May

14

I first saw the 'dead eyes' look of a poker player/loser when I was 13 or so. Still gives me restless nights and I know I cannot become that way.

My dad took me into the "stockman's bar" in Billings, Montana to impress upon me what degenerate, greedy people turn into.

Probably another sleepless tonight tormented by that devil.

Gary Rogan asks: 

What is the real difference between gambling and speculation (if you take drinking out of the equation)? Is it having a theory about the odds being better than even and avoiding ruin along the way?

Tim Melvin writes: 

I will leave the math side of that answer to those better qualified than I, but one real variable is the lifestyle and people with whom one associates. A speculator can choose his associates. If you have ever been a guest of the Chair you know he surrounds himself with intelligent cultured people from whom he can learn and whom he can teach. There is good music, old books, chess and fresh fruit. The same holds true for many specs I have been fortunate to know.

Contrast that to the casinos and racetracks where your companions out of necessity are drunks, desperates, pimps, thieves, shylocks, charlatans and tourists from the suburbs. Even if you found a way to beat the big, the world of a professional gambler just is not a pleasant place.

Gibbons Burke writes: 

Here is something I posted here before on this distinction…

Being called a gambler shouldn't bother a speculator one iota. He is not a gambler; being so called merely establishes the ignorance of the caller. A gambler is one who willingly places his capital at risk in a game where the odds are ineluctably, mathematically or mechanically, set against the player by his counter-party, known as the 'house'. The house sets the odds to its own advantage, and, if, by some wrinkle of skill or fate the gambler wins consistently, the house will summarily eject him from the game as a cheat.

The payoff for gamblers is not necessarily the win, because they inevitably lose, but the play - the rush of the occasional win, the diversion, the community of like minded others. For some, it is a desire to dispose of money in a socially acceptable way without incurring the obligations and responsibilities incurred by giving the money away to others. For some, having some "skin in the game" increases their enjoyment of the event. Sadly, for many, the variable reward on a variable schedule is a form of operant conditioning which reinforces a compulsive addiction to the game.

That said, there are many 'gamblers' who are really speculators, because they participate in games where they develop real edges based on skill, or inside knowledge, and they are not booted for winning. I would include in this number blackjack counters who get away with it, or poker games, where the pot is returned to the players in full, minus a fee to the house for its hospitality*.

Speculators risk their capital in bets with other speculators in a marketplace. The odds are not foreordained by formula or design—for the most part the speculator is in full control of his own destiny, and takes full responsibility for the inevitable losses and misfortunes which he may incur. Speculators pay a 'vig' to the market; real work always involves friction. Someone must pay the light bill. However the market, unlike the casino, does not, often, kick him out of the game for winning, though others may attempt to adapt to or adopt his winning strategies, and the game may change over time requiring the speculator to suss out new rules and regimes.

That said, there are many who are engaged in the pursuit of speculative profits who, by their own lack of skill are really gambling; they are knowingly trading without an identifiable edge. Like gamblers, their utility function is not necessarily to based on growth of their capital. They willingly lose their capital for many reasons, among them: they enjoy the diversion of trading, or the society of other traders, or perhaps they have a psychological need to get rid of lucre obtained by disreputable means.

Reduced to the bare elements: Gamblers are willing losers who occasionally win; speculators are willing winners who occasionally lose.

There is no shame in being called a gambler, either, unless one has succumbed to the play as a compulsion which becomes a destructive vice. Gambling serves a worthwhile function in society: it provides an efficient means to separate valuable capital from those who have no desire to steward it into the hands of those who do, and it often provides the player excellent entertainment and fun in exchange. It's a fair and voluntary trade.

Kim Zussman writes:

One gambles that Ralph and/or Rocky will comment.

Leo Jia adds: 

From the perspective of entering trades, I wonder if one should think in this way:

speculators are willing losers who often win; gamblers are willing winners who often lose.

David Hillman adds: 

It is rare to find a successful drug lord who is also a junkie. 

Craig Mee writes: 

One possible definition might be "a gambler chases fast fixed returns based on luck, while a speculator has time on his side to let the market decide how much his edge is worth."

Bill Rafter comments: 

Perhaps the true Speculator — one who is on the front lines day after day — knows that to win big for his backers, he HAS to gamble. His only advantage is that he can choose when to play. 

Anton Johnson writes: 

A speculator strives to be professional, honorable, intellectual, serious, analytical, calm, selective and focused.

Whereas the gambler is corrupt, distracted, moody, impulsive, excitable, desperate and superstitious.

Jeff Watson writes: 

I know quite a few gamblers who took their losses like men, gambled in a controlled (but net losing manner), paid their gambling debts before anything else, were first rate sports, family guys, and all around good characters. They just had a monkey on their back. One cannot paint with a broad brush because I have run into some sleazy speculators who make the degenerates that frequent the Jai-Alai Frontons, Dog Tracks, OTB's, etc look like choir boys. 

anonymous writes: 

Guys — this is serious, not platitudinous, and I can say it from having suffered the tragic outcomes of compulsive gambling of another — the difference between gambling and speculating is not the game, the company kept, the location, the desperation or the amounts. The only difference is that a gambler, when asked of his criterion, when asked why he is doing this, will respond with "To make money."

That's how a compulsive gambler responds.

Proper money management, at its foundation, requires the question of criteria be answered appropriately, and in doing so, a plan, a road map to achieving that criteria can be approached.

Anton Johnson writes: 

It's not the market that defines whether a participant is a Gambler or a Speculator, it's his behavior.

Gibbons Burke writes: 

That's the essence of my distinction:

"gamblers are willing losers who occasionally win"

That is, gamblers risk their capital on propositions where the odds are either:

- unknown to them
- cannot be known

- which actual experience has shown to have negative expectation
- or which they know with mathematical precision to be negative

They are rewarded for doing so on a random schedule and a random reward size, which is a pattern of stimulus-response which behavioral scientists have established as one which induces the subject to engage in the behavior the longest without a reward, and creates superstitious as well as compulsive behavior patterns. Because they have traded reason for emotion, they tend not to follow reasonable and disciplined approach to sizing their bets, and often over bet, leading to ruin.

"speculators are willing winners who occasionally lose." That is, speculators risk their capital on propositions where the odds are:

- known to have positive expectation, from (in increasing order of significance) theory, empirical testing, or actual trading experience

They occasionally get unlucky, and have losing streaks, but these players incorporate that risk into the determination of the expectation. Because their approach is reason-based rather than driven by emotion, they usually have disciplined programs for sizing their bets to get the maximum geometric growth of their capital given the characteristics of the return stream, their tolerance for drawdown.

If a player has positive expected value on a bet, then it is not a gamble at all. The house does not gamble. It builds positive expectation into its games. It is a willing winner, although it occasionally loses.

There are positive aspects of gambling, which I have pointed out earlier in the thread and won't belabor. To say that "all gambling is bad" is to take the narrowest view. Gamblers who are willing losers (by my definition all are) provide the opportunities for willing winners (i.e., speculators) to relieve gamblers of the burden of capital they clearly have no desire to hold onto, or are willing to trade in a fair exchange for the excitement of the play, to enable their alcoholic habit, to pass the time, to relieve their boredom, to indulge delusions of grandeur at the hoped-for big win, after which they will quit playing, or combinations of all of the above.

Duncan Coker writes: 

I found Trading & Exchanges by Larry Harris a good book on this topic and he defines all the participants in the exchanges and both gambler and speculators have a role to play. Here is something taken from page 6 that make sense to me: "Gamblers trade to entertain". Speculators to "trade to profit from information they have about future prices."

He divides speculators into those that are well informed versus those that are not. One profits at the expense of the other. Investors "use the markets to move money from the present into the future". Borrowers do the opposite.

May

13

The Treasury Dept. puts out a Monthly Treasury Statement that breaks down a lot of interesting data. Mostly it's redundant information to anyone following the daily data, but this month (i.e. April) the payroll tax receipts from self-employed enterprises is a few sigmas to the upside. This April's self-employed number was 8.86 percent higher than that of 2012. The non-self-employed number was up 4.55 percent, which interestingly does not agree with the numbers reported in the Daily Treasury Statement. Recall that payroll taxes for everyone were increased 2 percent. Also note that the Daily Statement is done without human intervention, whereas the Monthly Statement has fingerprints all over it.

Mar

25

Those who choose not to read good books have no advantages over those who cannot read. (Attributed to Mark Twain.) A similar thing applies to research and data: Those who do not collect (and scrutinize) their own data, have no advantages over those who get their ideas and data from journalists or poor data suppliers. I would venture an educated guess that most of the managed investment money is handled by managers getting their information from journalists. Gentlemen, that's your competition. Go forth and prosper.

In quantitative analysis (irrespective of whether its data origins are financial statements or market prices) the guy with the best data has a definite advantage. Conversely, the best analytical mind coupled with poor quality data is at a disadvantage. Let me first deal with the problems of price data.

In equities, back-testing requires using deceased stocks to eliminate survivor bias. That means that to test the Russell 3000 over say 15 years, you need data on maybe 8,000 stocks. You cannot collect those by symbol, because symbols get recycled. So you try SEDOL or CUSIP numbers, but even those have problems. The holy of holies, CRSP has problems. And you cannot simply toss out the missing stocks without experiencing bias. Also note that the constituents of the R3k decrease monthly and are refreshed annually.

Obviously you have to adjust for dividends because you want to compare total returns. That introduces the dividend adjustment problem: do you use multiplicative adjustment or subtraction? Either one is problematic: destroying round numbers or creating negative numbers.

However the problems with data create tremendous opportunities to those who mine it. You know you are on to something when:

1. A major data provider has all of the dates of certain data off by 1 day. (systematic error) You call to ask why that is, and they don't have any idea what you are talking about. "How can you possibly know apriori that their data is wrong?" So you quickly reverse yourself and apologize for being mistaken. Everyone who uses that data has the error. They are counting things that are impossible.

2. You circumvent data suppliers and go directly to the exchange (or government website) because intermediaries screw it up. Hey, you cannot expect data replication to be perfect. (idiosyncratic error)

3. You disregard seasonally adjusted data in favor of raw data, and do your own seasonal adjustment. You cannot do this for every dataset, but certainly for the important ones.

4. A free provider (e.g. government or an exchange) provides detailed instructions on how to data mine their site. But the instructions are wrong. You call and the service people don't know what you are talking about. You eventually get to speak to the geeks and somehow learn the right way to get access. They confirm that no one had those problems before. WHY? Because no one else is looking at the data. He shoots; he scores!
These examples are like lifting back the bride's burqa, thinking that she might have a beard, and being surprised that she is absolutely beautiful.

