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August 2005 Posts

8/31/2005
Bullish on the Big Easy, by Andrew Moe

The New Orleans I know and love is no more. Images of destruction pour in 24/7 as the city gives way to epic disaster. It's hard to imagine Bourbon Street's not teeming with life but there will be no reveling in the submerged streets. Tonight the living commune with the dead as they cling to opposite sides of life in the rising water. Looters rage, fires burn and petrochemicals spill into the mix. Conditions seem to have reached runaway proportions.

They say night is darkest just before dawn. It is just before dawn in New Orleans.

I predict the Big Easy will rise anew, ushering in a wave of prosperity centered in New Orleans. Engineers, architects and builders will compete for hurricane-proof designs that will withstand extreme conditions. Plans will be submitted from companies across the globe but the work will be done locally. Unions, contractors, vendors, shops and suppliers will all benefit from an enormous increase in supply. Jobs will pour in. The South is about to go to work.

The effects will be felt through a far wider swath than Katrina cut. If I owned a business selling any kind of water removal/restoration/replacement products or services anywhere in the country, I would be headed to New Orleans right now. There is huge opportunity to be Johnny on the Spot. Contracts will be awarded based on how many able bodied workers you can bring. Prosperity will be felt in many surrounding communities as strong ties to the new city are built. The people that rebuild New Orleans will visit there for many years to come.

The major oil and gas terminals will be rebuilt to withstand a direct hit. Increases in efficiency that were not cost effective prior will be introduced to streamline processing. In the short term, prices will soar but the cleansing effect of removing inefficient parts and replacing them with state of the art will herald future profits. And as we have incessantly heard, this is a big percentage of US supply.

Naturally the lawyers will have a field day. Handshake deals, backroom bargains and wink-wink transactions have all been washed away. I suspect property rights to be active, especially for areas that remain under water. But in the end even they will play an important part in rebuilding one of America's finest cities. After all, this is Louisiana. We took it from the French and we're not giving it back to a hurricane! Deeper, darker and more mysterious than ever, New Orleans will rise anew as the jewel of the South.

Rui Grenho replies:

Being in Europe (Lisbon), the looting I see in New Orleans is more Iraqi than American. Does Mr. Moe's conclusion imply that it will even be more positive here as there will be more to recover?

The Assistant Webmaster adds:

On returning from Stew's with $100 of groceries, my wife discovered a pack of burger patties she hadn't paid for. Seems they were packed into her bag rather than that of the preceding customer, their rightful owner. Our thoughts naturally turned to New Orleans as we feasted on these looted (or  found or taken) burgers..

8/31/2005
Musings on the Aristocrats, from Brett Humbert

For my birthday yesterday, Margie took me to a movie matinee before we went out with the kids. My choice of movies--which she tolerated admirably--was The Aristocrats. For those of you unfamiliar with this far-from-highbrow documentary, it features roughly 100 comics expounding upon and telling a single joke, which has the reputation as the world's filthiest piece of humor. It is, indeed, foul--so much so that even the traders at my firm recoiled in horror when I played them a clip off the movie website. Anything that can offend the sensibilities of prop traders is definitely worthy of exploration.

Well, it turns out that the movie really isn't about the filthy joke. It is about how superlative comedians improvise to create humor. The joke is their vehicle: it has a standard beginning and punch line, and all else in between is improvised. The result is a kind of creativity within structure, as the comedians follow the implicit rule that they can make up anything they want to fit the opening and punch line--as long as they don't repeat themselves.

So many exemplary achievements blend structure and creativity: a symphony, a sonnet, a building, a successful business. It got me to thinking about how the scientific method provides the structure for investigation, but the really great scientists improvise and create within that structure. It's not so different from John Coltrane, Michael Jordan, or any of the classic comedians. The blend of rigor and novelty is what makes for fine humor, drama--and, yes, market analysis.

Over the many years I've been privileged to be part of the List, many participants have expressed to me the point of view that the List's distinctive element is "counting". That's true, I generally reply, but what really makes the List is the analogical reasoning: the taking of truths from other disciplines--and from a keen observation of life--and applying them to everyday analytical concerns. Counting provides the rigor, but the genius of analysis comes from the ability to reason in fresh ways and count the right things.

8/31/2005
A Checkers Player Questions Gas Prices and the Government in Letters to the Editor

8/31/2005
Dr. Ross Miller Writes on Dr. Sharpe and His Ratio

Writing as someone who has never really taken to the Sharpe Ratio, it is generally the case that journalists and other nonprofessionals will mischaracterize theoretical work in finance. The Sharpe ratio is just one take on a reward/risk ratio it is popular because it has one neat geometric property that is wholly unrelated to the notion of "should." The definition quoted here comes closer to defining CAPM if one replaces "volatility" with "beta;" however, "should" is also out of place here because everyone "will" hold an appropriately leveraged version of the "market portfolio," which is, of course, an impractical abstraction commonly approximated by the SPX.

In defense of Bill Sharpe, in my recent retooling to get into "finance teaching mode," I have so far found only three financial theorists who are consistently correct, precise, and elegant. They are Stephen Ross, Philip Dybvig, and Bill Sharpe. These are guys whose written work (including several brilliant papers that were somehow never published) indicates to me that they have really thought through every angle that I could think of and then some. I am happy to take nominations for others to add to the list.

The bottom line:

1. Read the original source and not a journalist's or textbook writer's take on it.
2. All performance (and cost) measures are imperfect and they will be abused and gamed despite the best intentions of their inventor(s).

8/31/2005
Musings on Oil and Energy Markets

8/31/2005
Two of Bo Keely's Latest Adventures

8/31/2005
The Assistant Webmaster Visits Boston

1. Harvard Book Store is always a wonderful treat. Not to be confused with the Harvard Coop, oft-lauded by Chair, which is affiliated with the University. The Book Store, a couple of blocks down Mass Ave from the Coop, is independent and much smaller (unlike Chair, I have a preschooler in tow so my peaceful browsing in big bookstores is limited.) The Book Store is just plain smart. A good selection of good books (excepting the Harvardiana such as this Galbraith encomium) and a beautiful array of well-worth-reading remainders. In homage to New Orleans I picked up a Ballard novel to read on the way home.
2. Also the store has well-selected children's books. I have a good sense for what picture-books my boys will like. I can't pin it down, but I can rummage through a pile and find a few with the right Gestalt. Then I buy the other books by the same author and I'm all set for presents for the next birthday. This time I stumbled on A Camping Spree With Mr Magee and the boys loved it, so I bought Chris Van Dusen's other books online. Other favorites of my boys are Mark Teague and Dan Yaccarino.
3. Returning to Boston after having been away for some years, it's jarring to walk the Freedom Trail and notice the almost spiteful way that recent generations of politicians have despoiled the memory of the Revolutionary greats by erecting massive Stalinist slabs such as Government Center cheek by jowl with the 18th century buildings that symbolize exactly the opposite. Reminiscent of the People's Palace in Bucharest erected by Ceausescu to replace or overshadow Romania's true historical sites.
4. Locals are grousing about the Big Dig, still unfinished after all these years and all these $billions, and now said to be taking on water (literally). The "centerpiece" will go down as a monument of the dollarwise largest waste/fraud/abuse in human history. And of course, unwilling to waste only Bay Staters' money, the good politicians of Taxachusetts have arranged for US taxpayers in general to underwrite. All this for a city of 500-odd thousand, smaller in population than Jacksonville, FL.
5. Durgin Park was maybe 20% full at 7pm on a Monday. I've never seen so few diners there at any time of day. Hard to guess why. True, the R#d S#x were playing at Fenway, but it was a rainy sloppy night for a ballgame.
6. Harvard Square, and the University itself, is getting posher all the time. I dropped by Eliot House, and as I was pointing our where I lived to my (totally uninterested) boys, the super came over, introduced himself: "Let me guess, you're an alum.. I'm not busy, I'll show you around." The Eliot dining room has been re-done; tasteful blonde wood tables and chairs have replaced their dark, heavy predecessors, new hardwood flooring, and a massively upgraded kitchen area. "Now you can order your meal ahead of time." Quite a change from my day, when hungry undergrads were ladled copious mashed "p'tatuhs" by beefy middle-aged women working on a prison-style cafeteria line.
7. The Museum of Science kept the boys busy for 5- 6 hours, although no one attraction really stands out in my (or their) mind. The IMAX movie Everest, playing at the Museum and elsewhere, depicts the chaotic 1996 Everest climbing season from the perspective of the Ed Viesturs party, and is a fascinating counterpoint to the Krakauer book, which recounts it from the Rob Hall perspective.

8/31/2005
Livermore's Words on Disaster and the Markets, Sent in by Kedrick Brown

The influence of energy price strength on the stock market may make this situation a little different from those that have occurred in the past. The energy markets are exhibiting clear bullish action, and they are very sensitive to the slightest disturbance (I've seen this type of action in stocks before).

Energy market action has the potential to break the equity markets, so I don't think pure hurricane vs. stock market stats alone can give full insight into this situation. In other words, the stock market action is not occurring in a vacuum, and there is already a limited sample on hurricane/stock market relationships, let alone hurricane/stock market/energy market relationships, so this situation may be unique.

Anyway, differing opinions is what makes a market. Livermore had both good and bad trades, but the insights in his book about both kinds of trades have been helpful to me as a trader.

Tom Ryan adds:

As we discussed yesterday it is always good to have some numbers rather than anecdotes. Looking back 50 years, taking the top 20 hurricanes, we find six where the market was making a 20-30 day low at time of landfall. Of the six, the market was up four times in the next 20 days (Andrew, Hugo, Camille, Carol) flat once (Ivan) and down once (Donna). And if you look at all 20 you get the same result for the next 20 days as the general 20 day sample over 50 years. So although its a small sample and you wouldn't trade based on that alone, its better than anecdotes from the book by a guy who went bust and shot himself in the bathroom seventy years ago.

8/30/2005
Converting Rotary Motion, by Victor Niederhoffer

An interesting museum near St. Mark's Square in Venice displays two models of machines designed by Leonardo Da Vinci's that convert rotary motion into vertical motion. In one particularly ingenious machine, a cam that is three-quarters of a circle is in continuous contact with another circle (two reduction gears) until the circle breaks and the smaller gear turns wildly by gravity, and a hammer falls. Are there markets that turn around and around a fixed point in revolution, such as soybeans and oil (note soybeans below $6 a few days ago, before oil topped $70), that lead to the vertical motion of a third market?  

Many machines convert rotational motion into linear motion, the most common being the rack and pinion gears used, for example, in the steering wheels of many automobiles. As the wheel rotates, it slides a rack to the right or left depending on which way the wheel rotates. My favorite orange juice squeezer from Italy uses a similar mechanism.

It occurred to me that if such mechanisms are so common in useful machines, they might be applicable to market situations. I asked the Professor to study this. While the results aren't that useful, or else they'd doubtless be censored ("Vic, the readers are going to think I'm an idiot because you keep publishing non-predictive findings and keep the predictive stuff up your sleeve"), I find methods and ideas much more important than immediate useful tips, which are always ephemeral anyway due to the law of everchanging cycles.

