
    
     Chorus:
     You may put 'em on the list
     You may put 'em on the list
     And they'll none of 'em be missed
     They'll none of 'em be missed.
    

    9/26/2005
    Tipping Your Hat to the Currency Mistress, by Tim Hewson

    How the currency mistress must have enjoyed Friday,

    What was gearing up to be a lazy day, with overnight trading in holidaying Japan confined to a 30 pt range and no random economic data of significance due out of Europe or US she struck about 10:30am London time...USDJPY 111.55

    "CHINA WIDENS YUAN TRADING= BAND", the screen flashed

    The hitherto dormant squawk box erupts:

    "China widens band" "Guys, you get that? China widens the band, USDJPY 35 bid....30 bid...20 ...111 the figure!!!!" "hold on ...we're hearing they widening the non-dollar trading band against the yuan, its 20 offered...35..." and so on...

    So eager was everyone to jump on what has been one of the bigger non storys this year that the mistress happily let all participants of sound mind and body leap on board before gently squeezing, squeezing, squeezing all the was past 111.55 to close around 112.50 on Friday night...

    What can you do but smile, and tip your hat to her...

    9/23/2005
    Disney Finds The Sucker at the Table, Noticed by the Assistant Webmaster

    Disney Taps Hedge Funds, Investors to Share Film Funding Risk
    Sept. 23 (Bloomberg) -- Walt Disney Co., whose film unit said it will lose money in the fourth quarter, raised $505 million from investors to reduce the risk of financing movies, the first time it has done so in almost a decade. (.. ) The Kingdom Films LLC partnership is Disney's first film- financing venture since 1996, (.. ) Kingdom Films attracted hedge funds, an industry whose assets under management more than doubled to $1 trillion since 2001. `Several years ago, you would have found hedge funds require higher returns to invest' in film financing, Rafalski said. `With the heavy inflow of cash into these funds, we were able to structure something that met our needs as well as those of the hedge funds.' (.. )

    George Zachar replies:

    I dimly recall something like this from one or two cycles ago, where DIS let the suckers finance the live action films with high fail rates, while the studio kept the rights to the sure-fire cartoon winners...

    Easan Katir adds:

    Yes, two cycles ago, limited partnership era: Silver Screen Partners. When reading the offering doc I couldn't see the profitable light at the limited partners' end of the tunnel, so I mercifully avoided it. I seem to remember it was a percentage of net!  Ha ha ha ha ha! There's never a net in film deals.

    Victor recalls:

    A Hollywood producer wisely told me there are only two reasons to get into the movie business: to get your kid a job, and to get a little tail. Let's not forget this latter factor in the hedge fund's emoluments in the absence of any possibility of net on the other bottom line.

    9/26/2005
    RMBS, by James Sogi

    Hawaii's top mortgage foreclosure lawyer and I were chatting with our new judge about mortgages and foreclosures. He commented that some of the top mortgage holders/servicers are moving to non-judicial foreclosure despite possible challenges. Notably, he observed that many mortgage holders or their servicers s had difficulty properly accounting for and producing ledgers for their mortgage payments and matching them to specific mortgages. The mortgages are packaged and securitized leaving a servicing entity to do the collections and accounts. Cutting costs servicing leads to sloppy work.

    In Fabrozzi, Bond Markets, Analysis Strategies,valuation of RMBS and the yield and the option adjusted spread depends in part on the actual experience, and thus the the accounting of the income and the prepayment rates. Actual and expected cash flow may differ, but an additional issue of accounting for actual cash flow for identified securities may be problematical. Certain tranches may also be stuck with credit risk or unintentionally the sloppy accounting issue. Let's say a borrower defaults Normally the mortgage gets foreclosed, and security is. realized. But if the servicer cannot locate the ledger to show the default for that particular mortgagee it cannot prove default, and cannot foreclose. The servicing problem underlies the move to nonjudicial foreclosure. With sloppy accounting, both the security and the value may be called into question in some circumstances. As the need for accurate accounting and servicing is lowered by non judicial foreclosure, the amount spent on servicing will drop more to save costs and boost profits. The deterioration of accounting levels follows Nock's Law of Least Effort. The accounting issue might not be revealed by standard pricing models and is another example of accounting risk discussed before. The modeling of prepayment due to defaults will be affected. These issues do not arise in a rising real estate market, but are unveiled as the market falls. Profits often hide a multitude of sins.

    9/23/2005
    Punishment, by George Zachar

    FV1   107-15     - 11  12:47
              TY1   110-22+    - 17  12:48
              US1   115-04     - 24  12:46

    I can't find a solid, intelligent reason for this downtrade in bonds, other than simple exhaustion, waiting for the darned hurricane to hit. Debt rallied along with gold and energy in the Rita-discounting phase, and now the market is punishing everyone who bought those prices.

    9/23/2005
    Where Ideas Come From, And "Shooting for the Moon", by Russell Sears

    Ideas spring from life, needs and inspirations both imply this.

    We all realize that in 2001: A Space Odyssey that Hal is 'alive' when he has an idea, a need or agenda of life on his own separate from his creator. What parent of a teenager has not felt this pride in a kid coming up with his own ideas and agenda, whilst at the same time feeling the pain of separation from their creation.

    The core need is a need to live. A simple amoebae idea of swimming to capture food, to a trader -- the idea of capturing alpha; the need is to live. Most definitions of life that I have read have as a core concept this need or agenda. Thus idea, inspiration, need or agenda all imply life and life implies them. To answer where does an idea come from? is therefore a job for science, yet one which scientists have barely touched upon.

    Perhaps ideas or inspirations of plant life such as a tree is a good counter example to Hal's or a teenager's independent ideas. For plants the idea or inspiration spans generation upon generation and outlives the individual life. This gives us key insights into how competition affects evolution, such as in the markets.

    This also explains why I find gardening and plants fascinating. To me plants are very spiritual, with their core ideas spanning generations. This is the closest that I, a Baptist preacher's kid, have come to understanding the concept of eternal life.

    I have been thinking often about shooting for the moon as it is fall, and every fall I generally get to see a fresh crop of high school cross country runners learning the lessons of shooting for the moon. If you have ever trotted through crisp leaves from one point to the next on a freshly mown high school CC course you know exactly what I mean.

    Few kids, no matter the pace, are out of the race in the first 400 meters, (1/4 mile). It is rare a kid will to admit defeat this soon. By the 1600 meter mark, (1 mile), however, the pack has strung out with the few talented, or at least persistent, in the lead. It is a rare race that has many place changes by the 3,000 meter mark, except perhaps for the occasional kick at the last 200 meters of a 5k race.

    The same however, is not true with the adults' 5k race. It is the rare individual that does not immediately concede the race during the first 100 meters. In fact almost all races go by the honor system, letting you line up at your own pace. Most adults concede the race before it begins, even the adults doing this for time, or racing against themselves.

    The reason I have been thinking about this so much lately is that as I have changed jobs, it is apparent that many of my co-workers do the same. Voluntarily give me a competitive advantage, because they are afraid to "shoot for the moon". I walk into a room and act as if I know what I am doing and am the smartest guy there. The actual smartest guy therefore backs down, afraid to commit, afraid to be proven incapable. Many of the kids learn the same lesson as the grandmaster did in sports, pace within your means, but some learn that puking your guts out by 3000 meters is how you get better, or always aiming for the line with even more force, on the second serve, is how you get to be a champion.

    Vic asks how to tell if a company has lost its edge, and wants to go home and play with the kids as opposed to competing. My answer is when they stop shooting for the moon and trying to get better. It may be due to 'Enron' style conceit, the egoism that you can't improve perfection only spin your image better. It may be from third generation heirs that run the company only so they don't break a sweat.

    Shooting for the moon is risky and often hurts, but if a company won't take risks, it is doomed.

    9/23/2005
    Yishen Kuik on 'Experts and the First World War'

    In Manchester’s splendid biography of Churchill, The Last Lion, he recounts the struggle of Churchill, both in Parliament and in the war rooms, to keep England focused on a daring plan to sail to seize the Dardanelles in 1915.

    The Dardanelles are the narrow straits that connect the Black Sea to the Mediterranean and they where fortified and mined. The British however had new 15 inch guns on their battleships that outranged the shore batteries. The plan was simple - destroy short range shore batteries with long range ship guns whilst sending smaller ships ahead to sweep for mines and cut them from their moorings. In such a methodical manner the navy would be able to make its way up to Constantinople without much loss.

    Such a bold stroke could scare the Turks out of the Axis alliance, reopen the flow of Russian grain from Sebastopol and trap the German Mediterranean navy in the Black Sea between the Russians and the British, with no friendly ports. At the time, the two uniformed officers making decisions with the Cabinet were Admiral Fisher and Lord Kitchener. As they were both experts the civilian politicians tended to defer to their experience. Churchill pressed hard for swift naval action up the straits, but the experts preached caution. Manchester writes that the naval culture had a great aversion towards losing ships as that had a very negative impact on a flag officer's career.

    The plan went accordingly and the navy made swift progress destroying many batteries. Constantinople expected itself to fall - the Sultan and his harem were ready to board the trains at Uskudar, and gold was being shipped out to Eskesehir. 1 French ship was sunk however and 3 British ships damaged by mines that were close to shore and overlooked by the minesweepers.

    The losses sowed a great deal of nervousness among the naval commanders on the ground and Fisher openly questioned the merits of the operation based on the risk of losing ships. When Kitchener offered to take Constantinople by land, the naval commander on the ground De Robeck saw this as deliverance from having to risk his career by possibly losing more ships, and recommended postponing naval action for the army to mobilize.

    All this dithering and waiting allowed the enemy to regroup. The Germans sent fresh munitions and equally importantly, Turkish morale recovered. The resulting raid at Gallipoli was disastrous. Churchill was forced to take the blame for the disaster and was pushed out of the Admiralty and the Cabinet.

    Manchester opens this episode with a quote from Lord Salisbury: "No lesson seems to be so deeply inculcated by experience of life as that you should never trust experts. If you believe doctors, nothing is wholesome; if you believe theologians, nothing is innocent; if you believe soldiers, nothing is safe." In this case the Cabinet was bullied by the military experts' doctrine of attrition.

    When do we know how far to press on with a successful speculation? When do we know when boldness is called for after small wins, or that large wins are just around the corner? When does the taking of small losses and retreating from the battle sometime hide huge opportunity costs that might change the outcome of the war?

    9/23/2005
    Dick Sears Weekly Commentary: Weather Report

    9/23/2005
    A Letter to Victor About Risk Conversion, from Martin Lindkvist

    9/23/2005
    Market Tales of Summer, by Victor Niederhoffer

    It is interesting to reflect on the mysteries of the market, the amazing inventiveness with which she confronts you with new problems of a extremely trying nature, the kind that remind you of a very good mathematical challenge, the kind that appear for example near the end of most standardized aptitude tests. A case in point was Aug. 10, when the S&P opened at 1247 from its previous close of 1241, moved up to a high of 1259.5, then down to a low of 1235.5 and closed down a mere 0.5 point from the previous day's close of 1241. If the all-seeing eye could write about how lives were made and lost, hopes realized and frustrated, emotions elicited by such a move, it would be a fascinating novel and slice of life in the summer of '05. Looking at the 31 most similar events to such a day, I find that the average move some three days later -- down 1 percent -- not overly sanguine.

    The gyrations on Sept. 15, and the fit of its price in the summer confabulation, was another tale that our great storytelling novelists would have been proud to have concocted. The close at 1215.9 in the S&P was the lowest of the previous 14 trading days but 0.9 higher than the 1215.0 close 15 trading days before on Aug. 30 and higher than the 1212.4 close on Aug 26, two trading days before -- but except for that, the lowest since July 7 close of 1208.8.

    What does it all signify? Only the Shadow knows, But a little bit of counting can help. Indeed, one of the best ideas I had was to bring Adam Robinson, founder of Rocket Review, on board a few years ago to figure out just what the market wants you to answer in such situations. This is always a very good exercise in meals for a lifetime.

    9/23/2005
    A Comment on Innovation from Aaron Koral

    I just wanted to offer a quick tip of the cap to author Scott Brooks on his post Innovation from 09/21/2005. Mr. Brooks hit the concept of innovation right on the head.  One obvious example which came immediately to my mind are the development of ETFs. Here is a great article by the University of Pennsylvania on the development of ETFs as an example of how market participants developed a lower-cost, tax efficient alternative to mutual funds.

    9/22/2005
    Yishen Kuik Reviews "The Last Lion: Winston Spencer Churchill, Visions of Glory"

    9/22/2005
    Whence Ideas? by Laurence Glazier

    The dream phenomenon happened to me in reverse recently.

    Many composers, especially Bach, took folk melodies as raw material, and I have come to consider folk tunes as the prime numbers of music, with no known precursors. They must have originated somewhere, or were they always in the ether?

    When a tune has come to me I have always tried to develop its potential, even though it may not be in my style, I feel it is a task given to me. For two years I worked on an anthem but a minute long, convinced it was original (as was a composer I showed it to). Recently I considered it complete and placed it on the Net, and in the early hours of the following morning suddenly awoke with the realization that the opening seven notes occured in the same rhythm in passing during a famous English march. It may have been coincidence (though I doubt it), and interesting that the subconscious, which could presumably have told me this two years ago, held the information in check until just after I had released it to the public domain.

    9/22/2005
    Crutches and Creativity, by Grandmaster Nigel

    One of my beliefs is that people learn most from adversity and become more creative when they have a problem to solve. I think this explains the high number of chessboard turnarounds by the player on the ropes against his complacent opponent. I also think it is behind the outperformance of immigrants and the fact that many of the most brilliant and creative figures in history have had deep inner conflicts. The contended enjoy rather than create.

