I always enjoy finding interesting resonances from the past…

Here is Peter Bernstein, writing in the 1960s, in A Primer on Money, Banking and Gold, pp 165-7:

We know that interest rates reflect the interaction of the demand for and supply of money. With business activity rising so slowly, the need for cash to finance expanding production during the 1930s was obviously also growing at a slow rate. With ever-rising amounts of money in the checking accounts of individuals and corporations, those who held these idle dollars pressed to find some employment for them. Long-term yields on corporate bonds had been above 4 percent when Roosevelt took office in 1933; by 1938 they had fallen to little more than 3 percent and at Pearl Harbor were down to only 2 3/4 percent. At the same time, yields on short-term paper, which had run well above 4 percent before the crash of 1929, fell to nearly zero.

Yet, while the pattern of interest rates conformed to the theoretical proposition that yields will go down when the supply of money exceeds the demand for it, the most striking feature of this period from our viewpoint was really the degree to which the banks and their depositors were willing to hold dollars idle. Despite the avalanche of reserves that the gold rush brought to the banks, the banks were willing to lend and invest only a small part and were content to let cash resources in the billions sit idle, earning nothing. Even though the money supply rose about one-third faster than the output of goods and services from 1933 to 1941, the decline in interest rates was persistent rather than precipitous. Finally, it was clear that the sheer pressure of funds was by no means a sufficient condition to drive business activity upward to its full potential - nobody's money seemed to be burning a hole in his pocket.

Monetary policy as a means of stimulating business activity fell into wide disrepute as a result of this combination of circumstances. Some people saw little point in efforts to increase the the supply of money if no one wanted to spend those additional dollars on goods and services. What was the point of giving banks the resources to buy bonds that people wanted to sell of the sellers just sat on the proceeds instead of spending them? Others argued that the banks were clearly unwilling to buy long-term bonds at low interest rates; therefore, no means existed to push interest rates down far enough to encourage businessmen to take the risks of borrowing and investing money in new factories to create new jobs.

Indeed, as a result of both a general sense of insecurity and of a basic reluctance to part with cash for such a small reward in interest, the fetish for liquidity during the 1930's was extraordinarily powerful — the simple creation of money (or receipt of money from abroad in the form of gold) was no guarantee that it would be spent. Some observers compared the stimulus of monetary policy with the effectiveness of pushing on a string. As a result, increasing interest and attention was focused on Government spending in excess of tax revenues - deficit financing, as it came to be called — in which the Government would borrow the idle dollars no one else wanted to use and spend them for things the community needed.



 I never look at the news, but I usually can tell what the news is from the market moves, and I would guess at 7 pm, S&P issued their catch up warning on rating change, and yes, I would guess that those selling at 3:55 pm bringing the market to 1301.5 knew that the S&P would join. But they were temporarily discommed by the Google announcement but then baled out by the 7 pm announcement, and then people thought that the first announcement by Moodies did not make the market open down, so maybe like the last announcement that dropped the market to 1301 this one will not have a staying influence, and then the problem is that the options expiration is tomorrow and the "market makers" usually have positions bearish when the market has been going down and 1300 is a target. How to play it? What evil lies in the hearts of men. Only the Shadow knows.

Ken Drees writes: 

Skulduggery indeed. That darn Google is messing up my arrangements. Tessio, the underboss who brokered the meeting with Barzini.

Alston Mabry writes:

This sounds like revolution to me. Bond vigilantes riding through the night, striking fear into the hearts of the king's men.

Kim Zussman adds:

"why Moody's or S&P or Fitch or anyone else's rating on US Government debt should have had, or continue to have, any obvious and/or immediate effect on the S&P500 price"

Perhaps in part a conservation process: a back-and-forth conversion of equity capital to political capital. Markets regained much of 08-09 losses in great measure due to government interventions, creating a debt for the beneficiaries. Payment by the class that owns stocks can take the form of higher taxes or lower asset values, in either case accruing to the creditors.



Mr Ellison's home run indicator got me hungry for looking at some sports stats, so first I downloaded Sean Lahman's baseball database. Then I looked at the team stats and calculated the bases per game:

(singles + 2xdoubles + 3xtriples + 4xhomers) / number of games

for each team, and then the average bases per game for all teams for each year 1970-2010. Attached is the chart, and it shows interesting fluctuations. Big jump in the early '90s. Tapering off now.



Recently, Dr Z chastised justly, with: "What happened to numbers on the table?" Mea culpa. So here is some counting:

Russ's post from a couple of weeks ago, on inside and outside days, got me thinking and counting. Russ's stats showed that there were an unusually small number of Mondays that qualified as outside days. I ran a sim that randomly resorted the actual weekday designations among all the actual days (e.g., a Tuesday might be randomly reassigned to be a Friday, etc.), and then counted the number of Monday-inside days, Monday-outside days, Tuesday-inside days, and so on, for each run of the simulation, to 10,000 runs. The sim results confirmed all of Russ's binomial calculations closely, using SPY data from 1 January, 2000, to 22 June, 2011:

Mon-in  68  84.93%
Mon-out 35   0.01%
Tue-in  65  41.85%
Tue-out 80  99.30%
Wed-in  54   2.77%
Wed-out 82  99.65%
Thu-in  63  36.56%
Thu-out 54  10.77%
Fri-in  72  85.36%
Fri-out 55  15.51%

There were only 35 Monday outside days, and this number was at the
0.01%tile of the distribution of 10,000 sim run results (the minimum total for Monday outside days in the 10,000 sim runs was 34). Why? Is Monday less volatile than the other days? Mr. Sogi did some counting that indicated not. What other factors could be involved?

It turns out that SPY tends to go ex-div on Fridays, so could that be the reason for so few Mondays being outside days? A quick check of the 35 Mondays that followed ex-div Fridays shows that two of them were outside days. That's 5.7%, which is consistent with the 6.4% outside days in the total sample of 543 Mondays. So no indication that ex-div Fridays are a factor.

But inside and outside days are like a basketball going through a basket: the ball has to be small enough to fit through the basket, the basket big enough to let the ball through. But what if you also
*move* the basket? To account for "basket movement", we also have to look at the Close-to-Open moves preceding the days in question:

SD of Close-Open % moves:

(Note that holidays are included, so that some "Mon-Tue" moves are actually "Fri-Tue" moves, etc.)

Fri-Mon: 0.829%
Mon-Tue: 0.705%
Tue-Wed: 0.626%
Wed-Thu: 0.633%
Thu-Fri: 0.811%

So we see that the SD of the Friday-Monday move is the largest. To explore the effect of the Close-Open gap, I ran another simulation that used the actual Fridays and Mondays, but replaced the actual Close-Open % move with a value drawn from a normal distribution with the same mean and SD (+0.038% and 0.829%, respectively) as the actual Friday-Monday Close-Open values. The sim randomly assigned new Close-Open % changes to the actual data and then counted the number of inside and outside days in each of 1000 runs:

mean # inside days: 58.4, sd: 6.08
mean # outside days: 40.8, sd: 5.27

Then I ran the sim again, changing the SD of the Close-Open distribution from 0.829%:

SD: 0.629%
mean # inside days: 64.6, sd: 6.15
mean # outside days: 44.7 sd: 5.27

SD: 0.429%
mean # inside days: 71.1, sd: 6.32
mean # outside days: 49.4 sd: 5.21

We can see that the number of inside and outside days increases as the Close-Open gap gets smaller.

When the SD for the Close-Open distribution is set to the actual value of 0.829%, the sim doesn't produce the same result as the actual data. This is because the Close-Open % changes are not normally distributed; rather, the distribution has long tails. Here are probability plots for three sets of Close-Open % moves for the actual SPY data: Friday-Monday, Monday-Tuesday, and Tuesday-Wednesday:

The distribution of Close-Open moves for Friday-Monday has a greater range and denser tails, and the additional extreme values, or extra "basket movement", reduces the number of Monday outside days.

Monday also has the smallest mean High-Low range of all the weekdays:

mean High-Low ranges:

Mon    1.502%
Tue    1.571%
Wed    1.602%
Thu    1.636%
Fri    1.559%

So, between the greater volatility of the Friday-Monday Close-Open move, and the smaller Monday High-Low range, we seem to have a pretty good explanation for the low count of Monday outside days.



Some hypotheses regarding the reaction to information? Case very similar to the flexionic move down when the bailout was passed. Since it was known to all flexes, they had to liquidate when they realized that what they positioned for happened? Of course there was the certainty that the new man of change would be elected also? Or was it a case of going up whenever it looked likely that the vote in Greece would be positive, and then when it happened, …as Dooley would say "how will they make it happen? What you think?".

Alex Castaldo writes: 

Most were positioned in expectation of a favorable vote: long stocks and short bonds/bunds.  For a while it seemed the markets cared about nothing else.

At 6:41 am ET Papadimitriou (from the opposition party) announced that he would vote for. The S&P vaulted past 1300 and the Bunds future fell below 126.  The size of the market reaction perhaps incongruent with an announcement from a single politician. 

Then the voting started.

At 8:45 Kouroublis voted against, and there was a noticeable sudden decline in stocks and rise in bonds, bunds. This did not last long.

At 8:56 Athanasiadis, who had been expected to vote against, voted in favor, with the opposite (though smaller) effect.

After the 9:04 announcement that the votes are available to guarantee passage, there was a period of hesitancy and then an attempt by the majority to make a dignified exit now that the expected had happened, only to find the exits rather more crowded and disorderly than hoped…  The stock investors, especially, experiencing some downdrafts. 

Alston Mabry writes: 

Given the news about previous governments in Athens cooking the books to get into the €mark in the first place, and then all the reports of tax evasion and government benefit exploitation and so forth, it's easy to be skeptical, and even cynical, and take the view that things like "negotiated agreements" and "midnight parliamentary votes" and "austerity budgets" are things that politicians use as their own currency, and that they keep trying to spend this currency in an alternate imaginary world in which they believe they can hold off hard consequences with soft ideas. (See: "Munich agreement".)



Presumably the Tues move up and the Wed move down in SP were triggered by fixed speculators with systems to buy the turn of the month.

Alston Mabry writes:

Well, you had the last day of the month a Tuesday right after a 3-day weekend…just before the first day of the month being a Wednesday…and 30 days from the end of QE2…with a spattering of bad economic news thrown in for good measure– what am I leaving out? Talk about needing a good system for combining your forecasts…..

Gary Rogan writes:

The House rejecting the debt limit increase? Last time (fall of '08) the spineless tried to grow a spine the language of the falling markets was used to explain to them the error of their ways.




 There is nothing more competitive then tech: the smartest people from around the whole world trying to destroy each other globally, huge rate of innovation guaranteeing quick obsolescence and a killer breakthrough-based knock out punch that can come at any minute, lots of unpredictable trends and fashions with the "coolness" factor often ruling the day, very little customer allegiance, and what's there often turning to vengeful disdain when the expectation are not fulfilled even by a little bit. Yet Rocky evidently disagrees that tech cash flows are fleeting.

Alston Mabry adds:

Technological Revolutions and Stock Prices Lubos Pastor University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER) Pietro Veronesi University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER) February 12, 2008


We develop a general equilibrium model in which stock prices of innovative firms exhibit "bubbles" during technological revolutions. In the model, the average productivity of a new technology is uncertain and subject to learning. During technological revolutions, the nature of this uncertainty changes from idiosyncratic to systematic. The resulting "bubbles" in stock prices are observable ex post but unpredictable ex ante, and they are most pronounced for technologies characterized by high uncertainty and fast adoption. We find empirical support for the model's predictions in 1830-1861 and 1992-2005 when the railroad and Internet technologies spread in the United States.




The Winners of the least effort contest were jointly in a tie. Mr. Gary Rogan and Mr. Steve Ellison. I will split the prize between them. The creative and physical ideas of Mr. Rogan were very excellent and best of all, but there was no testing. Mr. Ellison gave a great test, and a complete answer, but Rogan can't be denied his place either. vic

I'll give a prize of 1000 to the person or locus of his choice that comes up with the best way to test the principle of least action or a related principle of least effort.

It's in honor of my grandfather. Whenever I'd ask him which way he thought the market would go he'd say, "I think the path of least resistance is down" starting with Dow 200 in 1950. We need some more quantification around here.

You might consider max to min or a path through a second market back to home. Or round to round? Or amount of volume above or blow. Or angle of ascent versus angle of descent. Or time to a past goal versus the future? Or some mirror image or least absolute deviation stuff?

Sushil Kedia writes:

With utmost humility and clearly no cultivated sense of any derision for the Fourth Estate, I would submit that since it is the public that is always flogged and moves last, the opinions of all media writers, tv anchors are the catalysts, the penultimate leg of the opinion curve. A test of the opinions of the fourth estate on the markets would provide the most ineffective wall of support or so called resistances. Fading the statistically calculated opinion meter (if one can devise one such a 'la an IBES earnings estimate a media estimate of market opinion) and go against it consistently over a number of trades, one is bound to come out a winner. Can I test it? Yes its a testable proposition, subject to accumulation of data.

Alston Mabry writes:

The following graph (attached and linked) is not an answer but an exploration of the "least effort" idea. It shows, for SPY daily since August last year, the graph of two quantities:

1. The point change for the SPY over the previous ten trading days.

2. The rolling 10-day sum of the High-Low-previous-Close spread, i.e., "max(previous Close, High) minus min(previous Close, Low)". This spread is a convenient measure of volatility.

Notice how these quantities move in tight ranges for extended periods. These tight ranges are some measure of "least effort", i.e., the market getting from point A to point B in an efficient fashion. As one would expect, the series gyrate when the market takes a temporary downturn. Also note how when one of the quantities swings above or below it's mean or "axis", it seems to need to swing back the other way to rebalance the system.

Bill Rafter writes:

 This nicely illustrates how relative high volatility is bearish on future price action.

Jim Sogi writes:

The path of least resistance would be the night session. Low liquidity allows market mover to move market. Every one is asleep. Dr. S did a study some years ago. Updating shows total day sessions yielding 94 pt, but night session yielding 232 points. Don't sleep…stay up all night or move to Singapore. Recent action is in line with hypothesis.

Bill Rafter writes:

Haugen's "The Beast on Wall Street" (i.e. volatility) came to the conclusion that if you want less volatility in the markets, keep them closed more, to essentially force the liquidity into specified periods. That is, 24 hour markets promote volatility. Or a corollary was that a market is never volatile when it is closed. [this is from memory and I may also be regurgitating from a personal conversation with him]. An oft cited example is the period in the summer of 1968 when equities were closed on Wednesdays to enable the back offices to get up to date with their paperwork and deliveries. During that time the Tuesday close to Thursday opening was less volatile than expected (twice the daily overnight vol).

One could take this thought and stretch it to say that the periods of least resistance would be those without heavy participation. One could easily compare the normalized range (High/Low) of those periods versus the same of the well-participated periods.

Craig Mee writes: 

Hi Bill,

You would have to think that in 68 there was sufficient control of price and news dissemination. In these times of high speed everything, that this could create bottlenecks and add to the volatility. No doubt a bit of time to cool the heels i.e limit down and up for the day restrictions, is a reasonable action, even if it goes against "fair open and transparent markets" but unfortunate it seems little is these days.

Bill Rafter replies:

I should have been more specific about the research: take the current normalized range for those periods of high liquidity (when the NY markets are open) and compare that to the normalized range of the premarket and postmarket periods. Do it for disjoint periods (but all in recent history) so you don't have any autocorrelation. My belief is that you will find there is less volatility intra-period during the high liquidity times. While you are at that you can also check to see during which period you get greater mean-reversion versus new direction.

If that research were to show that (for example) you had greater intra-period volatility during the premarket and postmarket times, and that those times also evidenced greater mean-reversion, you could then conclude that those were the times of least resistance. That would answer Vic's question. Okay, now what? Well you could then support an argument that with high volatility and mean reversion you should run (or mimic running) a specialist book during those times. That's not something I myself am interested in doing as it would require additional staff, but those of you with that capacity should consider it, if you are not yet doing so.

Historical sidebar: '68 was a bubble period caused in part by strange margin rules that enabled those in the industry to carry large positions for no money. The activity created paper problems as the back offices were still making/requiring physical delivery of stock certificates. The exchanges closed trading on Wednesday to enable the back offices to have another workday to clear the backlog. The "shenanigan index" was high during that time.

Phil McDonnell writes:

Bill, you said "During that time the Tuesday close to Thursday opening was less volatile than expected (twice the daily overnight vol)."

For a two day period and standard deviation s then the two day standard deviation should be sqrt(2)s or 1.4 s. So the figure of twice the volatility would seem higher than expected.

Or am I missing something? 

Steve Ellison submits this study:

The traditional definition of resistance is a price level at which it is expected there will be a relatively large amount of stock for sale. 
Starting from this point, my idea was that liquidity providers create resistance to price movements. If a stock price moved up a dollar on volume of 10,000 shares, it would suggest more resistance than if the price moved up a dollar on volume of 5,000 shares.

To test this idea, I used 5-minute bars of one of my favorite stocks, CHSI. To better separate up movement from down movement, for each bar I calculated the 75th and 25th percentiles of 5-minute net changes during the past week. If the current bar was in the 75th percentile or above, I added the price change and volume to the up category. If the current bar was in the 25th percentile or below, I added the price change and volume to the down category.

Looking back 200 bars, I divided the total up volume by the total up price change to calculate resistance to upward movement. I divided total down volume by the total down price change to calculate resistance to downward movement. I divided the upward resistance by the downward resistance to identify the path of least resistance. If the quotient was greater than 1, the past of least resistance was presumed to be downward; if the quotient was less than 1, the path of least resistance was upward.

For example:

                           Previous 200 bars
   Date     Time     Up Points Volume  Down Points Volume Resistance

3/25/2011   15:50   53   6.49  99431    61  -7.38  149867     15311

   Down       Resistance     Actual
Resistance      Ratio      net change
     20310       0.754       -0.03

Unfortunately, the correlation of the resistance ratio to the actual
price change of the next bar was consistent with randomness.



 I keep wondering if AAPL will be the first $1T-market-cap company. It's hard to accept that number if you're an old fart with a set of mental reference points that do not encompass market caps that begin with "T".

Right now AAPL has ttm net income of about $20B, and sells for 16x that number. So at the same multiple, $1T in market cap would require roughly $65B in net income. Is it possible they could get there in the next 3-4 years? They may break $100B in revs in calendar 2012. They also have $65B in cash on the balance sheet right now. By 2015 that will be…$150B? $200B?

The first $100B market cap was a big deal, too, though I don't remember which company it was.

Tyler McClellan writes: 

The reason apple will never get close to a 1 trillion market cap is very intuitive.

At that level they would be the largest net lender to the U.S. economy other than Japan or China. What are the prospects of a company that lends all its profits to the U.S. at zero percent interest rates. 

In fact, I will go further and say that the cash on the balance sheet at Apple is exactly equal to the amount of savings that society wants to do and apple refuses to accommodate.

For all of you who think you understand economic theory very well. What company supplies net capital to the economy at ever increasing rates even as its own prospects continue to improve vis-a-vis the economy?

Apple is a great lender to you and me, who have no need and no want for these lent funds, in exactly the opposite proportion to the amount you and I want to save in apple given its huge scope of opportunities.

Apple positively refuses to allow people to save. They force people to dis-save.

And for those of you who think the impetus to competition makes up for this (i.e., inducement effect of high market cap). Microsoft makes more net cash flow than all of the venture capital in the united states.

Apple itself makes nearly as much in free cash flow as the entirety of venture spending (that's in all categories at all stages).

Jeff Rollert writes:

Aren't market caps just measures of human preferences? If so, then they are good measures for where you are, not where you will be, as much of this behavior mapping is coincident.

A trillion seems to trite these days. 

Alston Mabry writes:

I think size matters.  Here are some more stats for AAPL:

last two quarters' YOY rev growth: 70%, 82%
last two quarters' YOY earnings growth: 74%, 91%
annualized growth rate of net income since 2005: ~60%

PE based on most recent 4 quarters: 16.3
PE after backing out $65B in balance sheet cash from mkt cap: 13.2

Now, imagine you saw those growth rates for revs and earnings, and that PE ratio, in a company with a $1B market cap, a company that had relatively limited market penetration for most of its products. "Is that something you might be interested in?"

So why aren't we more interested? Because people think AAPL is too big already. But maybe we have entered a new era of an expanding global economy in which there will be many companies with trillion-dollar market caps. As a popular and much-quoted writer and self-styled philosopher called it: the "JK Rowling Effect".

At one point in January 2000, the top ten (or twenty…I can't remember) stocks in the Nasdaq 100 had a total market cap of $1.6T and aggregate net income of about $19B, for a PE of 83. AAPL's current ttm net income is $19.5B, it's market cap $320B.

Frame of reference…point of view…big round numbas….

Alston Mabry asks: 

So you're assuming that rates will still be zero in, say, 2016? Could be. But what if the whole curve is pushed up two or three hundred basis points by then?

Tyler McClellan writes: 

Their actions as representative will force the rates to be low.

If the worlds most rapidly growing large enterprise refuses to borrow funds at 70% internal growth rates and is more than happy to lend them at 0% interest rates, then what possible companies demand to invest more than their willingness to supply savings?

It's a big fake that no one is supposed to talk about, our best companies don't want any money no matter how fast they grow, and in fact the faster they grow the less money they want. But wait, that's great, you say, because it means they create value out of nothing, and that what economics is. And isn't it true that companies can have value only if the sum of their discounted cash flows are positive, so doesn't that mean were wealthier if all of our companies have really high net cash flows.

And of course the answer to the above is categorically no, but I don't suspect what I've written to make a bit of difference, so back to my little day solving equations. 

Rocky Humbert writes: 

Tyler: I'm not sure it's appropriate to generalize from AAPL to the entire economy. AAPL is sitting at the top of the technology food chain, and they are benefiting from the investments being made underneath them. It's surprising, but Apple is NOT investing in R&D in a meaningful way… and this demonstrates that they are much more of a marketing company (like Proctor&Gamble) than a technology company. Hence they will eventually need to either buy back stock or pay a dividend….

R&D as a Percent of Revenues:
AAPL: 2.7%
P&G: 2.5%

INTC: 15%
MSFT: 13.9%
GOOG: 13.0%
IBM: 6%
(Source: Bloomberg, FA IS page, trailing 12 months)



 Just got an earful about Comex manipulators. Care to put a few holes through it?

Really? It's always a conspiracy when the market moves against you? I really have no explicit knowledge one way or the other about silver but people sure do like conspiracy theories– in government, in finance, etc. Plenty of this sort of "journalism" in the blogger financial press– it draws in the eyeballs.It always seems that people like to rationalize that it's someone else's fault where losing money is concerned since no one wants to face the shame of admitting a mistake. I have this theory that people like to use financial advisors so that they can blame someone else when their investments lose money: "That damn stockbroker sold me that loser, honey; it's not my fault".

Jeff Watson comments:

Having been on a margin committee (among many other exchange committees) before, my experience is that the margin will always be set in a way that will protect the exchange clearing house, the membership of the exchange, and to a lesser extent, the trade, end users, or what have you. Plus, the membership usually has an inkling that margin rates will be changed, no real surprises there.

Alston Mabry writes:

I love the author's analysis: in hindsight we shouldn't have gone long when we did. We should have gone long at the bottom and also a lot bigger.

And the conspiracy is:

1) Either using control over the exchange committee system to induce sudden hikes in performance bond requirements, or opportunistically using such hikes….

2) Using analysts to make extensive commentary to the mass media to the effect that the "silver bubble has burst" in the hope of inducing fear in the marketplace….

3) Using trading "bots" to transiently create thousands and, sometimes, tens of thousands of intra-day short positions….

4) Closing most intra-day positions into the mass of involuntary liquidations.

my favorite bit is "or opportunistically using such hikes".

Interesting profile, by the way:

Avery B. Goodman has been a licensed attorney for 26 years, and has concentrated in securities law related cases. He holds a B.A. in history from Emory University, and a Juris Doctorate from the University of California at Los Angeles Law School. He is a member of the roster of neutral arbitrators of the National Futures Association (NFA) and the Financial Industry Regulatory Authority (FINRA). He has also been an independent investor for many years. Snapshot Description: Independent / boutique research firm analyst. Trading frequency: Infrequent



 A while back, someone asked about the value of doing nothing. I had two positions on going into this morning - short S&P, and short natural gas. Had I not turned on a computer today, I would have made enough money to forgive many a sin of the first quarter. As it is, I ended the day breaking even when I had started out being significantly short two markets that gapped in my favour and then later basically went over a cliff. I won't go into the gory details of what and why I traded - nor share my feelings - but I'm pretty convinced that I'm going to have to hire a guy with a gun who, after I've set up the trade and the risk management, under contractual obligation is required to say to me "Sir, step away from the keyboard, or I'm going to have to shoot you in the head."

I would say there is value in doing nothing.

Speaking of doing nothing, the hockey game is on and the couch beckons.

Alston Mabry comments:

 One sympathizes. It brings to mind this proverb.

Kim Zussman writes:

 Randomly speaking, the market might have just as easily shot up and you could have avoided regret.

Gordon Haave writes:

Whenever I am in a business meeting and someone has come to it with some pressing need we have to react to right away, I always ask "what if we do nothing?". Everyone is always stunned.. they haven't even considered not doing anything. After asking that usually the consensus become to, in fact, do nothing.

Alston Mabry writes: 

 I would say that the over-arching issue is that the Market Mistress can torment her lovers in many, many ways. And experience would lead one to believe that tormenting her lovers is, in fact, her main obsession.

George Parkanyi replies:

Oh sure, Kim, you're right about that. But I had my risk management in place. Stops. But the point is, I had my idea right, and the method of executing basically set up to exploit the anticipated scenario. That would have played out very well, since there was nothing more that I needed to do at that point. Then I started changing stuff …

I don't mind being wrong, because that always happens in the markets, and you plan for it. What really gets me angry at myself is when I'm right and then I get in my own way. What other people do, I can't control, but what I do I SHOULD be able to control. Not being able to maintain self-discipline is a character flaw that has to be actively managed, and today it got the best of me. Doesn't always, but today it did. (Tomorrow may not be so good either, because before the close I went long a little silver.)

Jim Sogi writes:

Well, the next best thing to doing nothing is doing just a little to see what happens. If you're wrong, not such a big deal, but a small sample gives a good sign. Like Commodore when the guy gives him a hot tip in Reminiscences of a Speculator. See how it gets swallowed up.

Jeff Watson writes:

Jim mentioned probably the best thing I ever learned in my speculation game which is still going since 1973. "See how it gets swallowed up." Second best lesson I ever learned, but it only works with big orders and can tell so much about the markets, where they are, where they're going, who want's what, etc. Many things can be said with words, but until the order is put to the market, one can't say anything. The order getting digested is where the rubber hits the road and contains so much information(even in these electronic days), almost 10,000 pages per order if one is willing to keep an open mind and analyze it. The Commodore's system still works well in the grains, more than any other market I've seen and has been responsible for much of my limited success.

Vince Fulco writes:

The multi-day swing boys and the deep pockets are the big winners in GC1 so far tonight. Late afternoon, the contract came in like a ton of bricks as ES tumbled, with modest movement in equities after hours, zoom goes Gold as if the latter part of the day didn't even matter. The solid long moves all seem to be held "in reserve" till the day traders are flat.

Jim Sogi responds: 

I know its so minuscule, but the market knows when I put in my and my order makes it harder for Globex to move to the price and for a fill. I try to stealth even my limit orders keeping them mental until the price is where I want, ambush like. It puts me near the end of the queue, but at least its the right queue at the right price tick. Less chance of the hunter becoming the hunted, less exposure.



 Let us augment the Zacharian situation which I used to call a Finnegan where you look at the screen and a price is too terrible to contemplate because it's ruinous to you, and then you realize to your utter delight that the price was a misprint on the screen, and you're whole, and not losing at all, but …. by the end of the day or week, the price you feared actually turns out to be worse than you feared and you lose even more. Such a situation occurred in conjunction with the flash crash of May 6 when the price of 1060, which was ruinous for individual stocks and S&P was there for a second, but then it rose 8% in a day, and then Zachar predicted it would go bak there after it rose 100 points.

Okay, two other situations deserve a name.

You look at the screen, and you smile. Your market or stock is way up you think. But then– "Oh no," you were looking at the wrong market. And your thing is the only one that's not good or up if your long. That happened to me with my Rimm and Vix today. I see a market way up. I smile. Oh no. It's not Rimm, it's Vix that's way up.

What should this be called. And what about the variant where you have a price in mind to get out, and then you go to shave or take a call from a non-agenarian, and the price is realized, but by the time you can enter the order it's not there any more. And it never gets back.