The whole subject of gearing, starting with spur gears, is a useful way to think about markets. Two gears engage and maintain a constant speed times force (a smaller gear going faster with a lower force drives a larger gear going slower with a greater force (or vice versa). How many times do we see one market rotating faster but with less magnitude than another? The relation today between oil and stocks is one such example. Every little move in oil up and down creates a magnified effect in stocks, similar to a bike going up a hill in first gear.

       A pair of spur gears

The gear ratios and the different types of circular and linear motion that can result, especially the delayed reactions, seem to me to contain many meals for a lifetime. I recommend that all speculators buy gear toys.

Kim Zussman adds

When I was 12-13 I had an 8" Newtonian reflecting telescope. It had a German equatorial mounting, which is a kind of stand with axles that permits easy rotation of the telescope to follow object-drift due to earth rotation.

Adjustment was done by hand, nudging the telescope around the axis aimed at the point in the sky where the earth's north pole points. However the gold standard was a "clock-drive" motor; an expensive motor and reduction gear set which slowly rotates the telescope to compensate for earth rotation (the full circle is about 1440 minutes). With a clock-drive, not only would the object stay in view, but it could be possible to take time-exposures of astronomical objects!

We didn't have money for such a device, so I built one from parts. Sky and Telescope had an article giving various combinations of spur-reduction gears, in combination with 1-RPM synchronous motor and worm/worm wheels, which would result in good tracking. I ordered catalogs from Dynaco and other gear-makers, and tried to find gears with correct diameters, bore-sizes, and pitch to match the worm and worm-wheel I had found.

There was an outfit downtown that stocked gears that looked right, and I called them several times with various questions. Finally one day my father drove me there to buy the parts. The guy I had spoken with was surprised to see that Kim was a boy because my voice had not changed yet and he thought I was a woman!

The clock-drive actually worked; well enough for extended high-power planet observation, but not enough for astrophotography. Only later as an adult I learned that imaging required extremely precise drive gears, often diamond lapped, to keep periodic error less than 10 arc-seconds on the sky.

Easan Katir adds:

Following up on the Chair's recommendation, here is a Java applet of a motorcycle transmission, animated, viewable from any angle, shift able, perhaps illustrative of a market's changing ratios. put bike in high gear and go fast so your girlfriend will hold tight. When Katrina arrives, certain stocks (ie SGR, GLBL etc) shift to high gear. It takes a few minutes to download. worth it.

8/30/2005
Follow Dick Sears' weekly update of the Gilder Technology here

8/30/2005
Big Al on Dynamic Capitalism

Traveling around the Rockies, I notice lots of Eastern European accents. The youngest ones are working in the hotel/restaurant business, while the slightly older are owners. Romanians in Estes Park, Russians running the UPS store in Vail. And this morning, talking to the general manager of the place I'm now staying, I find that Poles own the majority of motels in Gunnison and Salida. Amazing how entrepreneurs charge into a new opportunity space.

8/30/2005
Speculators Provide a Valuable Service, by Jim Sogi

Speculators perform an indispensable service for the country and the world financial system. In times of panic, disruption or disaster, when many are looking for or need cash at any price, speculators provide the liquidity and take the merchandise. Cash money is worth more in times of panic or disaster when the funds are needed for other than capital projects. For this valuable and indispensable service, they are paid a higher rate of return to compensate for the valuable nature of their service. For the speculator, the service aspect can be as rewarding as the profits.

A friend commented that trading is very painful and stressful and a mistake can result in serious loss. Other professions are no less painful nor less stressful.. A mistake in any field will result in serious loss, even loss of life, or loss of the job. The stress is as great as are the length of hours or years spent mastering and performing the skills. Practice develops the mental and physical toughness to perform the daily task in any area.

Kim Zussman adds:

However the visibility of results in most trading reveals and drives home errors most unambiguously.

Less liquid forms of investing, such as real estate, do not provide moment-to-moment updates on the value of holdings. Consequently, there is less temptation to "cut the pain" when the disease destined to cause the pain is yet unrevealed and undiagnosed.

In health care professions there are many scenarios which result in pain and stress for patients and doctors. Since these reactions are emotions, good practitioners learn how to manage them to the benefit of all parties. Bad outcomes can be understood and endured with honesty and compassion.

I wish that worked for the cold-hearted numerical death spirals of markets.

8/30/2005
Jeff Sasmor Offers a H#mptons Price Report

93 Octane Premium = $3.16
In-town Day Parking = $20.00
Hamburger & Fries = $10.00
Small Ice Cream = $4-5
Localized Hoodie Sweatshirts = $40
Cavorting in the sun = Priceless

8/30/2005
Notes from Abroad, by Roger Arnold

This morning's Wall Street Journal reports: "PARIS -- The French government, facing talk of a Brazilian takeover bid for French metals and mining company Eramet SA and interest from foreigners in a privatization of its large toll-road companies, plans new measures to keep important industries in French hands...

This is disturbing but not totally unexpected. The French announced intentions to privatize ~1,000 state controlled companies ~4 years ago. Since then however every deadline for bringing a company public has been postponed. But, they are still running television adds in the US for Areva, the massive French nuclear services firm and what was supposed to be the first major public offering equity of a state owned French firm. They have missed several self imposed deadlines for bringing the company public and are now about 2 years beyond what they had originally promised. The 3% of the existing stock that is publicly available through Paris has tripled during that period of time and shows no signs of receding. Investors still believe that the French will come through. With Schroeder's 2010 agenda in a shambles as he faces election the French privatization plans have been the hope that many investors have been watching for to show that western Europe is cognitive of the dire economic and social situation they are in. But with the entrance of Turkey now the front issue for the EU and France against it it is increasingly looking like status quo is their economic policy. It is like watching a car accident in slow motion.

8/30/2005
Annual Reports, by Sushil Kedia

When one is unable to avoid noticing how many companies after companies have brought out fat, heavy, glossy, picturesque, colorful, designer composed, nicely bounded, printed-on-luxuriant-paper, ensconced-in-personalized-envelopes annual reports it seems to be surely the final phase of a major expansionary cycle. This one would need corroboration from testing though. One might be able to devise segregation of companies that have picked up these tendencies only recently vis-à-vis the ones that have been indulgent for some years. Another feasible study could be to measure the survival times of such pomp. Might be interesting to hear from those who watched the types of Enron, Worldcom et. al. closely if they too deployed a similar tool?

Hubris aside, this one might have more to do with a degree of deception embedded in markets where the stated goal of Finance Theory of expanding shareholder wealth stretches in the domain of expanding shareholder feelings (and that too with their own money).

8/30/2005
A Flat-Earth Market, by Jeff Rollert

Does 100% transparency (complete lack of privacy) in human behavior lead to central planning??

My recent trip to Medford showed me the same thing I saw growing up on the Cape: that as more older/retired people moved into the area, the more they watched their neighbors and reported just about everything., either to the gossip circuit, police, or town boards. As a result, the list of local ordinances was enormous and out of proportion to the population size.

Were the markets to go fully electronic/screen based (from the NYSE in its current form):

• Would stock prices move toward a central statistical model based on whatever was the current academic thinking?
• Would prices be assisted in that direction, as pushed by new legal strategies against managers/brokers? I could envision a world where it was illegal for anyone to be something other than a "value" investor.

Jim Lackey adds:

• Did electronics make the S&P futures more volatile?
• How many of the S&P 500 are traded on the Nasdaq?
• Do larger cap stocks have lower beta, less volatility, and a larger correlation with the "market"?
• Do Nasdaq stocks have more volatility intraday, weekly or monthly than NYSE stocks with similar market cap and daily volume characteristics?
• Do stocks have ever-changing cycles and become more or less volatile?

Jared Albert comments

my opinion on #1 is that going fully electronic/screen based has made the NASDAQ significantly more volatile than NYSE with it's more orderly market. So just going to electronic doesn't seem to produce a single price.

Perhaps if everyone used the same models with the same inputs, stocks would trade at the same price. However from what I recall, non-linear systems like the stock market are very sensitive to different starting positions, so even if everyone used the same models, if we used even slightly different inputs, I think it's a fair hypothesis that stock prices might remain as volatile.

8/30/2005
A letter to Victor and Laurel on 'Fed Funds Probabilities' by Bill Konrad can be found in Letters to the Editor

8/30/2005
Thinking Outside the [Colors-Only] Box, by Rich Bubb

I found this interesting article about Venetian painters mixing glass micro-beads with their pigments to enhance the overall effects. lesson I see is to combine what would ordinarily be two dissimilar elements and get magnified effects.

They're also teaching me a lesson: to try to go beyond the bounds of what I know and what I think is right, Berrie said. It s a good trick for an old artist to teach a new scientist something.

-truer words rarely spoken, very wise in intent and darned hard to implement-

article: Scientist finds secret Renaissance ingredient Tiny pieces of glass shown to give paintings special glow

8/30/2005
Sushil Kedia on "Running Money"

I just read Kessler's "Running Money".

Kessler's basic premise is - US firms specialize in design and organization. The rest of the world then engages in production based on this design and organization. His favorite example is how the US designs chips on a computer and sends it Taiwan for manufacturing, which then goes on to Malaysia for quality control and finally to Singapore for assembling into a finished good (like a DVD player) and shipping to all around the world. The same story can be told about many other industries.

Since US tariffs are lower than US corporate taxes, one would imagine that imports into the US would be declared as close as possible to their final market price, resulting in a big import figure. At the same time, most of the value added originates from a foreign sub, thereby contributing zero to the export ledger because they don't cross US borders.

In the example of the chip, a design which cost several thousand electrical engineering PhD man-hours in Sunnyvale, CA gets emailed to a Taiwanese fab and turned into a chip for $2. It can then be sold to Toshiba for $10, which then puts it into a DVD player and sells it back to the US through Wal-Mart at $10.50 (5% margin to Toshiba). The US books $10.50 of imports, Taiwan books $2 of revenue, Toshiba books $0.50 of profit. The design parent books the cost of those PhD man-hours as an expense. The value creation of $8.00 is booked to a foreign sub of the design parent in the US. Because the design parent emailed the valuable design to it's foreign sub for no consideration and received no other cash, it pays zero tax. However, since it can consolidate the $8 on the foreign sub's books for GAAP it gets stock market credit for it each quarter.

This distortion created by tax differentials combined with the new world order of a separation between design and manufacturing is, he asserts, responsible for growing and permanent US trade deficit. The continued well being and employment of the US consumer is, he says, evidence that all is well.

If this version of reality is not widely supported, at least somewhat well known.

But I wonder if it has been examined? A simple way to examine this, I'd imagine, is to examine 10Ks of the S&P 500 to estimate how much of revenue and profit is due to offshore entities. Before Congress passed on the tax relief for repatriation of offshore profits, I'd imagine that a great deal of academic study must have gone into this topic. If anyone has a good study they know of, I would be most interested.

8/30/2005
Speaking of Disasters, by Kim Zussman

Mandelbrot and the Expert show a graph of past 20 years of S&P500, with and without the 10 biggest 1-day moves:

Such divine interventions (from a scientific viewpoint G#d is the only one who can predict such days) result in final equity nearly double.