    So I wouldn't say that my present becrutched state (ruptured Achilles tendon) is a blessing in disguise but it has carried with it some powerful lessons:

    1. Good crutch technique involves little in the way of brute force, but rather good timing and consistency. Planting the crutches solidly in front of you and letting your body weight carry you forward is by far the most economical and effective way. It also seems that the pendulum-like motion is highly reminiscent of market swings.
    2. Planning ahead can lead to astonishing savings in time and energy.
    3. Personal accomplishment and pushing back one's boundaries is one of the most satisfying and fulfilling aspects of life.
    4. Many people are benevolent by nature but don't always know how to help.
    5. People with a temporary or permanent disability have less incentive to succeed than the able-bodied because their taxes go toward an almost exclusively able-bodied world.
    6. Make sure you warm up before attempting a sporting activity.
    7. Trying for the moon is a worthy goal, but bearing in mind one's capabilities it might be better to get there in small steps.

    9/22/2005
    An article In Praise of Cervantes, sent in by George Zachar

    Not long ago, the Norwegian Academy addressed one hundred writers from all over the world with a single question: Name the novel that you consider the best ever written.
    Of the one hundred consulted, fifty answered: "Don Quixote de la Mancha" by Miguel de Cervantes Saavedra. Quite a landslide, considering the runners up: Dostoevsky, Faulkner and Garcia Marquez, in that order. The results of this consultation pose the interesting question of the long-seller versus the best-seller. There is, of course, no answer that fits all cases: Why does a bestseller sell, why does a long-seller last?
    Don Quixote was a big bestseller when it first appeared in 1605, and has continued to sell ever since, whereas William Faulkner was definitively a bad seller if you compare the meager sales of "Absalom, Absalom" (1936) to those of the really big-seller of the year, Hervey Allen's "Anthoy Adverse", a Napoleonic saga of love, war and trade.
    Which means that here is no actual thermometer in these matters, even if time will not only tell: Time will sell. One might think that Cervantes was in tune with his times whereas Stendhal consciously wrote for "the happy few" and sold poorly in his own life, was given the reward of Balzac's praise before he died and only came into his own thanks to the efforts of the critic Henri Martineau in the 20th Century.

    9/22/2005
    Taxing Assets and Implied Gains, an article sent in by Kevin Eilian

    'French Farmers, Millionaires Join to Fight Wealth Tax'
    By Francois de Beaupuy, Sept. 22

    Bloomberg

    Rene Masse, a potato farmer and winemaker on the French island of Ile de Re, retired two years ago, counting on an annual pension of 12,000 euros ($14,650). Then he got walloped with a 15,000-euro tax bill. Masse, 78, had joined the ranks of the wealthy -- at least those with enough assets to be subject to a tax surcharge -- as a real estate boom drove up the value of his land. He sold half of his 1 1/2 acres to a homebuilder to pay the tax collector. `We spent an entire life working and saving, and we're punished because they say we're rich,' said Masse. `This land meant a lot to us. I would never have built these houses.' France is the only Group of Seven industrialized nation to tax wealth, and the doubling of property prices in the past eight years made 335,524 citizens subject to the levy, almost twice the number in 1997. Potential candidates in the 2007 presidential elections, including Interior Minister Nicolas Sarkozy, have proposed new limits, saying the tax drives away the rich and discourages investment. Singer Charles Aznavour and former tennis star Yannick Noah are among wealthy Frenchmen who've left for Switzerland. Pierre-Francois Grimaldi, a French entrepreneur, moved to Belgium after selling his start-up, i-Bazar Groupe SA, to EBay Inc. in 2001 for $130 million. The jump in wealth-tax payers `just because of rising real estate prices, which is only a potential capital gain, is an anomaly,' Sarkozy, who's also head of the ruling Union for a Popular Movement party, said Sept. 7. `Its regime is prompting many entrepreneurs to relocate. Let's have the courage to say it and to reform it.'

    Mitterrand Legacy

    The tax, Impot de Solidarite sur la Fortune, or ISF, was introduced by late Socialist President Francois Mitterrand two decades ago. It's applied to the net wealth of French residents, such as real estate, securities, racehorses and jewelry, and on the French-based assets of non-residents, excluding stocks and bonds. Art and antiques are exempt. The tax bite is 0.5 percent of total wealth of those with at least 732,000 euros in assets. The rate is 1.8 percent for those with more than 15 million euros in taxable wealth. Corporate holdings are exempt as long as the person has a stake of 25 percent or more of a company and is an executive there. Entrepreneur Grimaldi avoided the wealth tax, moving to the outskirts of Brussels. He has since founded an on-line photo business, creating 20 jobs, he said.

    Bad Measure

    `The measure is a bad one because it doesn't help France,'said Grimaldi in a telephone interview. `Entrepreneurs should almost be subsidized in France. We need to lure talent from all over the world.' Between 305 and 370 taxpayers left France each year from 1997 to 2003 because of the levy, taking about 10 billion euros in taxable capital, a 2004 Senate report showed. Denmark, Germany and the Netherlands scrapped their wealth tax in 1996, 1997 and 2001 respectively, the report said `It's the stupidest tax in modern tax history,' said Christian Saint-Etienne, an economics professor at Paris Dauphine University and an adviser to the government. `We risk a continual drain of talent and capital.'

    Reduce Evasion

    The tax yielded 2.65 billion euros in revenue last year, about 1 percent of the French government's receipts, up from 2.34 billion euros in 2003, and 1.54 billion euros in 1997.`The question is whether we should have a fiscal system, which is more in line with other countries that would allow us to reduce evasion,' Xavier Timbeau, an economist at the Observatoire Francais des Conjonctures Economiques. Forty-eight percent of the French favor exempting people with low income who have become subject to the tax as their property's value jumped, while 44 percent oppose it, a TNS-Sofres opinion poll held on Aug. 24 and 25 showed. The poll of 1,000 people aged 18 or more for Le Figaro Magazine didn't include a margin of error. President Jacques Chirac hasn't moved against the tax because scrapping it in 1987, when he was prime minister, may have contributed to his defeat against Mitterrand in the 1988 elections. Mitterrand reintroduced the tax in 1989. Chirac, who succeeded Mitterrand in 1995, lifted a cap on the levy in 1996 to reduce the country's deficit. Under pressure from his own camp, Prime Minister Dominique de Villepin Sept. 14 proposed limiting total household tax payments at 60 percent of income. Sarkozy, who plans to run in the 2007 presidential election, favors a 50 percent cap.

    Benefiting the Wealthy

    The opposition has accused the government of gutting the wealth tax. The change ``will benefit a few hundred of France's wealthiest taxpayers,' said Eric Besson, a lawmaker in charge of economic issues for the opposition Socialist Party. Philippe Marini, the Senator from the finance committee who supervised the report, said the 732,000 euro threshold should be raised to take into account inflation and that a tax break be introduced for those who keep their home for a period of at least five years. He also proposed a transition period for entrepreneurs selling their business.`The departure of business leaders is very costly for the economy,' Marini, a ruling party lawmaker, said in a phone interview. `And the majority doesn't do itself any favors with a reform that doesn't take into account low-income taxpayers hit by rising real estate prices.'De Villepin's proposed limit would more than halve the tax bill of Masse, the Ile de Re farmer. He was slapped with the tax for the first time in 2004 as his retirement changed the status of his land from a business asset to taxable property.`My wife and I, my parents and grandparents have always been here,' said Masse. `The boom in real estate isn't our fault. All my savings will vanish.'

    9/21/2005
    Science and Pre-Science, from Sushil Kedia

    "Necessity is the mother of all invention." Agreed.

    What is it that causes necessity to arise? What are the circumstances specifically that change 'a yet impossible to achieve want' into 'a possible to achieve want', also an unjust need (a luxury) to a just need and then to a compelling necessity? Finally, does the obvious necessity not turn into a nuisance that one wishes to get rid of either by replacing it with yet another similar cycle or letting it be the end of a loop on the algorithm? Marketing stratagem covering the entire spectrum from Tea Houses of the Orient to all shades of Religion certainly thrive on this routine in the affairs of human cognition.

    All inventions, if I may be allowed to make a sweeping comment, are the re-creation (replication) of the phenomena we come to understand operating in nature and permutating it ad infinitum. Can we imagine a colour whose shade is not found, say, in the ever-changing colous of the sky or of the oceans? Well, even if we may be able to imagine some, chances are mankind won't find that creative but absurd. Whatever original shape we may give to physical objects, communications or signals, thoughts or deliberations; the fine line that separates creativity from chaos is that we are possessors and the possessed of a mind - "a self organizing pattern seeking system". I can't resist resorting to the theory of least effort and the path of least resistance at this juncture to amplify this idea.

    For an example, one is told that it is not possible to see without light until the mid-schooling years. Whilst that assumption remained valid in the arena of engineering all inventions restricted themselves to recording, reproducing, transmitting, magnifying, getting closer to, projecting images etc., etc., arising from waves within the frequency spectrum popularly called as light. Then mankind was also observing how dogs, owls and cats can see in low or no light! That lead to an impossible to achieve want to replicate the same...and the cycle came to fruition with understanding of the mechanics of the infrared spectrum. The embryo of need comes by competing with the finest mind operating around us - Nature itself! The cycle thereafter goes on.

    Even science, for that matter, is constantly evolving. Its tools get refined with each round of frustration arising on the insufficiency of the existing ways of evaluating the truth. The way we define science, in common layman's terms, might then be a reality check on our imagination. It might be the measuring stick by which we estimate the effort required (force), the distance to be covered, the forces operating against, to figure out the optimal path or the trajectory of the projectile called progress.

    Wisdom could be defined as the ability to apply to another context intelligence filtered from the scientific evaluation of patterns of contextual information deciphered from understood patterns of data.

    So where do new ideas come from? In the chain of wisdom - intelligence - information - data, new ideas could arise at any of the links or in between the links as new frustrations are encountered. An overwhelming sense of inadequacy then whenever arising is actually the most potent source of all progress that our minds seek finally. So, whenever an enquiring soul gets perturbed with the linkage between characteristics of Oak-trees and characteristics of stock prices for an example, the frustration would drive either the said soul closer to grasping the wisdom or it would refine the application of understanding stock prices in the context of intelligence derived from the nature of Oaks. Sounds clearly like the spirit of indulging in Daily Speculations.

    So, in that sense too efficiency gains in our tools of communication have hastened the process of arriving at collective frustrations and hence the speed with which newer ideas arise is increasing. Imagine the vector sum of all human minds (as in the entire of mankind) is continuously writing and testing code for a programme that aims to replicate reality and truth. Individual minds get allocated within different modules, subroutines, procedures, functions, methods. The better the communication between the various units the better is the detection of coding glitches and faster moves the project for developing the 'programme'!

    Pre-science is not what science is seeking to my mind but only a validation of it. Whenever an invalidation comes by we get an idea that would seek to improve the tools of science, such that we can improve upon the existing tools of pre-science or refine ways of pre-science, the choice being discovered by the tenets of the theory of least effort, (so far).

    9/21/2005
    Innovation, by Scott Brooks

    The genesis of innovation is a function of:

    1. Inspiration (i.e., seeing a correlation between two seemingly unrelated objects or concepts)
    2. IQ (the smarter you are the better you probably are at this)
    3. Luck (i.e., noticing that a black walnut rolls down a hill and that the leaf does not; yet both fall off a tree)
    4. Just plain need (i.e., Grog the caveman's uncle notices that a certain seed planted in the ground grows. But after years of doing this, Grog is sick and tired of the backbreaking work and makes a conscious decision to figure out a better way)

    Communication between tribes is a huge factor in innovation. But the opportunity for communication and methods of communication are more important, because the more opportunities for communication that are available the more likely innovation is to occur.

    Look at how the world changed after Gutenberg invented the printing press -- probably the most important innovation of the last millennium. At the time of his invention, even Europe was still mostly tribal.

    Look at how our communication on this list is made possible  thanks to the incredible genius of Al Gore for inventing the Internet.

    The ability to communicate without necessarily being face to face is a huge driver in this equation.

    As far as brain function and the epistemology of innovation, I have to plead ignorance.

    9/21/2005
    Where Do New Ideas Come From? by Jim Sogi

    In the Logic of Scientific Discovery, Karl Popper expressly avoids the issue of conceiving or inventing a theory.  The question of how it happens that a new idea occurs to a man -- whether it is a musical theme, a dramatic conflict, or a scientific theory -- may be of great interest to empirical psychology; but it is irrelevant to the logical analysis of scientific knowledge.  This is a big gap which we now address.

    Creation does not reconcile with the scientific method. The purpose of science is to test hypotheses that are used to explain and predict. But where do new ideas come from? Popper's method requires only falsification, never proof of causality which fits statistical theory. Falsification is based on empirical proof. Empirical proof must arise from what already exists or every theory would always be falsified by a 'what if.'

    How does science deal with the creation of new ideas? Each new moment of history unfolds in a new manner unknown in all prior experience. Despite scientific theory, natural laws, and expectations and predictions, you don't always know what will happen. We come across this in law, every situation is different, new in some unique way. Every person is different and unique. A market pattern happened a thousand times in a similar gross manner, but the next time will be different, something some where is different. A million songs have been written, a million new books, but there will always be a new song, a new book a new story, a new idea. It is the act of creation. At every moment, the past is being destroyed, and a new universe is created. Creation is change. The defining aspect of humanity is our ability to create. Where do new ideas come from? New hypotheses can be tested, but their significance will not be clear for a period of time until the new idea or theory proves its mettle in experimentation.

    There are significant patterns and tests. A pattern will not be significant without a history. It is not clear that once its significance is established, conversely, it will not change by overuse or outside circumstances, changes in law, weather or other exogenous factors. New ideas arise and affect the status quo and sometimes change the world.

    Let me raise a toast to the Chair and my friends on the list and all the contributors for many new creative ideas, the means to test them, but above all, the courage and INSPIRATION to use our meager abilities to make the world of speculation a better place.