A related situation is that you're out of office for a second, and you hear an announcement. The economy is very strong. However, bonds are down because of the crazy idea that a strong economy is inflationary. But that's causing stocks to go down. Okay, you're losing money on your longs. The market is crazy right? You grit your teeth and go back to take a look. Amazingly the bonds are way up however. WHY? Because stocks are way down. In other words, you lost on stocks because bonds were going to be down, but they actually went up when stocks went down, so you lost for an opposite reason.

What are the proper names for all these? And what variants of these type of things deserve a name?

Peter Earle writes:

The one where you look at the screen and smile– perhaps that moment is best termed an "Eastwood", a "Harry", or a "Dirty Harry", or being struck with/by (a) "Sudden Impact", as demonstrated by the relevant portion of this scene: first from 0:18 to 0:51…and then from approximately 1:05 to 1:13.

Chris Tucker writes: 

The last situation could be referred to as a "Cyclone", not for the storm, but in honor of the Chair and the iconic roller coaster of his youthful digs at Coney Island. The Cyclone is terrifying, filled with thrills, dips, lunges and jerks. And people keep coming back to plunk down there hard earned cash for more.

Very nice short history of the park at Coney Island here.

Vince Fulco writes: 

The Cyclone seems most apropos. What is it about Mr. Market's ability, esp. with these leveraged ETFs to give you a nice gain but not hit your target price and then revert back to your cost in an instant (many multiple percent away and seemingly not to be seen again in the near future with the new info) then turn within pennies and return you back to profit mode testing your temperament so mightily? The silver ETFs have acted like scalded dogs the last few days.

George Zachar comments: 

The Coney Island Cyclone was the signature thrill ride of my youth. I've ridden it well over 100 times.

What's always fascinated me about it, is how the experience varied with one's position in the 12 rows of seats.

In the very front, with the center of gravity many feet behind you, the visual danger signs led the acceleration by a couple of seconds, giving you the sensation of hanging over a cliff.

In the very back, my favorite spot, the acceleration came before you could see the rails dip, so it would catch you unawares and whip you sooner/faster than your mind anticipated.

Also, at the start of the right turn off the NW corner, the right-front wheels would leave the track for an instant, making first-time riders wonder if they were destined to die on Surf Avenue, in the shadow of the D train.

Alston Mabry writes:

The one where you're out of the office for a second, and hear an announcement– It's called "duck season".

The followup is too good to leave out: "Pronoun trouble".

Craig Mee writes:

About the one where "it's even worse than the mistaken price you mistakenly thought was your" :

I thought you were going to say, Victor, if after getting heart palpitations at the first incorrect reading, just by the fact you had done this, it's better to get out of your said stock now anyway, as you've brought bad karma to the trade.



 1. "There is no such thing as easy money"

2. Events that you think are affected by cardinal announcements like the employment numbers at 8:30 am on Friday are often known to many participants before the announcement

[An example supplied on April 18 by Mr. Rogan: "The Reason For Geithner's Weekend Media Whirlwind Tour: White House Learned About S&P Downgrade On Friday" (zerohedge )]

3. It's bad to try to make money the same way several days in a row

4. Markets that have little liquidity are almost impossible to profit from.

5. When the stock market is way down, policy makers take notice and do what they can to remedy the situation.

6. The market puts infinitely more emphasis on ephemeral announcements that it should.

7. It is good to go against the trend followers after they have become committed.

8. The one constant, is that the less you pay in commissions, and bid asked spread, the more money you'll end up with at end of day. Too often, a trader makes a fortune on the prices showing when he makes a trade, and ends up losing everything in the rake and grind above.

9. It is good to take out the canes and hobble down to wall street at the close of days when there is a panic.

10. A meme about the relation between today's events and those of x years ago is totally random but it is best not to stand in the way of it until it is realized by the majorit of susceptibles

11. All higher forms of math and statistics are useless in uncovering regularities.

Mark Schuetz comments: 

A point about # 2: This one might be fun to try to rigorously measure and test, looking at price movements in the time leading up to and including certain announcements (knowing this type of thing has been shown by list members before, but usually it's more descriptive instead of measured). Is it possible to show which types of announcements are more often known by participants beforehand as opposed to other types? Also, if certain participants are informed ahead of time, how far ahead of time do they know and in which way will they "front-run" the announcement (there can sometimes be many different ways to make a position on one economic statistic) ?

Victor Niederhoffer replies:

Certain participants know it and they react to it, and you can figure out which announcements are go with and go against——-but but but. The pre and the post regularities are always changing vis a vis the flexions and cronies and their nephews.

Ralph Vince writes:

What a great post. Thanks Vic. I certainly must second points 1 and 11, the bookends….and they have me thinking…

1. There is no such thing as easy money

This is so true, in the markets, in everything. Those who happen upon money where it DID come to them easily, it seems, as a witness, have had it very fleetingly. In my own case, although I am supremely confident in the profitabliity of what I am doing, in practically any market, in virtually any "regime," doesn't mean it's easy. It works like clockwork and is incredibly painful and distressing. It would be so much easier to simply sell buckets of blood."

11. All higher forms of math and statistics are useless in uncovering regularities.

Certainly in a post-'08 world, quants are out of favor, and for good reason. Most anyone I know who DOES make money in the markets, does so with very simple, robust techniques. Having considered going to quant school, and studied a good deal of it, I finally came to the conclusion that they are simply working with "models." Models of how the world behaves. unlike hard sciences like Physics and such where you can perform a test, come back a year from now, perform it again and get the same results, you don't have this in financial modeling. And I think this is where the quants have fallen short. Models are NOT reality, and they never got down to the bedrock, the reality of what his game is about. Of course it had to fail, and in a large way, at some point. A good rule of thumb is that if I need a computer, if it isn't simple enough to do in my head on the fly in the foxhole after I have been awake for over 100 hours, I can't use it. 

Jim Lackey writes: 

About point # 10: It takes no time at all for the information to spread. Yet how many times have we acted, lost a bit, recovered, then seemingly too much market time expires, and we close out a position. We say "awe everyone knows that it's priced in." The meme is then repeated for the 57th time and on a low pressure day, month, or year and then, kaboom!

Of course, I can think of the few times where we missed a huge score, being short YHOO in 2000 or selling some short in 2008. Yet there are hundreds of low magnitude fantastic long only ideas that we forget about. I look back 6 months later and say wow look at that beautiful rise, what happened? It went up very small, day after day, and only buy and hold would have worked.

Alston Mabry adds:

 12. One should not make one's analysis more precise than one's actual trading could ever possibly be.

If the rational mind has not determined the parameters of a trade, then upon execution, the lizard brain will decide.

14. Never go on vacation with open trading positions.

Or, zooming in:
<click> home

<click><click> to lunch

<click><click><click> to the bathroom 

Paolo Pezzutti writes:

One could test how the stock market reacts to good (very good, wonderful) or bad (very bad, terrible)(a sort of matrix) news when the news is released and after some time. It might help build a strength indicator. Amazing how the earthquake in Japan and the unrest in Middle East, admittedly extremely bad news, were absorbed by the strong trending markets without any problem (so far). In other times, stock markets might have crashed confronting with the same news.

Alston Mabry comments:

Amazing how the earthquake in Japan and the unrest in Middle East, admittedly extremely bad news, were absorbed by the strong trending markets without any problem (so far). In other times, stock markets might have crashed confronting with the same news.

Chris Tucker adds: 

Stick to your guns, but realize when you are wrong. Easier said than done. Good ideas can lead to conviction, but only experience can strengthen ones resolve. Forget the last trade, look to the next. Try, try, try to learn from your mistakes, but also from your wins.

Anton Johnson writes:

15. When correlations among many typically disparate markets become high, one should reassess leverage and seek novel opportunity.

Jeff Rollert writes:

17. Sell side liquidity is an inverse function of cell signal strength and micros0ft patch frequency, especially at lunch time.

Rocky Humbert writes:

The First Law of Rocky – In every "macro market" (indices, bonds, commodities), all prices WILL be seen at least twice. The only unknowns are: (1) how long it takes and (2) how far prices go, before the price is re-visited. This Law is true 99.999999999% of the time.

The Second Law of Rocky – Rocky always keeps his calculator precision set to two decimal places. Any trade that requires more precision than the hundreth decimal place, is a trade that Rocky leaves for smarter participants

Jeff Sasmor writes:

About Jeff R's # 16:

16a. Never go to the doctor when you have a profitable position as it will reach its maximum profit and reverse exactly at the time that you enter the doctor's office.

Happened to me yesterday…

Ralph Vince comments:

With regards to the First Law of Rocky…."Unless it is a new high, that price has already been seen before."

Victor Niederhoffer adds:

Beware of using hard stops as it's bad enough that the floor can always know your physical hard stops.

Jay Pasch comments:

No wonder over-leveraged daytraders always lose as they are required to deposit a hard stop with their leverage, along with their hard earned money…

Ralph Vince adds: 

Despite numerous posts on this thread, it has not been opened up beyond Vic's original 11…

T.K Marks writes:

Aristotle felt the same way about drama, posited that it could be comprehensively reduced to 6 elements. And any additional analysis would by definition be but variations on those original half-dozen themes:

"…tragedy consists of six component parts, which are listed here in order from most important to least important: plot, character, thought, diction, melody, and spectacle…"

Jim Sogi writes:

Always be aware of and consider current market conditions and how they might affect or even negate your prior analysis.

Even the the weather forecast says sunny, if the clouds look dark and the wind is blowing, stay home or dress warm.

James Goldcamp writes:

One good anecdotal rule I've found that works for investing is that the market that causes you the most psychological pain, revulsion, and visceral response from prior bad investments, or overall perception, is probably currently the best opportunity since others may also have a similar overly pessimistic view (or over assign risk premium). This seems to be especially true for post calamity emerging markets, high yield bonds, and fallen growth stocks (tech). If for no other reason, this is why I think stocks like Citi and the West Virginian's company are good buys now (and perhaps government motors and Russian stocks).

Ralph Vince comments: 

 Thinking on this a great deal the past 24 hours, I think I would add one more, which is to me the most important of them all perhaps, or at least tied with #1 and #11. And that is that most people have no business being here. They don't know why they are here, and, if pressed, can only give a sloppy, struggling answer. "I'm here to make money." "I'm here to improve my risk-adjust return," or some other nonsense.

They are here for action– whether they know it or not, whether they acknowledge it or not. The market is a magnet for gamblers, a magnet for those who compulsively seek out the very action she puts out. People are here because they want to feel they have one-up on the masses, the system, or that they are not as inadequate as they suspect. The very proof of that is their utter inability to instantly articulate their criteria in specific terms. Absent that– they're in a bad place.

They're looking for girls in the wrong dark alley.

It makes no difference how well-capitalized the individual is. The world is full of guys with $10,000 accounts who will lose it all and then some, and full of guys with very fat checkbooks who will lose all of it equally as quickly, in similar fashion.

They still think it is about what you buy, when you buy it and when you get out, facets that have nothing to do with what is going on here (which is specifically why mathematics, simple or higher-order, fails in this endeavor; people are applying to aspects they mistakenly think this thing is about.)

If you examine institutions, they may be equally as clueless as to what this thing is about, but they have one big up on the individuals– they have a specific, well-defined criteria in most cases about what they are in this for, what they are willing to do to achieve something very specific.

Most individuals– of all gradations of wealth– can't, and that's the red flag that they here for all the wrong reasons.

Jeff Rollert adds: 

Amen. If it doesn't hurt a little, you're wrong.



 In the summer reading vein, I very much enjoyed Alex Berenson's first novel, The Faithful Spy, with his main character, John Wells. The next two books in the series, The Ghost War and The Silent Man, were very good, too. The next book, The Midnight House was just okay, and Berenson's most recent effort, The Secret Soldier, is unfortunately a failure.

Jim Sogi writes:

My son turned me on to the spy series by Vince Floyd, including Transfer of Power, The Third Option, Extreme Measures. The books are surprising well written current historical fiction with three dimensional characters with full backstories and touching personal details. The bad guys are complex but the series has a decidedly non PC attitude, so that's fair warning. Its good entertainment though and hard to put the books down. Great for airplane or vacation reading. The main character is an assassin but has realistic doubts and feelings. I briefly compared it to Clancy, but it is astonishing how the technology just a decade back seem so archaic and outdated. I have them downloaded to Kindle for iPad.

David Hillman writes:

And given our particular interest in markets here, one might enjoy the David Liss's "Benjamin Weaver" series. Set in early 18th Century London, Weaver is a former pugilist and highwayman come "thief-taker", i.e., private detective. The son of a Jewish Portuguese stock jobber, his cases involve intrigue and deception revolving around the relatively newly formed stock exchanges, combinations, Bank of England and corporate giants of the time.

Liss' has also written "The Coffee Trader", set 50 years before in Amsterdam, the locus of which is cornering the market in the newly discovered "coffee fruit" and "The Whiskey Rebels", set in America just after the revolution focusing on the attempts of those whiskey rebels on the western frontier attempting to bring down Alexander Hamilton and the Bank of the U.S.

Liss began by writing his first Weaver novel, "A Conspiracy of Paper" while a doctoral candidate at Columbia. All are well written and offer looks at finance and markets, many pretty familiar, not to mention murder, a large cast of ne'er-do-wells, prostitutes and a pretty frank look at the cultural and social biases of the time. He even has a Watson-like sidekick for Weaver, Elias Gordon, a likable bounder of a Scottish surgeon given to bleeding and such, who also schools Weaver in scientic method and probability. A lot going on, fun and good stuff.

The Collab writes: 

William Gibson plays with the theme of pattern recognition in his technologically edgy, subversive books. One of the books, in fact,is called "Pattern Recognition." I have devoured all of them as soon as they come out. The newest one, "Zero History," contains the throwaway insight that when/if someone succeeds in aggregating order flow, the market will cease to exist. Hubertus Bigend — not a hero or a bad guy, but rather a nexus — is one of the most fascinating and ambivalent characters in fiction — comfortable with unpredictability, glinting Bertelsmann, Ralph Lauren and Goldman Sachs.



 Burton Fulsom in his book The Myth of the Robber Barrons shows that many of the great industrialists of the 19th century, the ones that didn't get government help like Harriman and Fulton, but the independent productive geniuses like James Hill, Cornelius Vaderbilt, The Mellons (My friend Dan Grossman wrote a great review of the recent Mellon bio), and the Scrantons and the Rockefellers were great men who opened up new vistas of consumer benefit and weath.

It totally disproves the myth that has the world in its grip, and things like the Palindrome who calls them crook capitalists. We know who the crook capiatalists are today, and they're not the men like Steve Jobs, and many others.

Who else would you nominate as the opposite of the cronies? Let us come up with some good ones in honor of Rocky's Humbert's request for us to honor the creation of value.

Alston Mabry writes:

Deng Xiaoping and John Doerr.

Also here is something interesting from the original foreword to The Robber Barons, by Matthew Josephson, first published in 1934:

When the group of men who form the subject of this history arrived upon the scene, the United States was a mercantile-agrarian democracy. When they departed or retired from active life, it was something else: a unified industrial society, the effective economic, control of which was lodged in the hands of a hierarchy. In short, these men more or less knowingly played the leading rôles in an age of industrial revolution. Even their quarrels, intrigues and misadventures (too often treated as merely diverting or picturesque) are part of the mechanism of our history. Under their hands the renovation of our economic life proceeded relentlessly: large-scale production replaced the scattered, decentralized mode of production; industrial enterprises became more concentrated, more "efficient" technically, and essentially "coöperative," where they had been purely individualistic and lamentably wasteful. But all this revolutionizing effort is branded with the motive of private gain on the part of the new captains of industry. To organize and exploit the resources of a nation upon a gigantic scale, to regiment its farmers and workers into harmonious corps of producers, and to do this only in the name of an uncontrolled appetite for private profit — here surely is the great inherent contradiction whence so much disaster, outrage and misery has flowed.

…and from the Foreword to the 1962 edition:

In the crisis years of the 1930s economic intervention by the Federal Government was employed on an unprecedented scale, not only in the interests of human welfare, but also to regulate and control the masters of capital who, by their excesses and bad leadership, had helped to bring about the debacle of 1929-1933. At that period a critical literature also arose (of which the present work may perhaps be taken as an example), providing background material to the men of the New Deal.

Of late years, however, a group of academic historians have constituted themselves what may be called a revisionist school, which reacts against the critical spirit of the 1930s. They reject the idea that our nineteenth-century barons-of-the-bags may have been inspired by the same motives animating the ancient barons-of-the-crags—who, by force of arms, instead of corporate combinations, monopolized strategic valley roads or mountain passes through which commerce flowed. To the revisionists of our history our old-time moneylords "were not robber barons but architects of material progress," and, in some wise, "saviors" of our country. They have proposed rewriting parts of America's history so that the image of the old-school capitalists should be retouched and restored, like rare pieces of antique furniture. This business of rewriting our history — perhaps in conformity to current fashions in intellectual reaction — has unpleasant connotations to my mind, recalling the propaganda schemes used in authoritarian societies and the "truth factories" in George Orwell's anti-utopian novel 1984. 

Sam Marx writes:

Every time I'm in NYC going up the ramp at Park Ave So. I see the statue of Cornelius Vanderbilt and I'm reminded of how he created a shortcut to California by way of Panama.

After the California '49 discovery of gold, increasing the migration there, he cleared that thin strip of land in Panama, placed boats on the Pacific side and transported passengers by boat from NYC to Panama, horse and wagon to the Pacific and then by boat to California, thereby saving the long and dangerous trip across country or around South America. No robber baron in that endeavor.

Pitt T. Maner III writes: 

How about Ray Kroc? McDonalds in the news for hiring 50,000 new employees this month.

Kroc created a new kind of fast food with McDonald's, implementing Henry Ford's assembly line idea into his restaurants. He also utilized standardization, a business tactic that he used to make sure that every Big Mac would taste the same whether a person is in New York or Tokyo. Kroc also revolutionized the art of franchising, where he set strict rules on how the food was to be made. These strict rules also were applied to customer service standards with such mandates that moneys be refunded to clients whose orders were not correct or to customers who had to wait for more than 5 minutes for their food. However, Kroc let the franchisees decide their best approach to marketing the products. For example, Willard Scott created the internationally recognized figure known as Ronald McDonald to improve sales of hamburgers in the Washington, D.C. area. Kroc established various foundations for alcoholics, and also started the Ronald McDonald House foundation.

Jeff Sasmor writes:

A later Vanderbilt created one of the first concrete roads in the nation, the Vanderbilt Motor Parkway . Some remnants remain, my wife and I used to bike on a part of it that I believe still remains between Cunningham Park and Creedmore hospital in Queens NYC.

Allegedly the VMP was the first road designed for autos only.

A much later Vanderbilt, a great^n granddaughter, used to work for me and my partners in the early 1990s, but got fired because the wife of one of my partners got jealous of her good looks.

Jeff Watson writes: 

 Jay Gould was my favorite robber-baron, although he was deeply flawed, and a vile and disgusting cheat. One could say that Gould had an inner drive and a pronounced sense of pluck. Getting his speculative stake from the ashes of the Panic of 1857, he astounded the financial world with his decades of manipulations. His railroad corners were amazing. His attempt to corner the gold market resulting in Black Friday was something out of a novel, His bribery to influence legislation was legendary. His chicanery with using forged stock certificates set the bar for all other cheats and swindlers. He controlled Western Union. His corners in the Chicago commodities markets were equal to those of Armour, Cutten, and Gates.. As bad as he was, he still managed to combine a bunch of railroads together and creating value by achieving a better operating scale. I have problems with the way he treated the help, but at that time, laborers were very shabbily treated. Finally, when Gould died, he had an estate of $75 million dollars, so he must have done something right.



 The market was gyrating so much last night in a negative direction that I didn't even have time to see how badly the Knicks got killed while I was out. And the regression bias has never had a better examplar than the Knicks. Luck + skill determines every outcome. The luck is random. Whenever the Knicks have a good win, the luck factor was highly favorable. And then the next time out they lose by 47.

J.T Holley writes:

It's very much the same as my beloved Va Tech Hokies in all their sporting events. The listing of the samples for the regression bias can be used with football and basketball which makes it all the more interesting when I gather data.

The ultimate highlight that sticks out in the sampling of being a fan is 11-0 regular Season with Andre Davis on the cover of Sports Illustrated with the caption "Do They Belong?", meaning to me that luck got them there. Lost in the NCAA Championship to Fla. State in a 46-29 nail biting game that is still talked about as one of the greatest losses, great loss yeah right? That loss was 1/4/00, the S&P 500 top ticked within days of the loss.most recently to add was the NCAA committee somehow having watched the Hokies fight and claw with 7 players to beat Duke at home while ranked #3 only to follow up to losses to Boston College and Clemson in final two regular season games. Be casted in typical fashion as a bubble team. Go into the ACC Tourney win, then beat Fla. State on a tenth of a second made shot that was canceled after regulation. They must've said luck, thus snubbed from the NCAA Tourney for the 4th straight time after a couple years back being the only 10 game ACC winner not make the Tourney. S&P 500 is at hand in gyration.

It's sad and the life of a Hokie, but the regression bias to the S&P is there as well.

I have often wondered now as a grown man looking back at this game against Florida State (yes the Seminoles again) and the luck + skill that it required didn't curse or hoodoo Virginia Tech in some way?

I dare not even pull data from 1980 to see what the S&P did days after. It's like I know it somehow wouldn't even effect the averages in the regression bias if it was positive anyways.

Alston Mabry writes:

The Hokies got stiffed again. This year, though, I think they may be standing in the "stiffed" line behind Colorado. Not only did Colorado (overall 21-13, 8-8 conf) go 6-3 in their last 9 games, including a win over now-4-seed Texas, but in that stretch they won their first round game in the Big 12 tourney against Iowa State, then in the next round beat Kansas State for the third time this season, and finally went up against Kansas, a team that along with Ohio State forms the most common prediction for the NCAA final game…and Colorado scores 83 points against Kansas in a tough loss. But Colorado doesn't deserve any place at all in the NCAAs? They can score NBA-level points in a tournament game against one of the consensus two best teams in the country…but they don't deserve a slot in the NCAA tournament. If that makes sense, explain to me why Villanova isn't headed for the NIT.

Once one examines these situations at Va Tech and Colorado, as well as other seeding and bubble-team choices, one can't help but think that perhaps the committee is screwing this whole thing up on purpose so they can say, "You're right! We messed up! The only solution is to expand to 96 teams!"

J.T Holley replies:

Very simple. The NCAA Committee is made up of only TWO people that have played basketball or coached basketball.

The answer to Villanova is that they are in the Big East. The Big East gets a bias and free pass. They have the most Teams in 11 being selected for the Tournament. No other Conference constantly gets more at large bids, yes I'm aware they have the biggest conference with 16 Teams. There are what 37 at large bids. 11/37= a tad bit biased under 30%.

My conspiracy theory is the following: The Big East is such a lackluster Football Conference in the past decade that the NCAA overcompensates for them in basketball due to their humiliating play on the gridiron and the fact that the BCS favors the SEC.

Note that Alabama an SEC team was 12-4 and won their side of the conference in basketball in the SEC and got snubbed as well by the NCAA Committee?

Worth noting is the eventual winners and why the bias now? Who was the last Big East Team to win the NCAA Tourney? '04 UConn then prior it was '03 Syracuse. That is over 7 years ago? In the meantime either the ACC or SEC has won 5 of the last 6 Titles?

Also worth noting is that the NCAA now owns and operates that other Tournament "NIT". They own the NIT and have its Final Four and Championship held at the Madison Square Garden in Big East territory? Too funny.

I'm not some anti-monopoly guy, but hey the NCAA just needs to come clean and say we do profit and that's the way its going to be fella's.

I like Bobby Knights words "Let's just expand the Tourney to 128 Teams and everybody shut up", but then the NIT wouldn't be a money maker would it?



 As a man in a dream who fails to lay hands upon another whom he is pursuing- the one cannot escape nor the other overtake even- so neither could Achilles come up with Hector, nor Hector break away from Achilles; nevertheless he might even yet have escaped death had not the time come when Apollo, who thus far had sustained his strength and nerved his running, was now no longer to stay by him. Achilles made signs to the Achaean host, and shook his head to show that no man was to aim a dart at Hector, lest another might win the glory of having hit him and he might himself come in second.

Then, at last, as they were nearing the fountains for the fourth time, the father of all balanced his golden scales and placed a doom in each of them, one for Achilles and the other for Hector. As he held the scales by the middle, the doom of Hector fell down deep into the house of Hades- and then Phoebus Apollo left him.

–From Book 22 of Homer's Iliad, translation Samuel Butler

The scales have tipped against the seasonatarians thereby allaying the massacre they administered in the month of January.

Russ Sears writes:

One is reminded of March of 03 when fate was sealed and the hunt was on for a different dictator. 

Victor Niederhoffer writes: 

One is reminded of Secretary Baker's battle while talking about his meeting with Tariq Aziz, in January 09, 1991.

The dooms were placed on the scale and the terrible word was uttered "Regrettably…. " A 5% decline, big for those days ensued in the next minute. 

Alston Mabry writes:

In college we read the Lattimore's Illiad and the Fitzgerald's Odyssey. It was a great combination.

Russ Sears adds: 

Given that it looks like the US military will stay out of this, and the Secretary appears to have only a small part on the world stage, I am hard pressed to identify what the trigger may be. The timing and scale is always a mystery. However, not knowing the actors in this drama, it will certainly take people like me by surprise. 



 The Morningstar stats are:

years: 1945-2010 (count: 66)
mean S&P return: +9.08%
mean S&P return, 3rd year of prez cycle: +17.15%

Setting up a simulation that, for each run, randomly resorts the set of actual annual S&P returns among the actual years and then recalculates the mean return for the set of "3rd year of prez cycle" years:

simulation resorts: 1000
mean return of all simulated "3rd year of prez cycle" sets: +9.07%
SD of the set of means from 1000 resorts: 3.78%
z of actual "3rd year of prez cycle" mean (+17.15%) versus simulated set: +2.14

Victor Niederhoffer writes: 

Wouldn't that have to be adjusted by by a factor of slightly less than 3 or 6 to take account of the fact that each year might be the best or worst, and another factor of 5 or so to take account of different markets like fixed income or grains, and another factor taking into account when they started the years from, thus reducing the 1 in 100 to say 8 in 9 in favor of finding a difference as big as this. 



 Saw the Oracle get the Medal of Freedom yesterday. Will this enhance his stock?

Scott Brooks writes:

Another question: Who, on that stage, was truly deserving of receiving the Medal of Honor? I know there was at least one person on that stage who deserved the award for personifying what America is all about…..Stan "The Man" Musial. One of the 5 best baseball players of all time and a man who has lived to high standard all his life. He exemplifies what America should be….do the best with what you have and treat others with honor and integrity.



 Probably forever, roughly every week, Barron's has an article about a few big cap stocks that they say are pretty good bargains. What's different about the articles over the past year or two though is that they seem really compelling. That's true even now, after a big market rally.

This week's article is about drug stocks. Typical of the stocks they mention is Abbott, listed with a p/e of 10 on 2011 earnings and a 3.9% yield. All of them–Bristol Myers, Lily, Medtronic, Merck, and Pfizer–have similar numbers, yields higher than the 10-year treasury and P/Es around 10 give or take. They also list some European firms, AstraZeneca, GlaxoSmithKline, Novartis, Roche, and Sanofi-Aventis, that look even cheaper. E.g. AstraZeneca is at a P/E of 7.3 and yields 5.2%.

The point of the article is that some of the firms could help shareholders if they would do some restructurings, spin-offs, break-ups, but what struck me instead is that they are look surprisingly cheap as they are. Seems to me that a lot would have to go wrong for these to do poorly compared to bonds over the next 10 years.

Vince Fulco writes: 

That has been David Einhorn's contention for some time at least on PFE. I.E. the bad stuff is already well known.

Bill Humbert writes:

I suspect this situation of high dividends will continue for some time, but the causes are not being dealt with. The system, by which I mean the internal processes used in drug discovery, is broken.

All that is being done is shuffling managers in and out. Each old set of managers floats off on their golden parachutes. The new managers talk and talk but do not make real changes to return the system back to the productive way research used to be done. The industry will slowly decline, have more M&A, and golden parachutes, until eventually the internal research organizations are disbanded.

PFE is already chopping internal research hard. The big pharmas are turning into development and marketing organizations and will shed research completely. Once they all do that, it will be fascinating to see where they will get molecules to develop.

The biotechs are hurting bad. More than a few went under, and many of the remaining ones have had their research organizations corrupted by the amazingly stupid management practices of big pharma. Lots of big pharma people went to the biotechs and wrecked them, too.

Check this out. Some data on the drug industry:

Figure A: # new drugs by year

NME = new molecular entity (new drug, although its structure could be closely related to that of an existing drug, i.e., a me-too drug)

The industry is about half as productive as it was 10-15 years ago.