Curious about such outlying events, I looked at SPY daily returns (including dividends) from 1/93-present:

AVG 1.000446678 (0.04%)
STDEV 0.011061084
PRODUCT 3.392134831 (339% total returns)
3169 days total

Eliminating the days which were above or below 3, 4, or 5 STDEV from mean gave total return:

3SD 2.389453394 (41 days skipped)
4SD 2.779139806 (15 days skipped)
5SD 3.521641697 (6 days skipped)

So supernaturally eliminating outlier days from a buy/hold strategy hurt profits substantially unless skipping extremes beyond 5 SD. Perhaps experts in put buying are sad because their turns at the waterhole are something less than 6-days out of 13 years.

8/30/2005
Nothing New Here, by James Tar

Disasters, in this case the hurricane, are often a speculator's best friend. They often coerce the market to establish widespread consensus, and in such frenzy, reliably mis-price various instruments and asset classes to take advantage of. Naturally, disasters, either of the natural or man-made kind, should never, ever be on a speculator's wish list, but a speculator should always be prepared to act.

8/30/2005
The Forest Without the Trees, sent in by Will Huggins

I was checking into what successful PhD defenses had been submitted at the University I'm attending over here in pursuit of my own. I thought you might find the topic of interest to you, albeit with little vegetation.

I have no link, but I'll try to find a copy around the department.

Cheers from Holland,
Will

Dorota Piaskowska
Date of Ph.D. defense: June 27, 2005
Title of thesis: Essays on Firm Growth and Value Creation
ISBN: 90 5668 144 3
Promotor: Prof. dr. Harry Barkema

Abstract:

In an era of rapid technological progress and major political and economic transformations across the globe, changes in geographical and product portfolios of firms become more of a rule than an exception. Hence, prior research investigated which strategies and entry modes firms choose, and how they perform as a consequence. However, relatively little attention was paid to how organizational experience bases are developed and used as companies expand into a variety of countries and industries. In particular, the role of the novelty of an investment to be undertaken and the environmental conditions under which it is attempted, remained understudied. Studies presented in this thesis explicitly address these issues.

8/30/2005
George Zachar contributes to the 'Fixed Income Department'

Full article

Greenspan's valedictory remarks at the Fed's annual Jackson Hole boondoggle included his usual plea to recalibrate social security, and his standard warnings against fixed inflation targets and protectionism.

But he also rolled these two grenades into the tent he'll soon be leaving:

"Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures. The estimates of how much differ widely."

"The surprisingly high correlation between increases in home equity extraction and the current account deficit suggests that an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit..."

By hanging a bullseye on home equity extraction, Greenspan has brought it into the crosshairs every investor and speculator on earth.

The obvious parallel in Greespanography is this 1996 classic:

"...how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions..."

Rhetoric aside, on a summer vacation weekend in the mountains I lack the tools (and frankly, the inclination) to rigorously examine Greenspan's causation chain of home equity extraction -> personal savings -> imports -> trade deficit.

At the very least he has knowingly given the high-decibel doomsters yet another metric to obsess about. By Monday I expect the Street will have every conceivable aspect of this ready to launch in four color pdfs.

The spectrum of short-term outcomes ranges from a late-August shrug of ennui, to markets taking this as a signal that Greenspan's last act as Fed chair will be to kneecap the American consumer, and by inference, the global economy.

Monday's action will reveal a lot about positions.

8/29/2005
"Yes, I Admit It!" by Victor Niederhoffer

I was in Venice at 6 a.m. with canes in hand, and I woke up to receive a quote of  1196 on the S&P. It had been 17 days without a 10-point move up, and the cumulative drop was 42 points. The quote must have been a nightmare, but it was not; it stayed there, dead in the water for hours. It was like the funeral march that comes after the majestic first movement of Beethoven's Eroica. Surely all hope has ended...but then out of the ashes the scherzo comes like laughter. And the tempo picks up under pressure of interest rates so low relative to earnings yield and the inability of the doomsday boys to mount a sustained $1 trillion raid even in August. There is nothing to do in such a case except count. Do gaps of this nature tend to be filled? Perhaps the last 200 in a row don't count?

Easen Katir adds

Or as Larry Williams would say, "Oops". I remember reading a long time ago LW describing a pattern: gap down open on some catastrophe, causing the nervous brokers to call their clients advising them to get out, only to have the day end higher, whereupon they have to call their clients back and say "oops".

8/26/2005
B#ll Gr#ss Flunks Professor Miller's Course

The lack of understanding of basic finance in this article is breathtaking. I guess the SEC must have forced him to disclose that he got a C- in the course where he learned CAPM. No wonder he predicts that the Dow is going to 5000.

Gr#ss's theorem seems to be that the average return for capital assets must equal the average growth of GDP and he seems to think that this is CAPM. Somehow the concept of equity as a residual claim on the assets of a company (a.k.a, a call option) is lost on him. How does he reconcile the historical fact that U.S. GDP grows in the range of 2% to 3% a year and stock prices grow at least triple that rate?

Every time I read B#ll Gr#ss, I appreciate Caroline Baum that much more. She has a grasp of macroeconomics.

Tim Humbert replies:

Not to defend Mr. Gr#ss, but he did say nominal GDP, which has grown at a much higher rate than 2-3%. By that argument, however, a rise in nominal GDP as a result of inflation will increase stock prices. Seems unlikely, with the 1970s being the laboratory case.

The Assistant Webmaster notes:

The Prudent Premiumseller has been crowing about his profits -

P#mco's Default Swaps Betting on GM Debt Beat Funds

Aug. 26 (Bloomberg) -- Pacific Investment Management Co., manager of the world's largest bond fund, says it profited at the expense of hedge funds by betting that General Motors Corp. and Ford Motor Co. bonds would rally.

P#mco sold "several billion dollars" of insurance against defaults on the automakers' debt in April and May to hedge funds and securities firms holding the bonds, Mark Kiesel, an executive vice president who runs P#mco's investment-grade bond trading, said in an July 27 interview from his Newport Beach, California office. He declined to identify the hedge funds or how much P#mco made in fees from the transactions.

George Zachar adds:

1. I wonder if P#mco owned the paper in question, and was therefore "doubling down" its bets on the auto credits.
2. This crowing should be kept in mind the next time a P#mco spokesman claims the firm doesn't comment on its trades.

8/26/2005
Tranchant Analysis from George Zachar

Fannie Mae's portfolio shrank at a 25.3% annual rate in July, largely by not replacing mortgages that prepaid. Prepayments ran at an annual rate equal to 29% of its portfolio last month.

Despite the GSEs' absence from the buyers' pool, mortgage spreads remain near (though not at) historic narrows to Treasuries.

Concurrently, there is a brazen press campaign to talk down the housing market, newfound regulatory zeal targeting mortgage lenders, and a flattening yield curve taking the carry incentive away from potential mortgage bond buyers.

Despite this perfect storm hitting the MBS sector, there's been little (reported) disruption, ex the grumblings of accounts looking for low-risk profits.

The next "looming crisis" is that of MBS sector duration extension, as folks opt for fixed over floating borrowings, resulting in a surge of new issuance. The best estimates I've seen, however, peg this issuance at less than $50 billion thru year end, with sector extension of a fraction of a year, looking at option adjusted measures.

Note that with the agencies no longer buying MBS, most of the buyers are folks who do not need to micromanage/hedge their durations, making for far less volatility and risk in the overall financial system.

Foreign and domestic commercial banks, foreign central banks, and yield hungry global insurance companies are all buyers of the of the various carved-up cashflows spun off US mortgages. At these spreads/carry, hedge funds are not reported to be major players. The buyers are "real end users".

Recall the meta-context of the global savings glut, the paucity of good investment opportunities in ossified Europe, the Wild West nature of Chinese capitalism, a Japan that is actually shrinking population-wise, etc etc etc.

8/26/2005
A Good Poker Book, by Nick Marino

Far from a typical poker book, Barry Greenstein's Ace on the River is more of an EdSpec for professional poker players. Much about the philosophy and psychology of being a pro. Not a how-to, and not a memior. Something more, and better.

8/25/2005
Ask The Senator, a Continuing Series

Q: What do you think of the recent academic paper that finds hedge-fund managers from high-SAT colleges have better risk-adjusted performance?

A: There's more to life and success than SAT tests. I have a good many friends with near perfect SATs who have not been able to even hold a job. I'll take desire and hustle over SAT tests for most any job. In hiring people I've never looked at test scores.

Send queries for the Senator to senator<at>dailyspeculations<dot>com

8/25/2005
Jasper Johns, by Tom Ryan

Last year I visited MOMA when it was housed in its temporary dwelling in a warehouse across the river. MOMA had converted this warehouse into six or seven large rooms with dividers. In one room I noticed the way people were interacting with the work of Jasper Johns. The room, as is typical of any gallery, was fairly quiet but there was chatter coming from people who were viewing Johns's work. About half the patrons seemed to have negative things to say about the two paintings of his that were on display, "little Johnny could have done that in kindergarten" or "I can buy some paint and make something like that." Yes. But the interesting thing was that of all of the work in the salon, and there were many other very fine and famous works in the same room, it was the two paintings by Johns that people spent the most time looking at. So his works were the most engaging, if not the most popular.

Today, when the stock market is trading in such a tight range after making a substantial new 30 day low yesterday on rising volatility, reminds of that day in MOMA. People are fully engaged staring at the market but can't quite bring themselves to buy into it. A buying opportunity? I call this the Jasper Johns Effect.

8/25/2005
Unshod, by Kim Zussman

    Collab and Kim share a close moment

Research shows that man's lesser toes (the four excluding the big toe) develop smaller if he wears shoes. Which stands to reason since toes need not develop as much for grip and stability once hard soles were adopted.

Other research suggests that early man began widespread wear of shoes about 35,000 years ago; the same era when stone tools, art, and jewelry developed. Presumably these accoutrements supplanted primitive but effective mating incentives like club and hair-pull.

The transformed bone structure is not evolution. Bone is a dynamic organ which increases in size and density with increased loading and exercise. Even the mild pressure of teeth in jaw-sockets stimulates bone formation. When teeth are lost, jawbone resorbs and in extreme cases becomes thin and fracture-prone.

Fossil bones which are enlarged and thickened evidence of the historic strains before man was shod..

8/25/2005
Today in Letters to the Editor Leonard Lerer Writes About the Holy Grail of Speculation: Prediction

8/24/2005
Relativity, by Dr. Mike Ott

A friend and I discussed whether Einstein would be a genius if he lived today. My friend said that Einstein would have been a genius no matter what time period he lived in. I disagreed, saying that any discovery is predicated on the knowledge leading up to it. Einstein took a radical step and formulated a revolutionary new way of looking at the world. If he hadn't done it, perhaps no one would have. His math was severely lacking, but perhaps computers would have helped to overcome this shortcoming. This led to a discussion about how tools lead to new discoveries, and that new tools are potentially more important than new discoveries based on old tools. Somehow this discussion led to the topic of music. We wondered if there were songs that would be popular no matter what era they were released..