Ideas:

a. When at all possible, go directly to the source. That may mean the exchanges or the government agency itself rather than your data supplier, and may appear unnecessary on the surface. But if you want to find the mistakes that most cannot find, you have to look in different places.

b. Look for site or download counters and check them out. Come back to them and recheck the numbers later to see the average daily hit rate. I was absolutely delighted to learn that I was one of only four downloaders of certain data.

c. Further check that data (with the counter) to see if it is available on Bloomberg or another major source.

d. Look for alternatives to the data you seek. The alternatives might not be the exact data, but they may be good surrogates. Real numbers for something close to what you want are better than bullsh*t numbers from a poorly conducted survey.

e. I cannot overemphasize the importance of checking the data, and checking that your data mining routine has collected it properly. Errors (either systematic or idiosyncratic) regularly occur. As renowned data cruncher John Tukey said, "There is no substitute for looking at the data." (Exploratory Data Analysis)

Typical problems you have to avoid:

- Look-ahead bias and survivor bias

- Lack of statistical significance - engineers typically require 30-50 observations, but market traders (such as technical analysts) frequently consider one event as significant. Don't do that!

- Testing on a sample of data that may not include the pattern. The solution to that of course is to always use the population, rather than a sample.

- Frequently you may test something on an index as a precursor to testing on thousands of individual stocks (or worse, options). But indices do not necessarily behave like individual stocks. ETFs might be a solution, but they are in themselves just smaller indices.

Those who challenge the validity of data mining (and also market timing) tend to cite as their proof that the first order daily changes in stock prices are random. We can concede that point, but there are lots more relationships to be studied than daily changes.

Data mining can be successful for any number of reasons but the juiciest fruit is to be found in the following ways:

- Analysis of data that is unknown or unseen by most people or, better yet, subject to systematic error (~finding buried treasure)

- Better analysis of existing data. (~having a better brain) Note that some of this will be serendipitous. Exploration by definition will lead you to discovering things you did not expect.

- Incredible persistence (hard work).

Should you seek to do fundamental analysis you will find different and more exasperating problems. We know many of them first hand.

The first problem is that the data is not easily accessed. It tends to cost quite a lot of money, and much of it has systematic errors. We have not found a commercial data supplier that did not have systematic errors.

The cost can be prohibitive. The major high-end quote provider places limits on the amount of data one can retrieve in a given period. We also know that provider uses a lot of humans in the process and has a lot of errors. Looking further afield, the fundamental data vendors we found are three in number. One replied quickly with a quote of $30,000 for the back data and a 1-year subscription going forward. Another came back a month later and wanted $72,000 for the same, and the third never came back to us. When I informed the higher priced service that they were above their competitors, they asked if their "pricing committee" could know what we were quoted by their competitors. That does not tend to make one comfortable, as what kind of business does not know what their competitors charge? Particularly if they make the point of having a pricing committee.

There is an alternative to buying fundamental data – getting it yourself. In theory this should be straightforward: the S.E.C. has all of the relevant files online. But if you are looking to get data on say the R3k for 15 years, you will have to collect it from approximately a half-million 10K and 10Q files.

Uniformity is generally not the rule, and you need some uniformity when doing computer mining. For example, sometimes a 10Q will be labeled "Ten Q" which has to be planned for. Unless you have access to a lot of people from the sub-continent, you want to do this automatically, which will also enable you to avoid things like transposition errors committed by humans. But some things are easier for humans than for computers. For example, most data constituting a company's total assets are listed as "Total Assets". Sometimes that is misspelled, and sometimes the number appears with a double underline, and other times without. Usually the next line starts with "Liabilities", but not always. It's laughable, but not fun.

We cut our teeth on a subset of the universe, REITs. The 172 that we found interesting had approximately 8,000 10K and 10Q files. After a lot of work we managed to get data cleanly from all but about 50. We consider that a major success, but even that low failure rate means we will have to go through about 3,000 files manually for the entire universe of a half-million files.

The good news is that having unrestricted access to such data provides a lot of opportunities. We are making a leap of faith that the data and our analysis will improve our existing results. Of course there isn't a guarantee, but that's the way to bet.

Phil McDonnell writes: 

Thanks to Bill for his excellent survey of data collection techniques and especially the pitfalls. There is little to add to his survey except one thing. That is when there are retroactive changes to data. To handle that case one needs to time stamp your data as to the time received. This caution applies to both fundamental data as well as price data which can be 'adjusted' a day or two later.

The worst example if this was Enron. The Enron data which showed the fraud was only released several years after the bankruptcy.

Jan

28

The payroll tax numbers look bullish on the economy, but any conclusions have to be weighed against the quality of the data. The upcoming Jobs report will include data for the approximate monthly period ending January 12, 2013. That is, it includes data crossing over the year end. Normally that would not be a problem, but this most recent year-end includes tax law changes.

There was a significant amount of bonuses being paid out in December 2012 rather than in the first Quarter of 2013. That shows up in the data. Then of course the tax receipts would drop in 2013 to reflect the lack of bonuses paid in 2013. That also shows up in the data. But then you would see the receipts level off at a number higher than January 2012 because the Feds are taking about 2 percent more. That also shows up in the data. (see attached chart) So the tax receipts accurately reflect policies, the fact of which counters arguments suggesting that people and businesses do not pay attention to taxes.

If taxes reflect policies in this short-run, then their ultimate effects will also reflect those policies. That is, sooner or later the increased taxes will undoubtedly have bearish effects on the economy. Like, we didn't know that?

Is there a better metric of what is going on, considering that the changing rules have the payroll tax receipts jumping up and down? Yes there is, and it is the medicare taxes, officially known as "Hospital Insurance". I have previously commented on this space about medicare taxes, so forgive me for not repeating it. This report will be released at 2 PM EST on the 8th business day of February. The bad news is that it is only monthly data, but the good news is that it will reflect receipts through January 31, and as such should give us a clean look.

Dec

17

I'm sitting in a Panama City Youth Hostel next to a sailing board with departure times for Columbia. There are twenty sailings in as many days but most are filled by an assortment of backpack travelers from ten countries speaking five languages. It's musical chairs around the board for a $400 berth on a boat that takes four days to Cartagena, Columbia with a stopover at the San Blas Island. Every fifteen minutes a seat fills or opens and the standbys frown or cheer.

I arrived a week ago to help an American ex-pat on a Philosopher's stone land quest, a list of some 600 properties of which he has bought and sold five in the past year at perhaps ten times his dollar cost and two months research and surveying each to get the titles. I accompanied him a few days ago to seven hectares on the Caribbean Coast that sold for $250,000 on the spot to a Mexican developer, and viewed others on Lake Gatun within and Tobacco Island at the inlet of the Canal.

The primary reason for arriving in Panama, however, was to hike the Darien gap, a 90 mile jungle locked strip that is the only break in the Pan American Highway from the Arctic Circle to Tierra del Fuego. This is my third attempt to hike and canoe this gap and I flew in on the promise of a Darien village chief to guide me through to Columbia, but yesterday he backed out saying he couldn't be paid enough to risk his family's lives with recent increased activity of the Columbia rebel FARC throughout the region.
So, I set about alternatives and earlier today sat in Manual Noriega's Paymaster House eating a hamburger in a converted restaurant in Santa Clara, Panama that was one of his power centers with troops wearing boa constrictors around their necks to intimidate the locals and guarding the nearby airport. In December 1989 the sky filled with U.S. paratroopers who landed at the airport, asked the locals for an English speaker who pointed a Major and company of 30 Marines to where I bunked the previous night at an American ex-pat's home. He led them to the Paymaster House that was captured by the U.S.

I returned to Panama City and even as I write a space opened on the December 20th sailing of the Mars De Gato sloop and I grabbed a seat.

Tomorrow there's a 30th anniversary racquetball clinic at the Fort Clayton Gym where in the 1980's I led the racquetball invasion of Central and South America with clinics throughout Latin America, that was also the first failed attempt at the Darien Gap.
After the clinic and sailing I'll alight in Columbia and work south to climb 14,000' Ecuador mountains, and then ply rivers down to Peru where I was hired hours ago via Internet as a Butterfly hunter. I'll capture only five exotic species that an amigo collector sells on EBay for $500 to $1200 each. He has provided me with a net, glassine envelopes and mothballs, and will pay $50 for each rare species that I hope to net to finance my passage home in a few months.

Dec

13

My transparent, stretchable Fibonacci overlay seems to be successfully identifying price levels around which the main indexes cluster. This in itself does not predict the future, it identifies where the holes are on the bagatelle table, but not which one the ball will settle in. Moreover it may reflect a self-fulfilling prophecy rather than a rule. Nonetheless, the information can be useful in constructing multiple-leg options positions.

But my overlay is not predicting timing. All the pundits mention Fibonacci but this does not seem to be the case, has anyone tried other methods? Interested in any pointers.

Looking forward to stepping back in the water, but want to maximise the acuity of my toolset first.

I found this nice online chart for streaming SP500, also gives longer term charts.

Jim Sogi writes:

Not sure what you're doing, but I've been pondering time and time frames and relationships of time. Some systems using returns have time exits and a study of time seems like its important. Not sure exactly how, but the idea is to maximize return based on time while minimizing loss. The relationships change by cycle. It seems time itself and speed and roc volatility all have cycles in time. Perhaps survivorship times give some info.

Bill Rafter writes:

The question is whether one wants to value time or eschew it. Both can be done, so it's up to the practitioner.

Valuing time is easy, as most economics is time series processing. And most all market data comes dated. Shunning time is trickier; do you want to avoid just some time, or all of it?

Point & Figure analysis is what most subscribe to if they want to eliminate some time, and they do that by defining "box sizes" or the minimum move they consider significant. The theory is to define the noise level and throw that noise away. Sounds great, such that someone would be willing to be a tad late on a move if the signal had a higher degree of accuracy. Our extensive research says that P&F is certainly a tad late, but there is a decrease in accuracy. Here's another caution: most of the literature on P&F is written by those lacking native intellectual capacity (IMO) who have no concept of research. To them P&F is a religion akin to animism.

A more successful approach than P&F is not to create box sizes, but to drop all "inside days". I say more successful in that you eliminate insignificant data, and do not lose accuracy. However we have not been able to increase accuracy over normal data analysis. But we are still working with it, and may find something. You still get a time grid, but with lots of the days missing.