Figure B:

Pfizer R&D spend

"You can see that Pfizer's R&D spending has nearly tripled since the year 2000, but that cumulative NME line doesn't seem to be bending much. And, as Munos points out, two (and now three) productive research organizations have been taken out along the way to produce these results. It is not, as they say, a pretty picture."

Alston Mabry writes: 

As long as it's the weekend and we're kicking around stock ideas…consider TEVA: They will get huge new opportunities from the blockbuster drugs coming off patent, and they've been growing revs and earnings like crazy. They play well to the "rising cost of healthcare" theme, and they are global. You're buying growth, though, not dividend.

Dan Grossman writes: 

1. The Barron's article makes no sense. If a company is about to lose half its earnings because the patent on its most profitable drug is about to expire, how does it help to sell off products or a division where earnings are not expiring?

2. Teva is in much the same position as Big Pharma. While known as a seller of generics, more than 30% of its earnings come from its non-generic multiple sclerosis drug Copaxone, which will soon face generic competition itself resulting in disappearance of these profits. Only Teva has been a lot less honest about this than Big Pharma.

John Tierney writes:

….The problem is that they have failed to deliver any important new and important blockbuster drugs for years.

Right on the money. Some blame, though, must be placed on the FDA. This story from the NYT elaborates:

Medical device industry executives and investors are complaining vociferously these days that the industry's competitive edge in the United States and overseas is being jeopardized by a heightened regulatory scrutiny.

The F.D.A., they and others say, appears to be reacting to criticism that its approvals for some products had been lax, leading to a spate of recalls of some unsafe medical devices, like implanted defibrillators and hip replacements.

Device companies have been seeking early approval in Europe for years because it is easier. In Europe, a device must be shown to be safe, while in the United States it must also be shown to be effective in treating a disease or condition. And European approvals are handled by third parties, not a powerful central agency like the F.D.A.

This article follows another that the Times published (which I can't find at the moment) last week revealing that the two drugs most commonly used for surgical anesthesia are both made only in Switzerland. The drugs are no longer being made available since Arizona, running short of the primary drug, bought some from an independent supplier, and subsequently used it in an execution– a big EU no-no. As a result, Novartis, with no control over their customer's distribution, is refusing to sell any more in the states.

The article concludes by noting that venture capital spending on the medical device industry in the US dropped 37%. Yet billions and billions are sitting on the sidelines ready to pounce on the next techno-dweeb with a social networking idea. 

John Tierney adds: 

The study, covering 2004 through 2010, found the overall success rate for drugs moving from early stage Phase I clinical trials to FDA approval is about one in 10, down from one in five to one in six seen in reports involving earlier year.

Roger Longman comments: 

Guess I sort of agree.

But issue is that while downside isn't huge, the likelihood of some price decline is possible while near-term upside unattractive since tied so closely to successful product launches. BI is only company with really great recent news (launch of Pradaxa, which will likely be a blockbuster) — but BI is private. Bayer/J&J got great news on recent competitor drug — but launch some time away and by then BI will have sewed up most of the new prescribers. Novo could do well, given extremely successful launch of Victoza — but success probably priced into the stock. NVS has Gilenya (innovative small-molecule MS drug) but reports are that it's had a troubled launch because hadn't solved the neurologists' problems with cardiac monitoring when starting the therapy.

He's right that people could buy them for the dividends but I'd wonder if the potential downsides in the stocks might not negate the effects. Stuff can and will go wrong. Merck, for example, has lost a significant chunk of the future value of SGP acquisition thanks to poor launches of Bridion and Saphris, disadvantages of boceprevir vs. Vertex's telaprevir, and — the cause of its most recent stock problem — failure of vorapaxor (most important drug in SGP pipeline).



 It certainly is an interesting "debate" being carried viz the precious metals. Two thoughts nag at me when I watch metal news or read analyses: (1) A lot of the people who argue that gold is a bubble right now seem to be people who traded gold back in the 80s and 90s, when the only people who traded gold were in Chicago, New York, London and Hong Kong (exaggeration, but you get my drift); and back then gold never did much, so any big move must be a bubble. Which leads to (2), that many common folk in Asia have decided they want a hard currency, whether their government provides them one or not, and that this de facto hardening is something the folks with the old gold-trading mindset have a hard time grokking. Excuse me, but that leads to: (3) "There is no inflation", but there is actually quite a bit of inflation, just not here. However. though China may be serving as a global inflation sink, they are *not* cut off from the global metals market.



I hear again and again how profit margins for the S&P 500 are doing very well, thank you. I was wondering if there were any special variables affecting these profit margins. So, I pulled before-tax-income and total-income-tax data for a dozen S&P big caps in order to compare the tax rates being paid in the years 2006 through 2009, with the tax rate paid on 2010 income.


ticker / meantaxrate2006-2009 / taxrate2010 / diff

DIS   36.0%   34.9%   -1.1%
XOM   42.6%   40.7%   -1.9%
CSCO   22.8%   17.5%   -5.3%
JNJ   22.9%   22.1%   -0.7%
AAPL   30.7%   24.4%   -6.3%
IBM   27.4%   24.8%   -2.6%
KO   23.9%   22.8%   -1.1%
PM   25.8%   29.1%   +3.3%
INTC   26.8%   28.7%   +1.9%
VZ   23.8%   19.4%   -4.4%
GOOG   24.8%   21.2%   -3.6%
WMT   33.7%   32.4%   -1.4%

So, ten out of twelve of the companies had lower rates for 2010. The aggregate numbers are:

tax rate on aggregate 2006-2009 before-tax income: 32.8% tax rate on aggregate 2010 before-tax income: 29.4% diff: -3.4%

It does appear the government is trying to help out.



 Here are some good books I am reading when Aubrey is playing with someone else: The Mind of Bill James by Scott Gray has great stuff about James' methods including many based on regressions, the law of competitive balance, the non-existence of most shibboleths (clutch hitting doesn't work nor do streaks), the prevalence of miracles in compressed markets (leagues), leave a good young stock (player) alone, forget about stealing bases (if you want to win you have to go against the grind), similarity scores are predictive, pareto distribution of talent etc., stay away from the best performers (free agents) et al,

Stigma by Erving Goffman. How we relate to those whose relations stigmatize them, and don't buy them when we should.

The War at Troy by Lindsay Clarke. Finally tells you why the other women, and Peleus and the well meaning Nestor created the war and many other useful facts about the walls and the hypotenuse.

Honus Wagner by Dennis and Jeanne DeValeria. The greatest ball player, and how his business developed, and his touch for the common man and all the postiions he played, the importance of family inheritance et al.

Mortal Games by Fred Waitzkin. Everything about the killer instinct of Garry Kasparov, and how he won his matches even while being distracted with politics and showboating, and the peculiar relation that the writer, his son Josh had with Garry (while standing on his head or otherwise).

The History of Banks by Richard Hildreth, 1837. How free markets worked in the old days, and the attempts at flexonopoly by the banks after the before and after the first banks.

The Seventy Great Mysteries of the Natural World by Michael Benton. It clears up all the mysteries of evolution, and gives the best scientific explanations for such things as selfish genes, why we're big, who rules, why species die, how plants and animals relate.

Roundup by Ring Lardner. The best short stories including "Alibi Ike" which every one who hires or deals with a trader should know.

Secrets of Mental Math by Arthur Benjamin and Michael Shermer. Tells you how to do squares and cubes up to 10000 with a variety of methods, but the close together method is by far the best, and I can only go up to 1000 so far, but it keeps you from old mans' disease when not playing checkers.

Bayesian Models for Categorical Data by Peter Congdon. how to choose models and count outcomes. A highly technical book that requires a pencil and paper and does nothing for those without total background in categories, simulations, and bayesian methods to start. But it's an interesting reference.

American Business Since 1920 by Thomas McCraw. A beautiful discussion of what made p and g great, (the white shirts, the soap operas, the two person partnership, the combination of mass advertising and mass development of purchasers.) Written from a liberal perspective by someone who actually likes business but is a Harvard professor, and the anti-business and fund raising that is part and parcel of that nook of the woods often leaves the reader wishing it was not so biased, but written by a real scholar.

Jeff Watson adds a book:

 Although I have a well known prejudice towards the Rolling Stones as my favorite rock band of all time,

I've been reading Keith Richards autobiography Life. Since reading this book, I have a newfound admiration of his music ability, his composition skills, and his ability to improvise with different tunings of the guitar, eliminating a string making a six string a five string guitar etc. His knowledge of technique and music composition has put him in the category of the best trained from Berkee and Juilliard, His desire to emulate the best of the Chicago Blues, the Mississippi blues, the Nashville Country and the Bakersfield Country made him a much better guitarist, plus he became a very accomplished piano player along the way.

His associations with the people of that period, prefering the black musicians as, to quote Richards, they put the roll in "Rock and Roll." Richards knew and worked with everyone in that era from the Everley Brothers, John Lennon, Jimi Hendrix, to classical composers, to Johnny Cash and Chet Atkins. His love/hate (mostly love) relationship with Mick Jagger allowed for the creation of some of the most enduring songs of the rock and roll era. He was a musical theorist who improvised and created many things that are still in use today. His hooks are legendary.

One thing of particular note was that he stressed firstnlearning to play with an acoustic guitar with cat gut strings, mastering that, moving on to an acoustic with steel strings, before going electric, all the while reading and writing music. His claim was that progression would make one a better player. An interesting fact was that the small musician fraternity would gladly share techniques and short cuts without any expectations other than a quid pro quo. He preferred associating with black musicians over white musicians as he thought they were more original and daring and played with more emotion and soul. Richards is a deeply flawed individual, with many personal flaws such as womanizing, drug usage, legal problems, addiction etc. However, he has since gotten relatively clean, still plays better than most people 45 years younger than him, and has the constitution of a bull. His guitar technique is flawless, and he even had to develop techniques to make up for when the late Brian Jones flaked out and he had to add extra picking techniques as the Stones was a two guitar band.

Comparing the Beatles and Stones is like comparing apples and oranges as the Beatles were mainly a pop group, and the Stones were a rock/blues band. A lthough they did write many remarkable songs, the Stones started as a cover band, but they ended up writing music on par with the best of Lennon and McCartney, and while the Beatles career took a nosedive in 1970, the Stones were just hitting their stride with songs like "Sympathy for the Devil,"." Gimme Shelter,"" Honky Tonk Woman," You Can't always get what you want" and many others too numerous to list here. I manage to see most of of their concerts, and have since 1964, and one thing you can say is that they still have their chops and sound as good as in 1964, even better as one doesn't have to contend with adolescent girls screaming. On another note, they are coming out with an album of entirely new material later on in 2011. Richard's most poignant observation was that "I play not for the money or the adoration of the crowds, but I play for myself." 

Tyler Cowen writes in:

I also like Bill Simmons on the NBA…

Alston Mabry writes:

Exploring the Keef meme lead to this little jewel What Would Keith Richards Do?



 The jewelry business—like many other businesses, especially those that depend on selling—lends itself to lies. It's hard to make money selling used Rolexes as what they are, but if you clean one up and make it look new, suddenly there's a little profit in the deal. Grading diamonds is a subjective business, and the better a diamond looks to you when you're grading it, the more money it's worth—as long as you can convince your customer that it's the grade you're selling it as. Here's an easy, effective way to do that: First lie to yourself about what grade the diamond is; then you can sincerely tell your customer "the truth" about what it's worth.

As I would tell my salespeople: If you want to be an expert deceiver, master the art of self-deception. People will believe you when they see that you yourself are deeply convinced. It sounds difficult to do, but in fact it's easy—we are already experts at lying to ourselves. We believe just what we want to believe. And the customer will help in this process, because she or he wants the diamond—where else can I get such a good deal on such a high-quality stone?—to be of a certain size and quality. At the same time, he or she does not want to pay the price that the actual diamond, were it what you claimed it to be, would cost. The transaction is a collaboration of lies and self-deceptions.

from: The Lie Guy

Chronicle of Higher Education

Jeff Watson writes:

Back in the mid 80s, I was a co-owner of a small emerald mine in Colombia. The stones were plentiful, but the quality was mediocre, very dull. My on site partner used to gather all the emeralds, clean them up, wrap them in gauze, soak them in mineral oil, then put the whole gauze wrapped package over a 100 watt light bulb for a few weeks to "treat" the emerald with heat. After being treated, the emerald was not of higher quality but did look nicer, good shine, better colors to the eye. The emeralds also acted differently under fluorescent and UV light, We would wholesale the stones to buyers who came onsite, and we never dealt with the jewelery trade. The buyers all knew the stones were treated, and didn't care as they were mainly concerned with size and color and weight. I brought a treated stone back to the states and had a local jeweler look at it proclaiming it to be the best stone he ever saw. I showed him the equal stone but untreated and he couldn't believe the difference.

Deception really does work in the gem trade with everything from obvious phony stones, to treated stones, to cut stones made to look bigger, and a whole other bag of tricks. One lesson I learned is that 90% of the emeralds sold in the USA have been "treated" in one way or another, with only the untreated high end stones going to Winston, Tiffany, Stern, etc..

Bill Rafter recommends: 

Recommendation: Influence of Fear on Salesmen by Frank Budd. Excellent book from the 1970s, written for salesmen in the life insurance industry. One of his points is that only a fraud can sell something he does not believe in, and that eventually that fraud will be unsuccessful. Obviously he never knew Bernie M. who was both a fraud and successful.



The traditional explanation of a high put-call ratio was panic by the uninformed public. With the S&P 500 at a two-year high today, that scenario seems quite unlikely. Using another method to evaluate the little guys, the non-reportable positions in last week's COT report were net long 3.4% of the S&P 500 open interest (weighted average of bigs and e-minis). The non-reportable net long position has ranged from 0.9% to 5.2% in the past year.

Alston Mabry comments:

IMHO, the relationship between the ratio of leveraged-long instruments to leveraged-short instruments on the one hand, and the market on the other, went through a regime change this summer after the Flash Crash. To paraphrase Wally Shawn in The Princess Bride: "I don't think that means what I thought it meant."

William Weaver writes:

To pose another question to the list: What types of events can cause a regime change in a financial instrument?

To stick with equities, I use consumer spending data to define high vol and low vol regimes as I have found these fundamentals precede market action (not survey data).

Of my three business partners, two who have created models that best my own and use only price, volume, and open interest data.

Composition of OI? i.e. Commitment of Traders? Larry any thoughts on how a strategy may only work with one demographic instead of using the demographic as a signal itself? Maybe ICI data with fund holdings?

Sentiment data?

There was a company a few years back that suggested lookback periods consisted of all the data where a detrended version of price stayed within a standardized range, thus the last spike was the end of the prior regime. The flash crash could be a part of this.

Regulatory/mechanical changes: fractional to decimal, up-tick rule, naked short rules, no short rules, required reserves, etc.

So this gives us a few starting points: fundamentals, price/volume/OI related observations, demographic of a market, regulatory/mechanical, sentiment data and major dislocations in price (I believe this should be separated from the price category).

David Aronson replies: 


With regard to your question. We have recently added a type of modeling that searches simultaneously for an indictor to define distinct regimes (2 or 3) and then linear models that are optimal in each regime (distinct range of the regime indicator). I have not done much with it yet but we were motivated to add this tool because of the phenomena that you talk about in your post.



Thanks to rallying stocks (and no thanks to housing), net worth of Americans is approaching pre-crisis levels.

Using Prof. Shiller's housing price data, constructed a ratio of SP500 to house price index 1950-August 2010 (attached). His data is annual through 2006, and (approximately) quarterly after that, as seen in the attached chart.

The ratio of SP500 to housing hit a many year bottom ca 1981, then rose phenomenally to the peak of the tech bubble in 2000. The ratio crashed after that; bottoming around early 2003, and since then has remained fairly stable except for a drop in early 2009.

Recent government efforts to reflate assets appears to have been more successful with stocks than house prices. This may continue as QE2 has not been having the desired effect, and mortgage rates shot up from many-year lows recently.

Should QE fail to reflate the real estate market, there is a risk of further decline in house prices, more loan delinquency and foreclosures - a kind of positive feedback loop. To avoid this (and keep people happy– the same ones who are unhappy with the recent tax deal), the government could force lenders to write off mortgage principal on distressed properties– moving losses from mortgagees and the real estate market to lenders, and of course upper income taxpayers in future years.


Alston Mabry adds:

Attached is a chart of the gold price divided by the Case-Shiller nominal housing price index.



 This is a nice video bit where Hans Rosling does his thing on a BBC 4 show called "The Joy of Stats": "Statistics come to life when Swedish academic superstar Hans Rosling graphically illustrates global development over the last 200 years."

Got to give credit to BBC 4 for doing a show called "The Joy of Stats". Rosling doing the same bit in expanded form in his TED talk in 2006.

Maybe we'll get the entire "Joy of Stats" here on PBS at some point.



 1. Will someone please note that the amount of profit you can devolve is related to the amount of capital at your disposal for traders, the same way the profits of a company are related to its total capital, via the rate of return. When a firm such as a former broker now a bank et al, received hundreds of billions extra in capital availability through bailouts, investments from flexions, borrowing at the federal fund fate of zero, or having a fixed buyer in line for its assets, and many other emoluments such as having your former boss, or his nephew at the dept of the interior, that is the wherewithal that enables the entire profits pool to exist, and the bonuses that the public pays for through this increase in capital.

2. Here's an interesting kettle of empirical finance queries. Given that 6 of the last 7 days are up, what are the chances that the last day was up? One finds for bonds that there were 50 such occurrences when the last day was up. and 4 days when the last day was down. It's interesting to reflect back on your binomial formulas for this. And it's also interesting as a stepping stone for some useful counting for futures.

3. One can never read Mahlon Hoagland and Bert Dodson's work The Way Life Works recommended as the best biology book by James Watson without being amazed at the regularities it reveals in all aspects of life and markets.

4. Germany, Sweden, and Turkey up over 15% lead all the others. What mega trends does this reflect?

Gary Rogan comments: 

Germany and Sweden seem to be an affirmation of the rise of fiscal conservatism in Europe and soon around the world. Turkey seems to be a special case with a somewhat peculiar government getting a grip on a number of local problems plus their re-emergence as a leader in the Muslim world. 

Alston Mabry adds:

from the Globe and Mail this morning:

While it may seem odd, Germany appears to be benefiting from the European sovereign debt turmoil," said BMO Nesbitt Burns economist Benjamin Reitzes, who tracked the performance of German stocks and bonds since the beginning of the year.

Germany has become a driving force during the debt crisis, which has sidelined Greece and Ireland, and now threatens to engulf Portugal and Spain, pushing up borrowing costs and forcing harsh austerity measures.

"Weakness in peripheral Europe drives money into Germany, a safe haven, lowering German yields and stimulating the economy," Mr. Reitzes said.

"Another side effect of the crisis is a weaker euro, which benefits German exporters. No wonder Germany's economy is outperforming and the DAX is among the top performing stock markets in 2010. (+14 per cent year to date).



 One wonders whether there is excessive pessimism at this time.

Vince Fulco comments: 

Where is the bolt from the blue story to save all the longs and squeeze the life out of the shorts? Something along the lines of "Berkshire asking for outsized allocation of GM…"

Rocky Humbert writes:

Forgive me for asking, but where is the excess pessimism? Last week's AAII Survey had the second lowest level of pessimism of the year. And, even after this bond market shellacking, the five year tips are still NEGATIVE 11 basis points; and yes, the commodity space is having a Niagra Falls decline– but from the highest levels since 2008. If one's time horizon is twenty minutes, perhaps this constitutes "excessive pessimism" but in my world, one hopes the Chair's barrel is waterproof and well-lined should this evolve into a real waterfall (not that I'm predicting anything). I'll see y'all down river … !

Stefan Jovanovich writes:

 There is still considerable pessimism in consumer sentiment, measured by the Conference Board and Michigan Surveys. But, at the same time, the general public has greater confidence about the possibilities of good results from the recent political change than the professionals in D.C. do.

So we have a Hugh Hendry paradox: as Rocky notes, the investor class continues to believe in the future of risk assets and is, at the same time, pessimistic about political change, while the common (sic) people know they are in hard times but have hopes that the Tea Party/Republicans will actually change things for the better.

That, and $8 will buy Vic the cup of coffee I will soon owe him.

Alston Mabry writes:

Everyone needs to fret for a while and then wake up one morning and think, "Oh yeah, the New York Fed is buying $6B a day! What was I thinking?"

Paolo Pezzutti adds:

In no way. Europe can be a better haven than the dollar as bailouts continue to be the only way to delay the payment of an expensive bill. The dollar found a wall at 1.40, which is too high even for QE.

Victor Niederhoffer responds:

Ultimately the public will go on strike. Enoch Powell predicted this so clearly 25 years ago. By what normal human instinct, can people in Germany or any other country be expected to spend their money and work, to give to visible needy in another country they've never met or who are not part of their family. When money is printed and given to a specific group, it reduces the value of everything that other people own, by that total I believe, the same way a discovery of a mineral reduces the value of every other holder of that minerals by the amount of the value of the find. Landburgh is good on this point, and I think I am correct in generalizing.

Stefan Jovanovich comments:

 The Second National Bank had been chartered to act as an American cousin to the Bank of England - a private bank that would be the nation's depository for the taxes collected by the Treasury. When Jackson campaigned for reelection in 1832, he ran on a platform of "an independent Treasury" - i.e. the nation's precious specie would not be under a single bank's control but would be held "independently". What that meant in practical terms was that the specie on deposit in Philadelphia and the Bank of the United States' branches would be transferred to banks that favored the Democrats. (My own theory is that this was the first of several wars between the New York and Pennsylvania bankers. Henry Clay's running mate, the Whig Vice-Presidential nominee, was John Sergeant was from Pennsylvania; Jackson's Vice President was Martin Van Buren, "the Little Magician" from New York.) After Jackson's landslide victory in the 1832 election, he issued an executive order transferring the Treasury's gold to seven state-chartered banks. By the end of 1836 the Treasury had accounts at ninety-one of Jackson's "pet" banks. Most of these failed in 1837, causing the Panic that ended Martin Van Buren's political career.

Jackson and Clay - the first two prominent American politicians from west of the Appalachians - thoroughly hated each other. There survives a letter that Clay wrote to Nicholas Biddle, the 2nd National Bank's President, before the 1832 election. It says volumes about Clay's inability to count votes (in the election he won only 6 of the 23 states and gained 49 electoral votes compared to Jackson's 219 and the anti-Masonic candidate's 7) and his and Biddle's naïve optimism that people actually like bankers: "You ask what is the effect of the Veto (Jackson had vetoed the renewal of the bank's charter). My impression is that it is working as well as the friends of the Bank and of the country could desire. I have always deplored making the Bank a party question, but since the President will have it so, he must pay the penalty of his own rashness. As to the Veto message I am delighted with it. It has all the fury of a chained panther biting the bars of his cage. It is really a manifesto of anarchy such as Marat or Robespierre might have issued to the mob of the faubourg St Antoine: and my hope is that it will contribute to relieve the country from the dominion of these miserable people. You are destined to be the instrument of that deliverance, and at no period of your life has the country ever had a deeper stake in you. I wish you success most cordially, because I believe the institutions of the Union are involved in it."

I stopped reading Griffin's book when I got to this explanation of the Second National Bank crisis: Biddle's bank "had promised to continue the tradition of moderating the other banks by refusing to accept any of their notes unless they were redeemable in specie on demand. But when the other banks returned the gesture and required that the new Bank also pay out specie on their demand it frequently lost its resolve." Whatever Nicholas Biddle's faults, "resolve" was not one of them. Biddle used his position as the de facto central bank to call in the loans of the "country banks" in the year between Jackson's veto of the recharter and the October 1833 when Jackson's executive order took effect. Jackson turned that to his benefit by announcing that the country should not come to him for money but should go to Mr. Biddle: "he has all your money." Biddle proved to be a better banker than the state banks; but he was unable to survive the ravages of the Panic of 1837. By 1841 his bank was also gone.

Gary's theory about xenophobia is interesting but it does not fit the facts. Before the Civil War "the public" was chronically short money; there was very little for a central bank to steal, and there was no central bank. The episode from the Resumption Act to World War I is the exception in our history, not the rule; it is the only time when both the people and the government were net savers and the New York Clearing House handled all the transfers now handled by the Fed without finding it necessary to try to reconcile the divergent needs of the holders of money and the buyers and sellers of credit.

Russ Sears writes:

 I guess we will see tomorrow if such a nice start deflating late in day to negative for S&P index yesterday was close enough to count.

Gary Rogan writes:

According to G Edgar Griffin, the author of "The Creature of Jekyll Island" (here's an audio link where he explains everything he believes) the only purpose of all central banks (from the government perspective) is to steal money from the public through inflation in order to avoid explicit taxation. All else is pretense. The mechanism is exactly the same: print, give to a particular group, dilute the value for all pre-existing owners. It's interesting that it takes doing this very thing, but giving the money to foreigners instead of the government which of course spends it on the favored domestic groups, for the public to become agitated. It takes xenophobia to make people care about what is equally objectionable in both cases. 

Stefan Jovanovich adds:

There is no question that the Panic of 1907 created a trans-Atlantic consensus that trade had to be "better managed" by the financial authorities in London and New York through coordinated central banking. What is usually omitted from the story is how much of that consensus came from purely mercantilist interests. Both the Brits and the Americans had been literally shocked by how effective the Norwegians and Germans had become as competitors in the North Atlantic shipping trade. (J.P. Morgan's one conspicuous failure was his attempt to create a shipping trust; the Hamburg-American Line saw no reason why they should abandon their Wal-Mart approach to fare pricing.) Cecil Rhodes and Teddy Roosevelt contributed their view that the "Anglo-Saxon" race should rule the world and its gold supply. Gary's comment about xenophobia is, If anything, too polite with regard to Aldrich-Vreeland and what followed. Our modern monetary system has its founding in a joint desire of the more leveraged British and American banks to create a permanent imperial preference that would allow them to be able to clip their own coins in the name of "the money supply". What is amazing is that this is - even now - considered a good thing by the same academics who shudder at the idea that people should be able to ship goods and send services across sovereign boundaries by paying an ad valorem customs excise and not bothering the WTO.

Read more here.

What is completely forgotten is that the pre-WW I Left in the United States and France agreed with laissez faire capitalists on the question of open trade and the gold standard. As Michael Polyani's brother Karl puts it, "where Marx and Ricardo agreed, the nineteenth century knew no doubt." The Socialists and peaceful anarchists like my grandfather agreed with their class enemies: both opposed the Federal Reserve Act because it would allow the government to spend money it had neither borrowed nor collected in taxes. Both agreed that the gold standard and trade taxed at value but not otherwise restricted were the foundations of the capitalist economic order. The Socialists like Jean Jaures assumed that the growth of international commerce would lead to a peaceful transformation of world affairs because it would make war financially impossible. They were right, of course. And a lot of good it did them.

Without the Federal Reserve's literal monopoly over international transfers, it would have been impossible for the Wilson Administration to allow the Treasury Department to (1) suspend the domestic gold standard, (2) close the NY stock exchange for 4 months, and (3) reach swap agreements with Britain and France that allowed them to run a bar tab for war supplies. If international exchange had followed the old pattern of individual banks dealing with their foreign correspondents, the more cautious American banks would very quickly have come to the conclusion that their correspondent's IOUs could no longer be discounted and they would need to ask for some gold bars to be packed in barrels and put on a ship heading west before they sent the next shipment of artillery shell casings from Pittsburgh.



 It's finally time to paint or get off the ladder. The markets are sending eerie signals that they're out of whack vis a vis the past program of attempts to rob Peter to pay Paul. Witness the US stocks at 1105 a 20 day high in conjunction with bonds at 13000 a 20 day low. Something has to give. Or as Osborne would say, someone's going to get tarred, raw squawking and fully feathered, and something tells me it ain't going to be bonds. Finally the bond vigilantes are doing their job. The 10 and 30 year back to back auctions are about the worst in history. Finally, everyone who bought it didn't make an immediate profit. Indeed a 1 percentage point loss.

Finally, the whirlwind of spending money to weather proof buildings and create naming rites on highways for the program's reinvestment activities is meeting resistance. The idea that the money taken from the ordinary man who would have spent it on productive and useful thing, and given to organized labor and earmarks is meeting some resistance.

This backdrop is playing out against some shocking declines pointed out by Aubrey's rowing mentor in the payroll numbers. How will they be able to hold back the floodgates for two more announced numbers on the employment front?

If the bond vigilantes don't capitulate immediately as has been their wont in the past, one would predict some post employment depression in the stocks.

Alston Mabry writes:

Preseason is over. Regular season begins on Monday. Barring injuries, the first string will start every game and play most of the minutes. Offense will be more innovative, but defense quicker and tougher. The game will be played with more seriousness, more at stake.

Victor Niederhoffer writes:

the expression in mind is "someone's going to eat crow, raw squawking and fully feathered….