    9/21/2005
    Guiltenfreude, by Kim Zussman

    "Everything Is Illuminated" is a new symbolic film where Elijah Wood portrays obsessive Jewish guilt and the intrinsic need to memorialize.  Occasionally corny yet hypnotic for those who have ever been to Russia, have ever been Jewish, or have ever been among the pitiless crowd peering through binoculars at the hunting minds of eagles circling above. ("Have ever been" is a literary mechanism related to the film).  Wood plays Jonafan, who travels to Ukraine in search of the woman who saved his grandfather from the Nazis. The immutably idyllic wheat fields are Van Gogh contrast with the country's past horrors and modern decay.

    Arachnophiles will recall our pet tarantula, Mr. Clean.  He has a nice California McMansion now, with view windows and real gravel.  We bought him some crickets and surreptitiously observed his feast.  His venom of proteolytic enzymes liquefies the cricket as he holds it in his mouth parts.  The drippy thing is slurped up incrementally over a few hours and all that's left behind is a head and a leg.

    Mr. Clean is friendly, and though he could give a nasty bite he is happy to tip-toe gracefully up your arm in the rhythmically delicate pirouette of a feathery ballerina.  Some family members asked why his ticklish walk is worth the risk of a painful bite, and after some thought I said this was from the spec-list. The Mrs. felt sorry for the collection of hungry crickets, so we gave them some ants to eat.  Then I felt sorry for the ants and gave them a grape.  But I'm worried too that the grapevine has to make grapes and sugar, so it needs sun.  And what of the sun's non-renewable store of hydrogen to fuse?

    Here also we have large orb-weaving spiders in the garden.  They are diligent businessmen; their intellectual property of evolved Wofram-automate patternation, silk and spinneret commodity and machine, with the patience of a shop-keeper in wait of the next unsuspecting customer.  In the morning their soggy kiosks decorate my jog, and I duck to keep them from having to rebuild.

    Recently we thought about the lives of New Orleans businessmen in the context of contented SoCal suburbia.  Businesses here are doing well, supported (with little diversification) by the likes of Amgen's burgeoning employment university. (I still get a kick asking scientists, "How is Amgen?" who invariable answer "Up 5!".  Evidently the era of science for science's sake has lapsed).  However when prodded, one of them spoke of a Parkinson's drug which is sent to the brain by a pump implanted in the stomach.  He said it works, but between the cost of the medication and expensive surgery, it won't be a blockbuster. I was reminded of Hillary-care; which argued that health costs were spiraling out of control, and how much better this applied to the faceless masses than those of mother and father when they were sick.

    My assistant asked why I cared about the grape, as we did elective surgery on an eager patient. "This man purifies proteins used to dissolve cancers."  "They sell it to hospitals, who give it to dying people to delay their adult children's tears." "Their employers pay for the insurance that pays for the medicine, and we buy cars from the employer's company".

    "Oh", she said.  "Is that why you like wine?"

    9/19/2005
    Book Preview: How to Buy Companies, by Daniel V. Grossman

    Note from Victor Niederhoffer and Laurel Kenner: Dan Grossman, Esq., Vic's business partner for four decades, has been working on a book about his acquisitions and other business deals and some deals of others that he has liked. "My general theme is how an ordinary guy, without sizable capital or the backing of a well-known financial institution, can accomplish deals with large public companies," Dan says. We are pleased to provide a preview chapter exclusive to readers of Daily Speculations, "A Deal I Wish I'd Done." An excerpt follows:
    What was the best deal ever? When magazine articles ask this question, they usually cite such historic deals as the purchase of the Louisiana Territory from France, or the purchase of Alaska from Russia. The deal I nominate is not the Louisiana or Alaska purchase, and not Gibson Greetings or some other famous leveraged buyout. It is a transaction that even plugged-in dealmakers have probably never heard of. It is the buyout of the Spirits of St. Louis basketball team in the 1976 merger of the American Basketball Association and the National Basketball Association. The ten-year saga of the ABA from founding to merger was probably as close to pure frontier capitalism as one could get in late twentieth century America.
    The owners of the Spirits, Dan and Ozzi Silna, designated their partner Donald Schupak to negotiate with the other ABA owners the Spirits’ buyout price. The astuteness of Schupak’s approach was to focus on a form of payment currently being devalued by the other parties but still having exceptional future potential – NBA revenues from national television contracts.
    In the first twenty years of payments, the cumulative amount received by the Silnas and Schupak totaled some $50 million. Not a bad return on the $800,000 in upfront cash given up in comparison with the Kentucky buyout deal. But $50 million was just the beginning. During the1990s, leading sports attractions became crucial to the television networks in building audiences for the remainder of their schedules and the networks were willing to forego all profit, even suffer losses, in order to outbid each other for multi-year football and basketball contracts. The NBA’s $2.6 billion television package negotiated in 1997 resulted in the revenue share of the Silnas and Schupak reaching a spectacular $13 million per year. And a new NBA television contract currently being negotiated will likely result in their receiving an additional increase in the near future.
    To put this in perspective, there are only a few professional teams in any sport – in Major League Baseball, the National Football League or the NBA – that earn $13 million of bottom-line, pre-tax profit. And each of these teams must over an extended period invest many tens of millions to sign and develop players and win fan loyalty. The right to receive $13 million a year automatically, without the need to build a successful team, without the need for skilled management or an extensive organization, without the need for capital or risk-taking, is fantastically valuable. It is the equivalent of owning a senior bond issued by the NBA paying yearly interest of $13 million, with an added escalation feature that increases the interest pay-out as national television revenues grow. Depending on prevailing interest levels, such a bond would have a fair market value in the range of $200 million.
    Read the unabridged chapter

     

    9/20/2005
    From FEMA to WEMA: An article by John Tierney, sent in by Kevin Eilan

    I don't think Washington needs any more czars. But if President Bush feels compelled to put someone in charge of rebuilding the Gulf Coast, let me suggest a name: Lee Scott.

    Scott is the chief executive of Wal-Mart, one of the few institutions to improve its image here after Katrina sent a 15-foot wave across the north shore of Lake Pontchartrain. If you mention the Red Cross or FEMA to people in Slidell, you hear rants about help that didn't arrive and phone lines that are always busy. If you mention state or national politicians, you hear obscenities. But if you visit the Wal-Mart and the Sam's Club stores here, you hear shoppers who have been without power for weeks marvelling that there are still generators in stock (and priced at $304.04). You hear about the trucks that rolled in right after the hurricane and the stuff the stores gave away: chain saws and boots for rescue workers, sheets and clothes for shelters, water and ice for the public.

    "This was the only place we could find water those first days," said Rashan Smith, who was shopping with her three children at Wal-Mart on Saturday. "I still haven't managed to get through to FEMA. It's hard to say, but you get more justice at Wal-Mart."

    That's the same assessment you hear from public officials in Louisiana, and there's even been talk of letting Wal-Mart take over FEMA's job. The company already has its own emergency operations center, where dozens of people began preparing for the hurricane the week before it hit by moving supplies and trucks into position.

    I realize that Scott would not be a popular choice with Democrats. They concede that Wal-Mart and other private companies were far better prepared for Katrina than FEMA was, but they say FEMA would work fine if it were under the control of a virtuous, compassionate public servant - someone, as Bill Clinton suggested, like himself.

    Clinton looks back on the 1990's as FEMA's Age of Pericles. "I think we did a good job of disaster management," he said on ABC's "This Week." While criticizing the Bush administration for leaving poor people stranded in New Orleans, he said that he and his FEMA director, James Lee Witt, had been especially sensitive to the needs of poor people because of their own backgrounds.

    But if they cared so much, why didn't New Orleans ever work out a feasible way to evacuate poor people? FEMA had a golden opportunity to plan it during the 1990's. The threat of nuclear war had receded and terrorism wasn't yet a priority, so the agency's biggest concerns should have been an earthquake in California and a flood in New Orleans.

    But it was too busy dealing with the record number of other "disasters" that Clinton declared - an average of one a week, which meant FEMA was mailing out checks for every flash flood within range of a major media market. Upstate New Yorkers suddenly became incapable of coping with the cost of snow removal.

    In 1997, Congress gave FEMA $500,000 and ordered it to develop a comprehensive plan to evacuate New Orleans. The agency passed on the money to Louisiana, which used it instead to study building a new bridge. As Rita Beamish of The Associated Press reported on Sunday, FEMA didn't bother making sure a plan was drawn up - an aide to Witt said its job had just been to pass on the money.

    How often do you suppose someone at Wal-Mart headquarters dispenses $500,000 and doesn't bother keeping track of it? The company can tell you the precise location of every thumbtack in its inventory. It's legendary for tracking every transaction and pinching every penny.

    Its executives fly coach, and they empty their own wastebaskets. When Scott, the chief executive officer, travels with the chief financial officer, they cut costs by sharing a hotel room.

    That's the kind of leader we need to oversee the tens or hundreds of billions that Washington will be spending on the Gulf Coast. Scott could insist on low everyday prices while still leaving the area as well prepared for the next disaster as Wal-Mart was for Katrina.

    David Vitter, the Republican senator from Louisiana, was so impressed with the rapid response of Wal-Mart and other companies that he promised to introduce a bill to abolish FEMA and contract its job out to the private sector. I'm afraid the Wal-Mart Emergency Management Agency will be a tough sell on Capitol Hill. But I'd vote for WEMA. I don't think Washington needs any more czars. But if President Bush feels compelled to put someone in charge of rebuilding the Gulf Coast, let me suggest a name: Lee Scott.

    Scott is the chief executive of Wal-Mart, one of the few institutions to improve its image here after Katrina sent a 15-foot wave across the north shore of Lake Pontchartrain. If you mention the Red Cross or FEMA to people in Slidell, you hear rants about help that didn't arrive and phone lines that are always busy. If you mention state or national politicians, you hear obscenities. But if you visit the Wal-Mart and the Sam's Club stores here, you hear shoppers who have been without power for weeks marveling that there are still generators in stock (and priced at $304.04). You hear about the trucks that rolled in right after the hurricane and the stuff the stores gave away: chain saws and boots for rescue workers, sheets and clothes for shelters, water and ice for the public.

    "This was the only place we could find water those first days," said Rashan Smith, who was shopping with her three children at Wal-Mart on Saturday. "I still haven't managed to get through to FEMA. It's hard to say, but you get more justice at Wal-Mart."

    That's the same assessment you hear from public officials in Louisiana, and there's even been talk of letting Wal-Mart take over FEMA's job. The company already has its own emergency operations center, where dozens of people began preparing for the hurricane the week before it hit by moving supplies and trucks into position.

    I realize that Scott would not be a popular choice with Democrats. They concede that Wal-Mart and other private companies were far better prepared for Katrina than FEMA was, but they say FEMA would work fine if it were under the control of a virtuous, compassionate public servant - someone, as Bill Clinton suggested, like himself.

    Clinton looks back on the 1990's as FEMA's Age of Pericles. "I think we did a good job of disaster management," he said on ABC's "This Week." While criticizing the Bush administration for leaving poor people stranded in New Orleans, he said that he and his FEMA director, James Lee Witt, had been especially sensitive to the needs of poor people because of their own backgrounds.

    But if they cared so much, why didn't New Orleans ever work out a feasible way to evacuate poor people? FEMA had a golden opportunity to plan it during the 1990's. The threat of nuclear war had receded and terrorism wasn't yet a priority, so the agency's biggest concerns should have been an earthquake in California and a flood in New Orleans.

    But it was too busy dealing with the record number of other "disasters" that Clinton declared - an average of one a week, which meant FEMA was mailing out checks for every flash flood within range of a major media market. Upstate New Yorkers suddenly became incapable of coping with the cost of snow removal.

    In 1997, Congress gave FEMA $500,000 and ordered it to develop a comprehensive plan to evacuate New Orleans. The agency passed on the money to Louisiana, which used it instead to study building a new bridge. As Rita Beamish of The Associated Press reported on Sunday, FEMA didn't bother making sure a plan was drawn up - an aide to Witt said its job had just been to pass on the money.

    How often do you suppose someone at Wal-Mart headquarters dispenses $500,000 and doesn't bother keeping track of it? The company can tell you the precise location of every thumbtack in its inventory. It's legendary for tracking every transaction and pinching every penny.

    Its executives fly coach, and they empty their own wastebaskets. When Scott, the chief executive officer, travels with the chief financial officer, they cut costs by sharing a hotel room.

    That's the kind of leader we need to oversee the tens or hundreds of billions that Washington will be spending on the Gulf Coast. Scott could insist on low everyday prices while still leaving the area as well prepared for the next disaster as Wal-Mart was for Katrina.

    David Vitter, the Republican senator from Louisiana, was so impressed with the rapid response of Wal-Mart and other companies that he promised to introduce a bill to abolish FEMA and contract its job out to the private sector. I'm afraid the Wal-Mart Emergency Management Agency will be a tough sell on Capitol Hill. But I'd vote for WEMA.

    9/19/2005
    Bonds and Conviction, by George Zachar

    There does seem to be a very solid consensus behind the notion that the Fed will raise rates another 25bp tomorrow, but will also alter the press statement in an unknown manner.

    I lack the street's faith in the rate hike, as it ignores the political atmosphere in Washington and press' obsession with looking for politically expedient places to lay blame for every news cycle's hard-luck story.

    The energy price spikes could provide ideological "cover" for a Fed pause. There's ample evidence in the data and anecdote stream to justify characterizing energy prices as a tax/headwind/hurdle, making a rate hike for the moment, unnecessary/redundant.

    Long end implieds haven't done much, but short end vols have firmed, correctly discounting the heightened uncertainty/broader probability distributions for rates.

    9/19/2005
    The Shape of Prices, by Victor Niederhoffer

    I was thinking of the prices last week and other weeks in the S&P and other markets this morning,

    Date      Day    Price
    9/12      Mon    1247
    9/13      Tue    1239
    9/14      Wed    1235
    9/15      Thu    1234
    
    9/16      Fri    1242

    and the shape of the prices in relation to the three kinds of bridges came to mind. As a first step, Monday was ranked highest of the five days, and Friday was ranked second-highest.

