Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.

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February 2005 Posts

2/28/05
Some Variations on Big Cons, by Victor Niederhoffer

1. One of the tenets of movies about cons is that it's always the con man that gets to eat crow in the end. One sees many variants of this in markets but the losses that the con man faces with his own trading is often to be predicted.
2. Part of the big con, which always involves a big store with fictitious actors is the staged exit from the store, where such things as bogus policemen are called in to arrest the actors and mark unless they run. This often has the effect of bringing the mark back for more, even after he has lost everything the first time. Again, this reminds me of so many recent events.
3. The con in con comes from confidence that the con man builds up by convincing you of his integrity and legitimacy. Convincers such as a track record making much money in the first year, when presumably the trades were hypothetical or involved peanuts is a good convincer that we always find in our field. Other convincers are the appearance at seminars with lofty professors, and books and interviews in newspapers.
4. The con is good at appearing to be wealthy, with limousines, fancy offices, and Odyssian vistas standard props, operating in some cases out of a rented bank, just for the occasion. Wealth in the information age comes from high powered mathematics, rubbing shoulders with Nobelists, and great erudition in seemingly academic articles, and fake humility.
5. 'You can never con a honest man' is a standard adage of all such books, the classic being The Big Con by linguistics professor David Maurer  (I find it interesting that Maurer sued the producers of the Sting but settled on the Courthouse steps). The larceny in the mark in the market is their desire to get rich with a simple fixed system. It cant be done, and they become easy victims to the inside information con, or the other two big con prototypes, the wire or the payoff.
6. The big con evolved from a dollar discount store that served as a front and a lure for a three card monte game in the store. Since no one ever won in the game, and everyone lost all their money, the store didn't have to give away too many bargains. The store evolved into the big con where fake betting parlors, stock exchanges, and other elaborate scenarios were enacted. An ironic twist however is that one store became so successful at selling the actual discounted dollar goods that it became the seed corn for a national chain of department stores.

Perhaps some legitimate business will some day come out of the numerous big cons that we are subjected to in the market firmament each day.

02/24/2005
Rip Mackenzie responds:

Greatly enjoyed your segment on cons. Episode one in the deal junkie TV series I was commissioned to create is called, "The Fine Art of Deception" and, like all the episodes, descends deeply into the art of the con and the fear of the self-con. It would be difficult to imagine a better time than, if time allowed, six months of all-encompassing, all-consuming research into the art of the con.

Here is an excerpt from Louis L'Amour's The Walking Drum:

"Sometime," I told Suzanna, "I will write about the relationship between piracy and trade. The one always seems to proceed the other, and the most successful pirates have become traders, perhaps on the idea that it is easier to defraud a man than to kill him."

"Trade is much superior to piracy. You can rob and kill a man but once, but you can cheat him again and again and again."

"You are cynical," Suzanna said, "they only sell them what they want."

"If people were sold only what they wanted, there would be little trade, my lady. The soul of business is to inspire people to buy that which they neither want nor need."

02/24/2005
Moneyball? How about Money Flicks? by Art Cooper

There was considerable discussion on the List a while back about "Moneyball;" how the Oakland A's Manager used statistics to give him an edge over other teams.

In this same vein, "The Oscar Formula" on p W1ff. of today's WSJ describes a binary probit model developed by Prof. Andrew Bernard of the Tuck School to predict the winner of the Academy Award for Best Picture. The article claims 90% accuracy for the model, which gives "The Aviator" an 85% probability of winning this year.

02/24/2005
Unlike the Market, the Oscars Can't Go "Sideways," by Kim Zussman

Hollywood can't let Sideways win best picture since it involves white male middle-aged bookends of complementary human weakness, and was filmed near Indian casinos without naming Sacagewea. Yet the film's popularity may mean at last time has come to sympathize with the reason people indulge the soul with alcohol (it its finer forms) and self-destructive muff-diving: fear....Afraid of aging, dying, or worst of all, irrelevancy.

And yes there is an investment thesis, which forms the basis for counter-trendism. When all is lost and nothing left to hope, suddenly, implausibly, the clouds part and sun floods down just in time to resurrect the parched darkness. Well, at least that's what it says in investment books...

2/28/05
Marketable Aspects to Chess, by Grandmaster Nigel Davies

One question I've continually had to ask myself is whether there are marketable aspects to chess. I came to the conclusion that the best money for a chess master is as a babysitter, running seminars to take kids off parents' hands at the weekends. Naturally this involves a degree of artistic compromise..

What I've found with trading is that it can be just as much of an art as chess, though I don't think either are as 'pure' as music because there is an 'opponent' and competitive elements are prevalent. The main difference is that with trading the prize money tends to be rather better for the stronger practitioners.

02/24/2005
George Zachar offers:

The chess coach of a nearby Upper East Side high-end private school charges $85/hour to work with my 10 year old son, Adam. A very gifted and rigorous "old school" professional piano teacher charges $75/hour to tutor him. As I recall, the great multi-generation fortunes immortalized in lists such as the Forbes 400 tended to be generated in two broad categories: Long-term property investment (real estate / Sage-like equity positions), or more importantly, creating/marketing something desired by mass markets at "affordable" prices: Ford/cars, Rockefeller/fuel, Gates/digital tools, Dell/computers.

Piano and chess have proven very important in my son's development, and it saddens me that the devoted men who work with him seem to enjoy only the most pedestrian of "lifestyles" despite their talents and pedagogical abilities. They're most appreciative when I recommend them on to others, and seem embarrassed by the modest (Amazon gift certificate) holiday gifts I give.

Obviously some abilities, no matter how "great" objectively, do not scale in a wealth-producing manner: Why do great tennis players enjoy int'l fame, but not great squash players? Why are Eminem and 50-cent able to conjure huge income streams out the music industry, while thousands of virtuoso pianists, violinists, etc., treat their gifts as hobbies and exchange labor elsewhere in the economy to make ends meet?

I think Mises had it right when he said that in a free market, the consumer is sovereign: both merciless and capricious. Artistic wealth lies in titillating the heart of the income distribution. Artistic beauty often lies elsewhere.

02/24/2005
Take Stock of Yourself, by James Sogi

Tim Melvin wrote: How does one gain the same focus and intensity that allows us to perform at our highest and best levels and bring it to bear every game and every day?

"Count." ....Dr. Gerald Patterson, of whom I've written before, broke new scientific ground in the field of psychology by using statistical analysis of coded behaviors diagnosing troubled teenage boys and the behavioral correlations in their environment that lead to their troubles. Dr. Patterson also coded his own behavior and used statistics to analyze and chart them. One of the things he identified with life satisfaction levels was taking some time off. He loved his research, but found if he worked for more than 10 days straight without time off his satisfaction level would drop off.

Statistical analysis of traders, rather than their systems, is a risk management tool. Why not apply statistics to your own trading behaviors and factors that may or may not affect your trading? Many counter-intuitive things turn up in the markets and may uncover things about yourself that you never expected that may be holding you back. Dr. Patterson would code behaviors in the home such as: yelling, fighting, compliments, and place them in a chart then do the regressions on the data. The trader might chart a number of at first random items such as: weather, health, did you jog this morning?, day of week, time of day, season, family trouble, prior win/loss, drinking, indigestion, sex, or any number of factors. They may uncover previously undetected patterns of behavior. Baseball does it.

02/24/2005
Andrew Lo's Systemic Risk and Hedge Funds, by Kim Zussman

Andrew Lo details a hypothetical hedge fund, "Capital Decimation Partners," that shows extremely high returns and Sharpe simply by selling OTM S&P puts. Perhaps more salient in that Andrew Lo runs a hedge fund. As such, perhaps different motives to publish than pure academics (such as buttering one's own bread). Pass the toast please, NNT.

Their summary:

A conclusive assessment of the systemic risks posed by hedge funds requires certain data that is currently unavailable, and is unlikely to become available in the near future, i.e., counter- party credit exposures, the net degree of leverage of hedge-fund managers and investors, the gross amount of structured products involving hedge funds, etc. Therefore, we cannot determine the magnitude of current systemic risk exposures with any degree of accuracy. However, based on the analytics developed in this study, there are a few tentative inferences that we can draw.

1. The hedge-fund industry has grown tremendously over the last few years, fueled by the demand for higher returns in the face of stock-market declines and mounting pension-fund liabilities. These massive fund inflows have had a material impact on hedge-fund returns and risks in recent years, as evidenced by changes in correlations, reduced performance, increased illiquidity as measured by the weighted autocorrelation, and increased mean and median liquidation probabilities for hedge funds in 2004.

2. The banking sector is exposed to hedge-fund risks, especially smaller institutions, but the largest banks are also exposed through proprietary trading activities, credit ar-rangements and structured products, and prime brokerage services.

3. The risks facing hedge funds are nonlinear and more complex than those facing tradi-tional asset classes. Because of the dynamic nature of hedge-fund investment strategies, and the impact of fund flows on leverage and performance, hedge-fund risk models require more sophisticated analytics, and more sophisticated users.

4. The sum of our regime-switching models' high-volatility or low-mean state probabilities is one proxy for the aggregate level of distress in the hedge-fund sector. Recent measurements suggest that we may be entering a challenging period. This, coupled with the recent uptrend in the weighted autocorrelation and the increased mean and median liquidation probabilities for hedge funds in 2004 from our logic model implies that systemic risk is increasing.

We hasten to qualify our tentative conclusions by emphasizing the speculative nature of these inferences, and hope that our analysis spurs additional research and data collection to re-neg both the analytics and the empirical measurement of systemic risk in the hedge-fund industry.

02/24/2005
Value Beats Growth--Another Wall Street Myth, by Victor Niederhoffer

One of the gravest delusions is that Value stocks beat Growth stocks. And this becomes especially heinous and ubiquitous in years like now when value actually has beaten growth for the past 2 years. Left out of course is that growth stocks selected prospectively over the last 35 years have returned about 30 times more than value stocks cumulatively.

When I presented unobtrusive statistics on this in London the other day, a silver dealer, one of the shrewdest dealers I've ever run into came up to me after. He said "you said that companies selling at below book value are the ones that you never can sell because they stay below book value. Well the same is true in antiques".