Gary Rogan adds:

In an interesting metaphor-to-reality twist this post was the first thing I read after I finished painting and got off the ladder. More substantively, I would like to hear from anyone who has an opinion as to what the bond vigilantes could have seen last week that they didn't see six month ago, a year ago, or a year and a half ago. Has not the course of what actually transpired been obvious since the plans were first announced? Are they finally seeing signs of inflation? Are they collectively playing a game of chicken where nobody moves until they believe everybody else is about to move? If so, will their actions now be quick and violent?




6.73%, from Steve Ellison

September 8, 2010 | 1 Comment

Where can one find a decent return on investment? 3-month U.S. Treasury bills yield 0.13%. 10-year U.S. Treasury bonds yield 2.71%.

The expected earnings of the S&P 500 over the next four quarters are 74.30. At current prices, the expected earnings yield is 6.73%, nearly 2 1/2 times the 10-year bond yield. This "Fed model" ratio was below 1 for years in the 1990s.

Alston Mabry writes:

In early 2000, if you aggregated the top 10 companies in the NASDAQ 100 into a single virtual company, that company had a market cap of $1.6T and sold for 14.7 times revenues and 83 times earnings, for an earnings yield of 1.2%. It seemed like a pretty rich valuation, but people were willing to pay it– for a time. Who's to say the yield on the 10-yr won't go to 1.2%?

Tim Melvin writes:

While not disputing that there are opportunities in today's market, anyone who bases any decision on expected earnings is making a foolish mistake. The margin of error on these estimates is incredibly wide. 

Stefan Jovanovich writes:

Big Al's speculation about how rich the valuation of bonds can get finds some confirmation in the modeling of Marcelle Chauvet — another of California's intellectual property imports.

Rocky Humbert writes:

Quick, back of the envelope, the R-squared between the professor's recession index and the closing monthly bond price is 0.18. The r-squared between the professor's recession index and the closing monthly spx price is .16. If I lag the bond price, the r-squared drops to 0.03

The Professor's Index seems to be as useful as a blind man looking in the mirror….

Which means ….that bonds may yield 1.2% … or 3.2% … or …. ???

Tyler McClellan writes:

Time for the repeating track,

The real return to bonds in the 20th century (relatively long time horizon) ex post does not substantiate the claim that we are at an unusual place vis a vis the return to savings in the government bond market, which is the market for which there is much ability to coerce the means of paying this debt regardless of the source of economic prosperity from which it does or does not arise (I am quite confident unique in that stead, and the reason why anyone who has done a deep study of social security/etc… know that there is very trivial difference in the end between fully funded, pay as you go, etc..we get the prosperity we get, period.)

Future inflation expectations do seem to be very historically unusual in both their low mean level and the historically unusual international dispersion around this level.



As many have commented it is amazing to see the fixed incomes going up up up in conjunction with the stocks going down down down. Indeed the amazingness is such that putting a littling quantification on it on a four week basis with maxima and mimina respectively, one notes that it's only happened like this on 15% of all Fridays the last 4 years. What happens in the future on this amazingly frequent 1 in 7 event? In general the fixed incomes have deferred back to their old normal with about 2 to 1 odds.

One can only guess that the reason for this unusual consilience has something to do with point 32 of a conservative diatribe I received which could have been sent by the other list itself: "when he took a huge spending bill under the guise of stimulus and used it to pay off orgs, unions, and indivdis that got him elected, people said…" Yes. crowding out, and lack of incentives, and demoralization, create a revulsion to invest and hire. Perhaps Keynes would have done better to have noted this then to conclude that expectations of further increases in bonds tend to be self reinforcing et al in creating the lm.

Alston Mabry adds:

And one must consider the whims of the flexionic organizations who can borrow from peter at zero and then lend to paul "risk free" and skim a few hundred basis points for their trouble.

Ken Drees adds:

A hint of Japanese style negative interest rates rear view mirror double play USA helps the reinforcement of trend on a "believable story basis".



 Just a heads up for science buffs:

There are two very interesting shows on the Science channel these days: Wonders of the Solar System, with brit physicist Brian Cox; and Through the Wormhole, with Morgan Freeman.

I like a good science show and I'm really enjoying these two series. The Brian Cox show is particularly surprising because one thinks one has already seen whatever can be shown on tv about the solar system that's interesting, but WotSS surprises often and rewardingly.



electricity produced from magnetic coilIn the Dictionary of Theories, which contains an enumeration and 2 par explanation of 5000 different theories, I come across the question of how many theories in different fields have applicability to ours. The question makes one think that there are vast areas for formulating hypotheses and that many simple theories in one field are applicable in others. The almost exact relation between electricity and magnetism, and the many dualities in different fields leads one to search for general theories as well.

One of the most suggestive theories I came across in the dictionary was the Correspondence Theory. It says thats what true of the microscopic level is true of the macroscopic. I wish that were true. I studied the bid asked 50 years ago, and found many regularities. I have made a few augmentations at the microscopic level since then, but one wishes that they held up at the macro level.

One notes that when I found that closing prices tended inordinately to cluster at the round numbers in 1962 operation research, my thesis adviser at the flexionic university said I'd have a hard time getting it through the acceptance mill since it was really not economics. But now I note that almost half the articles in AER are of a market microculture level or expectations relating there to level.

Alston Mabry writes:

Concerning your thesis, this is a good example of how the quantity of new theories and published papers is related to how much work is required and what tools are available. Studying market microstructure is so easy now compared to back in the day. 

George Coyle shares:

Here is an academic paper on micromolar theory:

A micromolar approach to behavior theory. Logan, Frank A. Psychological Review, Vol 63(1), Jan 1956, 63-73



Google androidI had the opportunity in the last week to mix with a number of young cell phone app developers. It was refreshing to mix with such a positive group after running into negativity almost everywhere else. These people of full of ideas, full of excitement, and full of hope. It helps that they are all young; none were over thirty. They are very entrepreneurial despite the fact that many of them carry huge debt from school.

Why are they so positive? They see the world as just being created, and they see themselves as having the necessary critical skills to help shape that world. They are coming up with new ideas every day because they are exchanging ideas and using their cell phones for everything you can imagine. And they are getting funded!

That may be the most amazing thing. They are getting funded by companies like Sony and Disney. Almost none of their investors are angel investors of the type I have depended for so many of my projects. These are mainly old white guys, and they don't understand what these kids are doing.

I am one of those guys and though I admire their work, I often don't quite get it even after multiple explanations. When I do get it, I can see that they have been thinking about a whole world of possibilities that are not even on my radar. It occurs to me that you can't make tools for a world you don't live in.

David Aronson talks about how being a leading edge expert can be a serious drawback when the leading edge moves on. When you find yourself in that position, you really need to reboot and start over. These young app developers tell me rebooting time is here.

By the way, bad news for Microsoft: none of these kids carried a Windows smart phone. Not one! In fact, those that realized that I had such a device looked at me like I was carrying a pooper scooper bag. The dominant choice was the iPhone, but there was a reasonable sprinkling of Google Android phones.

Alston Mabry writes:

Remember the phase we went through when adults would tell stories about how they couldn't figure out something on the computer, and then their twelve-year showed them how to do it? But usually the twelve-year-old explained the procedure from the POV of someone fluent in "computer", and so the adult had to get multiple repetitions before understanding bloomed.

A while back I was reading a piece by a thirtysomething, about how he was seeing the future being formed around him but had only just noticed what was going on. What he was seeing was this: His friends would take their old smartphones, disable the call features, load them with games and other apps, and then give them to their preschoolers as toys. It struck him that new generations are now growing up from a very young age with a smart device in their hands pretty much at all times. These cohorts will be fluent in "smart device" and will push the use far beyond what us monolingual types can imagine.

Chris Cooper writes:

Just as you would not expect the political leaning of Fortune 500 CEO's to match that of the rank and file, so should you not expect Silicon Valley entrepreneurs to align with the majority of voters in the region. In my experience, Valley entrepreneurs tend to be more libertarian than the average. And as a company gets larger, there is pressure from shareholders and other interested parties to support the establishment. Perhaps the Google founders support Obama in public, but in private I can assure you their views are much more libertarian.



A good text to learn the study of changes in correlation is Pitfalls in Tests for Changes in Correlations.

Ralph Vince adds:

Maybe not related to what you are after, but the metric of correlation, however calculated (raw, rank, etc) is good for examining predictability in indicators and markets, along with lead/lag times.

But I strongly caution against using it as an input in relative allocations (what some call portfolio construction). When using it, people are holding it by the blade not the handle, and tend to not know it.



 I sort of accidentally made a dynamite meatloaf last night:

1 lb ground beef
1 lb ground veal
1 lb ground lamb
salt, pepper, thyme, oregano, basil, garlic powder, onion powder

About a cup and a half or two cups of Panko bread crumbs

Then the liquids:

About a cup or a cup and half of homemade tomato sauce ( i get a container of cherry tomatoes from Costco; throw them in a pot with olive oil, salt, black pepper, a few red pepper flakes or tabasco, and a couple cloves of garlic, chopped; cook the tomatoes med-low until tender and skin coming off, then pour in red wine, chicken stock and a little balsamic; keep cooking for a while and then go at it with a hand blender to puree; cook down to desired consistency; makes great pizza sauce, too.)

then the real kicker is that instead of the standard recipe where you add milk to the Panko, i added Yolumba Muscat desert wine (because I didn't have any milk). probably one and half to two cups. (notice i did not add any egg, as is also common.)

Mix it all together with your hands until it's thoroughly blended. Form in a dish and pour more muscat over the top. Put in a 450F oven for 50-55 minutes.

Tender, tasty, fantastic– best meatloaf I've ever made. Leftovers make great sandwiches. A skilled griller could probably add extra dimensions.

p.s. got the Yolumba Muscat at Costco, too.



abraham waldFrom Wikipedia: Abraham Wald (October 31, 1902 - December 13, 1950) was a mathematician born in Cluj, in the then Austria–Hungary (present-day Romania) who contributed to decision theory, geometry, and econometrics, and founded the field of statistical sequential analysis.

And here is a very nice paper on Wald's work during WWII:

Abraham Wald's Work on Aircraft Survivability Marc Mangel, Francisco J. Samaniego Journal of the American Statistical Association, Vol 79, Issue 386 (June, 1984)

The paper is an excellent bit of homework for those in the Counting 101 class, who also enjoy their history. One is forced to take out pencil and paper, but it's worth the effort.

Wald analyzed data on bombers returning from missions over the Continent. One objective was to determine what parts of the aircraft might be strengthened in order to reduce losses. The paper lays out the following case: Divide the surface area of a bomber into four parts and determine what percentage of total surface area each of the four parts represents:

aircraft surface area:

engine 26.9%

fuselage 34.6%

fuel system 15.4%

everything else 23.1%

Then examine the 380 aircraft that returned from a mission on which 400 were sent. Count the number of hits in each of the four areas and calculate what percentage of total hits this represents:

hit distribution:

engine 18.6%

fuselage 38.2%

fuel system 17.7%

everything else 25.5%

Doing a simple comparison between surface area and hit distribution gives the following over/under:

hit_distribution_% minus surface_area_%: engine -8.3% fuselage +3.6% fuel system +2.3% everything else +2.4%

It appears the engines are getting hit less often than expected, and the fuselage more, so we should strengthen the fuselage. But of course, we are leaving something out, and it's very interesting to work through Wald's analysis (at an introductory level, certainly) and see the results.

Bill Egan adds:

Go read Wald's book Sequential Analysis . Wonderful work; published 3 years before his untimely death. I have been working in that area and after reading Wald's book, I delved into all the work done afterwards. Surprisingly little progress, and after reading 20+ papers, I have thrown my hands up in the air. Lots of screaming pygmies flinging pygmy pellets at each other and at the dead giant Wald.  



sotheby'sA daughter webmasterist asked me how pools signal to each other to stand aside on auctions and not get into bidding wars so as to lower the average net price that you get with high quality goods from auctions with the majors to about 50% of the current market value. I didn't have a good answer except to say that it's the invisible hand. The big dealers partner on deals, and they decide in advance who's going to buy it. With that one big dealer the only presence the competitive elements is withdrawn. Also, if a non dealer customer comes in the dealers know what's good and what's bad. And how much to bid. And they often tell the customer that he'd do better buying from them without the hurly burly of having to wait a few hours while the blue bloods in their monotonous voice try to eke things above the reserve.

She then asked me how this is done in the markets. And again I didn't have a good answer. Some of them have dinners together, others go on the media to tout, and others ride in a car together or tergiversate who's weak and where the vulnerabilities are. Often it's a pilot fish in a peripheral market that's not so obvious like the fixed income vis a vis the equities.

But I didn't have a good answer like Dickson does in his baseball work, i.e. the hidden signals, and the changing nature during the game, as to the code, and who's giving it? What would you have said so as not to disappoint a daughter with one's naivete?

Henry Gifford writes:

I know of at least two ways cartels do this.

My mother used to be a licensed auctioneer, having done a few charity bits and wanting to be legit, which ended her up on the list for doing auctions for the city government. At the Dept of Sanitation auctions where she auctioned off contents of apartments that had been stored by the landlord for the required time period before auctioning, the boxes were sealed, but the Dept of Sanitation employees tipped off the cartel to which lots were good. The cartel bid a minimum and then held their own auction on the hood of a car outside. Each member put the cash on the hood as he won a bid, then at the end of their auction the money on the hood was split evenly between the cartel members, about 5 or 6 of them. One time one guy was in the hospital, sent a messenger with a low bid for one lot, which he didn't win, but he was eligible for his cut of the auction profits, delivered to him in his hospital bed. If an outsider showed up at an auction, everyone bid against him at a cost shared by the whole cartel if they won the bid, and encouraged him to win the bids on the crummy lots. If someone showed up saying it was their personal goods for sale, they did a "courtesy bid" and let them buy the stuff for $10. At the police auctions, the jewelry was not in transparent plastic bags, but in translucent bags which bidders were prohibited from opening to examine the goods. Insiders, of course, knew which were the diamonds and which were not.For public bidding on contracting work, it works a little differently. One scheme is a cartel takes turns assigning jobs to members, who are told how much to bid, and which jobs they will win. They are asked to bid high enough to lose on some, etc. This requires cooperation from the agency putting the work out to bid, to discourage participation by outsiders. This can take many forms, including "confusion" about the time and place of the bid opening, or simply waiting until two weeks after the bid opening and mailing the bid back with a note that it was late. As money paid to purchase plans and money spent to put together a bid is not trivial, a few experiences like this can discourage someone from bidding - my personal experience.

Another trick is to put out work worth about $100K and mention a $50K contingency fund for unforseen site conditions, unknown soil conditions found only after digging, etc., confusingly written, so if an outsider wins they are told their bid is to be reduced by $50K, while insiders get $50K added to their bid.

Or, heavy duty mechanical work is mixed with painting work, which contractors who lack housebroken workers are hesitant to bid on, thus only one or two friendly contractors bid, and maybe bid high to cover unforseen adventures with painting. Another variation is asking for a very expensive, special piece of equipment, which insiders know they can skip installing, while outsiders are held to the terms of the contract.

This puts the systems into two broad categories, as far as I can see:

1 Better information for insiders 2 Rules are different for insiders.

Number two was perhaps covered on the list when some firms on Wall Street were bailed out, leaving us mostly with what was described below as rides in cars together, etc.

When I can't avoid being near a radio which is playing, I am reminded of this when I hear "company such-and-such announced some problem, the stock fell x points today", of course telling me what is told on the news is not news any more, and there was someone getting the news ahead of time.

I used to own a newsstand, and get the Sunday NY Times Real Estate section on Thursday night, which led to some good real estate deals for me. But, otherwise, I don't know of any legitimate way to get any such advantages.

Alston Mabry writes:

At auto auctions, if the guy running the car has an in with the auctioneer, then you gotta watch out and make sure you're not "bidding against the wall", as they say. Crowded conditions make accurate observation difficult. 



the euroActually I think Europeans are happy to have a weaker Euro. Especially Germans. it will help their exports in times of low inflation.

I am not sure the fund Europe wants to establish will help. Typically, the European reaction to the Greek crisis has been slow and fragmented, with states once again moving based on individual interests rather than a collective European view. In Germany local elections weighed also in how the leadership approached the crisis. The long term issue is that in Europe the imbalances between north and south cannot be reduced without a common European policy. In Italy we know well how difficult it is to reduce gaps between different geographical areas (north and south specifically) even under the action of a centralized government and a more or less homogeneous culture within the country. You can imagine the kind of challenge when the areas involved have different history, culture, economy, social structure.

The problem of this crisis is that Europe should accept the default of Greece. Sorry for the creditors. By the way: who are the creditors? Mainly French and German banks of course, already weakened by the crisis. The PIGS are not the only problem for a risk of contagion. Eastern Europen countries do not have much space on the news these days, but you my recall that they were the first to suffer a lot in 2008 at the beginning of the crisis. Their issues are still there.

It is the social reaction to the fiscal policies around Europe that can produce the biggest changes in the next years, as peoples of Europe will blame capitalism for what happened. The risk is that a bigger role of governments in society and economy will emerge together with some sort of nationalism and protectionism. Not good for growth… Although the US in the long term may have serious issues with their deficits and debt, it is Europe which is going to be weak for several years ahead.

I was in Italy last week and listened to discussions about the state of the economy. People complain that there are no jobs and it is getting worse. Most say that "the government should do something about it"…..

Alston Mabry writes:

The EMU is adopting the drachma. They will print more €'s to pay off the debt and save the banks. The Germans will benefit from a weaker € and better ex-EU export power. And it will be clear that Portugal and Spain can be saved the same way. Gold up! 

Ken Drees writes:

I remember reading an article about the palindrome when I was just learning about speculation, it showed him sitting and playing chess outside. It was after he had broke england out of the currency band and creamed the pound. He said something to the effect that england was going to amass some large number to defend the pound–and he was prepared to sell twice that amount for starters. I think its similar to europe now as they bluster and puff about in hopes of throwing off the currency attackers. They are in a losing position as Paolo points out. Nothing gets the juices flowing like lines in the sand. They have to have a plan for the entire string of piggies–all the way up the ladder or the wolves will chase them all the way to the end. The euro is surrounded by wolves and swinging the torch around in a circle only works so long. Eventually the wolves get more and more agressive and the attacks become more brazen.

So far it looks like their best attempt to date will be their announcement today/tonight. Anything hollow or doubted will be attacked ferociously or anything a little workable may have the wolves waiting and keeping their distance, following along. And if Big Al is correct than gold wins either way–massive QE or massive breakdown–time will tell.

Alan Millhone writes:

I want to see the US Dollar become King and overshadow the Euro et all.

I am bone tired of political correctness.

I build and remodel and rent apartments. Not an easy trade but one I understand. Not for everyone to be sure. Lumber has dramatically increased of late. One learns to not quote jobs too far into the future.



Prom king and queen1. It is absurd to contemplate the ¼% movements in the S&P these days within a two minute period and to realize without looking at the news or having any outside contact that one can predict exactly what it was. A man was spotted at an airport in a polyester suit with a briefcase labeled S&P, Moody's, or Fitch depending on how South the airport was and the extent of the move.

2. A very interesting article in the Economist of Feb 2010 says that "the market makes the manners." The gist was that during the height of the economy tailspin everyone was nicer. A merger specialist says that when he went to tout a deal to a bank CEO, the bank CEO in the past would have his secretary usher him out after five minutes as he walked past 50 of his competitors. Now he says he gets an hour interview, the bank CEO tells him what the strategy is, and then walks him out to his car. Similarly with venture capital firms taking a few hours to tell management consultant how they see things. What is the economic explanation for this? The Freakonomics explanation? Or the Landsburgian explanation? And what is the market significance of this? How can it be used in romance and money-making?

Alston Mabry comments:

One thinks of the difference between the girl who has ten boys asking her to the prom, and the girl who has only one. Maybe there is an optimal number of suitors to maximize humility and minimize bitterness — say, two.

But the idea of manners, and the recent televised Capitol prom to which the former partners were invited (and surely there will be more dances this season), brings to mind Tullock and his insights about productive versus unproductive competition. How much greater is the aggregate cost than the illusory benefit?

Tyler Cowen suggests: 

More "marketing" because companies are more desperate for new business.

Also, high unemployment means that higher IQ people are in lower-tier service jobs and higher IQ people are in general more cooperative.



California wineryThis story from Vinography.com paints a very grim picture regarding California's wine industry. Those in the know may want to comment on whether the article is too extreme or spot on.

Alston Mabry writes:

the wine industry has been suffering from the same asset inflation that the housing industry was going through. Shelves full of $40-50 bottles of Kullyfornia reds with nothing to distinguish them at all. Even Ozzie wines were getting expensive, and now with the AUD trying for par, it's even worse. But there are plenty of very drinkable wines in the $10-20 range, especially now that Costco and the like carry wine, so it's easy to downshift one's spending habits in the wine budget. Bad for the folks trying to unload inventory.

Banks would need a winery manager because they would have to make sure the stuff is properly cared for and doesn't spoil.

Having spent years making trips to various wine regions on the left coast, I was also always struck by how trendy it had become to own a winery, especially for newly rich folks from Los Angeles or San Francisco. Money was cheap, so prices just went through the roof. And then they would build these very fancy tasting rooms. Not surprising to see a crash. 



 This reminds of "The Night Of The Long Knives" also called Operation Hummingbird. It is interesting how the market was "prepared" for this event that occurs after an impressive up leg. We will see if the event will be able to trigger more volatility. It will say a lot about this market.

Peter Grieve writes:

You've got to love a keg full of musket balls through the stern windows from the forward port side carronade.

Unless the free market you revere is on the receiving end, of course.

Alston Mabry writes:

With financial regulation reform next on the agenda, it's more like Trafalgar: What better way to start a battle than to cross the T on the enemy's biggest ship and rake them with a full broadside?



the asset side of the economy
I think we have a problem that stems from a confusion between the asset side of the economy and the liability side of the economy. The assets are land, plants, people. They produce something. They create wealth. Sometimes this is called "the real economy."

The liabilities are financing the asset side, but they don't create wealth by themselves, or only at the margin (via tax arbitrage mainly). They are: stocks, bonds, etc… They are the oil in the engine, not the engine itself. The Fed is part of the liabilities.

What macroecomics is sorely lacking is a Modigliani-Miller theorem. As you know, the Modigiani-Miller theorem is a corporate finance finding that what matters is the asset side of the balance sheet, not the liabilities. The way it is financed doesn't change the value of a firm. It needs to be extended from corporate finance to macroeconomics, and I am happily providing it here as a conjecture, because at this stage it is not a theorem yet: "In a tax-free world, finance is irrelevant to the real economy." That means monetary policy is irrelevant, the Fed is irrelevant. What matters for wealth creation and growth are people, plants, and land.

Things were going well until the late 1990s because of the asset side:

1. reconstruction after WWII
2. baby boom
3. cheap oil
4. wave of innovation
5. no competition from emerging countries– they were communist, and, in hindsight, communism was great for Western Europe and the USA, because it meant less international competition

All these positive factors meant the asset side of the economy created huge value. It would have done so with or without monetary policy, with or without central banks, with or without banks actually. Now the positive factors are gone. The real economy is doing poorly and it will do so no matter what is done in terms of monetary policy, which is I repeat, irrelevant.

That's why we can have huge unemployment, that's the assets world, and a booming stock market, that's the liabilities world. They really operate independently.

Alston Mabry writes:

I'll bite.

The last few years appear to have been a story of how much finance does matter, unless one argues that the global downturn was a purely secular matter coincident with a financial collapse. Now, I have felt that the importance of the cyclical downturn in real demand got less credit than it should have, but it would be tough to argue that finance doesn't matter.

At any given point, there is some interplay between the finance side and the real asset side. The nature of that interplay changes over different regimes. There are times when lax monetary policy is just "pushing on a string" because there is no demand waiting to be unleashed by loose money. There are other times when changes in policy can have a much larger effect. And monetary policy is just one vector of finance. Finance can matter a lot, in different ways, at different times.

The asset world and the liabilities world certainly can operate independently, but we may also be seeing the markets work as predictors of what is going to happen in the "real" world.

Rocky Humbert disagrees:

I disagree that what macroeconomics is sorely lacking is a Modigliani-Miller theorem.

The practical interpretation of Modigliani-Miller is that leverage doesn't matter (to an enterprise) and while it has limited merit in structuring an enterprise during normal times, any sensible executive (or hedge fund manager) who has lived through a severe business contraction or credit squeeze will laugh at the notion that leverage doesn't matter. M-M correctly observes that a lousy business with 2% ROE is still a lousy business with 20% ROE (after 10:1 leverage). However, M-M doesn't say that a decent business with 7% ROE can be turned into a lousy business with 70% ROE (after 10:1 leverage). That is, leverage can't turn a lousy business into a great business, but it can turn a great business into a lousy business. After after that cyclical downturn, the company with less leverage will have less competition, more market share and greater unleveraged ROE. Lastly, if debt doesn't matter, why does anyone care about a rising national debt? Given the choice, I'd prefer a restoration of the Papal Vix Pervenit to a M-M in macroeconomics.



 By the time the NCAA Men's Division I basketball tournament gets down to four teams, is it a toss-up as to which team wins? In other words, does each team have a 1 in 4 chance of winning?

Steve Ellison responds:

This is an excellent situation to apply the binomial theorem. In E****, you can write a formula: =BINOMDIST(s,t,p,c), where s is the number of successes, t is the number of trials, p is the probability of success, and c indicates whether to calculate the cumulative result (1=yes, 0=no)

Our null hypothesis is that the probability of success (winning the Final Four) is 0.25.

For example, for the teams that have made only one trip to the Final Four, the formula is =BINOMDIST(1,20,0.25,1), resulting in a p value of 0.024. This result appears to be statistically significant, but the significance is questionable given that we are doing multiple comparisons.

Teams that have made at least four trips to the Final Four have won more than a quarter of the time, so we can check the probability of winning 21 times or less and subtract it from 1, using the formula =1-BINOMDIST(21,65,0.25,1), which results in a p value of 0.070.

Russ Sears comments:

This is retrospective, and has "survivorship bias" or winner's bias.

This would be true if the championship wins and returning to the Final Four where independent. But they are not. If you win one year, the record most likely show you have a better chance of repeating in the final four.

You need stats that show winner only in their first appearance or second appearance, etc.

Here are the Final Four champs by appearance order:

appearance  count champs  binomdist

1st                  97     13          0.4%
2nd                 55     15         71.3%
3rd                 32      8          59.4%
4th                 24      9          94.5%
5th or more      80     25         92.0%
4th or more     104    34         97.0%

Alston Mabry adds:

Looks like an opportunity to run a quick sim. The sim sets up the Final Four participants for each year 1979-2009, randomly assigns the National Championship to one of the schools, and then records whether that school was one of the schools that actually went to the Final Four just once, twice, three times, or four or more times. Results of 1000 runs:

schools that went to the Final Four just once
count: 20
actual championships: 1
mean # of championships in 1000 sim runs: 5.00
sd of this distribution: 1.68
z score of actual # of championships compared to sim distribution: -2.38

schools that went to the Final Four exactly twice
count: 9
actual championships: 2
mean # of championships in 1000 sim runs: 4.49
sd of this distribution: 1.73
z score of actual # of championships compared to sim distribution: -1.44

schools that went to the Final Four exactly three times
count: 7
actual championships: 6
mean # of championships in 1000 sim runs: 5.33
sd of this distribution: 1.92
z score of actual # of championships compared to sim distribution: +0.35

schools that went to the Final Four four times or more
count: 11
actual championships: 22
mean # of championships in 1000 sim runs: 16.19
sd of this distribution: 2.53
z score of actual # of championships compared to sim distribution: +2.30



partial lunar eclipse in earth's penumbraThe penumbra is a partial shadow around an opaque body like the moon or market where only faint sight is possible. It was applied in a classic article by Taussig to the region around the intersection of supply and demand curves within which stocks fluctuate in a seemingly haphazard fashion. As anything Taussig wrote 100 years ago is infinitely superior to what passes for economic analysis of markets today, it is worth quoting in full on the concept of a penumbra. First described in stocks by Taussig in 1910 ish. For reference:

IS MARKET PRICE DETERMINATE? By Frank William Taussig. The Quarterly Journal of Economics 1921, vol XXXV

[ … ]

This does not mean that there are unlimited or quite unpredictable fluctuations. The underlying conditions of supply and demand are known for all the staples well enough to make possible a rough prognostication of the season's course of prices. It may be quite clear that potatoes will be higher than last year. But there will be a penumbra of uncertainty. Within this there will be ups and downs, many and perhaps wide fluctuations.