8/24/200505
Reflections on Leda and The Swan, from The Swan's Point Of View, by Peter Gardiner

Deception, Thy name
Is Mistress; Hussy Vixen
Conception time's here.

8/24/2005
The Proper Equipment, by Jim Sogi

HydroEpic boards look cool, but I've tried similar and also made a number of carbon fiber boards. I usually get custom made boards to suit. Like a suit, hard to get off the rack.k.

8/24/2005
A Perspicacious Spec Reads the Newspaper, a New Feature

Woman Offended by Doc's Obesity Advice
Aug 24 9:28 AM US/Eastern
ROCHESTER, N.H.

As doctors warn more patients that they should lose weight, the advice has backfired on one doctor with a woman filing a complaint with the state saying he was hurtful, not helpful.

Dr. Terry Bennett says he tells obese patients their weight is bad for their health and their love lives, but the lecture drove one patient to complain to the state.

And if he said nothing and she died of heart failure, her estate would sue for his not having warned her...

8/23/2005
Ask The Senator, a Continuing Series

Q: Has Dan Norcini found a potential trap in relying on COT data?

A: He misses the entire point of commercials vis a vis open interest and price levels, but also makes some very good points. COT is not a be-all end-all indicator, but certainly what the commercials own of total open interest can be most revealing. The commercials' long position as a % of open interest dipped this week into the area close to market highs. I find that looking at the COT position long or short vs total open interest is a good way to evaluate what this bunch is really doing.

Having used the COT data for more than 30 years, I'll tell you it is not a perfect timing tool but it is a very good setup tool.

Scratch the notion from your noggin that commercials make money trading. They don't. They don't trade as we do. They are hedgers, so the lower prices go, the more a user will buy, which lowers the cost of his product made from the commodity. The higher prices go, the more a producer will sell, if that price is above cost of production.

The large specs are funds, hence you see lots of them come in at 25, 50 and 255 day highs/lows where the major breakout buyers are to be found.

Send queries for the Senator to senator<at>dailyspeculations<dot>com

8/23/2005
Big Al Contributes to The Dept. of Chronic Bears

When I left Arizona a few weeks ago, regular gasoline (87 octane in AZ) was in the 2.40's. Now in the Rockies regular (85 octane in CO) is 2.80. However, nowhere is there any indication that this has put a crimp into anybody's summer spending plans. The campground, motel and business owners say it's been a "very busy" summer. And Gene, the camp host at Irwin Lake outside Crested Butte for fourteen years, says it's been "the busiest season ever".

Part of this could be ample water and few fires this year in Colorado. This compares to 2002, when fires and smoke and extremely low water levels made the summer a disaster. (A useful planning tool for summer trips is NOAA's spring snowpack data. More snow generally means fewer fires, nicer creeks and rivers, ample drinking water. Note how dry the Pac NW is this year -- not a good thing.)

Yesterday I did a quick survey of motel parking lots here in Gunnison. At the Comfort, Quality, Super 8 and a few local brands, there were 71 vehicles (not counting motorbikes), of which 46 were trucks or SUVs and 25 cars or minivans. Now, this is 4WD country, but with SUVs and trucks coming in at 65%, travelers are guzzling as much gas as they need.

It appears that people are not spending their marginal dollar on gas, so the price of gas doesn't restrict their budget. (Maybe credit has relaxed so far beyond demand that for most people there just isn't a marginal dollar at all right now.)

Real estate: Crested Butte is where everybody wants to be. Old Victorians in town that went for $300K as recently as 2002 now sell for $900k. Which creates an interesting disconnect between the value of residential vs commercial real estate. People might pay $900k for an old wooden house on a small lot, but they won't pony up $30 for a hamburger, so the commercial building owners can't just triple their rents (unless they're renting to real estate firms?).

Back when the National Forests were being put together, there were private mining claims scattered around within the NF lands. No provision was made for these claims to revert to the USFS when the claims ran out. Instead, they would wind up on county rolls for unpaid taxes and could have been had for the balance. But they sat there for years because few thought the claims worth buying. Now this same property can easily go for $100K/acre or more.

In sum, from here it looks like hotels/motels and restaurants are doing just fine this summer, maybe even having a banner season.

But this from the Dept of Ursine Voodoo: Gene at Irwin Lake reports that for the first time in fourteen years they have had a bear raiding the campsite. And it's not because times are hard for bears. Yogi is coming down for the dumpsters because the fat and happy humans are tossing so many goodies from their pick-a-nick baskets.

When times are good, people get sloppy and wasteful. True for markets, too?

8/23/2005
James Tar on The March of the Penguins

This is a masterpiece in film-making. It has been some time since I have seen a film where the cinematography, narration, and soundtrack are so perfectly matched that the sum is far greater than the parts. It exemplifies that nature is the superior plot to man-made stories, and reminds the speculator of many many things:

1. Even with perfectly matched partners, disaster always lurks.
2. Odds and probabilities guarantee that not everyone can win.
3. The market's elements are never static. Conditions change, and thus does your chance of success.
4. Not everyone survives.

8/23/2005
Summer Fishing Holes, by Jim Sogi

Always looking for those secret fishing holes. Another good Hawaiian fishing technique is palu palu using a hand line, a heavy cord with a big treble hook about 2" across, and a 6" rag tied near the hook, with a weight. The chopped fish parts are wrapped in the rag and loosely looped off, enough to hold it together as the hook, line, sinker and bait bag drops deep into the water, say 60 fathoms, till it hits the end of the line, then with a jerk, the palu (bait) is released when the bag opens at the correct depth. The fish, upon smelling the bait, start eating the hook, and hopefully 20-170 lb. tuna comes up. Sometimes after a big fish ball runs in the morning, the fish don't bite the rest of the morning. They go deep. Just like the market today...

Reading the news Sunday the reporter said that trading would be slow summer doldrums Monday. Assuming that they will be 1000% wrong is usually a good bet. Anyway, they were wrong, as today showed, both in volume and these big liquidity holes, nice summer fishing holes. Main thing is to put your bait at the right depth so that the sharks don't steal your bait and your fish down deep. It happens. Here is the data showing the lunch hour fishing hole. Might be some big ones down there, just watch out for the big sharks waiting to eat your bait and take your whole fish.

SP Globex Sept 05, Central Time
Cum Sum of Trades at        bid          ask     price
8:40-9:12                  47887        57318  1230.50
9:12-12:15:               206151       193684  1218.75
12:15- close               78841        93564  1223.50

vol Monday 789k
vol Friday 484k

(Just for the record, I never look at daily volume except to show here how wrong the reporter was.)

8/22/2005
Three Variations on Duplicity, by Victor Niederhoffer

When I read anything by O'Brian I learn a million things about duplicity, economics, medicine, food, strategy, geography, and the eminent traditions of the British Navy that made the world free.

Most recently I read the Ionian Mission, and found that Jack had to take the helm from Pullings. The Admiral had ordered his ship to head out on the tide but Maturin was late as usual, this time because Yagiello had been howling in the Armenian manner at his horses, and a lower class horseman from England had not deferred. But Jack had too many hands on board who were masters at deception and he was afraid that they'd overdo it under Lieutenant Pullings, and they'd be smoked. So he had to master the extent of deception so it wasn't too obvious that they were trying to make it look like they were working hard by doing nothing. This is at least a third-level form of deception.

It's practiced by Gail Niederhoffer's dog Lucy as well as the proverbial monkeys. Lucy likes to feign a bark and a rush to the front door to greet a visitor when good food is on the table so the dinner people will get up and she can rush back to steal the food. Apparently this is common among high-IQ dogs. My four year old niece is very good at doing this, pointing to the apple juice when her mom isn't looking so that my mother will give it to her without arousing suspicion and then giving her back the package so she won't be smoked by her mother.

There is a certain rule of law to the level of deception used in Naval morality. It's acceptable to feign a flag of a friendly county when you're a belligerent, but never to surrender and then fire, or indicate you're drowning on a rock and then start shooting. That would get you executed or ostracized.

I finds the same kinds of deception on the floor. There's the first level, where you put an order in and the member immediately puts his order in at the same price and you can get filled only after after him, when it goes bid or offered against you. And there's the second level deception, where the member knows you are going to have to buy or sell more and runs ahead of you to telescope the ultimate price. Then there's the third level, where the member tells you he has a big order or an announcement is coming and it's good to get out before the announcement comes because it's going to go against you, a process that will enable him to extricate from the position he's put on against you.

Of course many of these processes are indirect, and not done with agita but are merely the final outcomes of the mysterious and horrible workings of the mistress of markets, and one hastens to add that even with this duplicity, the customer gets an infinitely better deal amidst this den of vipers than he does on the gentlemanly rings and booths of the monopolistic specialists on the white-shoe exchanges where individual shares are traded.

As for how the levels of morality of deception on the floor and how it corresponds to not pretending surrendering, I have never known a broker to overtly pretend he is bankrupt and then wait for you to put on a small position and then bury you with big size. That, if it occurred, would be done with indirection.

Big Al adds:

We have two Australian shepherds, Dignan and Trevor. One night, around midnight, the two humans are asleep in the bed, and Dignan, is curled up in the space between, near the foot of the bed -- the only available dog space. I wake up to see Trevor casing the bed on each side and snorting quietly in disgust that Dignan occupies the prime spot. So Trevor goes down the hall into the TV room and lets out a there's a cat in the back yard bark. Immediately, Dignan leaps up, runs down the hall, through the  TV room and out the dog door, barking at the non-existent cat. Whereupon Trevor trots down the hall and into the bedroom and hops up into the warm, vacant spot. And Dignan prowls the back yard wondering where that darn cat is. I try not to fall out of the bed from laughing silently....

8/22/2005
Like an Old Friend, by Victor Niederhoffer

On a trip back from Maine, the first thing that comes to mind is that McDonalds has saved more lives from car accidents than all the safety rules since the beginning of time. Their coffee is excellent and after billions of servings in tens of thousands of restaurants, they've come up with the perfect blend for taste and staying awake. I had such a coffee on my journey and it kept me awake infinitely better than the comparable cups at competing places.

Some other great things about McDonalds:

1. It's like an old friend. You always know you're going to get the same food and of a high quality anywhere you go. Their limited menu from which billions of people have been served makes the incentive that McDonalds owners and customers alike have to create a better product. This means that each product has evolved so it fits the know-hows and tastes, and aptitudes of all humanity.
2. Everything is special, unique. The natural flavor in their French fries. The vegetable oil they cook them in. The flavor of their fish fillet. The variety of the goods served range from tofu and ginger salad to yogurt with fresh strawberries and a granola, fruit and walnut salads -- at all of their restaurants now.
3. Thousands of businesses and millions of employees have prospered and learned about customer service and responsibility from working for or running one, (or many), of the 30,000 McDonalds restaurants.
4. How many people have been made happy and clean by their clean restrooms, been able to go into a safe well lit establishment for their ease of mind, had their deals closed by young lawyers working late at a 24 hour establishment, had a chance to enjoy a family dinner with their kids or a meeting with their friends without being chased out or harassed, been able to read a book with good lighting -- or in the case of a McDonalds in New Haven, had an opportunity to run a club of antique car hobbyists in their parking lot without hassle and in complete safety.

