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Victor Niederhoffer:
Briefly Speaking


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12/15/2005 Briefly Speaking: Round Numbers at Year-End; Balmy Decembers; the Chairman Objects to Multiple Comps from the Firm's Stock Picker, and the Strong Letter That Ensued; A Conversation in the Woods

Briefly Speaking: Leaks and Announcement Effects

  1. Cardinality

    We're all aware by now that often by the time events are announced, they are widely known to bigger and more sophisticated players. The most vivid example here is the time two Libyan jet fighters were shot down by the US over the Gulf of Sidra in 1981 on a Sunday, New York time. But on the Friday before, gold went up 10 bucks. How could they have known about a cardinal event like the shooting down of a plane? One wants to say it was coincidence, the conjunction of a 1-in-10,000 event with a 1-in-100 event, which isn't too unlikely considering the number of events that occur. But then it turns out that we had been turning up the screws the whole previous week, threatening the Libyans over and over again, and telling them to restrict their flights or else.

    My least favorite example came five minutes before Henry Kaufmann turned bullish on bonds for the first time based on his crackpot flow-of-funds analysis: "The amount of fixed-income supply is $200 billion greater than the demand so rates must go up by 5 percentage points to create the weltanschauung." The firm he worked for offered me bonds at a very good price, two ticks below the market (a one and only), and they rose about 4 points in the next five minutes after the announcement much to the cost of the Palindrome and myself.

    The most startling example I came across was a little-noticed editorial by Caspar Weinberger in Forbes a few months before the impeachment hearings. He predicted that the day before the hearings, the U.S. would lob some missiles against the Mideast adversaries, to deflect attention and show the need for a strong imperial presidency, even if attenuated by excessive romance et al.

    It is well known that the market looked like Hades in the weeks before 9/11. I received a call the weekend before saying that another 10/19/87 was predicted. The market hadn't gone up two days in a row for the previous two months, which may have been a record of some kind. The S&P itself declined from 1330 on May 22 to 1103 at the close on Sept. 10 (using adjusted futures prices). And out of the clear blue sky, volatility on options went up by 14 percentage points from 19% on June 30 to 32% at the close on Sept. 10.

  2. Insider trading

    Insider trading, of course, is the heart and soul of much on the Street. Before merger announcements, the acquiree often rises. Put buyers abound before the announcement of inordinately bad earnings. Indeed, when I studied insider trades in detail with James Lorie in the '60s, we found that 75% of all insider buys and sells were at more favorable prices when the insiders traded than the price prevailing when the transactions were announced.

  3. Leaks

    Particularly reprehensible to me are the staged leaks that the great leaders at the Central Bank are so famous for. They leak to selected reporters what their plans are. They meet with the big brokerage houses to discuss their likely reactions to various events.

  4. The Recent Declines.

    Of course what brings this to mind at present was the decline in the market in the week ended Oct. 7, 2005. Five straight days covering 34 points, including the inordinately bullish first day of the month. What could possibly have caused this terrible and once in 50 times magnitude first-week decline? It seemed ridiculous that the three staged announcements that the Fed was near the upper band of its limit of tolerance for inflation could have caused the decline because this was a repetition after repetition of what had already been announced. The market isn't supposed to move based on historical events but on changes in anticipation. It's all so much clearer now that the story about the big brokerage house failure is becoming disseminated. It's like the Libyan negotiations. Big fund transfers occurred the previous week involving an Austrian bank. Resignations had to be prepared. Agreements to pay off debts had to be arranged. Doubtless dozens of professionals had to be involved in these and similar meetings, to say nothing of the pre-notifications to the authorities. The big owners and lenders would presumably have been given their opportunity to protect the interests of the public and themselves. There has been much notice about the planned family wine-tasting tour of the chief perp to Vienna that was on tape. Was such taping routine, or part of something else?

  5. A classification of events.

    I have long wished to classify events based on their information content and timing. The best I have been able to come up with is a three-category classification into uncertainty classes as follows:

    For example, an earnings release from GE would be known as to its date, and would receive a time of announcement of 10; magnitude of announcement would be uncertain, say 4-6; seeming favorability would be 6.

    An expected 1% increase in CPI would be 10 for certainty of time of announcement, 4-6 for magnitude and 1 for seeming favorability.

    A future change in the fed funds rate at an unscheduled meeting would be 1 for certainty of announcement, 8 for magnitude of effect, and 10 for seeming favorability.

    I am open to other ruminations on this deep subject including alternate methods of classifying events relative to their uncertainty.

