Mar

22

I was just checking some fares for a short trip. What does it tell you about relative sector performance and inflation expectations when a round trip coach flight from Europe to JFK costs less than an upscale hotel room in New York? In other words, 15 hours in the sky at close to mach one is about equal to 24 rrs at zero speed in a Manhattan small luxury room! Air travel probably can't get much cheaper than this, but real estate in Manhattan could have some room to correct. Like Japan in the mid 80s the process could stretch on for a while before it reverts, if it ever does!

Mar

21

I attended a drug abuse awareness/prevention meeting at my 6th grade son's school tonight. After the formal presentation, I introduced myself to the professional counselor, commended her for the comprehensiveness of her drug list, and asked what surprises the contemporary scene held for a parent who grew up in a setting where recreational drugs were common.

She described the "teen clubs" where designer pills are common.

"You'll know a club has pills for sale if they charge a lot for water. The club owners are too smart to sell the drugs, but they know the kids who take the pills get really thirsty. If they charge a lot for water, you don't want your kids to go there."

I marveled at how something as innocent as the price of water could hold such useful information.

Mar

21

A letter to the editor, from Donald Boudreaux:

21 March 2007

The Editor, New York Times
229 West 43rd St.
New York, NY 10036

To the Editor:

Sen. Charles Schumer and Rep. Jim McDermott want trade agreements that are "fair" (Letters, March 21) - by which they mean trade agreements that protect American workers from having to compete very hard against foreign workers.

I wonder if Messrs. Schumer and McDermott regard IBM, Apple, and Hewlett-Packard to have been "unfair" traders. By making personal computers and desktop printers so incredibly inexpensive, these firms destroyed countless jobs for office-pool typists. An American worker simply cannot compete with these machines. Would we have been well served had government restricted our ability to purchase these machines? If not, why suppose that we will be well served if government restricts our ability to purchase goods and services produced by workers whose wages are now lower than ours?

Mar

21

The sentence, "Even mathematicians don't have all the answers" is a frightening one. Mathematicians strain hard to have all practical answers. Even engineers go up a zillion blind alleys, and often don't know that the alleys are blind until they've already been announced as the answer.

"It may well turn out, of course, that what they need are more mathematicians." Heaven help IBM, and us.

The classic mid-life arc of the mathematician (esp. the pure one) goes like this:

  1. At 42 - Notice that some friends are getting rich.
  2. At 44 - Notice that zillions of "idiots" are getting rich.
  3. At 47 - Form company based on brilliant idea. Insist on maintaining complete control, to avoid corruption of idea by idiots.
  4.  At 50 - Declare bankruptcy.
  5. Later - New buyer of company makes a success out of it, sometimes a greatone.

I must admit that the high-tech age has reduced the probability of step 4 to, say, 96%. I am not writing as an outsider.

Rich Bubb adds:

Here is an article about one of IBM's chief mathematicians, and the real-world problems her department is solving. 

Kim Zussman writes:

Re: "Zillions of 'idiots' are getting rich:"

This is actually the key to everything. You will never get over how many less (intelligent/educated/motivate/ethical) people have more than you can ever hope to, and the explanations about randomness will fall on the deaf ears of all significant others.

What is much harder and more important to appreciate is how many of your betters will always live in incomprehensible hopelessness.
 

Mar

21

Here is an amusing headline, showing how central bankers measure one another:

Trichet: Price Expectations Better Anchored In Euro-13 Than US

Mar

21

Signals are interspersed within most of the games that I love. Nowhere are they more prevalent than in the games of baseball and investment markets. They largely go unnoticed by the pedestrian observer, the complex communication between the important players belying the perceived orderliness of the contest. However, to ignore or miss a signal often results in dire consequences, loss of a game or loss of your capital.

Many people decry baseball as dull or boring compared to more fast-paced games like basketball or football. Perhaps they are unaware of the action taking place each moment of each inning of each game. As a pitcher begins the wind-up, rather than the beginning of a play, it is instead the culmination of that play. The key participants have performed their secret pantomime designed to communicate, deceive, or reinforce the intentions of those players on their respective side.

Typically, the manger of the team in the field has signaled to the catcher the type of pitch he wants thrown to the batter through an elaborate series of signals; the catcher then signals to the pitcher (usually one finger for a fastball, two fingers for a curve, etc.); and the middle infielders will signal the outfielders with an open mouth hidden behind their fielder's glove for a fastball and a closed mouth for an off-speed pitch. For their part, the team at bat has their own communication system. Most hitters are allowed to determine which pitches to swing at, however, you will notice that before virtually every pitch the batter will step out and gaze at his third base coach. That is because his manager has signaled the coach before every pitch and he has the ultimate discretion as to what the batter can do. Many managers may want the batter to take (not swing) at a pitch in a count (2-0, 3-1) to work a walk. At a 3-0 count a manager may give a hitter a "green light" to swing, knowing the pitcher may send one down the middle expecting the batter not to swing.

With runners on base, the manger may signal for a steal, a bunt, or a hit and run. All of these occur simultaneously with the covert communication from the other dugout. Adding intrigue to the mix, the majority of the signaling being done is designed to deceive and mislead. A manager resembles a madman with a nervous tic as he goes through his repertoire of touching, tugging, and poking at himself, 90% of which is absolutely meaningless. However, once he displays the predetermined indicator (maybe it's the touch of the cap or the tip of the nose), the player is alerted that the signal or play is on. Missing this important part of the signal means the play falls apart.

In the investing arena, signals play an equally vital role in our success. What at first glance appears to be a simplistic exchange of capital for goods is instead rife with misinformation and deceit and head-fakes and head-games and attempts at whatever sleight of hand may separate a person from his stake in the game.

As we used to say, there in only one rule and that is that there are no rules. In baseball this serves as a proper excuse for notorious trickery such the spitball and the hidden ball trick. But for investors the stakes are so high that to ignore the markets signals is to welcome financial suicide. And that's not to be confused with the suicide squeeze.

Vic comments:

This is a brilliant post of yours. The stuff on baseball is very poignant, and the stuff on the markets is very suggestive — which is where I come in. Some day, when we have time, we should do it the right way, and have readers digest publish us. We should reference Dickinson's book on this, with his hundreds of layers of deception and coaches who are expert at stealing signals, and all the mechanical devices that have been used. If you don't have his book, which I guess you may not, let me send it to you.

Signals in the markets often come with the lead off batter causing a big move. There are signals before big meetings, like there were today, designed to make you think a bunt is coming when a big hit is really on the cards.

Gabriel Ivan adds:

This interview of the "wild man" by one of his employees is from last winter, but it illustrates the topic nicely. I posit here that these signals are not very powerful, though, and the dynamic hedgers have a stronger impact on price.

Mar

21

An exchange of verse, For better or worse, Is safer and often more fun.

Rime Of The Ancient Duck Hunter

I journeyed to the Meadowlands
from the world's most busy city,
An Econ book within my hands,
A work on volatility.
A stranger took the seat behind
and boldly whispered in my ear
"Your choice of books is unrefined,
'Tis a choice that could cost you dear.
A heavy sigh escaped his nose
A derisive laugh passed his lips.
"Tis more opaque than Siegel's prose
but less debased than Cohen's tips."

"And who are you if I may ask
to cast aspersions on this tome?
Your breath smells of a whiskey flask,
And your garb suggests no known home.
This book, you see, is all the rage
And gets four stars on Amazon,
Here's high praise from the noted Sage
And kudos from his hangers on."
"I know from whence you come, my son,
I lived there, too, not long ago.
But reading these can be overdone
And trusting them will bring you low."

"So say you, but your words imply
That I like you will miss the goal.
But I'm the caster of my die,
The captain of my ev'ry roll.
I've read the books and studied charts,
Mastered the orphic candle sticks,
Devoured Benoit's arcane arts,
And have learned to make the spondulix."
"Boy, listen to my woeful tale
Before you hold your present path,
How e'en the best are brought to quail
When forced to face the market's wrath.

"While your oversights linger on
Your triumphs will be ground down fine,
And though you doubt the denouement,
The path of hubris is malign.
I laud the dreams that brought you here
But warn that they can be interred
Through brief moments of abject fear,
Damning you to my unwashed herd.
You're on a quest but what's the goal?
Is it power, wealth, or repose?
The first two demand self-control,
The last resides in hobo's clothes."

"Do you plan on slow and steady,
or a style that's fast and gutsy?
Will the morning find you ready
Or a little vodka rusty?
Will your nights be spent in slumber
Or will you be hectored by the Yen?
Will your fate hang on a number,
Or will you hedge to play again?
Will you laugh and love, read and play?
If there's a life beyond the Street
will you enjoy the great buffet
or suck on lemons  and retreat?"

"When you've mastered the one within
and how he'll lay his chosen course,
Step forth undaunted and begin
To fight the dragons in your bourse.
The best laid trades go oft askew
While the visceral thunder home;
Both enticements you must eschew,
Your will another chromosome.
Success is but a bastard hope,
Accepted as beyond the drudge,
It's really just a fictive trope,
But free to those who self-adjudge."

"So, young man, it's time I leave you,
My terminal not far ahead,
A final chant and I bid adieu,
Repeat as needed before bed.
Ursa, Ursa, churning nightly,
Is that you knocking on my door?
I just heard, but only slightly,
Bear claws scuttling 'cross the floor.
If that's you then, go far away,
But if you linger and cavort,
Provide me with a single day
In which to set a monster short."
 

Mar

21

Martin's Boston Stock Market, Eighty-Eight Years From January, 1798, to January, 1886. Boston: Published by the Author, Joseph G. Martin

[Comprises a]nnual fluctuations of all public stocks and investment securities; government, state, city, bank, railroad shares and bonds; insurance, manufacturing, gas-light, mining, and miscellaneous, with the semi-annual dividends paid by each.

From the preface: 

The following pages have been compiled with the greatest care and research, with the view of producing a complete history of the Boston Stock and Money Markets….It is confidently believed that this work will supply the wants of a large class, comprising not only *capitalists* so termed, but a host of persons of smaller means, who seek out some of the various securities as an investment for their surplus means. The period included covers the great Bank Panic which commenced in 1837, failures, depressions of bank stock, with reduction of dividends, followed by the second panic in 1857, the depression and almost complete stagnation of 1861, the first year of the Rebellion, and again the panic of 1873, with the close approach to one in
1884.

Matters of historic value, in reference to the times passed through, are given in the first forty-one pages of the work, and cannot fail to be of value. Pages 42 to 60, under the heading of "The Course of the Boston Money Market," will be found of special interest, as in a great measure presenting a history of the times during the period covered; and for the sixteen years prior to 1886, the details are made very full, in view of the direct influence the condition of the finances always has upon the general prosperity of the country. On pages 120 to 122, under the head of "united States and State Securities," is presented and interesting record of the issues of government bonds, following which a full detail is given of the remarkable reduction in the enormous debts of the Rebellion, presenting a record unparalleled in any other country of the world.

From p. 36-37:

One of the most noted bank robberies in Boston was that of the Boylston, where $320,000 was secured, and this entirely the property of depositors; the bank not losing a dollar, its inside steel safe being unmolested. The burglars hired and adjoining room next to the safe, ostensibly for a "tonic medicine" department. Inside a neat little counting-room, and behind a secretary, was the board partition of the room. A trap-door cut through this, exposed a 20-inch brick wall, upon which the burglars worked steadily up to Saturday, Nov. 19, 1869. Between that time and Monday morning the work was finished; and the robbers had decamped with their booty, leaving numerous boxes labeled "Gray's Oriental Tonic," and carefully packed with "bricks and mortar." The bulk of the property taken was government bonds, these being considered the most easy of negotiation.

It is worthy to note, that, while prices of personal property were generally stimulated during the war, real estate remained unaffected almost to its close. When the paper dollar had fallen as low as forty cents, even houses and farms could be purchased on very nearly as favorable terms in this depreciated currency, as two or three years before with gold; or, to make it plainer, a person abroad, with his gold, could have invested here in real estate at an immense discount from former gold-values.

And…

Telegraphs and Railroads. - The closing-up of the war was marked by the completion of two great enterprises: the successful laying of working submarine telegraph cables between Europe and America, and the building of the Pacific Railroad, - both triumphs in their kind, the one of incalculable service to the world at large, and the other to the United States in particular. The railroad from Omaha to the Pacific, a distance of one thousand nine hundred miles, was completed in less than five years, -commenced the latter part of 1864, and the "last spike" driven May 10, 1869. It is a notable fact, that for some time only two subscribers to stock of the Central Pacific could be obtained in the city of San Francisco, and one of these was a woman; so doubtful was the venture considered in its conception.
 

Mar

20

James Sogi wrote:

I wonder why drops such as the last few weeks materialize out of a normal expectation as they seem to exceed the normal expectation of the current low volatility regime…

There are theorems in statistics that show that nearly any well-behaved distribution ultimately converges to the normal, given enough iterations. However, such theorems almost always require that the variance be stable and finite. Notwithstanding Professor Mandelbrot's assertion to the contrary, the variance of markets is finite. There has never been an infinite price quote nor will there ever be.But that still leaves the issue of stable variance. That is the catch in two ways. First, the variance as measured by the VIX and even the realized standard deviation has been known to swing wildly in a short period of time. It has also demonstrated varying regimes on the order of 14 years in length.
The other issue is slightly subtler and relates to the underlying process. In the traditional random walk the process is an additive one. Each day's net change is added to the previous to arrive at the new price. If the standard deviation were stable then such distributions would converge to normal.

But if the underlying distribution is multiplicative then that alone causes the standard deviation to grow with time as measured arithmetically. A multiplicative process is consistent with the long-term compounded growth found by Dimson, et al. The way to measure the standard deviation and variance is in the transformed (natural log) variable just as the usual option models do. This is reminiscent of the recent discussion on non-linearity.

From the above it is reasonable to expect large tails whenever the variance increases on a short-term basis. In effect it is like a new higher variability distribution is being superimposed on the more common low variability distribution.

Mar

20

The Interval of Observation

Ben Jacobsen, Massey University - Department of Commerce, Ben R. Marshall, Massey University - Department of Finance, Nuttawat Visaltanachoti, Massey University. February 2007

Abstract: We revisit Kendall's (1953) conclusion that "the interval of observation may be very important". Contrary to his other conclusions on return predictability, this conclusion has received surprisingly little attention. Most tests in finance and economics routinely regress daily, weekly and monthly observations on daily, weekly and monthly observations, respectively. This is especially surprising because, while convenient, this convention lacks economic reasoning in many applications. Using similar data to Kendall (commodity prices and US, UK and World Stock Market indices) we show how conclusions regarding stock market return predictability vary drastically once we deviate from this convention. Even more surprising: conclusions whether or not stock returns are predictable fluctuate strongly for almost similar intervals of observation. In other words, had the "Demon of Chance" in 1953 offered Kendall slightly different intervals of observation, Kendall might have concluded that stock market returns were predictable.

Mar

20

I have come to the conclusion that trades are soufflés and trading is cooking soufflés.

A soufflé is a quick and simple dish to make, yet it can flop easily. With hungry guests waiting at the dinner table, there is little margin for error, since soufflés have to be served hot from the oven. A messed soufflé cannot be served. Failure is public. Because of this, cooking soufflés is stressful, but it is also a source of pride, a statement of confidence in one's cooking skills.

All soufflés contain thoroughly whisked egg whites, with a variety of ingredients. Flour, butter and milk often figure in the recipe. But one can also use anything from chocolate to cheese, mashed potatoes or cauliflower. The mixture is put into the oven, at a specific temperature for a specific time. Since there are no two identical ovens, the cook must know his oven, just as the trader must know his market's idiosyncrasies.

Then it is alea jacta est followed by intense watching. If one doesn't wait long enough, the soufflé will not rise. If one waits too long, the soufflé will rise then collapse. Timing is key. Trades are the same. A trade must last long enough but not too long.

Like finance, cooking is replete with superstitions. The scientific method has been applied to cooking only recently and rarely. For centuries, people thought that soufflés rose from air bubble dilatation in the egg whites, but molecular gastronomy has shown that this is not the case. Soufflés rise because of vaporization of the water contained in the preparation.

Mar

20

Here is a list of books I wish I had read before my first year of graduate school.

Microeconomics:

1. David Friedman, Price Theory, and it's free online here!
2. Milton Friedman, Price Theory, A Provisional Text
3. Herschleifer and Herschleifer, Price Theory and Applications
4. Alchian and Allen, University Economics, Elements of Inquiry
5. Armen Alchian, Exchange and Production: Competition, Coordination and Control

Macroeconomics:

1. Snowden and Vane, Modern Macroeconomics, Its Origins, Development and Current State . The older edition, A Modern Guide to Macroeconomics will do just as well as the enw edition
2. Paul Romer, Advanced Macroeconomics

Math and Metrics:

1. Schaum's, Outline Introduction to Mathematical Economics
2. Schaum's, Outline Introduction to Statistics and Econometrics.
3. Ramu Ramanathan, Introductory Econometrics with Applications
4. Wooldridge Jeffrey, Introductory Econometrics: A Modern Approach
 

Mar

20

The first forever stamps will sell for 41 cents apiece. They won't have a price printed on them and they will remain valid for sending a letter despite any future rate increases.

While a forever stamp will always be valid for mailing a letter, that doesn't mean the price won't go up. If rates were to increase to 45 cents, for example, that's what a forever stamp would sell for. But stamps already purchased at a lower rate could still be used without extra postage.