I have heard this advice in many forms, e.g. "don't buy commercial stuff--there will always be an abundance of it, but buy the best, the tiffany stuff ". I have found it true in the tens of thousands of things I have bought, but academic studies in the art market like those in the stock market seem to come up with opposite conclusions, due of course to the same kinds of retrospective bias and hatred of business that energizes the Buffetologists.

02/25/2005
Tim Melvin responds:

Anyone that knows me knows I consider the chair one of the greatest investors/traders and philosophers that ever walked the landscape...he has been a benefactor, a major influence and simply put, one of the greatest men I have ever known. But at the risk of being ostracized, I disagree. There is no study ANYWHERE that indicates that a price insensitive growth methodology beats a price sensitive value method. NONE. You can't used a managed value line program against a an unmanaged index to prove it...put the best "growth mangers against the best value managers, the value guys win. put the value indexes against the growth indexes, the value guys win. Period. Numbers on the table, value wins, every time, all the time. For the long term investor, price and value matter. the only time I've had bad years were when I abandoned my basic value methodology. I have not achieved a fraction of the chairs success in life or markets, but I'll debate this one with anyone, anytime, anywhere, with numbers on the table. Properly applied a value philosophy of buying quality at a discount beats any other method of long term investing

02/25/2005
The Senator Sides with the Chair:

I must agree with the chair on this. Growth outperforms value, and usually hands down. The problem is knowing of growth stocks early on; my experience is once I (we) know they are growth stocks, said growth stops, but had you been able to know in the early stages (the potential for growth) value is beaten. However, value is a much easier approach, very easy to find compared to potential growth stocks.

02/25/2005
Tim Melvin retorts:

WAIT A MINUTE! I find myself in disagreement with two legends of our business. I should back down at this point but no one has ever accused me of refusing to do something stupid.

Senator, how can you make that statement when your last book espoused low price to sales ratios, high yields and the darlings of the Dow strategy--all value oriented strategies?

02/25/2005
The Senator explains:

I have great value for value. The problem with growth is I cannot assign it or find ratios that catch it early enough for me to profit thereby. So my point is if you could find that, then it beats value. Until I know how to find growth (that lasts) I stay with value. This was more of an academic point.

02/25/2005
Pam van Giessen reasons:

My pea brain has a tough time with the whole value versus growth thing. A good buy is a good buy whether it's spicy or sweet, no? Why this obsession by investors with the flavor of the thing? And who cares really? Bogle pointed out in Common Sense in Mutual Funds that for the 60 year period from 1937-1997, growth funds returned 11.7% and value funds 11.5% (p. 232). I know investors want every fraction of a percentage point gain they can get but the whole growth versus value debate seems more an exercise in intellectual masturbation than an uncovering of real profits -- at least for most investors (though perhaps not specs).

Anyway, in my view, I wonder why investors would limit themselves one way or the other. Making the distinction even seems weird to me but then again I like both spicy and sweet foods, as I know Chair does too.

02/25/2005
GM Nigel talks Value vs. Growth in Chess:

There is an interesting chess analogy to growth vs. value issues in chess, i.e, in dynamics and structure. Structural advantages are things that are immediately visible (material, pawn weaknesses, bishop pair etc) whilst dynamic features (piece activity, time etc) are much harder to assess, especially for beginners.

It's interesting that players who value structure, the chess Buffets and Grahams, seem to enjoy a much better reputation than dynamic players such as Alekhine, Tal and Bronstein. Even when the structuralists lose there's the suspicion that it was 'just tricks' and that more sober times are just around the corner. In this respect it's interesting to hypothesize that the tricksters' methods may be even more frowned upon when people are afraid. But perhaps that's exactly the time they are most likely to succeed.

02/25/2005
Rudof Hauser examines the subject.

Vic's contention on growth beating value raises some interesting questions. The general assumption is that markets are reasonably efficient. Naturally for any given past period one would expect one group to come out ahead of another. But does that mean it should continue into the future? If markets are reasonably efficient over a longer time interval then risk adjusted returns for all assets should be equal.

The first question is how would one define a growth company versus a non-growth company?

I prefer Joel Stern's definition that says a growth company is one that has a return on investment in excess of its cost of capital, that is the return the market requires for the level of risk involved with regard to the company. One would expect investors to bid up the price of the stock relative to its economic book value (not historical cost) to the point where the future returns are no longer in excess of its cost of capital. If a company earns less than its cost of capital, one would expect the stock price to decline relative to the economic book value until it is priced so that the stock yields (total return) the required cost of capital in the future.

Whether all non-growth companies would be called value companies or only those selling below economic book value depends on whether one divides the universe of stocks into two or three categories. The only time one should earn excess returns in the market is if one buys before the market fully recognizes the current nature of the company or if the relation of the companies returns on investment over its future life changes. To the extent that those latter changes can be expected, one would expect an efficient market to do so and to be reflected in the current price. To expect current growth stocks to always outperform non-growth stocks over longer periods would assume that growth companies are more likely to have more upward than downward changes in expected future returns on investment relative to what the market expects than non-growth companies do – and all this continuing to be the case because of some bias in the reasoning ability of investors.

Given the ability of investors to envision great future returns based often on no more than a promising idea and that most people tend to be risk adverse for smaller risks but a good number are willing to risk some capital for potentially very high returns (like playing the lottery or gambling where you know the odds are in favor of the house) that bias does not seem all that intuitively evident. But is that what you are assuming Vic, or on what basis do you make your claim? And if you assume this bias exists, do you have any assumptions on the nature the sub-conscious functioning of the human brain that explains it?

02/25/2005
Yishen Kuik chimes in:

Perhaps it is useful to define growth very loosely as companies that are experiencing growing revenues. Whether it is because these companies have succeeded in producing newer products, better products or cheaper products, they are getting more sales - the ultimate vote of confidence in what you are doing from the economy.

It seems that investing over the long term must be about hopping from one island of growth to the next, before the previous one sinks, the inevitable victim of changing tastes, loss of touch with what the economy wants or technological obsolescence.

A 100 year look-back at the composition of the Dow Jones Industrial Average tells you that entire industries tend to wax, wane and eventually completely disappear. So it seems to me that over the long horizon, there can only be growth as one tries to keep up with what new thing the market demands, for it is always demanding new things. If it happens to be your new thing that the market decides it wants next - the market will tell you in your sales growth. Eventually and inevitably though, the market will move on to the next new thing, and unless you are among the very few companies who possess the ability and luck to change correctly with the times, the market will pass you by, just as it has the scores of DJIA components who have long since faded away from the Big Board.

If my premise has merit, and growth is about really about trying to figure out what society will want to purchase tomorrow, then it is a difficult thing to try to wrap numbers around - which might explain why the foremost seekers of growth, the venture capital business, is entirely qualitative.

"I prefer Joel Stern's definition that says a growth company is one that has a return on investment in excess of its cost of capital, that is the return the market requires for the level of risk involved with regard to the company."

I respectfully challenge Mr. Stern's definition as more useful as an example of a failure of market efficient models (i.e. return greater than risk) than providing us with any insight as to what growth is really about - the future.

J.T. Responds:

I know that I have previously mentioned my love of baseball card collecting and the love of math it taught me as a youngun' studying stat figures on the backs of cards. This is by far one of the greatest examples of free markets that I know of today that is UNREGULATED, NONGOVERNMENT, NONTAXED and has one company Topps Inc. dominating a oligopoly of small players Upper Deck, Donruss, Fleer and the likes.

eTopps is the "electronic" version of older paper cards- you hold in street name at eTopps and they have IPOs, EBay is trading floor.

How does this relate to value vs. growth? It both supports the 6 percent return of IPOs, and the fact that people pay premium for whatever definition of Growth you want to throw out there vs. whatever definition of Value you want to throw out there. For example, when a player breaks into the Big Leagues he has a "forward looking" card created. These cards are the IPOs and in high demand which create premiums vs. the other already seasoned players that have been in the leagues for awhile. Future star cards, rookie cards are all highly sought after! Who wouldn't want to purchase a pack of cards for 2 bucks that has the next Henry Aaron or Mickey Mantle inside? If one is inside then you might have an immediate 500 percent return on your hands. Delmon Young, Felix Hernandez, and Kendry Morales are Topps 2005 hot rookies, these are immediate 15 buck cards, have you ever heard of them? Have they pitched a no hitter yet? Have they swatted 50 hrs? Won any Golden Gloves? Answer to these is no, no, and no! But you can be your sweet tail that my son and I will be opening up packs and looking for them not Greg Maddux, Barry Bonds, Pedro Martinez (Value Guys). My son just turned five and this is the first year that he wants to start collecting (trading) cards! I bet a nickel on a doughnut that he'll understand the growth vs. value argument by the end on the season! Once you see that Barry Bonds is worth 2 times less than those up and coming HIGH PE, HIGH PEG types it kinda defines itself. It ain't always peaches and cream though; for example, Joe Charboneau was a hot rookie with Cleveland Indians and was Rookie of the Year in 1980 he smacked 24 hrs w/ .289 avg in 453 at bats. His card shot up and then fell straight down when he got back problems and only basically had a 2 year career! I was holding 10-15 cards that were worthless and at an est. 80% loss - I was only 9 year old. I did corner the Rickey Henderson market with his 1979 As card - I had about 100 of these and they went up to 200 bucks a piece in 1991 (that's right 12 yr holding period) when he broke Lou Brock's stolen base record, as I unloaded and don't have a clue what I used the money for being a sophomore in college.

On etopps in 2003 the LeBron James card came out (you want to talk about Growth!) Etopps did the IPO w/ only 10,000 cards, I was part of Dutch Auction and landed 1 card at $9.50 and it is worth roughly 27.50$, the Dewayne Wade came public at 6.50 and is now 42.50 and they only had 1208 of these at IPO.

Give me Growth or give me Death!

James Morin Responds:

It occurred to me there are many other parallels to card collecting and the markets; I remember in the early 1990s there was a significant increase in the popularity of card collecting across all ages. I am sure many folks who had collected over the previous 30-40 years finally got their big payoff, at the expense of all those rushing to get rich quick etc. It was a valuable lesson as I know many friends that accumulated expansive collections in the hopes one or 2 cards will be that magical one that goes from .10c to $1000 in their lifetime....I wasn't interested at the time, rather I continued to simply collect a few cards of the players I admired, specifically Jose Canseco (I was a teenager, he was a larger than life heroic figure!) and continued to do so...I have accumulated hundreds of cards of his, hoping someday his "unique" career would payoff. Things are looking better now, having cost no more than $50 to accumulate this collection, it could be unloaded to the right buyer for well over 10x that amount...but that is the key I suppose, the right buyer would make an emotional purchase well over the actual value of the investment, perhaps as I did initially.