Not to be minimized is the freedom that McDonalds provides for all families to allow a two wage earner family where the cooking doesn't have to be at home every day. And related to this are all the men that don't have to worry about messing up their home and cleaning the dishes for a breakfast. I once read that something like 15% of the population eats breakfast at McDonalds each day. And considering the opportunity cost of cooking, and cleaning the quality of the Egg McMuffin, this seems like a reasonable choice.

It's a litmus test for the servile people to hate the fast food restaurants because as Durkheim said, such restaurants take away the conspicuous consumption that they were able to achieve by being able to afford a meal away from home that their lower status neighbors or competitors were not able to afford. Don't tell me however that the lack of alcohol at McDonalds, the cleanliness, the lack of smoke, the ability to be with their kids has not done more for the happiness and good of the world than all the do-gooders and tree-huggers combined.

Jason Schroeder Adds:

Having eaten too many times, too young to know better, at my slow food haven years past near Spring & Sullivan, I lost the desire for the McDonalds near-taste.

(South African radio advertises the safety effects of a frequent snack break or free cool water break during the insane Easter weekend driving.)

When I have traveled, I have traveled alone without performing any initial research of my destinations. Everything is totally new, very raw. I want to interact with a place like I might belong there. But one McDonalds break in Tokyo or Rome or Reykjavik brings order to a jumble of senses and experiences. Every expectation is unchanged. There is no need to worry that the liturgy of ordering changes. There is essentially no barrier to satisfaction save the noises one utters. ("Minding the gap" of maddening nuances introduced by McDonalds in England.)

I found that I needed a McDonalds about once a week to recharge for the adventure.

J. T. Holley adds:

My McDonald's stories, diatribes, and opinions:

1. I once got to sit and listen to Lou Holtz speak to a bunch of recruits at PaineWebber. He mentioned that he wasn't a good investor, he thought of buying a McDonalds' franchise but once he saw the sign Millions served he thought he was late to the party.
2. Being a father of three, I agree with Vic that it has brought families together and given a environment to enjoy a meal in between whatever activity is being done i.e.. Football, soccer, church, pool
3. The one point that I will disagree with Vic and suggest that cleanliness just isn't there is during flu season. Being a father of three, my wife knows now that when our children go play in the Playground or Spacestation provided by McDonald's then three co-pays totaling 75 bucks and Amoxicillin totaling 15 bucks must be added to the tab. Those play area's are Petri dishes. That is close to a 100 dollar meal!

Kim Zussman adds:

As kids we inadvertently infuriated our mother with our enthusiasm for McDonald's hamburgers and indifference to hers. She made the case that they used low-quality meat whereas hers was ground sirloin. But they had made a science of taste and economy, and poor mom couldn't overcome our animal instincts.

These days at airport and mall food-courts there are various "healthy" fast-food alternatives, including pasta, salads, and wraps. Usually only the McDonald's line is long as preferences, convenience, and economy demonstrate ecology.

Years ago I met Betty Agate, who with her husband opened one of the first McDonald's franchises in the midwest. She loaned me Ray Kroc's book which described their franchise. On the morning of the inaugural opening, Betty's husband put their last $50 in the cash drawer for change. And they needed it since there was a half-block line at the door by the time they opened. Ray Kroc used the Agate's busy, clean restaurant as a showpiece in selling additional franchises. This McDonalds was very successful but eventually the Agates had a falling out with Kroc and sold the business.

Andrew West comments:

On a recent vacation in China, in Shanghai the golden arches lured my daughter to lunch a couple of times. The menu had more variety there, and the localized new items tasted reasonably good, more interesting than a Big Mac at this stage of my life. Do not believe what people say, a public restroom with commode is still hard to find even in Beijing and Shanghai, when out and about, and that in itself is worth the inexpensive price of a meal at a Chinese McDonalds, though I would recommend having only a taste so as to save one's appetite for an evening banquet.

Even more interesting was that KFC in China is superior in almost every way to American KFCs. Not only do they pay greater respect to Colonel Sanders than Americans, their menu offers much more variety, and better quality fried chicken as well.

Thomas Miller comments:

A movie you might not like is Supersize Me, where Morgan Spurlock does a Michael Moore type documentary about what happened when he ate nothing but McDonalds. for a month, and had the clerks supersize him every time they asked. The big surprise was that doctors told him that his health was suffering from this stunt.

If you eat nothing but the calorie and fat laden menu items at McDonalds your health would suffer, but they also have added more healthy choices to choose from. I understand Spurlock ate about 5,000 calories a day which is way more than anyone should eat. Because of this, his "documentary" was slanted. He must have learned from the other "documentary" maker who looks like he eats 5000 calories a day at McDonalds. A woman reportedly ate nothing but McDonalds for 90 days and lost 37 lbs. by watching calories and eating healthier choices. .

Management is smart. The stock stumbled from March to July but has recovered nicely since with comparative sales increasing due to new and healthier menu items. They are the 800 lb gorilla of fast food, and although sometimes slow to adapt, when they do they are tough to compete against.

Steve Ellison adds:

Regarding the "servile people", there is an excellent article by Anthony Daniels in the current issue of National Review. Commenting on the Live 8 concerts, he makes the following excellent points:

1. Ostentatiously showing one cares about African problems gives one an appearance of virtue that is a counterfeit and may in fact prevent one from the much more difficult (but less socially praised) task of showing real kindness to the people with whom one is directly in contact.
2. It is not at all clear that aid from wealthy nations has benefited Africans at all. Simply handing out money has enabled monstrosities such as Tanzania's forced resettlement of 75% of its population into communes (a 1960s initiative much praised by Western "progressives" at the time). Africa's problems, by and large, are internally generated, and there is little or nothing that residents of wealthy nations can do to solve those problems.
3. The spectacle of aging rock and rollers waxing moralistic is quite strange.

8/22/2005
International Consumer Prices: Magic Numbers, by Nick Marino

The Euro has held the $1.20 through $1.24 range more often than any other since 2001, which leads me to believe it will continue to bounce in that trading range. Note how popular the .?8's - 0.88, 1.98, 1.08 - seem to be.

   0.86   19 xx
   0.87   51 xxxxx
   0.88   86 xxxxxxxxx
   0.89   78 xxxxxxxx
   0.90   65 xxxxxxx
   0.91   58 xxxxxx
   0.92   41 xxxx
   0.93   15 xx
   0.94   15 xx
   0.95   10 x
   0.96    7 x
   0.97   48 xxxxx
   0.98   83 xxxxxxxx
   0.99   74 xxxxxxx
   1.00   40 xxxx
   1.01   33 xxx
   1.02   15 xx
   1.03   14 x
   1.04   13 x
   1.05   20 xx
   1.06   22 xx
   1.07   51 xxxxx
   1.08   70 xxxxxxx
   1.09   41 xxxx
   1.10   28 xxx
   1.11   21 xx
   1.12   28 xxx
   1.13   30 xxx
   1.14   48 xxxxx
   1.15   33 xxx
   1.16   40 xxxx
   1.17   53 xxxxx
   1.18   61 xxxxxx
   1.19   64 xxxxxx
   1.20  100 xxxxxxxxxx
   1.21  131 xxxxxxxxxxxxx
   1.22  121 xxxxxxxxxxxx
   1.23  125 xxxxxxxxxxxxx
   1.24   99 xxxxxxxxxx
   1.25   61 xxxxxx
   1.26   53 xxxxx
   1.27   51 xxxxx
   1.28   57 xxxxxx
   1.29   70 xxxxxxx
   1.30   71 xxxxxxx
   1.31   48 xxxxx
   1.32   38 xxxx
   1.33   43 xxxx
   1.34   25 xxx
   1.35   19 xx
   1.36    5 x
   1.37    2

8/22/2005
The DailySpec Dept of Education Continues, With a Second Market Tutorial, by Phillip J. McDonnell. To see the his first tutorial, click here.

Q1: Correlated Markets

There are two concerns when trading correlated markets. First if you trade both markets or spread them somehow, then you are doubling the vig. Make sure that any edge you have is large enough to overcome the double vig.

Second, when making positively correlated trades it is necessary to reduce position sizes. The reason is that if one loses the other is more likely to lose than if it were uncorrelated. On the other hand if you are trading assets which are negatively correlated then it may be safe to increase the position size because they are less likely to lose at the same time. The amount by which you change position size is a function of the covariance (not correlation) between the two assets. There is a whole theory of portfolio management which deals with this and any reference on Sharpe - Markowitz portfolio theory should be helpful.

Q2: Optimal Trade Size

The maximum trade size f as a fraction of net worth is that f which will maximize the sum:

sum[ p(i) * ln( 1 + f * r(i) )  ]

where:  r(i) is the return number i (expressed as a fraction and derived
from backtesting or theory)
        p(i) is the probability of that return

For counters the inputs to the above formula are relatively easy to obtain. Take each backtesting outcome as r(i) and set each p(i) = 1 / n where n is the number of outcomes in your sample. Then find the f which maximizes the sum.

Note that this f is only optimal in the sense that it maximizes the compounded return if one looks at this as a series of trades. In that sense it should be thought of as 'maximum f'. One should be especially cognizant of the fact that it assumes a utility function which is indifferent to risk.

One simple way to use the above formula is to calculate it as is and then back off from the maximum f. If we graph the above formula it looks like an upside down letter U. The peak of the graph is the point of maximum compounded return, but the graph is relatively flat around the top. So reducing one's f from the maximum will cost little in return but can often greatly reduce the oscillations, risk and drawdowns of trading. Ultimately the decision as to how much to back off is a personal one. If you are more a risk taker back off only a little, if more conservative reduce the f even more.

The above formula is preferred to the Senator's because it takes into account every outcome from backtesting and weights each appropriately by both probability and the natural log which represents that outcome's contribution to long term compounding. Note that the formula gives the largest drawdown the heaviest negative weighting because of how the log function works. It provides a more robust estimate of the compounded return than just using the largest loss. It's a bit like estimating the average size of a basketball team by only looking at the shortest player.

The Kelly formula is often touted as the ultimate scientific money management formula. Unfortunately it is only correct for two outcome games of chance such as coin flipping. For such games the maximum f and the Kelly formula will yield the same result. For multiple outcomes such as trading the Kelly formula is just plain wrong. It can literally lead to ruin as demonstrated by numerous simulations. Traders should avoid.

The max f formula directly deals with the question of how much to trade each time. If you are on a losing streak using a fraction will automatically reduce your trade size as your account size diminishes. If we recall Zeno's paradox - take 1, divide by 2 to get 1/2, then 1/4, 1/8 .... We never quite get to zero. In the same way using a fraction of net worth also avoids ever getting to zero and thus eliminates the gamblers ruin problem. Thus the formula directly deals with the issue of successive losses.