What of a government-issued paper currency that won't lose purchasing power? Is the assumption that the denomination is so low that use as an inflation hedge is impractical? One or two postage hikes down the road, will bulk quantities of these trade relative to then-current postage? I see an economics masters project.

Mar

20

We are now 15 days since the drop of 2/27, and SPY is about three percent below where it was 16 days ago. This is near the 2.9% below 5/11/06, which occurred 15 days after that decline started.

To compare these events I plotted change in SPY closing price for each series such that the declines are superimposed trading day for trading day:

Though the recent decline was much sharper initially, it rebounded more quickly before converging with last summer's drop. Hopefully there is little to conclude from the parallel beyond this.

Mar

20

“It is better to set wide perimeters for profits than to take the quick profits.” (Duncan Coker)

Is this true as well in volatile markets, in that volatility tends to cluster? Isn’t it prudent to trade smaller (your profits will be the same over shorter periods with higher ranges, as will risk of extreme loss) or analogously shorter? Consider that many participants have been mortally wounded and are trying desperately to get back to even, do or die. If you have not been mauled in this way maybe there is a current advantage to slow and steady.

Like in motocross, the answer is different if you are trying to win the race rather than just finish well. There are lots of racers who will crash in the bumpy downhill section of the course. And perhaps you don’t mind being one of them if that’s the risk it takes to win.

Mar

20

A Swiss bank's research says Alt-A and Subprime adjustable mortgages account for 13.8% of outstanding first lien mortgages. Let's say a third of those were issued most recently, populating the oft-cited cratering indices. That would be around 4.55% of outstandings.

Now, let's say a quarter of those are in trouble. That would be 1.14% of outstandings. Finally, let's say the underlying value of the paper is only 60 cents on the dollar, for a 40% haircut. Forty percent of 1.14% is 0.46%, a loss of 46 bp of outstandings.

Away from the human tragedies of folks losing their houses, etc., it is very hard for me to come up with a scenario where a market-wide loss of less than half a percent foreshadows material macro fallout.

Bear in mind the securities losses will be concentrated in funky first-to-die paper, much of which is held overseas. And the unfortunate folks losing their homes weren't among the economy's biggest spenders.

Bud Conrad writes:

I like your method of looking at the situation. I come up with a worse number starting with the Alt A added into the sub prime as likely candidates for failure added in. Another view has Alt A about 18% of new issues in 2006 for $350B according to inside MBS & ABS. Subprime was 25% of new lending in 2005 and was said to be $600B.

Combining these gets closer to 40% or say a third of the loans for a guess. I leave one reduction step out entirely, the number of such loans just recently, as they might all have some risk.

I give a higher recovery rate of 75% so 25% loss. Now apply the 25% in trouble, and I get 30% X 25% X 25% = 1.9%

2% loss on all mortgages would be much worse in the sector that I suggested was 30%, more like 6% to them. So I can concoct a problematic, if not catastrophic scenario on this back of a napkin.

Charles Sorkin adds:

I'm not sure the focusing on the dollars lost directly through bad loans is the proper approach for predicting the impact on the economy going forward. After all, with prices of lower-rated residential mortgage backed securities now well below par, much of that money has already been lost, and with the GSEs playing a diminished role these days, much of that money has been lost by private entities.

Tighter lending standards will reduce the amount of consumer spending that was derived from cash-out refinances. Homeowners that do not default on their ARMs will still have less discretionary income to support purchases of big-ticket items (cars, appliances, retail electronic gizmos, etc.). Consumer psychology is generally such that negative headlines can easily convince the marginal buyer to put off homebuying for a couple of quarters. So on and so forth.

Will it be enough to generate a recession? Futures markets are now implying 2-3 rate cuts in 2007, so perhaps we are at a key rate-setting juncture Fed-wise. Keep in mind that if a rate-cut is implemented with the expressed hope that it will support adjustable-rate mortgage debt, it is important to keep in mind that many loans reset only annually.

Mar

20

I have to admit, bookshops are one of my weaknesses. They seem magically to attract me, and once I am in there, I am always delighted either to find, “The Education of a Speculator,” or “Practical Speculations” on the shelves. Another book, however had, intrigued me for a while and I finally gave in. It must have been titled: The UK Stock Market Almanac 2007.

While not having digested all tables and lists yet, here’s my brief review:

The content of the book is as ensnaring as its title suggests. The backbones of the author’s analysis are seasonal phenomena. Calendar months, days of the week, quarterly and sector specific behaviours are being examined. While it might be tempting to regard the title as shortcuts or extensions to the Chair’s seasonal analyses, I advice fellow Daily Specs to do the homework by themselves. Concepts of statistical significance, parametric vs. nonparametric methods, cross-correlations, are simply neglected. Results are not reviewed for robustness over time and Dr. Costaldo might be interested to know that the author includes January twice in his “January — Rest of Year” analysis. This book appears to have been written not with scientific precision but with inspiration of the Market Mistress, luring the reader into false security.

Mar

20

Following up on the inflation expectations threads, today we have ECB Governing Council member Klaus Liebscher on the wire:

“The credibility of the Eurosystem’s monetary policy and the euro area’s sustainable fiscal policy framework will improve our resilience to shocks…”

“By solidly anchoring medium- to longer-term inflation expectations in the euro area at levels consistent with price stability, monetary policy can make an ongoing contribution towards fostering sustainable economic growth and job creation in the euro area…”

As Bernanke adopted the ECB’s wording of “vigilance”, so it seems the burghers of Frankfurt have taken up the “anchoring expectations” banner.

Victor Niederhoffer adds:

As a courtesy, presumably all Central Banks are converged, always maintaining the Chinese Wall with all their people.

Mar

19

One of the tenets of my life is that I want to be known as the guy with the most losses. I want to be the guy that lost the most. My reason for this is simple: the guy with the most losses is also the guy with the most victories.

As a kid, I figured out that even though I did not like losses, I could learn from them. Therefore, I stopped looking at them as losses. I looked upon them as learning experiences. I figured out early in my life that my viewpoint and the events surrounding it were paramount to my success (or failure).

Therefore, I want to share with you all my viewpoint of the recent robbery of my farm.

Yes, I'm unhappy about what happened, but there's nothing I can do about it. I can only work to prevent it from happening in the future.

But what wisdom can I glean from this "learning experience?"

I thought about this as my buddy Jeff and I were driving home on Friday night from the farm (he volunteered to go up with me and give me a hand). We both were discussing successes and failures in our life. Jeff shared some of his more poignant experiences in his very successful life. He's a dermatologist who specializes in reconstructive surgery usually involving facial cancers of some sort.

What ended up happening in our discussion is that after we talked about our successes and failures, we both began to focus on the good things that came out of them and how our lives were blessed.

I concluded that even though I lost a bunch of stuff, I could have lost a whole lot more. The deputy was stunned that I hadn't been robbed sooner (especially after he saw all the stuff I kept in there) and he thought I was lucky that they didn't get more. He figured that someone or something had scared them off. I also concluded that even though I lost a bunch of stuff, all I lost was "stuff."

You see, the reason I got all of my stuff was because of all the actions I had performed in my life, my actions being my efforts directed towards gaining success. And I concluded that I had done it once and I could do it again.

You see, I already know what it takes to get the job done; therefore, all I have to do is repeat those actions. I know how to do it. I'll do it again. I don't have to invent something new, or figure out some mystery, or solve the problem of how to gain that level of material wealth. I have the knowledge, the skill, and ability.

Years ago, I used to be asked to teach others about little secrets of success. I enjoyed giving these talks. The teacher always learns more than the pupils. It was a great journey of self-discovery and introspection. One thing I used to say at these meetings was, "You could take everything that I have in this world: my home, my business, all my assets, even the clothes on my back. You could then beat me with a baseball bat and toss my naked, bloodied, financially devastated body out into the middle of nowhere and leave me for dead, and I would get it all back. Why? Because I know how to do it.

My purpose for saying this was twofold:

First, because I didn't want anyone listening to me talk to think that anything about their situation was an excuse for failure. And second, because I knew it was true.

Little did I know that in the late 90s I would get a chance to put those words to practice. I experienced a devastating personal crisis that lasted for several years. It cost me my business and I came within hours of losing my home. I nearly lost my mind fighting a battle against an unbeatable foe. I discovered who my friends were. I also discovered who the  weasels and cowards were.

But most important, I discovered that I had the resolve to withstand an experience what was, at the very best, surreal in it's unbelievably. There were times I felt as completely and hopeless lost as ship adrift at sea. There were times that I went days without sleep. At times I doubted everything.

But always, there was that little voice inside my head that said, "Hold fast. You resolved to hold true to your beliefs, now hold on to them."

That voice saved me. That little voice was so deeply imbedded into my core beliefs that this adversity, no matter how dark of a comedy it became, no matter how much it resembled a scene in Alice in Wonderland where the Queen says, "off with their heads," that belief was not going to go away.

You see, I had worked for years to train myself to believe that I was destined for success, that I was destined to have a wonderful, joyful life of meaning. That this situation was merely a learning opportunity for me to gain strength and test my resolve and it would be the launching pad for greater and more meaningful things that were to come.

That was more than a decade ago, and when I look at my life then and where I am today, I know I am a blessed man. I believe that I am better off today than I would have been if I had continued on the path I was on. My business partner at that time turned out to be a complete weasel. You don't ever truly succeed when dealing with weasels. Because of what happened, this partner was revealed to me to be the weasel that he was. I am far better off without him in my life!

I believe that positive thinking and looking at everything that happens to me as a learning experience has served me well. I've said on this list many times that I am far from the smartest spec. To be truthful, if we set up an IQ bell curve for specs, I am confident that I would find myself in the far left tail of that curve. That's OK. I am what I am. I can't change the fact that I don't have abilities that come so naturally to many of my spec friends. But, if you'll recall, I wrote a post in the last few weeks about being a great follower (which I'd like to think I am). You see, I like to surround myself with people who are much smarter than I, and then learn from them.

One of the things that I've discovered since being invited to be a spec is that I had small but important error in my thought processes that has plagued me for years. You see I've always said to myself, "my resolve will overcome your intellect." It didn't matter how smart a person was, I would eventually win because I would never, under circumstances, surrender.

Well, the error was simple, yet important. I may win with my resolve, but if I could add to my intellect on top of that, I would become a force greater than I could ever even imagine. So I made a decision several years ago to increase my knowledge. Lo and behold, seemingly out of nowhere, I was introduced to the spec list and invited to be a participant, and my knowledge has increased exponentially since being honored with membership here!

But what can I give back to all those who have given so much to me? I know what I am on the spec list. I am the student sitting at the feet of the masters fervently trying to take notes and grasp the seeds of wisdom. But still, I have to give back.

I guess the best thing I have to offer is my philosophy of life. That is the philosophy of "never give up," and the philosophy of wanting to be the known as the guy with the most losses. The philosophy of wanting to be the guy who never loses, but has a whole pile of learning experiences.

I guess what I have to offer to my spec friends is an example. If a guy like me can do it, then any of you can, too. And whatever it is that you're doing, you can do more of it and do it better. Because by adding an unbending resolve to your keen intellectual abilities, you will achieve anything you want.

I am grateful for being allowed to be a part of this community. It has blessed my life in incalculable ways.

Oh yeah, and I will get the "stuff" back that was stolen from me by focusing only on my blessings and the positive increase I will experience, the gain I will experience above and beyond what was stolen from me, by performing the activities necessary to achieve what I desire!

Mar

18

A Potential Avenue for Further Exploitation of the Halloween Effect:

Abstract: All US stock market sectors and industries perform better during winter than during summer in our sample from 1926-2005. In more than two-third of all sectors and industries this difference in summer and winter returns, known as the Halloween effect, is statistically significant and in half of all sectors and industries risk premia are negative during summer. However, while all sectors and industries show this effect, there are large differences across sectors and industries. The effect is almost absent in sectors related to consumer consumption but strong in production sectors. We illustrate how these differences between sectors might be used to improve the risk return trade off using sector rotation based on Fidelity sector funds and show how an investor might have benefited from such a trading strategy.

Mar

18

In explaining the theory of Steinitz, Lasker tells us that the strength of an attack must be in proportion to the amount of advantage held at a particular time. A player can be 'right' about who holds the advantage in a chess position, but they will lose anyway if they gauge the extent of their advantage poorly.

How should someone gauge his or her advantage? Lev Alburt proposed the idea that advantages could be stated in terms of expected results between equal opponents, and thus a 55% position would mean that White should slightly outscore his opponent (e.g., 5.5 points from 10 games). But if someone thinks his advantage is much bigger (e.g., 85%) he'll probably lose to someone who is essentially 'wrong' on the judgment but who is closer to the correct proportion (e.g., 50% or 45%). The point is that a large overestimation will lead to someone over committing to the attack and paying too little regard for the weak underbelly of his position.


The applicability to trading is very clear, but usually these issues seem to be dealt with as just a binary signal (e.g., 'bullish', 'bearish', 'entry,' or 'exit') and with money management being approached as a separate issue, again with rather artificial discrete inputs (what is the maximum adverse excursion, what can I risk, where's my entry/exit, etc.).

It strikes me that a more proportional approach is much better, e.g., committing or reducing forces according to the amount of advantage. But how should one model such an approach and test it statistically? The problem would seem to be that highly variable commitment dramatically increases the complexity of any test.

Alan Millhone writes:

Excellent article. Tom Wiswell used to say, "Position bests possession." Two weekends ago I entered the yearly Lebanon, Tennessee Checker Tournament. The tourney had around 60 entrants and 23 in the Masters. In my last round I played Dr. Robert Shuffett, author of three excellent checker books. We drew an opening that became the 'White Doctor' and with reds I went down a piece early into the game. Despite being a piece short, I had a death grip on his pieces which were held on his double corner side of the board. I had to maintain carefully that grip to keep any kind of edge or else he would have traded pieces with me and then being a piece up on me would have won the game through attrition.

The market holds simililarities to a checker game, as one is always conjuring ways to keep ahead of the game and the market and to have more winners than losers at the end of the day. At the Tennessee Tournament we played eight rounds of two games each. World 3-Move Champion Alexander Moiseyev was there and won eight out of eight rounds. A truly remarkable feat to accomplish against veteran Masters. To be able to 'win' every trade would be also a remarkable feat of accomplishment and you would thus become a sought-after advisor to the multitudes of traders as Grand Master Mosieyev is to checker players.

Stefan Jovanovich adds:

I had a chance to ask Gil Hodges some questions once after the Mets had finished winning a game. The first question was whether he thought that a well-hit ball would be a hit 50% of the time (this was and has been the prime number of baseball statistics: a perfect hitter will have a .500 batting average). Hodges said that the number was about right but it was probably slightly less than it had been when he was a player because fielders had much better gloves and greater range than they had in the "good old days." He smiled when he said that.

Did he think that there was such a thing as "clutch?" Yes, but it was not that certain players got better in pressure situations, rather that they did not get worse. If the pitcher threw them a hanging slider they would hit it out of the park in October just they way they did in April. "Clutch" for a pitcher was the ability to throw good pitches behind in the count. Whitey Ford was the definition of clutch. Hodges said it took "us" (meaning the Brooklyn Dodgers) three World Series to figure out that Ford would deliberately fall behind in the count. "We thought that gave us an advantage but what it really did was get us to over-swing against the 2-0 or 3-1 curve ball and hit another weak grounder to a corner infielder."

At its best baseball is chess with spitting and cleats.

Mar

18

Here are some books I am reading with valuable techniques, stories, and insights for speculators.

Modeling Survival Data: Extending the Cox Model , by Terry Therneaus and Patricia Grambsch.

Survival statistics are the branch of statistics that are most applicable and useful for speculators relative to their use. It answers such questions as how long you should expect it to be before an event happens, like a 10% decline, or a return to 20% in the vix, or a run of X declines, or a move down of four percent, or a down month, or an X day maximum, and many more important questions. As such, you can never know too much about survival statistics and the above book is an excellent augmentation for those who have done some preliminary work in the field with a book like Hougaard's Analysis of Multivariate Survival Data.

The Therneaus book is particularly good in extending the survival model to improving fits thru residual analysis, taking account of multiple events for the same subject, like an extreme in either direction, or heart attack, or gum disease, time dependent decays, influences of other variables, frailty models (excess risk in different categories), individual survival estimates, likelihood methods for estimating the expectations and confidence intervals for failure, and survival probabilities. It's written so that anyone with a basic stats course and calculus course could profit from it.

I am also reading HMS Surprise by Patrick O'Brian. I always find that the insight about human behavior from a keen observer like O'Brian or Hemingway is infinitely superior in explanatory power to the latest ad hoc studies of behavioral anomalies in the field of cognitive psychology. For example, in Surprise, O'Brian talks about the state of lassitude and happiness that anticipated wealth causes and how this can lead to complacency. I find this insight much more useful than the endowment effect studies with college students that show they'd be much more distressed to lose 10 bucks than pleasured from making 10 bucks, or the similarly flawed studies that show once you've bought a big ticket item, you'd only sell it for much more than you paid. Of course the O'Brian books are a flow activity, that bring you into a good world, with noble men, and heroic accomplishments, hilarious anecdotes, marvelous examples of benevolent behavior, and perfectly evolved customs for maintaining an even disposition when exposed to the unpredictability of the sea or markets, and the most beautiful friendship in literature, as well as being the best historical novels ever written. I have only read the complete set three times so far, but I have been listening to the Patrick Tull recording on tape relatively continuously for the past 10 years.

Evolution and Human Behavior, by John Cartwright.