[ … ]

Now it is with regard to the fluctuations within the penumbra, the familiar ups and downs of the market, that we need to be cautious in stating any theory of market price. The daily or weekly or monthly "equilibrium" of supply and demand is a very ticklish matter. To return to the egg market, mentioned at the outset by way of illustration: demand and supply and price are not necessarily connected, for short periods, in the way commonly assumed. Suppose a well-known dealer cuts the price and puts eggs on the market at a lower figure; others follow his lead; the price will fall further; the lower price will quite possibly stimulate still others, not to make purchases, as is usually assumed, but on the contrary to make sales — until the edge of the penumbra is approached. Then indeed there will be a reaction, or at least a check. Eggs will not go down indefinitely. But within the penumbra there is no certainty about the effect of lowered price on supply or demand or on the further course of prices. Conceivably the course of events may be just the opposite of that just described. The well-known dealer who cuts his price may be confronted by another dealer equally well-known, who snaps his offers up and bids for more at the same figure. Then still others will follow his lead, country dealers will hold back, not force their supplies on the market, and eggs will go up until the other edge of the penumbra is approached. And so it is, I take it, in the wheat pit or at the cotton post. There is no telling what immediate response there will be to an offer of larger supply or to a decline in the day's or week's quotation. A heavy sale by a big operator and a lower price accepted by him may easily mean, not that more will be bought by others, but that buyers will be scared off and that price will fall still further. This is precisely what the big bear operator expects to bring about. Or the bear's maneuver may not succeed. Price may not fall further; it may rebound and rise.

To put the matter in more technical terms: the demand curve over "short periods" — which may be a matter of weeks or even months — is not necessarily inclined throughout in the same direction. It may be inclined positively.1 And similarly the supply curve, indicating what quantities are offered for sale at different prices, does not necessarily have that constant positive inclination which is usually assumed. In the course of the higgling of the market this in its turn may have a negative inclination.

The combats of bulls and bears, familiar phenomena of the market, are incomprehensible under the orthodox theory of market price. They can be understood only if we admit that within the penumbra there is no determined or determinable market price. A good observer has said that the successful speculator is not necessarily a man of wide statistical information or of much experience in the trade. But he must be a shrewd judge of human nature. As regards the fluctuations within the penumbra, there is much truth in the statement. The market may react in all sorts of ways to changes in offers and bids and going prices. The outcome depends on men's hopes and fears and guesses and momentary states of mind. The nervy man may make money by coolly watching his more sensitive fellows and playing on their frailties.

[ … ]

From a reference that I cited with approval in my 1964 thesis, and that Professor Zeckhauser has been looking for for 30 years, and kindly provided by Alston Mabry. The area beyond the penumbra is one that Taussig felt might have continued moves indicative of shifts in the demand curve and new equilibria.

I thought to test this starting with the pencil and paper at an elementary level. I considered the 10 best Nasdaq and 10 worst performing Nasdaq 100 stocks in the first quarter of a year. Next I looked at the subsequent performance of these two groups of 10 stocks in the subsequent 9 months. I repeated this process for each of the last four years. The results are interesting.

Year Best10 Worst10 Medn10 Comment

2006    11      6        3   sd = 40% non signif (ILMN = 50%)

2007    93     46       22   sd 200% FSLR up 500% 1 rnk both periods

2008   -28    -29      -38

2009    90    130       63   reversal of fortune


Year - Calendar Year

Best10 - Performance of best 10 stocks in next 9 months

Worst 10 - Performance of worst 10 stocks in next 9 months

Medn10 - Median performance of all stocks

The results indicate that in the bad year, the worst stocks did the best in the last three quarter, but in the good years, the best stocks in the first quarter continued to excel. The 10 best performing stocks this year are Baidu, Liberty, Wynn, Sears, Garmin, Illumina, Hologic, Ross Stores, NII Holdings, Mylan. The 10 worst performing stocks this year are nvidia, Linear Tech, Foster Wheeler , Google, Qualcomm, Expedia, Warner Chilcott, First Solar, FLIR , KLA Tencor . One would be interested in other first efforts to explore the penumbra concept of Professor Taussig.

Phil McDonnell performed his own study:

In 1921 Taussig argued that there exists a penumbra around the current price in a market. He based this on the argument that at any given time the supply in a market is relatively inelastic. There is only so much wheat and more cannot be grown until next year. There are only so many shares of stock and it would take a while for the company to issue more.

This suggests a simple strategy. One could keep an average of recent highs and lows and use that as a predicted high or low for the day. One would buy at the predicted low and exit at the close. One would sell at the high and exit at the close. The following study was done using SPY daily data. For this study the average was a 10.72 day with lag removed.


       Sell Hi     Buy Lo

avg   0.022%    0.040%

std    0.994%    1.255%

count 1290        1273 %

up     48.84%     51.61%

t-stat 0.79           1.13

Results are not significant.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Alston Mabry shares another Taussig work:

The Silver Situation in the United States F. W. Taussig 3rd ed, 1900

A discussion of the silver situation in the United States divides itself naturally into two parts. On the one hand, we have the purely economic aspects of the problem — the working of the silver legislation, its history, the results that have flowed from it in the past or may be expected in the future. On the other hand, we have the intricate and difficult questions of policy involved — the right and wrong of the legislation, the evils or benefits that have ensued and may be expected, the best course to be followed in view of all the emergencies of the situation; the treatment of the problem not only from the economic, but from the wider social and political point of view.



On top of K2It is interesting to speculate about what happens when the market is up 10 days in a row and then again at the open, since this has never happened before so one can't do it. This is a quandary for frequentists and perhaps mysteries of the Bacons, Dave and our readers could shed light, as I can't.

Alston Mabry writes:

I'm looking at SPY closes, only one peak higher than this, back in Sep 1995, 12 up days in a row. lt's like standing on K2 and being able to see Everest from there. But maybe I'm just tossing coins…

Bruno Ombreux comments:

I found a funny rule in Statistical Rules of Thumb, by Gerald van Belle, called the Rule of Threes: "Given no observed events in n trials, a 95% upper bound on the rate of occurrence is 3/n." There is one very simple demonstration based on the Poisson distribution.

Victor Niederhoffer comments:

The van Belle rule would say that in 1000 repetitions, it would be 19 to 1, that a decline would occur less than 300 occasions (i.e. a probability of 3/10), a truly precise but completely misleading answer in this case, especially when the underlying base estimate is 0.5. Sort of the way people talk about Microsoft's answer to a help question. However, in this case I predict a decline of 0.25, just to make the people waiting for a reversal crazy and even poorer.



Shiller and SiegelThere was an article in yesterday's WSJ updating the bear v. bull debate between grad-school buddies Jeremy Siegel and Robert Shiller .

Shiller, who correctly called the 2000 stock and 2006 home price bubbles, contends the current rally has taken (his version of) stock market P/E above its long-term average, and the on-life-support real estate market will continue to drag on corporate earnings. The concern is that for some time FED/government intervention has artificially buoyed stocks above their "natural P/E"; beginning with the 1998 Russian debt default (thank you Mr. Meriwether), Y2K, 911, tech bubble bursting, and the recent credit crisis. In spite of all this help, we just ended the worst decade for stocks since 1930.

Professor Siegel counters that Shiller's P/E method is flawed, and that a version of analyst earnings estimate suggests that earnings will increase now that the credit-crisis write-downs have been taken.

Another possible explanation for a new, higher P/E regime is the transformation of investor thinking: Stocks changed from the "sucker bets" of our parents and grand-parents to the main-stream, primary investment for retirement. This is a self-fulfilling prophesy: since people associate economic well-being with the market, governments now borrow heavily to buy puts (of course someone has to pay for these, hopefully only those making more than $250,000/yr).

There is no reason embedded in nature that stocks must center about a certain P/E. They could stay higher or lower for decades without reason. One of the weakest arguments in Siegel's "Stocks for the Long Run" relates to the question of who will buy stocks as baby-boomers retire. His answer was foreign investors in developing countries -who currently look to be pretty well stocked up on American securities.

Currently the heroes of liquidity-provision are the mavens of Wall Street, who now hold the P/E levers and remain beholden to a market too big to fail.

Stefan Jovanovich comments:

I share Kim's skepticism about Professor Siegel's end-game for American securities. There is no historical evidence for the proposition that wealthy people in developing countries want to put their savings into the common stocks of the already developed/relatively declining countries. The periphery does not send capital to the center. Europeans bought American securities in the 19th century and again after WW II, when the U.S. offered superior growth prospects; those were precisely the times when Americans kept their capital at home, except, of course, for buying trips for foreign baubles. (Every time I visit the Huntington Library I find myself wondering how much the sale of Gainsboroughs for the pound; perhaps the rich in Singapore will develop a taste for the Hudson River school). The only event that could drag capital from Asia to North America would be the political collapse of China; if that were to occur, the money would be flight capital, and that would hardly be enough to cash out 50 million IRAs and 401(k)s. If the United States is going to return to the path of financial progress, like Sebastian the crab we will have to do it ourselves. It is going to take a while.

On another note, I finally understand Keynesians. You guys literally don't think balance sheets matter; it's all about the flow. But what do you do when the pipes have sprung a permanent leak? Opening the sluice gates won't help because the little water left behind the dam has to be kept so no one will worry about a drought and the Valley farmers have already used up their allotments.I have no understanding of the world of 3rd party incomes and investments - the one where the students don't pay the teachers and the money to invest is always OPM. I have not lived there in 35 years; my last brief visit was 1 year as a salaried tax lawyer before the combination of the 1976 tax reform act and my unfortunate manner got me fired. Since then, all I have known is the world of incorporated wallets. Right now in Munchkin Land investment bargains exist; but they are there precisely because the income flows are diminished. The prices have come down because the people who own the businesses do not themselves have the cash to reinvest. They simply want out. And, many of the bargains are anything but because the businesses are simply failing.

That, combined with the likely further extension of confiscatory regulation, makes any current investment here in California very much of a dodgy proposition. The risk of loss seems much, much greater than the reward. If there is to be new investment, it will have to come because we greedheads think we can make money, not because we have a positive cash flow. Until we can see a prospect for profit at the prices for capital assets, the flows will go into the bank to wait. Those businesses that have access to bank and government credit may, indeed, be recovering; but few, if any, small businesses and non-government employee customers are. Their own income prospects are lousy, and their balance sheets are under water. Hayek would blame all this on the past nationalization of credit and money. (Cf. Good Money, Vol. I and II). That, and the prospect of having the government tax more of the flow is only encouraging people to look for ways to camouflage their wealth. Someone - it may have been Jim Farley but I can't find the precise source - said about Joseph Kennedy, Sr. that "he was the only guy I knew in 1932 who could buy something without having to sell something else." The Kennedy political tradition may be dead, but the bootlegger legacy is alive and growing.

Kim thought Siegel was being naïve in expecting that new capital to be invested in America from abroad to buy out the retiring geezers like me. I agree, but God only knows; perhaps Brazilians will acquire a taste for windfarms in Tornado Alley. What we do know is that growth in real wages is a pure function of increased investment. Workers who get to play with newer, more expensive machines make more money because things and services can be provided better, cheaper and faster. I don't like the term capitalism, but one should give Marx his due. He did understand what was at stake. The money and credit and assets held by competitive enterprises - what he would define as "das capital" - are the only chips in the game. If the capital stock is diminished, the holders of cash who are able to invest at 6 or 8 x present earnings will probably make money; but they will be doing it at a time when the workers will be making less - as they did in the decade after the 1982 bottom. (Marx would say it was BECAUSE the new investors were making more money; and even if he was wrong about the causality, he was right about the coincidence; workers' wages do not increase dramatically while capital stock is being rebuilt. They have to wait their turn.)

What we also know is that a world of lower stock prices is one in which profits have declined and the prospect for future earnings has grown less cheery. Those situations usually do present opportunities for future gain but only if someone has "das capital". Andrew Carnegie said that, if you have a choice between losing the factories and losing the people, you want to lose the factories because, with the people you can build a better factory. Being a 19th century primitive, Carnegie presumed that a prudent businessman always had a stash of money - what used to be known as a reserve - whose value was not subject to confiscation or abolition by the government. Carnegie also presumed that he and other prudent businessman would use the cash to pay the workers their wages while the new, better factory was getting up and running. What was different in the past was that there was a stock of private capital willing to speculate after a factory had burned down or the market had crashed.

The question that Kim raised– and for which there is still no apparent answer - is where will that real cash come from now? The diminished future can only be a Grand Bargain after private savings are restored. Until then, it is likely to be a Grand Fail with both the young and the old getting far less than they expect. "Other than that, Mrs. Lincoln, how did you like the play?" 

Phil McDonnell writes:

One important aspect of this discussion is to look at the required level of stock prices. To this end it is helpful to consider that there is a large store of wealth in the world which must be invested somewhere. Right now Real Estate is in the dog house so people are dis-investing in that area. But bonds and stocks are relatively close substitutes with comparable liquidity.

Thus the required yield on stocks is simply the reciprocal of the P/E ratio. To be competitive stocks must yield something comparable to and competitive with bonds. But bonds yields are remarkably low now largely through Fed intervention. So stock P/E ratios can go quite high and still remain competitive with the historically low yield of bonds.

Alston Mabry comments:

Perhaps Dr Siegel's thesis will be supported by a new paradigm that dispenses with the connection between "American" and "securities", i.e., is Coca-Cola really just an "American" stock? Or Exxon-Mobil? Or Microsoft? Or many smaller US-based companies whose business is actually global in scope? Or think about the large foreign companies that are a big part of daily trading volume here and also part of most/all retirement accounts. Increasingly, it may be that boomers are selling their holdings into a more and more homogeous global market.

from the WSJ article:

"They say they've been chewing over the issue during vacations together at the New Jersey shore."

One shudders to think of the reality-tv-show possibilities….

Rocky Humbert comments:

An alternative way to look at this issue is to consider whether one's ownership of equities is an investment based on an assessment of future earnings and dividends — or a speculation based on a greater-fool theory.

To quote Keynes: "Most of these [professional investors and speculators] are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the public. They are concerned, not with what an investment is really worth to a man who buys it "for keeps," but with what the market will value it at, under the influence of mass psychology, three months or a year hence." Source: Keynes "General Theory," Harcourt,Brace & World 1965 ed. pg 155

This quote is reminiscent to statements made by a certain gentleman from Omaha, whose company has now outperformed the S&P-500 for the past 1, 3, 5, 10, 20 years…

Stefan Jovanovich adds:

The gentleman from Omaha has an easy standard of comparison. If you apply the average tax rate of the S&P companies to Berkshire's past 20 years' earnings, the company's book value drops by roughly 1/3rd. Never mind being a specialist in a bull market; in my next life I want to come back as the owner of an insurance company who is on a first-name basis with the Secretary of the Treasury.

I hate to trash what was once part of Dad's backlist, but Keynes' presumption about what is in the minds of investors and speculators is the truth only because it is theory that has won the academic beauty contest. It has been the most fashionable theory going since neo-Marxism trumped all else (note the reference to "mass psychology"), but it no more likely to be the truth than any other guess about something that is unknown and unknowable.

"The man of system is apt to be very wise to his own conceit. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board." - Adam Smith

Tyler McClellan writes:

I don't understand the relevance of any of the above. There are complicated ways in which falling stock prices affect on economic growth and even more complicated steps through which this transmission affects corporate profits.

But surely other than these effects, we don't care about the price of the capital stock. We care about the return to the capital stock at the given price of transfer. If the profits don't decline, so what if the old transfer the assets to the young at 12x or 15x, excepting of course the old.

Considering the IRR of social security has gone from high 30s for the first generation to slightly negative in mine, I can assure you that we need not worry about the "misfortune of the old". Social security is a flippant example, but the fact is empirically undeniable, the current generation of old people have benefitted from the most massive transfer of wealth to them from the young the world has ever seen. The baby boomers will do materially better than breaking even at current projections (driven almost completely by medicare), and the next generation will do substantially worse.

Its astounding to me that we allow the "old" to impart their wisdom to the "young". Now of course the young will benefit in the non-taxed sectors. If no one in Westchester's children can afford their parents houses, then in aggregate the houses must go down in price. This is a benefit to the children, just as lower stock prices with the same future earnings are a benefit to the young.

I call this the Grand Bargain, either we eliminate the entitlements and the asset prices can stay high, or we pay the entitlements and the asset prices fall. I'm not sure which is preferable.

I am basically a doctrinaire Keynesian, although I'm not sure what analytic work such a concept does or does not perform.

I would simply say that the process you outlined in the below is actually quite different than where you began. You seem to argue on the one hand that the businesses wont reinvest because they don't have any cash flow and then in the second that they wont reinvest the surplus cash flow because they are not confident in future X, Y, or Z.

As you can see those are mutually incompatible facts. Keynes believed that because changing expectations of the future largely effect plans reliant on the far future (such as investment), that in times of panic one should create investment to make use of the excess demanded savings, specifically when the excess of demanded savings was sufficient to make lower interest rates incapable of increasing the demand to invest sufficiently to absorb this excess savings.

Expectations of the future are a source of current period aggregate demand. Changing expectations of the future where everyone wants to invest less than he wants to save (which by the way savings is a flow of income as you correctly identify further down in you argument), can only be accomplished by destroying enough income such that the savings is not actually produced. There cannot be more savings than investment. There is no way to store money, there is no flow of savings that is not spent. That is to say, all savings is spent, just some of it is spent on investment.

I suspect you agree with the above and simply doubt that the way to get people to demand greater investment is to do it for them, and that rather we should provide future tax clarity, lower regulation, jump through hoops… fine, and I don't particularly disagree, but you will see that the fundamental insight remains. With no demand to invest, we cannot fulfill the demand to save. Period, end of story.



buy low, sell high cufflinksBuy Low and Sell High. It is the oldest maxim on Wall Street. The trouble is that it is difficult to do without a copy of tomorrow's newspaper. Even better would be a copy of next year's paper.

An article cited by a reader claimed that buying at the low in the second year of a Presidential cycle and selling at the high produced superior returns. To test whether there really is something remarkable about the second year of the Presidency we can compare the return in that year to the results for all years again assuming the unrealistic advantage of knowing when the annual low is and the next year's high.

The results for all years:

average      41.4%

std             25.7%

count          81 %

Up           100%

t-stat        14.50

Minimum   11.0%

The results for the second year of any presidency:


std           18.5%

count         20 %

Up            100%

t-stat        12.13

Minimum   16.9%

The second year slightly outperforms by 8.8% but that hardly seems significant compared to all years. The t-stat for all years is better primarily because of the larger n. Again we are reminded of the Chair's admonition that of the four possible hypotheses (1st year, 2nd year, etc.) one of them had to be the best.

When we consider the claimed monthly seasonal study the picture is even murkier. We recall that there are twelve months. But that is not 12 hypotheses. That is 12 possible starting months. There are also 12 possible ending months. This gives us a combined total of 144 (12 x 12) hypotheses. The article then assumes that using only 100 data points is sufficient to test 144 hypotheses. It sounds like junk statistics to me.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Steve Ellison replies:

I have tested the presidential cycle. Comparing the actual prices of the S&P 500 index to a 4-year centered average, I got the following t scores for 1950-1983:

Election year t plus score

0 2.95
1 0.78
2 -6.97
3 0.30

There was a clear tendency for highs to occur in presidential election years and lows to occur in midterm years. However, when I did the same analysis for 1984-2003, the results were not statistically significant:

Election year t plus score

0 -0.25
1 -0.56
2 -1.52
3 0.05

An investor who noted the presidential cycle in the early 1980s when its wonderful record became clear would not have profited much from it, sitting out not only the terrible decline of 2002, but also double-digit advances in 1986, 1998, and 2006. I have heard of the presidential cycle many times, but never of the caveat that it should be ignored in a second term, which makes me suspicious the caveat is retrospective curve fitting.

Another indicator that was strongly correlated with stock price changes until 1983 was the 12-month change in the US unemployment rate. From 1948 to 1983, there was a strong positive correlation between changes in the unemployment rate and subsequent changes in the S&P 500, i.e., when unemployment went up, stock prices followed. However, from 1984 to 2008, that relationship was also statistically insignificant; in fact the correlation was slightly negative.

Alston Mabry responds:

The "Xth year of the presidency" strategy debate brings to mind the "sell in May and go away" strategy.

To analyze the "buy and hold for 6 months" strategy (for all years, not just 2nd-year-of-presidency), I look at all the Dow months since October 1928 and calculate the return for each of the 12 strategies that correspond to "buy on the open of month Y, and sell on the open of month Y+6". Here are some stats:

For each month, showing the total return (since Oct 1928) for the strategy where that month is month Y, the average return for all the 6-month periods with that month as month Y, and the SD for those 6-month periods:

Jan  673%  +3.51%  14.30%
Feb  829%  +3.42%  11.48%
Mar 1604%  +4.47%  15.09%
Apr  295%  +2.86%  15.48%
May   19%  +1.03%  12.57%
Jun  142%  +2.04%  13.61%
Jul  349%  +2.95%  14.12%
Aug  241%  +2.55%  13.77%
Sep   91%  +1.84%  13.82%
Oct  926%  +3.89%  13.93%
Nov 3134%  +5.28%  13.09%
Dec 1370%  +4.42%  14.15%

In the actual data, November is a clear winner, though March and December are nothing to sneeze at. But how to get a context for the significance of November's outperformance?

Just can't help but run a quick simulation, and the easiest thing to do is to take all the percentage gains for all the possible 6-month periods and randomly reshuffle them, so that a 25% gain that historically fell in the November column might wind up in lowly May, and so on.

Running that 1000 times produced the following results: For all 1000 runs, the smallest maximum total return was 1072%. In other words, each run produced a set of 12 total return percent figures, one for each month. Looking at only the maximum return in each run produces a set of 1000 maximum return observations. The smallest of these was 1072%.

For these 1000 maximum returns, the mean was 5035% and the median was 3943%. So the actual total return for November was below the simulated median and well below the simulated mean.

This was surprising because when you reshuffle data like this, you tend to reduce the overall volatility by mixing volatility regimes. Also, the actual data series of all possible 6-month % changes is highly auto correlated (+.84 at a lag of 1).

So, another way to try to establish a random benchmark is to take the month-to-month percent changes in the actual data and reshuffle those, creating a new series of 6-month % changes each time, with each simulated series being highly autocorrelated like the actual series. Running that simulation 1000 times produced the following stats:

smallest maximum (of 1000 total): 1289%
mean of 1000 maximums: 5045%
median of 1000 maximums: 4153%

Again, the actual data for November are well below the mean and median values in the runs. So, the results of these simulations do not provide any support for the idea that the November-April holding period is outside what one would expect from a random process.



think about what you are eatingIt has come to my attention that MOTU has a strong buy on Popeye's fried chicken:

I refuse to do fast food, having given up my Burger King and Wendy’s addiction long ago. The only fast food I will eat is Popeye’s Chicken. They make the best fried chicken, 10 times better than KFC or Publix deli, and their biscuits are world class. Whenever I’m in North Sarasota, I hit the Popeye’s up there; We don’t have one in South County.

I reiterate that strong buy. Gmail chat users will see that my profile picture is the Popeye's logo — that was set up by my colleagues while I was away, but I am not ashamed, so I've kept it.

I think there is some variation in the Popeye's experience depending on location and timing. I'd guess that you'd get the best stuff in New Orleans. There is also a premium on getting your chicken fresh, right out of the frying pan. Offer to wait for a new batch if one is on the way within a few minutes.

There is no reason for anyone to order anything other than spicy. The level of heat is not that high, and it adds to the experience.

I don't want to totally dis' the Colonel, but I agree that Popeye's is 10 times better.

Alston Mabry writes:

As far as fast food fried bird, Popeye's is the best I have ever had. And the biscuits are dangerous, leading to all sorts of crumb debris issues in the car, especially when the biscuits are acquired via the drive-thru window.

Fried chicken is surprisingly variable, with the main drawbacks usually being insufficient flavor and/or overabundant grease.

For you lucky Big Applers and other contiguously situated, the Food Network show "Best Thing I Ever Ate" just aired their "Crunchy" episode which featured fried chicken from Brooklyn Bowl which is, amazingly enough, a bowling alley in Brooklyn.

Charles Pennington adds:

Rating a few Manhattan Popeye's:

Midtown, 26th and Lex: Excellent. In a neighborhood full of Indian restaurants and run by Indians. Good service. Also near Baruch college, so there's a student crowd. (Off topic — supposedly there is a Chick-fil-A somewhere near this spot, the only one in Manhattan, but I haven't found it or tried it.)

Chinatown, Canal/Bowery: The best. Very fresh, good service. Chinese staff. The only problem is it's very, very crowded. Manager wanders around telling loiterers to move along because tables are scarce. Near the bus depot for Fung Wa buses, which can give take you to Boston for a very cheap fare — rumor has it the triads have turf wars over running these bus lines.

Downtown, Chambers/Church: Big footprint site, but very unkempt, with lackadaisical service

Times Square, 40th and 7th: At first I didn't like this one, but I warmed up to it after a while. It's very small. Service was at first indifferent, but it got better after I became a regular.



central parkInteresting weather data can be downloaded at WeatherUnderground.

For a counting exploration of weather effects, take the daily data for the Central Park location for 2004 (recent year without a lot of large volatility events in the S&P). Then match the weather data to the daily data for the S&P (requires some cleanup). For each S&P day, calculate the High-Low gap as a % of the Open for each day. Two data columns in the WU data are "Cloud Cover" (0-8), and "Maximum Temperature". Sorting the days of 2004 so that one pulls out the 20 days with highest [Cloud Cover] and then lowest [Maximum Temp], one gets the following stats:

All S&P days for 2004:
mean H-L gap: 0.984%
sd: 0.400%
count: 252 days

20 days with:
Cloud Cover (highest) then Max Temp (lowest)
mean H-L gap: 1.158%
z versus All S&P days: +1.95

Of course, other factors bear on the analysis, but a fun and interesting start.



Speaking of ratios and round numbers and other perceptual voodoo, it is oddly mesmerizing to see:

1 Dow ˜ 10 S&P ˜ 10 gold ˜ 20 NASDAQ ˜ 1 Nikkei ˜ 10,000 USD



Whale corpseSurely there must be some good market analogies here in this wonderful, brief video narrated by David Attenborough showing the feeding strategies of Bottlenose Dolphins.

Pitt Maner III comments:

Amazing video. Dolphins also can echo locate a pin on the bottom of a pool from large distances.

While we are on the topic — sessile, bottom feeders appear to make out fairly well in the long run also! Talk about a meal for a lifetime…

Dead whales constitute an unpredictable food source, as it's impossible to figure when and where one will die. And it's a one-shot deal. But nevertheless, when the hefty animals die, they sink to the seafloor and the payoff is big for marine species able to cash in. Scientists estimate one whale corpse provides the nutritional equivalent of 2,000-years worth of normal biological detritus sinking to the seafloor.

Nick Higgs is on a research cruise off Japan to find out more about the amazing ecosystems that form around dead whales on the seabed.



Greek Temple at AgrigentoGreek and Portuguese bonds are in a nasty spiral. Very little seems to be working in terms of convincing the markets to mop up some paper. Greece 3.7 2015 is now trading 86-86.5, yielding approx 6.6 pct and some long term Portugal bonds are down a point or so since yesterday. I don't think Europe is in any way capable of rescuing Greece, or anybody else for the matter; the virus will soon spread to Italy, as it suffers from the samle chronic high debt to gdp ratios as the afore mentioned countries. Thus the trade of the day could be long Bunds short Btps.

Jeff Rollert writes:

Would it be unreasonable to compare the inability of any country to act as the world's military police, and in a similar sense, one country being the worlds bank?

Seems like the ECB built a wing on their house with wood full of termites.

I've always enjoyed the science fiction writers observation that the world will never unite until there is a non-Earth threat. Perhaps that includes monetary unions.

Alston Mabry writes:

It used to be so simple: The Greeks would have a crisis, the drachma would fall, and the Neuro's would swarm down for sun and fun and economic stimulation. The Greeks then took the extra money and started another story on the house because they knew that keeping the cash was not a good long-term investment. You'd see half-finished buildings everywhere, bristling with rebar — just the local version of a savings account with a currency hedge.

Bruno Ombreux adds:

Have you been to Athens recently? That's exactly what they have. Half-finished houses. They don't even bother covering the concrete. I was told that it was for tax reasons. As long as the house is unfinished, there are no real-estate taxes. So they don't finish their houses. This is very creative.

Jim Sogi replies:

Same thing in Peru.

William Weaver comments:

I didn't attend either event, but I remember in 2003 when Athens hosted the FISA Junior World Rowing Championships and then in 2004 Olympic Games someone made a comment about how clean everything was. It wasn't until about a week into Jr Worlds that someone finally noticed the grass on the sides of the highway between the athlete village and the rowing venue wasn't grass, but a green tarp covering heaps of trash.

The state of the art rowing venue is to my knowledge abandoned today. It was also only finished one week prior to Jr Worlds, and no one thought to anticipate the mid-August winds that sweep the city. The winds created such waves that the Men's eights heats had to jump ship and swim their boats between 500m and 1000m to cross the finish. Finals were reduced from 2000m to 1000m. The Games were lucky and didn't have this problem.

