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01/06/2006
Repetitions and Crocodiles

The performance of the S&P surrounding year-end 2004 and year-end 2005 has been inordinately opposite. The S&P closed in December 2004 within 1 point of its high of 1213 and 35 points above its December 2004 low. During the next four days, the S&P registered a continuous decline of 25 points to 1187. In December 2005 the market closed at 1248, at the low for the month, down 25 points from its December 2005 high of 1273. During the first four days of 2006, the S&P has risen 35 points to 1283.

The behavior of crocodiles can provide insight into these stylized facts:

Year-end 2004:             Year-end 2005:
35 points above low        25 points below high
First 4 days down 25       First 4 days up 35

The crocodile has the largest brain among reptiles. It uses that brain to remember how to eat by taking account of the repetitive behavior of its prey. I first learned of this when I heard Crocodile Hunter Steve talk during a visit to the Western Australia Zoo in 2004. Steve mentioned during his talk that the keepers like to jump over a certain low point in the fence completely out of the area where the crocs normally congregate, to feed them each day. But they have to count the crocs before they do so, because the crocs remember where the keeper jumps the fence and lay in ambush for them.

I had been sensitized to this information because Alex Elder had once told me that experienced fisherman in Australia learn never to fish in the same place near a bank twice because the crocs remember where they fish and wait at the same time and place, completely camouflaged below the bank to hurtle out of the water to catch the overly repetitive fisherman. He added that the crocs particularly hate Steve because he was the one who captured them all, and they remember that and hold a grudge.

I subsequently found verification of this behavior in the Nova report Outlasting the Dinosaurs, where croc researcher Dr. James Ross said crocs "particularly learn to avoid dangerous situations very quickly. For research purposes, we find that we often have to change capture techniques, because it's very hard to catch them with the same trick twice."

Study of croc life shows that there is much to learn from them. All researchers agree that they are the greatest survivors among all reptiles, having existed in unchanged form for 200 million years, outlasting the dinosaurs by 65 million years, and often living currently over 100 years, actively reproducing the entire time.

The basic design of the crocodile, very thin and long, a large perimeter relative to surface area seems to have great survival value. Heat loss is proportionate to surface area, and thus energy required to keep a croc going is less than for any other form. To see this, consider the various rectangles that could be constructed with integer sides that have an area of 16. They could be 16 and 1, looking like a crocodile; 4 and 4 , looking like an oak tree; or 2 and 8 in intermediate form. 

The 16 and 1 rectangle has the biggest perimeter to surface area ratio (34 to 16), and the square has the lowest perimeter to surface area ratio (16 to 16). The square will always have the shortest perimeter for a rectangle of a given area. A natural extension is that the circle is the two-dimensional form that minimizes perimeter for a given surface area.

The applications of these two basic characteristics of crocs to markets are clear. I call on readers for proof, extensions, and profitable applications.

Steve Leslie replies:

First thing crocodiles do is observe the characteristics of their prey: nuances, habits, tendencies. Second they plan and develop a strategy to capture the prey: location, time of day, wind, deception. Third they lie in wait for the right opportunity: patience, discipline, economy of motion. Fourth, when timely, they attack with full fury. One major assault. An explosion of energy with one goal and expectation in mind. A singleness of purpose. Finally, they fill themselves with the conquest of the victim, relax and live sumptuously for some time.

If crocodiles can stalk and kill man, who supposedly stands atop the food chain, what does that say about man?

Victor adds:

From Nightmares of Nature by Richard Matthews:

On the night of 19th February, 1945, Japanese troops were trying to escape from the Island of Ramree, off the coast of Burma. Bruce Wright, a member of the British forces, was trapped on the island and wrote of what then happened.

"That night was the most horrible that any member of the Marine launch crews ever experienced. The scattered rifle shots in the pitch-black swamp punctuated by the screams of wounded men crushed in the jaws of huge reptiles and the blurred worrying sound of the spinning crocodiles made a cacophony of hell that has rarely been duplicated on earth. At dawn, the vultures arrived to clean up what the crocodiles had left. Of about 1,000 Japanese soldiers that entered the swamps of Ramree, only about 20 were found alive."

I am not familiar with the incident but I shed a real tear, not a crocodile tear, at the deaths and will refrain from comparing the incident to any market events.

Stefan Jovanovich offers:

The foundation of the Morgan fortune was the hotel business. J.P. Morgan Sr.'s grandfather, Joseph, bought the Exchange Coffee House in Hartford with money gained from selling his share of the family farm. He later traded the Exchange Tavern for the City Hotel. The cash flow from the hotel was invested in common stock in Aetna Insurance and the Hartford & New Haven Railroad. Operating a profitable hotel requires the skills of a crocodile. Most of the profits come from the relatively brief periods when the hotel owner (read: trader) can predict that all the rooms will soon be booked. Relatively steady if smaller profits come from being able to assess what a walk-in customer's price point will be. During the slow periods the ability to live on a near starvation diet is the difference between success and extinction. None of the Morgan biographies pays much attention to the nature of Joseph Morgan's business and its legacies for son Junius and grandson John Pierpont. They tend to look from wide end of the telescope and view the Morgan's success as a matter of "investing" rather than trading. I wish it were so. Those of us who have been successful investors know that the traders are the people who make the money in any business whose profits come from the margins on "turns". The difficulty for investors is in finding a trader whom you can fully trust to simply "buy 'em and sell 'em". The problems come when the traders decide to "invest" - i.e. make large unhedged bets where the positions cannot be squared. In our radio business that has come several times from having the traders fall in love with a particular type of equipment or be seduced into making a large inventory purchase in advance of any actual orders.

Morgan Senior was a ferocious trader. His father's letters to their partner George Peabody complain about the risks J.P. took. Peabody is more sanguine. He is happy to have the firm's "idle" capital put to use. Most of the time, the "idle" capital is a large sum because the firm's biggest allocation is to "money" itself - i.e. gold. Peabody's only caution for the junior partner is that he not lay on a trade that he cannot as quickly reverse. Since he trusts J.P. Morgan's character, Peabody reassures the elder Morgan that the firm has the right "crocodile" for the trading post. J.P. Morgan never stopped being a crocodile at heart. What his biographers described as investing - the railroad recapitalizations, the formation of U.S. Steel - were, in fact, large trades - using cash to turn bad old paper into good new paper. Sometimes, as with the maritime trust International Mercantile Marine, the trade failed. Only then did the paper become an "investment".

The only investments Morgan actually bought and held were art objects. When he died, he gave those away.

 

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