The most effective way to eliminate all time is to use Lissajoux patterns. That link will give you an animated example of such with two sine waves. There are lots to be said about this, but I don't think many have the appetite for it

Dec

5

The payroll tax receipts are virtually identical to that of a month earlier. If there is any tilt to the data, it is slightly higher (i.e. bullish equities). If the media expects it to be down (maybe because of Sandy), then the released data will catch them a little off guard.

From the end of the reporting period Nov. 16th thru Nov. 28th, the data has been higher, but that should be reflected in the next month's report. Please note that I remove the seasonal effects to avoid enthusiasm over the temporary Christmas employment.

Nov

27

A post purporting to show that buy and hold investing does not work has appeared on our list. It is reprehensible propaganda and total mumbo. They do not take account of the distribution of returns to investing over long periods that have been enumerated by the Dimson group and Fisher and Lorie. It is sad to see this on our site. The arguments against buy and hold seem to be that the professors found that short term investing didn't work so they erroneously concluded that long term investing must be the alternative. Shiller is mentioned and cited with approval.

Alston Mabry writes: 

To explore this issue numerically, I took the monthly data for SPY (1993-present) and compared some simple fixed systems. In each system the investor is getting $1000 per month to invest. If during that month, the SPY falls a set % below the highest price set during a specific lookback period (the 3, 6, 12, 18, 24 or 36 months previous to the current month), then the investor buys SPY with all his current cash (fractional shares allowed). If the SPY does not hit the target buy point this month, then the $1000 is added to cash. Once the investor buys SPY shares, he holds them until the present.

For example, let's say the drop % is 10%, and the lookback period is 12 months. In May of year X, we look at the high for SPY from May, year X-1, thru April, year X, and find that it is 70. We're looking for a 10% drop, so our target price would be 63. If we hit it, then spend all available cash to buy SPY @ 63. Otherwise we add $1000 to cash.

Each combination of % drop and lookback period is a separate fixed system.

Over the time period studied, if the investor just socks away the cash and never buys a share (and earns no interest), he winds up with $239,000. On the other hand, if he never keeps cash but instead buys as much SPY each month as he can for $1000, then he winds up with over $446,000, which amount I use as the buy-and-hold benchmark.

If the investor uses the fixed system described, he winds up with some other amount. The table of results shows how each combination of % drop and lookback period compared to the benchmark $446,000, expressed as a decimal, e.g., 0.78 would that particular combination produced (0.78 * 446000 ) dollars.

Results in this table.

The best system was { 57% drop, 18+ month lookback }, or just to wait from 1993 until March 2009 to buy in. Of course, it's hard to know that 57% ex ante. The next best system was { 7% drop, 3 month lookback } coming in at 0.99.

This study is just food for thought. It leaves out options for investing cash while not in the market. And it sticks with fixed %'s without exploring using standard deviation of realized volatility as a measure. So, there are other ways to play with it.

Charles Pennington comments: 

Thank you — that is a remarkable "nail-in-the-coffin" result.

Nothing beat buy-and-hold except for the ones with the freakish 57% threshold, and it won by a tiny margin, and it must have been dominated by a few rare events–57% declines–and therefore must have a lot of statistical uncertainty..

That's very surprising and very convincing.

(Now some wise-guy is going to ask what happens if you wait until the market is UP x% over the past N months rather than down!)

Kim Zussman writes: 

Here are the mean monthly returns of SPY (93-present) for all months, months after last month was down, and months after last month was up (compared to mean of zero):

 One-Sample T: ALL mo, aft DN mo, aft UP mo

Test of mu = 0 vs not = 0

Variable      N      Mean     StDev   SE Mean  95% CI            T
ALL mo     237  0.0073  0.0437  0.0028  ( 0.0017, 0.0129)  2.58
aft DN mo   90   0.0050  0.0515  0.0054  (-0.0057, 0.0158)  0.92
aft UP mo  146  0.0083  0.0380  0.0031  ( 0.0021, 0.0145)  2.65

 The means of all months and months after up months were significantly different from zero; months after down months were not.

Comparing months after down vs months after up, the difference is N.S.:

Two-sample T for aft DN mo vs aft UP mo

                  N    Mean   StDev  SE Mean
aft DN mo   90  0.0050  0.0515   0.0054   T=-0.53
aft UP mo  146  0.0084  0.0381   0.0032

Bill Rafter writes: 

A few years ago I published a short piece illustrating research on Buy & Hold. It contrasted a perfect knowledge B&H with a variation using less-than-perfect knowledge using more frequent turnover. Here's the method, which can easily be replicated:

Pick a period (say a year) and give yourself perfect look-ahead bias, akin to having the newspaper one year in the future. Identify those stocks (say 100) that perform best over that period, and simulate buying them. Over that year you cannot do better. That's your benchmark.

Then over that same period do the following: Buy those same 100 stocks, but sell them half-way thru the period. Replace them at the 6-month mark with the 100 stocks perfectly forecast over the next 12 months. Again sell them after holding them for just half the period. Thus the return from the stocks that you have owned and rotated are the result of less-than-perfect knowledge. Compare that return to the benchmark.

Do this every day to eliminate start-date bias, and then average all returns. The less-than-perfect knowledge results far exceeded the perfect-knowledge B&H. Actually they blew them away in every time frame. It's really obvious when you do this with monthly and quarterly periods as you have so many of them.

The funny thing about this is the barrage of hate mail that I received from dedicated B&H investment advisors, who somehow felt their future livelihoods were threatened.

If anyone wants that old article, send me a message off the list. We called it "Cassandra" after someone with perfect knowledge that was scorned.

Anton Johnson writes in: 

Here is a link to BR's excellent study "Cassandra", as it lives on in cyberspace.

Nov

8

One has found that there is an electronics circuit that almost always retrospectively provides a great description of price action in markets. I wonder if there is an electronics circuit that compresses the voltage output keeping it in a range, sort of like the finger in the dike, but then after the compression is over on the negative side, e.g after the negative feedback is taken away, the voltage doesn't immediately lead to tremendous negative voltage. I seem to remember such a circuit with op amps.

Jon Longtin writes:

There are a variety of electronic circuits that perform such a role, depending on the application. One common application is a voltage regulator, which provides a (nearly) constant voltage, regardless of the load applied to it. The circuit monitors the actual voltage currently being provided and compares to a pre-set reference value. The difference between the actual and desired (setpoint) values is called the error, and is used to adjust the current provided to the circuit to bring the voltage back to the setpoint value. For example if the load increases (more electricity demand) the load voltage will drop and the voltage regulator will provide more current to bring the voltage back up. Same goes for a decrease in load.

There are some limitations and compromises in such a circuit. First is there is a finite amount of current that the power supply/voltage regulator can be provided, and if the error signal requests more than this amount, the output will not be maintained. Also of importance is the time response: a circuit with a very fast time response will respond more quickly to fluctuations in the load, but can also result in so-called parasitic oscillations, in which the output oscillates after a fast change in load is made. By contrast a longer time response provides a slower response to a variation, but tends to damp oscillations. This same behavior, of course, is seen in countless financial indicators, and is part of the art in deciding, e.g., how many prior data points to include in a signal.

A somewhat more complex version of the above, and perhaps more closely aligned with the behavior of a market signal, is an audio "compressor/limiter". This is a device that constantly monitors the volume (magnitude or voltage) of an audio signal and makes adjustments as needed. A limiter is the simpler of the two and simply sets a threshold above which a loud signal will be attenuated. The attenuation is not (usually) a brick-wall however; rather a signal that exceeds the threshold value is gently attenuated to preserve fidelity without overloading the audio or amplifier circuitry. A compressor is a more complicated animal and provides both attenuation for loud signals AND amplification for quieter ones. In essence a HI/LO range or window is established on the unit, and signals exceeding the HI limit are attenuated, while signals below the LO limit are amplified. This resulting output then (generally) falls within the HI/LO range. This is used extensively (too much!) in commercial music. Humans naturally pay attention to louder sounds (ever notice how the volume universally jumps when commercials come on TV? They are trying to grab your attention with the louder volume). Pop music attempts to achieve the same by using aggressive compression to provide the loudest average volume for program material without exceeding the maximum values set by broadcast stations or audio equipment. The result, however is that the music sounds "squished" and doesn't "breath" because the dynamic range of the content has been reduced considerably. With such devices there are a variety of adjustments to determine the thresholds, time before taking action (the attack time) and how gradually or strongly to attenuate (amplify) signals that exceed the envelop range.

Here' s a fairly decent article that describes this in more detail.

Incidentally both of the above are examples of a large branch of engineering called Controls Engineering. The idea, as Vic stated, is to monitor the output by using feedback and make adjustments accordingly. There are countless different algorithms and approaches, as well as very sophisticated mathematical models (people build careers on this) to best do the job. Like most complex things, there is no single approach that works best for every problem, but rather involves a balance of performance, cost, and reliability.

I highly suspect such algorithms have already found their way into many trading strategies, one way or another.

If interested, I can suggest some references for further reading (though I am not a Controls person myself).

Bill Rafter writes: 

 Think of your voltage regulator as a mean-reversion device. If a lot of this is being done, then your trading strategy must morph into simply following the mean.

In light of recent changes in the investment climate we suggest that one should tighten up controls in which one is long a given market. Perhaps that might also or alternatively mean (a la Ralph) tightening the size of the positions. The result will be taking less risk and incurring less return, but taking additional risk would seemingly not be rewarded in the current milieu.

Jim Sogi writes: 

Dr. Longtin's description of compressors and limiters was
fascinating.  A compressor on my guitar signal chain prolongs the
sustain on a signal in addition to smoothing out the volume spikes and has less fade as the signal weakens.  With added volume, one gets a
nice controlled feedback.

Sometimes in the markets one sees a sustained range with the spikes being attenuated reminiscent of a nice guitar sustain.

On a different note, one curious thing is that people cannot  discern differences in absolute volume.  It's very hard to hear the differences
in volume between two signals unless they are placed side by side.

Nov

6

The problem with polling is because of the response rate. A generation or two ago people were honored that someone would solicit their opinion. No so today, for whatever reason. Two days ago the Pew Foundation revealed the percentage of those persons contacted who are willing to give their opinions. Take a guess as to what that percentage is: According to Pew, their "success rate" is nine percent, or one out of every eleven persons they speak with. Thus they cannot get a reasonable random sample and the Central Limit Theorem does not apply. Therefore most polls are GIGO.

Sep

24

Somebody is spending, but who? This chart shows YOY customs duties and excise taxes which are a fairly good surrogate for retail spending.

However, here's a question: if the federal government buys a fleet of new Chevy Volts (the ones that burn up, LOL), do they pay excise taxes?