This is not only a history of the ideas and trends that have led to our current knowledge of human behavior from an evolutionary, anthropological, and psychological viewpoint, but a modern review of Darwin's thinking on how natural and sexual selection shape activities. Every page has numerous suggestive specific hypotheses relating to markets that one can derive from the extensive work that has been done on the field in birds, mice, fish, dogs, and primates.

Human behavior in markets has followed similar paths to those traversed by other species in adapting to their environments. Our understanding of these processes has suffered from the same limitations and biases as those that prevented the evolutionary biological approach from reaching its current pinnacle of explanatory and predictive power. The main overall insight I have is that the market has adapted itself to provide a forum for the struggle of humans to maximize the future of their genes, money, and reproductive fitness. The book suffers from the idea that has the world in its grip and is particularly unfair and strident in its reviews of Galton's work, as is customary for all agrarian reformers. This is because they have to believe that humans are perfectly malleable to accept the egalitarianism embodied in the Robin Hood Society.

The Romance of Commerce , by Gordon Selfridge 1918 (Written in 1910).

Our current material and psychic well being, which in the last hundred years under a enterprise society have undergone more improvement than in the previous 100,000, and allow the common human today to live better and healthier than the kings of yesterday, is due to the entrepreneurial sprit, improvement in technology, and the institutions that encourage it. Selfridge's book which covers such topics as commerce of the ancients, the Fuggers, the Hanseatic League, the East India Company, The Hudson Bay Company, the Fantastic in Trade, the Great English and Japanese Merchants, guilds, early British commerce, along with such titles as Improving the World, by Indur Goklany, get me into a positive spirit so that I wish to continue the game, and improve myself and the world by investing and speculating. This is a sorely needed pillar to stand on when the latest weak links in the economy are brutally about to create undue pessimism for the strong to take chips from the weak as documented over and over again in other species and situations by Cartwright.

Mar

18

Since it is rainy outside, I am reading a good book: Common Errors in Statistics and How to Avoid Them, by Phillip Good and James Hardin. 

Mar

18

A thoughtful Spec asked me off-list:

How do the wise heads at the Fed know the difference between a 'good' price increase - an appropriate market response to increased demand and/or decreased supply - and a bad one, i.e., one that is a sign of 'inflation?'

The answer in polite Fed circles would be something like:

We know that energy prices are very volatile, so we're confident we can ignore shocks whose demand origins are transient, like weather. The same goes for supply shocks to food production.

Energy shocks driven by real supply disruptions like war are likely to be longer-lived and thus more prone to feed through into folks' plans and price structures. But, by watching non-energy price data, we can learn if this is just a move in relative prices or if it is feeding through to a general rise in all prices.

The former we don't care about. The latter would be a cause for concern and trigger the process of starting to plan for a credit tightening. Perhaps the most important non-energy price we watch in this regard is wages, hence our obsession with public expectations and perceptions of inflation.

The answer for Specs is:

The Fed's rhetoric and symbolism foreshadow its actions, and must be monitored to assess their forecasting bias, and hence the likely trajectory of short-term US interest rates.

The answer for cynics is:

Obviously this is all a scam. Mushrooming economic complexity plus globalization plus the spread of arbitrary government diktats, all atop a fluctuating sea of fiat currencies, make a useful calculation of purchasing power as fanciful as Ponce de León's quest for the fountain of youth.

Public media organs continue to portray the Fed as clever and well-meaning, routinely reminding us that Constitution Ave. guided the economy through the calamities of Black Monday, LTCM, 9/11, etc.

If public faith in the currency (inflation expectations) is managed well, the game can continue. The Fed, Argus-like, does monitor every conceivable indicator to see if stability is threatened.

The good inflation/bad inflation line is simply one rhetorical tool that allows the Fed wiggle room in its pronouncements as it figures out what to do and say to keep things under control.

From Alston Mabry:

From the St Louis Fed:

Monetary Policy, Judgment and Near-Rational Exuberance, by James Bullard, George W. Evans, and Seppo Honkapohja.

We study how the use of judgment or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We examine the possibility of a new phenomenon, which we call exuberance equilibria, in the New Keynesian monetary policy framework. Inclusion of judgment in forecasts can lead to self-fulfilling fluctuations in a subset of the determinacy region. We study how policymakers can minimize the risk of exuberance equilibria.

And the companion paper: A Model of Near-Rational Exuberance

We wish to think of the news or add-factor that modifies the forecast as a qualitative, unique, commonly understood economy-wide variable. An example of a judgmental adjustment is suggested by Reifschneider, et al. (1997), when they discuss the "financial headwinds" that were thought to be inhibiting U.S. economic growth in the early to mid-1990s. As they discuss, the headwinds add-factor was used to adjust forecasts over a period of many quarters. Federal Reserve Chairman Alan Greenspan communicated it to the public prominently in speeches. It was thus widely understood throughout the economy and was highly serially correlated. This is the type of variable we have in mind, although by no means would we wish to restrict attention to this particular example. Other examples might include the Y2K millennium bug, or the 9/11 terrorist attacks in the U.S., as well as a host of more minor events thought to influence economic performance. We think add-factoring is occurring continuously.

Mar

18

The combination of hysteria about sub prime which presumably has a one percent impact on big banks, a recent decline of some 10% in many of the bank stocks, (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital would seem to provide meals for scientific study and or caneology.

To me, the case for avoiding these stocks seems particularly like pseudo talk. It depends on a general tendency of banks to lend too much in good times, and to gamble. I've never found banks overly aggressive in lending to anyone I know, and I see no reason to believe they are not as good at learning from past mistakes and getting a proper return from the risk they take as others.

Nor do I believe that the financial market suffers when weak fringe players are forced to go to bigger entities to help bail them out. this happened in the Long Term Capital case, in the large and in the small, every day, when banks confide to their stakeholders how their privileged position often enables them to make opportunistic investments in times of crisis for the common good.

J T Holly adds: 

I myself am taking the cane out and looking more into finding the hypothesis that will unlock the significance other than my intuition. A couple of things that seem different this time that the "critics" and "bear camp" aren't taking into consideration have to do with legislation and government doings that make banks more apt to produce revenues since before the reversal of legislation happened.

1) Clinton signed to reverse the Glass Stegal Act. Banks now are not only banks but also brokerages, trading houses, insurance companies, and lend in millions of ways via auto, credit cards, and such.

2) "Do Not Call List." Having experienced the adverse effect of this as a broker in a former life, the banks use this to their advantage whereas the smaller players can't "reach out and touch someone." They have the legal right to call existing clients and cross sale products that the first aforementioned points allow now.

3) Bankruptcy Act recent development. Complete utter hypothesis on my part or conspiracy theory, but banks don't make any margin on perfect scores or good credit other than those folks feeding the system with deposits. The ability of banks through forcing those who are losing more than they deserve to go below 700 on a round number and be classified as sub prime allows them higher margins. The average score across America is around 670 allowing for this higher margin to be maintained. Not to fuel the Dead Horse last week, but this wasn't mentioned in the espousing.

It's plain and simple. They have the government, numbers of clients, and ecosystem to survive flourish and devour and recycle their own folks and keep on truckin'.

I had a client when I got into this business who told me that the best business to run was a whorehouse because "you got it, you sell it, and you still got it." It seems banks these days are about as close to this as possible.

The only legislation that I could find that limits growth and has prevented me further is some 10% rule that states that they can't have more than 10% of the total amount of money in circulation in business. Are C and BAC the closest if not at the max? Does anyone have more clarity or know of such Fed Reserve law that prevents this? I guess they can't make acquisitions or grow organically. It seems like an anti-competition type law, like in Atlas Shrugged!

Mathematically most pay a yield of around four and higher via dividends, and you have the wonderful drift of the market that they belong in to add on top of that. If you look at the Fed Fund Model, they are a sexy and attractive piece of the pie. To be able to get that which is equivalent to risk free and have something also that is apart from the earnings yield of the S&P is nice.

I guess the bear camp feels that the dividend can't be maintained. They can't re-invent themselves over and over like they've done thus far. It is called Citicorp not Citibank! I always have to remind myself that they get paid to write, versus getting paid to be right.

J T Holly continues:

The other one to test is the old utility adage that everyone hangs onto: "They are heavy borrowers and go down when rates rise." It's like they don't see the diversification that utilities have gone through for the past two decades. They also have a government hedge internally with fixed cost controls that they've adapted to and work to their advantage.

Andrea Ravano adds:

The first reason one should be interested in banking stocks is of course the fact that the industry is selling the "do it yourself" online strategy as a great breakthrough, whereas what it amounts to is just pay less for employees, get rid of risk, and get fees.

I suspect that the years to come will see the trend of home banking increasing to the point of having a human-free bank. It's every banker's dream to be able to use a switch to stop operations instead of laying off people. Yet the greatest interest lies in the fact that the banking industry is scattered around the globe, fragmenting the market pie in such a way that none has a dominant position.

The epitome of this is Italy, where the banking industry's biggest players don't exceed five percent of the entire market. Hence, I believe more takeovers, mergers, and other such measures to consolidate and reduce the number of players in the market will and must occur. As I'm writing the market buzz is on Barclays, which should announce merging activities with ABN Amro bank of Nederland. This would have been hardly thinkable just a few years ago.

Other reasons include the combination of hysteria about sub prime, which presumably has a one percent impact on big banks; a recent decline of some 10% in many of the bank stocks (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital. 

Jeff Rollert adds:

I have found bankers at large firms (not referring here to investment bankers) do not share much investment courage as it isn’t part of their compensation plan.

Small and community bankers are pure salespeople, chasing after the highest spread product to the greatest extent the regulators permit. They start, build, sell, repeat. They also have higher construction and R/E spec lending.

Regional bankers are difficult, as they have both personality types. My point for making money is that their manner in approaching risk is very different.

Mar

17

Now that the "too low risk premium" problem has been ameliorated, this week the Fed has an opportunity to stabilize recently volatile markets. Since Bernanke took over the bank, has there been any change in market reaction compared to his predecessor?

Checked weekly SPY returns for weeks which contained FED meetings (dates from FOMC calendar site), and compared returns for the last eight (Bernanke) and the 17 prior back to 1/27/04 (Greenspan):

Two-sample T for Ben rt vs green rt

              N     Mean   StDev  SE Mean
Ben rt      8   0.0019  0.0155   0.0055  t=0.4   4/8 pos
green rt  17  -0.0005  0.0128   0.0031           9/17 pos

The difference is not significant, but interestingly while B weeks were positive, G weeks were slightly negative in the period. Here are Green and Ben weeks:

wk start   green rt
01/30/06 -0.018
12/12/05  0.006
10/31/05  0.019
09/19/05 -0.017
08/08/05  0.001
06/27/05  0.005
05/02/05  0.012
03/21/05 -0.012
01/31/05  0.024
12/13/04  0.006
11/08/04  0.013
09/20/04 -0.015
08/09/04  0.003
06/28/04 -0.008
05/03/04 -0.009
03/15/04 -0.010
01/26/04 -0.008

wk start  Ben rt
01/29/07  0.019
12/11/06  0.007
10/23/06  0.008
09/18/06 -0.004
08/07/06 -0.009
06/26/06  0.023
05/08/06 -0.025
03/27/06 -0.003

Also from Kim Zussman:

Based on MC's suggestion, for FED weeks since 2004 what is the effect of the prior week? Checked this with regression: Ind var = week before, dep var = week after:

Regression Analysis: wk ret versus wk before (all weeks, Ben and Al)

The regression equation is wk ret = 0.00040 + 0.108 wk before

Predictor      Coef   SE Coef     T      P
Constant     0.0004    0.0027  0.15  0.886
wk before    0.1075    0.1714  0.63  0.537

S = 0.0135695   R-Sq = 1.7%   R-Sq(adj) = 0.0%

Shows slight, insignificant positive correlation.  Next checked same
since Ben took over:

Regression Analysis: B week versus B-fore

The regression equation is
B week = 0.00533 - 0.996 B-fore

Predictor      Coef   SE Coef      T      P
Constant   0.0053    0.0058   0.92  0.392
B-fore      -0.9963    0.7486  -1.33  0.232

S = 0.0146648   R-Sq = 22.8%   R-Sq(adj) = 9.9%

Here there is a trend toward reversal of prior week's return (rsq pretty hi). In that Ben's weeks tended to reverse the priors, since 2004 Al must have had positive correlation:

Regression Analysis: G week versus G-fore

The regression equation is G week = 0.00008 + 0.172 G-fore

Predictor      Coef   SE Coef     T      P
Constant   0.00008  0.0032  0.02  0.981
G-fore       0.1716    0.1700     1.01  0.329

S = 0.0127503 R-Sq = 6.4% R-Sq(adj) = 0.1%

Hope springs eternal from so little n. Or at least next week.

Click for chart. 

Mar

17

    event      day       830     930 open      close
    cpi         3 16 fr    1397   1406            1399
    ppi        3 15 th    1398   1399            1404
                3 14 we                                 1402

 A seemingly bearish PPI number was greeted with a one half percent gain from open and a seemingly bullish CPI number that was expected at 8:30 to be bearish. It turned out, however, to be very bullish at open turned out to be bearish.

It's only a half percent here and there, and for those that have the luxury of holding on for the 100 to 500-fold gains that 30 year holds can make, they were ripples in the tide. But for those who try to catch the wiggles, there were so many opportunities to go wrong. What seemed bearish was bullish and what seemed bullish was bearish. How typical of the market mistress and other real life counterparts.

Of course, the CPI and PPI numbers are retrospective numbers from one month ago, and markets should be focused on expectations for the future. That's why they are so meaningless. There has been an average of one month of new actual price data to tell us where the market things prices are going to be after the surveys and seasonal adjustments that make up these contrived numbers. That's one of the virtues of speculation. It provides information as to where prices are expected to be and moves quantities over time as describe by Heyne.

Fortunately, for the first time, in Bernanke we have a Chair who focuses on current prices rather than past economic numbers. This has to create an equilibrating force in the market in the sense that he's not always behind the curve the way the previous Chair was. Also to the good is he looks at hundreds of indicators and doesn't focus on one pet new one each quarter the way the past Chair did in an apparent effort to appear Merlin-like.

Good-bye and good riddance to the Phillips curve in this new regime of good economic sense. The old order caused so much mischief in the mistaken belief that past numbers on employment and production, if very good, were bearish for fixed income and stock markets, because it meant that there was more inflation.

Mar

17

The variegated and splendid forms of disease, both macro and microscopically, are simultaneously wonderful and awful. Lifetimes are spent studying cell morphology and disease categorization, usually accompanied by a fascinated respect for the curves that nature throws.

Here is a sequence of benign and malignant conditions of the female reproductive system, which if taken in the non-objective context of lovers, mothers, and daughters, requires humility of the highest order.

[Editor note: graphic image.] 

Mar

17

One thing I do my best to track down while traveling is a Financial Times each day. Finding myself with the Asian and European editions, along with global currency tables this past Monday, I ran some numbers to see what it costs in different countries.

Seventy countries had prices listed between the two editions and the overall average was 3.56 US dollars.

(Prices are in USD)

Highest:
New Zealand - 6.89
Lithuania - 6.46
Ukraine - 5.40
Czech Rep - 5.35
Japan - 5.08

Lowest:
Pakistan - 1.32
India - 1.70
Sri Lanka - 1.83
Gibraltar - 1.93
Philippines - 1.96

Mar

16

Daniel Dennett on YouTube trots out several examples of parasites that turn their hosts suicidal: lancet flukes that turn ants into zombie ants climbing plant stalks for no reason; toxoplasma that turn mice into Mighty Mouse, fearless of cats; and flukes that make fish jump into bird's beaks. His motivation in citing parasites that modify host behaviour is to cast doubt on religion.

Memes seem like a similar kind of parasite, modifying their hosts' behaviour, such as causing people who normally wouldn't presume to have anything useful to say on an esoteric topic to suddenly behave like experts, forcefully arguing the few talking points learned from last night's CNBC show as if they were the conclusions from a lifetime of investigation.

Abe Dunkelheit writes:

Every year I tend to fall for a new meme. Last year a friend of mine called me from Monte Carlo and sucked me into an oil exploration 'insider' deal which lost me 1% of my overall performance in less than five days. This time it was this article on Feb 28, which quoted Thomas Brown, that made me brainlessly buy lend shares two days before they tanked — a tiny position which lost me another 1% in a couple of days. The monetary loss is not even the worst thing. What makes it so bad is the mental turmoil and emotional disequilibrium such a memetic infection can have upon one's psyche, which substantially increases the likelihood of additional misjudgments. It is hellish!

What sucks me in?

I think it may be the following:

First, there is the appearance or mystique of knowledge: "Tiger Management alumnus and former top bank analyst Thomas Brown."

Second, there is a prediction: "Investors with at least a one year investment horizon will be very happy they bought the stock at current price."

Third, this so-called knowledge is conveyed with an unshakable conviction, which turns the prediction into a prophecy: "This is one of those times in investing, I believe, when it will pay to be very, very aggressive."

And forth, there must be a heightened level of emotion, excitability, vulnerability, and/or distraction so as to inhibit the analytical mind from properly functioning and to increase suggestibility.

[I had experienced an unusual amount of emotionally unbalancing news before my memetic infection: (1) I just had made and immediately lost an unusually large amount of money in the previous five days. (2) Before Feb 27th I had the best month ever and outperformed the market by 12 points. (3) I just gained the mandate for a large private investment account. (4) I had won a lawsuit that had haunted me for more that a year and a half. (5) I got very unexpected news of former bank colleagues who had been doing extremely well financially since I had left banking some five years ago, which made me weak and doubtful in a very subtle way. Basically, from what I had heard I concluded that I had missed out on millions, a thought that sort of traumatized me and introduced a sense of urgency into my life for a day or two. This contributed to the reduction of my mental immune system and made me ready for the memetic infection!]