    Note that Friday has been lowest empirically for 24% of all weeks since year-end 1995, versus a 26.5% expectation from simulation with replacement, taking account of drift, and this appears somewhat non-random.

    But the general question remains. What is the best way to characterize the shape, the path, the magnitudes et al of moves within a week.

    We are thinking around the court here about this and thought that it might be of general scientific and meal-ific interest.

    9/19/2005
    High-Risk Opportunities in Outcast Countries Present and Former? Analysis by Yossi Ben-Dak

    The recent political occurrences in North/South Korea, Iran/Iraq and Libya may be of interest to those interested in new investment opportunities, especially those who believe risk-taking is necessary. Certain rationales for these gambles follow:

    1. North/South Korea

      The fledgling U.S. relationship with North Korea offers a true opportunity to expand markets and economic expansion throughout the two Koreas through the three trading corporations totally controlled by the North Korean elite. Also, it opens a gate for leaders in both Koreas to think in terms of organic integration of heavy industries and sourcing of materials in the North and supply of food and consumer goods from the South, without the rancor and backlash of the ideological stagnation of the past 50 years. Clearly, not all is in order; but a promising scene like this is predicated on fairly immediate reinforcement or it falls back to inertia. I give it three months to move either way. If delayed, worse scenarios will unfold, with China having more of a say.
    2. Iran/Iraq

      Mahmoud Ahmadinejad, Iran's new president, has stated very specifically that he takes Islam to completely disallow nuclear weapons. He actually has repeated this declaration in front of the advisory or guiding board and in front of the Supreme Leader. He is inviting third parties, especially European, to participate in energy projects and thereby inspect "any" move to the contrary. Certain statements re "local" innovations in plutonium "processing" and the availability of first-class expertise in the dozen or so pertinent Iranian lab sites suggest a degree of real danger in less than the "quite a long period" that weapons can be deployed. On the other hand, a clear threat by Zarqawi and his insurgents to all Shiites, with a growing number of evident murders of Shiite civilians, must be taking its mental toll in Iran. There is but little that separates Iraqi and Iranian elites, religious and political. The opportunity I see is in a major dialog between the U.S. and Iran about combining forces and diminishing conflict intensity in several areas of serious disagreement, e.g., Israel-Palestine (by indicating a future confederation plan involving a Palestinian state and a secure Israel), and the Iranian-financed and guided Hizsb Il-llah (as it must and should disturb nobody in self-governing Lebanon or Israel and help Gaza move towards productive life).

      Ahmadinejad, who was the first mayor to be barred from attending cabinet meetings during his predecessor Khatami's time and has regional covert operations experience, would both want to (a) show his unforeseen strength in a dialog with the U.S. (b) do something real for his coreligionists in Iraq, something that can add up to a regional leadership status and would appeal to Shiite leaders all over.

      On the other hand, there is the Muta'ah principle, which resembles deception in speculation lingo; it roughly translates to misrepresentation of self to nonbelievers, very endemic in traditional Shiism, which may negate all said above or become a point of careful observation and examination if one undertakes exploiting the opportunity.

    3. Libya

      Libya is one country that converted from the devil's way to become a more constructive member of trading and market openness. It chose to totally expose its arsenals of nuclear knowledge and options in favor of this explicit choice. More trading, interaction and highlighting the benefits to them and to world community are in order.

    Clearly, if you do not believe in medium- or high-risk gambles, the above is not for you to consider as whatever evidence for proper moves is fairly scanty.

    9/19/2005
    Stochastic dominance in plain English, by Phil McDonnell

    The idea of Stochastic Dominance is an interesting one which has been around for a while.  The idea that a particular cumulative probability distribution function (usually abbreviated cdf) is everywhere "better" than another or the null distribution has intuitive appeal.  It is an idea which has always struck me as a close cousin of the Kolmogorov-Smirnov non-parametric test for different distributions.  The approach is also reminiscent of the more modern D'Agostino test which uses the squared differences between the two distributions.

    Proponents rightly claim that SD can be used as a non-parametric proof of the dominance of a particular trading strategy.  However when one distribution dominates another it is also always true that the mean of that distribution will dominate the other as well.  So while the concept of SD needs less restrictive assumptions, in order for a dominance condition to apply in any given empirical situation the data set needed is also much more restrictive.

    If we consider the very common case that a cdf of one distribution crosses another distribution at some point then the SD requirement of strict dominance does not hold.  Thus all of the real world cases of murky partial dominance do not hold.   For these the better understanding is achieved through the usual statistical concepts of mean, variance and perhaps skew.

    If we consider the equally important case of non-equal variances, the situation is equally confused.  Using SD non-equal variances requires an appeal to utility functions.  One problem with utility functions has always been that I don't even know my own, much less all others.  Another major issue is that utility functions are almost certainly not stable.  After a big down trend traders may be more risk averse.  After a large rise traders may have greater confidence and willingness to assume risk.

    When SD is used to compare two distribution with unequal variances it tends to get confused.  It is possible that the two cdf's will cross one or more times.  It is also likely that the right hand part of one will dominate while the left hand of the other will dominate.  All of these cases lead to confusion and loss of power for the concept of SD.

    9/19/2005
    Desperate Solidarity by Andrea Ravano

    Weekends are the spare oxygen reserve of subs, the much waited relief from the pains of every day life. Its the time when you try to taste every bit of pleasure, happiness, calm with your family, friends and teammates.

    The Romans used to separate public life from "Otium". To the first belonged working, discussions, finding a meal, going to the thermes: in other words every day life in the sense of survival. To the second, which many Italians translate wrongfully as "farniente", belonged instead all the really important matters such as philosophical discussions, studying, writing, speculating in general.

     This is more or less what I was enjoying on Saturday night (Otium ,that is), sipping a glass of excellent Czech beer with my wife in beautiful Bordighera. Strange things happen in life, mysterious at times. We were chatting when a street seller of roses, (Italy is literally invaded by Ceylonese men who often work as waiters during the day and go around public places at night to sell flowers, of course many of them are clandestine), approached  our table trying to sell me some flowers. I politely said we were not interested, when from the corner of the street a crippled man on a wheel chair arrived. His left hand was totally twisted to the back and only a leg was visible. Not a pretty sight. The guy's only hand was extended in the typical gesture of he who begs for mercy. I thought that a handful of pocket money could have helped him more then me and so I put in his demanding hand some change. The crippled guy thanked me and talking to the Ceylonese told him he wanted a rose from him. Oddly enough  without even asking for a dime the flower seller handed him his rose. Next the rose was offered to my wife.

    I'm not entirely sure that there is something to learn for us specs in this story, if not the fact that beyond private and public interventions, government or corporate spending, socialist or capitalistic economic systems, there is a world of suffering, hunger and desperation. Disregarding this reality is meaningless, as the desperate outnumber us, the fatboys, by a very large margin.

    9/19/2005
    The Myth of Persistence, by Jim Sogi

    There are  basic characteristics of markets and their participants which create opportunity for the speculator.

    1. People are short sighted for the future and the past.
    2. The myth of persistence.

    Of these, the myth of persistence is the deepest rooted, the most damaging, and presents the most opportunity.  On a practical level people believe that current conditions will persist, and cling to that belief in the face of change.  We see it daily in the markets. The truth is embodied in change rather than persistence. This is the most basic law of all.

    Eastern philosophies state that  all suffering and loss is caused by change.  The suffering and loss arises from the myth of persistence, the illusion that the status quo will continue. In the markets participants hope trends will continue, that fixed systems will continue to work, that their luck will continue, that low long term rates will continue. They won't. They will change.

    Alex Park responds:

    A related idea I read from a CIA document entitled the 'Psychology of Intelligence Analysis' that discussed the pitfalls and traps of various modes of analysis.

    One concept I found of use was the author's discussion of how can analysts so often get it wrong and by a considerable magnitude. He described the (familiar) scenario that when you look back at given geopolitical events and connect the dots it all seems so obvious yet at the time it was anything but clear.

    One explanation he gives is that at any given time there is a prevailing view (meme) to explain the situation. New evidence may come to light that puts the prevailing view in doubt. However, rarely is the new evidence so overwhelming that it causes a re-assessment of the prevailing view. Instead the new evidence is dismissed or explained away so that the prevailing view remains intact. Only when the evidence is so over-whelming or enough evidence piles up does the prevailing view give way. At that point you look back you see that all the warning signs were there if you had just read them correctly.

    I have seen this same theme appear in two separate arenas. One was in an interview with Steve Jobs (posted on List 2/3 months ago i think). I cannot fully recollect the context but, in describing his life, said that at the time it is difficult to connect the dots and see where they are leading you. Only when you look back do they make sense and take on a significance. Similarly, E. O. Wilson, a sociobiologist, made reference to the fact that in science it is much easier to start with an 'end-product' and works backwards to identify its source (e.g. look at evolution of an organism and see what selection pressures impinged upon its development) than it is to start at any given point and move forwards to a solution. (e.g. look at today's ecology and predict future adaptations of organisms).

    In market terms this is the descriptive vs. predictive dichotomy. It is much harder to predict than describe. That said, it also suggests that the answers are there if we only look hard enough and have the abilities to understand their meaning. I presume this is the province of the hedge fund stars.

    Alston Mabry responds:

    When I look at the past, it seems so easy to create coherent, rational stories that explain what happened and why. However, when I do a one-eighty and look at the future, it is blank.

    The Katrina landfall on 29 August would seem to be an excellent case study in what the market at least partially anticipated (e.g., NGS), and what it did not (e.g., GVA). And the key would be finding ways to anticipate what others do not expect.

    The natural fade is a situation where it is clear what everyone expects and how everyone has prepared for that expectation. The image that comes to mind is the magician who can focus the audience on what his right hand is doing, while he completes the real trick with his left.

    9/17/2005
    Briefly Speaking: Music, Physics, Stocks, Buffett, by Victor Niederhoffer

    1. I woke up after seeing “Music from the Inside Out,” the magnificent, second-best movie about music ever made (behind only “Beethoven's Nephew”), and felt the poignancy of David Kim’s admission that after being a star and being the only American to win a medal in the Tschaikovsky Competition at 17, and using it to get better dates (the Collab says for musical performances and I say with the more attractive women). In his 30s, playing in places like Sioux City, he came one night  to a realization that he was never going to make it as a top soloist. So he joined an orchestra (the beautiful Philadelphia Symphony as it turned out). Yes. Does a company have a similar time when it's lost its edge? Perhaps when it joins a big Index? Is there a time after it's gone public to great acclaim that it loses its luster because of the "only the young is good " syndrome so common in music, where audiences will pay a fortune to see a 8-year-old kid play a million times worse than any journeyman performer. Where does the point come. in terms of years after gong public, that a company become stable and humdrum? Does it depend on the path? I knew when it was time to quit racquetball when I found myself hoping I’d lose early in a tournament so I could rush home to see my kids. What's the corresponding time for a company when it throws in the towel? Perhaps after a period of bad earnings, when finally the auditor says, "No more. I can’t let you squeeze another increase out with those accruals any more. We're stretched too thin." Such queries demand to be tested.
    2. I’m reading my favorite book on physics, Conceptual Physics by Paul Gittewitt, and started today with Chapter 11, “Tension and Compression.” There I see that the bottom of a beam is compressed and the top is stretched, but an arch puts these two forces in equilibrium and has much greater strength. What creates an arch for stocks? Is it a stock near the middle of its range for the past period? No, it's based on the duration and type of holder of the company, my counterpart answers. Yes, but why is it so much easier for a chicken to break out of an egg than for an enemy to break in, and what are the market implications of that, I immediately rejoin.
    3. The U.S. continues to lag behind every other stock market this year. Confounding the Bond Maven, Germany crossed 5,000 from below before the Dow crossed 5,000 from above. In what other years has the U.S. been in the bottom 10% of performance as of the nine-month mark in a year, and how have the forces of gravity managed to affect it during those periods?
    4. I am often asked about the negative impact of a downward-sloping yield curve. But all this means is that expected short-term rates are going to fall in the future from where they are now. It so happens that in the past, such ugly slopes, memorialized nicely for 40 years by the wild squash player Ian McAvity, happened when short-term interest rates were in the 6% to 20% area with corresponding long term rates of 7% to 12%. How in the world is that relevant to a period where 4% short rates and 4% long-term rates are the norm.
    5. Berkshire Hathaway has been hobbling along near its lows in the 81,000 handle as is appropriate for a company whose chief honcho infuses with disguised hubris his mantras: "I am so much more honest than you or her," and "I cant find any good stocks to buy for the last 10 years" and, " I find dishonesty rife in the investment field as compared to myself and the companies I buy, which I can buy in a flash by just looking at their financials, and I just look for companies I understand like See's Candies and Brown Shoes." However, the Friday 9/17 close of 2720, a 21-month low, seems to me the manifestations of the "Morse effect" (see EdSpec) so common in markets and life where a former revered statesman finds that all his former hagiographers are the most vehement in their execration when he stumbles. I found the same effect directed at me when I "went under" in 1997 (have I mentioned it in the last week?), as is appropriate.

    Steve Ellison adds:

    My hunch is that the retirement of the founder(s) is a watershed event and that the replacing of the original entrepreneurial management with people trained to be corporate executives leads to much changed behavior. The graph below, from "Creative Destruction" by Richard Foster and Sarah Kaplan,  show that the median S&P 500 company begins underperforming about 15 years after entry to the index.

    9/17/2005
    Rudolf Hauser on Yield Curves:

    An issue I have touched on before is the conundrum of inverted yield curves. Vic reminds me that the long-term rate is thought of as a function of expected future short-term rates. But it also contains a risk premium to account for the fact that the price of a long-term instrument is more volatile than that of a short-term instrument.

    Rates can go up for a number of reasons, but a prominent reason why real rates rise swiftly is the event of a liquidity tightening, often brought about by a non-accommodative Fed policy. In such a situation, there is a desire to obtain more liquidity, which makes the more liquid instrument more valuable relative to the illiquid one. One would expect this to cause the yield spread to widen rather than narrow or invert. But it usually does the opposite. Why would that happen?