I think I will hold a little longer, lets see how this steroid saga will affect baseball's history.

02/25/2005
Vic Calls Upon the Don to Sum Things Up:

The very pleasant discussion that has been engendered by my thoughts that the unobtrusive evidence is that growth beats value, a thought consistent with the raison d'etre of the stock markets role in an enterprise system, an exchange system where entrepreneurs with ideas as to how use  capital more productively and urgently desired reward investors who have their money committed to less urgently desired areas brings to mind chapter 4 of Don Quixote.

The Don demands " let all the world  acknowledge there not  in all the world a maiden more beautiful than the empress of La Mancha."  A merchant wag  says " sir knight, we know not the lady you refer to. Discover her and if she proves as beautiful as you say, with pleasure and without reward, we shall acknowledge the truth of your assertion. "   The Don immediately says "Should I show you her, ' what profit in the acknowledgment of a truth so  obvious? The thing is without site of her you must acknowledge and believe it, affirm, swear, and defend it or fite you unnatural and presumptuous louts".

What reminds me of this is the remonstrations of the value people who without data demand that the wisdom of Ben Graham who found the market overvalued  at  a p/e of 10 and found individual stocks overvalued  when  cash was less than twice liquidating value and whose fund the Rea-Graham Fund was one of the worst performing funds of all time, be accepted without evidence.

Enclosed below are the actual results year by year with value stocks versus growth stocks as chosen prospectively by Value Line each month for the last 40 years. Value stocks are those with the lowest 10% of price sales, or price book or price earnings as of the end of month in the Value Line universe   using the latest available reported results as of the time ( without retrospection or deletions or additions from the big retrospective file)

Year by Year Performance of Stock Market strategies studied by Value Line. Each year, for each factor, they form a portfolio of most undervalued 10 percent of companies within their universe

02/25/2005
A Good Strategy is Hard to Find, by Charles Pennington

A good strategy is hard to find, and it doesn't always hang around. From the data that the Chair posted, below is listed the percentage outperformance of Value Line 1-Rank stocks over the Value Line Composite.  There was clear, obvious outperformance before the 1990's, but now it's dramatically not there anymore.

2/24/05
Ross Miller: Adventures in Retailing Part IV: Woodbury Common

With Presidents' Day Weekend giving me the first opportunity in over a month to get ahead of the curve in my teaching, it is time to get back to retailing with a visit to Woodbury Common. Though it might sound like a socialist utopian planned community, Woodbury Common is a "premium" outlet mall situated immediately off the Harriman exit of the New York State Thruway not far from Bear Mountain.

I was inspired to write about this mall when I noticed on a recent visit that I was apparently the only patron whose spoke English. Some of my fellow patrons were familiar from my days back in Houston when I would visit Neiman-Marcus purely for entertainment--at the end of the Disco Age, academic salaries did not go very far at the city's high-end retailers. Back then, certain customers from foreign lands would pay from their purchases with crisp $100 Federal Reserve Notes peeled from rolls that barely fit into their pockets.

I travel in circles where plastic is the coin of the realm, so after witnessing two transactions where money (in big bills) did the talking, I had an epiphany. Although the items being purchased would undoubtedly be whisked away to distant shores within days, I did not expect that any trace of them would appear on our country's balance sheet as exports to offset our gaping foreign-trade deficit. A back-on-the-envelope analysis, however, demonstrated that unless the number of alien visitors willing to "underdeclare" the value of the goods leaving the country was on a par with our indigenous population, such transactions could only explain a small fraction of the trade deficit. Still, given the difficulty of accounting for anything these days, one has to wonder just how much faith some be placed in government statistics that implicitly assume a world of honest people.

With the topic of international finance (about which I know nothing) out of the way, I will address the mall experience at Woodbury Common itself. I discovered Woodbury Common in its early days when it was still small and outlet malls were the new, new thing in retailing. Woodbury Common is an outdoor mall with stores arranged to resemble a retailing "village' rather than a series of adjacent, yet askew, strip malls, which is what the mall really is. In theory, the mall is built on concept of selling luxury goods at ridiculously low prices. In practice, there is more schlock than luxury and more rip-offs than bargains. I do not intend this remark to be viewed as disparaging, just an objective observation or what my old colleagues in the economics of industrial organization would characterize an optimal strategy in the price-quality state space. If one understands the game that is being played in such a mall, shopping can be profitable as long as one enjoys the process.

Basically, shopping in an outlet mall is like being a fund manager; if you don't know what something is worth, you are going to pay too much for it. The optimal shopper enters the outlet mall with a mental shopping list and a target set of prices. When shopping for good sold by mainline retailers, such as the Coach Store, it is wise to visit the flagship store first to know what the true retail price is. Some stores, such as Brooks Brothers, have special lines of merchandise that sell only at their outlet stores and very little of their "good stuff" makes it to the outlet store. (With Brooks Brothers, the best bargains are to be had at the semiannual sales at the flagship stores and through their catalog.) Some stores, such as the Sony Store, actually have the temerity to sell many items at their full retail price. (In the Sony Store's defense, it has some great "refurbished" items that beat the best prices available on the Internet. I wonder how you say "caveat emptor" in Japanese.) My visits to the footwear outlets are driven not so much by price as by the superior selection afforded to one with outsize feet.

I should mention that after one serious misadventure on Memorial Day Weekend, I never visit Woodbury Common on a weekend (Fridays included). I even go out of my to avoid its stretch of Thruway, which can back up for ten miles, during prime shopping hours. The best time to visit the mall is on weekday mornings in the dead of winter--the colder, the better. While the locals around here think nothing of wearing short in subfreezing temperatures, many of the visitors to the mall come from climes where significantly negative Celsius is cause for a national emergency. A bargain is not a bargain is you have to wait in line for half an hour to cash it in.

For a mall that purports to be premium, the edibles are rather pedestrian. A big fuss was made several years ago when the mall added an Applebee's--the McDonald's of sit-down dining. (The real McDonald's is available in the food court along with the usual suspects.) Before I lapse into a restaurant review, it is worth noting that those insidious Dippin' Dots have long been a feature of this mall.

In my assorted travels I have stumbled across other outlet malls, but I must give the nod to Woodbury Common for general atmosphere--the mall does resemble a village, albeit a tacky one, at the base of a wooded hill that is sometimes quite beautiful--and because some luxury items (by my standards, not Sarah Jessica Parker's) do manage to find their way to the mall at attractive prices. (When Manolo Blahnik sets up shop in an outlet mall, can the final day of reckoning be far away?)

Woodbury's competitors seem a mundane lot. Gilroy, California has diversified its economic base to outlet malls, but its setting has much more of a strip-mall (not to mention, garlic) flavor to them. The Jersey Gardens outlet mall benefits from the local tax breaks to be found in Ikealand-by-Newark-Airport, but is decided downscale and fully enclosed. It had a good Asian restaurant--a real restaurant, not a chain--but my sources tell me that it has closed. The very existence of Jersey Gardens is evidence that the salad days of the outlet mall had passed.

I will resume this retailing series once I get a chance to visit the Wal-Mart SuperCenter that recently opened to the north of me where mobile homes run free. I am beginning to have second thoughts about my tilt toward Target as repeated visits to their stores indicate inventory management policies that leave much to be desired.

The next few commentaries will focus on things that I have run across while gearing up to teach finance course for the first time in fifteen years, which is like an eternity in financial time. (This gearing-up process is what has been making me more sporadic than I had planned.) My first installment in this new series is called "Outlaw Financial Calculators."

02/25/2005
Style Investing, by Bruno

It seems that the concept of style investing is relatively recent. So does it make sense to study the performance of styles over long periods? No investor in the 1920's or 1940's would think of himself as a value or growth investor. So there is actually no track record for style investing. Except perhaps the one from VL that Vic mentions, but it is only from the 60s. This paper about stock valuation history also seems to show that valuation methods evolve from recent market behavior. In a prolonged bull market, people will focus on the future and growth-oriented valuation methods prevail. After a severe bear market, people go back to caution, and value-based valuation is back in fashion.

02/25/2005
The "IBD 100", by Charles Pennington

Investors Business Daily each week publishes a list of 100 high fliers called the "IBD 100". The paper is cagey about whether it's actually recommending those stocks, and even if it did it would tell you to wait for some vaguely defined price pattern to emerge. Also the list changes weekly, and I'd guess that a stock's typical lifetime on the list is perhaps one to three months. The characteristics of the stocks on the list include rapid growth in earnings and sales, high profit margins and returns on equity, good recent performance of the share price, and institutional ownership. I don't know exactly how all these things are calculated.

Nevertheless the list is there to see, and in fact this website provides the list as it stood each week, starting in December of 2003.I took the list as of 12/27/2003 and looked at the price changes of these stocks from 12/31/2003 through 2/18/2005. It turns out that as a group they did quite well, with an average return of 27% and standard deviation 49% for the 98 stocks for which I could easily find price data from yahoo. There were two stocks for which I couldn't find price data. Assuming that went bankrupt with no residual value would knock the average return down by 2%. During this time the price change of SPY was only about 8%.

A word of caution thought--if you had bought only the highest 10 rated stocks in the IBD 100, you would have lost about 10%. Also many of these stocks have low market caps, some less than $100 million, so it would be difficult to buy them in quantity. Nevertheless it's a little evidence in favor of the high fliers, and a very good argument against shorting them.

02/25/2005
Feedback from California, by Jean Paul Schmetz

I am attending a small conference with the greatest minds of our time here in Monterey (Venter (genome), Watson (DNA),... but also Brin, Bezos, Doerr, etc...). One of the consensus here is that the petro-chemical industry is doomed in its present configuration. It seems also (acc. to Venter) that this may happen much sooner than previously thought (the talk is 5-10years or even less if a lucky break through is achieved). Venter (financed by Moore of Intel fame and the DOE) circled the globe in his luxury yacht and collected water to identify 2000 new genes involved in photosynthesis (light --> Hydrogen) and is starting to build bio-tech power plants that can reproduce. He is also working on organisms that convert CO2 into methane. The whole process seems to be much more efficient than electronic or chemical means of producing/recycling energy. Nothing to trade on but the prediction is that there will be an oil crash sometimes during the next ten years (note also that the announcement of this possibility can come anytime during the period -- as soon as Venter creates the first self-reproducing power plant, it will be a media event even if it takes ten years to implement in practice).