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 US.,. possibly caused by the equal conduction of return theorem.

Music, Physics, Stocks, Buffett

  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 has lost its edge? Perhaps when it joins a big index? Is there a time after it goes 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 an 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. As the Wiz, says, Germany crossed 5000 from below before the Dow crossed 10,000 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 B has been hobbling along near its lows in the 2700 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.

Briefly Speaking: Incentives; Open Sesame; The Dangers of Ephemeral Information

1. The key to understanding the world of choice and decision making is incentives. One blade of the incentive scissors is that higher prices elicit increased supply and reduced demand. Today one reads that gold is down $3 because of concern that Indian jewelers will reduce usage, that oil was down yesterday on increased levels of shipments from Europe, and notes that the CRB Index is at 320 approximately where it was 6 months ago. Another blade of the scissors is that people work harder when they can make more money out of something. The Wall Street Journal article yesterday contrasting the beautiful and effective efforts of Wal-Mart and Home Depot to provide food, equipment and shelter for the hurricane victims, and the knowledge that the jails in New Orleans were emptied and prisoners released because no evacuation plans were developed by the government, reminds one of the heroism of business in responding to the profits incentives, the many escapes from jail that have occurred in conjunction with natural disasters, and the importance of developing the taste and experience of property as a necessary concomitant of civilized behavior, and of Martin Anderson's the Federal Bulldozer in which he records how public housing, residents of whom again constituted an inordinate residue of the remaining occupants of NO after the flood, leads to looting and inhuman behavior.

2. What is the magic bullet, the golden key, the "Open Sesame" that will open the chest for market prediction? Is it the movement of a certain market in a certain hour? The market sentiment that arises from the happiness of people, the nearness of releases of energy from fixed decision makers like the trend followers, or those lacking in margin, the changes in uncertainty and a priori risk, the influx of liquidity from monetary injections, corporate buybacks, the changing mix of money being raised by equity versus debt, the flows of money from into money market funds versus stock funds, the liquidity of the public based on money received, the prospects for future profits, inflows from abroad, the strength of the existing holders of stocks, the path of least resistance, et al.?

Yes, all these are important. and all can be quantified. But if there is one single lozenge, that I like to hang my hat on, one that's not always discounted, it's the relative moves of fixed income versus stocks. Yes, there's always a relation, a feeding relation between them, a substitution that is the golden key, ... but the problem is it's always changing. (One attempted to reduce the fogginess of same in his chapter on Kira's education about the evils of regulation of health lozenges, and one's own amiable idiocy, in chapter 16 of ones worst selling book, a book reviewed most recently as "feeding on each other's insecurities and inadequacies, .. lack of success as a trader, ... stupidity and embarrassment, ( with ) an empty message from an empty mind," that one can hardly refrain from a sense of satisfaction.

3. If there's one key mistake that traders make it's to base their decisions on information that is past or ephemeral. The former has been discounted many months ago, and the latter, like the employment last month, or PPI last month has nothing to do with the value of stocks. Of what moment is it that PPI in August was up 0.6% when the CRB is down 10% since then except for those who would spur friction to cover the costs of the market firmament or as Bacon would say, cause the public to lose so much more money than they have any right to lose.

Briefly Speaking: A Big League Query;  Buying the Dollar; Post-Tax Day; Genesis

1. A big league query. Given the market has been down three days in a row and the current day is up, what are the chances that the current change will be above 5 points? The answer is very surprisingly 4 to 1, but this is the kind of useless query that we encourage you never to make. Always look ahead not at the random probabilities of a previous event occurring.

2. Trim Tabs has been beating the bush saying that smart buyers like corporate buybacks, and acquirers and dollar holders aboard are having a field day buying the hades out of the market while hedge funds sell it to them with abandon regardless of the price. They wish that when the hedgies are forced to cover, there is not much carnage like occurred in oil and foreign exchange. Let us hope they maintain a proper humility and can walk the tight rope of making money on shorts that no one ever has before.

3. The average move for the second day after tax day is surprising and well worth investigating with a pencil and envelope.

4.For want of a nail a war was lost. But for the column that the collab and I wrote on April 20, 2000, up on site, we all wouldn't be here and the world would be so much different. You see we were both out of work, and Markman saw that column and said "it was the best column he ever read" and then he hired us. And if he hadn't, my goodness--- don't finish that sentence.