Mr. Krisrock writes: 

The combination of Higher Energy, Higher Dollar, Higher Commodities, and the September 15 California Tax on the internet has caused a SURGE in amazon orders to beat the increase…and of course Obama's playing with the numbers. Look at the huge drop in employment a year ago in October. Obama knows how the numbers work a year ahead, and of course, where do auto parts come from…electronic components come from Asia…for starters…and foreign car assemblies do buy foreign parts.

Sep

12

What are the best markets to trade? Many futures markets trade differently. Some have a lot of depth and intraday gaps are infrequent (I consider these the best to trade). Others have ample liquidity but are prone to gapping. Others still are downright scary. E-minis and 10 years seem like very "safe" trading markets. Eurodollars as well. Crude oil has a lot of liquidity but can gap. Gold seems prone to fast and erratic moves. Grains seem like they can get a bit dicey. Less trafficked softs seem rather risky. Commodities in general appear to have more erratic price risk than stock index futures or financial futures. FX is fairly liquid and seems ok. I am largely making observations based on personal experience and in some case I have none so I am curious for thoughts from seasoned specs.

Bill Rafter writes:

Ask yourself, would I rather trade an extremely efficient market in which information was digested immediately and most of the fluctuations not related to new information were due to randomness, or would I prefer a market that was less so. As you gain experience you will learn that one of these mutually exclusive choices is more profitable to trade than the other. One of these requires virtually no expertise to trade, and indeed expertise would not appear to be helpful, whereas the other requires considerable expertise. One is the frequent choice of novices, whereas the other tends to be avoided by novices. Then ask yourself, how do novices typically fare?

Jeff Watson writes: 

Grains are impossible right now. The 30 cent daily ranges make it too much of a gamble. Even trying to predict, or have a gut instinct of where the carry spreads, the corn/wheat/bean spread, the crush, are going….Oy Vey. To play the grains, to coin a surfing analogy: You better be in really good shape, you gotta see the wave (move) coming toward you, then paddle real hard, pop up and catch the wave. You better either be quick to bail or commit to the wave, make a bottom turn, then ride it until it's over. Determining when the ride(trade) is over isn't as simple as it sounds, and many dangers exist on and below the surface that can still mess you up when you bail the trade. The most important decision a grain trader can make right now is whether he wants to gamble a lot for a potentially big reward, or hunker down and reduce risk.

 

Sep

5

We have recently learned something with regard to trading currencies; specifically that in a strategy involving switching or rotating currencies they should also be traded with debt and gold. That is, excluding gold and debt from the universe of currencies lowers rates of return and/or increases drawdowns to less than optimal.

Background: We are equity traders who occasionally run from equities when our various quant manipulations suggest we are about to get thumped. Traditionally in such a circumstance our go-to place has been treasuries, specifically the 10-year. But there are times (like now) when fleeing to bonds doesn't seem like a good idea. So we decided to reassess our strategy vis-à-vis alternatives. And our full-court-press of research shows that the best alternative is a strategy of moving between bonds, gold and the U.S. Dollar Index. This beats ALL strategies involving only one or two of those assets. More importantly for others is that it also beats ALL similar rotations among the Dollar Index and a collection of other currencies. (N.B. we are free to choose whatever time frame seems to be best suited.)

With regard to our strategy, it trades combinations of those assets rather than one alone. However there are times when the strategy will have us in only one asset, and many would express fear at being entirely in gold or the dollar. Few would fear being entirely in treasuries, although the period of greatest decline was indeed a time when all monies were employed in debt.
No one is going to get excited about the alternative rotation strategy; it does not have an exceptional rate of return. But it does have very good risk control, which is what we want in an alternative. None of this should be surprising, as we know how interrelated they are. Currency is all debt, except gold which is the traditional debt alternative vis-à-vis inflation. But then one of the costs of holding gold is the foregone interest. Since they cannot be separated fundamentally, it is logical that they not be separated in a trading program. But it took testing to convince us of such.

If you are a trader who exclusively trades currencies, you should experiment with expanding your universe to including gold and debt.

Aug

12

I have found a worthy complement to the O'Brien series: Dumas' The Last Cavalier

In 1997 someone had gone through an old French newspaper and found a serialization of Dumas's last work, which had never been published as a book because it was unfinished. Finally it was published in 2005. I happened to buy a copy then, but have only just gotten around to reading it.

I have found it absolutely fantastic. For those who like historical novels, it provides great coverage of the Napoleonic era, the period after the revolution. If you are (as many on the list) a fan of the Patrick O'Brien series about Jack Aubrey, you will find this book gives you the French side of many of the events. One of Aubrey's counterparts would have been Robert Surcouf, so-called King of the [French] Corsairs. Of course Aubrey was fictional and Surcouf real. Dumas' tales of Surcouf are just as good as O'Brien's tales of Aubrey. The protagonist in Cavalier is mentored by Surcouf. Additionally there is an excellent play-by-play account of the Battle of Trafalgar and Nelson's death.

Dumas has written so much, that there are bound to be repeated scenes. An obvious one is that in which an engaged couple signs the marriage contract. That scene in Count is repeated in Cavalier including where the groom disappears immediately before signing, although the respective grooms depart for different reasons. The Tuileries Palace discussions of Louis XVIII and his staff in Count are repeated with Napoleon and his staff in Cavalier, although chronologically Cavalier precedes Count by at least a decade.

Dumas seems to want to please everyone, and refrains from taking sides, which probably accounts for his publishing success, as both Republicans and Royalists could find something to cheer about. He also provides entertainment for his female audience - lots of social gatherings.

This is a long book. My copy was 700+ pages; the action spanning six years with additional prior history.

The first 300+ pages deal with politics and troubles of a police state, somewhat on edge because of an uprising in Brittany. The parallels to the current political scene are startling. Supporters of Napoleon attributed everything good to him, while the Royalists blamed everything bad on him. One hopes we do not undergo a similar war of extermination. Finally our protagonist gets his freedom and goes on one swashbuckling episode after another, much like the Musketeers.

Dumas meant for it to cover perhaps another eight years if you consider the 14 years from the signing of the marriage contract mentioned by the soothsayer. And I truly wished it had. It's one of those books you hate to have end.

Further editing to put it into a book by Dumas would have made it even better. Still, some of ways he conveys information are extremely well done. He spoke of Surcouf (Jack Aubrey's counterpart) as a man whose one good fairy not invited to his baptism was Patience. And he chastises young men for leaving their health in brothels and their purses in taverns. Another: "While Nature may have given him a lot of excellent qualities, it had refused him like qualities of the mind."

As the Chair has said, some of the best reading is over a hundred years old.

Aug

6

As a hedge fund manager you have nine assistants employed solely to give you advice. Each of the assistants has a different perspective on the markets. They are all good advisers, as any one of them improves your trading immeasurably. For example, the market has a 2 percent annual return, but with your skills you can generate a 10 percent return. If you also add the advice of any one of your assistants you can bump that return up to between 12 and 18 percent.

Over the last 12 representative years there have been times when the nine were universally bullish. But despite their unanimity the market did not always rise. Conversely, even in the protracted down moves of 2008, their bearishness was not unanimous. Put another way, there was always one or two that wanted to go long at the worst times. Yet each and every one over time provided great advice.

You would like to find a way to combine their advice to get even better results than by using any one alone. But that's not easy. Sometimes, adviser A is early, and late at other times on a move. Likewise with the other assistants. One simple solution would be to have them vote, but the performance result of the vote underperforms some of the individuals, although still better than not having any adviser.

*Note here that we are only considering return and not the risk taken to achieve that return. Risk should always be considered, but for the sake of moving along, let us assume that taking the advice of your advisors never increases risk and that their respective upside contribution to profits is directly proportional to their downside exposure to risk. That is, much of their positive return contributions come from reducing risk, which is what we have observed generally.

Now, let's suppose that these advisers are not people, but algorithms. That's actually better because as algorithms they can be combined in ways that individuals cannot. They can be viewed logically (on/off) as in the voting experiment, or they can be ranked by their actual values. If they have scalar values they should be normalized (given the same order of magnitude or scale). For example, you cannot compare the slope of the Dow Industrials with that of the S&P 500, as the former is an order of magnitude larger. But if you put them on the same scale (e.g. divided by price), you can easily compare them.

Normalization is exactly what you would do to your inputs if you were using a neural net, and you might be tempted to go the NN route. But NNs have problems; among them would be your inability to discover the actual combination of what worked best. You might say "who cares" as long as it works, but that philosophy does not have a good history. However there is a very good use for a NN, and that is as a trial. That is, if you are good at NNs (and most people fail), then you should by all means try. If the NN gives you good results, then proceed on your own to find a good combination without the NN. But if using a NN does not improve results for the experienced practitioner, then it is going to be very difficult to find a better combination.

But how do you combine them to your best advantage? Well, there's an app for that. It's called linear algebra. It is somewhat vertigo-inducing for most traders, because most of them are comfortable with things they can chart. For your average trader that means two dimensions; options traders tend to be comfortable in three dimensions. But with our illustration we are likely progressing to higher dimensions, and they are not chartable, although the problem's solution is indeed a chart, albeit a virtual one.

Subsequent "chapters" (if the topic flies): Operations, Testing.

Jim Sogi writes: 

"But with our illustration we are likely progressing to higher dimensions, and they are not chartable, > although the problem's solution is indeed a chart, albeit a virtual one."

One of my first posts ever to the SL was Flatland, and the idea that multiple dimensionality is lost in two dimension charts which are typically used.

Easan Katir writes: 

Flatland, one of my all-time favorite books since I read it 40 years ago, offers insights in many arenas. Perhaps some enterprising ex-game coder would turn his attention to finance and provide charts where the point of view can be changed with a click. Will traders of the future be trading on an X-box-like device?

Jul

31

On a recent trip to the Allerton Botanical Garden in Kauai the guide noted that the mango trees have recently gone through 3 seasonal cycles in one year when only one is normal. He had no idea why. Our mango tree did the same. The explanation here was the big unseasonable rainstorm that knocked off the flowers at the beginning of the season. Now we have ripe fruit, unripe fruit and flowers on the same tree. Chair often compares trees to markets. I wonder if unseasonable shocks (EU, Fed,) might have thrown off the seasonal tendencies in the markets, shortening cycles, or forcing cycles. The changing cycles are the hardest to understand.

Bill Rafter writes: 

That is not unique to mangoes.