8/22/2005
The place where we all got drunk, by Jim Sogi

The word broker is derived from the French Brochier who were ones that bought kegs of wine from the farmers and tapped them and sold the wine in cups at the fairs in twelfth century EU. The name 'Manhattan' is derived from the Delaware Indian language word "Manahachtanienk". Indian legend has it that when trader speculator Henry Hudson came to Wall Street, He sat in a circle with the Indians. Hudson produced a gourd and poured liquid into a cup from which he drank. He refilled the cup and passed it around, but the next Indian smelled it, and passed it and the responsibility on to the next in line. The cup went almost all the way around the circle when a chief jumped up and lectured the tribe on the discourtesy and the consequences. He bid farewell to the group, and drained the cup. The chief staggered and fell and was soon sound asleep. The chiefs began to mourn him, whereupon he jumped up, declared how well he felt, and asked for more. Soon the others joined him and all were intoxicated. The Delawares and the Mohicans called the place, Manahachtanienk, which means, "the place where we all got drunk". A very fitting name, especially considering the open bar at Delmonico's at the Spec Party where Yale Hirsch practiced Kung Fu moves wearing a Chinese outfit, which will pass into the legends of the Spec-list. From The Lore and Legends of Wall Street, Sharp.

8/22/2005
Errol Morris Gets Inside People's Heads, by Ross Miller

Errol Morris is not the world's most popular maker of documentaries. That honor belongs to someone else who is unworthy of being plugged by me. Errol Morris is, on the other hand, arguably the best documentarian and I have never seen anyone willing to argue that the other guy is the best. Morris does not rant, he does not rave, he interviews.

In the early part of this century, Errol Morris did a series for the cable network Bravo (now part of GE) called "First Person." The show lasted for just two seasons, with the second season being noticeably shorter than the first. The show then dropped out of sight until coming out on DVD a few weeks ago. Well, it didn't drop out of sight entirely. One of the subjects for the series, Robert McNamara, did so many hours of interviews that they could not be condensed into a form that would fit in the cable series. Instead, his interviews were turned into a feature film, "The Fog of War." That film won the most recent Oscar for best documentary-an award that had already been devalued by the other guy.

Robert McNamara, former head of Ford Motors and the alleged architect of the Viet Nam War in his days as U.S. Defense Secretary, lies at the intersection of genius and death. These two topics are the parallel themes that run throughout First Person. This makes sense because Errol Morris is one of the few certified geniuses running around-he is a recipient of the McArthur Foundation's five-year genius grants-and he harbors a morbid (is there any other kind?) obsession with death. Most of his feature-length documentaries involve death front-and-center: murder, euthanasia, pet cemeteries, etc. The notable exception is "Fast, Cheap, and Out of Control," a series of intertwining interviews that clearly contains the embryo of "First Person".

I first ran into "First Person" on IFC, the abandoned cable sibling of Bravo at the start of the series' second season. IFC would later rerun the first season, so I saw most of the interviews before their recent reincarnation on DVD. I even taped a few of the better ones. The show was hard to ignore because it was so visually arresting.

Morris specializes in creating two kinds of images. The first kind is that of the subject being interviewed. These images are as "in your face" as you can get. Morris does the interviewing, but rarely appears on-screen and when he does he is on a television monitor. Being a genius, Morris has invented an interviewing machine called an Interrotron in which he conducts the interview as an image on a monitor that is placed adjacent to the camera that is filming the subject. This creates the illusion that as the subject is talking to Morris that he is really talking directly to the audience. It is an effect that works, possibly too well. Morris uses a second kind of image to illustrate the points being made by the subject. These images generally have a mid-twentieth-century army instructional film flavor to them, though there is enough variety in them that they wear only a bit on the viewer (at least this viewer).

As for the content of the interviews themselves, I would say "disturbing" is an adequate one-word description. More than adequate. Picking the most disturbing of the seventeen interviews makes for good cocktail-party conversation and I would give the nod to "Smiling in a Jar," an illustrated chat with the curator of a museum of medical oddities. It is the only episode that I stopped in the middle of and have no intention of returning to. Ever. And I don't consider myself squeamish.

The best interview in the sense that people would actually enjoy it and find it interesting is "Leaving the Earth," which features airline pilot Denny Fitch. He tells the story of finding himself as a passenger on a DC-10 whose center engines explodes and takes the plane's navigation system with it. Fitch goes to the cockpit and manages to crash-land the uncontrollable aircraft in a cornfield purely through seat-of-the-pants improvisation. Fitch manages to save over half the lives on the plane, but continues to feel guilty about those who perished. This is the perfect interview to watch after a "hard day at the office."

Another tale of impressive human accomplishment is "The Little Gray Man," the story of the CIA's master of disguise, Antonio Mendez (assuming that we can believe anything he says). His stories of how to avoid detection in exotic foreign surroundings would seem to have direct application to the financial markets.

Two interviews that have a lot to do with genius and little to do with death involve two men, Rick Rosner ("One is a Million Trillion") and Chris Langon ("The Smartest Man in the World"), who are geniuses as measured by standardized tests. While one might expect such smart guys to be professors or hedge fund management, both spent much of their working lives as bouncers. Apparently, bar bouncing is a career that, between fights, gives one a lot of time to think.

Rick Rosner is by far the more interesting of the two geniuses. Just as Cameron Crowe did to write the book (better known as the movie) "Fast Times at Ridgemont High," Rosner went back to high school as a young adult. Unlike Crowe, however, Rosner did not obtain the permission of the school officials and also unlike Crowe he did it not once, but several times. Apparently, Rosner did not enjoy his first excursion through high school and wanted what he calls a "do over" (in golf, this is known as a mulligan). This is the central theme of his interview because when he lost as a contestant on "Who Wants to be a Millionaire" he also wanted a do over because the question that he was eliminated on was "flawed."

I found Rosner's desire to return to high school as long as he could get away with it to be rather curious because I have long subscribed to the popular theory that "real life" is nothing more than an endless recapitulation of high school. Rosner also subscribed to this theory and refers to high school as "abridged real life," a form of living that goes on in a controlled setting. Rosner seemingly prefers the abridgement to the genuine article and so continued his secondary schooling until he could no longer fool the authorities.

Both Langon and Rosner are amateur physics. Rosner's take on physics, which he calls "lazy voodoo physics," is particularly enchanting. He posits an absurdly long age for the universe by the standards of contemporary science, presumably because the extra time is required to provide each particle with the requisite number of do overs.

The magic of Morris' interviews is that one really gets the feeling of looking inside people's heads and what is in there is, like in real life, not always attractive. It makes sense that the subjects are more narcissistic than the average person is; however, these subjects also come off as a rather pathological bunch. If psychology classes are anything like they were in my student days, it is easy to see this DVD collection being used as instructional material. (I sat in on a psych class at Cornell in 1972 where tapes of famous alum Allen Funt's "Candid Camera" TV shows were used to illustrate several points.)

Next time, I get back to serious stuff. The beginning of my summer was spent finishing up the first round of research that I was doing on mutual fund expenses and writing the results up as a working paper. My next piece looks at how some basic financial engineering tricks can be used to gain new insights into what mutual funds really cost their investors.

8/22/2005
Disruptive Technology, by Jeff Sasmor

Fujitsu has developed what it claims is the world's first electronic paper that can be flexed, can display colour images and can do so when the power is turned off.

links here and here

Analysis. The end of conventional print media approaches

8/22/2005
Brain Damage = Investing Success, by Nigel Davies

Better still may be to have a fully functional brain yet be able to overcome emotional responses with strength of will. There's a good example of this in the sci-fi novel Dune in which Paul Atreides faces the 'Gom Jabbar'. Also in every sporting contest devised by man in which the winners are those able to push themselves beyond the pain barrier.

It's a pity that so many people believe that the only way to overcome emotional responses is to have brain damage. It seems a bit like the efficient market hypothesis in which the academics decided the markets had to be random (and that anyone who succeeded was a lucky monkey) because they, in their wisdom, couldn't find any pockets of non randomness themselves.

Nigel

'Dune begins on the planet Caladan, which is ruled by Duke Leto of the House of Atreides. The House of Atreides is one of the families that rules over the planets and planetary systems of the universe. Duke Leto s son, Paul, is in bed when his mother, Jessica, and Reverend Mother Mohiam check in on him. The old reverend mother mutters that Paul may be the Kwisatz Haderach, the one who brings about important changes in the universe. Reverend Mother Mohiam says that the next day, Paul will meet her gom jabbar, an instrument that poisons and kills instantly, unless he passes her test. To test whether Paul is human, the Reverend Mother Mohiam has him put his hand into a small box. The box brings great pain to Paul, but he knows that if he moves, the Reverend Mother Mohiam will stab him with the gom jabbar. He passes Mohiam s test, which means he is a human being and not an animal. He then discovers that Jessica took the same test long ago; the reverend mother was her teacher at the Bene Gesserit school. The two women reveal to Paul that something terrible will soon happen to the House of Atreides and that his father will die. The two women tell Paul that the duke s death will happen soon after the Atreides move to Arrakis, the desert planet, now ruled by the Atreides s mortal enemies, the Harkonnens.'

Taken from sparknotes

8/22/2005
Fish Finders, by Jim Sogi

The fisherman have fish finder sonar that can see how deep in the water the fish are. The computer display shows the fish there. You bait your hooks and drop them as deep in the water to where the fish are going to bite, and wait. One rig fisherman use is called 'damashi' where several hooks are tied in a series along the line, so as to cover different depths on one dunk.

Traders have their statistics to find where the fish will be. They can bait their orders and lower them to the correct depth and hope for a fill. Some time ago the writer posted a study that gaps over 4 points have a good chance of getting to the prior open price during the day. The 'gap gets filled' is standard trader's lore which tests well. If one was bullish, and wanted to add to longs, or enter, dropping some bait to around yesterday's close in the gap area might have yielded some nice fish without suffering a draw down by chasing the open.

8/22/2005
Why graphical Analysis is important, by Jim Sogi

M. F. Osborne in "The Stock Market and Finance From a Physicist's Viewpoint" and Francis Diebold in Elements of Forecasting , two recent favorites, recommend graphing and eyeballing the data before doing any statistical analysis or choosing a model to use. Everyone looks at the price charts, the basic workhorse of the time series, but when detrending and looking at the first and second moments, "the human eye is a far more sophisticated tool for data analysis and modeling than the most sophisticated modern modeling techniques. Graphical analysis alone will not get the job done, but it is the best place to start." Diebold.p 49. Osborne suggests looking for and studying the outliers, the points of failure as areas rich with new insights.

Anacombes quartet data provide a striking illustration of the need for statistical graphics. Here is the data, (From Diebold) . Nothing seems amiss looking at the data chart. The R2 = .67 and SE of the Regression = 1.24 and is identical for each set. However by looking at the graphs, it is clear that different processes are at work and different models are needed.

A histogram or stem and leaf provides a simple estimate of the probability density of a single variable. Relational graphics, such as Bivariate scatter plots used in Practical Speculation show the relation of two variables. Under certain conditions the conditional mean is a good estimate of the forecast. Diebold says changing the aspect ratio may reveal new information.

Tufte wonderfully discusses graphical style in his series. . See also prior reviews in Daily Speculations.com.

Even Diebold advises, avoid chart junk and non data ink. R has an extensive set of graphic tools which beats the pants of the chart junk heaped in commercial packages which lack even the most basic useful tools. Defenestrate the chart junk! Its ballyhoo.