02/25/2005
Statistical Musicology, by Victor Niederhoffer

The area of statistical musicology is a gold mine for improving one's understanding of art and markets.

Musical pieces may be considered a time series consisting of an open and moves by favored intervals above and below  the open occurring at various speeds and durations, with other time series from other instruments (or markets) creating the harmony.

I was particularly intrigued by a study that attempted to quantify jumps in consecutive notes in melodies according to the 11 intervals in the chromatic scale. A four-interval jump corresponds to a major third, and a five-interval jump is a perfect fourth, etc.

The bivariate distribution of consecutive jumps, i.e., a scatter diagram of how often a jump of a given magnitude is followed by another, is a very fruitful area in understanding music. Jumps can be considered on an algebraic or absolute basis.

I particularly enjoyed looking at scatter diagrams of Bach pieces, because they corresponds to much to consecutive changes in the stock market with jumps of 4 and 5 intervals being most common. These are almost invariably being followed by jumps of 1, 2 or 4, in descending order of frequency. The jumps down of 4 or more are invariably followed by a much greater frequency of up jumps. And this is because the composers are much more likely  after a decline to write notes that are higher than notes  that are lower.

The music of Mozart is much more evenly divided in the four quadrants, and Scriabin is wild like the derivatives expert says that the market is.

I found some new ways of analyzing markets by considering these jump distributions and I will illustrate with some work and charts and examples  that the I did not have the chance to present during my lecture, accompanied by Laurel at the piano, at the Feb. 23 student investment conference at the London Business School (the reason for our silence last week). A good link to the literature>>>      

An After-Talk Photo at the Royal Chinese:

L. to R.: GM Nigel Davies, Laurel "nanny" Kenner , Professor Elroy Dimson, Chair,"stache" Mustafa, and Patrick Boyle.

02/24/2005
James Sogi responds:

The Blues: it's emotional; it's simple; it's powerful. The simple 1-4-5 progression evolves emotionally with the context of the progression using a repetitive pattern. Try play the basic 8 bar blues, 1-4-5, 2 times: EAEB, EAEB, four beats each. Its the same thing on paper twice but the second time on the second B there is an emotional resolution when heard in person. The song cycle is typically played 3-4 times through with final resolution at the end sometimes an octave higher. The songs are often distinguished by their rhythmic signature which is a whole level of communication which does not appear in standard music notation, and which oddly is also missing from your regular time series bar chart. African drum rhythms are able to communicate meaning. Rhythmic fluctuations would be fruitful area of study in the market in addition to price. Counting is done by tapping (or stomping) the foot. The foot itself contains the rhythm.

Price bars have no more intrinsic emotional content than quarter notes on a music chart, but WE know better....they are packed with emotional intensity as fortunes are made and lost. Look at 2/23-25 SP chart. Its a perfect blues progression starting on the downbeat Tuesday night. A repetitive 1-4-5, each day and the climax today. A move, small pullback, mini resolution top at the "5", a turn around, repeat. Same notes, same chords, different context and different emotional resolution. Seems to be a fairly distinctive and repetitive pattern. Don't forget the obligatory overextended guitar solo or drum solo in there this morning.

02/24/2005
Spin-offs, by Alex Castaldo

While Prof. Pennington has been making great progress in estimating the performance of spinoffs during the past few years, I have been continuing to review the academic literature on spinoffs. Here are two articles:

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Desai, Jain: Firm performance and focus: long-run stock market performance following spinoffs Journal of Financial Economics 54 (1999) p75-101

Examined 155 spinoffs between the years 1975 and 1991. Divided them into "focus increasing" and "non focus increasing". Examined the long run performance (up to 36 months) as well as the short run.

Three alternative measures of focus (1) Using data on sales revenue for individual business segments, compute the Herfindahl Index. A spinoff is a focus increasing spinoff ("FIS") if there is an increase in the Herfindahl index of the parent from the year before the spinoff to the year of the spinoff (i.e if sales revenue is more concentrated). (2) A spinoff is focus increasing if there is a decrease in the number of segments reported by the firm. (3) A spinoff is focus increasing when the two digit SIC code of the subsidiary is different from the two digit SIC code of the parent.

>From the full sample of 155 spinoffs, 111 are classified as FIS and the remaining 44 as NFIS. (In about 90% of the cases the classification is insensitive to the measure of focus used.)

-Quote Our results are as follows. Similar to Daley et al. (1997) the 3 day announcement period abnormal returns are significantly larger for the focus increasing spinoffs (4.45%) than for the non focus increasing spinoffs (2.17%). However we show that the superior performance of FIS persists in the post-spinoff period. In particular the abnormal returns (based on size and industry matched control firms) for the FIS are statistically significant 11.12%, 20.77% and 33.36% over holding periods of 1, 2 and 3 years following the spinoff [this includes both the parent and the subsidiary]. The corresponding abnormal returns for the NFIS are statistically insignificant -0.96%, -7.66% and -14.34%. [ ] The results are robust to the use of alternative definitions of focus and to a number of alternative benchmarks for computing abnormal returns.

[For the subsidiaries only of FIS (i.e. leaving out the parents) the abnormal returns are 22%, 47% and 54% for 1, 2, and 3 years. All are statistically significant.]

Cross-sectionally, the change in operating performance is significantly positively associated with the change in focus. [ ] Thus the stock market results are corroborated by the operating performance results. Also, we do not find any evidence of disproportionate transfer of debt from the parent to the subsidiaries through a spinoff. We show that the firms that undertake NFIS are spinning off poorly performing subsidiaries. -End Quote

Abnormal return is computed using a matching firm methodology (i.e. a firm chosen at random that is close to the sample firm in market cap and is in the same two digit SIC code). Alternatively, the CRSP EW and VW indexes were used, with similar result.

In summary, from an investment point of view, the subsidiaries from FIS (focus increasing spinoffs) are preferable.

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Krishnaswami, Subramaniam: Information asymmetry, valuation and the corporate spin-off decision, Journal of Financial Economics, 53 (1999), p73-112

Prior academic research considered 4 reasons for the gains from a spinoff: (1) improvement in focus and elimination of negative synergies, (2) transfer of wealth from bondholders to shareholders, (3) tax and regulatory advantages, (4) recontracting benefits after the spinoff. This article instead looks at mitigation of information asymmetries as the reason for the spinoff. In layman s terms the spinoff somehow makes the parent and the subsidiary more understandable to financial analysts and investors.

Sample includes 118 firms in the period 1979 to 1993. This study looks at the return at the time of the announcement only, not at the longer term return.

Five measures of information asymmetry were used: (1) Analyst earnings forecast errors (from IBES) (2) Standard deviation of analysts forecasts (3) Normalized forecast error (defined as the ratio of forecast error to the variability in earnings of the firm). (4) Volatility of abnormal return around the earnings announcement (specifically the standard deviation of 3-day abnormal return around the quarterly earnings announcements of the last 5 years). (5) The residual volatility in the firm s daily returns, i.e. the unsystematic volatility

Empirically these measures are found to be higher (before the spinoff) for the firms doing the spinoff than for the control firms.

Also, these measures are found to decrease from before to after the spinoff. For example the earnings forecast errors decrease significantly (by 78%) after the event.

The measures are also found to be related to the size of the abnormal return at the time of announcement. For example, using the forecast error measure, the mean two-day return for top-quartile firms is 4.11%, while it is 2.28% in the bottom quartile. This difference is significant at the 5% level.

-Quote Stock analysts typically have industry preferences and tend to track firms in one or a few specific industries. When these analysts encounter firms with divisions in different industries, their valuation of the unfamiliar divisions is likely to be less accurate, leading to higher forecast errors for such firms. -End Quote

Because this study looked only at returns at the time of announcement, the practical application for investors is not clear. If the results hold for long term returns as well, then one should buy spinoffs of firms with large analyst forecast errors before the spinoff. But this study is more concerned with "why" firms spin off than with what investors should do.

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One disappointment in these studies is that the data used is fairly old.

02/24/2005
It's Good to be Admired, by Charles Pennington

Every year Fortune magazine posts a list of the "Most Admired" companies in the U.S.  This year the 10 most admired are DELL, GE, SBUX, WMT, LUV, FDX, BRK, MSFT, JNJ, and PG.

Contrarians might guess that these are stocks to be avoided.
However, a year 2000 paper by some scholars at the Federal Reserve Bank of New York suggests otherwise.

The authors looked at the results of buying the top decile of "most admired" companies as rated by Fortune each year and holding for one year.  Their purchases well after the list was published in Fortune.  They found that the top decile of most admired companies outperformed the overall market by 3.7% per year over the years after portfolio formation, and outperformed the "least admired" decile by 5.3% per year.  The study covered the years from 1983 through 2000. (Time for an update.)

I looked at the 10 most admired companies, as rated by Fortune, for the years 1995-2003.  The list is typically published in February, but I waited until the end of the calendar year to form the portfolios. *I didn't include dividends.

Here are the results:

list year      investment period    perf (%)  perf.SPY (%)  diff
1995            1996                45%          20%        15%
1996            1997                25%          31%        -6%
1997            1998                39%          27%        12%
1998            1999                20%          19%         1%
1999            2000                -1%         -10%         9%
2000            2001                 0%         -12%        12%
2001            2002               -26%         -23%        -3%
2002            2003                28%          26%         2%
2003            2004                 8%           9%        -1%

Summarizing the results:

--The "most admired" clearly do NOT systematically underperform, as a contrarian might have expected.  They outperformed in 6 years and underperformed in 3.

--During the 3 bad years (2000, 2001, 2002) SPY lost a cumulative 45% (I know, I know, I should consider compounded results.), and the "most admired" lost only 27%.

--For the past three years, there has been little difference between the "most admired" and SPY.

--The biggest embarrassment in the list was LU, which showed up in the year 2000 list, and lost 53% in 2001. And note...there is about 10% in statistical error associated with looking at just 10 companies, with standard deviation of the 10 company returns' typically being about 20 or 30%.  