Take grape vines for example. Generally the only fertilizer you should use on grapevines is a shovel-full of manure in the spring. My wife thinks we should have flowers in between the grapevines and occasionally will hit the vines with some spray fertilizer she is using on those flowers after midsummer. Relatively soon thereafter the vines put out some new flowers (although most people would not recognize them as such), which will bear fruit (grapes are mostly self-fertile). But the fruit won't have time to develop fully and is a waste.

Fig trees typically produce two crops each year. The early crop (called breva) has generally unworthy qualities, whereas the late crop is to die for. But if you wanted, you could fertilize the tree weekly and have figs all summer long. People with summer vacation homes tend to do that as they know they will not be around after Labor Day, when most of the big crop would come in. You could even fertilize yourself to a second crop of determinate tomatoes, which are "programmed" to bear one crop all at once.

I don't know how good that is for the respective plant because I don't do it. And the lessons for the market seem to relate to Quantitative Easing. Perennial plants (particularly fruit trees) need a dormancy period. If they don't get it, they produce poorly until they do. I believe the same is true with markets: you cannot preempt or "outlaw" the business cycle and expect the economy to respond favorably all the time.

Jul

13

To what extent does the concept of speed ratings, popularized by Crist , have applicability to markets. One variant of the idea being which horse had the fastest quarter last race, or which one had the greatest move down from 1 quarter to the next, like from first quarter to stretch, or stretch to close. Can this concept be applied to days within weeks, or months within years? How would some of the handicappers or horses extend this and what would Bacon say?

Bill Rafter writes:

While in grad school a buddy and I used to go to Golden Gate Fields regularly. For some reason it was always on a Thursday, and we went for the last two races to avoid the entrance fee. The lack of admission was critical because it removed the necessity to bet. (relation to low fixed costs?) The Racing Form was a critical part of the exercise, and I would bet on the horse with the highest speed rating that was showing greater than 8 to 1 odds close to post time. The bets were on the minimal side.

My results were successful if you measured my wine supply, which was quite good. The accumulation of wealth from horse racing was not something I relied upon, so any winnings were spent on the way home at the liquor store on the main drag. Racing bets were not something to aspire to, for a very good reason. Going to the payout window revealed the demographics of those who typically bet on longshots, as an 8-to-1 horse was considered. We also tended to meet those same people in the liquor store, where they were buying Thunderbird.

Jun

18

This is a chart illustrating the S&P shaded to reflect the yearly trend of Initial Unemployment Claims (Fed St. Louis series ICSA). While the chart does not prove anything, it does illustrate a possible relationship. Note that the data relating to the claims have been inverted, such that increases in claims implicate poorer economic conditions and in-turn declining equity prices.

Editorial comments: I do not prefer the ICSA data because it is weekly and goes through a process of human intervention (?corruption?). I prefer daily data that gets recorded electronically without any possible manipulation. HOWEVER even the ICSA data is now showing bearish market indications. I could torture this data to present the current situation as bullish (by introducing significant lag), but have tried to show it similar to how most would be receiving the information.

Jun

10

How do multiple lead changes, and their duration in minutes very close, i.e. from up to down from close or open, or within + or - 2 for multiple minutes, affect the outcome of the day in markets? In the playoff game they had a 14 point lead. "There were six lead changes and five more ties in the final 7 minutes of the third. For the next 13 minutes, a span of 46 dizzying possessions, neither team led by more than two points." By the way, the quotes are from the AP story about the game. One of the few times that I've ever seen a good meaty story rather than boiler plate from the AP.

Bill Rafter adds: 

Sounds like a job for the Spearman Rank Correlation.

Jun

8

When I was a kid, my father got the family out of blue-collar South Philadelphia to blue-collar Wildwood, NJ for the entire summer. The beach towns of New Jersey are either nice or tacky, and Wildwood was extremely tacky, with most tackiness related to its boardwalk. When you are at the seashore for the summer, collecting shells wears a little thin, so a friend Buzzy and I got a discarded window screen and would go under the boardwalk just below several pizza shops and shovel sand into the window screen. Patrons reaching into their pockets for coins would regularly drop some through the slats in the boardwalk. A few hours work would produce about two bucks each for Buzzy and I, and that was in the days when a quarter could buy you a slice of pizza.

It was dirty work, but rewarding. And of course the dirt was easily washed off in the ocean. Invariably when one of the other kids would find out about our wealth their comments were, "You guys are sooo lucky!" Luck had nothing to do with it. There was a distribution of coins that would fall through and a lot of work by the harvesters. The same is true of the markets.

Jeff Watson writes:

Bill, your experience reminds me of that failed, but magnificent musical, "Paint Your Wagon" where Clint Eastwood discovers that the gold dust gets spilled on the floor and falls through the cracks. Eastwood, Lee Marvin et al proceed to dig tunnels under the entire town and they collect all of that spilled gold dust. They do extremely well for awhile, until a black swan moment where everything collapses and the entire town caves in. There are many market lessons in this movie. About 2:50 of this video is where Eastwood has his eureka moment. 

Vince Fulco writes: 

For those who have never been to Chair's Weston office, right next to the Captain's chair is a painting depicting a similar scenario. Not sure if it is a L'Amour story but the gold miner/spec is on the verge of hitting a nice vein while the precariousness of the surroundings become increasingly more apparent. The moment on the razor's edge is caught perfectly.

Just a beautiful piece.
 

Jun

5

I recently visited a Dr. and when I got there, the nurse asked me to fill out a computer questionnaire that took 1 hour to fill out. After I filled it out, I was asked to sign a statement that said such things as "you will not be paid for filling out this questionnaire, the contents might be used by commercial factors, there are unlimited people in the survey" and a hundred other things that gave it a false aura of legitimacy.

I am wondering to what extent the false aura of legitimacy pervades our field. The classic example is the elections in a marxist or democratic regime, or the government institution that's there ostensibly to protect you from harming yourself but is really a gate for preventing competition from small and new entrants into the field. The committees in the markets to maintain order and proper pricing that are really arenas for the members to mark the positions in their favor, and force out the non-members through margin changes and rule changes comes to mind. The rules against competition in all fields, the licensing requirements, and for example the ethics tests that one must pass in certain fields. How pervasive is this and what is the relevance to our field?

Sam Marx writes: 

I agree that the urge not to compete in a fair open market if one is able to set up a monopoly or obtain an advantage is there, and it's a part of human nature. I believe that it cannot be eliminated entirely but there are some changes that would help. I also believe that lying and cheating obtained a large impetus and some begrudging approval when the graduated income tax became constitutional. Therefore, a recommendation I would make is to do away with the graduated income tax and have a flat income tax or replace the income tax with a sales tax. I don't expect to see any of this in my lifetime however. 

Bill Rafter writes: 

Sham credentials. There exist a variety of market-oriented groups whose stated purpose is to identify the truly worthy. However all they really do is confer the aura of legitimacy on those in need of same, while providing income for the executives at group headquarters and hoodwinking the public. The group is frequently a "non-profit", adding more prestige. The legitimacy is conferred by letting the novice fork over not-insubstantial funds, taking a few tests and eventually getting the rights to put letters after his or her name, provided he stays a dues-paying member of the group. The orientation of the group can be fundamental, technical, quantitative, retirement planning or risk aversion.

My personal observation is that some market-oriented groups are worthy, and those which do not offer the paid initials are the best.

Apr

29

A bittersweet moment in Ty Cobb's life reportedly came in the late 1940s when he and sportswriter Grantland Rice were returning from the Masters golf tournament. Stopping at a Greenville, South Carolina liquor store, Cobb noticed that the man behind the counter was "Shoeless" Joe Jackson, who had been banned from baseball almost 30 years earlier following the Black Sox Scandal. But Jackson did not appear to recognize him, and finally Cobb asked, "Don't you know me, Joe?" "Sure I know you, Ty," replied Jackson, "but I wasn't sure you wanted to know me. A lot of them don't."

Stefan Jovanovich adds: 

Given the fact the Jackson remained a respected figure of the community and the liquor store was owned by Jackson and his wife and his name was above the door, the story could be one of Grantland Rice's maudlin inventions. For the people of his home town, Greeenville, SC, Jackson always was a figure of respect.

The site shoelessjoejackson.org has a link to the PDF of Furman Bisher's interview with Jackson — the only one he ever gave. Eliot Asinof's book (the one John Sayles relied on for Eight Men Out) is a very large pile of crap which completely ignores Bisher's interview and the Jackson's own grand jury testimony. If Jackson had, in fact, been guilty, it is hardly likely he would have prevailed on the civil suit against Comiskey for his pay for the 1920 and 1921 seasons.

Apologies to all — this subject always gets my dander up. During the series Jackson had 12 hits (a Series record) and a .375 batting average—the best record for a player on either team. He had no errors and threw out a runner at the plate. The principal "proof" against him was that the Reds had hit a number of triples to left field (where Jackson played) because Jackson deliberately dogged it in running the balls down. None of the contemporary newspaper accounts mention ANY triples being hit to left field by the Reds. Once again, the lies run round the world while the truth is still putting its boots on.

Thanks, Bill, for bringing up one the 10 greatest ball players of all time.

Feb

21

This past week there was an item published about the drop in miles driven by the population. The point of the missive was to suggest that miles driven is a surrogate for economic activity, and that we should prepare for another recession because the miles driven showed a huge decline.

Part of the problem in analyzing the data is that mileage did not directly address the price of gasoline, and it is logical to assume that at a high price of gasoline, the public curtails some discretionary driving. So some of the drop in miles driven could be related to price. Another item could be the Cash for Clunkers program, which could offset the price rise to some extent as the newer cars generally get better mileage. The latter apparently did not happen to any large degree.

The chart presented with this link shows the allocation of household expenditures spent on gasoline (top panel) and the annual growth rate of those expenditures.

My conclusion: There is a drop in mileage driven, but I would not bet that it foretells further recession.

Mr. Krisrock comments: 

105 dollars in crude tonight as Obama and his communist central planners try to figure out the new narrative and who to blame this on…

Feb

7

Do markets learn from each other? For example, is the S&P market this year, following a similar path to bonds last year, with every trepidatious move down being requited with a rise? Are such "learnings" graduated to the point of regularities. And is it a domino effect or a path of least resistance or consilience or convergent evolution or what have you? What do you think? Can it be quantified? Should it be quantified?

Gary Phillips writes: 

Price discovery has become as anachronistic a term as capital formation. The Fed is supposed to be listening to the market to give it guidance in it's policy decisions, not dictating to the market, what the market should do. If investors feel there are no surprises left, as the Fed is concerned, they will once again lever up, and inflate asset prices…QE1 - QE whatever. Rinse and repeat.