8/22/2005
Recursive Estimation Procedures for Diagnos, by Jim Sogi

Diebold, in Elements of Forecasting, suggests a procedure and some tests for model selection and testing parameters in the chapter on Recursive Estimation Procedures for Diagnosing and Selecting Forecasting Models for univariate series, in which he begins with a small data sample, estimates a model, adds an observation, and re-estimates the model, and continues until the sample is exhausted. The recursive residuals are computed one step ahead on out of sample data at a 95% interval forecast. He uses a a series of tests and a CUMSUM of the standardized residuals to learn about inadequacies of various models. this estimates out of sample forecasts using in sample residuals. The model is then tested on out of sample data more than one step ahead..

Why is this not curve fitting? Good models fit signals, not noise, because by construction, noise is unforecastable ... if it is it is not noise. The noise is what remains after accounting for component signals. Data mining expeditions, in contrast, lead to models that fit very well offer the historical sample, but do not predict well because they tailor the model to fit the idiosyncrasies of the in sample noise, which improve fit, but not predictive power. Presumably this can lead to what the right questions are to ask and the appropriateness of the parameters estimated.

R-Cran has the suggested tests:
F- test, R Squared
Schwarz Information criterion
Box.test(): Ljung -Box test used to determime the mull hypothesis for independence in a given time series (stats)
dwtest(): performs the Durbin-Watson test for autocorrelation of residuals (lmtest)
Akaike information criterion.
Charles J. Geyer discusses model selection a bit differently than Diebold.

Is this a red herring or a worthwhile avenue of further research?

Phillip J. McDonnell adds:

"Why is this not curve fitting?"  is a deep philosophical question underlying all of statistics. In essence everything we do is curve fitting in some form or other. Sometimes people will warn of the dangers of curve fitting. Although the dangers are real they usually come from one simple source - too many degrees of freedom. Too many degrees of freedom can lead to spurious results even if the curve you are fitting is a straight line.

The real issue is better understood of one thinks in terms of fitting too small a data set with too many variables. The key to avoid this is to have enough data and the most parsimonious choice of parameters possible. The tests to understand whether a given study has overfitted the data are: F-test, Schwarz Information Criterion (SIC), and the Akaike information criterion (AIC). It is notable that each of these three tests explicitly includes a correction for degrees of freedom.

In Diebold's sub-chapter on recursive diagnostics the process starts with a fit of k parameters to k observations. Obviously this fit has zero degrees of freedom and no statistical validity. But that's not the point! The point is to look at what happens as we add on more observation (k+1) to estimate the k parameters and then k+2 and so on. What we want to know is if and how the fitted parameters and residuals change as we add more data and as we vary the time frame. The purpose is as a diagnostic only, not as a way to fit a model per se. Note that Diebold makes no reference to F tests, SIC or AIC statistics because they aren't relevant to the diagnostic intent.

This sort of technique has applicability in models where the underlying model is known to change with time. In particular the vix index changes with time and appears to cycle in a semi predictable fashion. The time varying nature could be identified using the recursive diagnostic techniques suggested by Diebold. If one believes in everchanging cycles, one believes in time varying parameters.

8/22/2005
100 statistical tests, sent in by Sushil Kedia

100 Statistical Tests by Gopal K. Kanji, Sage Publications comes in as a much sought relief helping to simplify Statistical Testing as much as possible.

Exactly a 100 Statistical Tests are compiled in this paperback. The high degree of utility apparent in this publication comes from:

1. A list of these 100 tests briefly explaining the objective of each test.
2. A classification of each of these tests as numbered in the said list in a single table, helping narrow down between relevant choices of tests.
3. All the relevant Statistical Tables that help finding the critical values at one place in the book.

A short introduction to Statistical Testing at the beginning of the book is sufficient elaboration for not only newbies but possibly enlists critical parameters that advanced practitioners would also like to bear in mind.

Each of the 100 tests has a page or two devoted wherein the object of the test, limitations, method and data-specific examples are provided succinctly.

For this massive subject of testing I feel that this book definitively lives up to the Einsteinian idea that, "Things should be made as simple as possible, but not any simpler."

Not only those specs who are coaching neophyte under-studies in the practise of counting, but also the experienced and seasoned counters could find this volume a handy, short & sweet reference.

8/19/2005
Dick Sears Weekly Commentary: The Bear Days of August

8/19/2005
In Defense of B#ll Gr#ss, by George Zachar

The lawsuit against P#mco over allegedly b0rking the ten year contract is a comical put-up job.

Page 2, Part II, paragraph 5, of the complaint says the accuser lost some money on a one-lot.

At one level, this is just funny. At another, obviously, it now pays for a predatory law community to take tiny offsetting stakes in every conceivable instrument, waiting for the chance to hit the lawsuit jackpot every time an event beyond the comprehension of a simpleton juror occurs.

The Assistant Webmaster adds:

B#ll Gr#ss vs the ambulance-chasers brings to mind Henry Kissinger's quip about the 1980 Iran-Iraq War: "It's a pity they both can't lose."

A Distinguished Attorney replies:

Please, the facts, the numbers!

While the legal profession has many areas for improvement and valid areas of criticism, and some in the profession perhaps do not live up the the highest professional standards, the large majority do. The members of the profession follow a strict set of professional and ethical guidelines. They are licensed and subject to review. The Assistant Webmaster might do well to show the numbers to prove the case. Name calling does little to prove a point. The investment business profession would be also wise to be sensitive the the many ethical issues that the legal profession has struggled with over the centuries.

How would you, on behalf of the investment profession, plead to the Citigroup $2.65 billion settlement on the WorldCom fiasco? Without legal action would the investment profession have voluntarily admitted fault, and paid the money back to bilked investors? Perhaps it is good that the lawyers are there to oversee the investment profession, and other areas. It is a balancing act for the good of society. There are criminals out there doing bad things: Kozlowski, Ebbers, Fastow, Skilling. Who else? Who will protect the uninitiated? The SEC? I doubt it. I am willing to debate this issue. Bring out the facts.

Do you personally know whether P#mco cornered the market or not? Do you have the figures for those trade dates specified in the complaint? Do you know whether or not it is possible for P#mco to corner the treasury future market and affect the futures price? Please, provide the facts, the numbers proving that the complaint is groundless.

George Zachar responds:

The Treasury note futures market is perhaps the most transparent market in the world. Anyone can readily obtain the basic information as to the open interest in the contract, and the issuance/supply of securities available for delivery into the contract. It is 100% public information.

Someone deliberately entering that market who then claims to be surprised by price action driven by the dynamic of deliverable supply/demand is either a fool or a liar. In no case does he have a basis for accusing another party of being responsible for his losses.

Position sizes in that market are very closely watched by both the CFTC and relevant exchange. P#mco would needlessly expose itself to substantial reputational risk by engineering an illegal squeeze.

Do I personally know the hard numbers here? No. But the specifics are irrelevant to the larger point: An investor who makes an unforced error by not doing his homework and ignoring obvious public warning signs can't have standing against professionals who are, by all accounts, playing within the known, public rules.

8/19/2005
A Three Hour Tour, by Kim Zussman

The Russian River cuts splendidly through redwood forests of northern California's wine country . "Russian" because in 19th century, California north of San Francisco bay was colonized by Slavic trappers and colonists who erected Ft. Ross, short for Rossiya, which is how they pronounce the motherland.

Today it is more a chimera of river-bottom hermitages and natural formations teeming with fish, flora, and aquatic birds and the bald eagle. You can rent a canoe and paddle downstream for several idyllic hours in sweet air to the pick-up spot, stopping at inviting shores for a swim or nibble. On such a recent venture, the teen girl attendant asked if we had canoed before. We had not, but were comfortable with kayaks and rowboats.

Unlike lakes, rivers have currents and the floating center of mass presented a disequilibrium realized within the first five minutes. Unable to steer in moderately fast water, we struck the rocky bank and our own reflexes, meaning to stabilize, instead oscillated for two cycles past the tipping point.

The splash and shock were moderated by the comfortably cool water under an August sun, and it was only chest-deep. We dragged the listing ship ashore and set about to dry the camera and cellphone. Remarkably the digicam was damp but operational. However the squawkbox had clearly drowned and showed no sign of life.

Bundling our courage with the positive psychology to jump right back, we set out again. This time careful to position ourselves defensively, within the canoe and upon the river, in order to anticipate dangerous currents. Over and over we encountered such currents. Wherever the river became shallower the water accelerated in order to maintain constant volume flow and total kinetic energy. Navigation of acute directional change in tight bends would spin the boat like a propeller.

At one rapid bend, we were jammed against a felled redwood log; stuck on a submerged limb and unable to push free. The Mrs. shouted "Lets get out!", but I insisted we wait and try to break free. After several minutes of tense rocking and pushing off with paddles, we spun away and floated safely onward. We discovered that the canoe does not intend to tip -- we did it ourselves. We learned to ride in the boat and trust that it will float over daunting currents and turns, all the better for lack of our fearful efforts.

These lessons gelled as the downstream river became wider and deeper in the lowering sun. Here and there children splashed on rocky shores and anglers trolled their jerky bugs. Snowy egrets speared fishes, and ducks dried their feathers sprawled on smooth boulders.

We lunched on a rocky beach, where the phone was disassembled and set on hot rocks to dry. Once the condensation inside the screen had evaporated, it was re-assembled and -- still dead. Back at the hotel, plugged into the charger in hopes the battery had discharged -- dead. Hairdryer for five minutes -- dead. With all hope lost, the defunct talkie spent the night in penance shackled to the charger.

In the morning as we packed, I shouted when noticed the phone had been resurrected. "It lives!". On our journey we learned to go with the flow, not to fear the below, and that the dead tend to remain dead unless acted on overnight by battery chargers.

8/18/2005
A Meditation On Leptokurtosis As Viewed From The Wrong End, by Peter Gardiner

How I long to be
Long of thee, sweet S&P
Not hopelessly short.

8/18/2005
Venal Sinners, Venial Sins, by Ryan Humbert

Even though most of the CME floor has emptied out, the fines and comic relief of violations continues. My favorite from the past is a fine of $5000 for "leaving the CME parking garage and repeatedly creating a public nuisance." Here are the highlights from the July report:

B####r brought a shaving cream pie on the trading floor. $250 fine

B#####o shoved another member while in the Eurodollar options pit. $2000 fine

D#####t provoked R. G######g which resulted in an altercation. $2500 fine

F#y participated in hitting another member in the face w/a shaving cream pie. $250 fine

G######g engaged in a physical altercation with P. D#####t. $5000 fine

H#######s threw a shaving cream pie in the face of another member. $1000 fine

K##n directed highly offensive, profane language at a non-member employee in the Eurodollar Options pit. $10000 fine

O####r left the trading floor approximately the same time as an Exchange member and then initiated a physical altercation with that member on CME premises. $5000 fine and 15 day floor privileges suspension

Generally it's the same people every month making the violations list.

8/18/2005
Competition, by J. T. Holley

As far as romance and competition go, it is worth mentioning the old sayin' "when a man walks into a room he is lookin' at all the women for potential opportunities, but when a woman walks into a room she is lookin' at all the other women to see her competition."