02/24/2005
Investments, A Review by Russell Sears

I hesitate to give a review of a book I am still in the middle of reading, and probably always will be. Due to its depth, I found that I never really finished reading the 3rd edition of Investments, by the time I progressed to the latter chapters, I had already found myself constantly referring to the book earlier chapters.

Often the world of investments are full of jargon and complex subjects. Investment professionals throw out not just a language but usually a philosophy intended to beat your thoughts into subjection. I consider it a great benefit that my intro into Investment was through this early book. It explained these complex concepts in simple enough language that I could understand. Simple, but comprehensive, I have yet to pick up an investment book that has come close to explaining the range of concept of this one. Further, it presents the philosophical concepts with at least an effort to present both sides. Yet, I detect the authors inclination to index, at least for the masses, rather than actively manage a portfolio. But the 6th edition presented active management in a better light than before.

A caveat to the numerically challenged, this book probably is very difficult reading for those without a basic statistical knowledge. While the texts does review the concepts of standard deviation, covariance, regression etc. it is probably not the easiest way to learn these concepts. As the text assumes you have mastered these ideas fairly quickly. Yet personally, coming from a math background with only basic stats knowledge, I found this book to be an excellent way to solidify a better understanding of stats. Learning stats for a grade lacks motivation incorporate it to long term memory, and the meaningfulness of practical numbers. And what could be more motivating than the hope of increasing your wealth. I would recommend this book for concurrent reading for a beginning stat student.

The sixth edition is definitely worth the purchase if you have not updated your edition for a while. This edition makes extensive use of the Internet. With purchase you obtain access to a web site with power point presentation of each chapter, a glossary of term and quizzes. There also are Excel application on the website for students that want more complete look at a concept than a normal text question.

Both the book and website contain links to relevant websites for each chapter. Like the book itself many of these sites are well known by most connected investors. The website also contains news feeds, by chapter. While often I did not see the direct relevance to the chapter. This I suspect rather is a reflection on web news. Also the site has "power web articles" which appears to retain the most relevant and often the current think on the topics in each chapter. I found this site valuable for the few chapters I have referenced it for. This living updates makes this edition a step ahead of most textbooks, not just investment textbooks. Finally a trial subscription to market data is available for free. But I must confess I did not bother with activating, since I have access to Bloomberg at work.

The sixth edition has done an excellent job of updating topics that have become more relevant recently and keeping up with the best ideas on the current thinking of academic research on the markets. A good summary of recent scandals is given in chapter one for example. And the regulation environment that has grown to meet them. Another example, that caught my imagination, is research by Jaganathon and Wang. This research uses a 3 beta factor model of value weighted market, spread of high grade to low grade bonds as proxy for the business cycle and the cost of human capital. They find "that the significance of the book-to-market and size factors disappears once we account for human capital and cyclical variation of the single-index betas" (Chapter 13 page 425.) Small caps are dominating large and China India and outsourcing are large influences on the cost of human capital. Spreads on junk bonds are tighter than I can have ever experienced. Such concepts invariably divert my attention from the book. This version I again will never complete, and that is a good thing.

2/23/2005
You Can't Navigate the Market Ocean If You Can't Recognize the Chop of Her Seas, by James Sogi

After watching the ocean for 35 years and intraday market data for half a decade, there is chop everyday, uneven short period surface conditions, different than the long ocean swells or rogue waves we've discussed before. There are many names for the ocean conditions, many types, many causes for the chop: Beaufort Force 1-10, describing calm blue seas to violent hurricanes; Cat paws, small ripples caused by puffs or gusts of wind showing as a black shadow across the surface of the ocean; Squall lines caused by a thunderhead and front coming through strong enough to knock a boat down; Whitecaps, small white spray as the tops of the wave briefly feather in the wind; Ocean breakers, blue water breaking waves in the open sea enough to fill and sink a small vessel; Wind chop, small choppy 2-3 foot waves that splash, Storm seas with 15-30 foot confused breakers in many directions, with breakers; Whirlpools, swirling eddies that can swallow canoes in the Northwest passages near Juneau; Glassy, calm conditions when the blue skin of the sea sparkles like diamonds. These phenomena are caused by wind, currents, undersea formations, continental and island land formations, sun spots, the rotation of the earth, tides, the moon, and environmental effects.

The intra day markets have moods like the ocean, and everyday there is the constant chop. Some days are quiet with slow movement, other days with huge breathtaking drops, or powerful up surges, sometimes lurching up and down, some days flat with violent breaks with the entire days move in half an hour. Many make money working the chop, the constant up down motion of the bars. Some consider the daily up and down mere chop in the weekly and quarterly moves. Eskimos have over 27 names for snow. The Hawaiians, who live and die by the wind, have hundreds of names for different winds as they pass over the water: makani 'olu'olu, the fair wind; Moa'a, the trade wind; makani palua, the daily diurnal wind; hau'oki, the icy wind; Ulu, the rising wind; Ehukai, sea spray, all responsible for ocean effects. Speculators need better names for different market conditions. /George has names for his bond work such as "classic firming" , "forward trajectory assessments", "rate back-up out the curve", "convexity". This might lead to better quantification and better profits or different systems. Newton had to invent the names for mass, velocity and inertia to formulate the laws of physics and quantify them. Accurately naming market conditions and what is generically referred to as 'chop' might help speculators frame their hypotheses better.

2/23/2005
Checkers Anyone?

2/23/2005
A Daily Run, by Kim Zussman

This morning's trail jog through the hills was an intrepid one snatched during hiatus in recent centennial record southern California rainstorms. My new running shoes ran slower than usual since they were worried about the mud. However, the hills were splendid; ablaze with deep green celebration laced with bubbling brooks by the hundreds. Curiously, the usual areas of mud and mire were quite passable at the behest of numerous firm sandbars which were easy to hop. It seems the heavy rains washed away the finer, lighter clay particles, leaving heavier sand to stand. The volatile deluge taketh and giveth anew in rebirth.

All the creeks tumbling dutifully downhill; off one cliff a roaring waterfall. Gravity will always let you down. And it pulls water along with great energy to strip mountains of aged skin and over millenea creating a new land, eyes cleansed with tears to face the sky.Gravity preoccupied Einstein 100years ago this year as he began his seminal work on relativity and heuristics.

2/22/2005
Got to Have Faith, by Nigel Davies

Dr. Zussman asks the great question: "Can faith steady nerves when the going gets rough?"

I suspect it depends on the faith. A belief in divine intervention on your behalf must surely be extremely dangerous, and the faith will (or should) be shattered when the protector fails to appear on cue. But faith in your methodology must surely be a very positive thing, provided of course that the methodology is sound. Personally speaking I find that my wife and son help a lot in dealing with the pain of both chess and trading, mainly by putting things into perspective. Good health matters more than money, and being a good father is more important than winning lots of chess games. But if you don't have other things in your life, losing can be very hard.

2/22/2005
Red Fingers, by Kim Zussman

Dad was an artist who was a successful car salesman working for Jim Moran in Chicago in the 1960's. Moran started as a teen mechanic at a service station. Often customers asked if he could sell their cars for them, and over time the inventory grew. He saved enough to buy the station, and as his service/sales business expanded Moran acquired property and eventually developed what became the largest Ford dealer in the US.

Besides initiative and hard work, Mr. Moran's success evolved from innovation in advertising. He was a pioneer in selling cars using the new medium of television. Moran sponsored "Friday Night Fights", a program where cameras cut between rounds to Jim's live descriptions of gleaming beauties driven past spotlights by salesmen. Even before the boxing was over customers lined up at the dealership eager to buy that fancy TV model or even a better substitute.

As a boy I used to watch the fights on the flickering black-and-white rabbit-ear with Dad. We had a tradition of eating pistachios while feinting and dodging, promising Mom not to drop shells on the floor. The old-style nuts were dyed red, as were our fingers once the show was over.

What would I give for just one more of Moran's shows cracking nuts watching with Dad!

2/22/2005
How to Use & Interpret Logistic Regression, by Professor Tony Corso

Binary Logistics Regression & Industry Modeling shows how to use logistic regression to properly frame the kinds of questions the Chair and Professor McDonnell are constantly encouraging us to ask: "If this, what are the odds that.. ."

Its examples are industry effects, but extensions to other sorts of questions are obvious.

Makes me want to go and break out some old regression code from 5.25" floppies and my tattered Schaum's Linear Algebra.. .

2/22/2005
Dick Sears Weekly Commentary: Another Dreary Week

2/20/2005
Humphrey-Hawkins, deconstructed by Roger Arnold and George Zachar

Roger:

Ron Paul from the 14th district in Texas has made challenging all aspects of the Fed his own crusade. And Greenspan's continuous condescending treatment of him right on television! When that happens you have to ask yourself what the Chairman is thinking. He knows he's TV; he knows that an elected official is questioning him. And he smirks when Ron Paul questions him EVERY TIME! It's like watching a kid stick a hornet's nest with a stick!

George:

Ron Paul and Greenspan are friends "off stage," as are Greenspan and Sarbanes. The Fed may be "corrupt" when measured by a historical yardstick that encompasses the true 19th century gold standard, but now it is best modeled as a semi-independent bureaucracy with the standard attributes of mission creep, survival bias, and organizational/political competition/threat response.

Roger:

Yes, it is obvious that the interaction between the two of them is not adversarial and that there is a mutual relationship of some kind there. More like watching a theatrical production than a congressional hearing. I was referring more to how the lay-audience perceives that interaction. Greenspan does not seem to appreciate that, or perhaps he is just letting Ron Paul have his fun. But I would think that he would play his part too, by taking the questioning seriously.

George:

A Greenspan appearance on Capitol Hill is a goldmine of material for rhetoricians. The questioners have a very wide range of intelligence, and a veritable checklist of political motives, both local for their specific constituencies, and specific for inside the beltway. In this, they could not be more transparent.

But Greenspan is speaking to the national and financial press (his conduit to the great unwashed), and to the markets themselves. This accounts for the awkward discontinuities in what looks like a Q&A, but are really alternating speeches to different audiences.

These "players" are all frighteningly far removed from the day-to-day lives of the populace. I do worry about the momentum Washington has in eroding our freedoms. Vic's eloquent posts on medicine and regulation are the classic example.