Bill Rafter adds: 

Here’s a related (perhaps derivative) question: Do stocks learn from each other?

Let’s say you take a list of ~6,000 stocks and look at them over a 10+ year period encompassing both up and down markets. And you come up with a trading plan that buys a stock if it exhibits pattern ‘A’ and sell it if it exhibits pattern ‘B’. It is not unreasonable to then have a universe of perhaps 150,000 transactions.

On the first pattern you pick you will find positive average results for certain stocks, while other stocks on average will be negative. Some of these winning stocks will knock the cover off the ball by having say 35 of 50 trades positive, and vice-versa.

Now let’s say you pick different patterns, and again you find a collection of stocks that outperform. You think this is going to be somewhat of a random process where some of the winning stocks from pattern A/B become losers when you try patterns C/D or Y/Z. And that does occur. But you also find that some stocks are consistent winners throughout the various patterns. And of course, some are repeat losers (perhaps hoo-do stocks).

That leads to further inquiry to find what constitutes winning qualities or hoo-do qualities. Note that this is not a study of profitable patterns since the behavior is exhibited across different patterns, some mutually exclusive like trend-following and mean-reversion. Nor is it a study of good management styles, as the same behavior is exhibited with ETFs, which typically have no management.

You then try to identify specific characteristics (or group membership) of the winners. You might think sectors, because the behavior also occurs in ETFs, but not all of the constituents of a winning ETF are consistent winners, and ETFs behave differently than their constituents. You trot through the various possibilities: volume, volatility, beta, name recognition, size, sales, earnings, debt, short interest, institutional holdings, etc.

Continuously you come back to the possibility that some stocks are simply winners and others hoo-dos, until you can prove otherwise. It turns out (tongue firmly in cheek) that this is a good thing to know.
 

Alex Castaldo writes: 

Probably I misunderstand or oversimplify the issue, but I think what is happening is like this.

Among stocks in your database there are some that have considerable price runups and declines, and others that have fewer such features. It is not exactly a question of volatility as conventionally defined, but it is somewhat related to it.

When you examine trading rules, selecting ones that are more successful with some stocks, you are necessarily picking up more stocks in the first category and fewer in the second.

There is a kind of oversampling at work that concentrates the successful population with stocks from the first category.

To take an absurd extreme to make things clear, if there is a stock that spent the entire data period at 10.00 (the ultimate quiet stock), then no method will make money from this stock, not trend-following, not mean-reversion, not seasonality, etc. This stock has zero chance of being among the 'winner' stocks, not because of its industry, or who is the CEO but simply because of the time-pattern of prices.

 

Feb

5

I ordered a few fruit trees today from an orchardist in California and had an interesting conversation with him. I wanted some special plums and noted that the guy also had quite a variety of pluot trees for sale. I have never eaten a plumcot, pluot or aprium and asked his opinion. For those who don't know what I am speaking of, a plumcot is a 50-50 cross between a plum and an apricot. If you then take that and cross it with a plum you get a pluot, which is 75% plum to 25% apricot. Should you have crossed the plumcot with an apricot, you get an aprium, the 75-25 split long the apricot. Think of it as a fruit tree version of pairs trading.

According to that professional orchardist, the pluots of many (most?) growers are really plums masquerading as pluots. California has imposed a tax on the sale of plum trees, but not on pluots. So, surprise, surprise, they're all pluots. The tax police are fighting back with DNA testing for pluots suspected of being plums, and the growers are legally challenging the authority of the state to do the DNA tests.

Oh, when will they ever learn?

Jan

20

The problem with most of the polling is that it is done nationally. I argue that my own opinion does not matter as I vote in New Jersey. Stefan's opinion in a poll also does not matter if he votes in California. Both California and New Jersey are blue states and the opinion of anyone polled in those states is a curiosity only. Oklahoma and Texas are solid red states and their voters' opinions are equally valueless. Those opinions would be of value if and only if they reflected a national mood, which is doubtful. Thus the only polls that would seemingly matter are those which concentrated on the swing states: Florida, Ohio, Iowa to name a few. I have only seen one such poll (about a month ago) which did exactly that.

Dec

22

1. There is a critical point in the market, a critical decision that the market gods weigh on a scale like Zeus with his balance scale deciding whether Achilles or Hector will win, that determines the market fate, and it is key and should be the focus of all news stories and market considerations but never is.


2. Never trust anyone but your family and best friend because everyone is disloyal in a pinch. Peleus was left for dead by his father in law after killing his brother in law to become ruler and this led to the Trojan war. Caesar trusted his best friends but they turned on him when an opportunity for power, money, and romance reared its ugly head.

3. Deception is key. The most successful Greek was the Deceiver Odysseus, and he tricked everyone he dealt with as the market tries to trick you with Odyssean power.

4. The goal is always to come home. Odysseus went home, as does the market. The only loyal ones were the wife and son and the best servant. The market retraces and comes home to break even an inordinate number of times.

5. Never mix romance with business or the market. The Trojan was was started by Paris intervening in romance and being swept off his feet by Aphrodite, and Achilles killed tens of thousands and prolonged the war by 10 years when Menelaus stole his mistress.

6. Don't try to walk with the Gods. Peleus married a half God and married her the last time the Gods and mortals mingled at a celebration and it caused him to be the most distressful of men. Trying to emulate Soros or the other greats is the seed of destruction.

7. Okay, give me the rest. And correct and tighten the above. I'm out of my depth but wanted to get the gist across.

Ken Drees comments:

Like using a mirror against Medusa, one must plan against the adversary and sometimes use their expected attacks to beat them. Like shielding oneself from the siren song, one must be totally prepared, seek council before the journey (the trade) about what dangers are expected.

Also, it seems every entity in mythology had a weak spot. It's probably best to note these weaknesses in your thinking and in your emotions, not how can I beat the market, but how can the market beat me today?

Bill Rafter writes:

The greatest two rules:

(1) nothing to excess and (2) know yourself.

Pete Earle writes:

One lesson from mythology which resonates with me is the oracles/prophets/predictors almost always forecast correctly, but rarely in an obvious or immediately relevant way. The predictions made are usually realized, but not before taking extremely circuitous, and usually counterintuitive ways to reach fulfillment.

In my experience, predictions regarding the direction of equities or commodities inferred from option markets so often prove accurate…but only after traveling in the most wrong, most unanticipated ways.

Alston Mabry responds: 

Pete, I think of that as "shaking the tree", i.e., we're gonna get there, but we're gonna shake out as many weak hands as we can along the way.

Peter Earle replies: 

Absolutely. Stop-running and the like as the "gods" way of seeing who's "worthy"; who can withstand the flood, the fire, the sturm und drang.

Jim Lackey writes: 

In 2008 I learned from Ryan Carlson– Sisyphus. There is a little useless book Wit and Wisdom from Wallstreet. So many of the quotes are the exact opposite from 3 pages ago… yet for a day they are seemingly sage advice. Worse for the long term. It's all good advice, yet in the mean time we must eat, and in the long term we all end up dust in the wind.

Traders lament when we miss profits. We are miserable when we lose. If we are not careful we are never happy. I have the habit of having to work myself up into a fury to win a race, pass a test or trade. My wife calls it "business mode" everyone else calls it being a jerk. Finally this year I have the ability to take a loss and this week miss a glorious rally and profit… yet at 4:20 PM its over. I am done pushing the boulder back up the hill for the day. I will return at 1:30am or by 7am, all but two business days a year. It can be torture if you do not like to trade, but if you love it…

Here is a quote from my kids music, "This is Our Science" by Astronautalis: "Our work is never done/ We are Sisyphus".

p.s I notice that if I don't like the rap beats I miss quite a bit of new poetry. I hear my teenagers say random lines and say what! That is amazing. Then I hear the song and say no wonder I never heard that line before. Damn drum machines.

Jack Tierney adds: 

Recently I've been reading up on complexity, system dynamics, and the unpredictable consequences that occur when tinkering with non-linear systems. The markets seems subject to all and, if I'm even remotely correct in interpreting the literature, there's only one certainty: expecting linear consequences (e.g, provide banks with more liquidity, bringing about an increase in business borrowing, resulting in a resurgent economy) is rarely, if ever, realized.

Instead, the unseen effects on unimagined factors, almost always derails the logic train. A source I've referred to on occasion is "Cassandra's legacy." Appropriately enough, the custodian of that site provides an interesting historical allegory, in the form of Goth Princess/Roman Empress, Galla Placidia, and her part in the demise of the Roman Empire. It's a very lengthy read and, unless history like this interests you, tough going. So, a few highlights:

"Managing any large structure is difficult and we tend to do it badly; a whole empire may be an especially difficult case. To do it well, we would need to use a method what I mentioned before: system dynamics; which is a way to describe systems and the relation of the various elements that compose them.

"…every time that the Romans fought the Barbarians, they could win or lose, but each battle made the Empire a little poorer and a little weaker. The empire was using resources that could not be replaced; non-renewable resources, as we would say today….the solution was not more troops but less troops. It was not more imperial bureaucracy but less imperial bureaucracy, not more taxes but less taxes.

"In the end, the solution was right there and it was simple: it was Middle Ages. Middle ages meant getting rid of the suffocating imperial bureaucracy; it meant transforming the expensive legions into local militias; have people paying taxes locally, in short transforming the centralized empire into a decentralized constellation of small states. Without the terrible expenses of the Imperial court and of the Imperial bureaucracy, these small states had a chance to rebuild their economy and start a new phase of prosperity, as indeed it happened during the Middle Ages.

"What Placidia could do as an Empress was, mainly, to enact laws….It seems that Placidia was acting according to her style; ease the unavoidable, don't fight it….Placidia forbade the coloni, the peasants bound to the land, to enlist in the army. That deprived the army of one of its sources of manpower and we may imagine that it greatly weakened it. Another law enacted by Placidia, allowed the great landowners to tax their subjects themselves. This deprived the Imperial Court of its main source of revenues."

Stefan Jovanovich comments:

As much as King George's scribbler Edmund Gibbon despised Christianity, he had the Middle Ages even more because its bureaucracies were the worst of all — local and mean and stupid.

Professor Bard should revise his history. What he wrote here — "Middle ages meant getting rid of the suffocating imperial bureaucracy; it meant transforming the expensive legions into local militias; have people paying taxes locally, in short transforming the centralized empire into a decentralized constellation of small states. Without the terrible expenses of the Imperial court and of the Imperial bureaucracy, these small states had a chance to rebuild their economy and start a new phase of prosperity, as indeed it happened during the Middle Ages." - is nonsense.