    Well, let us look at another puzzle. To take a simple example, let us assume short-term rates are expected to average 4% per annum for the next twenty years and that a 20-year bond also yields 4%. Assume interest is paid annually at the end of the year. Now the Fed tightens to deal with a temporary problem and short-term rates rise to 7%. Assume the market is gloomy and assumes those rates will fall to only 6% the following year and 5% in the year after that before falling back to 4% for the next 17 years. That should cause the bond price reflecting those short-term rate expectations to fall from 100 to 99.65. But in such circumstances one would normally expect bond rates to rise also. An increase to only 4.25% would seem modest, but even that implies a price decline to 96.68, 3.0% below where it should be for a fairly pessimistic outlook for future short-term rates. (This all assumes future inflation expectations and basic expectations for future productivity have not changed- just a short-term heating up of the economy as at present.)

    Clearly, long-term rates are not just a function of expectations of future short-term rates and a constant risk premium but also have a variable liquidity premium that fluctuates with liquidity conditions. The market knows that at some point that liquidity situation will improve and at that time that enters current expectations a rise in bond prices is assured. This expected gain that reflects the current under-pricing of the bond relative to realistic future short-term rate expectations and added to the reported yield spread of long less short-term rates represents the true yield spread of long over short-term rates, which rises during periods of tight liquidity. When that spread is very wide, the reported yield spread could still be positive, which is why I believe that was the case in the Great Depression of the 1930s.

    At the current level of long-term rates (4.56% on a 20-year Treasury), it is difficult to say that one should expect an assured capital gain in long bonds. At that level the rates are down from last year. So even though the reported yield spread has narrowed, the implied liquidity premium for long versus short-term instruments still seems quite modest. To the extend the market anticipated the realized capital gains to be had in bonds from the higher rate levels, one could even say the true liquidity premium has declined, not risen. (But I have my doubts about the move in bond rates having been anticipated, so I would not push that idea.) It suggests that concerns about narrowing yield spreads brought about by declining or stable long rates and rising short-rates should be considered differently from situations where both long- and short-term rates are rising.

    9/18/2005
    Ask the Specs: Stochastic Dominance in Plain English

    A young spec writes from the nether lands: "I've just started into my PhD course work on asset pricing and quant finance and was wondering if you and I might discuss stochastic dominance.

    Alex "Doc" Castaldo replies:

    If I were you I would avoid the terms mean, variance, skewness in discussing Stochastic Dominance. These terms do not appear in the basic SD definitions.

    Mean and variance are basic concepts of Mean Variance Analysis (MVA). This theory by Markowitz et al. has been widely used but is felt to be deeply inadequate by most theorists. Basically it is too restrictive. (If the VN utility curve is quadratic and the probability distributions are gaussian then MVA is valid, but that seems quite a big assumption to make).

    SD theory (developed by the enemies of MVA) tries to say something about the choice between two gambles while making very few assumptions. (A disadvantage is that the ordering provided by SD theory is not complete, i.e. given two gambles A and B, there are three situations possible: A stoch dom over B, B stoch dom over A, or neither i.e. "we can't say that one gamble is necessarily better than the other").

    Intuitively First Order Stochastic Dominance is based on the <position> of the two probability distributions. Notice that I did not say <mean>. If one distribution is positioned to the right of the other (in a sense that can be made mathematically precise) then it will be preferred to the other by all investors who prefer more to less. This is FSD. It can be proved that when A > B by FSD then the mean of A is greater than the mean of B but the converse is not necessarily true.

    Second Order Stochastic Dominance adds the concept of <spread> of the probability distributions. Notice that I did not say <variance>. Suppose two distributions have the same mean, then if one distribution is less spread out than the other (and there is a specific equation for this, which does not have variance in it at all) then all risk averse investors will prefer the less spread out distribution. This is SSD. Once again the application of SSD to a specific case might give an inconclusive result: A is not preferable to B by SSD, nor is B preferable to A by SSD.

    ..but it has been a while since I thought about this so I could be wrong ...

    This discussion of SD seems to be good

    Alessandro Castaldo, CFA, is a researcher and trader for Manchester Trading. Dr. Castaldo wrote his PhD dissertation on stock market volatility at the City University of New York, and taught courses in finance and options to undergraduates at Baruch College (CUNY) from 1998-2001. He has been associated with Circle T Partners, LP, a $400 million equity hedge fund; and Willowbridge Associates, a $1 billion-plus commodities trading adviser, where his responsibilities included the ongoing refinement of a market-neutral statistically based ("stat-arb") stock selection model.  Dr. Castaldo holds a B.S. in electrical engineering/computer science and an M.S. in management from the Massachusetts Institute of Technology, and worked as a software engineer at SEI Corporation/TMI Systems, Software Research Corp. and Systems Constructs Inc. before entering the finance profession.

    9/17/2005
    Film Review by Laurel Kenner: "Music from the Inside Out"

    Director Daniel Anker spent three years filming the 105 members of the Philadelphia Orchestra to answer the question, “What Is Music?” A definitive answer would need more than a lifetime. Anker gives a brilliant, uplifting approximation by interweaving interviews with the musicians with footage of their performances, their practice sessions, the music they play outside the orchestra, their other pursuits.

    He has good subjects. The Philadelphia musicians featured in "Music from the Inside Out" are full of intelligence, good nature and fun. Nobody is pompous or snobbish.  Some of the best scenes:

    Synesthesia, a subject of discussion on this Web site in the past couple of days, is mentioned in passing; one of the musicians who paints on the side explains that she has always experienced music and feelings such as pain "in color."

    The film omits interviewing the conductor, Charles Dutoit – on the surface, a strange decision, but a wise one, I think. Conductors are interviewed all the time -- not so orchestral players.

    I can think of few films that have made such great use of the medium's possibilities. The sound, cinematography and editing were masterful. “Music From the Inside Out” doesn’t try to dumb down classical music for a supposedly dumb audience, as so many of the packaged classical recordings found in the record stores do nowadays.  It is 90 minutes long, and while there are many funny moments, much of it is pretty intense. It has gravitas. But it was so beautiful and uplifting that when the lights came on in the Greenwich Village theater last night, the audience had joy on their faces.

    I’m a lapsed pianist who spent 20 years studying the instrument and earned a degree in performance from UCLA. I’ve always loved playing. But this is a great film for anybody who wants an idea of what all the fuss about music is.

    9/17/2005
    Is Significance Testing Significant? from Vince Fulco

    While into the early stages of understanding the pitfalls of significance testing, I found another mini-tutorial similar to the earlier referenced "Why Most Published Research Findings are False."

    This piece is called "The Insignificance of Significance Testing" in the Journal of Wildlife Mgmt. The author describes hypothesis testing, misinterpreting P values, shortcomings in testing and some alternative methods (all in 20 pages).

    9/18/2005
    Book Recommendation from Tim Melvin: Appaloosa

    Robert Parker's new Western, although a very quick read, its a very good story with many of the themes we enjoy.

    9/17/2005
    Shell Game, by Bo Keeley

    A strange act of nature occurred this morning, Sept. 16, 2005, on the way to the computer to write you. I took a habitual, early hike in the Sonora desert along flats and rolling hills of rock and cacti given a green tinge by an autumn cloudburst. It was already 100 F.

    I heard a gasp on rounding a barrel cactus. Two giant desert tortoises copulated famously before me. The mounted male tipped at 45 degrees as if holding a bucking saddle. He threw up an open, grunting mouth. The horizontal female was smaller -- chica, say the Spanish -- with knees and head withdrawn into the world of its own brown and gold shell. The male right front leg whipped the air high, lacking only a tiny cowboy hat to make me laugh.

    I set my own hat against the bright light and sat ten feet away. The male swiveled its head, abruptly dismounted and charged me. Until that second, I didn't realize a tortoise could gallop. Was the rush defensive or amorous?

    He came to my knee, stared and I looked back. This was a rare treat because tortoise populations have declined 90% since the 1980s, and the remainder spends 95% of the time underground. His shell was 12 and the head extended 6. Obsidian eyes with wrinkles and a green beard from grazing grass and wildflowers suggested ancient wisdom. He was older than most senior citizens and still breathed hard.

    Shortly, he crawled beneath my legs for shade and I rubbed his chin for a while. The sun drew high until it was time to go. I left him panting, and with a new respect for the ways of the wise tortoise.

    9/17/2005
    The Expert as Literature, an Essay in His Honor, by Steve Wisdom

    Every university offers "The Bible as Literature" class, a venue to discuss the literary grace of the King James Version without venturing into the content, whether an iron axe-head could/did float in 2 Kings 6:6, etc., and in the same spirit our trading room found itself discussing The Expert as Literature the other day

    To my taste, the focus should be on the "middlebrow" character who appears in each of the Expert's printed and online writings, canonically the guy "across the street in Larchmont," a buffoon who leads a charmed life (for a while) at a big bank. True, there's grist for many PhD theses in the "highbrow" character as well: as a Christ-figure, subjected to scorn and abuse by the mere mortals around him; or as an unreliable narrator (from Wikipedia: "In literature and film, an unreliable narrator is a first-person narrator, the credibility of whose point of view is seriously compromised, possibly by... a powerful bias...") though we must distinguish the dancer from the dance; or as a doppelgänger paired with the "middlebrow" character.

    But "middlebrow" really gives his writings their zest. We were casting about: middlebrow thinks he's clever, but finally gets his comeuppance from highbrow. Of course, thoughts turn immediately to Br'er Fox and Br'er Rabbit, and to the precursory West African folktales. And one suggestion was Aesop's Fables; there's always a moral to the Expert's story. But then it dawned on me. Oedipus! (to digress: at Stratford a few years back I saw a production of one or two of the cycle, and they pronounced it OY-duh-POOS, as versus the American ED-uh-PUS; not sure if that's a British or a Greek "thing").

    The middlebrow stumbles through the story, figuratively "blind" to his fate, whilst highbrow serves as the Chorus. (to borrow from Cliff Notes re Oedipus at Colonus: "throughout the drama the chanted odes of the Chorus prepare for the conclusion of the play and the end of Oedipus life.") Gentle murmuring, just offstage: "Beware the Blaaaack swaaaaann.. Blaaaack swaaaaann.. Blaaaack swaaaaann.. Blaaaack swaaaaann.." And there is no hope for middlebrow; the Gods have ordained his fate. The reader knows this from page 1, and looks on in horror as if on a car-wreck from which he just can't avert his gaze

    Victor Niederhoffer comments:

    There is truth as well as beauty in your characterization of the Expert as Literature. In all frankness, his colorful references to such middlebrows as "the minor quant" or "the apparently successful former hedge fund manager for Soros" or "the naked put seller with a seemingly high Sharpe ratio" are so close to home that I don't know whether to laugh or cry. All one can do in such a case is to throw out the welcome mat to the author you critique; invite him to share his thoughts, especially those of a literary nature, with us on a more regular basis with the assurance that all will be published and featured prominently on our humble site; and extend our urgent exhortation for his sabbatical to end and best wishes for an even greater renewed trading effort on his own part.

    All good-natured kidding aside, of the many tens of thousands of posts that we have shared on this site we cannot think of any that have generated more thoughtful and profound responses than those elicited by the expert's fruitful remarks on synesthesia.

    9/18/2005
    Dr. Taleb responds:

    Thank you for the study. But I feel compelled to correct a severe misconception in the remarks made here by VN. Whatever I think of Victor Niederhoffer's ideas, opinions, or inferential methods, I consider him as the antithesis of the "me-too middlebrow" or the unimaginative formulaic "minor quant" (my new name for this class of persons, borrowed from Nietszsche, is Bilgunsphilister, educated philistine). He is a) intense, b) ferociously independent thinking (making him the exact reverse of the "me-too" and middlebrow imitator), c) original/creative, and, not least, d) nondull. These are some (but not all) of the traits that I would be honored to have in my obituary.

    While many would find it the greatest honor to have a person of such caliber as a friend, I find myself with the far higher privilege to be his nemesis.

    Dr. Niederhoffer replies:

    The least I can do in response to your kind remarks about my creativity and ferocity is to thank you with a little story. There was a time 50 years ago where my abilities were not so questionable and my track record not so ephemeral. That was in the field of paddleball at Brighton Beach . At 11, I stood a good chance of beating anyone at the game. Moey Orenstein, the great handball doubles player and hustler, promoted a match between me and George Baskin, then the unofficial champion. George, a former National Handball champ, had everything an athlete should have, except that he was prone to a very bad temper. In that context, he once missed a shot, belted the front wall with his hand in anger and broke his wrist, thereby ruining his then very likely chance to become a professional baseball player. He subsequently served for many years as head lifeguard at Brighton Beach, which was quite a comedown from his potential.

    I beat Baskin in that match, and received an award of a new pair of sneakers from Miltie's. But my father, Artie, told me that afternoon that if he were there at the time, he would have stopped the match and dragged me off the court (as recounted in EdSpec) because he didn't want me to grow up to be a gambler.

    There was a time some 15 years later when, unlike today where your performance, persona, presentations and published work are so much prominent than my own, I was in the limelight -- for my squash exploits. It seemed that almost to the extent of the veneration and attention that the media focuses on you today, everything I did was of interest. I was in the habit then of telling the story of Baskin and how I beat him 21-16 in that money match when I was just 11 and he was in his prime, and what a great he was. Finally, Artie took me aside.

    "For crying out loud, Vic, will you please forever leave Baskin alone. Never tell that story again. He's had enough troubles and he's a very fine guy."

    Nassim, I hear Artie talking to me right now, with that same guidance, but not about Baskin but about you. (And wish that some had shown the same mercy to me, a few years back.) I wish to supplement it with my best wishes for your comeback from your sabbatical to actual trading, which I read has just started, and the hope that you will continue to favor me and my extended family of readers on this site with your literary and philosophic contributions, stories from coffeehouses and other places, and reports of your own success. I assure you that no matter how brightly they shine or how critical they are in comparison to my own, I will disseminate them with pleasure and pride in a spirit of fairness and Artian good fellowship.