2/20/2005
Sector Rotation, by Professor Mark McNabb

Interesting how S&P 500 subsectors flip from the top 10% of returns in the market to the bottom 10% in a short period of time:

Top Dozen Subsectors
2002                   2003                   2004
GOLD                   INTERNET SFTWR & SVC   FERTILZR & AGR CHEM
METAL & GLASS CNTNRS   DVRSFD MTL & MINING    INTERNET RETAIL
INTERNET SFTWR & SVC   SEMICONDUCTRS          INTERNET SFTWR & SVC
PHOTOGRAPHIC PRODS     COMPUTER & ELEC RTL    STEEL
APPAREL RETAIL         HOMEBUILDING           OIL & GAS REFIN & MKTG
HOMEBUILDING           COMP STORG & PERIPH    WIRELESS TELECOM
CASINOS & GAMING       INTERNET RETAIL        MANAGED HLTH CARE
INTERNET RETAIL        ELECTR MFG SVC         AGRICULTURAL PRODS
OFFICE ELECTRONICS     ALUMINUM               OIL & GAS DRILLING
HOUSEWARE & SPECLTY    SEMICONDUCTR EQ        HTLS RESORT & CRUISE
HEALTH CARE SUPPLY     STEEL                  TIRE & RUBBER
FOOD DISTRIBUTORS      WIRELESS TELECOM       SPECIALIZD FINC
DVRSFD MTL & MINING    CONST & FRM MACH       TRADING COS & DISTR

Bottom Dozen Subsectors 
2002                   2003                   2004
MOVIES & ENTERTAIN     HLT CARE DISTRBTR      GOLD
FOOD RETAIL            THRIFT & MORT FIN      ADVERTISING
APPLCTN SOFTWARE       HEALTH CARE FAC        PHARMACEUTICALS
HOME IMPROVE RTL       PHARMACEUTICALS        BROADCAST & CABLE
COMP STORG & PERIPH    FOOD RETAIL            HEALTH CARE FAC
WIRELESS TELECOM       PACKAGD FOODS & MEAT   AUTO MANUFACTURER
SEMICONDUCTRS          MOTORCYCLE MANUFTR     ALUMINUM
TIRE & RUBBER          INTEGRTD TELE SVC      INSURANCE BROKERS
IT CONS & OTH SVC      HOME FURNISHINGS       ELECTR MFG SVC
ELECTR EQUIP MFR       HYPERMKT & SPR CNT     SEMICONDUCTRS
COMM EQUIPMENT         TRADING COS & DISTR    SEMICONDUCTR EQ
MULT-UTL & UNREG PWR   PHOTOGRAPHIC PRODS     IT CONS & OTH SVC

Charles Pennington responds:

By my count:
1 of 2002's top dozen is in 2003's bottom dozen
3 of 2002's bottom dozen are in 2003's top dozen
2 of 2002's top dozen are in 2003's top dozen
1 of 2002's bottom dozen are in 2003's bottom dozen

It looks pretty random to me. What am I missing?

2/18/2004
"As Predicted," Certain Companies Involved in the FDA Hearings Showed Rises of 6-10% After All the Bad News Was Out

With stocks driving higher during the last few months following each downward reaction, the situation was ready made for Livermore. The Street stories are that he went short of a large line of issues such as:– United States Steel, Montgomery Ward, Simmons Co., General Electric, American and Foreign Power and half a dozen other of the markets pivotal issues. He then started his familiar hammering tactics under which the market first faltered, then broke

Cutten, the Fishers, Durant and others of the group known in Wall Street as the “Big Ten” were large holders of these particular stocks and have seen their plans and pools wrecked by what were natural economic developments, coupled with much shrewd short selling.

One of the tales started and circulated in the financial district yesterday, was that Livermore had the backing in a bear campaign of Walter P. Chrysler, who was said to be piqued because he suspected that the Chicago-Detroit group had hammered at Chrysler motors in the market, driving it down below 55 from its high of 135 this year.

The outstanding Bear leader appears to be Livermore, who has regained a tremendous fortune through adroit short selling, and who, temporarily at least, is regarded as being exactly “right” on this market. Cutten, who started as a grain trader, has amassed an estimated 100 million or more, in the stock market during the last three years of bull markets. Cutten is the leader of the bull faction and is temporarily at least regarded as “wrong” on the market.

Mr. Cutten was in New York and watched the market from the office of the head of the stock exchange. His expressed opinion to friends is that much of the selling had been hysterical, and that he believes good stocks should be held for higher prices. He has not changed his formerly stated position about the long distance outlook.

Source: New York Times, quoted by Stock Market Solutions

p 69: "Milking the street". This is a combination to put the price on the Street down so that parties may buy. The stock is then Bulled by the holders who instantly sell out. ... In the excitement the combination reap a golden harvest. They have milked the street"

2/18/2004
Alex Castaldo offers:

Nathan [Rothschild], knowing that information is power, stationed his trusted agent named Rothworth near the battle field.As soon as the battle was over Rothworth quickly returned to London, delivering the news [of Napoleon's defeat] to Rothschild 24 hours ahead of Wellington's courier. A victory by Napoleon would have devastated Britain's financial system. Nathan stationed himself in his usual place next to an ancient pillar in the stock market. This powerful man was not without observers as he hung his head, and began openly to sell huge numbers of British Government Bonds. Reading this to mean that Napoleon must have won, everyone started to sell their British Bonds as well. The bottom fell out of the market until you couldn't hardly give them away. Meanwhile Rothschild began to secretly buy up all the hugely devalued bonds at a fraction of what they were worth a few hours before.

2/18/2004
Hedge Fund Vigs, by Tom Downing and Victor Niederhoffer

In order to determine the extent to which fund of funds (FOFs) further add to fees charged by hedge funds, we carried out the following experiment: Given the number of hedge funds that an FOF buys and the correlation structure of the funds within the FOF, what is the corresponding expected return and volatility? The results are below:

Simulated Annual Fund of Fund Returns:

Simulated Annual Fund of Fund Volatility:

Assumptions:
Expected Return: 5 percent
Expected Volatility: 15 percent
(except in case of 'Mixture', where Expected Return is 0)
Fee Structure:
Each Hedge Fund charges 2% mgmt/20% perf
FOF takes 1% mgmt + 10% of net

Correlation Structures:
POS: All hedge funds have expected correlation of .5 with the other hedge funds in the FOF.
NEG: Separate funds into two groups (A and B); funds in A are correlated .5 with each other but correlated -0.5 with each in B and vice versa.
ZERO: All funds have expected correlation of 0.
PERFECT: All funds nearly perfectly correlated.
MIXTURE: Half of the funds have expected return of 10 percent and the other half have expected return of -10 percent, and all are ucorrelated.

2/18/2005
A Philosophical Question, by Philip J. McDonnell

Much of my research has recently focused on developing methods to predict shorter term market moves on the order of one to 10 days. In reviewing the results a curious pattern emerged. The variables with the highest correlations with the market seemed to show weaker results when tested as trading systems. By contrast variables with near zero correlations often showed dramatic results when used as threshold variables.

A threshold variable would be something like:

If the S&P yesterday was up more than 1% use the actual value otherwise use zero (ignore the data)

In this case the threshold value would be +1%. One way to view this oddity is that the high correlations indicate a strong linear relationships. The threshold variables may indicate a non-linear relationship or possibly one which only comes into play when a threshold is surpassed.

One theory as to why this may be happening is that the rise of all the statarb shops has milked out most of the excess profits from simple linear correlations. Corresponding to this is that linear relationships are the easiest to understand and identify because the statistics are universally available. By contrast the threshold variable methodology may be little used and certainly requires a bit more thought as well as deciding on or "fitting" a threshold value.

Another theory is that the market is fundamentally non-linear. If so, attempts to predict its behavior with linear models and techniques will at best prove weak. This may explain why the market appears so random to its linear thinking human participants. To the extent this theory applies then the most fertile ground to hoe will be in the area of non-linear models.

2/18/2005
Nullius in Verba, by James Sogi

As the Temple of TA comes tumbling down at Smith Barney and the high priestess is banished, what better time to look at the history of the speculative sciences. Nullius in Verba, was the 17th century Royal Society of London 's motto, Don't take anyone's word for it. The society had such distinguished members as Newton, Bacon, Hook, Halley who celebrated the scientific method, sought to deflate ballyhoo, and rejected appeals to authority. They lived in a time when the European languages lacked words or concepts for some of the concepts they were developing. Descartes suspected mechanical demonstrations of hyperbolic and elliptical functions such as sails, or the line traced by a pencil in a circle as it rolled, or the ellipses drawn by a string on two foci. He lacked the conceptual framework and the mathematical concepts to grasp what was before his eyes. Their math did not allow use of the infinitely small. Science in the early 17th century lacked the language or the mental framework to understand the heavenly phenomena before their eyes nightly as their concept of velocity was just beginning with a knot line tossed over board a sailing ship.

We see many obvious things in the market each day, but struggle to make workable hypotheses and tests to advance the speculative sciences. Do we possess sufficient concepts to understand the market? It took over 1000 years to deflate Aristotelian ballyhoo. We still cannot explain what gravity is. Are speculators like ancient mariners believing the world is flat? Are we missing obvious explanations of market machinations for lack of an adequate conceptual framework. The work here is an advance and will carry forward. The answers need not be exact as rocket science, for even Newton only sought to calculate "pretty nearly". Time is the father of truth. The testing of market hypotheses will continue. The results will remain suspect until disproved according to the scientific method.

2/18/2005
Victor Niederhoffer: An Interesting Hypothesis...

appears in a recent Merrill Lynch report titled "The Economics of Volatility". Their main point is that volatility is the price that investors demand for providing insurance, i.e. risk capital to the market. They go through some charting mysticism to predict that an increase in short term yields leads by 2 years an increase in volatility. Since short term interest rates rose one percent from June 2004, they predict a spike in volatility in the near future and recommend buying long term volatility now a la the expert, albeit his recommendation is for all times and if he's wrong he tends to put the blame on the demand schedules of his clients. But that's not the point. The authors state "when risk capital withdraws, riskier investments tend to be liquidated first. Emerging markets generally slot in that category quite well". Thus they predict that shortly Asian equities will fall and that volatility in Asian markets will rise. Of course, this is untested. But like everything else it deserves to be tested. I hypothesize that Asian equity markets lead US equity markets and that turning points in the former occur earlier than the latter. It's a good and useful thing to test and I might recommend the Henry George type of analysis that we used to test similar relations between real estate prices and equities in Practical Speculation as a related phenomenon and template.