The Roman Empire's tax collections were always "local"; that is why Roman politicians were willing to pay such enormous bribes to be appointed provincial governors. The legions were also "local"; the Empire's expansion came from granting "foreigners" - i.e. the people we would today call Spaniards, French and Syrians - the privileges of citizenship, which meant they were also qualified to serve in the local legions. This was equally true under the Republic; "crossing the Rubicon" would not persist as a bad metaphor if Rome's soldiery had been centralized.

As for economics, whatever the "terrible expenses of the imperial court", they were nothing compared to the ravages of coin clipping. The solidus of the Eastern Empire maintained an unchanged weight and measure for 4+ centuries - a record that is likely never to be broken. (It exceeds the span of sound money for the British Empire and the United States of America put together.) After Princess Placida's day coinage, under the wonderful decentralization of the Middle Ages, effectively disappeared.

"Dearth of provisions, too, increased by degrees, and the scarcity of good money was so great, from its being counterfeited, that, sometimes out of ten or more shillings, hardly a dozen pence would be received. The king himself was reported to have ordered the weight of the penny, as established in King Henry's time, to be reduced, because, having exhausted the vast treasures of his predecessor, he was unable to provide for the expense of so many soldiers. All things, then, became venal in England; and churches and abbeys were no longer secretly, but even publicly exposed to sale." - William of Malmsbury wrote this in 1140 AD - the period that Professor Bard praises so highly for its progress over the degeneracies of the Empire.

Hume deserves the last word on this and most other subjects that interested him.

"Mankind are so much the same, in all times and places, that history informs us of nothing new or strange in this particular. Its chief use is only to discover the constant and universal principles of human nature."

Easan Katir adds: 

The Greeks have fooled people since the Bronze Age. Instead of a horse, they now have Trojan bonds.

Steve Ellison comments: 

Jack, the Atlantic had an article about why projects that had successful pilots often failed when rolled out to the general population.

Why Pilot Projects Fail– Here are some excerpts:

Promising pilot projects often don't scale … Rolling something out across an existing system is substantially different from even a well run test, and often, it simply doesn't translate.
Sometimes the 'success' of the earlier project was simply a result of random chance …

Sometimes the success was due to what you might call a 'hidden parameter', something that researchers don't realize is affecting their test. Remember the New Coke debacle? …

Sometimes the success was due to the high quality, fully committed staff. …

Sometimes the program becomes unmanageable as it gets larger. You can think about all sorts of technical issues, where architectures that work for a few nodes completely break down when too many connections or users are added. …

Sometimes the results are survivor bias. This is an especially big problem with studying health care, and the poor. Health care, because compliance rates are quite low (by one estimate I heard, something like 3/4 of the blood pressure medication prescribed is not being taken 9 months in) and the poor, because their lives are chaotic and they tend to move around a lot … In the end, you've got a study of unusually compliant and stable people (who may be different in all sorts of ways) and oops! that's not what the general population looks like.

Oct

26

Does anyone have this in PDF? The Amazon hardcover is 300+ dollars.

Propaganda Analysis: a Study of Inferences Made from Nazi Propaganda in World War II

Jonathan Bower comments:

Here it is:

Scribd: The-Jewish-Enemy-Nazi-Propaganda-during-World-War-II-and-the-Holocaust

You can read it for only $21.

William Weaver responds:

That's the problem, there are a lot of books with similar titles, but the one I'm looking for is by Alexander George, written in 1959. The Gladwell article 

(Open secrets, Enron, intelligence, and the perils of too much information [10 page PDF])  that Jeff Watson mentioned referenced the book and it seems like an interesting read. Here is the Amazon listing:

Propaganda Analysis: Study of Inferences Made from Nazi Propaganda in World War II [Hardcover]

Alexander L. George (Author)

ISBN-10: 0837166306

Out of Print–Limited Availability. 

Bill Rafter writes: 

Regarding out-of-print books, some dirtbags have been identifying those books in a local library that are both (a) in demand, and (b) out-of-print. The dirtbag then advertises the book on Amazon as "used" for a substantial sum, say $150, or in your case $300. If someone orders the book the dirtbag then goes to the library and borrows the book.

A few days later he goes back to the library and confesses as to having lost the book in a fire or flood and pays the library their lost book fee, which might be $25. At that point he has paid the library for the book and cannot be charged with selling stolen property. And you as the buyer cannot be charged with receiving stolen books. But the whole thing really stinks.

Oct

21

A good friend of my daughter asked me for advice on the best way of winning a man's heart on a first or second date.

I told her to use the Jennifer Flowers Gambit (the surprise erotic interlude when stopped on a drawbridge) or the Lee Raziwell gambit (listen intently to everything he says and ask about his expansive greatness), or the Leona Helmseley Gambit (pretend that there is another suiter waiting for you that evening so you have to leave at 11 pm as nothing inflames a man more than competition) but I feel that others here are more sapient in this area and others and I  would appreciate your insights.

An Anonymous  writer comments: 

My conclusion is that the number one sign of a good long term relationship with a woman is based on the quality of her relationship with her father.

I am basically engaged to be engaged with a woman, and the emotional commitment on my end happened after a dinner where much of the conversation was her describing her relationship with her dad, and how he helped her with her math and physics homework, and then they would walk to the store for a treat, etc, and just the general way that her face lights up when talking about her dad.

So anyway, that's what worked on me. Perhaps she should try it.

/my 2 cents

 Gary Rogan responds: 

This sounds like good advice and the father thing is pretty well-known, but I'm just amazed that you have made some conclusions about long-term relationships after having dated women in around ten countries over two years. 

 Pitt T. Maner III comments:

Well then there are some who base decisions and strategies on a few minutes of observation. The HFT of the dating scene—your most important impression—the first 3 seconds!
 

 José Bonamigo shares:

From Forbes Magazine:

The mating practices of human beings offer a reason for thinking beauty and intelligence might come in the same package. The logic of this covariance was explained to me years ago by a Harvard psychologist who had been reading a history of the Rothschild family. His mischievous but astute observation: The family founders, in 18th-century Frankfurt, were supremely ugly, but several generations later, after successive marriages to supremely beautiful women, the men in the family were indistinguishable from movie stars. The Rothschild effect, as you could call it, is well established in sociology research: Men everywhere want to marry beautiful women, and women everywhere want socially dominant (i.e., intelligent) husbands. When competent men marry pretty women, the couple tends to have children above average in both competence and looks. Covariance is everywhere. At the other end of the scale, too, there is a connection between looks and smarts. According to Erdal Tekin, a research fellow at the National Bureau of Economic Research, low attractiveness ratings predict lower test scores and a greater likelihood of criminal activity.

http://www.forbes.com/forbes/2005/0815/096.html

Best regards from Brazil

JB

 Gary Rogan inquires:

 After a while this degenerates into just socially dominant and not necessarily intelligent men. This modified effect can be readily seen in the Charles/Diana coupling, at least in the older Prince William. Of course how did Charles come about if the theory is correct? 

 Stefan Jovanovich comments:

Trusting Forbes magazine on stories of family history is more than a bit like buying a Degas ballerina sculpture from Toby Esterhase's Soho gallery. The notion that the 5 founding brothers were "supremely ugly" is part of the standard viciousness of the portrait of the Jewish banker as Shylock that survives to this day. There is no evidence of any special ugliness in their portraits.

http://en.wikipedia.org/wiki/Salomon_Mayer_von_Rothschild

http://en.wikipedia.org/wiki/Amschel_Mayer_Rothschild

http://en.wikipedia.org/wiki/Nathan_Mayer_Rothschild

http://en.wikipedia.org/wiki/Carl_Mayer_von_Rothschild

http://en.wikipedia.org/wiki/James_Mayer_de_Rothschild

The Rothschilds married money - the Ephrussis, the Guggenheims and the Oppenheims. One suspects that, as in most things, the question of beauty was left to the beholders.

In the 19th century the great minds were certain that criminal behavior could be predicted by examining the bumps on people's heads. It should hardly be surprising that we are back to estimating future viciousness by measuring the asymmetry of human features.

http://en.wikipedia.org/wiki/Phrenology

http://en.wikipedia.org/wiki/Smiley's_People

 Jim Wildman comments:

I would say that she can't on the first or second date. Winning someone's heart in a deep, lasting way, takes time. Anyone can fake interest for a while. What about when she is sick? When he is grumpy? When life intrudes on the lovers? Are their hearts still connected?

Granted, I haven't dated anyone for over 3 decades, but I have watched 3 daughters struggle with guys..

 Marion Dreyfus questions:

My question:

And some may find this offensive–

Does the ubiquity of pornography, specifically for the ones who purvey it day and night (I understand that equals a LOT of the male population), make falling in love with and making love with real women –including the physical aspects of affection–much more difficult than it used to be before every late-night channel offered a raft of such virtual substitutes for real relationships?

Rocky Humbert comments: 

Choices:

(a) Korean BBQ. Nothing excites a man more than watching a lady handle chopsticks amidst an open flame. Alas, times change. Woo Lae Oak has gone out of business. http://nymag.com/listings/restaurant/woo-lae-oak/

(b) Take whatever advice a parent provides, and do exactly the opposite.

(c) Que Sera, Sera

(d) http://www.datingish.com/695368212/how-to-win-your-guys-heart/

Score 1 point for picking the right answer. Deduct 1/4 point for picking the wrong answer.

 Bill Rafter writes:

When you are fishing, you need to match the bait to the fish. Striped Bass like clams, but Bluefish and Flounder will eat anything, so you might as well use bunker. Think of it this way: a young lady would wear one kind of dress on a date and a different dress when meeting the young man’s mother.

If a man is 25 or younger he is probably only interested in one thing and he is not looking for lasting qualities. Not that there’s anything wrong with that. The interlude on the drawbridge is something he will never forget. A woman with an interesting job is attractive as long as it does not threaten him.

At some time the man starts to look for additional qualities in a mate. Maybe because of pressure from his parents he starts to think of having a family. Then he starts looking for someone who might be a good wife and mother. A schoolteacher is attractive in this case.

In foods, women are attracted to chocolate whereas men are attracted to cinnamon.

 Tim Melvin writes:

I told my daughter in response to a similar question that anything won so easily or quickly likely had little value in the long run. She should be herself at all times and the man who liked and fell for that woman was likely a better match. I taught all the tricks her old man had used over the years to win fair lady specifically so she could avoid them.

 Jose Bonamigo responds:

My intention with the Forbes extract was not to present solid evidence, just a likely explanation for couples like Charles and Diana (a common combination), as Gary pointed out.

