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9/17/2005
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.

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