    9/16/2005
    The Cruelty of the Market Mistress, by Victor  Niederhoffer

    There is something very cruel about the Mistress of Markets. Some corpora delicti: After crude oil closed at a 40 day low at 63.11 on Tuesday, thereby playing havoc and footsie with the fixed system boys who love to sell the short term minimums, it promptly went up 4% in the next two days, a nice loss on the 5x leverage that the pros like to use. But the pros who work on a 200-day basis and those who envision $1000 gold could smugly note that they were still up big, big, and the trend once again gave them the sweet spot in time. Yes, the pros' fixed-rules following index, the S&P Managed Futures Index, closed down 2% on Monday at 1041, down 4% from the high September 1 of 1092. But then today, crude oil closed again at 63.00 taking back all the hope and hype for a week, the way it did so often to the bulls in stocks during the 2000-2002 period, a period that is still in the hearts and hopes of the chronic bears.

    As an aside, I could not refrain from placing an order to sell some crude at 65.45 on Thursday at 10:38 A.M. Ten minutes after my order was entered it traded 65.50 three separate times, and 65.45 twice. Needless to say, I wasn’t filled. "We'll make sure they take those prints down". The 65.50 prints were indeed excised, as so often happens in the S&P pit in Chicago. I have given up trading in that pit, as I will in the comparable pit in New York for energy. Volume in Chicago has been reduced by 80%, taken over by millions of mini contracts a day that trade electronically in their stead. I predict a similar revulsion in New York unless some people of vision undermine and reduce the public's tendency to grind and bid-ask itself to death.

    9/16/2005
    Letters to the Editor: Music and Colors

    To the Editor:

    (I am sure you are surprised that I am writing to you, but I looked at the site the other day and saw an interesting discussion of music and colors -- whatever we may disagree on, I could not hesitate to invite myself to  comment.)

    There is a human condition called "synaesthesia" (or synesthesia) in which the person can visualize letters, numbers or musical notes as colored (an "A" will be consistently red, a "3" blue, etc.). Rachmaninoff was a synesthete. So were many poets/aesthetic prose writers like Rimbaud, Nabokov -- and many more who did not say so explicitly. Some people claim that synesthetes are over-represented in the artistic community, but I have not seen any serious empirical study.

    Why am I interested in synesthesia? Because of the synesthete's ability to identify patterns that other persons cannot detect. Some people with prodigious memory were synesthetes. They can see associations in an additional dimension. By attaching a color or physical location to concepts, you can increase your mnemonic ability (something as old as the Greeks, called the "method of the loci") -- and memory works best by patterns.

    Indeed, while I believe that we humans are fooled by false patterns in random things, I also believe in the converse: many things are thought to be random, all the while having patterns. Our statistical methods are not powerful enough to detect them.

    One of the best literary-scientific books I know is by A. L. Luria on the prodigious memory of a synesthete. The best discussion is in Ramachandran's book in which he explains that the birth of metaphor ("dark" moods, "luminous" mind, etc.) comes from a weak form of synesthesia in all of us humans. Synesthesia is cross-wiring in the V4 visual cortex --we are all cross-wired to an extent.

    It is also true that synesthetes only discover their "condition" accidentally, late in life. I have been puzzled by the condition as I am obsessed with the notion of pattern detection.

    Nassim Nicholas Taleb

    Victor Niederhoffer responds:

    You could be receiving a check for "best letter" at the end of the month.

    Mark Mills responds:

    Ramachandran's book goes into some detail about tests for specific synesthesia. For example, imagine a rectangle filled with what appears to be random numbers. Actually, the numbers are carefully selected for the synesthete who sees the number '8' as red. (Yes, their brains automatically color the number. My choice of color and number is arbitrary.) In the box, there are 15 examples of the character '8' and they form a triangle. The synesthete will instantly see the triangle. A mathematician might see it after an hour of study. The average person will never see the triangle unless they literally 'connect the dots' with a pencil.

    Think about this in terms of identifying price patterns instead of making sense of a jumble of numbers in a box. The ability is the by product of unusual neural connections, generally thought to be caused by successful neural bridges between the canonic loci of 'linguistic' and 'color' cognition. Though these loci seem 'intellectually' distant, they are physically only a few centimeters away from each other on the surface of the brain.

    The most important blending of canonic cognitive loci is the movement of most 'mouth' neuro-motor primitives to the human hand. In other words, most of what a dog will do with its mouth, we do with our hands. It may not be as visually interesting as seeing the number 8 as red, but probably far more important for human evolution. Try tying your shoes with your mouth.

    For a neurological understanding of how this works, read about 'mirror neurons.' A good introductory book is Mirror Neurons and the Evolution of Brain and Language.

    David A. Whitese responds:

    I've been reading your site for some time, and noted Mr Taleb's letter. Having read his book, I can say that I am comfortable with his general surmise, but only to the extent that his surmise is part of the General Systems Theory of the markets that I am developing. His ideas, and those of all pattern maintenance folks, fit nicely into the adopted Rules of General Market Systems as offered herein.

    Under My General Systems Theory of markets; the prevailing conclusion is; " Price is an artifact of Prevailing Systems Intent."

    Therefore, all logical constructs of General Market Theory are subject to the prevailing Intent of the Systems controlling the market. Mr. Taleb and practically everyone else forgets that the market in stocks trades off of an underlayment; that underlayment is a relative Constant. When mathematics gives you a constant; you better learn how to use it. All disconnects of a stocks trading with its underlayment are manifest system effects, in effect, the hand of man tinkering to achieve goals. Those goals are set forth below and capture the full span of action available to the system. Let's repeat the market's goals; under this system the hand of man is manifest through use of system tools.

    Lest anyone have any doubts please reread the markets rule book. End all speculation as to whether price is an artifact of a systems opportunity in action.

    Characterize the action within its proper context and you've essentially discovered a truth worth knowing.

    L - The function of pattern maintenance. The function of pattern maintenance refers to the imperative of maintaining the stability of patterns of institutionalized culture defining the structure of the system. There are two distinct aspects of this function. The first concerns the character of the normative pattern itself; the focus lies in the structural category of values. The second concerns its state of institutionalization, which concerns the motivational commitment of the individual. A very central problem here is that of the socialization of the individual, taken as the processes by which the values of the society are internalized in an individual personality. Overall, systems do show a tendency to maintain themselves (inertia).

    G - The function of goal-attainment. Goal-attainment becomes a problem in so far as there arises some discrepancy between the inertial tendencies of the system and its needs resulting from interchange with the situation. A goal is therefore defined in terms of equilibrium, and directional changes will tend to minimize the discrepancy between the two systems. Goal-attainment, or goal-orientation is thus, by contrast with pattern maintenance, tied to a specific situation. Systems often have a plurality of goals. For the social system as such, goal-orientation concerns, therefore, not commitment to the values of the society, but motivation to contribute what is necessary for the functioning of the system.

    A - The function of adaptation. Adaptation is another consequence of goal plurality. A system has only so many set, scarce resources, and when goals are many, often one goal must be sacrificed so the resources may be used to attain another goal. this means that the system loses the benefits of the sacrificed goal. The sacrificed goal is chosen through the function of goal-attainment. Adaptation is concerned with providing additional disposable facilities independent of their relevance to any particular goal. More generally, at the macroscopic level, goal-attainment is the focus of political organization, and adaptation is the focus economic organization. Within a given system, goal-attainment is a more important control then is adaptation.

    I - The function of integration. In the control hierarchy, integration stands between the functions of pattern-maintenance and goal-attainment. The functional problem of integration concerns the mutual adjustments of segmented units or subsystems from the point of view of their contributions to the effective functioning of the system as a whole. In a highly differentiated society, the primary focus of the integrative mechanism is found in the system of legal norms and the associated legal system. The system as a whole is concerned most with the allocation of rights and obligations. For any given social system, the integrative function is the focus of its most distinctive properties and processes.

    All action happens against a float; all floats are relative constants.

    The Grandmaster comments:

    This 'condition' may be far more widespread than suggested in the coffee-colored email.

    Our culture is full of associations between mood and color that wouldn't exist if they had no meaning to people:

    As music also appeals to our emotions, we then have a two-stage link between sound and color. So it's not surprising to hear that some people may be adept at skipping the link, though I'm not sure this means they are seeing patterns in a new way.

    Meanwhile I'm toying with the idea of annotating chess moves by color: green for developing (growing) moves, yellow for brilliance (sunshine), red for brutality, grey for dull etc. Taking this one stage further one might describe an attractive young woman as being truly 'Sicilian Najdorf' or her dodgy friend as being 'Czech Benoni.'

    Paul Marino adds:

    Jimi Hendrix is widely recorded in interviews as saying he saw music more in color than anything. I wouldn't say that drugs were the reason; he stated it since childhood. A famous composer, either Bach or Mozart, also said he saw music in terms of color.

    Yishen Kuik adds

    Bit late on this topic as I had been away for the weekend, but a wonderful lecture series has been given on this topic by Vilayanur S. Ramachandran courtesy of the BBC. Ramachandran is erudite, witty and compellingly lucid in his description and analysis - a great rarity among academics. It makes for a soothing after-work listen in an armchair and is available on their archives

    Laurence Glazier adds

    Our current scientific paradigm cherishes the belief of random development. Although patterns detectable in physical phenomena thought to be random are sometimes subject to statistical analysis, the consequences can run so counter to our view of reality that science may "shrink to its component parts again".

    Retha Roux Responds:

    To describe synesthesia as "cross-wiring in the V4 visual cortex" sounds convincing yet feels rather orange.

    I appreciate Cytowic's work because (like Luria) he adds the psychological view to the neurological. Many composers (we could add Messiaen) and writers (such as Nobokov) may have described colored hearing but in "The Man Who Tasted Shapes" Cytowic suggests that if you wish to reclaim some of your deeper knowledge which has been lost from consciousness albeit part of your normal brain function, you start with emotions (energy in motion?).

    Ayn Rand considered herself to have "stomach thought" and said that a "clear understanding" also means a "feeling" and that "higher man will perfect this ability". According to her, man has never learned to live with volitional consciousness. Man needs a state of psychological (volitional) integration - of inner unity... Your emotions is the union of, the product of the integrating mechanism by which your mind (or consciousness according to her) controls your body. Descartes considered the pineal gland to be the "seat of the soul", the point at which the mind and body are conjoined. For Herophilus, the pineal is the organ which regulates the flow of thoughts. In Descartes' mind's eye the process may have looked like a scarlet circle and sounded like "A", reminding him of a brilliant white diamond set in silver, but despite the correlation with idiom, I will be surprised if the "feeling" of "higher man" has anything to do with one's gut. Perhaps this "feeling" is a feeling of resonance throughout the entire body as if something is ringing true.

    If we experience seven different notes in this physical world, does that mean that consciousness is experienced as solid, liquid, gas and four different etheric states? I certainly think so and I recall a certain spec alluding to this fact many months ago. Can feelings and their corresponding emotions be so highly keyed that they are able to serve as accurate cross-checks for rational conclusions because of resonant harmonic effects? Memory has been described as essentially being a harmonization with a specific part of our consciousness at that particular age or point in time (Luria starts vibrating and so does "a matter of identity" in Oliver Sacks' The Man Who Mistook His Wife for a Hat ). Is it true that there exists a vibrational/frequency relationship to time which is in addition to the particular frequency characteristics of the fabric of matter? Is it possible that by shifting the frequency focus of one's consciousness, one may be able to tune into specific time frames outside of the present?

    Is photographing the phantom-leaf-effect an indication that there can be interactions between higher and lower octave energies through resonant harmonic effects? Is the same possible between positive and negative space/time at frequencies that exceed the speed of light? (Without the presence of an intermediary substance?) This brings us to the Einstein-Lorentz Transformation and Tiller's Positive/Negative Space/Time Model which opens up new possibilities but not without associated problems. Will resistance to measurement remain an obstacle in proving the existence of etheric and possible other states/frequencies? Is this where new ideas and patterns originate and others roam until they are invited and welcomed by us or just show up or are they merely emotionally charged (or not) thoughts? The time has come to retire certain prototypes (or will we allow them to continue to resonate harmoniously with most of us?) and fight side by side with Don Quixote (...he has had a good run and I know he will not give up but anyone else would have been rather tired by now). Hopefully, unlike Theseus, we will stay conscious even after our giants and dragons have been faced and slain.

    It was with great amusement that I noticed the synchronicity (or was it a mere projection?) as I read from the August edition of Scientific American on the plane back from New York: "Is the Universe out of tune? Like the discord of key instruments in a skillful orchestra quietly playing the wrong piece, mysterious discrepancies have arisen between theory and observations of the 'music' of the cosmic microwave background. Either the measurements are wrong or the universe is stranger than we thought. Imagine a fantastically large orchestra playing expansively for 14 billion years. At first, the strains sound harmonious. But listen more carefully: something is off key. Puzzlingly, the tuba and bass are softly playing a different song..."

    I have a distinct feeling that we'll have more fun if we attune ourselves to the gentle song of the tuba and the bass for a while...

    9/16/2005
    Invasion of the WaBenzi, by Laurel Kenner

    Traffic in midtown Manhattan has been hopefully snarled the last couple of days by a host of foreign dignitaries attending the annual hoedown at the UN down the street from where I live.

    Every other minute, a major thoroughfare is closed off to autos so that a convoy of black armored SUVs filled with hulky guards can be sped through without obstacles, shepherded by NYPD patrol cars and motorcycle.

    On my way to Fifth Avenue today, I was told by a patrolman to scurry along so that my passage wouldn't impede the arrival of some WaBenzi or other at the St. Regis. (The term "WaBenzi" is a Swahili term coined to describe African leaders who use foreign aid to purchase customized Mercedes-Benz autos, but the phenomenon is universal, as Aidan Hartley noted in an April 26, 2005 piece in the Spectator, "Africa: A Tale of the WaBenzi."