In religion, we have a similar structure. First, there is the appearance of knowledge [the priest caste]. Second there is a prediction regarding the future. Third is the prediction revealed in a do-or-die urgency ["Believe me or die"]. And forth, emotional excitability, vulnerability, and distraction are strongly triggered by all sorts of techniques like induction of mass hysteria, forced confessions, dehydration, sleep deprivation, induced fear and guilt, peer-pressure, induced imaginations and phantasmagorias [the promises of hurries in Paradise and the vivid depiction of the pains of Hell], predictions, awe, synchronicities, interpretation madness [everything appears to be significant in some higher sense], etc. Often the victim has already suffered from an emotional destabilization in their life like a divorce, job loss, a rejection, etc.

What makes the meme so dangerous is that when the prediction turns out to be wrong [and they tend to be wrong all the time] the meme-infected mind has the tendency to 'explain' the failure away and that has the effect of sucking the person in even more! [See: Leon Festinger, When Prophecy Fails (1956), and also the recent documentary "Waiting for Nesara" ].

In, The Psychology of Human Misjudgment, Warren Buffet's life long friend and partner Charles Munger writes:

"Pure curiosity made me wonder how and why destructive cults were often able, over a single weekend, to turn many tolerably normal people into brainwashed zombies and thereafter keep them in that state indefinitely. I resolved that I would eventually find a good answer to this cult question if I could do so by general reading and much musing."

Abe Dunkelheit continues:

Not only does information help the public very little, but instead it helps predators! (This is a very rough calculus; I know that even between predators Pareto law applies).

Information has no implicit value. The value of any information is relative to the person's experience structure, which in turn depends on the person's relative position inside of the social fabric, and on hereditary factors.

There are no winners because it ends with death. But there are relative winners [predators] and losers [prey] in relation to each other. And that relation is relatively rigid. It doesn't change in one's lifetime. Ninety-five percent are food. Only five percent can be helped, which in turn seals the fate of the other ninety-five percent.

Free dissemination seems not to reduce the paretian effect, but on the contrary seems to help make things still worse. So what to do?

The question is rhetorical, because one cannot be interested in any serious solution. If one really wants to reduce harm simply stop educating stupidity! Don't do anything and don't go anywhere. It is almost certain that this way one would outperform any other solutions. But nobody can be seriously interested in such a solution.

So one will come up with lots of justifications why it is good to do something, anything, and thereby seal one's and everybody else's fate. Here is mine: I have no conflict with reality. (Implicit assumption: I will be saved from the cruel fate of the ninety-five percent. In fact, everybody will be saved.)

Hope and wishful thinking can be wonderful things. They can make things happen!

Alston Mabry adds:

In nature, predators are not "winners," nor are prey "losers." Being preyed upon by lions does not make zebras into losers. The lion, too, will eventually be food for another creature. The zebra does not compete with the lion, but with his fellow zebras and other herbivores. Likewise, the lion competes with the neighboring pride, the leopard, or the pack of hyenas. And when the watering holes dry up, they all die.

Mar

16

March 13th, 2007, by Curt Schilling

After a long day of travel to Philly and back (flight left at 6:30am and we returned around 4PM) I felt good on the mound. I'd like to extend a sincere thank you to Mr Henry who flew us up and back on his plane today, something he did not have to do but did anyway. Not surprising given what kind of person he is.

Mar

16

I enjoy reading your blog. It is very educational. I like your use of the scientific method in analyzing markets.

I would like to point you to the following page that I just came across. It contains links to three papers (all by the same authors) on value investing. I know you have a strong views on this subject. If you have any views on the studies, please publish them!

Mar

16

Here is one valuable lesson that I gained from a pirate. Call it the Captain Hook principle if you like. It involves understanding how an alligator eats its prey.

I learned this from Vic Sperandeo's book Methods of a Wall Street Master. He mentions this on page fifteen.

"The more the victim struggles the more the alligator gets. Imagine an alligator has you by the leg: it clamps your leg in its mouth and waits while you struggle. If you put one of your arms in the vicinity of its mouth while fighting to get your leg free, it lunges and then has your arm and leg in its clutches. The more you struggle, the more the alligator takes you in.

So if an alligator ever gets you by the leg, remember that your only chance to survive is to sacrifice the leg and drag yourself away. Translated to market terms, the principle is when you know you are wrong, close your position!"

Aron Ralson describes in his book, "Between a Rock and a Hard Place," how he broke his radius and ulna bone in his right arm and then self-amputated his hand at the wrist after being pinned under a rock for 6 days in Utah's Canyonland's National Park.

This illustrates clearly what happens when you are in a bad trade. Be an adult. Don't rationalize. Don't pout, don't freeze, and don't call your mom. Admit you were wrong and sacrifice the hand to save the life. Most important, live to fight another day. Accept your humanity. Look rather at a bad trade as suspension of success.

Vince Lombardi said, "We never lost a game we just ran out of time." And in the timeless words of John Maynard Keynes, "The markets can remain irrational much longer than you can remain solvent."

Mar

15

Pages 178 and following of The Economic Way of Thinking: a brief summary.

(1) Speculation arises because of uncertainty about the future and is quite common. Many everyday activities involve an element of speculation. For example a college student getting an education is speculating (he hopes, but cannot be sure, that the increased income he will get after graduating will outweigh the cost and effort of going to college). Another example might be a motorist who passes by a gas station hoping to find another station with a cheaper gas price further down the road, even though the next one might actually be more expensive.

(2) A more important example involves price speculation on agricultural commodities such as corn.

If it is expected that the next corn crop will be smaller than usual (perhaps because of signs of corn-leaf blight in the Midwest corn fields) a number of economic responses take place that tend to reduce current consumption of corn and increase the amount stored for future consumption. Some of these are the result of the actions of ranchers, or companies who use or store corn in their operations; others are the result of organized futures markets. All these can be classified as speculation. The result is an increase in the spot price of corn. Heyne emphasizes that this is a beneficial effect; the price increase is a signal that corn is scarce and it encourages people to consume less corn or store more of it for the future.

As Heyne says:

"the speculative activities cause corn to be transported over time from a period of relative abundance to one of relative scarcity".


The price increase takes place even before the next corn crop comes on the market, and this is as it should be (even though some people do not appreciate it): if corn is going to be scarce we might as well start economizing on its use right away. It is entirely possible of course that the predicted corn blight will not occur, but the speculators are rewarded for being right, they lose out if they are wrong.

Participants in the futures markets include both hedgers and speculators:

"Futures markets allow people to allocate their risks and deal with uncertainty as they see fit. Those who wish to reduce their risk have the option to hedge, those who wish to increase their exposure to risk have the option to speculate."

(3) The futures markets generate information (namely accurate prices for commodities) and are thus valuable even to people who do not participate in them. For example farmers can use futures prices for corn to make crop decisions. The futures markets also encourage the generation of information, in the sense that the speculators are rewarded if they understand all factors (fundamental and technical) that affect prices and are presumably hard at work to uncover them.

(4) A favorite passage of Vic's appears on page 179:

"Adam Smith once compared those who speculate on the future price of grain to the prudent captain of a sailing ship, who puts the crew on short rations the moment he discovers there is not enough food on board to last through the voyage. Grain speculators, Smith argued, reduce the suffering that bad harvests cause by inducing consumers to start economizing early."

Mar

15

Today is the Ides of March, a phrase that has come to mean foreboding or doom. It is generally associated with the assassination of Julius Caesar, by the Liberatores (Liberators), who did not think of themselves as murders. They considered what they had done tyrannicide.

Legend has it that Caesar was summoned to the Senate and warned by the soothsayer Titus to "beware the Ides of March." Caesar was later approached by a soothsayer on his way to the senate and said, "Well, the Ides of March are come" to which the seer replied, "aye, but they are not gone."

Enter Brutus and the others and the rest is history.

Some see it as a liberating event. Some see it as the death of one of the greatest leaders in the history of the world. Historical opinions are based on suppositions of what might otherwise have been.

Some see today's market movement as the calm before the storm. Some see it as the beginning of the next big move up. But unlike suppositions of historical opinions, market opinions are laid bare for the whole world to see.

I guess very shortly we'll all get a glimpse under the toga of the market mistress to see what side of history we come down on!

The good news is, that right or wrong, we'll all still likely be alive next week to play another game against the Mistress. Thank goodness it's the Market Mistress and not Brutus!

Mar

15

Ephemera from a Famous Wall Street Haunt.

…The first printed American bill of fare is issued by New York's 5-year-old Delmonico's Restaurant at 494 Pearl Street and lists as one of its most expensive dishes 'hamburger steak.'

The bill of fare (the word menu will not be coined until next year) offers a 'regular dinner' at 12 cents and lists hamburger steak at 10 cents (the same price as roast chicken or ham and eggs; regular beef steak is only 4 cents, as are pork chops, corn beef and cabbage, pigs head and cabbage, and fried fish. Roast beef or veal, roast mutton, veal cutlet, or chicken stew are 5 cents)…

Mar

15

Brothel Discounts 'Matinee s-x' for Pensioners

Mar 14, 2007 11:57 AM Reuters News Agency

BERLIN — A brothel in Germany hopes to capitalise on the growing number of pensioners interested in "matinee" s-x by offering them a 50 percent discount during the afternoon hours.

The "Pascha" in the western city of Cologne has introduced reduced rates for s-x sessions for clients aged 66 and above — provided they can prove they are old enough.

"All clients need to do is show us some proof of age," said a spokesman for the brothel's managing director Armin Lobscheid. "A 'normal session' costs 50 euros with us — and we're now paying 50 percent of that for these older guests."

"Life begins at 66!" it says in an advert for its "senior citizens afternoon" next to a picture of a motorcycle rider.

Brothels have Managing Directors? Wow, I bet those MDs at Morgan Stanley feel super-special now.

Gordon Haave replies:

And I'd bet the "talent" are all vice-presidents.

Roger Arnold queries:

How does this get accounted for in GDP? Is it a deflationary indicator or indicative of an increase in productivity? Are there any hedonic adjusters that need to be accounted for? Looks like free market animal spirits are beginning to reawaken in Europe!

George Zachar responds:

Simplistically, I'd say it would show up as a decline in productivity, as seniors will simply shift their s-x purchases to the earlier time slot, with the establishments earning only half their prior revenue per session. GDP would similarly take a hit, and assuming quality remains constant, this would show up as a price decline.

So look for Trichet, at his next press conference, to be asked about stag-de-flation.

Marion Dreyfus explains:

George's explanation is a wrong take entirely. The early bird special is income that would be extra, since these are men who would not be coming in at all, short of lowered price per assignation. These are men who are thus providing income in the slow early afternoon hours when nothing much else is happening. Since the wear and tear on the females is supposedly less (I don't know from experience what the difference is in men from 20s, 30s, to 70s, etc.) than from the younger males that give them a harsher workout, maybe the lower price is fair, since they are not working as hard for the money.

Thus it seems like a win-win, actually. Management is selling product in normally slow hours, and the clientele will be doubly pleased at low-priced but professional action and can get a workout without having to be especially nice to their wives. Or if single, they can feel manly again, despite not being able to date perhaps, at their age or with a paucity of date-objects around. And likely as not, some of the men will use the opportunity to simply talk, as a surrogate for therapy, and bloviate on topics they can't share comfortably with their wives or friends without censorious responses.

I think the whole thing a fit subject for a PhD, actually, when one considers all the ramifications.

Adi Schnytzer adds:

I agree entirely. This is very definitely a topic for a PhD in sexual economics, a field I will be delighted to pioneer if anyone wants me as a supervisor and who isn't scared of fieldwork. Marion's gritty microanalysis makes a lot of sense and an econometric analysis of the wear and tear caused by different age males on working females is long overdue. 

Mar

15

12:38 — Senator Clinton Says Borrowers Should Be Offered Counsel, Information

"Counsel" as in a lawyer, or counsel as in therapy? Both fit the modern left's vision of therapeutic government. 

Mar

15

Overseas accounts, net, added almost $100 billion in US paper in January; so much for the flight from the dollar, eh?

The bulk of the add was by "private" buyers. But I assume clever CBs mask their trading in a way that makes the official/private distinction meaningless.

Mar

15

After the brutal sell-off of the last two days, markets are now enjoying some much-needed respite. Last night, the S&P 500 gained +0.7%, while the NASDAQ added +0.9%. This positive momentum continued this morning, as the Topix is up +1.4%, the Hang Seng has added +0.8% and the Kospi is up +1.3%. Meanwhile, the Yen has weakened by -0.7% to ¥117.3/US$, as investors piled back into the carry-trade.

And interestingly, yesterday, we saw a number of stories in the financial press about how exaggerated the subprime mortgage story has been (for an example, see this article in Forbes). In addition, Lehman Brothers, the second biggest US underwriter of mortgage-backed bonds, came out and stated that the risks posed by rising home-loan delinquencies are "well-contained", and that they will have little effect on the firm's earnings.

What about additional risk to the housing market? As we see it, the most likely development is that vulture funds will eventually buy up mortgages on the cheap. Then they will probably sit on their collateral until they can sell it at a profit. They are unlikely to accelerate foreclosures for properties for two reasons. First, there is absolutely no bid for such properties at almost any price. Second, subprime loans are almost all second mortgages, which cannot foreclose without agreement of the first mortgage. It is hard to see why first mortgages would allow this to happen, since they would also lose money and face write-offs in forced sales. In any case, second mortgages are usually just 20% of the property value and almost every foreclosure would wipe this out immediately. Thus, subprime lenders who foreclose today would face immediate 100% write-offs. They (or their liquidators) would be better off selling the mortgages for 10 or 15 cents on the dollar to vulture funds which can afford to hold onto the paper for a few years, while house prices stabilise and recover.

And aside from the stress on the relatively small subprime lending sector, economic fundamentals are still looking very decent. US overall mortgage applications rose by +2.8% to the highest level since early December (see chart); UK February unemployment fell by -3,800 to the lowest level in a year;

China's retail sales rose by +14.7% YoY in the first two months of the year; Chinese industrial production accelerated to +18.5% YoY (expected +15.0%); and South Korean February unemployment fell to 3.2%, the lowest level in four years. On the market side, we note that the BDI has jumped +17% in 17 straight sessions of gains, hardly a sign of an impending global slowdown.

Overall, we remain very optimistic on equities, especially since the last sell-off failed to break through the lows of the previous deluge. As we see it, this is a sign of strength by the markets and could very well prove to be an attractive buying opportunity.

Mar

15

My true love gave to me,
A black eye and a kiss you'll see.

Daily range is high when volatility spikes, and decays over time. Yesterday was day 12 since the 4% decline in stocks. Checking the SPY intraday high/low as range (actually (H/L)-1), I used linear regression to measure the rate of decline. Here is a plot of SPY daily range since 2/27/07 (inclusive):

One might argue that range or volatility decay is not linear since it cannot progress continuously downward. In fact tests using quadratic regression showed better RSQ by adding **2 term, though linear term explained most of the variance. For simplicity the 1st 12 days are modelled as linear.

As a check on the current daily range decline against historics, I repeated regressions of the intraday range vs. the day following (analogous) declines; defined as 1day cl-cl drop worse than -3%, preceded by 5 days without a drop worse than -1% (SPY since 1993). Here is a table of the regression slopes and T-values for the range vs. the day following big declines, by year:

Yr       slope      t
2007  -0.0011  -1.8
2003  -0.0001  -0.2
2002  -0.0018  -2.4
2000  -0.0019  -2.8
1998  -0.0027  -1.5
1997  -0.0004  -0.9
1996  -0.0018  -2.4

It looks like the current change in range lies mainly in the plain, and is consistent with prior such events.

Bernd Dittmann adds:

As Kim outlined, both daily volatilities and daily high-low ranges decline after a spike. I estimated for the S&P 500 between Jan 03, 2000 and today a simple garch based on daily returns rather than daily range. The equation of the conditional variance ("h") seems to be consistent with his findings: Its regressor of lag 1 is 0.9276. A one-off vola spike (with subsequent error terms of the equation of the mean being zero) feeds through the model and decays as shown below:

day h
1 0.9276
2 0.8604
3 0.7981
4 0.7404
5 0.6868
6 0.6370
7 0.5909
8 0.5481
9 0.5084
10 0.4716
11 0.4375
12 0.4058
13 0.3764
14 0.3492
15 0.3239

This yields a similar picture as declines in daily high-low ranges.

Mar

15

I was asked by Laurel why I think that out of the clear blue sky we've had two days that were larger in magnitude than any of last for years. My immediate response was they can't take it down permanently so they wish to have a violent move so that they can let it to go back to where it's going to be without losing money and making everyone panic.

The violent moves are the ones that always come when it's going the other way. When they want to take it one way, they keep you in. It is sort of like the frog that's put in cold water that is gradually heated up. They couldn't take it down the way they did last year in May because they don't have the Israeli war and the increase in good faith in their hip pocket. So they had to do in one week, much earlier and sharper, what they accomplished in three months. That is to say a doubling in volatility and a decline of 90 points, because they can't keep it here with stock returns 11 or 12 percent and bond yields just 4.5 percent.