Dr. Alex Castaldo Responds:

Aussitot dit, aussitot fait.

Using quarterly data from 1997 through 2004. The correlation between the % change in MSCI Emerging Markets Index Free and the subsequent quarter's % change in the S&P is -0.075 with 31 observations. This seems to be statistically indistingushable from zero.

The correlation coefficient multiplied by the number of observations is 2.3, which is less than the threshold of 10 that Henry George would consider "useful".

Kim Zussman Responds:

A former physics professor who manages money uses what he described as mathematical models of the stock market. With a book of charts he quizzed me on spotting repeating patterns among individual names and sectors, with the desired revelation that there are wave patterns in channels which are predictable.

Instead I noticed that stocks making waves waved up over longer periods. I did not have time to tell him that this is how markets work and why they go up (who would take this from a periodontist anyway): Volatility is risk, and the pain of volatility shakes out the weak to feed the strong (or patriotic). One is compensated for enduring this, and it can be profitable only since not everyone can endure it. If no one felt pain there would be very little buying (in hope) and selling (in fear).

Puts act as insurance against disaster, albeit at a cost too dear. Historically volatility mean reverts after spikes in profitable ways while low volatility doesn't. Yet how gratifying it was to have such protection at 2005 inception; and so too must it have been in '87, '97, and 9/11.

Recalls the patients who ask for Vicodin by name. This highly-abused narcotic is a favorite of the pain-intolerant. What price will you pay for pain reduction (it reduces physical as well as other pain)? Labeling? Addiction? Constipation?

Perhaps puts are too expensive because most are too weak. The strong sell this narcotic at a steep price yet sleep well even with 1000 airliners aloft every night.

Is this what Ayn was saying?

Bruno adds:

Liquidity Black Holes, edited by A. Persaud, deals with this concept, among other things. They make the interesting point that the prevalence of VaR for institutional risk-management could lead to herding behavior. That's when similar risks models all indicate more or less simultaneously that some positions should be liquidated. VaR people will liquidate riskier investments first because that the easiest way to get back within their risk limits.

There are actually a couple chapters in the book that test for herding behavior (looking for Granger-causality). They find evidence of this type of behavior, but don't show that it is linked to the widespread use of similar risk models. There are other explanations. VaR-induced liquidity black-holes, starting in the most volatile markets or instruments, look more like a scenario for possible future crises than the reason for past ones.

2/18/05
Another Reason to Distrust Finance Academia, by Ross Miller

I was in the process of preparing my first derivatives exam for my poor, unfortunate accounting graduate students, when it hit me that something was really screwed up with standard textbook treatment of options. I am used to finding little errors and inconsistencies of every variety left and right, but this is a more serious one that affects every treatment of options that I have ever seen. To Continue:

2/17/2005
The Inefficient Stock Market by Robert Haugen, reviewed by Philip J. McDonnell

I must confess to a certain affinity for outspoken rebels. Robert Haugen, the author of The Inefficient Stock Market, is an academic rebel who is willing to confront the established aristocracy of academic finance. For that reason and more I enjoyed reading his book and can recommend it with a few reservations.

Haugen is a Professor of Finance at the University of California, Irvine. He is the author of several books and papers and is probably most famous for his popularized work on the January effect.

Key points of the book include:

1. The book takes issue with the standard business school beta model, where beta is used as a measure of non-diversifiable risk. Empirical evidence is presented that the return to highest deciles for beta are uniformly below the returns to the lowest beta deciles. Additionally the beta based decile rankings are substantially in the reverse order which is predicted by theory. Hence the market does not reward increased non-diversifiable risk contrary to the last 35 years of business school teaching.

2. The author takes issue with the factor models of the 1990's. In particular the Fama-French (FF) (3 or 4 factor) model is disputed. In substitute he offers a 51 factor (!) model in which he shows that the variables used in the FF model are quite weak when other correlated variables are explicitly broken out. For example the book value factor used in FF becomes weak when explicit earnings variables are used because book value is essentially an accumulation of earnings over time.

3. The major model presented in the book attempts to predict the future returns of 3000 stocks and thus, is of fundamental interest to investors. The model shows a substantial 42% annual return differential between the best decile and the worst decile over a period of more than a decade.

4. The most important factors were: 1 month excess return -.72% 12 month excess return .52 Trading volume/Market cap -.20 (2) month excess return -.11 Earnings to price .26 Return on equity .13 Book to price .39 Trading volume trend -.09 6 month excess return .19 Cash flow to price .26

No risk factors such as beta or historical volatility made the top factor list. Four price change, four value and two liquidity variables made the top list. All 51 variables were included in the regression.

5. Mean reversion in the one and two month time frame is reported, which is attributed to correction of "market error". Serial correlation in the intermediate 6 month to 2 year time frame was found which was explained as corporate exploitation of competitive advantage. Mean reversion was again found in the 2 to 5 year time frame. The book explained this as the time frame for competitors to react to any temporary competitive advantage. Furthermore the assertion is made that the markets routinely overestimate the length of time for which a competitive advantage will be sustained.

6. The author considers and effectively refutes most of the usual biases and flaws in such historical studies. Included in the list are survival bias (manually addressed), look ahead bias (3 month post publication delay and use of actual data files after 1987), data mining (the 51 variable model was the first one they tried) , counterfeiting (real time test with real money by a Norwegian fund). The author pleads guilty to data snooping which is the practice of reading other people's published reports and papers and then using variables which they found successful.

7. One of the amazing findings of this model is that the best performing deciles routinely had lower risk as measured by beta and variance. The worst performing deciles had the highest risk flying in the face of accepted CAPM theory.

My reservations include the following:

1. The model uses 51 variables fitted with ordinary least squares (OLS) regression. Because of the endemic cross correlations between financial variables I am very dubious of the quality of the confidence estimates of the individual regression coefficients. Given the more than 2500 possible cross correlations it is certain that the 99% confidence levels claimed by the author are specious. However I do find the overall results quite convincing simply because the deciles nicely line up in their expected rank order.

2. The study used Compustat data which is notoriously flawed for the purposes of historical testing including issues such as retroactive adjustments etc. After 1987 the author saved the original data releases and used only data available at the time with an appropriate lag. Although I don't trust the results before 1987, they appear to be in good agreement with the results after 1987 which are more trustworthy.

3. The book was published in 1999 and the factors must be updated before being used.

I especially enjoyed the author's irreverent tone, which is quite unbecoming one who professes in finance. He refers to the established big names in finance as the College of Cardinals and defenders of the Holy Temple of the Random Walk. His model is part of what he has termed The New Finance, which he admits is ad hoc and has little or no theory to support it, but does offer much better predictions with respect to future returns. His style makes for an easy read and motivates one to go out and seek his Super Stocks and avoid the Stupid Stocks.

2/17/2005
Keeping Count of Your Counterpart's Count, by Leonard Kreicas

Thorp's idea of betting with odds that are "rich" is intriguing for counters. In the game of Hearts, for example, by knowing how rich in suits the opposing player is, the player knows that certain suits will come out. This analogy might be fruitful in the market when the counterpart is "rich" in a holding he will eventually have to dump or cover.

2/17/2005
Bond Grey-Beard humor, from George Zachar

Q: What is the most frightening phrase on Wall Street?

A: There's a problem on the mortgage desk.

2/16/2005
Sunspot Cycles, by James Sogi

Climate change may have destroyed fisheries. The Aleutian low pressure system is the dominant meteorological winter feature in the North Pacific and helps stir up ocean water, bringing nutrients to the surface. (and brings 50 foot waves to Hawaii) This climatic phenomenon is called the Pacific decadal oscillation because a review of past climatic data shows that the low pressure system seems to shift with near decadal periodicity. The fairly regular oscillation may be a response to an 11 year solar cycle of sunspots. The eruption of solar flares with a near decadal frequency increases the heavy solar particles(atoms), which take approximately 6 months to reach our atmosphere. Solar particles reacting with the upper atmosphere may lead to higher atmospheric pressures, which may intensify and displace the Aleutian low pressure system to the east. recent oceanographic research has shown that Pacific decadal oscillation is part of a greater cycle defined as near century oscillation on the order of 70-100 years. From Islands of Refuge, Rauzon. (about the northwest Hawaiian Islands.)

The waters are so wild up there, my fisherman friend tells me, that humans cannot go in the water. Schools of 50 or more 100 pound Ulua (trevally) attack divers. A friend tells of schools of ulua hitting the flashing spinning props of dual 200 horsepower outboards running at full speed causing the outboards to jump in their mounting. Seals and sea birds cover the shores. It is dangerous to put your hand into the water.

2/16/2005
Reflections, by Victor Niederhoffer

The hearings on pain killers at FDA will be held during the next three days. And it will be good to study the kinds of statistical errors that are made in weighing the results of one study with a percentage of heart attacks that varies about 1% a year from expectation with the base figures as this will enable one to see better the kind of randomness that fools the mystics in our field. Of course, with us, it’s just money.

Every now and then a number of forces come together that crystallize the million wrong things that emanate from the idea that a human does not have the right to his own life. Such is the case with the tests, propaganda and hearings associated with the well publicized side effects of the pain killers. The main thing that's wrong with such hearings is that every patient should have the right to decide for himself whether he should be taking the drug after assessing the benefits and costs. The related main problem is that there is a total emphasis in the controversy about whether there is an increased risk of heart attacks and strokes without regard to the benefits involved in pain reduction and cancer prevention.

It turns out that the risk of heart attack in the most frequently cited studies by the "take it off the market group" goes up from 1% or 2% a year to 2% or 3% a year for people in the 50 year old bracket. That's what they're referring to when they talk about the doubling of rates. But compare that to the approximately 100% reduction in pain the drugs cause and the approximately 50% reduction in polyps that the drugs cause, with many estimates of about an 80-90% conversion of polyps to cancer.

But that's just the first of the problems. The whole subject is junk science at its worst. The drugs themselves have been used for hundreds of millions of patient-years. And they have been tested for efficacy and safety in double blind studies in hundreds of studies. They have numerous spillover benefits in all sorts of off-label uses. And indeed at the time they were pulled hundreds of studies were going on as to their efficacy for such things as prostate, breast and colon cancer, and stroke. Of course, one of these studies with a hundred patients or a thousand patients is going to show a increased rate of disease of 1% a year. That's guaranteed to happen with randomness. As a benchmark, consider that the variability of a proportion is of the order of 2% with a study of 100 patients.