    No signs saying "UN out of New York," but the city does begin to resemble an occupied zone. Manhattan is a low-crime city nowadays, and one wonders at the need for all this protection. Let's grant that these leaders are afraid of being assassinated by their own people, or kidnapped, perhaps by the Midwestern tourists who populate Fifth Avenue; but why don't they meet somewhere else than the most important commercial city in America?

    I'll answer that: It's an assertion that power is better than individually earned money.

    As if the UN dignis weren't enough, Manhattan is simultaneously hosting Fashion Week. The celebrity WaBenzis have commandeered every remaining taxi and hotel room and restaurant reservation in town. The celebrities may be equally annoying, but at least the fashion industry serves an honest commercial purpose.

    9/16/2005
    Sticking to my Knitting, by George Zachar

    So, why are bonds getting smoked? Beats me.

    Reverse engineering from prices and scuttlebutt, the best explanation I have is big sales in the 7 to 10 year part of the swaps curve triggering a cascade into treasuries, and stopping out the arb consensus community who overstayed their welcome in the curve flattening trade.

    Mortgage extensions are part of the story too, with FNMA 5.5%s (largest cohort) extending nearly 50% from 2.3 to 3.4 years, just since the start of Sept.

    As for the data, the upspike in claims and collapse in confidence were forecast and discounted before it stopped raining in New Orleans.

    Now, for sticking to my knitting: I was graciously informed today that I had my earlier emerging market swaps series analysis bass ackwards. The gently rising value, which I interpreted as a widening/weakening of credit, is in fact a price index, whose ascent indicates a strengthening of the relevant credit. Mea culpa.

    9/20/2005
    Five Variations on Creative Destruction on the NYSE, by Victor Niederhoffer

    "Creative destruction" is the name given by the economists Joseph Schumpeter and David Ricardo to the process whereby companies pursuing their changing comparative advantage destroy the old and grow the new. It's a buzzword for the great deeds that the Wintels performed in the '90s and the dotcoms in the Oughts.

    Looking through the 42,000 entries on Google, "creative destruction, NYSE" one finds a patchwork quilt ranging from the most virulent pro-capitalist writings of Becker and Posner, the always politically astute centerpiece of almost every Alan Greenspan speech to 500 references to the job destruction, the discrimination against women, and the "monopolistic" nature of the leading retailer, and numerous references to the churn and turnover of all the typically used indexes with particular reference to that old standby, GE, the one company from the original Dow that is still with us, to numerous academic studies on such matters as performance of companies by concentration ratios and time of entry in this or that index. The subject cries out for some current work free of the slow-moving , retrospective, out-of-dateness and political biases that makes work of this nature so hard to pick the wheat from the chaff.

    If there's one prime example of creative destruction, reinvention, flexibility, churn and dynamism on the NYSE, it has to be Corning, which sold at 113 in 2000, 1.1 in 2002, and now has ground back to 20, with sales of $3 billion projected for 2005, down from $8 billion in 1996 but up some 25% from 2003. Its major business read like a poster for what is, was or will be good in tech: display technologies, environmental technologies, control substrates, optical fiber cable, life science equipment, diesel engine filters, advanced materials -- what a whirlwind it is. Hardly a quarter goes by without a major spinoff, acquisition or joint venture, shift in strategy, changed core, sale of now non-core, restructuring of the balance sheet, change of chair, major contract ready to be signed or business ready to enter, closing of factories, massive layoffs, etc.

    Amazingly, Corning has done this repeatedly since its founding albeit on a slower time scale. Yes, this is the same company that used to be known mainly as a sleepy manufacturer of plate glass, fiberglass and cookware in the formerly sleepy upstate NY company town of Corning.  Some of the things they've pioneered and subsequently deemphasized include fiber-optics, glass for the first light bulbs, traffic lights, all the plate glass and cookware of the '30s, specialty glass for cookware in the '40s, lab service in the '70s, the artful spinoff of bankrupt Dow Corning in 1995 and Qwest, selling off consumer brands in late '90s. Five billion dollars of acquisitions in 2000 in optical fibers. Laid off 25% of its staff in 2002, closed plants.

    In short, a company that changes its game to keep in step with the pitiless consumer, the consummate Rod Laver of tennis who can hit any shot from anywhere on the court with four kinds of spin, the very model of a flexible young-hearted company at 140 years old. Definitely not the kind of company that the Sage would buy, and that's probably a good summary of one of the reasons that Corning is within a stone's throw of its five-year high and the Sage's company at a 25 month low. Subsequent installments will provide a systematic study of the performance of companies manifesting various syndromes of creative destruction.

    9/20/2005
    CFA SAT study questions answered by James Lackey

    A fulcrum for the future profit potential of a trader is the fear of losses over the fear of missing profits.  I find it laudable when traders go into self-preservation mode. When an individual daily loss could wipe out a trader's career, he finally runs.

    However, that point is only reached after a cumulative loss over many days, when my friends are scared: "This is just like January when the market closed down from 2-cl every day day after day." "This is like '98, oh no, 198. ,"

    I retort: "The last time I parked my car there it was stolen....Redheaded women are dangerous...Don't drink the water in Mexico."

    An individual's buy or sell decision and what emotions motivate movement are as individual as the individual. Crowd dynamics: a fire in a movie theater, the appearance of a man with a handgun at his employer's workshop -- the crowd would seemingly evacuate to the path of least resistance.

    Yet if a man at the door was met by a gunfighter, in perfect position, with his back to the wall, the crowd may not have time to move. The gunfighter took down the the X-employee invader, before anyone in the crowd knew what happened. Gunfighters are trained over thousands of rounds to fire, move, fire, cover and fire.

    The after-action report would then include statements of the men to the left and the right who were at the table of the gun fighter. "Were you scared?" "No, I knew he was the fastest gun in the West, and we were in little danger." Or at the next table: "It happened so fast I didn't have time to move."

    Now add the infinite combinations of invaders and gunfighters. Who would shoot first? Who would be last?  Would an invasion ever be attempted if the X employee knew there were gunfighters present? How would the crowd react if they knew they had security at their firm vs. just a bunch of gunfighters?

    The security guard (risk manager), if entirely honest would always say, "I didn't see it coming, lucky we had the fastest gun in the West at our firm." Finally and most regrettably a certain statement would follow, "We need more funding for security". We need more gunfighters.

    9/20/2005
    James Lackey on Pleasure and Pain

    You all saw the silly report circulated this week that the best traders are psychopaths. Dr Z posts behavioral finance coupled with his experience in his medical profession, that patients and perhaps traders seek drugs to avoid pain. We have all met athletes that "like pain." That is the difference in not feeling pain, enjoying it, avoiding pain or, God forbid. an individual seeking pleasure by profiting.

    Assuming that all traders came from the same base of education and are "smart," what feelings would motivate them to move individually and as a crowd is of great importance. A seemingly good descriptive way to explain would be a post civil war period. Let's assume that all traders, research and managers are war veterans. They were all educated in the basics of infantry, firing rifles, marching formations for battle and, most importantly, supply lines and moving camp.

    A good question is what do these "veterans" do after the war? There is a great migration west, savages to be fought, gold to be sought, 40 acres and a mule for all. Some move back east.

    After a few years of study and a bit of experience on wall street what does the individual choose to do now? Some stay in the government, become Pinkertons. Some become gold miners, some sell the dry goods for mining or farming. Some populate cities, a few prefer the lawless camps of the wild west.

    A gunfighter or warrior as a solo act has few choices to profit. He could become a thief or he could provide security in lawless camps for honorable speculators in gold.

    A gunfighter takes on the biggest risk to provide security. Does that make him a psychopath? Does it make him smart for seeing and taking on the big risk for a big profit? Is he just using what god gave him his natural ability to be cool in the face of fire? After all it is not the ability to use a gun. Anyone can pull a trigger.

    I would hypothesize the best gun fighters are as scared of death as any man. I would think they hate to see the death of others especially at their own hand. God for bid a daytrader profiting off of a financial disaster and the losses of others.

    I know the last thing a gun fighter or trader would need is a lack of emotion. As a matter of fact a trader might have more of a feel for others pain and ones fears which gives him the ability to cope with loss. I guess a 19th-century gun fighter laments others deaths and looks at his own scars, wounds and inabilities to cope in the real-world-crowd-behavior as costs of doing his business. I wish day trading was as romantic as the Wild West.

    Jeff Rollert adds:

    One should read the story of Wyatt Earp, including that of his very-wild-almost-too-much-so wife. Many forget he stole the wife of another man, which precipitated a number of things. His reputation was such that no one would offer to fight him, and he lived quite a full life in Alaska and other places usually off of his reputation. I've met a number of traders who also use their reputation to get others to back-off on trades.

    From Kevin Depew:

    Can anyone pull a trigger?  I don't think so. It doesn't matter whether it's a gun or a trade or a marriage proposal, and some who even manage to pull triggers regularly do so with extreme reluctance.  That is perhaps  why so many  methodologies that appear to be successful are in fact acts of randomness whose success is rooted in an external affirmation that, yes, it is OK to pull the trigger this time. If you visit a racetrack for a few hours and listen carefully, you'll find that pulling the trigger is actually one of the most difficult tasks.

    Trading is similar.  Analysis is the easy part.  Initiating the risk is another story, and what about emotions when pulling the trigger?  Emotions are often used in a catchall sense, and occasionally used in sense where any one is believed to be as good, or as bad, as another.  Trade with emotion, trade without emotion. Trade with little emotion.  Or not. Indifference is itself an emotion. Stendhal wrote beautifully about indifference in The Red and the Black.  Julian and Claire engage in a feedback loop where ones indifference creates a sense of urgency in the other.

    Markets are indifferent to our love.  That is why the emotions we feel toward the market are often perceived as negative. She never reciprocates. Worse, she is indifferent.

    9/19/2005
    The Shape of Prices, by Victor Niederhoffer

    I was thinking of the prices last week and other weeks in the S&P and other markets this morning,

    Date      Day    Price
    9/12      Mon    1247
    9/13      Tue    1239
    9/14      Wed    1235
    9/15      Thu    1234
    
    9/16      Fri    1242

    and the shape of the prices in relation to the three kinds of bridges came to mind. As a first step, Monday was ranked highest of the five days, and Friday was ranked second-highest.

    Note that Friday has been lowest empirically for 24% of all weeks since year-end 1995, versus a 26.5% expectation from simulation with replacement, taking account of drift, and this appears somewhat non-random.

    But the general question remains. What is the best way to characterize the shape, the path, the magnitudes et al of moves within a week.

    We are thinking around the court here about this and thought that it might be of general scientific and meal-ific interest.

    9/19/2005
    High-Risk Opportunities in Outcast Countries Present and Former? Analysis by Yossi Ben-Dak

    The recent political occurrences in North/South Korea, Iran/Iraq and Libya may be of interest to those interested in new investment opportunities, especially those who believe risk-taking is necessary. Certain rationales for these gambles follow:

    1. North/South Korea

      The fledgling U.S. relationship with North Korea offers a true opportunity to expand markets and economic expansion throughout the two Koreas through the three trading corporations totally controlled by the North Korean elite. Also, it opens a gate for leaders in both Koreas to think in terms of organic integration of heavy industries and sourcing of materials in the North and supply of food and consumer goods from the South, without the rancor and backlash of the ideological stagnation of the past 50 years. Clearly, not all is in order; but a promising scene like this is predicated on fairly immediate reinforcement or it falls back to inertia. I give it three months to move either way. If delayed, worse scenarios will unfold, with China having more of a say.
    2. Iran/Iraq

      Mahmoud Ahmadinejad, Iran's new president, has stated very specifically that he takes Islam to completely disallow nuclear weapons. He actually has repeated this declaration in front of the advisory or guiding board and in front of the Supreme Leader. He is inviting third parties, especially European, to participate in energy projects and thereby inspect "any" move to the contrary. Certain statements re "local" innovations in plutonium "processing" and the availability of first-class expertise in the dozen or so pertinent Iranian lab sites suggest a degree of real danger in less than the "quite a long period" that weapons can be deployed. On the other hand, a clear threat by Zarqawi and his insurgents to all Shiites, with a growing number of evident murders of Shiite civilians, must be taking its mental toll in Iran. There is but little that separates Iraqi and Iranian elites, religious and political. The opportunity I see is in a major dialog between the U.S. and Iran about combining forces and diminishing conflict intensity in several areas of serious disagreement, e.g., Israel-Palestine (by indicating a future confederation plan involving a Palestinian state and a secure Israel), and the Iranian-financed and guided Hizsb Il-llah (as it must and should disturb nobody in self-governing Lebanon or Israel and help Gaza move towards productive life).

      Ahmadinejad, who was the first mayor to be barred from attending cabinet meetings during his predecessor Khatami's time and has regional covert operations experience, would both want to (a) show his unforeseen strength in a dialog with the U.S. (b) do something real for his coreligionists in Iraq, something that can add up to a regional leadership status and would appeal to Shiite leaders all over.

      On the other hand, there is the Muta'ah principle, which resembles deception in speculation lingo; it roughly translates to misrepresentation of self to nonbelievers, very endemic in traditional Shiism, which may negate all said above or become a point of careful observation and examination if one undertakes exploiting the opportunity.

    3. Libya

      Libya is one country that converted from the devil's way to become a more constructive member of trading and market openness. It chose to totally expose its arsenals of nuclear knowledge and options in favor of this explicit choice. More trading, interaction and highlighting the benefits to them and to world community are in order.

    Clearly, if you do not believe in medium- or high-risk gambles, the above is not for you to consider as whatever evidence for proper moves is fairly scanty.

    9/19/2005
    Stochastic dominance in plain English, by Phil McDonnell

    The idea of Stochastic Dominance is an interesting one which has been around for a while.  The idea that a particular cumulative probability distribution function (usually abbreviated cdf) is everywhere "better" than another or the null distribution has intuitive appeal.  It is an idea which has always struck me as a close cousin of the Kolmogorov-Smirnov non-parametric test for different distributions.  The approach is also reminiscent of the more modern D'Agostino test which uses the squared differences between the two distributions.