Briefly Speaking: The Magic DAX Number; Momentum Investing; Market Cycles

  1. The DAX is at a four-year high at 4971, approaching the magic number of 5000, during a seasonal period where since 1994 there has not been a good summer rally since 1994. At this time the cumulative gain during the two months was about 5%. The average move since summer 1996 during these summer months is about -4% and the current change since June's month end is 2.5%.
  2. A learned gentleman informs me that that he has read the paper Momentum Investing and the 52 week high by George and Huang and that he may update it with a current enumeration. The key variable the authors find indicative of superior returns is the proximity of the current price to the six month high. They show that portfolios based on this variable are slightly better than the standard banal momentum results found in the literature. The paper uses CRSP data from 1970-2001 and it certainly provides an opportunity... on the other side.
  3. Regarding the idea that there is such a thing as a bull and bear market on a prospective basis: As indicated in our tests of the depiction of  market cycles formulated by my tennis partner Mr. L. B., there is no evidence that it is possible to come up with a retrospective depiction of turning points that is inconsistent with randomness. Thus, ideas regarding sluggishness, selectivity, increasing highs and lows must be taken as untested and unproven. Like so many good things, it is impossible to select the wheat from the chaff.

Briefly Speaking: The Sage's Troubles; Fountain Patters; Happiness and Markets

  1. We return to our roots here because Briefly Speaking was inspired by the Sage's admonition that he was never briefed on anything illegal relative to the transaction with AIG. However, an article about Berkshire read '"... the government is inquiring about its bookkeeping. BRK has always been viewed as a company that's above the fray and operates on a higher level" said Christopher Bebel, a former prosecutor.' Yes, who else could refer to this investigation as a bookkeeping problem. '"It is inconceivable to me that Buffett would have allowed any improper accounting" said Fairholme's Trauner.' May I suggest that the worst taskmasters are often your former greatest admirers.
  2. Henry Gifford made a nice contribution to the Spec Party by describing the random behavior of the flows and spouting of a fountain that seemingly contained patterns. He's augmented his real estate with stock investing and says he gets many insights from the plumbers that he associates with as the world's leading expert on boilers. They're always talking about how their broker told them this, and they told their broker that and that taught him a lesson. It seems they get more satisfaction about having the most prestigious brokers and outsmarting them then they do about making profits. Henry bought a stock where he spends most of his money.
  3. More and more I believe Babson's theory that the state of happiness is a key to stock market movements. We've had a terrible spate of bad weather in New York, with a run of four days with a high above 90. The heat is such that in France there would be many excessive deaths. I hypothesize that excessive runs of miserable weather in New York are associated with inordinate future instantiations of large multi-day declines.

Briefly Speaking, by Victor Niederhoffer

The oak is well described in its contributions to civilization and survival strategies in the book Oak, The Frame Of Civilization by William Logan. While the oak is not the record holder in any niche, it seems to survive in all niches. "They are so successful because they never found a niche". They can survive everywhere, and their distribution throughout the world seems to be coterminous with civilization and trade. Further the oaks preceded the growth of trade and civilization everywhere rather than the other way around. In short, they are generalists that seem to survive with many of the same flexible strategies that humans have.

I was led by reading this book to conduct a study on generalist strategies in stocks in the OEX 100. I looked at the two months with the largest declines over the last 2 years: July 2004 and Jan 2005 (both about 6 percent). I next looked at the 10 companies that showed the greatest rise during those months. I found that during these two months, the average rise of the 10th largest gainer was approximately 5 percent. A list of the companies with their subsequent performance over the next five months to yearend for the July gainers, and the next six months for the 10 best January gainers is as follows:

July 2004 GainersJan 2005 Gainers
Ticker % Return
Ticker % Return

The gains for the average stock for the next 6 months in both periods was approximately 12 percent. The gains for the July gainers appear to be about 1.5 as great as the average stock during the subsequent period. Note that this is a hand study, made during the period of the spec party, when invariably this firm loses considerable money but it is suggestive nevertheless and I believe the extensions of the strategies of the oaks to stock research with related more extensive studies might be fruitful.

Briefly Speaking: Unrest in Europe: History of Science in England

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

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

Briefly Speaking: Body Snatchers

Two of the reasons given for the market's fall yesterday bring to mind the body snatchers. It went down because oil fell below $50 and the oil stocks account for 1/3 of the S&P index decline. But just a few days ago, the reason posited for the market decline was that oil was high and it would bring consumer spending down. Similarly for the decline attributed to retail sales twice as high as expected. "Well," as one manager said, "it's perverse. That's bearish because now the Fed will have to raise rates faster."  Finally, the dollar increase: the Euro was $1.36 at 2004 year-end and is $1.26 today. Wasn't the decline in the dollar last year one of the major planks for why the Buffetabelsons couldn't find any stocks they like?

