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Some Variations on Happening Again, by Victor Niederhoffer

On Sunday, Oct. 22, at 6:34 a.m., the S&P spiked up from 1374 to 1396 in one minute, shocking the sensibilities of all shorts, raising the hopes of all longs, and alerting all risk managers to the possibility of a squeeze of shorts the same way they are always attuned to the bust of longs, from the work of the doomsdayists and their academic legitimizers. Within a minute it had moved back to 1376. and it seemed like just a bad dream to those caught the wrong way and to longs who didnít take the profits. I was immediately reminded that the most important thing that the Palindrome taught me in the 16 years of our close relationship was always to use two cans of tennis balls when playing a practice match as it saves time, and the one and only thing that a personage who worked for me and then became a billion-dollar fundist specializing in wringing out 3% annual returns taught me was that when a terrible price against you appears on the screen, enough to take your breath away and give you a heart attack if you're old and out of shape, and then you realize it's just an error, forget about it -- then you're really in trouble, as shortly thereafter the market will inevitably go to that price and much worse. I believe that he called such events "Finnigans," although when I took him out to dinner after giving him a drubbing in tennis recently he failed to remember the appellation. Such a "Finnigan" occurred on Oct. 22, as this week the S&P went from 1370 to 1395 in a gradual ascent over four straight days of rises -- the same terrible distance as the misprint that was taken down by the authorities.

It's Oct. 27 again today, the ninth anniversary of the only day that they closed the NYSE after the market declined the circuit-breaker limit of 550 Dow points, a day that will live in infamy as it was enough to bring me down, cause enormous losses to my customers and me, put an end to my customer business for many years, and appropriately humble me for the rest of my life (I was humble before also, but not enough). I have made it a point to remind everyone of how liable to error I am every week or so ever since, but it is always good to repent and reflect on the anniversary of such a tragedy (such tragedy a source of great merriment and misrepresentation and hoped-for recurrence by my enemies.

In the immediate aftermath of the Oct. 27 disaster, I received 50 copies of Tuesdays with Morrie, one of the most boring and depressing books I have ever read. Now, I receive many letters suggesting that I take the day off, and others inquiring indirectly and gently: "How are you doing this year, Vic? We were worried (hope, hope) that tragedy might have befallen you again. We heard you looked crestfallen at the Spec Party and you've stopped reporting your results."

Yes, I have stopped reporting my results for the same reason that General George Washington didnít report his troop strength during the Revolutionary War. If the situation were bad, then the enemies would gather strength and confidence and be able to attack with renewed vigor and impunity. If the situation were good, then he wanted the enemy to be overconfident so that they would be asleep on holidays, especially around the end of the year when great victories can be won. I answered such correspondents with the Washington lesson, and added that it is possible that the hoped-for reports of our demise, such as have appeared on the message boards and papers spawned by the enemies encamped with opposite positions and agendas, the same way the reports of Washington's death that were spawned by the French generals who came to America hoping for prestigious positions only to be humiliated with token corporalships may possibly have been exaggerated.

The Fantasticks, currently running as a revival on Broadway, is the perfect musical, as it has all the elements of the whole history of musicals stripped down to bare essentials, the boy hero climbs a wall to assure his father that there is nothing on the other side (actually, there is a beautiful damsel he plans to run away.) It was one of those moments that seem eerily familiar; I had just read Frankensteins of Fraud by Joseph T. Wells after a very educational visit to the Fraud Museum in Austin, Texas (which I'll report on in detail later). In one part of the book, Wells describes how the Crazy Eddie team was able to engage in a hundred different inventory frauds. At the top of the list was the story of how one of the Antars climbed a ladder to report inventory that was actually empty boxes or vacant space. Here's a sample:

When the auditors came to make their counts [the warehouse manager] climbed on to the product stacks himself and called the numbers down to the person below. If the auditor insisted on climbing up, the warehouse manager held the auditor's notebook and marked the contents himself. He used a range of inflationary strategies: counting empty boxes as merchandise, listing cheap merchandise at premium prices, building tall dummy columns at the edge of a large shelf and claiming the containers were stacked three or four deep when the rear area was in fact empty...The warehouse also fiddled with what retail people call "the reeps," which are repossessions -- products that have to be returned to the manufacturer, who then refunds the wholesale cost of the merchandise to the store. How easy it was to do all this! Pulling it off is like playing with kids. The big firms use their audit detail as a training ground. It's not their fault, but these auditors, they're kids just out of college -- nice ones with 3.5 to 4.0 grade point averages. The auditors only took inventories at a third of the stores anyway, and I helped them decide which stores to look at. The auditor would hand a warehouse clerk a sheet of paper and say, 'Make me a copy of this, will you?' The paper lists the test counts showing which parts of the inventory the auditor planned to do tests on and which parts they'd just take rough counts. Of course we'd make a copy for ourselves. We knew where they were counting and where we could do what we pleased.

Considering the ease and variety of the frauds that this retailer was able to perpetrate, the methods of inflating comp store sales was particularly ingenious. The above is merely the tip of the iceberg detailed by the author, with much help from the divorce and family feuds between the parties. I have a certain skepticism for reports of fantastic profit growth from many fledgling retail chains, especially when the audits are not performed by auditors who donít rely strictly on recent graduates, and if they do rely on old codgers, at least make sure that they do all the climbing of ladders and emptying of boxes themselves, with reports and notations to a member of their own staff rather than to the company representative itself.

How can one talk about the current bull move in stocks, from a low of 1223 on June 15, 2006 when the octagenerian Alan Abelson returned from his four months on leave to continue writing his humorous and acerbic bearish 40 year running column "Heard on the Street". He returned with the query at the market bottom, "The only question is whether the market is in a cyclical or a secular bear market" and made witty remarks about how this time Chairman Ben Bernanke is truly serious about inflation. Since that time, he has been continuously bearish about the market trotting out what seems like (I have not performed the content analysis here the same way I did in Prac Spec, where I analyzed all of his permanently bearish columns from 1966 to 2002 while the Dow moved from 800 to 10000) over a hundred reasons to be bearish with nary a single column bullish and merely one nod to his cloudy crystal ball, as the S&P climbed continuously to its current level of 1389. What can one say about this documented record of what must be the least accurate but most influential forecaster since Cassandra and Laocoon of the Iliad 10,000 years ago? One can say that perhaps he is part of the necessary backdrop of pessimism for a bull market to occur and that it is not chance that his return from leave coincided with this continuous increase in wealth.

Dr. Phil McDonnell responds:

The Chair writes of a mysterious event called a Finnegan. During such time the market appears to hit an ephemeral number but it is quickly nullified. Market participants are induced to think about possibilities previously unforeseen. In like manner managers conducting audits are all too willing to believe inflated numbers. It feathers their own nest.

Such events should not be dismissed as mere urban legends. I have met Finnegan. He is very real.

When counting the tomatoes in my garden one would think that would determine how many I have. One would think that a bitch suckling her newborn pups would know how many mouths to feed. It is all a matter of counting and auditing. So one would think.

Finnegan has traveled about 10 miles from his home in Renton to our home. He never knocks or introduces himself. He doesn't have to. I have seen him and know him from his mug shot Everyday when I check the garden there are more vegetables with little bite marks. Tomatoes which I had previously counted are now inedible. All my audits are completely useless. The only thing I am left with is a little green (*) souvenir with bite marks from a tiny mouth. For that I am grateful. Without that, my story would be just another Bigfoot or UFO anecdote. After all both stories started right here in the Northwest. Ostensibly the first UFO's were sighted in 1947 by Kenneth Arnold flying near Mt. Rainier. Mt. Rainier is the biggest and probably the most spectacular mountain in the lower 48 states. It is located nearer Renton just a few miles South of here.

There is no doubt about which one Finnegan is. He is the one who built his nest in a particular tree with a vantage point so he could watch our dog. Of all the gray squirrels in that nest Finnegan stands out. When our dog barks at the squirrels Finnegan barks back. After all he was the oldest of his puppy litter and knows what it takes to be the alpha male.

For any doubters who think this may be an urban legend.