    Proponents rightly claim that SD can be used as a non-parametric proof of the dominance of a particular trading strategy.  However when one distribution dominates another it is also always true that the mean of that distribution will dominate the other as well.  So while the concept of SD needs less restrictive assumptions, in order for a dominance condition to apply in any given empirical situation the data set needed is also much more restrictive.

    If we consider the very common case that a cdf of one distribution crosses another distribution at some point then the SD requirement of strict dominance does not hold.  Thus all of the real world cases of murky partial dominance do not hold.   For these the better understanding is achieved through the usual statistical concepts of mean, variance and perhaps skew.

    If we consider the equally important case of non-equal variances, the situation is equally confused.  Using SD non-equal variances requires an appeal to utility functions.  One problem with utility functions has always been that I don't even know my own, much less all others.  Another major issue is that utility functions are almost certainly not stable.  After a big down trend traders may be more risk averse.  After a large rise traders may have greater confidence and willingness to assume risk.

    When SD is used to compare two distribution with unequal variances it tends to get confused.  It is possible that the two cdf's will cross one or more times.  It is also likely that the right hand part of one will dominate while the left hand of the other will dominate.  All of these cases lead to confusion and loss of power for the concept of SD.

    9/19/2005
    Desperate Solidarity by Andrea Ravano

    Weekends are the spare oxygen reserve of subs, the much waited relief from the pains of every day life. Its the time when you try to taste every bit of pleasure, happiness, calm with your family, friends and teammates.

    The Romans used to separate public life from "Otium". To the first belonged working, discussions, finding a meal, going to the thermes: in other words every day life in the sense of survival. To the second, which many Italians translate wrongfully as "farniente", belonged instead all the really important matters such as philosophical discussions, studying, writing, speculating in general.

     This is more or less what I was enjoying on Saturday night (Otium ,that is), sipping a glass of excellent Czech beer with my wife in beautiful Bordighera. Strange things happen in life, mysterious at times. We were chatting when a street seller of roses, (Italy is literally invaded by Ceylonese men who often work as waiters during the day and go around public places at night to sell flowers, of course many of them are clandestine), approached  our table trying to sell me some flowers. I politely said we were not interested, when from the corner of the street a crippled man on a wheel chair arrived. His left hand was totally twisted to the back and only a leg was visible. Not a pretty sight. The guy's only hand was extended in the typical gesture of he who begs for mercy. I thought that a handful of pocket money could have helped him more then me and so I put in his demanding hand some change. The crippled guy thanked me and talking to the Ceylonese told him he wanted a rose from him. Oddly enough  without even asking for a dime the flower seller handed him his rose. Next the rose was offered to my wife.

    I'm not entirely sure that there is something to learn for us specs in this story, if not the fact that beyond private and public interventions, government or corporate spending, socialist or capitalistic economic systems, there is a world of suffering, hunger and desperation. Disregarding this reality is meaningless, as the desperate outnumber us, the fatboys, by a very large margin.

    9/19/2005
    The Myth of Persistence, by Jim Sogi

    There are  basic characteristics of markets and their participants which create opportunity for the speculator.

    1. People are short sighted for the future and the past.
    2. The myth of persistence.

    Of these, the myth of persistence is the deepest rooted, the most damaging, and presents the most opportunity.  On a practical level people believe that current conditions will persist, and cling to that belief in the face of change.  We see it daily in the markets. The truth is embodied in change rather than persistence. This is the most basic law of all.

    Eastern philosophies state that  all suffering and loss is caused by change.  The suffering and loss arises from the myth of persistence, the illusion that the status quo will continue. In the markets participants hope trends will continue, that fixed systems will continue to work, that their luck will continue, that low long term rates will continue. They won't. They will change.

    Alex Park responds:

    A related idea I read from a CIA document entitled the 'Psychology of Intelligence Analysis' that discussed the pitfalls and traps of various modes of analysis.

    One concept I found of use was the author's discussion of how can analysts so often get it wrong and by a considerable magnitude. He described the (familiar) scenario that when you look back at given geopolitical events and connect the dots it all seems so obvious yet at the time it was anything but clear.

    One explanation he gives is that at any given time there is a prevailing view (meme) to explain the situation. New evidence may come to light that puts the prevailing view in doubt. However, rarely is the new evidence so overwhelming that it causes a re-assessment of the prevailing view. Instead the new evidence is dismissed or explained away so that the prevailing view remains intact. Only when the evidence is so over-whelming or enough evidence piles up does the prevailing view give way. At that point you look back you see that all the warning signs were there if you had just read them correctly.

    I have seen this same theme appear in two separate arenas. One was in an interview with Steve Jobs (posted on List 2/3 months ago i think). I cannot fully recollect the context but, in describing his life, said that at the time it is difficult to connect the dots and see where they are leading you. Only when you look back do they make sense and take on a significance. Similarly, E. O. Wilson, a sociobiologist, made reference to the fact that in science it is much easier to start with an 'end-product' and works backwards to identify its source (e.g. look at evolution of an organism and see what selection pressures impinged upon its development) than it is to start at any given point and move forwards to a solution. (e.g. look at today's ecology and predict future adaptations of organisms).

    In market terms this is the descriptive vs. predictive dichotomy. It is much harder to predict than describe. That said, it also suggests that the answers are there if we only look hard enough and have the abilities to understand their meaning. I presume this is the province of the hedge fund stars.

    Alston Mabry responds:

    When I look at the past, it seems so easy to create coherent, rational stories that explain what happened and why. However, when I do a one-eighty and look at the future, it is blank.

    The Katrina landfall on 29 August would seem to be an excellent case study in what the market at least partially anticipated (e.g., NGS), and what it did not (e.g., GVA). And the key would be finding ways to anticipate what others do not expect.

    The natural fade is a situation where it is clear what everyone expects and how everyone has prepared for that expectation. The image that comes to mind is the magician who can focus the audience on what his right hand is doing, while he completes the real trick with his left.

    9/17/2005
    Briefly Speaking: Music, Physics, Stocks, Buffett, by Victor Niederhoffer

    1. I woke up after seeing “Music from the Inside Out,” the magnificent, second-best movie about music ever made (behind only “Beethoven's Nephew”), and felt the poignancy of David Kim’s admission that after being a star and being the only American to win a medal in the Tschaikovsky Competition at 17, and using it to get better dates (the Collab says for musical performances and I say with the more attractive women). In his 30s, playing in places like Sioux City, he came one night  to a realization that he was never going to make it as a top soloist. So he joined an orchestra (the beautiful Philadelphia Symphony as it turned out). Yes. Does a company have a similar time when it's lost its edge? Perhaps when it joins a big Index? Is there a time after it's gone public to great acclaim that it loses its luster because of the "only the young is good " syndrome so common in music, where audiences will pay a fortune to see a 8-year-old kid play a million times worse than any journeyman performer. Where does the point come. in terms of years after gong public, that a company become stable and humdrum? Does it depend on the path? I knew when it was time to quit racquetball when I found myself hoping I’d lose early in a tournament so I could rush home to see my kids. What's the corresponding time for a company when it throws in the towel? Perhaps after a period of bad earnings, when finally the auditor says, "No more. I can’t let you squeeze another increase out with those accruals any more. We're stretched too thin." Such queries demand to be tested.
    2. I’m reading my favorite book on physics, Conceptual Physics by Paul Gittewitt, and started today with Chapter 11, “Tension and Compression.” There I see that the bottom of a beam is compressed and the top is stretched, but an arch puts these two forces in equilibrium and has much greater strength. What creates an arch for stocks? Is it a stock near the middle of its range for the past period? No, it's based on the duration and type of holder of the company, my counterpart answers. Yes, but why is it so much easier for a chicken to break out of an egg than for an enemy to break in, and what are the market implications of that, I immediately rejoin.
    3. The U.S. continues to lag behind every other stock market this year. Confounding the Bond Maven, Germany crossed 5,000 from below before the Dow crossed 5,000 from above. In what other years has the U.S. been in the bottom 10% of performance as of the nine-month mark in a year, and how have the forces of gravity managed to affect it during those periods?
    4. I am often asked about the negative impact of a downward-sloping yield curve. But all this means is that expected short-term rates are going to fall in the future from where they are now. It so happens that in the past, such ugly slopes, memorialized nicely for 40 years by the wild squash player Ian McAvity, happened when short-term interest rates were in the 6% to 20% area with corresponding long term rates of 7% to 12%. How in the world is that relevant to a period where 4% short rates and 4% long-term rates are the norm.
    5. Berkshire Hathaway has been hobbling along near its lows in the 81,000 handle as is appropriate for a company whose chief honcho infuses with disguised hubris his mantras: "I am so much more honest than you or her," and "I cant find any good stocks to buy for the last 10 years" and, " I find dishonesty rife in the investment field as compared to myself and the companies I buy, which I can buy in a flash by just looking at their financials, and I just look for companies I understand like See's Candies and Brown Shoes." However, the Friday 9/17 close of 2720, a 21-month low, seems to me the manifestations of the "Morse effect" (see EdSpec) so common in markets and life where a former revered statesman finds that all his former hagiographers are the most vehement in their execration when he stumbles. I found the same effect directed at me when I "went under" in 1997 (have I mentioned it in the last week?), as is appropriate.

    Steve Ellison adds:

    My hunch is that the retirement of the founder(s) is a watershed event and that the replacing of the original entrepreneurial management with people trained to be corporate executives leads to much changed behavior. The graph below, from "Creative Destruction" by Richard Foster and Sarah Kaplan,  show that the median S&P 500 company begins underperforming about 15 years after entry to the index.

    9/17/2005
    Rudolf Hauser on Yield Curves:

    An issue I have touched on before is the conundrum of inverted yield curves. Vic reminds me that the long-term rate is thought of as a function of expected future short-term rates. But it also contains a risk premium to account for the fact that the price of a long-term instrument is more volatile than that of a short-term instrument.

    Rates can go up for a number of reasons, but a prominent reason why real rates rise swiftly is the event of a liquidity tightening, often brought about by a non-accommodative Fed policy. In such a situation, there is a desire to obtain more liquidity, which makes the more liquid instrument more valuable relative to the illiquid one. One would expect this to cause the yield spread to widen rather than narrow or invert. But it usually does the opposite. Why would that happen?

    Well, let us look at another puzzle. To take a simple example, let us assume short-term rates are expected to average 4% per annum for the next twenty years and that a 20-year bond also yields 4%. Assume interest is paid annually at the end of the year. Now the Fed tightens to deal with a temporary problem and short-term rates rise to 7%. Assume the market is gloomy and assumes those rates will fall to only 6% the following year and 5% in the year after that before falling back to 4% for the next 17 years. That should cause the bond price reflecting those short-term rate expectations to fall from 100 to 99.65. But in such circumstances one would normally expect bond rates to rise also. An increase to only 4.25% would seem modest, but even that implies a price decline to 96.68, 3.0% below where it should be for a fairly pessimistic outlook for future short-term rates. (This all assumes future inflation expectations and basic expectations for future productivity have not changed- just a short-term heating up of the economy as at present.)

    Clearly, long-term rates are not just a function of expectations of future short-term rates and a constant risk premium but also have a variable liquidity premium that fluctuates with liquidity conditions. The market knows that at some point that liquidity situation will improve and at that time that enters current expectations a rise in bond prices is assured. This expected gain that reflects the current under-pricing of the bond relative to realistic future short-term rate expectations and added to the reported yield spread of long less short-term rates represents the true yield spread of long over short-term rates, which rises during periods of tight liquidity. When that spread is very wide, the reported yield spread could still be positive, which is why I believe that was the case in the Great Depression of the 1930s.

    At the current level of long-term rates (4.56% on a 20-year Treasury), it is difficult to say that one should expect an assured capital gain in long bonds. At that level the rates are down from last year. So even though the reported yield spread has narrowed, the implied liquidity premium for long versus short-term instruments still seems quite modest. To the extend the market anticipated the realized capital gains to be had in bonds from the higher rate levels, one could even say the true liquidity premium has declined, not risen. (But I have my doubts about the move in bond rates having been anticipated, so I would not push that idea.) It suggests that concerns about narrowing yield spreads brought about by declining or stable long rates and rising short-rates should be considered differently from situations where both long- and short-term rates are rising.

    9/16/2005
    Cajun Vegas, by James Tar

    I believe Las Vegas will eventually have a sister in New Orleans, perhaps even a big sister. New Orleans has access to the sea, and I can only imagine how the cruise ships will be lining up to deliver passengers to this Vegas on the shore. The investment/tax incentives in real estate, construction, and development are a perfect match for the gaming industry. New Orleans is geographically superior to Las Vegas. I suspect you will see a sale soon by that casino king whose name is synonymous with victory, and he will make a devastating play for positioning in Cajun country.

    The need for employment opportunity cannot be better fulfilled than by the gaming industry. There is an ample amount, billions in fact, of private money always looking to snap up gaming industry securities. I doubt anything else can take a substantial amount of pressure off of the public (federal, state, local deficits).

    Perhaps we will someday be familiar with "What happens in New Orleans stays in New Orleans."

    9/16/2005
    Empirical Study of Deficits and Bond Rates, James Sogi

    Empirical study of annual deficits and bond rates.

    Negative correlation between deficit and 10 year rates of -0.186. Higher the deficit (negative), the greater the borrowing rate. Makes sense.

    Test of correlation: Pearson's product-moment correlation

  • data: bonds[, 2] and bonds[, 3]
  • t = -1.2001, df = 40, p-value = 0.2372
  • alternative hypothesis: true correlation is not equal to 0
  • 95 percent confidence interval:
  • -0.4640627 0.1245638
  • sample estimates: cor -0.1864254
  • Null hypothesis not rejected.
  • Data:

    Historical 10 year bond rates 10 years
    Historical deficits.