Regrettably the problem runs into the tort system. Lawyers using junk science have an industry in suing companies whose products have side effects. In a typical such study, the patients get 100 bucks each and the lawyers get 50 million. But politicians benefit because the tort lawyers are one of their biggest contributors. While the litany of abuses runs deeper and deeper, all stemming from the idea that people are incompetent to make choice, the drug companies, or big pharma as they're known in the industry, should not be absolved. The outcome of all such hearings is to preclude competition, reduce their permitted level of expenses, and make it harder for other companies to bring out competitive drugs. Think of the tobacco settlement as an example here, with restriction on entry into the industry by companies that didn’t participate in the settlement. Multiply such witch hunts by 1000 fold, and think of all the molecules that don’t get invented, and all the patients that don’t get treated, and the delays and restrictions in the drugs that do go through the pipeline, and you can readily estimate that the average life span of all of us would be increased enormously, say five years, within five years of the abolition of the organization that likes to think of itself as a proper noun, with benevolent influence, FDA.

2/16/2005
George Zachar adds:

1) Amen.

2) I actually read the public treatise Hillary used to promote nationalizing healthcare a decade ago, and the only possible conclusion one could draw was "they're trying to kill me". She even advocated racial quotas for training/hiring in each medical sub-specialty!

3) A simple way to project the logical outcome of current trends in government/legal medical meddling is to visualize health care a few decades hence as the auto manufacturing business looks today: A creative dead zone where zombie firms crank out fill-in-the-blanks products, with engineers in thrall to regulators and lawsuit generators.

4) I am pessimistic about slowing the "big trend" toward stifling innovation and freedom in health care. It is far too easy for rent-seekers to rig the information, legislative, regulatory and legal dimensions.

5) Innovation and freedom is likely to manifest at the margins of US society, in off-shore facilities (India's booming surgery tourism for example), and in smuggled pharmaceuticals produced outside the increasingly suffocating American regulatory framework.

6) I expect to see a black market in medicinal pharmaceuticals develop in parallel to the existing one in recreationals.

2/16/2005
Victor Niederhoffer rejoins:

The omniscient libertarian bond trader George Zachar has developed the meta frame "your own man" to help understand the multitude of occasions liberals try to spin pro agrarian reform measures. I pointed out that Alan Dershowitz noted the same phenomenon at Harvard where he was unwittingly put on committees that were going to come up with anti-Semitic choices for important faculty and admin posts at Harvard so they could say "hey, your own man was head of the committee."

Such would seem to be going on with FDA hearings on pain killers today where Curt Furberg is on the committee. He is the proud author of the paper that showed that Bextra tripled heart attack and stroke risk in heart bypass patients. Recall that that study raised the risk to about 3% a year from 1% versus placebo, which had less than 0.5% a year risk versus the population of 50's which seems to have about 3% risk. Furberg's hobby horse is "many studies compare Cox 2 Inhibitor with other NSAID's instead of a placebo."

There are so many things wrong with the statistics of the placebo study that Furberg did, as well as the reasonable idea that people who are in pain wish some relief so a placebo shouldn’t be given, and there is a balance between pain relief and heart attack relief, that one almost wouldn’t dignify the professor's hobby horse. But he's on the committee. Why? He's obviously biased and should recuse himself. Is it a case of   "your own man" or is FDA truly a witch hunt forum where the lead member of the southern contingent on the committee shows where they want to go?

I vote for Zachar's "your own man."

2/16/2005
Michael Stallings adds:

"Universal Health-Care", as Hillary sees it, is not DOA, but on life-support, to be revived when she's elected President. The Dems couldn't get it through on her husband's watch, as she was his wife and not the leader. But heads-up if she's elected to the big job.

2/16/2005
Dr. David Brooks writes:

So it strikes me there are basically two issues:

1. Should pharmaceuticals be allowed to pitch their meds to the public through the same mechanism as Coca-Cola and Walmart, and

2. Are the Cox-2 meds better than standard aspirin or NSAIDs at the appropriate dose in preventing polyps/cancer?

I believe the answer is "no" for the first (and this goes for erectile dysfunction meds, cigarettes, statins, etc) because I do not believe that the public has the sophistication to parse through the various claims of pharma. You, Vic, review the studies to determine their efficacy; 99% of the others believe that anything they see on TV must be right or it wouldn't be there.

As for #2, if they are better (and so far as I know there are no studies comparing the two head-to-head) then let's use them. If not, they should be reserved only for people with a bleeding diathesis.

2/16/2005
Pam van Giessen says:

With all due respect to the good doctor, I disagree with his answer to #1. Doctors are the barrier in place to protect the completely idiotic through which we all have to pass to get a prescription for just about everything. I also disagree that 99% of the folk believe all marketing that comes at them (which is pretty much an insult to the hoi polloi but a typical attitude among health care professionals).

What is so bad about people hearing the marketing for drugs that might give them relief from whatever ails them, and then engaging their physicians in discussion about that drug? That's not the same as "believing." It's about learning about a product for which they may have use, and then turning to the gate keeper of that product to find out if it is right for them. Good gatekeepers will explain the pros and cons to their patient/clients who will then take the guidance from their trusted medic. And even if we break down the doctor/prescription-giver barrier, the market will quickly take care of bad companies promoting bad products. Companies with products that may help us shouldn't be constrained from promoting their goods to us just because the product may not be right for everyone, or even if their product is a lemon. In today's hyper-connected world, no company will be allowed to get away with selling lemons for very long before the news gets out to millions, and it would be easy enough to put penalties in place that would make releasing bad drugs not worth the short term gains (though the market penalty will be harshest). Personally, I would never take a drug without discussing with my doctor but I've been well indoctrinated. Doctors, in the form of the AMA for instance, could easily do outreach campaigns promoting the value of having one's doctor review drugs before ingesting.

Unfortunately there is an attitude among many health care providers that they should be the conduit through which all (or any) information passes to the masses (or maybe it's the same bunker mentality every profession under fire feels), and it can be very frustrating for patients and their families. You would think that a daughter of both a nurse and a doctor would not have doctors playing these games with them, but I've personally experienced it twice, the first time being devastating for my family. Pain being a great teacher, I learned a valuable lesson about taking responsibility, doing research, then following up with the doctors to ask intelligent questions. People should engage in their and their family's health care, with their providers, and if that comes about by drug company marketing, so be it. Doctors should rejoice in even modestly informed, engaged patients.

We have created a weird health care system in this country where doctors and patients are at great distance from each other (instead of neighbors or long-time family caregivers as they once were, and with 3rd party payments further separating them), and so patients act like dogs at the vet, dumb and almost afraid, or blathering idiotically. And then there is the ever pleasant exam situation whereby the annual (if that) conversation between patient and doctor is usually had while patient is stripped, on an uncomfortable table, covered by a napkin, with cold instruments or fingers in uncomfortable places. When asked by the medic (who one sees but once a year) and whose fingers are poking and prodding in places usually reserved for no one or intimate partners only "and how are you feeling? Any problems?" most of us do sound a little stupid in the ensuing conversation (likely because our brains are saying "I'll be fine once you remove your fingers from my x').

Further, the economic incentives for doctors have changed so much that they are overburdened and hardly have time to ask "how do you do?" during regular exams, and likely resent discussion about some drug they heard about on TV. My father often saw that his patients were not very forthcoming during exams, but at the school picnic and other events, they would disclose, and he would learn more about their problems, and could effectively treat them because he was engaged in discussion with them when they felt comfortable. He lived among them. Not so any more. You get your 15 or 20 minutes and that is that. I think my vet spends more time with my dogs than my doctor does with me. But then again I am paying my vet cash money, at rates he sets, and not dictated by insurance, and if I don't like his rates or his demeanor or his treatment, I can go elsewhere easily -- not so when one and one's employer combined pays thousands of dollars for insurance every year and choices are limited. I also have the power to get just about any drug my vet may prescribe from mail order sources (and often no prescription is needed). I even have the power to give my dogs their annual distemper shots (which I have done). My dogs have not suffered because I took their health care into my hands. Not even when I used the (medical) staple gun on my pointer when he slashed his leg.

Direct marketing to consumers by drug companies, and doctors promoting the value of consumers *paying* doctors for a professional vet of their drug choices could be beneficial to everyone and the entire system if it gets people to take more responsibility, and brings about a more competitive marketplace whereby the value of health care professionals outside the insurance system is increased -- in which case everyone benefits.

2/16/2005
The Good Dr. Brooks answers:

In general, I agree with the vast amount of what she says. And I would be the first to acknowledge that there is a considerable amount of paternalism in the medical world. That said, I for one, do not have the sophistication to prescribe, for instance, a specific statin, a specific ACE inhibitor or a specific beta-blocker and can't imagine why I should leave the decision of whether I need that medicine to the marketing department of Pfizer or some such company. And yes in an ideal world, the physician could be a gatekeeper and discuss these issues with the patient, but if you have ever tried to tell a patient why you believed that he/she didn't need a medication or procedure you will know that that is a fool's mission. It's easier to acquiesce.

Furthermore, as any MD reader of NEJM knows, preliminary results are often just that and need to be viewed with a skeptical eye. We talk over and over again about evidence based medicine when in fact we often accept received wisdom as the coin of the realm. Since I do not believe that I (with a small degree of medical sophistication) can interpret many of the new studies that are published each year, I fear for patients who are easily swayed by marketing. Look at the Fen-Phen diet drug.

It's instructive to look back at the situation in the latter half of the 19th century when patent medicines were routinely available and sold to the unwitting without any oversight. A generation of hucksterism and a class of scoundrels preached the wonders of these drugs across the West. Furthermore, as a surgeon who deals regularly with cancer I can assure you that the number of people "out there" touting unproven cancer cures is horrifying. People with advanced cancer will do almost anything if they think there is even the slightest chance of cure. Coffee enemas, shark's fin, eye of newt. While there is much arrogance in modern American medicine, we do at least make a supreme effort to subject our medicines (if not our surgeries!) to rigorous controlled trials. I would refer you to my colleague Jerry Avorn's book Powerful Medicines: The Benefits, Risks, and Costs of Prescription Drugs as well as the one written by Marcia Angell, The Truth About the Dr