Briefly Speaking: Spartanism

It's getting a little ridiculous that the main way big companies have to improve their stock price these days is by cost cutting. It happened in two of the companies I owned, right after or in conjunction with my selling: IBM and Pfizer. Such efforts strike me as Sage-like, Scrooge-like, short-sighted activities whereby accounting changes -- "We'll write off $5 billion now to save $4 billion a year in three years" -- similar to acquisition write-offs, can mask the intrinsic rate of profit increase.

But like the machinations of the Sage, such as his selling ABC to Disney without a brokerage fee (ain't Disney happy) and similar cost savings and knockdowns in all his other transactions and serial acquisition fees (apparently it was common to boast in the old days that through shrewd accounting, in the Caribbean, an acquisition could boost the reported earnings of the acquirer by 25%), such maneuvers are finite and do nothing for the long-term prospects of the companies, which are embodied in the expected future growth rate, and discount rate-adjusted for risk.

Please understand that one has nothing against economism, or the great Scrooge McDuck®, or Carl Barks, his heroic creator, and never should the Sage or the Palindrome be compared to them

Briefly Speaking: Behind the Form

1. The market awaits the minutes of the Fed meeting of March 22 with bated breath to see how hawkish they were on inflation. Since March 16, and March 22 , the CRB index has gone down respectively 6% and 3% respectively. Talk about the public being behind the form.

2. The market down today additionally on record trade deficit of 61 billion compared to 59 billion estimate and concomitant weakness of dollar. But dollar actually up about 3/4 percent on the news. Reminds one of all the times that market down on fixed income rate hikes when interest rates actually going down.

3. One reflects on tax payment week of April 2000 when market dropped 160 points. That's S & P points. Many other years grotesque also to non-random extent. Reminder of who owns most of our lives.

4. Interdisciplinary studies often give most incite to a field as they bring up universal factors and fresh perspectives. The book Regression Methods in Biostatistics by Vittinghoff et al Springer, 2005 I find helpful.  Nice discussion of exploratory techniques for physicians including the LOWNESS Smooth and survival statistics, the most neglected useful method for our field.

Briefly Speaking: Monster Oil

It's guaranteed to happen that on the last day of a quarter a brokerage house will disseminate a model that shows that one of their major holdings is due for a 100% increase in price imminently. Also, that the model will be generated by an agrarian reform-loving mathematician who does not understand the first theorem of economics: the higher the price, the greater the incentive for increased supply, and the greater the incentive for reduced consumption.

The brokerage house model should be understood in terms of Ben Green's "Horse Trading" rather than considered a legitimate economic exercise.

Briefly, the attention given to the nice Monster numbers reminds me of a truly proper exercise in "forecasting " undertaken by the great Paul DeRosa. He polled the 10 major banks, to get their deposits, then put them thru a Bureau of Labor Statistics census adjustment seasonal program to come up with an estimate. How beautiful. So good that he had to stop it, as the edge was embarrassing.

But because of these adjustments, and the unholy politicking going into the employment number release (do they want people to control their own retirement, or do they want the government to decide, not that the relatively non-government administration has been elected), it is shameful to use a series like Monster to predict employment since the random components are paramount, whatever one part of the numerator may be estimated to be.

Briefly Speaking

We today inaugurate a new feature, "Briefly Speaking," in honor of all CEOs who were not "briefed" beforehand in conjunction with any activities that subsequently were investigated by authorities.

Briefly speaking, the WSJ article about Maurice Greenberg's "Last Tumultuous Days" at AIG should have appeared in a Harold Robbins novel. Some excerpts.

He called and yelled at several directors.

He had his own elevator guarded by his own security detail, his living living room adjoining his office and  private chandeliered dining room.

At monthly management meetings, he was served hot tea in a china cup by his butler [while other execs sat around in coats and ties without refreshment].

"That would be stupid!" he said when asked if the board should lessen the conflict between AIG and related entities essentially controlled by Mr. Greenberg
"You couldn't even spell the word insurance," Greenberg, calling from a speaker phone aboard his boat in Florida, told a group of outside AIG directors assembled in their attorney's office to discuss subpoenas from the SEC and the New York State Attorney General. The group included a former U.S. secretary of defense, a former U.S. ambassador and a Harvard economics professor.
"Let's go home now," he replied after an awkward silence to a board toast on March 15 to a "great, great friend, the man who made AIG what it is today."

Goodness knows, the staff of his own operation will never be allowed to serve him lunch ahead of the others ever again.