8/16/2005
In Memory of James H. Lorie (1922-2005)

University of Chicago professor who helped start stock research database.
Instructor and dean who also helped apply a new method to teaching business management.

By Tonya Maxwell, Chicago Tribune staff reporter
Published August 11, 2005

Much of the mystery shrouding the stock market dissolved when James H. Lorie began documenting the historic rise and fall of stock prices.

The idea was simple but laborious: chart stock prices from 1926 to1960 and beyond. Dr. Lorie, a University of Chicago professor, helped establish the Center for Research in Security Prices at the Graduate School of Business.

Dr. Lorie, who lived in Chicago's Lincoln Park neighborhood, died of pancreatic cancer Saturday, Aug. 6 in Northwestern Memorial Hospital in Chicago.

He was 83.

"He was responsible for building up the stock exchange database," said economist Milton Friedman, a fellow professor at U. of C. "It provided the information of various stock prices. It allowed researchers to analyze stocks in ways that couldn't be done before."

The data, never before compiled, gave researchers the ability to understand the long-range performance of the market and eventually gave rise to the field of index funds.

It was one of many accomplishments in Dr. Lorie's 45-year career at the University of Chicago.

He is credited with bringing top business scholars, many of them eventual Nobel Prize winners, to the university.

While associate dean of the business school from 1956 to 1961, Dr. Lorie helped apply a new method to business management education. Known as the Chicago Approach, it introduced students to other disciplines, such as sociology and anthropology, to make them more effective managers.

But Dr. Lorie would have been just as happy being a cowboy.

About 35 years ago, he and his wife, Vanna, built a house in Tesuque, N.M., just outside Santa Fe. The couple spent half the year there, and half in Chicago while Dr. Lorie taught.

Although the house recently was sold, few things gave Dr. Lorie more pleasure than riding for hours with his wife's uncle, Melvin Pfaelzer, like a couple of ranchers.

The two were full of bawdy jokes--Dr. Lorie had a knack for telling the goofiest ones--and good conversation, said his stepdaughter Erika Bartelstein, who often rode with the men as a teenager.

"This man was a great thinker. He brought in all those guys [to the U. of C.] who won all those Nobel Prizes," she said. "But he was just as happy sitting on his horse telling stupid jokes."

He was also quick to rib his family with his brand of gentle humiliation, said stepdaughter Victoria Lautman.

When students went into Dr. Lorie's office, pictures of the girls, then in their 20s, faced potential young suitors. "He always had our pictures facing out, and he would actively set us up with these young lions of finance," Lautman said. It never took, she joked, adding that Dr. Lorie and their mother, Vanna, wanted the kids to experience a love affair like their own. They were married 38 years until her death in 2004.

Victor Niederhoffer, who received a doctorate in 1969 from the U. of C. Graduate School of Business, studied under Dr. Lorie. He is just one of hundreds of students who owe their business development to the professor, said Niederhoffer, a futures speculator living in Connecticut.

They remained lifelong friends, bonding beyond their academics. Together, they won the 1966 squash doubles Western championship held in Chicago. Niederhoffer won 10 national titles, but Dr. Lorie ribbed that he was the better player, though his younger partner was the one diving on the court.

"He always used to say he was the better man and he was the coach, because I hit all the balls," he said.

Off the court, Dr. Lorie was a giant of business, building the foundations of modern finance through stock databases, Niederhoffer said. Without that knowledge, he added, other profound thinkers never would have been able to begin their work.

But always, Dr. Lorie was gracious, never considering himself a giant of anything.

"I went to chemo [therapy] with him about three weeks before his death," Niederhoffer said. "He said, `Thanks very much for coming, Victor.' I said, `It's the least I can do.' He said, `No, it's the most you can do.'"

"A very tearful moment was that," Niederhoffer said.

Other survivors include a stepson, Karl Lautman; another stepdaughter, Katharine Wexler; and four grandchildren.

A memorial service will be held at the University of Chicago, but a date has not been set.

I would add to the above the following:

Lorie was the consummate businessman, the perfect loyal friend, the ideal family man and a man of infinite hobbies and interests. Among his many accomplishments was building the Graduate School of Business starting from a budget of $500,000 and 10 professors; it is approximately 500 times as big today. This growth was even greater than the returns he documented, of some 300-fold, that would have been achieved by a buy-and-hold strategy for randomly selected stocks on the NYSE during a comparable period. His strategy in building the school with Dean Alan Wallis was to hire the best professors in each discipline who were waiting in the shadows in lower level positions in at other graduate schools. He would invite these potential recruits to Chicago, get a great hamburger at a Polish dive in a rundown section of town, leaving his keys in the car as they greased it. "I lost a few cars that way but I managed to dispel all the fears that those guys had heard about back home," he would say in one of his characteristic witticisms. Among those he hired in this way were the Nobel Prize winners George J. Stigler, Merton H. Miller, Myron Scholes and Robert Emerson Lucas Jr.

It is a fitting tribute to Jim that the Graduate School of Business will fly its flag at half mast for the 10th of September in memoriam.

He was a pillar and founder of the Chicago business community, which forms the backbone of Chicago's cultural and commercial life to this day. He and Bob Gwinn of Sunbeam; Irving Harris of Standard Shares (later Pittway); Ben Heineman of Chicago & North Western Railway; Edward Levy, dean of the Chicago law school; Peter Peterson of Bell & Howell; Jay Pritzker of Hyatt; Alan Muchin, founder of Katten Muchin Rosenman LLP; and Bill Jentes, the arts philanthropist met regularly along with others on a social and business basis and were responsible for countless projects that have made Chicago and its environs the vibrant community it is today.

Jim served on the boards of many companies during their most dynamic stages including Merrill Lynch, NASDAQ, Standard Shares and The University of Chicago Press. His integrity and wisdom was such that whenever an outside view of a crisis was necessary, he was the point man and arbiter par excellence.

He was an expert on Winston Churchill, Mark Twain and Conservative political philosophers. His extensive collection of books of these statesmen has augmented the University of Chicago's collections, and his frequent lectures on these subjects has introduced their greatness to many an aspiring student. His lecture on Churchill upon his death in 1965, which was attended by some 1,000 students at the U. of C's biggest lecture hall, and his talk before the American Statistical Association on the pioneering statistical insights of Mark Twain were two major exemplars. Another one of his hobbies was backgammon, which he played for fun and pleasure, and used to pay his way through school.

One of Jim's favorite activities during the last twenty five years of his life was to lunch at the University of Chicago's faculty club surrounded by his friends, Ronald Coase, Milton Friedman, George Schults, George or Steve Stigler and Arnold Zellner, Peter Dembowski, Ted Cohen, Richard Stern, Charles Grey, Robert Ashenhurst and Bernard Meltzer . After some lively conversation about the day and fray, and how all problems would be solved if only government were to go away and competition were extended, Jim liked to shoot an hour or two of pool to sharpen the wit, pocketbook and eye.

Jim's academic career may be compared to that of Linnaeus or Mendeleyev. He established the database, fomented the research center and performed the first studies from which all subsequent work in biology, chemistry and, in his case, finance flourished. He wrote three books about his work, one on agricultural cycles, another on marketing and a third on stock market behavior. [Lorie: Causes of Annual Fluctuations in the Production of Livestock, 1947. Lorie and Roberts: Basic Methods of Marketing Research, 1951. Lorie, Dodd and Kimpton: The Stock Market - Theories and Evidence, 2d ed. 1984. He also wrote a pamphlet, "Public Policy for American Capital Markets," 1974, which advocated centralizing stock trading electronically by means of a Consolidated Limit Order Book or CLOB]. Each of his books was widely used. And whenever a dean or professor at the U of C called for more elegance, or more simplicity, or more beauty in writing, Jim's books and articles were the model.

Jim's rules for writing were to create short, simple declaratory sentences with each getting over a point that led to the next sentence. I once spent a year researching an article on insider trading with him that ultimately appeared in the Journal of Law and Economics. I still remember that Lorie wrote and completed that paper in one and a half hours in his office dictating one short and simple thought after another. That was his way.

Along these lines, he carried the same elegance in his ability to tell stand-up jokes of an academic nature a la his beloved Johnny Carson. All who knew him always marveled at how, as soon as he came into a room, no matter how exalted the attendees, a crowd formed around him and he told one pointed joke after another to elevate the spirits and provide a benevolent and pro-U. of C., pro-conservative ambience.

Always Jim loved his wife and family. They were never apart in the 40 years since they met, they never argued, they always reached out to new friends in the communities they lived in with dinner parties, introductions and recommended books. Jim derived the greatest pleasure during his last years from spending his time with his children and his four grandchildren.

Characteristically, he put some money aside for each of them when they were at an early age and saw that it was invested 100% in stocks throughout the period. He practiced what he preached, buying stocks on margin with whatever money he had and letting it ride, placing it in index funds or investing on tips he received from friends.

He is certainly the key force behind the multitrillion-dollar index fund business. His studies and consultancies fomented the first such funds at Wells Fargo in the 1960s, Vanguard in the 1970s and the Ford Foundation. His directorships and wisdom and databases at the stock exchange-related firms where he served provided the backbone, the emphasis and rudder that enabled these firms to play their proper role in the buy-and-hold, get-extra-return-for-risk field.

Two index funds were founded in 1973: the Wells Fargo Index Fund sparked by John McQuown and the Dimensional Funds sparked and headed by Rex Sinquefield, who now manages $40 billion in index funds. McQuown was a steady fixture at the University of Chicago where Jim and his students, including myself in a very minor role, guided him in every aspect of setting things up. Rex describes Jim's contribution to the Dimensional Funds in this way.

It was Lorie who persuaded them (American National Bank), who persuaded them to bring in a couple of MBAs [including himself], let them run around the place, and apply their ideas ...[and he continued to] persuade some of the senior management that you ought to embark on this path.

Jim is most remembered as the founder of the Center for Research in Security Prices. Everything in finance was changed and fomented from that database. It wouldn't have happened if Jim weren't there to field a random call from Louis Engel of Merrill Lynch in 1959. Engel, who later became one of Jim's best friends, wanted to know how well investors performed in stocks relative to other investments. Only Jim would have had the temerity and vision to say that Merrill should finance a database to answer the question. It started with a $300,000 grant, and the rest is history.

Always he was reaching out to someone. If a student needed a loan, if a student needed an investment, if a student needed a scholarship, if a student was down on his fortunes and needed a break, Jim was there to provide it. Countless such students owed their start to his generosity, including myself and Gary Hoover, the founder of mass marketing of books and Hoovers, among others. The students came together in 2002 to commemorate and establish the James Lorie Professorship at the U. of C., while he was still living, a very unusual and appropriate memorial.

Above all Jim was kind and humorous, brilliant, scholarly and decent. He lived a long and happy life, always surrounded by friends and family, never having to dissemble, always augmenting his own knowledge and others'. All who knew him would be the first to say that he was their mentor, their second father, the key link in their subsequent path to success. He would just say something like, "I just prevented you from hurting yourself