The stuff about sub prime is part of the dynamic nature of capitalism. These companies get compensated for accepting risk. Some years they win and some years they lose. Their return is probably like ours, with a nice little something for the risk they take. We can only expect the sage to say something like it's terrible that so many take risk like that when there are only certain insurance companies who are genetically programmed to take it at double the rates, taking account of the complete likelihood in their rates of total meltdown, like this should be. And it's terrible that there's a derivatives market that allows those who don't wish to take such risks to offset them, as these companies have so much risk. But of course all this must be tested.

Laurence Glazier adds:

The Sage did make some interesting remarks to his favorite CNBC interviewer Liz Claman. For example that it was wrong for him to be paying a lower rate of tax than his receptionist and that the very significant rise of the market is in the long term inevitable and born out by history.

I enjoy the Sage's interviews, something warming there. CNBC has many good points. I like the literary asides from Mark Haines. He often quotes Poe, "the tintinnabulation of the bells," during those August ceremonies. 

Sam Humbert remarks:

The Sage has spent his entire career sedulously arranging his affairs to minimize taxes — and now bemoans paying too little? This brings to mind the boy who slew his parents, then pled for clemency because he was an orphan.

I would have awarded extra points for 'artistic merit' if the Sage had made these 'interesting remarks' in Pinch's famously untaxed newspaper…

Vincent Andres adds:

From a violence specialist: "La force d'une armée, comme la quantité de mouvement en mécanique, s'évalue par la masse multipliée par la vitesse." ["The strength of an army, like power in mechanics, is the product of the mass by the velocity (speed of action)."] Napoléon I

Mar

15

Electronic payments is an industry that I perceive to be fertile for large growth, and I am invested accordingly. Two books worth reading on the subject are The PayPal Wars and Paying With Plastic .

My favorite of the two is The PayPal Wars which was written by an early employee of the company. Besides offering a great entrepreneurial story which described all the tribulations that nearly sunk the company on multiple occasions, it's about a business that was founded on Libertarian thinking.

The author quotes PayPal co-founder and current hedgefund manager Peter Theil's vision in starting the company:

"Of course, what we're calling 'convenient' for American users will be revolutionary for the developing world. Many of these countries' governments play fast and loose with their currencies. They use inflation and sometimes wholesale currency devaluations, like what we saw in Russia and several Southeast Asian countries last year, to take wealth away from their citizens. Most of the ordinary people there never have an opportunity to open an offshore account or to get their hands on more than a few bills of a stable currency like U.S. dollars."

"Eventually PayPal will be able to change this. In the future, when we make our service available outside the U.S. and as Internet penetration continues to expand to all economic tiers of people, PayPal will give citizens worldwide more direct control over their currencies than they ever had before. It will be nearly impossible for corrupt governments to steal wealth from their people through their old means because if they try the people will switch to dollars or Pounds or Yen, in effect dumping the worthless currency for something more secure."

The other book, Paying With Plastic, is an in depth book that describes just about everything one would ever want to know about electronic payments. I'm a bit apprehensive to buy anything published by MIT Press but it wasn't as dry as I imagined and kept me interested.

Describing how important the development of the industry is, the author offers this perspective:

"Although cash and checks may not be toppled for generations, if ever, payment cards have nonetheless wrought a revolution. Humankind has seen only four major innovations in the most routine aspect of economic life—how we transact with one another; the switch from barter to coin around 700 BCE; the introduction of checks by the Venetians in the twelfth century; the shift to paper money in the seventeenth century; and now the payment card. Let's be clear again, though—it is not the card, it is the digits, and as we will see, when it comes to the electronic transfer of funds, plastic cards are not the only game in town."

Mar

15

In retrospect, the breakthrough of the Dow below 12,000 at 12:12pm, and the subsequent move down to 11,940, was a classic signal for cane. The momentum players were waiting for the lowest low of the year. Others were waiting for a pivot at Dow 12,000 to sell. Others from the public held onto their positions until worries about the subprimes finally made them capitulate. Those who were frustrated with the Dow's not dipping below 12,000 got their release. It was perfect for a close above the round number of 1400 in S&P futures, up from 1376. That was a nice range of points in the S&P.

There was much excitement among the permabears, finally able to crow about the Dow's breaking 12,000, if not about a 10% decline in S&P. There was much kibitzing from significant others. "The market will always be there another day."

Not to be forgotten is that the indexes were within half a percent of their 90-day lows, so that when they went below, they gained from the ephemerals who sell the breakouts and extremes in the S&P. Nor should it be forgotten that the Fed Model was at its most bullish, with earnings yields having risen yet another 1/2% above bond yields.

All this reminds me of a song Laurel and I once wrote:

Just in Time

(Music by Jules Styne; original lyrics by Betty Comden and Adolph Green)

Intro: I was resting comfortably face down in the gutter
Life was serene, I knew where I was at
“There’s no hope for him,” my brokers all would mutter
I looked like something dragged in by the cat

A. Just in time,
Stocks rallied just in time
Before they rose my funds
Were running low.
I was lost
The losing dice were tossed
My brokers all were cross
Nowhere to go

B. Bulls in debt
The stocks looked like they could be heading
Down still lower yet
But something changed
Stocks rallied just in time
They rallied just in time
And put me in the black that happy day.

C. Just in time,
Stocks rallied just in time
To save me from
That margin call
Five down days
My mojo went away
It looked like fund flambé
I tried to stall

D. Clearing said,
You’d better lighten up or
Else we’ll all be in the red
Then something changed
Stocks rallied just in time
They rallied just in time
I had a nice bounce back that happy day.

B. Bulls in debt
The stocks looked like they could be heading
Down still lower yet
But something changed
Stocks rallied just in time
They rallied just in time
And put me in the black that happy day.

Mar

14

I have written before about meaningless statements in finance, like "overdue correction." This sort of thing is not unique to finance, however.

Someone flipped his Mustang over the median and ran into a truck in Oklahoma City today. I am watching the news right now. The police say "speed was a contributing factor." Well, isn't speed a contributing factor in every automobile accident? How does one car hit another if speed is not a contributing factor? I suppose that if a car were parked precariously on the wall of a parking garage and the wind blew it off and it fell on to a car below that speed would not be a contributing factor, but that's about the only example I can think of.

What they mean, of course, is that excessive speed was likely what caused the accident, i.e., the idiot was doing 100mph around a turn and lost control. But if so, why not just say that?

It reminds me of the two years I spent on a federal grand jury (one or two days per month). A DEA agent was before the grand jury telling us about a drug bust, and he emphasized that the suspect had a "saleable amount" of cocaine.

I asked him what a saleable amount was. He said "He had X grams, and that is enough to sell." I said "But isn't any amount of cocaine a saleable amount?" He said "Well, he had X grams."

I said, "I understand, it's just that you didn't say that he had 'an amount' of cocaine. You said he had a saleable amount. I am trying to determine what the cutoff is for a saleable amount. If he had the tiniest amount on the eraser on a pencil, would that be a saleable amount"

He said, "Well, yes, you can sell any amount of cocaine."

And I said, "Well, that is my point, the phrase 'saleable amount' has no meaning, and you just use it for effect."

He started to say something, and then the Assistant US Attorney stepped in and stopped my line of questioning. Something also happened when I questioned the definition of "packaged for sale" when it comes to drugs. In short, unless it is scattered on the floor, it is packaged for sale.

Craig Mee replies:

I recently drove with my father. He has much driving experience, though he hadn't been on a highway for quite some time. With me in the passenger seat, he was tailgating cars at 100kph, not something he has normally done. The perception of distance and safety for him has obviously been impaired, as has sensing trouble with cars braking in front of him.

The relationship to the market is this: Having a good understanding of trading and knowing what needs to be achieved may be fine. But diminishing perceptions and feel for the market may interfere with results over time and might lead to a major disaster if not detected early.

My father also recently mentioned to me that life and death situations which he narrowly avoided in his youth, and did not think too much about at the time, had recently come back to haunt him in the shape of dreams and waking up in cold sweats.

Being on guard and aware of changes taking place is paramount.

Nigel Davies adds:

Consider how someone knows he's driving too fast. Speed tolerance varies greatly from one person to another. For me it's when I feel tired after the journey because of the stress. My body's telling me I wasn't fully in control. Of course, here in the UK there are so many speed cameras now that it is difficult to get so stressed without losing one's license.

Can this be applied to markets? Are constant feelings of market-related stress due to "lack of control" an important message from our bodies? 

Sam Humbert notes:

From After the Race, in James Joyce's 1914 collection Dubliners: 

The car ran on merrily with its cargo of hilarious youth. The two cousins sat on the front seat, Jimmy and his Hungarian friend sat behind. Decidedly Villona was in excellent spirits, he kept up a deep bass hum of melody for miles of the road. The Frenchmen flung their laughter and light words over their shoulders and often Jimmy had to strain forward to catch the quick phrase. This was not altogether pleasant for him as he had nearly always to make a deft guess at the meaning and shout back a suitable answer in the teeth of a high wind. Besides, Villona's humming would confuse anybody: the noise of the car, too.

Rapid motion through space elates one; so does notoriety; so does the possession of money.

Mar

14

Why is it whenever the government decides to protect us from market forces, we tax payers get the shaft? Would it not be better just not to interfere in the first place?

Financially it would be better to let the foreclosures happen. Not foreclosing on bad debts means the economy doesn't get to reallocate capital to its best uses. That, in short, was the cause of the 10-year recession in Japan.

If it is in the interest of the lenders to give people breathing room, they will do so without the government forcing them to.

Rich Ghazarian adds:

Not long ago, I was involved in building predictive models for sub-prime products for one of the major shorts in the market today. There was no way of predicting today's scenario, because a large part of the poor credit performance is due to fraudulent mortgages (loans originated on falsified information). Thus, most of the models are based on false historical data. For instance, a borrower with a Debt to Income Ratio (DTI) of 0.4 is now all of a sudden a borrower with a DTI of 1.4 … oops! It is interesting that this fraud was mostly conducted by "Loan Officers" and not the borrowers. Here is an example of quant models being useless! 

Mar

14

A new hiking strategy along the 1000-mile rough finger of land called Baja that has thwarted me for many years was mastered in February '07. The method was a series of two to four-day hikes for one month on old trails, each time emerging to the trans-peninsular highway to hitch or bus to the next walk. My pack weighed 30lb. loaded with a sleeping bag, biv sack, food, water, no stove, change of socks, and map.

During a dozen hikes to remote missions, oases, mountaintops, and the seas, I saw no other hikers and cleaned up weekly at motels if needed. The altitude ranged from beach through deserts to 6000' mountains with temperatures of 35-90 degrees F, from the U.S. and Mexican border south to the tip before I pulled out at mid-peninsula in early March due to rattlesnakes.

Mar

14

Every so often I get the desire to sample the intoxicating perfume of the developing world and nothing else will satisfy me short of that wonderful combination of open fire smoke, dust, exhaust fumes and body odor in a new, strange land. The scent of cherry blossoms in Japan, kitchen aromas in Italy, or fresh Rocky Mountain air can't so effectively fire excitement about what unknown days lie ahead. When one of my best friends and I decided to head off on a guy-trip, there was no doubt that the best place to immerse ourselves in the developing world was Africa.

This trip was taken for many different reasons but a prominent one was to spend the truest wealth we have, our youth. I once heard a person mention that any older, monetarily wealthy person would give their entire fortune just to be young again. At 27 and financially comfortable, I'd give it all up to be 19 and broke once more. The worst thing I could imagine is to sit on my rocker at 80 years of age and have regrets about squandering youth and the opportunities that passed me by. Maybe it's just because I'm approaching 30 and believe that 30 is the new 40 when it comes to midlife crises that I'm thinking about these things.

Sir Richard F. Burton described the beginning of a trip best:

"Of the gladdest moments in human life, methinks, is the departure upon a distant journey into unknown lands. Shaking off with one mighty effort the fetters of Habit, the leaden weight of Routine, the cloak of many Cares and the slavery of Home, man feels once more happy. The blood flows with the fast circulation of childhood. Afresh dawns the morn of life."


The first stop was a two-day layover in Dubai that captivated me enough on visits a couple years ago that I wanted to return and see how it's continued to develop. I was amazed to find that construction hasn't visibly slowed down and projects that were initiated a couple years ago are still being completed. The Burj Dubai is still a couple years from opening as the world's tallest building and I figure I'll have to return by then to view the audacity of it all. Certainly the most surreal experience in the Emirates was snowboarding at the new snow slope in the Mall of the Emirates and then later that day going sandboarding in the desert during a break on a dune bashing tour in a Land Cruiser.

I arrived in Uganda at one of the most infamous airports, Entebbe, although the buildings that were around during the Israeli hostage rescue have been replaced. Because the Entebbe airport is on the breezy shores of Lake Victoria, it doesn't give that developing country smell immediately which normally kicks me in the face the first step out the door. Certainly one of the most unpleasant travel experiences is getting a taxi at a third world airport that lacks a taxi queue, which is virtually all of them. The most aggressive driver generally gets the fare. That is why I was happy to realize that I could somehow arrange for a driver to meet us and avoid the charade.

Kampala is by African standards quite safe, jovial, and entertaining. The capital appeared to have quite a large middle class with enough disposable income to support a relatively large number of restaurants and bars of good quality. Serving as the economic backbone to much of the country was the Indian population which owned many businesses that I frequented such as hotels and higher quality shops. The ownership of many successful businesses by Indians has led to an underlying resentment by the local black population similar to that experienced by the Lebanese in West Africa and Overseas Chinese in Southeast Asia. But as Idi Amin found out, the Indians are needed for the country to function. When it comes to functional ease as a tourist in Africa, I firmly believe that it doesn't get any better than being white, male, American, and young, all in that order.

One of the highlights of Uganda is the opportunity to go gorilla trekking in Bwindi Impenetrable Forest National Park in the southwestern part of the country near borders with Congo and Rwanda. It also has a mountain gorilla population. Generally you can see the same wildlife over much of Africa but the only place to observe mountain gorillas is this region. It's quite refreshing to experience a safari on foot because the only way to get to the gorillas is a one to four hour hike up a 45-degree slope in the dense forest. Thankfully, we pursued the closest gorilla family and reached them in less than an hour.

So as to not disturb the gorillas too much, tours are limited to around a dozen people and can only observe them for an hour. The other restriction is that the park won't allow anyone with a communicable disease (flu, etc) to go on the trek because the mountain gorillas share about 97% of their biology with humans. Like most wildlife in the region, the gorillas are used to tourists and went about eating leaves the entire time we were there. Observing the gorillas, particularly the silverback, from less than a meter away was an amazing experience that I cannot accurately describe to others. It was also great to hike through the forest because much of Uganda has been cleared from slash and burn agriculture, which has left much of the countryside naked.

The other overwhelming highlight of Uganda is whitewater rafting down the Nile, just slightly below the source of Lake Victoria. A few years ago I had a great time rafting on the Zambezi below Victoria Falls and the guide mentioned that the only other place to experience high volume, warm water rafting was Uganda. So I knew such a visit was inevitable. Due to the large amount of flat water which required paddling, I thought the Nile was more arduous than the Zambezi but enjoyed it regardless. My main concern wasn't the class five rapids but what health problems that can result from the water. Most books I read advised against simply swimming in the Nile or Lake Victoria. But I happened to swallow multiple mouthfuls of water as the raft often flipped.

The final stop was 24 hours in Cairo to get a quick refresher glance at the pyramids, which if built today would still be stunning. As the pyramids at Giza were built in 2500 B.C. and have been receiving visitors since, the local population has had plenty of time to master the art of ripping tourists off. I'm not saying that all Egyptians are like this but simply around the tourist areas there is a hustling culture that is unmatched. I'm particularly annoyed that Middle Easterners like to call me friend while they're trying to rip me off.

It's also a shame to have such a wonderful tourist attraction as Giza. But the grounds of the pyramids could use some serious enhancements which only private enterprise could undertake. With the push into infrastructure assets, why not have someone like Macquarie Bank (with local partner of course) bid for the rights to oversee the attraction, clean up the place, and add much-needed improvements to facilities in return for a lump sum and a slice of revenue?

Mar

14

Movies are an excellent compliment to exercise, helping to reduce the ill effects of market abuse. When in doubt, hit the weights and treadmill, then follow up with a movie. My recent bullishness is well documented; it will not change. Without question I was bludgeoned yesterday, yet I did not capitulate today.

Last night, after a fairly intense workout I got home and popped in the film, "Stand By Me." It offers several good lessons on life and friendship, but mainly shows how devout comradely is generally the best weapon against outsized adversity. Such should always be the case when market enthusiasts, Bulls, are up against a much larger opposition.

To me, by taking a big step back and looking at this year and comparing it to May-July of 2006, the same story is revealed: Liquidity.

Last year, with inflationary pressures rising faster than the market's ability to price in further global central banker tightening policy, the market finally got the cue with the May CPI and PPI releases. We know what happened after that.

This year, liquidity is coming into question in a different form — under the perception that a huge component of the US economy is severely damaged. Is it really that huge? My estimation of the sub-prime component says something different.

Mar

14

I do not believe there is a night crew, specialists, floor traders, et al., going out after my stops or my positions.

I think that is a sophomoric concept. If you are getting stopped out a lot it simply means your stops are too close and market randomness is doing it to you — not some cabal that meets in secret prior to the opening every day.

Jay Pasch lauds:

Another gem from the Senator. One voice speaks of responsibility, ownership, and self-empowerment, the other voices, blame. 

Mar

14

While Prof. Gregory Mankiw 's Principles of Economics still maintains its high popularity as an introductory textbook for first year undergraduate students, I also strongly recommend Dr. Yoram Bauman's refreshing exposition of Mankiw's fundamental principles.