But what about selecting cities in order to build athletic facilities that will help the community in years to come? I wonder if there is been any research regarding future price performance of munis issued to build venues for Olympic Games. Most venues go unused after the event.

Henry Gifford adds:

Another reason for the rebar sticking out the tops of buildings in some places is that they expect to build the building taller later, when money is available, but without a mechanism for collecting on debts there is little money available for lending, thus things tend to be paid for in cash, and built gradually. Here, with loans available, that strategy doesn't pay as well as borrowing the money to build a property to it's "best" economic use, as the cash flow is much worse on a partially built-on property - same land taxes, same land cost, lower return, higher hassle/permit costs for repeated small construction jobs.



 For a great Christmas movie, try The Lion in Winter. Probably best after the extended family has gone home. Katherine Hepburn and Peter O'Toole — all you might need. But the rest of the cast is so good, too. Just the exuberance and the machinations. The Great Man theory of history, packed tight in an old castle. If it's been a long time since you've seen it, it's worth watching again.

Dean Davis agrees:

I second this. The supporting cast includes Tim Dalton and Anthony Hopkins, too. All in all a fine film with some mature themes.



 Checklists have been shown to reduce errors, improve accuracy, and increase profits in many fields. Most recently, a study in the New England Journal by Atul Gawande shows that use of a 19 point check by surgeons could reduce deaths by 30% and save billions. Such simple things as knowing all the names of your colleagues and being sure that an adequate supply of blood and respiratory equipment is available are useful.

When it was suggested to me that a checklist for my own trading might be useful, I originally had the same reaction as the doctors. "I've flown with the eagles, climbed the highest mountain, captured the mountain lion, been a member of all the exchanges, played 12,000 refereed matches, went to Harvard." But then I read the reaction of the Drs. "I'm from Harvard. I don't need such a list. But if I was operated on, I'd like such a list."

Here's a list I came up with for the forgotten man, the hundreds of thousands of traders in stocks, futures and options.

Before the Trade

1. Do you know the name and numbers of all your counterparts, especially if your equipment breaks down?

2. When does your market close, especially on holidays?

3. Do you have all the equipment you'll need to make the trade, including pens, computers, notebooks, order slips, in the normal course and in the event of a breakdown?

4. Did you write down your trade and check it to see for example that you didn't enter 400 contracts instead of the four that you meant to trade?

5. Why did you get into the trade?

6. Did you do a workout?

7. Was it statistically significant taking into account multiple comparisons and lookbacks?

8. Is there a prospective relation between statistical significance and predictivity?

9. Did you consider everchanging cycles?

10. And if you deigned to do a workout the way all turf handicappers do, did you take into account the within-day variability of prices, especially how this might affect your margin and being stopped out by your broker?

11. If a trade is based on information, was the information known to others before you?

12. Was there enough time for the market to adjust to that information?

13. What's your entry and exit point?

14. Are you going to use market, limit or stop orders?

15. If you don't get a fill how far will you go? And what is your quantity if you get filled on all your limits?

16. How much vig will you be paying if you use market or limit orders and how does that affect the workouts you did knowing that if you use stops you are likely to get the worst price of the day and all your workouts will be worthless because they didn't take into account the changing price action when you use stops, to say nothing of everchanging cycles?

17. Are you sure your equipment is as good and as fast as the big firms that take out 100 million a day with equipment that takes into account the difference between being 100 yards away from an exchange and the time it takes the speed of light to reach you?

18. Are you going to exit at a time or based on a goal? And did you take into account what Jack Aubrey always did which is to have an escape route in case all else fails?

19. What important announcements are scheduled? and how does this affect when and what kind of order to use? For example, a limit before employment is likely to be down a percent or two in a second. Or else you won't get filled and you'll be chasing it all day.

20. Did you test how to change your size and types of orders based on announcements?

21. What's the money management on this trade?

22. Are you in over your head?

23. Did you consider the changing margin requirements when the market gets testy or the rules committee with a position against you increases the margins against you?

24. How will a decline in price affect your margin and did you take into account what will happen when you get stopped out because of margin?

25. What will happen if you need some money for living expense or family matters during the trade? Or if you have to buy a house or lend money to a friend?

During and After the Trade

1. What's your game plan if it goes against you and threatens your survival?

2. Will you be able to get out? Did you take that into account in your workout?

3. More typically, what will you do if it goes way against you and then meanders back to give you a breakeven? Or if it immediately goes for you or aginst you?

4. Would you be willing to take a ½% profit if you get it in the first 10 minutes?

5. Did you test whether taking small opportunistic profits turns a winning system into a bad one?

6. How will unexpected cardinal events affect you like the "regrettably," or the pre-annnouncement of something you expected for the next open? And what happens if you're trading an individual stock and the market goes up or down a few percent during the day, or what's the impact of a related move in oil or interest rates?

7. Are you sure that you have to monitor the trade during the day? If you're using stops, then you probably don't have to but then your position size would have to be reduced so much that your chances of a reasonable profit taking account of vig are close to zero. If you're using 10% of your capital on a trade, they you'll have to monitor it for survival. But, but, but. Are you sure you won't be called away by phone calls, or the others?

8. Are you at equilibrium in your personal life? You're not as talented as Tiger Woods, and you probably won't be able to handle distressed calls for money or leaks on the home front. Are you sure that if you're losing you won't get hit on the head with a 7-iron, or berated until you have to give up at the worst possible time?

9. After the trade did you learn anything from the trade?

10. Are you organized sufficiently to have a record of all your trades for your accounting and learning?

11. Should you modify your existing systems based on it?

12. How does recency and frequency and value affect your future?

13. Did you fit your after activities to your mojo?

14. If you made a good profit, did you take some capital out of the fray for a rainy day?

15. Have you learned to say "fair" whenevever anyone asks you how you're doing and are you sure that you don't spend a fortune after a good trade, and dissipate your profits with non-economic activities?

16. Is there a better use for your time than monitoring the ticks or the market every minute of the day if you do, and if you don't, do those who do so and have much faster and better equipment than you have an insurmountable advantage against you?

Well, specs, that's what I come up with off the top. How would you improve or augment it?

Nick White comments:

If a position begins moving against beyond what was anticipated in the workout can one, through either contacts or acquired counting skills, figure out as fast as possible why the move against is occurring? With that information, can one then discern whether or not such a move needs to be heeded, faded, or left alone?

What legitimate information sources can one leverage to better understand a particular trade? A buddy who is a floor trader, a mentor, a high ranking friend of a friend in a central bank?

Are one's current skills commensurate with one's trading goals and ideas? Perhaps, more importantly, are one's trading skills of the same league and caliber as those one is competing gainst in a particular market? If not, surely best to wait and keep capital safe until one is sure of one's edge. This strongly accords with Chair's admonition to never get in over one's head, and to not spend inordinate amounts of time watching each tick when that time could be more profitably invested in training and developing new and existing skills — counting, programming, etc.

Make the strongest effort possible to find out whether the tail wags the dog in a particular instrument that you're trading. If it turns out that it does, does it happen with significance at a particular time, such as expiry? Or after a particular event? Can it be exploited after costs or is it better to fade it after the fact?

If one asks these questions and takes note of them in the essential lab notebook that ought to be at one's fingertips during all trading and researching activities, have those questions subsequently been answered by oneself? I have found this to be the most fertile soil for developing new insights and ideas. If you observe it, note it and question it — hypothesize about it and answer it.

Alston Mabry comments:

Here's one: Don't fool/confuse/tire yourself by making your execution more precise than your analysis. If your target is 2% within the next five trading days, then chasing two bps on the entry isn't going to make or break the trade.

Easan Katir adds:

  1. If you trade odd hours, get enough sleep and appropriate caffeine dosage.
  2. One well-known S&P pit trader advised two bowel movements in the morning before setting foot on the floor.
  3. Start the day with a centering routine — affirmations and goals. Remind oneself of one's larger purpose.
  4. List important times and dates on an online calendar with appropriate alerts: government numbers, earnings, ex-dividend dates.
  5. Rehearse successful behaviors and outcomes. And disaster recovery.
  6. Minimize other life stressors: long commutes, family arguments, risky vices, debt.
  7. Test backup equipment and systems regularly. I test my diesel backup power generator weekly.

Victor Niederhoffer responds:

I would add a small point. Trading foreign markets always seems much more difficult than domestic ones. For one, you never know what the important announcements are. For two, you get killed on the spread on your foreign exchange prices. For three, it seems to be 100 times more time-consuming to get into the queue than even the 1/100 of a second that's enough to give the domestic high frequency traders an insurmountable edge on you. For four, you have to go without sleep for at least one night, and then on the second night when you can't stay up the required 48 hours without sleep the move you expected and closed out is sure to happen.

Alan Millhone writes:

Checker master Tom Wiswell said to always keep the draw (escape) in sight.

Scott Brooks adds:

I have to disagree with Easan on the caffeine. I know there are many people that have to have their morning cup(s) of coffee to get their day going, and without it, don't feel/function right.

I do not want to go through life being so dependent on something that I have to have it to make myself feel right, let alone function right. I know this will be anathema to most (everyone?) that reads this, but I have to say it.

When I removed the caffeine addiction from my life (and don't fool yourself, it is an addiction…..if you have to have it everyday and then quit it, you will go through withdrawals……it is an addiction), my life changed so much for the better. I can think clearly. I can process information more quickly, and I can see solutions with greater clarity.

And your sleep will improve immensely. I suffered from severe insomnia for years. Kicking caffeine out of my life has lead to my being able to fall asleep, usually within minutes and being able to get up earlier and feel more refreshed!

You will find a level of "mental processing" that you never thought possible when you replace coffee and caffeine with purified water (I drink around a gallon a day) and a glass or two day of the organic juice of your choice.

But be prepared, you will likely have around two weeks of headaches when you go through caffeine withdrawals (you know, from the caffeine that you're not addicted too).

Nick White agrees:

Ditching caffeine is a good move. Best to save it for when may really need it on an overnight (or two) session. As mentioned in the past, Dr. Shinya is fervently anti-caffeine. Like many others, I found Dr. Shinya's principles promoted many positive health benefits for my wife and me.

On that note, i find that the Shinya nutritional principles — when moderated by the ideas behind the paleo diet — are a real winner; the increased "good" protein from the Paleo program does much to mitigate weight gain from increased carbohydrate consumption when kicking off on the Shinya program. There is a Paleo program for those involved in elite endurance sports.

George Parkanyi writes:

On any project or major activity, the first question I ask is how much time I have. That frames everything that is to come.

The very next thing is to build a contact list with names, phone numbers (backup phone numbers) and email addresses (and account numbers and passwords). This is also true in Scouts, where we need to have that information at our fingertips for safety reasons — in fact for every camp we have to draft an emergency plan — police, hospitals, parents, primary first aid responsibilities, etc. In a trading operation this is critical. If you have key support resources who have to act on your behalf at a moment's notice, then they need to be available, you need to able to access them, and if not, there must be a ready backup contact and plan B, even C. Chair's point about having a pen available can even be a critical detail — what if, in the heat of battle, you have to write down, say, a wire transfer number? In my case, reading glasses would be another.

Kim Zussman comments:

As a periodontal surgeon, I have found it much easier to stay composed and rational during difficult surgery than unruly trades. Chair's excellent list hints at why, in the form of the question "how do you know?".

Surgical complications follow rules of biology, and mistakes usually come when overlooking something or miscalculating the compounded risk of several factors. One can and should practice with a large margin of safety, which in almost every case is easy to determine. Biology is almost immutable, but markets morph wildly in real-time. It is very difficult to stick with a position if you are honest about your cluelessness and unwilling to go down with the ship. When the trade goes bad:

1. What was your hypothesis? How many others had your idea too? Or the opposite one? Are they right? What do they know that you don't? What is the source of your confidence that you can out-smart (or out-run) the million-mind-march?

2. Did you test properly beforehand? Did you miss something; a signal from another market, a subtle backdrop to your traded market? What is the chance this time is different, and should this doubt change your mental stop?

3. How heavily is your market being manipulated? By government? Big banks? Goldman's trading desk? Does persistent manipulation / insider trading change your hypothesis or render hypothesis formation useless?

4. How do you know whether the move is merely noise of your correct hypothesis, or part of a regime change you have not noticed?

5. Deep and abiding doubt is essential to science, but how do you incorporate doubt into market prediction when most of the movement is random?

6. Does the non-linear, mostly random reward system of trading corrupt your judgment (sleep, personal life, etc)? Do some people lead a happy, well-rested life with long periods of gut-wrenching loss alternating with gain, and are you one of them?

7. What unalterable beliefs are necessary to trade successfully? If you hold them, are you sure they are the right ones? Should some beliefs be discarded as a result of a changing world? Are there new ones you should know, and are you confident you will see them when they develop?

Steve Ellison adds:

Margin of safety is a key concept in many fields. While skiing, I put on the brakes a bit earlier than I absolutely must so that if I miss my footing or hit a patch of ice, I have another chance to avoid the hazard (e.g., other skier, tree, out of control speed). Graham and Dodd wrote about margin of safety in investing. Rather than buy a stock that is below book value, a value investor might wait for an opportunity to buy a stock below 80% of book value.

If I ski 10 times a year, even on the same mountain I am likely to encounter 10 different sets of conditions — temperature, wind, length of time since last snowfall, etc. One day last year, the fog was so thick I could not see the trees on either side of the trail. Some conditions dictate caution; others are more forgiving and allow me to be more aggressive. A warmup run is an excellent way to get a feel for conditions.

Nigel Davies proposes:

Checklists are very good whilst learning, but I believe that one should ultimately aspire to be able to do without them because everything has been internalised. In my own field I tend to believe that conscious thought of any kind can be a distraction, which is why I don't like the old Blumenfeld Rule (a checklist used before playing a move).

Ken Drees writes:

I just did an experiment with my son with one of his Christmas presents, an electronic learning kit. We have learned so far the basics of how electricity works. Resistors (series and parallel), Capacitors, etc. Each lesson has a page explaining the experiment, a schematic, a drawing of the circuit in relationship to how water moves through pipes — the water analogy for electrical flow resonates with my son. And each experiment has an electronic "wiring checklist'.

The checklist comes in handy since its easy to forget a connection, misrun a wire, or leave an extra connection from a previous experiment in the lab circuit.

I associate checklists with "must have"–high accuracy functions. Like programming, wiring, piloting, fixing a car, cooking –its all routine, but items can be omitted, done wrong and can be forgotten due to human error. The checklist is a tool, an aide that removes ego from the scenario. Used in trading it helps set the trade up, helps initiate or close the trade, and removes emotion from what needs to be done automatically. A checklist in the grey area of a trade like the middle game in chess, or an operation where the patient is being worked on really doesn't help much–you need to make gut-inferred decisions, unless your trade is so automated that you remove yourself from the trade entirely and rely upon a program.

Using trading checklists help bring focus and energy towards the trading exercise. Using checklists of some sort during the "live–life of its own phase of the trade" must be explored further. Maybe there are ways to check off your decisions, check your options, use your skills with the pressure of time taken into consideration–during this live phase.

But when your hand is on a hot stove, trade going wrong, does one need to look at a post-it-note do determine if one should remove hand from stovetop?

FYI: a 9 year old boy is understanding electricity –public school may teach a child these ideas in 7th grade. I am amazed at what can be taught to children that most think is way over their heads.

Alan Millhone adds his two cents:

I will add my two cents. Some years ago I bought an International dump truck and it has air brakes. My late father and myself drove it for use in our construction projects. Because it has air brakes you need your class B driver's license to be legal. We drove it several years without the proper license. Finally my father got the book and studied and took the written part for class B. After he took that part he gave me the book and I studied and took the test and passed. Quite a book to study.

Now the second part was an over the road test with the instructor in the truck with each of us. He said he had never given a back to back test to a father and son. Dad and myself had to back the truck then drive to the right close as we could to an orange cone– without touching the cone. Then each of us had to do a 50 point check list of our truck that we earned (I still remember the list ) and still check my truck before taking it onto the road. So checklists are valuable in many applications ranging from dump trucks to the Market.

On a side note, dad and I rode to the test center in our dump truck without the proper license. The instructor said he was not going to ask how we got there.

David Brooks comments:

All very good ideas. I wish there were some good way to test Atul's theory historically. Why? Because I am convinced that poorer outcomes in the last decade come from fragmentation of the system - shift work, decreased work-hours by house staff, the high volume being forced through the system and de-professionalation of nurses.

Alas, we can't measure the past, but I am convinced that the hospital I started in (The Peter Bent Brigham of the early to mid 70's) was a safer, more humane place with better (allowing for technological changes) outcomes.

All the same, the reason we have embraced checklists a la airlines has to do more with the aeronautical outcomes than medical outcomes. The amount of information that a pilot has to process is order of magnitudes more than what a surgeon has to process. Furthermore, when a pilot fails completely 300 lives are lost, and when a surgeon completely fails, 1 life is lost. The former is far more dramatic, of course.

It's nice to know the anesthesiologist's and scrub tech's name, but it's hard to believe that that is going to affect the outcome of a significant number of operations.

That said, I have the greatest admiration for Atul. He sits a short distance from me, and I am proud to have had even a small role in training him. He is a remarkable young man and we will being hearing from him for many years to come.

Newton Linchen comments:

Once I took an airplane pilot course, and I was amazed how everything was done with checklists. Actually, the first time I heard the word 'checklist' was there. (Even here in Brazil they keep all the terminology in English, for standard procedure). I realized how checklists can keep you out of trouble and save your life. In markets, perhaps a great deal of losses could be avoided if I followed my own trading checklists.

Russ Sears writes:

Checklists can be very useful in an emergency. I have found that a simple checklist was valuable in a race. When the going gets tough it is easy to panic. The list It went something like this 1. relax 2. pump the arms smoothly 3. breath in normal rhythm (One hard puff out, relax in). It is easy to panic on the edge of your limits. These 3 things are the first signs that you are starting to panicking, subconsciously without knowing it.

Runner, use checklist often as part of their diary. Each day you check your weight, evaluate your nights sleep and your overall mental state. You check your diet and fluid intake .

Before a race you follow your pre-race checklist from what to pack, to when and what to eat, and when and how you should be warming-up and stretching.

Then after the race you check how well you followed the plan, where the plan worked and where if failed.

Finally at the end of the year you check the philosophical underpinnings of your training. Your goals, why you are doing it all, what are the cost that you are willing pay and what is the best path to get there.

So checklist have there place, but you need to 1. put them in the right point of time in the process, 2. not let them lose their relevance and meaning . 3. keep them simple at critical points, simple enough that they are potent.

Easan Katir adds:

Thinking about checklists, and watching the Haiti disaster coverage, made me think about a checklist for emergencies. Then thought about a list of the various types of emergencies one might encounter, big and small. What came to mind:






home invasion


mistaken id

false accusation






missing person


currency replacement/devaluation

market crash

partner deceit


power outage




i suppose each needs its own checklist, though some may overlap. What did I miss?

Scott Brooks adds:

The best checklist you can have is to either be a great leader or be around a great leader.

It's been my experience that average and ordinary people need checklists (which they rarely if ever have or use…which is one of the reasons why they are average and ordinary), but smart people with leadership skills don't need a checklist when it comes time for a disaster.

Most disasters/problems rarely follow a fixed pattern. It takes a leader who is capable of thinking on his/her feet who can stand up, take charge and direct people as to what they need to do.

And this doesn't have to be right all the time, he just needs to make decisions and get people moving and be willing to take responsibility and shrug of criticism of the naysayers…..while listening to them to extract the wisdom that might be contained in their "naying" (I think I have just made up a word).

A leader has to have insight and the ability to see several moves ahead. A leader has to be able to see correlations and connections between seemingly disparate pieces of information.

A leader has to then take this data and formulate a solution and then direct people to execute the solution….and if possible, get people to see the vision of the completed project so that they can begin to work towards that goal with minimal supervision.

But most importantly, a leader has to be willing to make a decision when it comes time to make a decision even when the solution is not apparent. A course of action that fails is better than inaction that is guaranteed to fail.



KnicksOne of the striking things about the NY Knicks is that their offensive rebounding percentage, 23%, is the lowest in the NBA, going along with their third-worst record. What is the comparable statistic for markets that's not too much biased by part/whole fallacy in that it assumes knowledge of scores implicitly?

Alston Mabry writes:

Any thorough discussion of rebounding must include Dennis Rodman. He maintained that he gave up on "boxing out" because he was simply too small compared to other NBA post players. Instead, he would use the "locking up" technique, which meant using his elbows and legs to hinder other players' movement, then break away quickly to get the rebound, leaving the other player flat-footed. Also, he claimed that other players would start to focus more on how annoying Rodman was than on how the actual game was going.

That was what he said publicly, but it's also been confirmed that privately he would watch hours and hours of videotape, studying individual shooters, where they shot from, and where the ball tended to go when they missed. He would position himself on the court to maximize the probability he would be near the ball when it bounced off the rim. But he never liked to talk about this so as not to give away his best stuff and also because his studious statistical/analytical side just didn't jibe with his popular "crazy rebel" persona.

The comparisons to trading are clear.

Scott Brooks writes:

I once sat down with Bill Bartman, who told me the story of when he was trying to buy the Chicago Bulls. He got to meet the players and spend some time with them.

One was Dennis Rodman. Dennis was notorious for sitting in the locker room and on the sidelines before a game listening to his Walkman. Dennis always said that he was listening to music — he was a Peal Jam fan. During one pregame warmup, Bartman walked over to Rodman and sat next to him. Bartman struck up a conversation and asked what he was listening to and how the music psyched him up before the game.

Rodman just smiled, grabbed his head phones and placed them on Bartman's head. Bill Bartman said he could only smile at what he heard. Instead of hearing Pearl Jam, what he heard was Dennis Rodman's voice.

You see, after every game, Rodman dictated notes to himself about the other players as well as notes to himself from watching the films.

For all his bad boy persona, Rodman was a student of the game.

As to Big Al's comments about Rodman's not blocking out because other guys were so much bigger and stronger, when I read the description of "locking up", it sounds just like a variation of blocking out, with a strong emphasis on the "intimidation" part of the equation.

For all its high flying acrobatics, and ballet/gymnastic moves, and fancy passing and dribbling and all the emphasis on not being able to touch the opponent (fouling), basketball, played right, is an incredibly physical game — but the physicality is nuanced. It's like boxing, except you don't want to let the judges see you hit the other guy.

I wish my knees weren't in such bad shape. I really miss banging under the boards.

Craig Bowles remarks:

If you think of rebounding as an underlying fundamental health measure, it’s not so different from the market trying to go up when it begins being outpaced by both oil prices and interest rates. You see that now when you compare short-term growth rates. Even in intraday trading, stocks pull back when this happens. Another is basic materials and energy sectors. The market has trouble when these become the strongest sectors. It’s like a football team with no running game.



 December 16th is the 65th anniversary of the Battle of the Bulge. Many historians consider this the turning point of the war.

I would love to hear people who are more knowledgeable about military history write on this subject. A simple exercise in counting tells us that there aren't many of these warriors left.

They, and all veterans of American wars, deserve our utmost respect and, if you're lucky enough to know one, maybe a handshake, a warm smile, and a thank you.

I am very grateful to those that have served and would like to extent my personal warm wishes and a thank you to those who were there in the Ardennes 65 year ago.

Chris Tucker replies:

My grandfather's brother Uncle Rube (Reuben Henry Tucker III) was the commander of the 82nd Airborne Divisions 504th Parachute Infantry Regiment or as the Germans in Sicily called them "Those Devils in Baggy Pants". Their exploits in The Bulge are chronicled at this Wikipedia entry.

 I only met Rube a couple of times as he passed when I was very young, but he was loved and respected by everyone that knew him. In the film "A Bridge Too Far" a character played by Robert Redford is a montage of two commanders, my uncle and Major Julian Cook. Rube distinguished himself throughout the war. To quote the wiki entry on him:

Lt Gen James M. Gavin, who originally commanded the 505th Parachute Infantry Regiment, and later the Commanding General of the 82nd Airborne Division, stated in his book, "On to Berlin", "The 504th was commanded by a tough, superb combat leader, Colonel Reuben H. Tucker was probably the best regimental commander of the war.

Interestingly, Gavin would admit that Tucker "was famous for screwing up everything that had to do with administration. One story going around was that when Tucker left Italy, he had an orange crate full of official charges against his soldiers and he just threw the whole crate into the ocean. Ridgway and I talked about it and we decided we just couldn't promote Tucker." (from 9/28/82 interview of Gavin by Clay Blair)

Colonel Tucker was one of the most decorated officers in the United States Army. He was awarded two Distinguished Service Crosses, the United States' second highest medal for bravery, one of which was personally awarded by President Franklin D. Roosevelt during a visit to Castelvetrano, Sicily, in December 1943, for extraordinary heroism under hostile fire in Italy in September.

Stefan Jovanovich comments:

KurskThe only historians who consider the Battle of the Bulge "the turning point of the war" are those who believe in the Band of Brothers version. Hitler launched the offensive in the Ardennes because he thought it would scare the British and Americans into suing for a separate peace and that would allow the Germans to have one more chance to halt the advance of the Red Army. What is remarkable about the Battle of the Bulge is how close the Germans came. All they needed was another week of bad weather to keep away the Allied air cover. After Bradley woke up to the fact that something was happening (it took him over a day from the time he heard the news until he returned to his headquarters), his assessment was that the Allied had to pull back towards Paris. (One of Eisenhower's many great accomplishments is that he ignored Bradley's hysteria and ordered Patton north to support the 101st.)

The turning point, if any, in the European part of WW II was Kursk. The war diaries of the Germans soldiers are consistent; those in the West still thought they had a chance to win until the Allies finally crossed the Rhine. The Germans in Italy actually thought they were winning; and, given Clark's performance, they probably were. But, in the East, no German with any sense thought the war could be won after the summer of 1943. The best evidence is how people acted. The largest single civilian migration in modern history remains the flight westward by Germans and others in 1944 and 1945 in hopes of escaping the Red Army.

Alston Mabry writes:

"Turning point" arguments are always fun. The Bulge would rank lower down the list (a tense operational showdown, but not a strategic turning point), and Kursk would definitely be at the top, along with the air campaign in the West.

The Allied air effort, though causing significant industrial damage, actually reached a low point in fall 1943 because of the loss rate, but then had an extended "bull run" (including the introduction of the P-51 in early 1944) which devastated the Luftwaffe and established Allied air supremacy in the West. The Red Army was the hammer, while the USAAF and the RAF were the anvil.



 Many will recall Ross Miller's study of Fidelity Magellan fund under Robert Stansky, in which he shows the fund to have been essentially indexing — without adding manager value (however you define that).

This paper appeared circa Feb 2007; shortly after which Mr. Stansky was dismissed.

Here is a check on whether Fidelity Magellan's new manager is real or just a shadow. FMAGX daily returns (cls-cls) were regressed against big-cap SP500 index ETF, SPY. First for an equal 704 day period prior to Ross' study:

Regression Analysis: FMAGX- versus SPY-

The regression equation is
FMAGX- = - 0.000106 + 1.06 SPY-

Predictor        Coef       SE Coef            T      P
Constant   -0.00011  0.00011  -1.01  0.313
SPY-           1.064     0.01640  64.88  0.000

S = 0.00278542   R-Sq = 85.7%   R-Sq(adj) = 85.7%

FMAGX slightly underperformed SPY (NS), with high correlation.

Here is the same regression for the 704 days since the study:

Regression Analysis: FMAGX+ versus SPY+

The regression equation is
FMAGX+ = 0.000011 + 1.07 SPY+

Predictor       Coef         SE Coef      T      P
Constant   0.0000111  0.00023   0.05  0.961
SPY+        1.075         0.01152  93.22  0.000

S = 0.00594187   R-Sq = 92.5%   R-Sq(adj) = 92.5%

Basically identical to SPY, with same beta as before, now with even more correlation.

Eclipsing the shadow.

Alston Mabry continues:

However if one invests in 200+ large cap stocks stocks among 60 subgroups, they are going to likely going to correlate closely with the S&P 500. For example, over the past two years, an equal investment in each the nine stocks he listed would have had a 95% daily correlation with SPY.

Following a similar path, one calculates correlations for the daily log% changes of a few stocks vs SPY, over a 120-day period:
MCD by SPY: +0.36
MSFT by SPY: +0.52
PG by SPY: +0.54

Then, simply add the daily log% changes of one or more stocks together, day by day, and run the correlation against the SPY:

MCD+MSFT by SPY: +0.58
MCD+PG by SPY: +0.55
MCD+MSFT+PG by SPY: +0.67

It doesn't seem surprising that for any combination of components of SPY, one gets a higher R than any of the individual components in the combination.This is just a "back of the envelope" test, and I don't know how it would look for all possible combinations, or taking cap-weighting into account.

Phil McDonnell adds:

If one were to re-do Big Al's study it would be better to use simple percentage changes not logs. Logs are for compounding and are needed for one time period following another if reinvestment is allowed. But since step two in this process is to average the stocks into small 2 & 3 stock portfolios a simple average would be better.

In general building portfolios of positively correlated stocks will tend to move the portfolio toward the average return. However if one searches for negatively correlated investments with positive expectation returns can be achieved with less risk.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Kim Zussman writes:

MSFT is 2.4% of SP500/SPY; MCD is 0.7%



 I heard that 25% of stocks were responsible for all of the market’s gains this year. Wasn't this Peter Lynch's mantra? It's the "10-baggers" that are responsible for all the gains in a portfolio. Play for them, while trying to avoid or weed out the real losers.

Alston Mabry writes:

This is the "ICBM" effect. It showed up a couple of years back when we looked at these guys' work on trend following. They were arguing for a back-tested system that bought mo-mo stocks and then sold them on certain rules. But the key issue was to buy enough smaller stocks so that you snagged some of the ICBMs and rode them up, which created essentially all the gain long-term. Now they're saying that was true for the whole market.

Competition and innovation!

Victor Niederhoffer comments:

One should test all these random gyrations with the cross section for a bunch of stocks that investors could reasonably have in their port like the S&P 500, and survivor based, and see that probably all these enormous pareto type concentrations with 10% accounting for 90% the way they do in everything else are most probably due to normal properties of the normal distrituion with reasonably wandering.

Kim Zussman writes:

 What Art write reminds me of this joke:

“… y’know, the, this… this guy goes to a psychiatrist and says, “Doc,
uh, my brother’s crazy; he thinks he’s a chicken!”

And, uh, the doctor says, “Well, why don’t you turn him in?”

The guy says, “I would, but I need the eggs…”

Woody Allen, "Annie Hall"



 My second-oldest daughter Katie's post on Igon Values is very relevant to our field. Who are the useful idiots in our field and how can their self-serving posings be used for profit? Let us start in the Midwest. Or the islands.

Alston Mabry adds:

I thought the "igon values" thing was a joke, but upon reading Pinker's review of Gladwell, I find it isn't. For one who writes about research, as Gladwell does, to not be able to sit down and work linear algebra problems is fine (me neither), but to not know that there is a word, "eigenvalue", which may arise in conversation with scientists — that's embarrassing.

The issue of "igon values" bears on the more general issue of knowledge production and dissemination. I like watching science shows, but even when I'm watching a high-quality show like NOVA, I'm wondering, "Where are the folks, with the same level of expertise, who think at least some of this is crap? What is their critique?" It often seems that a well-communicated disagreement can help the audience understand more of what's important. And actually, a good example is Pinker's review of Gladwell.

In most or all fields of research, one could assemble a group of experts who have similar training and knowledge, but who disagree on important points in the field, especially at the boundaries of discovery. Then you have popular writers trying to understand and condense some field into book form — but if the experts don't agree, how can the popularizers possibly be "right"?

Stefan Jovanovich writes:

Mr. Mabry is far too kind. Scientists talk their books all the time. A scientific reputation is made by presenting a theory that is striking, original and difficult to evaluate.  That theory becomes the scientist's brand. His/her future in academia is tied to the success of that brand.  Few, if any scientists, are crazy/honest/selfless enough to challenge the truth of their brand.  Hence, Heisenberg's comment that "the progress of science can be measured by professors' funerals."

In science, practitioners would rarely be lying about what they are doing. But in markets, who tells the "truth," unless that truth is consistent with the talker's book? Then there is the sheer volume of new "knowledge" produced on a daily basis. How does one cope?

Bruno Ombreux writes:

H G G JrHere is a suggestion. I believe it is linked to the Igon.

I am halfway through a book that is dealing with all these issues: Scientific Method in Practice by Hugh G. Gauch. It sheds light and fosters reflections on such things as scientific questions and methods, disproving or proving hypotheses…

It is a book about science. Since good trading is a science, this is a book about good trading too. Good trading is necessarily scientific, because good trading requires good predictions. Only science can yield good predictions. If trading is not scientific, it can't be good.

This is also a philosophical book. After a few chapters, I have enough philosophical ammunition to completely destroy the Black Swan school, on epistemological grounds. The Black Swan ideas that we cannot have models that work, that variance is either infinite or undetermined, are just as naive, and far less nuanced, version of David Hume's radical skepticism. In one sentence: we can't know anything. Scientific Method in Practice advises not to waste time arguing with radical skeptics. They are not targeting science, but common sense. Common sense is literally what humans can sense in common. In this case, we all can measure variances. Common sense is a key presupposition of science. Without common sense, there can be no science. Without science, there cannot be any debate between scientists and radical skeptics, since the later are saying in effect that the former don't exist.

Incidentally, the fat tails debate wonderfully illustrates one problem mentioned in the book, that is the underdetermination of theory by data. Observing fat tails, I can find offhand a bunch of explanations:

  1. power law
  2. slowly converging normal
  3. Student
  4. truncated Levy flight
  5. mixture
  6. Markov switching model
  7. Agent-based dynamics

The same evidence produces a handful of theories. We are confronted to the issue of theory choice. In this case, I would start by getting rid of those that don't make predictions. Power laws would be the first casualty.

EigenvaluesNow, on to another book recommendation: a first-year course in linear algebra and as such is related to the original topic. "Igon values for dummies," if you want. And it is free. This is a useful book for traders, because it is impossible to understand any recent article on economics or statistics without at least a passing knowledge of linear algebra.

I don't think mastery of Igon values is required to trade well, but other concepts can be very useful. For instance, the notion of projections, covered in chapter 3.VI, really helped me understand multicollinearity in regressions. Multicollinearity is the rule in financial time series. Often, its presence is not a problem, but you'd better know about it and when it can be a problem.

Combining this book's chapter 3.VI.2 about Gram-Schmidt Orthogonalization, with chapter 3.2.3 of this other free book, one gets a clear understanding of multicollinearity.

Jack Tierney writes:

 Being unfamiliar with eigenvalues (whether spelled correctly or not) led me to follow the threads in Katie's article. Those threads, in turn, led to still others. I finally landed on this.

The author laments the increasing propensity of Rhodes Scholars to go into the world of finance as opposed to some of the nobler scientific fields that once claimed so many of those blessed by old Cecil's beneficence.

"This break in an almost century-old pattern coincided with great increases in occupational earnings differentials, which have continued to grow, seemingly exponentially…the differentials in earnings…were often rationalized by Rhodes scholars as reasonable additional compensation to balance the lower standing of business jobs among their peers. "When differentials could become a hundredfold or far more — and as investment banking and similar firms started to recruit young Rhodes scholars who had degrees in math, physics or even history, English and theology — the yawning prospective wealth chasm understandably became impossible for many to ignore…"

So there we have it. Offer enough money and even the brightest will sell out. Let a dilettante like Gladwell emulate them, though, and the wrath of the informed will be merciless (just follow some of the threads and you'll discover that Kate's handling of Gladwell was relatively humane).

However, numerous responses seemed refer to the incalculable worth of the scientific method and were it adhered to, we would all be much better off and far less likely to be exposed to the ditherings of Gladwell et al.

Back in '93 a remarkable book written by a woman embittered by her brother's courtroom experiences hit the best seller list. It was "Whores of the Court" and detailed the lengths to which those supposedly trained in the scientific method quite easily (and lucratively) sold their conclusions. Each side could present "experts" with similarly impressive credentials; each side had access to the same evidentiary material; yet their conclusions could not
have been more different.

It might be legitimately argued that psychiatrists/psychologists aren't scientists in the pure sense of the word. Currently, however, we have scientists whose credentials most definitely measure up. Yet on issues ranging from the efficacy of ethanol to global warming to the amount of oil left within the earth's crust, their conclusions couldn't be more disparate. To put it bluntly, our scientists' opinions are for sale and this is occurring as government policy is
more and more determined by their conclusions.

Whose opinions are the most sought after and well rewarded (at least through speaking engagements, articles in the mainstream journals, and in research grants)? Generally, those whose views are the most dire or the least apocalyptic. This, in itself, is a sad development. But increasingly scientists whose expertise lay elsewhere are chiming in on one side or the other. As a result we are faced with promotions that announce that "X Number of PhDs Support Global Warming Theory", or "Y Number of PhDs Claim Peak Oil is a Sham."

I am increasingly exposed to individuals who claim (and firmly believe) that their opinion is as good as anyone else's, that it's unnecessary to study both sides of an issue, that it is quite OK to shout down a speaker whose views diverge from yours, and that it's quite alright to do whatever it takes to get whatever it is one wants.

In such a world, is Gladwell to be condemned or lauded? Are the newly minted Rhodes Scholars so misguided in pursuing wealth? Are scientists who missed the gravy train to be faulted for making a last mad dash for the gold ring on the caboose? Was Linus Pauling correct in observing that peers are nothing more than people who pee together?

Alston Mabry adds:

This post reminded me of the book "Psychology of Intelligence Analysis" which contains these guidelines:

"Start out by making certain you are asking–or being asked–the right questions."

"Relying only on information that is automatically delivered to you will probably not solve all your analytical problems."

"Do not be misled by the fact that so much evidence supports your preconceived idea of which is the most likely hypothesis. That same evidence may be consistent with several different hypotheses."

"Proceed by trying to reject hypotheses rather than confirm them. The most likely hypothesis is usually the one with the least evidence against it, not the one with the most evidence for it."

Chris Tucker replies:

Wow.  Some great reading in that book.  Thanks, Al. This is from Chap. 2 "Why Can't We See What Is There To Be Seen?":

People tend to think of perception as a passive process. We see, hear, smell, taste or feel stimuli that impinge upon our senses. We think that if we are at all objective, we record what is actually there. Yet perception is demonstrably an active rather than a passive process; it constructs rather than records "reality." Perception implies understanding as well as awareness. It is a process of inference in which people construct their own version of reality on the basis of information provided through the five senses.

This is so important in my line of air traffic control.  I am constantly telling trainees that listening is not something that happens to them, it is something one must actively engage in.  Upon hearing a pilot read back a clearance, whether it be an altitude, heading, speed or route, one must pay close attention to what is said and to check it against what is expected to be heard.  It is common for trainees to simply assume that they heard the correct readback and disconcerting to them when it is pointed out that this was not the case.  We spend a great deal of time teaching them how to listen attentively.

Another facet that I have mentioned before is teaching them to get the data from the scope — to look at groundspeeds and recognize overtakes, to look at altitudes and calculate rates of climb or descent, to look at aircraft types and make hypotheses about expected performance, to look at routes and destinations and see who has to get below whom, and to create plans based on all of these.  And then to observe and check hypotheses, again and again to make sure that what one expected to happen is really happening.  And if not, how to take steps to create the reality one intends.

The key to improvement in these areas is a combination of repeated exposure and active thinking about the available data. Exposure alone can make some tasks become automatic, but active thinking and attentiveness can accelerate learning and skill acquisition.

Phil McDonell comments:

Gladwell self styles as a translator from the arcane indecipherable world of science to the everyday world of business and laymen. A good translator must understand the vocabulary of the original source language and must have a command of the vocabulary of the target language. However a command of the two relevant vocabularies is not sufficient. If it were computers would be the best translators.

What Gladwell lacks is semantic comprehension. It is often not sufficient to merely translate the words without a deeper understanding of the content. His Igon Value mistake is a glaring example.

Clearly his substitution of Igon Value for eigenvalue comes from only hearing the word as opposed to actually reading it in a book. Perhaps someone explained it in a phone or lunch conversation and Gladwell seized on it as an interesting buzz word.

Eigenvalues are actually a very beautiful construct in linear algebra. A simple intuitive way to look at them is the amount by which a quantity is stretched in a certain dimension. Suppose a stock or mutual fund has a beta of 2 and an alpha of zero. The equation is:

stock return = 2 * market return + zero

The eigenvalue for the above system is simply 2 because it stretches the market return by a factor of two.

The idea generalizes to 2 or more dimensions. Each dimension of a linear system has its own eigenvalue. If you have ever looked at yourself in a fun house mirror then you can understand this idea. The mirror that makes you look tall and thin has a stretching eigenvalue in the vertical direction and a shrinking eigenvalue (<1) in the horizontal direction.

Like the fun house mirror a matrix can be thought of as a transformation or mapping of one image to another. If one takes the eigenvalues of a matrix and multiplies them together the product acts much like a volume just as length times width of a rectangle gives the area. In Linear Algebra this volume is called the determinant. If any of the eigenvalues is zero then one of the dimensions has collapsed. It also means the determinant will be zero, the system of equations cannot be solved and any regression will be meaningless.

I have never seen any financial model take into account a determinant. Yet there seems to be a grudging acceptance of the idea that when a financial panic hits all the correlations approach 1 as people seek liquidity by whatever means necessary. Rather than simply look at risk from a simple beta model or VAR approach perhaps the proper way to model disaster is the determinant where all the risk are multiplied together.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



A once popular eigenshibboleth is the need for stocks to finance retirement. There are lots of graphs of historical compounding of the SP500 over various periods, but I was curious about account balances over periods of retirement consumption. This is a simple (* see note) study of hypothetical $1M retirement accounts invested in the SP500, for 5 different individuals each retiring at the beginning of a decade: 1950, 1960, 1970, 1980, and 1990.

For everyone (except Goldman Sachs employees), they say one needs about 80% of their pre-retirement income to retire comfortably. $8,000 per month is 80% of $120,000 annual income (average government employee). Each of the 5 retirees puts $1M into the SP500 at the beginning of his retirement (his because a woman's work is never done), and each month sells stock and draws out $8,000 - leaving the balance in stocks. The balance of each retirement portfolio varies due to monthly drawdown + stock exposure, and the running account-balances are graphed in the attachment to compare balance variability and time to depletion for the different periods.

1950 did very well, with his account varying about $1.5M from 1955-69, and he didn't run out of money until 1989. Men didn't live so long then, so his widow must have been smart. The money lasted 39 years.

1960 wasn't so lucky: his account dropped rapidly in value, and was gone by 1974. Hopefully his wife was a professor too, and for the rest of their days they read books from the library together. Money lasted 14 years.

1970 unfortunately had to go back to work after 10 years, when his $1M was gone. Fortunately he got a job as a photographer for Playboy.

1980 made Einstein look like a Troglodyte. His account is still nearly $1M in 2009, and at times approached $3M. 1980 is a widower, and is friends with 1970, who set him up and he is now happily wed to a centerfold. Has been spending for 29 years and no end in sight.

1990 got off to a great start, but the last decade put him into Cymbalta, Cialis, and Metamucil. His account, which was worth $1.6M in 2000, is worth only $280,000 now, and he is calling the Senate today to make sure his meds will be free. 19+years and looking precarious; money may be gone in 3 years.

Note: *(study is very simple: inflation not factored, ignore effects of taxes, SP without dividends, earlier periods hard to index, no one has 100% in stocks, etc).


Anton Johnson comments:

An excellent study that demonstrates the perils of excessive withdrawal rates and underfunded retirement savings.

If we account for dividends and inflation which are not trivial, add government retirement benefits, and the modeled retiree varies withdrawal rates to the widely recommended annual 4-5% of gross account value, certainly a rosier picture emerges.

Kim Zussman adds:

There are many ways the retardees [Ed.: spelling?] could or should have allocated/withdrawn, but here I was trying to elucidate the effect of luck: when you retire vs the market then.  The graphs are reverse of often shown compounding up to retirement — adding X per month to stock account (Famous example Mr. Hill, the engineer who used Value Line to compound millions).

One notes the effect here of changing cycles:  1977-00 worked for all stocks, not just growth.  And since then, well, it's been more difficult.  Even difficult for Value Line:

"November 10th, 2009

Last week the SEC charged Value Line Inc., an affiliated broker-dealer Value Line Securities (VLS), and two of Value Line’s senior officers with defrauding the firm’s family of mutual funds. Value Line’s CEO Jean Buttner and its former Chief Compliance Officer David Henigson have both settled the charged by consenting to the entry of a cease-and-desist order, though they have neither admitted to nor denied the SEC’s charges.

The Commission found that Value Line had been redirecting portions of the funds’ securities trades to VLS from 1986 until 2004 and that Buttner and Henigson overall received “over $24 million in bogus brokerage commissions from the funds pursuant to this scheme, as VLS did not perform any bona fide brokerage services for the funds on these trades.”

According to the SEC’s press release, Value Line, Buttner and Henigson further misrepresented VLS’s “phantom brokerage services” to Value Line’s shareholders, the Independent Directors/Trustees, and the SEC."

What if you invest in something other than the stock market? In the interest of ethnic diversity, attached is chart of $1M retirement accounts, each drawing $8000 per month, and compounding 1, 2,3,4,5% interest monthly on the remaining balances.  I left off the current 0% interest environment, as an exercise for the reader.

Alston Mabry replies:

That's funny, because one of the authors of one of the investment books you listed previously, recently penned a journalistic piece about how maybe it didn't make sense to go to college, because if you put the college money instead into a savings account earning "just 5%", then you would get a better lifetime return.

The whereabouts of this magical savings account was not given.

Jason Ruspini writes in:

The effects of demographics on the underlying returns can't be too auspicious for more recent vintages. The parallel the Sage drew between 1954 and today seems very shaky in that respect.



I have recently been exposed to the wiles of many a con man. I wonder what revisiting the subject of the techniques of the big con could teach us about the current situation in the markets. I think of such things as leaving the victims fearful of claiming restitution at the end, and the imprimatur of the respected elder at the beginning. What is missing to the layman is the degree of complicity of the victim. What do you think?

Scott Brooks responds :

High level cons: Con men seem to prey on issues that the Victim has, at least, a peripheral knowledge of or experience in. This allows a con to speak to the Victim and use words and situations that the Victim can relate too.

The key to this is it allows the Con to mix in just enough truth to get the Victim to agree with the con on some points, thus showing that Victim that the Con knows what he is talking about, as well as add an air of expertise to the Con's resume. The "truth" that Con mixes in are the "white swans" that the Mark so desperately wants to see.

This is a Con's ultimate fantasy, because the Mark will then do most of the work to build up the Con's resume in his own mind as the Mark see's a world swirling in white swans and purposefully ignores the black swans.

The con shows some small and perfectly plausible area/idea that has not yet been exploited (the exploitation point or EP). If the Con can build up Mark's confidence in him by supporting the exploitation point with some sort of 3rd party reliable material, then the Mark will further build up the Con's "Cred's" in his own mind. Even if the 3rd party material is only tangentially related, it will be viewed as more white swans by the Mark.

The Con will then play up the profit potential of the EP and get the Mark very excited. When he plays it up, he has to be careful not play it up too much……..his figures have to be appealing, but can not sound, "too good to be true". If the Con is smart, he will then "play down" the profit potential that he just built up to show that he's not some "pie in the sky"over seller and that he has a reasonable outlook on the profit potential….i.e. "Now, I know those numbers are exciting, but let's look at the downside….." He then shows what appears to be a reasonable low end profit potential.

The Con will then spring the trap…..and spring it with a sense of urgency.The con will usually request a reasonable amount of money that the Mark won't have any trouble accessing and can quickly write a check for….BUT…..the money will be needed within a short period of time…usually right there on the spot. If the Mark balks, the Con will back off and let the Mark tell him when he can have the money available. Lets say the Mark says that he can get the money to the Con on Wednesday. The Con will usually make a reasonable request and say, "I can only hold out until Tuesday. So can I get it on Tuesday instead of Wednesday"

The Con will then usually say something like, "Okay, great, let's do it on Tuesday. Now the banks don't post any deposits after noon for that day, so I need to make deposit before noon on Tuesday.Can I come by at 10 am on Tuesday?" The Con will then usually treat the Mark to lunch to pick his brain about the Mark's idea's about how to move this forward and solicit any advice the Mark can give, based on his extensive knowledge of (whatever the Mark has extensive knowledge of) and how it might apply to the EP (which the Mark has a peripheral knowledge of). More meetings will be scheduled to go over "details" between now and the day the check is to be picked up so the Mark will feel involved and and excited about the opportunity. At these meetings, the Con will play to Mark's ego and let the Mark brag to the Con that he has lots of money…and the Con will then drop very subtle hints that more money may be needed in the future. By now, the Mark feels very good about the Con and feels that they are closely bonded due to this "insider secret" that they both share. The Mark will want to enhance this feeling of closeness as it is the "white swan" in their relationship and allows the Mark to ignore the "black swans" that he needs to be seeking that are sometimes screaming but often whispering,"you're being conned". When the Con picks up the check on Tuesday morning, he arrives a little early, gets the check and has a refresher "rah, rah" meeting with the Mark and gets the Mark even more excited…..the Con will usually have some"extra" good news about the EP that has just come to his attention and it will likely involve some sort of 3rd party expert saying something that is related (usually in a very tangential manner) to the EP that the Con displaying the Mark on.

The Con will then return as many times as he can to get more and more money from the Mark, always playing to the emotions of the Mark. Even if the Mark begins to have doubts, he'll not want to waste all the money he's put into the EP so the Con will be able to get money from the Mark even after the doubts begin (the mind of the Mark says "I know I'm $200k into this thing,so investing another $20k is not that big of a deal if we can pull this off.Heck all good things take time and are little harder than we initially expect"). This goes on until the Con can't get anymore. There are many more steps and an infinite number of variations on the"Con/Mark" relationship. But many of those relationships contain most of the factors that I've listed above. 

Bill Rafter comments :

Bill RafterIf one were to tell “others” (i.e. not in our immediate circle of market watchers) that the market was pulling a con on us, they would think us more than a little paranoid. However if the market is the digested knowledge (and emotions) of its collected population, then thinking of it as sentient is not too absurd. Once we have accepted that, however, it’s a fine line between what comes after and paranoia. What is the first concern of a sentient being? Self-preservation. Now for a market to keep itself alive, it can never allow any one participant to gain such an advantage that the participant wins all the money. Should the latter happen, the market would be destroyed. Thus the market’s future existence depends on its not letting anyone get an insurmountable advantage. Consequently, there can never be a “Holy Grail” or flawless indicator. Perfection in trading can only be defined in statistical rather than absolute terms. Once you realize that you find it easier to live with your mistakes.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy

Alston Mabry comments :

In considering the elements of a con one is inevitably drawn to the rich genre of American Movies, which for the most part have glorified the con man. David Mamet gets a lot out of the con. See:

1 House of Games

2 Homicide

3 Heist

4 The Spanish Prisoner

5 Spartan

6 Redbelt



In his WSJ article this weekend, Prof. Boudreaux argues that insider trading shouldn't be illegal, as price-movement from such trading transmits better information about company value to the public. Presumably this also extends to legalizing burglary, as burglars perform valuable tests on home penetrability of use to homeowners not yet foreclosed on.

Relatedly, one thought the currently unfolding grand experiment in US socialism would have been considered bad for free-markets and the securities used to capitalize on them. Current and planned government control, confiscation, and regulation appears to be the biggest since the New Deal (bigger not adjusting for inflation). To put a little lip-gloss on this porcine, here is comparison between SP500 (via tradeable SPY, including dividends) weekly returns under Democrat and Republican presidencies since 1993 (Clinton + Obama so far, vs GWBush):

Two-sample T for DEM WK vs REP WK

.         N     Mean   StDev  SE Mean

DEM WK  457   0.0036  0.0228   0.0011  T=2.41 P=0.016

REP WK  415  -0.0005  0.0265   0.0013

Michael Moore would pop a suspender to learn that not only do stocks do better under recent Democrats, but ALL the positive returns since inception of SPY (Jan 1993) occurred under Clinton and Obama. Note, as is often the case, this happened with less volatility:

Test for Equal Variances: DEM WK, REP WK

95% Bonferroni confidence intervals for standard deviations

.          N      Lower  StDev   Upper

DEM WK   457  0.0212  0.022  0.024

REP WK   415  0.0246  0.026  0.028

F-Test (normal distribution)

Test statistic = 0.74, p-value = 0.002

How can this be? Shouldn't high taxes, government spending, socialized medicine, pay controls, huge deficits, and trading restrictions reduce profits and stock returns?

Then on this morning's run, the Homer Simpson (DUH) moment hit in the form of a question: Who does better as government deepens its grip on the means to production, and un-levels the playing field? Not the public - at least not mom and pop 401K. The smart people do better. The ones with the brains and resources to find loopholes in a byzantine regulatory and tax environment. Wall Street firms. Hedge funds. Large banks able to package off bad bets to taxpayers.

OK if that doesn't Liberate you, listen to this while thinking about who gets to pay for political bubble remediation:

Phil Collins: Another Day in Paradise

Springsteen/REM: Man on the moon

Alston Mabry replies:

I always thought it would be interesting to make insider trading legal, within a framework that included real-time reporting of trades made by those registered as "insiders". (And perhaps any employee of a company would be considered an insider.) Then the information contained in the trades would at least get transmitted to the markets quickly and overtly. You could extend it so this system would apply to any trades made by insiders in their industry.

Laurel Kenner notes:

The Loeb Award has been the most prestigious in financial journalism since it began in 1957. It's ironic that the founder's methods are now against the law…

Gerald Loeb, co-founder of E.F. Hutton, created the award to encourage methods that "inform and protect" individual investors. He himself relied almost exclusively on working his contacts for information. He would then publish the information for his clients. It's all there in his book, "The Battle for Investment Survival."

My goodness, how else are you supposed to get tradeable information? Are we all supposed to wait with our hands out for handouts? I guess that is the socialist model: handouts and no work.

Gordon Haave objects:

Legalize insider trading? Sure, in theory — but in reality nobody is going to play in a game where he feels his opponent has an edge on him. All you have to do to see how this works is to look at a place like Mexico [& many other emerging markets], where insider trading is rampant and blatant. The average person doesn't play.

Gregory Rehmke writes:

Some years ago Virginia Postrel argued that "insider trading" rules should be left to companies and to the various exchanges to decide. Exchanges will want to reassure investors and would fine members who broke the rules. I also think it is interesting that we only hear when "insider trades" make money. Such information is usually imperfect, so many trades based on this information lose.



What would a weekend be without my noting that Mr. Dow crosses back and forth over magic 10000 gravitational level six times on Friday, as was guaranteed to happen.

Allan Millhone comments:

I note a different Isaac Newton effect as pump prices rise in the last ten days. I read in morning's paper an inside trader hedgie arrested. I feel as a sheer novice it is scoundrels like him who moved the Market to ten thousand and not a solid economy; as to foreclosures we have yet to see the true picture. This coming Winter will be a very cold one and demands will be made on natural gas and ole Reddy Kilowatt. People will use their cash for food and fuel and home utilities and holiday retailers will suffer.

Alston Mabry takes out pencil and paper:

The Dow first crossed 10,000 on 12 March, 1999. The first open above 10,000 was 19 March, and the first close above was 29 March.

Looking at all Dow days from 29 March, 1999, to present and calculating how far in points each close is to its nearest round thousand, produces the following stats:

Total days: 2657

Mean distance in Dow points from nearest round thousand: 265.46

Histogram (using 25 point bins):


0-25 112 4.22%
50 122 4.59%
75 104 3.91%
100 119 4.48%
125 132 4.97%
150 135 5.08%
175 105 3.95%
200 124 4.67%
225 144 5.42%
250 115 4.33%
275 126 4.74%
300 135 5.08%
325 140 5.27%
350 116 4.37%
375 131 4.93%
400 156 5.87%
425 168 6.32%
450 156 5.87%
475 157 5.91%
500 160 6.02%

Looking again at this histogram, one can total the bin %'s in different ways:

distfromround / %totaldays

.   0-250 45.6%
250-500 54.4%

.   0-125  22.2%
125-250  23.4%
250-375  24.4%
375-500  30.0%

We are honored to receive this communication from Prof. Charles Pennington:

Benford's Law gives expectation frequencies for the first digit of a numerical quantity that's thought to be uniformly distributed logorithmically over several orders of magnitude. The Dow has varied by about 2 orders of magnitude since 1928. Here's its distribution along with the Benford's Law prediction:

first digit / frequency of occurrence in daily Dow 30 prices /
expected frequency from Benford's Law

1 35.0% 30.1%
2 12.5% 17.6%
3 6.3% 12.5%
4 4.7% 9.7%
5 3.7% 7.9%
6 5.5% 6.7%
7 6.1% 5.8%
8 14.2% 5.1%
9 11.9% 4.6%

(There were 20,352 observations.)

So there are "too many" 1s, 8s, and 9s, and not enough 2s, 3s, 4s, and 5s. Because of the serial correlation in the daily prices, it's not obvious (to me) whether this is statistically significant, but over history the Dow has spent some extra time hanging around near the powers of 10.