Mar

14

I am both an investor and trader. But looking at my results I should probably only be an investor. It is not easy to trade with a full-time job on the side.

As an investor I am 100% long with my stocks. I will stay 100% long no matter what. I can sell a stock, but only if I am able to find a better one to replace it. I am not going to sell because of the overall market. Actually, I could sell if it goes up 130% like Shanghai last year. But I am never going to sell because it has been going down.

Today, my investments are down 2% from 12/31/2006, and down 10% from February intraday peak equity. I don't care the slightest bit. They could go down 30% and I wouldn't care either.

I am not crazy. There is a very good reason for this stubbornness.

I started investing seriously in stocks in 1996. Since then there has been a crisis in 1997, another one in 1998, and one of the biggest bear markets in history in 2000-2002. I was investing with a mix of stock picking, market timing, style timing, and small/big timing. Believe it or not my market timing allowed me to sell at all the intermediate tops in 1997, in 1998, and in March 2000. It allowed me to avoid the bulk of the bear market in 2000-2002. I came back too early in August 2002, sold in September, came back at the exact bottom in March 2003!

With this nearly perfect timing, you would think I have impressive compounded returns. That couldn't be further from the true. At the end in 2005, I did a complete audit of my 10-year record. It was prompted, among other things, by some things I read on the Spec List, mostly from the Chair but not only from him. So thank you guys for your down-to-earth audit-prompting approach.

Results of the 10-year audit:

Market timing resulted in dramatically lower volatility and draw-downs than the market; but who cares? It resulted in only a 2% over-performance compared to the index. In terms of absolute returns, beating the index by only 2% is ridiculous. It is incredible that even though I caught most major tops and bottoms in 10 years, I only over-performed by 2%. Even more sobering is that if I had kept the first 10 stocks I ever bought and never sold them, forgot them and never done anything else, my over-performance would have been 4%.

How could this happen? Well, that's very easy:

First, I caught all the actual tops, but also about 10 of them which never turned out to be tops. The market continued higher and I missed part of the move. Second, even when the top was an actual top and I was flat, it created the problem of knowing when to get back in, which in most cases occurred a bit too late. Third, buying and selling too much is created a lot of friction in the form of commissions. Over 10 years, the amount paid in commissions can be really impressive.

Based on this I decided to be always 100% long. I am not timing the market, styles, or anything any longer. I still hope to continue beating the market by a couple percent a year from stock-picking (probably more beta than alpha). I don't care if the results are more volatile. This is largely compensated by a huge decrease in workload and worry. Freed time can be dedicated to more useful pursuits, like learning to trade.

Jaime Klein writes:

I have, well, had, two now only one extremely financially talented relatives. The late one, when told I was going into the financial business, laughed rather rudely, I thought. And noting so many of my family members were already in that line of work, he asked me who was going to bring home the bacon. Well, he said, seeing as you're determined, I'd give you this bit of advice: Never buy a stock if in your lifetime you don't see it returning your original investment to you annually in dividends. And if they're any good, they only pay two percent.

Absurdly enough, his own results were so far beyond this as to make this counsel seem the most conservative expectation possible. He was probably 30 years ahead of the sage into Coca Cola, which he obtained by selling Minute Maid to them for stock. He never sold it except to buy the occasional Goya or Renoir, or make a charitable donation to Harvard or MIT.

I was aware of only two other plays: one was a quick flip which his partner told me netted over 100X in less than three years. The other was selling United Fruit, which I imagine he paid near nothing for, to Eli Black, right at the top back in the conglomerate heat of the '60s. I can't remember much about the foolish and ill-fated acquisitor except that he defenestrated himself shortly thereafter, taking his briefcase along with him.

Anyway, it's been my pleasure, while unfortunately lacking in outstanding talent myself, to have met so many ingenious and interesting people in my all too brief 65 years. One of these days I'm hoping I'll learn something from them. But in the meanwhile, it's always fascinating, albeit particularly in the political and religious arenas sometimes quite alarming, to see how clever so many people are.

From Scott Brooks:

Volatility is a terrible measure of risk. There is no risk on the upside of volatility. The goal should be to reduce all down side volatility, thus my patented investment strategy of buy low and sell high (Green List/Red List post from several months ago).

In all seriousness, I am fixated on the discovery of ways to mitigate downside volatility while participating in most of the upside of volatility. But since I'm far from the smartest person on this list and have been told in no uncertain terms that it can't be done, I feel like I'm fighting an uphill battle. Still, who knows, maybe there is a way!

I've never been one to give up just because others say it can't be done. If I listened to others (like my guidance counselors), I'd probably be laying carpet back in Maplewood, going to the corner bar, watching COPS every night, and aspiring only to be the "Maplewoods, King of White Trash."

From Craig Mee:

I accept these results, however…

Plenty of you know a lot more about stocks then I do. But I would like to offer here that a two percent increase in returns and with this, the opportunity to be out of the market in major declines, represents to me some nice sleepy nights.

With a bit of fine-tuning maybe marks can be picked slightly better on entering and exiting longer term positions. But on that black swan event, when something may drive the market into a huge selling spiral, I believe for me at least it may be worth that extra agro.

From Kim Zussman:

Similar but less quantitative self-assessments:

1. At least in US, taxes bite deeply into putative alpha (or masquerading beta) if you trade vs buy and hold.

2. Concur that most effect was lowering volatility. You will get lower volatility with stocks<100%, and pretty much always lower returns. Looking back, you will regret not being 100% stocks, but during the ride you live happier <<100%. Thinking about a big down year as a future possibility feels a lot different than having one.*

3. Besides drift, the reason buy and hold works is that there is too much temptation for the vast majority of people to time the market. It is unnatural not to check your investments, and not to be tempted to act on them. People don't like it when their million $ port becomes worth $800,000, and sell before "losing it all". Then it turns around and people don't like missing up 30% years, and buy back in. The hope-panic-irony cycle makes the market rise over time only for those not riding the emotocycle.

* The abstraction of future pain and foolish willingness to fall in love is nicely summarized by the late Sam Kinnison.

Jack Tierney adds:

I was invited to a dinner party but expected very little. The guests were getting thin on top and hefty through the middle. Our host was dressed in colors that defy the known spectrum and civility was to be shown the greatest horse's rectum. So we mingled and we spoke and mentioned our positions. I mooted that I was all in cash and was swarmed by five physicians. "Perhaps an evil humor attacked him on his flight or maybe he's an infidel who has yet to see the light." Their concern was very real and they needed to be consoled so I admitted that in addition I owned a little gold. Screams and wails followed and the panic gained momentum.

To quell the crowd I shouted, "Wait, I also own argentum." Now that they were fully aware of these judgmental flaws they ripped away my velvet gloves and exposed my hairy paws. They marched me toward the door when the host yelled out to quit, "Why this poor benighted soul has never heard of drift."

So began my lessons and I've brought them to the south, a bearish thought may cross your mind but never cross your mouth.

Abe Dunkelheit adds:

Bruno's post was very interesting. I made exactly the same observation. Market timing lowers volatility but doesn't guarantee any substantial out performance. And yes, one's first ideas tend to be much better researched than all these other in and out decisions. Never to sell them would have turned out the best in my personal case also.

And there seem to be people who don't make any professional impression and live a very retired life who tend to buy and hold and accumulate incredible returns without doing much.

I know about a guy in Switzerland who was retired and did it with wine. He bought all these Chateau Mouton Rothschild wines for USD 500 a bottle 10 years ago and they now go for USD 10,000 at auction because rap stars and Russian mafia are pushing prices up. I only know about this guy because I was one of the sellers. I had bought my bottles for USD 300 and thought a cool 60% gain in less than two years could not be wrong. He had an incredible cellar with all these wines, but his house and car and his whole appearance were very modest.

Another example I know about is a guy who was jobless and lived on social security, but had saved several hundred thousand euros [back then deutschmarks] and invested them through the accounts of his children. He put it all into Deutsche Telecom at the IPO and cashed in a 600% profit during the Internet boom. That was his one and only investment.

Mar

14

Measurement of Insider Trading in Wagering Markets

Shin (1993) proposed a method to calculate the extent of insider trading in bookmaker markets, with z as the measure of insider trading. He assumed that bookmakers manipulate the supply-side of the market to protect themselves against the risks of adverse selection involving counterparties with proprietary or inside information and against excessive payouts from wins by high odds horses. This article uses a large sample of thoroughbred races (n = 1796) over 4 years on Saturdays at major venues in Melbourne to validate the Shin methodology. Analysis derives a z-measure of insider trading in bookmaker markets of just over 2% (which closely matches results from multiple UK analyses). The surprise is that an almost identical value (p < 0.001) is obtained for z in the Tote market which does not have a supply side and so should have a zero value of z. It seems that factors driving a nonzero value of z arise in the demand side of wagering markets and not the supply side as assumed. This conclusion illustrates the risks associated with what Fama (1991, p. 1575) termed 'the joint hypothesis problem' where the conclusions of a mis-specified market model are likely to be invalid.

I have published an empirical refutation of Shin and can supply it to anyone interested. But more to the point, if the extent of insider trading in horse betting markets is really 2% (2% of what? turnover?) then insider trading is a trivial and unimportant phenomenon. Now, since such trading is legal in horse betting markets, it would be expected to be even less in markets where it is illegal. This is a load on rubbish. Read Shin's paper and think about his assumptions. Then decide whether you think he ever saw either end of a horse! He's a brilliant economic theorist, but knows little about betting markets. Les Colemen's work is interesting and he and I are planning to hunt down insiders in the stock market when I take a sabbatical in Melbourne in 2009.

Mar

14

I was in Florida in the late 1980s when Bill Seidman and the RTC took over massive amounts of commercial real estate and began to liquidate pristine properties with impunity because investors in limited partnerships were just walking away from their obligations.

Many were hurt — some severely, some permanently — and it ultimately did get resolved. But it took years, and some properties took many, many years. Big developers such as DeBartolo , Trammell Crow, JMB and Balcor took huge hits and some investors lost their entire investments in these packages.I believe one would be well served to go back 15 years and study that time.

It was promulgated by a gigantic change in the tax code that limited deductions from investment property and severly curtailed aggressive accounting and depreciation techniques used by limited partnerships.

It had a trickle down effect on many levels, especially to other areas of residential real estate, from middle America to carriage-trade neighborhoods such as Malibu and Newport Beach, to the pockets of wealth in the South such as Palm Beach and Miami, to the East Coast from New York to Maine.

Those who were well-positioned financially rode out the storm, and those who had available capital snatched up blue chip properties for pennies on the dollar. Those who were not were stampeded.

Citigroup and other major banks traded at historic lows. When Citi was at $12 per share, many analysts suggested they could go bankrupt. Richard Bove at Dean Witter said this was the opportunity of a lifetime to buy Citicorp and was summarily fired for being an outlier in his opinions.

The wise man, who goes into the recent past and studies it in detail, who will stand the best chance of being rewarded.

Mar

14

I cannot fail to remind all of the benefits of Spirulina, especially the well grown varieties — not all algae ponds are equal. It is a superfood that simply is more useful to the body than other volumes of food, and the brain gets the message by being less hungry. I find Atkins in addition to Spirulina beats the cravings while simply using the proteins and fats to turn the dials on the metabolism.

Charles Pennington writes:

The last thing that I did in my academic life, or rather the last thing that a very, very talented student in my lab, Luisa Ciobanu, did while I watched, was to obtain a magnetic resonance image (MRI) of a single cell of the algae Spirogyra, which is very similar to Spirulina. It's a plant cell shaped like a cylinder, with a diameter of about 40 micrometers. The "spiro" in the name is there because the cell has green chloroplasts that align in a spiral pathway along the inner cell wall. Dr. Ciobanu was able to resolve these chloroplasts (each just a few micrometers in diameter) piercing in and out of the image planes. The MRI images are on page 75 of our review article, and Dr. Peter Sengbusch has also made some pretty pictures using a regular optical microscope. It never occurred to me that it would be a good idea to eat these things!

Mar

14

Goldman May Have Ousted Citigroup as Market Indicator, WSJ Says

March 13 (Bloomberg) — Goldman Sachs Group Inc. may have taken over from Citigroup Inc. as the best indicator of U.S. financial companies' health, the Wall Street Journal reported.

It's at the heart of the recent boom in bond sales, increasing use of derivatives, growth of hedge funds and buyout activity, the newspaper said.

Todd Harrison, the founder and chief executive officer of Minyanville.com, says what happens to Goldman shares on any given day is a good indicator of what's happening to the market as a whole, the Journal said.

This story, though lacking quantification, suggests many avenues of research. For example, what is the best predictive market indicator, which market is most correlated with others predictively, and, when certain relations hold is it bullish or bearish?

Sam Humbert adds:

I made a file of daily prices, from 2000 to now, of SPX and the usual brokerage suspects — GS C MS MER BSC LEH — and wrote a quickie R script to display the correlation matrix of daily contemporaneous log-changes, broken down by year.

"As advertised," among the brokers, C was the most correlated with the SPX every year from 2000 to 2004, whereas GS has been the most correlated, by far, in 2007 to date. My script/output follows:

> Data<- read.table('f:/BROKERS.txt',header=T)
> head(Data); tail(Data)

DATE--------Y---M--D-W---SPX-----GS----C----MS----MER----BSC---LEH
31-Dec-99 1999 12 31 5 1469.25 94.19 38.76 71.38 41.75  42.75 21.17
3-Jan-00  2000  1  3 1 1455.22 88.31 36.88 67.50 40.31  40.13 19.77
4-Jan-00  2000  1  4 2 1399.42 82.38 35.27 62.81 38.78  38.69 18.59
5-Jan-00  2000  1  5 3 1402.11 78.88 35.45 60.13 36.72  37.44 17.50
6-Jan-00  2000  1  6 4 1403.45 82.25 37.80 61.25 38.19  37.94 18.22
7-Jan-00  2000  1  7 5 1441.47 82.56 38.02 63.28 38.41  38.06 17.75

DATE--------Y---M-D-W---SPX-----GS-----C-----MS----MER---BSC---LEH
5-Mar-07  2007 3  5 1 1374.12 190.00 49.25 71.64 79.97 144.50 71.12
6-Mar-07  2007 3  6 2 1395.41 197.37 50.58 73.55 82.10 149.00 74.23
7-Mar-07  2007 3  7 3 1391.97 195.59 50.22 73.89 82.21 149.37 73.90
8-Mar-07  2007 3  8 4 1401.89 199.94 50.50 75.41 83.25 152.06 75.75
9-Mar-07  2007 3  9 5 1402.85 201.70 50.33 76.00 82.95 151.98 75.83
12-Mar-07 2007 3 12 1 1406.60 202.60 50.36 76.06 83.49 153.15 76.55

> Date<- 1:4
> Diff<- cbind(Data[-1,Date],apply(log
(Data[,-Date]),2,diff))
> lapply(split(Diff[,-Date],Diff[1]),function(m) round(100*cor(m)))

$`2000`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  59  66  62  60  53  62
GS   59 100  59  79  71  61  73
C    66  59 100  62  60  60  65
MS   62  79  62 100  80  69  78
MER  60  71  60  80 100  69  78
BSC  53  61  60  69  69 100  76
LEH  62  73  65  78  78  76 100

$`2001`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  75  81  77  75  78  77
GS   75 100  72  85  82  80  84
C    81  72 100  78  73  76  77
MS   77  85  78 100  82  83  85
MER  75  82  73  82 100  81  82
BSC  78  80  76  83  81 100  87
LEH  77  84  77  85  82  87 100

$`2002`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  79  83  83  81  80  81
GS   79 100  78  88  85  83  89
C    83  78 100  77  76  74  75
MS   83  88  77 100  87  83  88
MER  81  85  76  87 100  82  85
BSC  80  83  74  83  82 100  87
LEH  81  89  75  88  85  87 100

$`2003`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  83  84  82  84  77  77
GS   83 100  77  81  82  81  80
C    84  77 100  77  76  72  72
MS   82  81  77 100  83  77  75
MER  84  82  76  83 100  75  75
BSC  77  81  72  77  75 100  82
LEH  77  80  72  75  75  82 100

$`2004`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  72  77  70  72  59  64
GS   72 100  53  75  76  71  75
C    77  53 100  58  56  50  51
MS   70  75  58 100  79  65  70
MER  72  76  56  79 100  65  74
BSC  59  71  50  65  65 100  73
LEH  64  75  51  70  74  73 100

$`2005`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  65  60  56  76  63  67
GS   65 100  45  63  67  64  72
C    60  45 100  49  56  42  43
MS   56  63  49 100  64  56  57
MER  76  67  56  64 100  66  70
BSC  63  64  42  56  66 100  73
LEH  67  72  43  57  70  73 100

$`2006`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  72  64  77  70  73  73
GS   72 100  49  78  78  80  82
C    64  49 100  52  49  51  47
MS   77  78  52 100  74  78  77
MER  70  78  49  74 100  77  79
BSC  73  80  51  78  77 100  85
LEH  73  82  47  77  79  85 100

$`2007`
----SPX--GS---C--MS--MER-BSC-LEH
SPX 100  88  77  84  76  78  78
GS   88 100  71  87  82  79  75
C    77  71 100  74  68  69  61
MS   84  87  74 100  89  85  78
MER  76  82  68  89 100  89  86
BSC  78  79  69  85  89 100  83
LEH  78  75  61  78  86  83 100

Mar

14

I liked what I read on each of us "holding hands" and being supportive of everyone we know who has a deep interest in the market, whether in stocks or real estate. Excessive negative talk will serve no useful purpose and will undermine and erode our confidence.