Victor Niederhoffer bypasses Benford's Law in his evaluation:

Yes, it seems significant. There were 45% within 250 points and the standard error expectation was 25. So the deficiency of 130 is five standard errors from expectation.

Alston Mabry follows up:

I broke the Dow into non-overlapping 250-day segments and counted the number of times within each segment that the Dow had an 8- or 9- handle. Chart of the results (click on All Sizes [magnifying glass] to see large version).

Conclusion: the big skew is there from the mid 1960s into the early 1980s.



CEO Michael Dell said his Round Rock-based company is “rapidly developing” merger expertise and plans to make more deals similar to the $3.9 billion acquisition of Perot Systems — MSN Money news report

When I read this I was bothered by the phrase "rapidly developing merger expertise." Like somebody is trying to convince somebody else that "we have a new expertise," or essentially, a new business we are entering. The "merger" business. Which is harder to run on negative capital than the making-PCs business.

Victor Niederhoffer notes:

Dell discussing company acquisition strategy, pulling out all stops. When that's your big suit, you're in trouble. No shots left.

James Sogi writes from Hawaii:

Dell bought a hotel in Maui at the top of the market and it is bankrupt now. "[R]apidly developing expertise" or fooled by randomness?



I had occasion to follow the college football games this weekend and analyze the results versus the betting spreads as of Friday evening. The results for 44 games (arbitrarily picked by someone else):

Total games: 44

Beat the spread: 18
Did not beat the spread: 25
No action (tie): 1

Calculate the "net spread", which is the line/spread plus or minus the actual score spread. For example, if Tulsa (line: -14) beats Rice (+14) by a score of 27-10, then the net spread is -14 plus 17 equals 3. That is, Tulsa beat the spread by 3.

For all 44 games, the net spread stats are:

mean: -2.23
sd: 13.12

Gotta figure if the mean net spread is less than a field goal, it's pretty tough to beat.



Flying is a risky proposition at all times, there are just so many, many ways to err in a completely unforgiving manner. One of the things that kills a lot of private pilots is "Get Home-itis". The need to get back can easily overpowers ones good judgment. "Perhaps if I hurry I'll beat that storm" or "visibility isn't really that bad, I've flown in worse" or "Yeah, icing conditions have been reported, but if we fly high enough I'm sure we can avoid it" and even (yes, pilots actually make this mistake) "I think we should have enough fuel to get back, no need to top off the tanks, Let's Go!" Good pilots are constantly reading about and discussing the mistakes that have killed other pilots. Not because we are morbid, but because there are always valuable lessons to be found in them.

The need to "get back" in pilots I think is synonymous with the need for traders to do the same. Wanting badly to get back to even can prevent one from focusing on the higher priority goal of doing it safely or at least with a modicum of judgment.

Alston Mabry adds:

One of the differences between the markets and an activity like flying is that in flying, if you decide to be prudent and land the plane rather than brave the worsening weather, you never know what would have happened. You might have been perfectly safe.

But in markets, you get to see what would have happened. With a catch: The deceptive part being that you don't know how you would have reacted along the way. "I could have been up 50% if I'd just bought the index in early March!" Except that if you had bought the index, you might have sold to capture the first 15%.



After I looked at the data from 1900 to 2008, it is safe to conclude that September historically was the worst month for investors, period. — A Reader of Dailyspeculations.

A MAnalysis of seasonality effects often falls victim to one of the most common oversights in probability. It is illustrated by the birthday problem in which a group of 23 or more randomly chosen individuals will be found to have (with probability greater than 50%) at least one pair sharing a birthday. With two individuals and 365 days in a year matches are rare, and 23 individuals still do not seem many compared to 365 days, but this apparent paradox is resolved by considering the number of possible pairings between those 23 individuals instead [Ed.: 23*22/2 = 253 pairings, which is close to 365].

In much the same way as a naive application of probability will massively underestimate the odds of two individuals in the group of 23 sharing a birthday, seasonality studies suffer from a similar effect. When grouping by week, month, or season, combinatorial considerations come into play. While 63 out 108 Septembers having a loss might appear statistically significant as a series of Bernoulli random trials (assuming an underlying 50/50 split between up and down months, p = .03), such effects are washed away when we instead consider the underlying empirical distribution of days or weeks, randomly permuted to form months. When comparing the months composing September to a random basket of days the results are random. Attempts to find seasons of non-randomness are frequently subject to data mining bias, as the same permutation test debunking the September drift is easily used to identify (falsely) statistically significant periods.

The study: Running a bootstrap permutation study on Dow data from 1960 to 2008 we estimate the empirical distribution of differences in monthly return between September and other months. We test the hypothesis that a random September is no more bearish than a composition of random days sampled with replacement. We find that the mean difference between populations is 0.0695%, yielding a p-value of 0.3612 – random.

Bob Humbert writes:

The same September underperformance anomaly exists in the municipal and corporate bond markets. Doesn't this seem "unusual" or is it simply a byproduct of relative value transmitting itself through the various asset classes?

I am not as numerate as you; but keep in mind this: if a coin comes up tails 20 times in a row a Trader would examine the coin… while a Quant would merely assume he was witness to an extremely remote event…

Alston Mabry reports on another study of the issue:

Stats for all Dow months from Oct 1928 thru Aug 2009:

All Dow months:
mean: +0.37%
sd: 5.44%

Take all days in this period, randomly pull 20 to create a month like September, and do this 1000 times (with replacement) to create 1000 randomly-selected "months" with the following stats:

1000 randomly-created months:
mean: +0.26%
sd: 5.03%

Close enough, given the vagaries of the actual monthly data, the use of replacement, etc. Randomly pulling out days creates a distribution of "months" very much like the actual distribution, so one cannot find a solid critique of the use of the actual monthly data, given the similar stats of the randomly-created months.

Then pull the actual Septembers out and compare them to the actual months:

All actual Septembers:
mean: -1.66%
sd: 6.37%
z vs all Dow months: -3.34

That z is spot on with the result from the random resorts of months posted earlier. So, one must conclude again that, in the time period under study, September has been unusually cruel.

The thing about the previously-posted analysis with the random resorts is that one is really asking the generalized question: If one treats the monthly % change series as a set that can be redistributed among the months-as-containers, what is the likelihood that any month will have an extreme mean like -1.66%? I think this eliminates the multiple-comparison problem, since it doesn't have to be September.

But another issue is: Can you treat a series like Dow monthly % changes as a set that can be re-sorted? One concern is the issue of volatility regime changes. For example: in a volatile year, September is the worst month at -4%, and December the best at +4%; then in a calmer year, September is the best month at +2%, and December the worst at -2%; now you have September's mean return as -1% and December's as +1%. But is September really "worse"? Or does it just appear so because of the problems inherent in mixing volatility regimes?

One way I've tried to address this issue is to normalize each month as a z score compared to the mean and sd of the previous 12 months. So that in the example with September and December, the values for September might be -2.5 and +2.5, and the same for December, making the months equivalent.

Normalizing the Dow months (again, Oct 1928 though Aug 2009) in this way and then analyzing September again, one gets:

All Dow months normalized:
mean: -0.05
sd: 1.19

mean: -0.37
sd: 1.23
z vs all months: -2.42

So this adjustment pulls the z score in (as it does in all cases I've used it), but here the z for September still leaves it in the "unusually cruel" category.

Mr. K wrote: "Shorting September every year for 80 years could be fine, but on any given year, it is a crapshoot."

Alas, yes — a crapshoot with a bias. But the analysis is fun.



Statistically speaking the month of September has the worst returns of any month — A Reader of Dailyspeculations.

The data I have easily available is only monthly Dow from Oct 1928, but doing a quick random-resort Monte Carlo provides interesting results. After calculating the % change for each month and then determining the average change for each month, one gets:

high month: December, +1.34%
low month: September, -1.66%

Then resort the actual % moves amongst the actual months, compute again the average move for each month, and then pull out the high month and low month for this random resort. Do this 1000 times and get a mean "high month % change" and a mean "low month % change" and sd's for each. And here they are:

mean high month % change for 1000 random resorts: +1.33%

sd of high month % change for 1000 random resorts: 0.28%

mean low month % change for 1000 random resorts: -0.62%

sd of low month % change for 1000 random resorts: 0.31%

So if we look at the actual -1.66% for September, it has a z of -3.38 compared to the random resorts. But also interesting is the fact that the actual high month of December is right on the nose with the random resorts.

Just more of that voodoo that up moves tend to be consistent with randomness, but down moves aren't.

Martin Lindkvist adds:

Old man Bacon almost always says it best: "But by the time Labor Day has passed the general form change is well under way." In "Secrets of Professional Turf Betting" - from the "Picking September's Wake Up Longshots" chapter.



 My simple query about what baseball can teach us about markets has tapped into a beautiful reservoir of insights and consiliences. In that spirit, and I honor Larry Ritter, who challenged Collab and me to come up with 100 relations before he told us the truth about the "doctoral degree" he awarded to the former Chair, as his thesis adviser. I am going to sponsor a contest similar to the one we sponsored about whether prices tend to Lobagola. For the best little paragraphs, hopefully with some numbers that show what we can learn from baseball about markets, I will award a $500 prize. All entries will be published. The deadline will be June 15. The judges will be me, Doc, and the east coast surfer.

Nick White clarifies:

Two quick things:

1) Must we limit the baseball contest to baseball, or might we generalise to the wider lessons that elite sport in general might teach?

2) A repeat of the best, most fundamental lesson: while waiting for our GDP number to come out, I cut my position till the print. I loaded my order into the screen and hovered my mouse over the trigger for when the number hit the wires. However, I hadn't noticed that I'd accidentally right clicked while staring at the screen until 2 seconds too late…after 22 lost points an d much cursing I recalled that one is always handsomely rewarde d for checking their equipment prior to taking the field….No more trading for me today as I'll be far too tempted to chase.

Steve Ellison adds:

Rule changes, environmental changes, and new techniques can greatly affect the game, in baseball and in markets. Jeff Pearlman wrote an article for The Sporting News in April entitled "The Death of the Stolen Base". Mr. Pearlman presented some statistics about the decline in stolen bases in major league baseball over the past two decades and then looked for reasons for this decline. He singled out two major factors.

There are increasing numbers of baseball parks with retro designs, such as Camden Yards. These parks typically have smaller dimensions than the generic stadiums of the 1960s and 1970s, increasing the value of power and decreasing the value of speed both on offense and defense.

Pitchers responded to the baserunning havoc wrought by Rickey Henderson and Vince Coleman in the 1980s by developing the slide step, a technique that shortened the pitching motion and hence the jump a would-be base stealer could get.

Alston Mabry adds:

Regarding the article "the death of stolen base", does it mention that the Bill James and the sabermetrics folks have been arguing against stealing for years because of success rate doesn't justify the cost of an out. They may be having an effect on manager thinking.

Stefan Jovanovich interjects:

Saber metrics can be a bit like the joke about the 3 actuaries at the carnival shooting gallery (the 1st misses 1" to the left, the 2nd 1" to the right, the 3rd says "we won the prize"). What James' statistics don't adjust for is that the "success rate" for steals includes the runners thrown out on missed swings on hit and runs. A good base stealer (one who is safe 80% or more) is worth the risk because, with his speed at 2nd base, a run can be manufactured with one hit instead of two. Since competent pitchers average 1 hit per inning, stealing from first to second is worth the risk. So, for that matter, is stealing from second to third with less than two out. The decline in stealing is a function of the fact that base stealing takes practice, and few managers even at the high school level are willing for accept the error part of the "trial and error" process - even though it is the one skill that gives the ordinary hitting team a chance to defeat a superior pitcher. Also, at least here in the U.S., the kids with the smaller frames and quickness that you need to be a good base stealer are playing soccer and basketball. There is hope, however; Ichiro is now the model for the Japanese leagues. Somewhere in Osaka Prefecture a kid is probably studying Maury Wills video right now.



 1. My 18 year old Lab regularly wakes up and barks at 5 am, and the coyotes are waiting right outside the door and howl in unison. One wonders if they are waiting for a meal or believing a friend is close. The market often is near death at 5 am and lurches in a spiral, with the Dax plummeting below the round.

2. The last hour on Friday often reminds me of the last two minutes of many basketball playoff games, especially those of the Celtics. The lead changes five times. There are violent moves with three-point shots and running of stops on both sides, and a complete recap of what has happened up to that time. Slow but steady wins the race.

3. The Dollar/Yen and the S&P do a very nice dance together and when you trade one you are really making a forecast of the other. Many times all the people who use the program I invented are waiting for a move to happen predicted by this or that market on this or that day or time, and out of the clear blue sky, someone like Dr. Greenspan will be speaking at a lunch, and will say something that makes the prediction come true. How did it know? And how if it didn't could you keep up with those who don't pay commissions and are always ahead of you on the bid or offer no matter how fast you are?

4. The many and increasing 100 million trading days that the "banks" are realizing these days presumably will help their kids get into certain Ivy League schools or at least get them a good letter of recommendation from former "bigs" there.

5. After a 35% rise, when the market drops 5%, the bearish commentators and the newspapers are not as hopeful of the big decline as they are after declines that follow terrible moves.

6. The Laffer Curve should be generalized to encompass the incentives that people have to buy and pay whenever any purveyor tries to siphon away their margin of benefit.

7. I can never read a Patrick O'Brian book without finding in every chapter insights into how by following the wisdom of Jack or Stephen, I could trade better.

8. I wrote a letter to a little boy telling him that having a strong and long base of operations is a key to success in life and I would be pleased to share it with those who might find it of interest in life or markets.

Alston Mabry writes:

My dogs and I have made a casual but first-hand study of coyote behavior (less casual, perhaps, for my dogs, especially Trevor who lost a dollar-sized chunk of fur and flesh to a coyote bite when he was about three). We call it a "hoot-up" when they howl as a group. In my experience, a hoot-up is a claim on territory. Coyotes coming back into the mountain park here just before dawn, after having spent the night scavenging and hunting cats and ducks in the suburbs, will stop at a familiar waypoint and do a hoot-up: "We're back. This is our territory." Several times, too, when I have been out with the dogs at 3am, and they have found and noisily chased a rabbit through the cactus, the coyotes came along twenty minutes later and did a hoot-up on the spot where we barked and whined, to claim it and try to scare us off. When you have a group of coyotes like that, they are a family, not a pack, with the parents and usually one or two cohorts of siblings not yet struck out on their own.

The end-of-day action reminds me sometimes of a football game, when there are six or eight minutes left in the 4th quarter, and the team that is behind starts throwing long passes and marching down the field. And I wonder, "Why didn't they play like this all game?" But similar to markets, they didn't play like that all game because of risk. When they get to the point where the game is on the line, then everything must be risked or else all is lost.

It's also interesting to throw the Nikkei-S&P correlation into the analysis. Is it time to go long the AUD again?

Is it that we watch the market turn and then interpret contemporaneous news as the cause? And when nothing much is happening, we ignore the news– if the market isn't reacting, then it can't be important. It's good that with both news and market data, there is an uninterrupted supply.

Paolo Pezzutti writes:

Two good friends interact and follow the same path in life. Some time one is leading, some time some the other takes the initiative. Overall they share the same values and enjoy spending time together. Suddenly, for some reason difficult to explain they part and go to different directions and not without pain. Similarly markets correlations emerge and increase to a point where you think there must be really very good reasons for them to work. Then you find out that it was all ephemeral and they were may be brought together inexplicably and randomly. With sadness you look at your friend and do not understand any more, it is simply a different person. And you hope things could go back to the good old days. Sometimes they do, but most of the times they don't.



 A little NCAA Tournament counting:

If you go to Yahoo Sports you can grab data on each team in the NCAA basketball tourney. For any team, determine an average weight and average height for the players that are actually playing.

Take the average minutes per game for each player and multiply this stat by the player's weight, and also by his height (in inches) to create two new stats that show an aggregate value of the weight and height that player contributed during the team's total time on the court per game.

Total these stats for the entire team and divide by the total of the average minutes played for all the players, and you have essentially an overall average weight and average height for the five players the team had on the court during games.

Here is an example:

University of Oklahoma

Player   GP  Min  HT  WT  min*HT  mi*nWT
Allen    18   4.7 83  267  7,022   22,588
Cannon    9   6.8 80  230  4,896   14,076
Crocker  35  29   78  206 79,170  209,090
Davis    34  14.9 77  208 39,008  105,373
Franklin 12   2.2 71  161  1,874    4,250
Gerber   13   2   80  228  2,080    5,928
Griffin  34  33.1 82  251 92,283  282,475
Griffin  35  29.8 79  238 82,397  248,234
Johnson  35  31.3 75  176 82,163  192,808
Leary    33  10.2 71  173 23,899   58,232
Pattillo 18  13.7 78  216 19,235   53,266
Warren   35  31.2 76  207 82,992  226,044
Willis   16   6.4 78  172  7,987   17,613
Wright   32   8.1 81  234 20,995   60,653

total team min:  7020.5
total height:  546,001
total weight: 1,500,630

Avg Team Height:  77.8 in
Avg Team Weight: 213.7 lbs

These calculations were done for the 32 teams that made it out of the first round.

Then the point differential was calculated for each of the 28 games that those 32 teams played in rounds 2, 3 and 4.

In 18 of 28 games, the team that won also had the heavier average player. In 19 of the 28 games, the team that won had the taller average player.

To run a correlation, a winner/loser score ratio was calculated for each of the 28 games (i.e., Big State beats Western U by a score of 100 to 80, then the score ratio is 100/80, or 1.25), as well as a difference between the two teams playing in average height and average weight.


Louisville 79, Siena 72

avg wt: 211.7
avg ht:  77.0

avg wt: 201.2
avg ht:  76.3

score ratio: 1.097
weight diff: +10.5
(i.e., winner heavier than loser by 10.5 lbs)
height diff: +0.712
(i.e., winner taller than loser .712 inches)

Running a correlation of the score ratio and height difference for the 28 games produced a surprising p of -0.24. So while the winning team was taller in 68% of the games, there were shorter teams that won by big margins, and taller teams that won by small margins.

The correlation between score ratio and weight difference was initially even more surprising - to me, at least, because I was certain a priori that weight mattered significantly. But the correlation was only +0.08. So, the winning team was usually heavier, but more bulk affected the margin of victory only slightly

The Final Four looks as follows:

Team / avg ht / avg wt

North Carolina 77.2  /  216.1
Villanova      77.1  /  207.7

Connecticut    79.0  /  215.5
Michigan State 77.2  /  212.2

So, it looks like Carolina beats Villanova on weight (though Pitt weighed in at 217.3), and UConn beats Michigan State on height. Then it looks like it's UConn on height again in the final against Carolina (with their weights being too close to matter).

All 32 schools, sorted by average weight:


Xavier  78.1  221.5
Pittsburgh  76.3  217.3
USC  78.4  217.1
Gonzaga  78.4  216.7
North Carolina  77.2  216.1
Connecticut  79.0  215.5
Syracuse  77.0  215.3
Memphis  78.7  214.7
Oklahoma  77.8  213.7
Arizona State  76.7  212.4
Michigan State  77.2  212.2
Wisconsin  76.9  211.8
Louisville  77.0  211.7
Duke  77.6  209.6
Marquette  75.6  209.1
Maryland  77.5  208.1
Texas  76.2  208.0
Villanova  77.1  207.7
LSU  77.7  207.5
Washington  75.5  207.5
Missouri  77.8  207.1
Dayton  77.2  207.1
Arizona  76.8  206.4
Oklahoma State  75.6  206.0
Texas A&M  78.0  205.8
Kansas  76.6  205.2
UCLA  77.2  204.7
Purdue  76.7  204.0
Siena  76.3  201.2
W. Kentucky  76.6  200.4
Michigan  76.1  197.7
Cleveland State  76.1  197.3

All 32 schools, sorted by average height:


Connecticut  79.0  215.5
Memphis  78.7  214.7
Gonzaga  78.4  216.7
USC  78.4  217.1
Xavier  78.1  221.5
Texas A&M  78.0  205.8
Missouri  77.8  207.1
Oklahoma  77.8  213.7
LSU  77.7  207.5
Duke  77.6  209.6
Maryland  77.5  208.1
UCLA  77.2  204.7
Dayton  77.2  207.1
North Carolina  77.2  216.1
Michigan State  77.2  212.2
Villanova  77.1  207.7
Syracuse  77.0  215.3
Louisville  77.0  211.7
Wisconsin  76.9  211.8
Arizona  76.8  206.4
Purdue  76.7  204.0
Arizona State  76.7  212.4
Kansas  76.6  205.2
W. Kentucky  76.6  200.4
Siena  76.3  201.2
Pittsburgh  76.3  217.3
Texas  76.2  208.0
Cleveland State  76.1  197.3
Michigan  76.1  197.7
Marquette  75.6  209.1
Oklahoma State  75.6  206.0
Washington  75.5  207.5



 Actually this is a tricky question: Even after defining a bear market, could a given decline have occurred by chance — given a random arrangement of returns? One aspect of a bear market could be down weeks clustering more than would be expected by chance, giving rise either to more frequent or deeper declines.

4194 DJIA weekly closes were partitioned into non-overlapping 40 week periods. At the end of every such period, calculated the maximum decline as:

min(this 40) / max (last 40)

Done this way the maximal decline could have been as long as 80 weeks or as short as 2 weeks; the idea was to capture large drops over various periods of interest to investors.

A simulation was used for comparison: The same 4194 DJIA weekly returns were resampled 100,000 times, and multiplied ("compounded", without dividends) out to produce a 100,000 week series. Like the actual market history, the series was partitioned into non-overlapping 40 week periods, and every 40 weeks min/max was calculated for the current and prior period.

One definition of a bear market is "a decline more than 20%". In the actual series, such declines occurred in (a surprisingly high) 26% of 40 week intervals (27 out of 104 40 week pairs). If this were more often than random, it would have occurred more often than in the simulated series. However in the simulation declines more than 20% actually occurred 32% of the time.

So if anything, declines of 20% or more occurred less often historically than by chance along.

But what if 20% is too arbitrary to capture a bear? In the actual series, here are the 40 week pair declines above the 95th percentile (ie, declines worse than 94.2% of the rest):

Date    40 min/max
06/20/32    -0.751
04/03/33    -0.642
09/14/31    -0.564
12/08/30    -0.542
03/02/09    -0.499
08/15/38    -0.469

The mean of these 6 40 week pairs is -58% (all but 5 from the depression). In the 100,000 week simulation, the 95th percentile is -34%. The actual 95th percentile and above mean of -58% is lower than even the worst simlated 40 week pair decline of -56%, which was the bottom of 2496 pairs (99.96 percentile, like the Obama cabinet SATs).

The worst 5% of actual 40 week pair declines dropped much more than would be expected by chance arrangement of down weeks. This is consistent with "fat tails" (at least on the downside), but you have to go out further than -20% to see it.

Alston Mabry comments:

Great study, Dr. Z. One thing I would want to explore would be whether in the simulation process, one intermixed different volatility regimes. That is, in the actual 4194 weeks, you may have periods of high volatility and periods of low. High volatility periods would have larger moves in absolute terms than would low volatility periods, and if the simulation mixed them together, the simulation might tend to produce lower volatility overall - this might account both for more 20% moves but fewer +50% moves. If this were a problem, one solution might be to normalize all the weeks against some preceding period, say 52 weeks.

Kim Zussman replies:

 Knowing that volatility clusters, if one is resampling a long data series this gets shuffled up. So you'll get 4% days near a bunch of 0.2% days (though the stdev of the whole series should be the same -shuffled or not). But if the question is whether the market has structure which is not random, does it make sense to stipulate whether you are in a volatile regime or not? Relatedly, maybe sticky volatile regimes translate to down markets, which is kind of the point.

Alston Mabry responds:

Exactly. To be precise, what I'm saying is that the fact that the simulated distribution produces more +20% moves but fewer +50% moves is simply an artifact of the shuffling process, especially when you shuffle individual weeks and then use 40-week stretches for calculating results. I'm thinking that the shuffling takes the actual distribution of % moves and increases the kurtosis and pulls in the tails.

This is not arguing against the hypothesis, just questioning that meaningfulness of the % comparisons.

Charles Pennington adds:

Prof POne uncontroversial hypothesis that might unify and explain many of these studies is that "markets get more volatile after they've gone down".

If you compute the skewness of the weekly or monthly returns of the Dow since 1929, it's quite negative. However if you take those same returns and divide them by some measure of the volatility over the following week(s)(*), then you'll find that both the skew and the kurtosis are close to zero, i.e. it's similar to a normal distribution of returns. That means that someone trading backwards in time, i.e. he has next week's newspaper but not last week's, would experience safe, non-Black Swannish returns if he just adjusted his position size for the volatility that he had experienced in his recent future.

* for example, one might use the following week's high/low range, 100*(h/l-1), or the average of that quantity over the following N weeks, where N is "a few".

To illustrate, here is a model.

First, create a series of random normal numbers with standard deviation 1, with one number for each trading day.

Now, use the following rule: "If the average of the last three days' numbers is negative, then today's return is 2 times today's number. Otherwise today's return is 1 times today's number."

I ran 2500 simulated trading days using that rule, and it gave 715 5-day maxes and 622 5-day mins. That's similar to what the Chair reported for the market.

More generally, I suggest that whenever you see one of these apparent anomalies of "market falls faster than it rises", try to see if it can be distinguished from the uncontroversial hypothesis that "volatility rises following down moves".

By the way, over the past 10 years, the standard deviations of daily returns of SPY under two scenarios:

all days 1.39% after up three-day move only: 1.17% after down three-day move only: 1.61%

Kim Zussman replies:

The simulation made the skew and kurtosis go away.  Here for the 40 day min/max both from actual series and simulation:
Descriptive Statistics: min/max, sim

Variable   Mean     StDev      Min    Median   Max       Skew
Kurtosis         N
min/max  -0.1435  0.1463  -0.7506  -0.1134  0.0313    -1.70      3.66
sim         -0.1604  0.1008  -0.5576  -0.1504  0.0654     -0.53
-0.04         2496

Even accepting there could be non-randomly down markets, this is a different question than whether they can be predicted.  So a small decline results in higher volatility, and trading smaller long positions can be on average profitable.  But some of the small declines go on to become big ones, and its hard to tell one from another.  Using stops (physical or otherwise) is tuchass saving, but it's hard to know whether "cutting your losses and let profits run" is worse in theory or execution. Which doesn't preclude that others can discriminate good from bad dips, or that they found work-arounds using opportunities independent of short term decline-reversal.

Phil McDonnell writes:

It may be helpful to look at the underlying hypothesis a little more closely. When we randomize by individual time periods we are deliberately randomizing any period to period dependencies. I presume that this was Dr. Zussman's point. Thus we are implicitly testing a null and alternate hypothesis something like:

Null: The original distribution or returns is similar to the distribution of a randomly ordered sequence of returns.

Alternate: The original distribution is not similar to a randomly reordered sequence of returns.

One good test of the difference between distributions is the non-parametric Kolmogorov-Smirnov test. Also one can use the more powerful D'Agostino test.

Another way to preserve the known autocorrelation in variance is to perform block resampling. From memory I believe the autocorrelation fades after about 35 days or so. Block resampling of 40 days should keep something like 97% of the variance autocorrelation and even other unknown dependencies even non-linear effects in that range. Comparing the distribution of the original returns to the 40 day resequence might tell us if there is something non-random even beyond the 40 day block level.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



 This paper makes one think of the effect of actually having money in the trade, vs just sitting analyzing data on a Sunday. And the real question is still, how to be free of it? Or control for it?

"The tree of experience in the forest of information: Overweighing experienced relative to observed information." Uri Simonsohn, Niklas Karlsson, George Loewenstein, Dan Ariely


Standard economic models assume that the weight given to information from different sources depends exclusively on its diagnosticity. In this paper we study whether the same piece of information is weighted more heavily simply because it arose from direct experience rather than from observation. We investigate this possibility by conducting repeated game experiments in which groups of players are randomly rematched on every round and receive feedback about the actions and outcomes of all players. We find that participants’ actions are influenced more strongly by the behavior of players they directly interact with than by those they only observe.

[ … ]

One important distinction, when it comes to the process leading to acquisition of information, is whether the information was obtained through personal experience—i.e., in a process that had or could have had direct consequences for oneself—or only by observing the experience of others. We refer to the former as “experienced information” and the latter as "observed information."

Legacy Daily adds:

In Battle for Investment Survival Loeb says: "Knowledge born from actual experience is the answer to why one profits; lack of it is the reason one loses. Knowledge means information and the ability to interpret it marketwise. But, in addition, making money in the market demands a lot of "genius" or "flair." No amount of study or practice can make one successful in the handling of capital if one really is not cut out for it." I think that the education of one's own $1000 put to work in the market cannot be substituted by reading, theoretical analysis, or observation. My questions are: "Do you feel that making money in the market is a natural gift or a learned skill? To which one or two key factors would you attribute your success?"

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