Forgive me, as I hardly ever post, but isn't the above "statement" much the same as a trader who doubles down in the hopes the position will work out? Or the idea, "stick your head in the sand," and hope for the best?

Do you not think that the Asian Flu that hit the markets a week ago was a "signal" much like back in April of 2000, when the drop hit the INDU hard? Is the weakening of the US dollar, the geo political climate, and the "Asian" markets (down around 500 or so as I write) not pressure on the "bull." How about the simple saying, "what goes up, must come down?"

I would save the handholding for a nice romantic getaway. I prefer to listen and watch what the "forces" are telling me, and capitalize in any move, or any business cycle that may come. The Art of War, my friends - I know it's been used in cheesy books and movies. But Sun Tzu's methods are basic principles in life.

Mar

13

It is interesting to note that Viacom is going to provide video to Joost. Behind Joost are the Scandinavian super entrepreneurs Niklas Zennström and Janus Friis (who founded Skype and Kazaa). Keep an eye on Joost as TV is moving to IP distribution.

Wired has a good article on Joost. 

Unfortunately it is not a public company, but maybe Google should make a strategic investment. 

Kim Zussman writes:

Content now on Youtube will soon only be on the boobtube.

Mar

13

EU Loophole Allows City 'Farmers' to Reap Millions in Subsidy Harvest, by Anthony Browne, Chief Political Correspondent

Auctioneers and brokers who used to sell cattle and farm-land are now focusing their attention on selling the rights to receive European taxpayers' money –known as entitlement trading — in what one described as a "ferocious" market with the rights to subsidies "flying off the shelf".

Demand is outstripping supply by five to one, because the profits from investing in subsidies are up to ten times higher than putting the money in a bank. After making a one-off payment, the investor is entitled to receive from the taxpayer every year a cheque that typically amounts to a third of the original investment.

Mar

13

I am a great follower. I have no problem being a follower. In fact, I look for people I can follow. One of my strong suits is finding people of competence and then watching them carefully and learning from them.

I learned the hard way a long time ago to shut up and listen when dealing with someone competent, and not try to act as if I know what I'm doing.

Great things are accomplished great leaders are allowed to lead. Chaos ensues when the wrong leader is in place. Lead, follow, or get out of the way. And be a good helper to the person in charge.

Mar

13

The odds of one person's filling out a perfect bracket for the NCAA basketball tournament, i.e., the odds of picking every single game winner correctly is nine quintillion to one.

Another way to view this is that if every person on the planet were to randomly fill out one million sheets the chances would be one in 1000 that a perfect sheet would be found.

The odds of picking the five numbers in the Powerball lottery are one in 3,563,609 but to pick all five numbers and the powerball are one in 146,107,962.

Alston Mabry writes:

If the tournament were a coin-tossing exercises, there would indeed be 2^63 = nine quadrillion outcomes. But can we improve those odds?

Looking at the NCAA Tournament results for 2005 and 2006, 86 of 126 games were won by the higher-seeded team, a 68.3% win rate for the NCAA seeding committee. If the seeding were random, one would expect a win rate of 50% with a 4-5% standard deviation, so the committee's results are inconsistent with randomness.

If you go further and rank the games by the difference in seeding (low seed minus high seed, so that a one seed playing a 16 seed would be a 15-spread game), and then look at the quartiles, you see that the committee is even more successful. The first column is the average difference in seeding between the teams in the quartile, and the second column is the rate at which higher-seeded teams won in that quartile:

seed diff / win rate
12.29 87%
7.79 75%
4.25 69%
1.27 42%

Andy Moe remarks:

I would suggest that spreads and seedings should be examined closely in the tournament, as there are statistically significant edges that can be of use both at the sportsbook and in an office pool. For the most part, I believe the edges are present because the tournament selection committee is better at seeding the teams than the general public is. Add plenty of "amateur" money chasing favorite schools and you have the perfect recipe for mispricings.

The memes surrounding the tournament are surprisingly similar to those found in the markets. The length of time since a #16 seed beat a #1, the danger of the #5 vs #12 matchups, past greatness of teams, coaching vs players, upset specials, giant-killers, hot hands, the list goes on and on. Thankfully, almost all of this centers on how to pick winners, not how to beat the spread.

So while the rest of America concentrates on filling in brackets, I'll be packing my bags for Vegas. As in the markets, it pays to know when to break out the cane and hobble down to the sportsbook.

From John De Palma:

From the New York Times : 

"When it comes time to pick a champion in an N.C.A.A. bracket, people tend to cluster around a few of the favorites…. At first glance, this focus on the favorites seems to make perfect sense. History suggests that the top-ranked teams really are more likely than other teams to win the tournament. If you cared only about picking the correct national champion, it would be smart to choose a team like Ohio State or Kansas this year. The problem is that you would have a lot of company. To finish at the top of your pool, which is what matters to most people, you would have to do extraordinarily well in the rest of your bracket … The lesson is basic: As long as everyone else is clustering around a couple of favorites, you hurt your chances by joining them … But pools do make a broader point about human behavior. Frequently, people make decisions without fully taking into account the actions of others. Investors, for instance, may buy stock because they believe a company will do well in coming years, but they fail to consider the possibility that the stock price already reflects that information…"

Mar

13

From an economist email newsletter:

Washington, DC's city council is considering a proposal to invest $50m in the Verizon Center sports arena. In return the city would get a luxury 24-seat box and would assume ownership of the arena in 2047.

Mar

13

Bill Egan wrote:

Plotting the data different ways pays off all the time. I earned a US patent because I examined bi-plots of ~50 variables and saw something interesting. Further investigation showed a sensible relationship to the physical mechanism I was interested in modeling, I always use bi-plots. Once I have a feel for the data and can throw out some variables…

Reminds me of an old and slightly caricatured study we did in my R&D lab. We were always searching data to test our algorithms. One day, we got some astronomy data. A huge volume, nearly fifteen variables. The guy who brought us the data was quite proud about the quantitative numbers. So much data, so many variables. Must be serious. We didn't know much about the physics of the problem and we were also a bit impressed. (Because, also, we had to find how practically to manipulate this data amount with our software.)

Once the practical aspects were solved, the study revealed to be very rapid. In fact, a real variables slaughter. When finished, it appeared the real dimension of the data set was between one and two. Some kind of spiral in 3D.

On the statistical forums and lists I follow, there are very regularly people complaining: "I have too much data for my computer memory/ software abilities. Please how can I handle them as a whole?"

Sounds like we made big progress since 1637 and we could forget Descartes.

"Diviser chacune des difficultés que j'examinerais, en autant de parcelles qu'il se pourrait, et qu'il serait requis pour les mieux résoudre."

[To divide up each of the difficulties which I examined into as many parts as possible, and as seemed requisite in order that it might be resolved in the best manner possible.]

Mar

13

I would like to offer some simple thoughts on non-linear relationships. The usual way to study non-linear correlations is to transform one or more of the variables in question. For example if we have a reason to believe that the underlying process is multiplicative then we can use a log function to model our data. When we do a correlation or regression of y~x we can just take the transformed variables ln(y)~ln(x) as our new data set. We are still doing a linear correlation or a linear regression but now we are doing it on the transformed variables.

Ideally we would know the form of the non-linear relationship from some theory. Absent that we could use a general functional form such as the polynomials. So our transform could be something like X^2, X^3, or X^4. Using one of these terms is usually pretty safe. But combining them in a multiple regression can be problematic. The reason is that the terms x^2 and x^3 are about 67% correlated. Using highly correlated variables to model or predict some third variable is a bad idea because you cannot trust the statistics you get.

One way around that is to use orthogonal polynomials or functions. We have previously discussed Fourier transforms and Chebychev polynomials. Both of these classes are orthogonal which also means that we can fit a few terms and add or delete terms at will. The fitted coefficients will not change if we truncate or add to the series. Each term is guaranteed to be linearly independent of the others.

Bruno Ombreux asks:

Using one of these terms is usually pretty safe. But combining them in a multiple regression can be problematic. The reason is that the terms x^2 and x^3 are about 67% correlated. Using highly correlated variables to model or predict some third variable is a bad idea because you cannot trust the statistics you get.

I have a question.

One of the reasons for adding regressors is to take into account all possible reasons behind a move in the variable we are trying to explain. However, multicollinearity being prevalent in finance, it is a source of headaches.

If we could randomize and/or design experience plans for empirical studies, as we do in biology, we could get rid of part of the problem.

Is it possible to randomize ex post? Let's say I what to study Y = aX+ b + e. If instead of taking the full history of observed (Y,X), I am taking a random sample of (Y,X), it creates some kind of post-randomization, which should reduces the impact of other factors.

Does it make sense? Of course, we would lose all the information contained in the non-sampled (Y,X). That means even less data to work with, which is not nice with ever-changing cycles.

Are there books about this type of technique? I have never heard about it so maybe it doesn't exist.

Rich Ghazarian mentions:

And of course if you want a more powerful model, you fit a Copula to your processes and now you are in a more realistic Dependence Structure. Engle has a nice paper on Dynamic Conditional Correlation that may interest Dependence modelers on the list. The use of Excel correlation, pearson correlation, linear correlation … these must be the biggest flaws in quant finance today. 

Jeremy Smith adds: 

With linear functions we can compute the Eigenvectors to get an orthogonal representation. One problem that gets in the way of nonlinear models is that it isn't clear what is the appropriate "distance" measurement. You need a formal metric of distance to model, compare, or optimize anything. How far apart are these points?

With linear axes, distance is determined by Pythagoras. But what is suggested for the underlying measure of distance if the axes aren't linear?

These remarks about correlation resonate with me, especially in the case of the stock market.

From Vincent Andres:

If you did replace your original axis X and Y by new axis X'=fx(X) and Y'=fy(Y) this is a transformation of the kind P=(x,y) -> P'=f(P)=(x',y')=(fx(x), fy(y)).

This transformation can be reverted without worry. P'=(x',y') -> P=(x,y) where x and y are the antecedents of x' and y' thru the reciprocal functions fx^-1 and fy^-1.

A "natural" suggested distance measure in this new universe is thus : dist(P1, P2) = dist(ant(P1), ant(P2)) ant = antecedent.

This works for all functions fx and fy being monotonous, e.g., (ln(x), x^2, etc) because there is a strict bijection between the two universes. It could even do something for a more large class of functions.

Sorry for the difficult notations, but I hope the idea is clear.
 

Mar

12

Mexican Carlos Slim, world’s 3rd richest person, sits several unattenuated standard deviations above the mean of a very poor nation.

"Diners at Slim's ubiquitous Sanborns restaurants can use Slim's wireless service to connect to Slim's Internet provider and check their holdings through Slim's brokerage, part of Slim's Grupo Financiero Inbursa group. Banking online, they can pay bills to Slim's car insurance company or credit cards for Slim's retail stores, among them Sears Mexico and the Mixup record store chain."

From Hany Saad: 

Here is what I wrote about Slim a few days back in response to Scott Brooks's post about the new Forbes list of billionaires. Slim had the most unusual jump in net worth.

News like this, while interesting to skim through, can be very valuable if analyzed deeply. In fact, they can give you subtle clues on what cycles are about to change (specially if you keep historical data of the list year over year). I certainly try to keep in mind that the data can be flawed especially when it comes to analyzing the net worth of the super wealthy. I will state here the obvious example as an exercise in analyzing humdrum data like the above profitably.

Notice how Carlos Slim, 67, Mexico, $49 billion, telecom, had the highest jump in net worth and is getting uncomfortably close to Buffet? You compare that with a chart of the peso to weed out the possibility of a huge jump in the local currency as the main reason for the increase in net worth. This is not really important in the case of Slim and most of the others since they mostly keep their wealth in US dollars. In fact, Slim doesn't even reside in Mexico. This exercise is, however, useful in the case of others like the Egyptian Naguib Sawiris, whose OTOH is required by law to keep a significant percentage of his "disclosed" net worth in the Egyptian pound.

Some other obvious questions to ask other than the general currency differentials include: What sectors are they involved in? How did the sectors do in general over the period? How did their specific company fare relative to the sector? Did they target new markets? Which ones? How did these new markets do? If all the above is not significantly changed compared to the previous year to warrant the big change in their net worth, then the info can become even more valuable and more digging can be worth your while.

In general, this can be a good exercise in ever-changing cycles, if you keep in mind the importance of incentive and self-interest as the only driving motives. This is how this trader reads the news.

Mar

12

The Education of a Speculator is required reading here at Radical Funds now. The market chose it. Enough people liked it that we give copies to all incoming, along with Johan Norberg's In Defense Of Global Capitalism and some others, like Hoover's Vision, which we require our entrepreneurs to read. We distribute the books over time, and strategically when the volumes are of utility to the individuals.

A Managing Director who joined us about a year ago was given his copy of The Education of a Speculator this weekend.

He came in today saying, "This book you gave me — I'm learning so much from it. I'm 20% into it."

I replied, "Yep, it's the single tome I learned the most from. And it is both rational and interesting."

He added, "Yeah, and Niederhoffer is crazy. He's like us, man. Something is seriously wrong with his brain — it has to be, to write something like this. I really dig it."

Mar

12

Recently I attended a luncheon at the historic Lafayette Hotel in downtown Marietta, OH, where about 300 attended the Economic Roundtable of the Ohio Valley to hear Steve Forbes speak on the economy. He told of his grandfather's coming to the US as an immigrant with a grade-school education, one of ten children, and living the American dream. After his talk he was presented the Bernard P. McDonough Award for Excellence in Leadership. Mr. McDonough grew up in my town, Belpre, OH, and later owned Ames Tools and a variety of other businesses. Today the Bernard P. McDonough Foundation is in Parkersburg, WV, directly across the bridge from Belpre. Forbes publishes the Gilder Technology Report and a number of other investment newsletters. News media were on hand and all who attended listened intently to Forbes's speech and the Q&A session following. I took a couple of pictures of the event as well. It was a good experience for me.

Mar

12

The recent forecasts by the former chair of the Fed about the likelihood of a recession are a case study in how not to forecast. Alan Greenspan believes there's a 1 in 3 chance of a recession this year. There are 3 cornerstones to his theory because "we are in the sixth year of a recovery." First, short term interest rates are above long term, and according to Fed research, such divergences have been good at predicting recession. Second, we are in the sixth year of a recovery and there is a tendency for recessions to become more likely as we enter the "well-known 10 year cycle." Third, profit margins are declining, and Greenspan believes this will lead to a decline in capital spending that will lead to the recession. The problem with these forecasts is the same thing that's wrong with most over-determined forecasts. There are so few observations that it are guaranteed that one indicator or another will provide a perfect forecast of the recessions in retrospect. For example, since 1945, there have been only 12 recessions. The hazard rate for a recession ending given the number of months of the previous expansion is as follows:

   Number of          Number of           Chances of
   months of          observations            failure
   expansion           remaining           next 12 months %
    12                         11                        10
    24                         10                        11
    36                          9                         33
    48                          6                         17
     60                       05                          0
    72                        04                        20
    84                        03                        33
    96                        02                        50
  108                        00                      100

The results show that a fairly constant hazard rate of 20% throughout 84 months, with all of the remaining three expansions dying in the next 24 months. However, because there were just three observations, there is nothing but randomness in such an estimate because estimates based on three observations are completely unreliable. They have at least three times the variability of an estimate based on 25 observations.

The same flaw would apply to an attempt to relate the recessions to movements in interest rates. With only 11 observations to predict and approximately six turning points in the indicator that are doing the predicting, the chances of finding a pattern when none exists are close to one, when one considers the number of forecasting indicators, measuring in the thousands, that were implicitly considered before coming up with the divergence between short term and long term as the magic bullet.

I have previously discussed a similar error in using the short term — long term yield differential to forecast stock prices, showing that just a small error in the reporting was enough to change the conclusions, and the completely useless forecasts that such indicators gave for stock prices. (They were bearish throughout 2006 for example.)

A much more fruitful way of thinking about business cycles is the way Milton Friedman thinks about them. "I've always questioned whether there is really such a thing as a business cycle. What you have is an economy that is subject to shocks from time to time."

Such shocks according to Friedman are caused by the Fed with mistaken monetary management. Part and parcel of these mistakes is reliance on over determined, multiple comparisoned indicators, similar to but even more useless than the Super Bowl indicator for stock prices.

Q: So the business cycle is becoming less important?

Milton Friedman: No. I've always questioned whether there is such a thing, really, as a business cycle. What you have is an economy which is subject to shocks from time to time. And a shock comes along which knocks the economy down, and then it recovers. But the idea that there are regular intervals, regular size, I think that is not supported by the–I have no doubt whatsoever that to a large extent past recessions were produced by mistaken monetary management; that they were not natural in the economy, that they did not have to occur; but you had a situation in which the monetary authorities–this is particularly after the Federal Reserve was established–followed a policy of tending sort of a stop-go policy. They were late in reacting to changes in the economy, and when they acted, they acted too strongly.

And even the Fed has learned from experience. And I believe that the performance of the Fed under Mr. Greenspan has been better than any prior chairman. You may know personally I'm in favor of abolishing the Fed.

Peter Robinson: Yes, I know. I know. I'm going to get to that.

Milton Friedman: I would rather substitute a computer for it.

Peter Robinson: The business cycle is one of those phrases that is almost incantatory, people say it over and over again, and so I assume there must be a business cycle. Now I hear you saying that you're not sure that such a thing even exists.

Milton Friedman: If you want to see a real cycle, think of a seasonal cycle.

Peter Robinson: Right.

Milton Friedman: That's an event. It's warm in the summer, it's cold in the winter, you grow food in the summer, you don't grow it in the winter.

Peter Robinson: Predictable, regularity.

Milton Friedman: So you have a real cycle predictor, that would be a real honest-to-God cycle.

Peter Robinson: All right.

Milton Friedman: Now the image of the business cycle that people have had is that there are reactions in the economy of a similar kind which tend to run with reasonably regular frequency.

Now for one time, to give an example, one favored theory at a time was the so-called sun spot theory. There are spots on the sun which have a physical cycle, 10-year cycle roughly. And that does affect the fertility of crops on the earth. It affects the growing conditions. And Stanley [Jevins], an English economist in the 19th Century correlated, the movements in agricultural output with the movements in the sun, and argued that that was a cause of a business cycle. That would be a real honest-to-God cycle.

Peter Robinson: Right.

Milton Friedman: And people had been searching for some other mechanism. But what I think is really going on is a very different thing. I think that you have a reaction mechanism in the economy. The image I've always had is, think of a piece of wood up here with an elastic band glued onto the bottom of it. And every now and then something comes along that plucks it down. For example, you get the shock of the oil embargo.

Peter Robinson: You're talking about the '70s.

Milton Friedman: In the '70s. That knocks it down, and that creates a recession. And then there is a reaction mechanism within the economy, which you can understand, that it takes time for what happens then to have its full effect. Some things react immediately. Some things react later. And that reaction mechanism means that we'll take a reasonably predictable amount of time for the economy to react back to there, and get back up to that board up there which defines its long term path.

And similarly there might be something that pulls it up. All of a sudden, you've got a war in which in order to finance it, they print a lot of money, it causes inflation, that produces a temporary boom, and then you react down to it.

So the image I have is of an economy which is subject to shocks from time to time, and which reacts to those shocks in a rather predictable manner, with a predictable reaction mechanism in it.

Steve Ellison adds:

For sales forecasting, APICS teaches a decomposition method:

Demand = Base + Trend + Seasonality + Random Error

One can develop forecasts by evaluating the seasonal pattern and longer-term trend to estimate underlying base demand.

More sophisticated sales forecasting methods take substitution into account. For example, if a technology company introduces a new product, usually there is an old product for which sales will drop as customers switch to the new product.

Substitution can occur across time, too. Many sales promotions succeed only in rearranging the timing of demand, but fail to increase base demand. Customers who were thinking of buying in the future rush to buy at low prices. With much future demand already satisfied, sales fall far below normal when the promotion ends (possibly at about the time the marketing department receives bonuses for increasing sales). Such a case is a microeconomic example of Dr. Friedman's elastic band being stretched up and then reacting down.

Mar

12

It is spring in Hawaii and the hens are laying eggs and chicks are hatching. We hunt for eggs and when we find a nest we take the eggs. The hens can't count. If at least one or two eggs get left, they hen keeps laying. If you get greedy and take them all, the hen will give up and move. The hens don't know exactly how many eggs they have. When eight are gone, they only have a vague feeling that something is not quite right, but they can't quite pinpoint it. So they keep laying eggs, and we keep having omelets. They can't get very precise about what is the most efficient way to propagate. Of course some chickens are not too smart, like the ones that try to lay their eggs in a tree on branch.

There are vague feelings of unease when a trillion market dollars disappears. But, the eggs must keep getting laid. Sometimes it's good to be able to count the eggs so that so many don't disappear and to keep the right place in the ecology.

Mar

12

I have used Roger Federer several times as a metaphor or example of markets excellence. Everything the man does to prepare himself for victory is first class. But what has not been mentioned before (because of the rarity of such an event) is how he handles himself after defeat:

"That's not the way it is. A guy put me away when he had to. He played a perfect match in the end. He didn't give me any more chances. He served well. He didn't give me any unforced errors and I was just playing too poorly in the end to come back. So the right guy won today. That's just a fact."

Take the loss and move on.

Mar

12

Here is a nice update on central banking's somewhat obscure inner dialogue by Gov. Kroszner, the Chicago academic:

…[E]xpectations are important in the inflation process…the improved conduct of monetary policy, by influencing the formation of expectations in a favorable manner, may account for many of the changes in inflation dynamics that we observe."

Or, as a very wealthy Wall Streeter once told me, it's all marketing, marketing, marketing.

…shifts in the way a central bank conducts monetary policy imply changes in the way the public forms its expectations…

Is public perception of inflation the new gold standard?

And noting the reduced efficacy of the Phillips curve, he cites,

 a reduction in the correlation between inflation and unemployment….

Finally, Kroszner says even the vaunted Taylor rule (targeting output gaps) isn't reliable, proposing a Greenspanian eclectic approach that, by no small coincidence, leaves the Fed with maximum latitude and scant benchmark accountability.

In today's economy, it is very difficult to know whether any given change in output or employment will have inflationary consequences. One lesson that is fair to draw, however, is that resource utilization generally does not tell us much about the future course of inflation over the next year or two. Rather, the near-term inflation outlook is more likely to be dominated by cost factors, such as productivity growth and the price of raw materials, than by the tightness of labor and product markets. Furthermore, the weak relationship between inflation and the unemployment rate means that it is probably more difficult than ever to gauge the economy's productive potential–and hence estimate so-called output gaps–especially in real time. In light of these uncertainties, prudent policymakers should take an eclectic approach and base their policy decisions on both a wide variety of indicators and views about how the economy may work and avoid a narrow focus on economic slack.

Meet the new boss. Same as the old boss.

Mar

12

In a follow up to Mr. Sasmor's wonderfully enlightening Youtube post simplifying economics, a friend shared his thoughts with me on all the things that could go wrong in the markets. After reading this, I know for sure that we're heading to Armageddon!

Or maybe we can all just realize that there is always something out there to get the bears excited about impending doom.

Possible problems:

The potential for derivative crises
The bird flu
The next hurricane season
The Japanese demographic tsunami
Low risk premiums
Corporate profit margins at record levels
Outsourcing
Poor US performance in math and science
Iranian nukes
Iraq war
Terrorism here and abroad
The federal budget deficit
The national debt
High consumer debt
The return of high inflation
The housing bubble

The credit bubble
The oil bubble
The commodities bubble
The coming crisis in Social Security
The US demographic tsunami
Oil supply risk
The bubble in San Francisco real estate
Oil at $100/barrel, natural gas prices
Global warming
Global cooling
Globalization
Rising long term rates
Rising short term rates
Falling US dollar
Asset Inflation
Asset Deflation
The European demographic tsunami
Consumer spending post-asset bubble
Consumer spending if assets keep inflating
Exogenous events
Global imbalances
Foreign surpluses

US consumer stretched to the breaking point
The bond carry trade bubble
The unwinding of the Yen carry trade
Overvalued US stocks
The "house of cards" US financial system
The condo bubble in Miami and Las Vegas
The Chinese demographic tsunami
The hollowing of US manufacturing
Ports owned by Arabs
Reckless fiscal policy
Wage stagnation
The health care crisis
The bankruptcy of GM and Ford
Declining productivity
The impending increase in volatility
The yield curve inversion
Negative US savings rate
Corporate Malfeasance

Mar

12

Comments about the Uber bear and the groundswell surrounding the impending, inevitable, implosion of the subprime market, which will lead to a recession of diluvial proportions, remind me of several things.

One is that everyone no matter who they are face difficulties in life. It is one of the great illusions that is promulgated especially by publicists and spin-meisters that their clients somehow soar above this and thus live idyllic lives.

Whether it is that Brad and Jennifer have a wonderful marriage when it is suddenly revealed that in fact they are in the midst of a very acrimonious divorce and the stunning actor suddenly and without malice aforethought quickly assumes residence with the collagen lipped adopt-the-world Angelina.

Alternately, that the two presidents for one theme that was so soundly pounded by the oval office inner circle as being wonderful for the country, is followed by a vast right wing conspiracy which is followed by a very revealing Starr report on infidelity and romping in the Map Room.

The world is full of canard, misrepresentation, misdirection, and sleight-of hand, carefully designed to mislead and confuse an eager yet gullible and naive public. Those at the forefront who wish to obfuscate rather than educate, and to further their own agenda rather than yours carefully craft this methodology.

That such a collective consciousness can buy into the old tried and true maxims, however incorrect, time and time again, and who forget that in the words of P.T. Barnum, "There is a sucker born every minute," and, "A fool and his money should have never gotten together in the first place." Also, "If after 20 minutes at a poker table you can't identify the pigeon, it is because it is probably you." And that is why you were invited to the party in the first place.

That in the end the cards are stacked against you so why bother in the first place.

That shadenfreude is ubiquitous and worth what you pay for it.

These are the things I think about.

Yet I am also reminded when I hear of those who constantly denigrate the opportunities in the greatest of all countries in the world, and for that matter in the history of mankind, that opportunities abound everywhere and that one can also rise above the maelstrom of despair and struggle and survive and fight and can achieve great things if they keep their shoulder to the wheel. That if it were done before it can be done again. That it is not different this time because people are not different.

Finally, I ponder the words of perhaps the greatest president this country has ever had the pleasure of having been led by and one of the greatest men and leaders in the history of modern civilization:

"It is not the critic who counts: not the man who points out how the strong man stumbles or where the doer of deeds could have done better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly, who errs and comes up short again and again, because there is no effort without error or shortcoming, but who knows the great enthusiasms, the great devotions, who spends himself for a worthy cause; who, at the best, knows, in the end, the triumph of high achievement, and who, at the worst, if he fails, at least he fails while daring greatly, so that his place shall never be with those cold and timid souls who knew neither victory nor defeat."

Theodore Roosevelt "Citizenship in a Republic," Speech at the Sorbonne, Paris, April 23, 1910

Mar

12

The Derivatives Expert writes:

I just had to withdraw a piece from publication. The copy editor wanted to "improve" the sentences. I pulled it out immediately upon hearing claims that she represented the "general public," with the assumption that she knew what the "general public" needed ? not realizing that she was talking to an empiricist who despises impressions (based on anecdotal evidence) and pompously stated superstitions. There is an expert problem with copy editors particularly when they are self-appointed representatives of the "general public." ("Advice" from book editors reminds me of Warren Buffet's comment about people in limos taking stock tips from people who ride the subway). Fooled by Randomness was not copy edited (with close to 200 typos in the hardcover edition). My next book will not be edited. An edited text is fake. Really fake. It is as shameful as ghostwriting [read more].

One doesn't have to believe in the black swan and the man behind the curtain to find the Expert's website, as messy as it is, dare I say, entertaining. OK, I admit I have been reading it. The text in French and his translation of Plato's passage on apology are highly entertaining. I was very critical of his book, yet he somehow manages to entertain me even despite all his scientific flaws.

I respect a guy who appreciates the writings of Voltaire. Voltaire's Histoire d'un Bon Bramin and Madame du Chatelet's Discours Sur le Bonheur are two well-chosen works, and I have to agree with the expert's recommendations. And I find his ramblings on Socrates and on Greek and French literature more enlightening than his stock market remarks.

Elsewhere on his website, he talks about how book reviewers hurt writers' feelings with bad reviews. I hope I didn't hurt his feelings with my bad rating of his book, but unfortunately I still hold that the book was scientifically flawed and can lead to vast losses in practical, day to day, humdrum trading.

That said, I would highly recommend his website.
 

Ken Smith adds:

HedgeFundGuy, writing on Mahalanobis, says the Expert "thinks his genius must be unedited and unrefereed."

But poetry need not be submitted to an editor. If edited it would not be an original poem. We do not expect a painting to be changed by an editor. Would a famous expressionist painting be authentic if it were edited? Would an Ayn Rand character submit to editing? 

Mar

12

The events of the last two weeks are startling and disruptive. No matter how many counts others and I adduce, that show that after a 5% decline in a week there is on average a 2.5% rise, relatively continuously over the next 10 days during the past seven years, someone's going to say that this one is different — the old rules don't apply. We have to go back to 1987 or 1929 of course, as the chronic bear weekly columnist said on March 2nd, when the March S&P was 1398.

He is bearish now because even his good friend who caught the decline was expecting a little rally before the ultimate swoon. As he said last week, there is a time to reap, a time to sow, and a time to panic. And that time is now.

In the back of our collective memories are the many occasions when a terrible end of world like decline such as this has occurred before, then there was a bit of a rally in the week following, and then subsequently a huge decline occurred again. Such a decline, which I liken to the tortures of the inquisition where they put you through one torture and then brought you back again for worse tortures when you thought that it all had ended, occurred subsequent to the May 2006 declines.

This also characterizes many of the big declines in 2000, when the NASDAQ 100 went from an adjusted 5209 on March 24th, to 4540 on April 3rd, up to 4742 by April 7th, but was then followed by a decline of 25% in the week of April 14th, and continued to plummet to 1600 by April 4th, 2001.

As I said when we compared those early 'naughties' declines to the end of the world, parts of the first movement of the Fifth Symphony, the melody, the hopeful march of fate, was rejoined. But there is the eerie knowledge for those who know, that Beethoven is not yet through with such despair. In this light, where counting is superseded by fear, I thought it might be helpful to turn back to something I am more expert at, the lessons that you might apply to this situation that you learned as a kid.

For guidance I turned to Roberg Fulghum , who said, Everything I need to know I learned in kindergarten . I also look to my own extensive training in street games: Street games have been designed to teach kids what they are going to need to know to succeed in life. I believe I am on firm ground here.

The first lesson to learn in street games is to look both ways. One can see the wisdom in this by seeing what happens if you don't look both ways. You're likely to be hit by a car, or almost as bad in truly competitive games, tagged out by the opponent who was hiding on your blind side.

After a decline of this current magnitude, one should always think about what could happen if the market continues to go down, or reverses and goes up. Are your positions so life threatening that a further small decline could take you out of the game? If so, it's only a matter of time until they do you in as the odds are about one in four that big cane calling declines will continue into the next week after the initial decline. You may only have a one in four chance of withstanding four declines in a row, but on the other hand, there is a three in four chance that you'll make money by keeping your position into the next week. And there is a 10% drift per year.

If you're not at the wolf point, like those who are in danger of margin calls might be, then by all means, this is a great chance to take account of the Dimsonesque ten thousand fold a century returns.

Another rule is to always put things back where you found them. If you don't put the equipment back after the game is over, you won't be able to play again. Or worse, you could be banned from playing at the night center, and then become x on the block, as often happened to me. When you have a position, and you're forced to lighten it due to money management, do get ready to put it back on as soon as your liquidity and ability to withstand loss is greater.

Perhaps you're one of those prudent people who have followed the message of the doomsdayists to keep 50% of your portfolio in fixed income. If now that bonds have gone up about 2% and stocks have gone down 5% you're 51% bonds 47% stocks, you have to do some switching and increase your stock exposure by 5%. Know when you do this that you will have the wind at your back, because in times like this when the estimated earnings yield is some two percentage points higher than the bond yield, the returns from stocks these years have averaged some 15 percentage points. You don't have to follow Abbey Cohen to get such a forecast for this, but merely turn to the Collab, Mr. Downing, and my quantification of this through regression forecast and bin analysis on our web site under the Fed model links .

One thing that all kids should know is to look out for traffic, but there are big boys who have every reason to go for broke when doomsday is in the air. First there are the chronic bears, those who are almost broke from fighting the almost 75% rise during the last three years — put a beggar on horseback and he'll gallop. Then there are those who have lost almost everything and will be taking no prisoners in their desperate attempt to get back their chips and reputation. They will be joined in this by the hundreds of billions of delta neutral money, and funds of funds with short exposure, who must or at least should justify their existence at times like this by pointing to the immense losses that those who played the long side only were exposed to during this squall.

One can expect them to pull no punches in mounting the pulpit to talk about how great their 5% a year returns in the last four years really are, compared to the 15% a year for stocks, because of such declines. They will certainly be joined in this chorus by the big trading firms who always have a bearish bias because they find so many things wrong with our situation that they accept the sacrificial egalitarian idea that has the world in its grip.

The problem is that these speculators will have to be particularly mobile around this time because stocks have such a high return relative to bonds, and because the public is beginning to believe that stocks aren't so bad after all, especially with the 6% earnings yield + 5% growth yield built into the average stock versus 4.5% 10-year bonds. If the market goes down gradually the public is going to come in and prevent the trading firms from getting out of their positions at a profit, so the only hope for the bearish forces is that their lieutenants can fan the flames of fear and take the market down so violently that the public will be too frightened to come in.

This brings us to a fundamental law of street games, which is not to panic. In the games of slap ball I played on a 25-foot long cross street on Brighton 10th court, and other venues, there was always one very big guy twice our age and size who could sometimes be induced to play. In my case it was Alfred Evaso who at fourteen, five foot eight and 150 pounds was twice my weight and one foot taller. He had a way of advancing to third when I was the catcher and then madly running like a steam roller for home on a steal. The obvious course was to panic. But wily players knew that the best way was to step out of the base path, yell for a pitch out, and take a fast pitch and tag him on the ass as he passed you. Such would be very helpful in the market as you wait for all days of decline to occur, and then come in at the close.

The final rule, from Fulghum this time, is to hold hands and stick together. In such conditions as these we have done well, as panic has not occurred and the call that it's every man for himself has not been given by the Captain.

Allen Gillespie adds:

My father always told me a bull market will try to scare you out, but a bear market will slowly devour you. The reason this sounds reasonable to me now is that bear markets relate to prolonged economic weaknesses; hence, time is a critical, but slow moving factor. Alternatively, bull market liquidation is all about margins and stops that are all quickly hit.

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