Looking at the portraits it seemed to me they were "regular" uglies (just kidding)…

For a more scientific approach, at least in the physical part of dating:

http://www.ncbi.nlm.nih.gov/pubmed/17173598

http://www.ncbi.nlm.nih.gov/pubmed/16318594

Sep

28

FFT (Fast Fourier Transform) constructs a “best cyclic approximation to the data” that can be constructed with N cycles. And you get to pick the N value. Better yet is that the output is a smoothed representation of the raw data without any lags. Wow, no lags! However, FFT assumes that the cyclic behavior is repetitive from the beginning of time to the end of time. That’s great for fitting data, but not generally reliable for forecasting markets. Also, every time you add or drop a datapoint, a subsequent cyclic approximation will have different values over the entire period.

Suggestion: FFT is fine for seasonally adjusting past macroeconomic data, but your expected value of using it for trading will be negative.

Sep

26

"Never let a crisis go to waste." That political statement can have implications for those of us who speculate. Specifically, we can learn from what has recently happened, and by knowing history can hopefully avoid repeating those lessons.

I noticed just today that the option volume attributed to market makers ("MMs") was particularly high relative to that of firms and customers. That is quite logical, as emotional demand in options is usually offset by the MMs providing liquidity. That of course is the function of MMs, for which they are usually rewarded. But has that been the case historically, and if so, can it teach something?

I looked at the volume of market makers relative to their counterparties in two ways; first with the MMs buying and second with the MMs selling. Then I took the differences of those two calculations and smoothed it. More on the smoothing after you see the results:

Here you see SPX shaded to reflect the smoothed balance of MM liquidity. If SPX is blue, the MMs are providing liquidity to put buyers as of the previous day, and if orange, the MMs are providing liquidity to call buyers as of the previous day. These are of course generalizations, as I really do not know who is doing what, but simply following the logic of the positions. Of course it isn't perfect. If you are expecting certainty, you would be better off in another field.

The smoothing period is extremely interesting. These transactions by the MMs usually last 24 hours or less. But their counterparties do take positions and try to hold them. On average options positions by customers and firms last slightly less than a month, although they are frequently rolled-over. Thus the chart represents on-balance accumulated demand by options traders for liquidity. So what would you suspect to be the best smoothing period?

Wrong! It happens that the period used in the chart was a whopping six months. That fooled me also. That is, the data used in the smoothing is as "old" as six months. Of course, that is a static period; the best smoothing period will always turn out to be adaptive. But this works for illustration.

At this point the work is merely anecdotal; there is no statistical significance worth speaking about. But I present it here as something for further study.

Sep

25

One has always wondered why the banks according to their regulators are being prohibited from investing in this and that thing, derivatives, mortgages, stocks et al, but never have I seen a mandate that they don't invest in sovereign debt of the solid as a rock countries such as those they invested in as did Rome after the Trojan war. Could it be that instead of being prohibited from such investments, the opposite is true, and that is why whenever a country is about to go bust, the banks are in danger of falling. Could it be that they are that foolish as to always hold the short straw?

Gary Rogan writes:

Based on multiple occurrences of coming close to the short end of the stick but somehow being saved by the US or the IMF it has not been a bad strategy. How many times has it happened in Latin America? The IMF resolved the early 80's crisis and Brady bonds were used in '89. So it wasn't just crazy people who would loan to Latin America that is guaranteed to blow up sooner or later. There was clearly an implicit understanding that French and German banks would be bailed out from their losses to the various PI**GS, and the way everyone behaved towards Iceland and Ireland, this was clearly expected that they would be the slaves to the big brothers, and the banks would be helped to be made whole by the taxpayers of the less-important countries, and when the bigger countries are involved the big brother taxpayers would have to chip in.

To the banks this was the frog in the boiled pot situation, except in stages: you warm the pot up a little bit, and then some savior helps you jump out, so you learn that the pot is safe. Then the frog jumps back in, and the pot is warmed up a little more, and the savior helps again, and so on. But now he can't help, but who cares? The old bank CEO's are enjoying margaritas some place where they used to lend to or even nicer and safer, or are dead, so on the average this was worth is to the banking flexion leaders. 

Bill Rafter writes:

Several of the 15th and 16th Century Florentine banks including that of the Medicis had problems with their sovereign loans. Despite problems the banks continued to lend for political/military reasons.

George Parkanyi writes:

Banks are large institutions and, like large institutions at the senior levels, don't pay attention to detail beyond a certain point. (I see that in government a lot for example.) Behind every major transaction is some mid-to-senior manager trying to close a deal, land a big client, or in the aggregate hit some number to make a bonus or whatever. I would think that to win a sovereign account would be a big deal, so of course you would trade or perhaps make a market in a client's debt in that situation. Smart sovereign clients, because of their size, can easily play one bank off against another depending on how hungry and competitive the players are at each. Sure institutions have systems, but ultimately deals are made by people, and the culture in investment banking is typically to do whatever it takes to make the deal, even if it means being "creative" and circumventing part or all of your controls, not digging too deeply in case you find something that might compromise the deal, and/or simply treating widely-accepted assumptions as fact (AAA credit, too big to fail etc…). There are many paths to these untenable outcomes, and they are all rooted in human nature. Nicholas Leeson never set out to bankrupt Barings, he started out by just trying to keep a big client happy.

Gary Rogan adds:

Still, moral hazard is what makes all of this possible (having some implicit savior). You don't see Procter and Gamble negotiating a deal with Walmart or some little dictatorship where they will sell them detergent at what winds up being a big loss, and least not very often. The suppliers who are foolish enough to do that disappear without anyone hearing about them, other than in some CNBC special about Walmart. Socialism in any form will ultimately destroy itself: when people have a right (or the idea that they have a right) to other people's resources, eventually they will consume/destroy enough of them to sink everyone involved.
 

Stefan Jovanovich writes:

The Bardi and the Peruzzi had two enormous technical advantages. Their staffs had fully mastered the science of double-entry book keeping and taken Pacioli 's discovery (probably lifted from the Byzantines) and improved it to the point that they could easily do present value discounting. This was a very big deal at a time when Italian banks were under the same prohibitions that banks in the Muslim world still operate under - charging interest was a sin. Their skill in double-entry was complimented by their shrewdness in dealing with the intricacies of canon law. The Bardi and Peruzzi were the first to figure out that they could get round the problem of usury by issuing loans at a discount and balancing their books by showing the difference between the cash paid out and the loan amount as a gift from the borrower. In a Christian world gifts were perfectly acceptable and (I love this part) the ability to receive them a proof of worthiness. Most of the discounting was not on loans but on relatively short-term bills of exchange. Many of them were remittances to the Papacy. You can see this in the list of the Bardi branches in 1300 - Barcelona, Seville, Majorca, Paris, Avignon, Nice, Marseilles, London, Bruges, Constantinople, Rhodes, Cyprus and Jerusalem. What is supposed to have killed both banks was, as Bill notes, their difficulty with sovereign debt. But it was only one sovereign - Edward III of England. According to the Peruzzis, Edward borrowed 600,000 gold florins from them and another 900,000 from the Bardi and then, in 1345, told them he would not be able to pay on the agreed upon schedule. The Italians had no choice but to agree to a workout, and they ended up taking much of their eventual repayment in wool rather than specie. The problem for them was that the combination of the Black Death and the exhaustion of the German silver mines had produced a monetary deflation that made the repayments worth far less than the nominal loan amounts. But, it is risky to take even this story at face value. The author of the Wikipedia article on the Hundred Years War (where Edward pissed away all the money) has his doubts. He writes that "the Peruzzis' records show that they never had that much capital to lend Edward III….. Further, at the same time Florence was going through a period of internal disputes and the third largest financial company, the Acciaiuoli , also went bankrupt, and they did not lend any money to Edward. What loans Edward III did default on are likely only to have contributed to the financial problems in Florence, not caused them."

What is not in dispute is that it took another half century for banking in Florence to revive on even a regional scale, and in scale and international reach, the Pazzi and Medici were secondary players compared to their 13th and early 14th century predecessors. The Medici are famous because of their adventures in Italian politics, their family stories and their art patronage; but, in terms of finance, it would be like comparing the current House of Baring with the one active during the Napoleonic Wars.
 

Sep

19

If you have not read this, you should: "Letters from a Self Made Merchant Man to his Son"  by George Horace Lorimer.

Craig Mee writes:

I simply mention Stan in passing as an example of the fact that it isn’t so much knowing a whole lot, as knowing a little and how to use it that counts.

Oh, how I have learned this the hard way. As an old squadron commander told me in my 20s, “You get a whole lot more bees with honey than you do with vinegar, young man.” Great advice, and I am happy to say I am finally following it many years later.

Sep

17

Have you ever noticed how those who have done you the most wrong, or those who loathe you the most, when they come onto hard times will often come back to you asking for assistance. This often happens to me with former colleagues. I can't always differentiate between whether the colleagues are in such bad straights that they will go to their most unlikely and ill wanted savior, or whether they wish to take their worst enemy down with them once more before they finally go under. I believe it is a variant of rats deserting a sinking ship. The British Navy and I believe all navies have a standard order from their captain "every man for himself " when the ship is sinking. And there is doubtless maritime law about when it is legal to put the captain in chains, (albeit this is somewhat a different situation). I believe the idea has many market implications, especially when markets have gone to the nadir like last week, but more important is how to protect your life in such situations I think.

One finds that there are only 25 suicides a year at Niagara Falls these days, and The Golden Gate has much more, but one can't speculate as to whether the sight causes the suicides or whether people with suicide on their mind tend to go there to do the deed. As for market moves, they must cause many more such catastrophes but again whether the person seeks out the opportunity or the opportunity causes the action, or both, it would be hard to unravel and a quantitative study of the types of moves that induce same would be helpful for saving lives and profits. 

Russ Herrold writes:

I've had this happen a few times. I think the reason is that the former colleague or friend is sufficiently 'intimate' with the weak spot that their former friend had, and so can 'get past your guard' more easily.

Factor in some perverse pathological character trait, and they may even feel justifies in taking advantage of someone they feel has 'done them wrong' in the past. Indeed, it may be that there was an intent to deceive (conscious, or latent) from the onset of them approaching you, 'the mark'.

The best approach is to probably to buy the lunch, but to keep one's checkbook firmly locked up.

Polonius: (to his son)

Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.

Hamlet Act 1, scene 3, 75.77

and later

Polonius:

This above all: to thine own self be true, And it must follow, as the night the day, Thou canst not then be false to any man. Farewell, my blessing season this in thee!

Laertes: Most humbly do I take my leave, my lord.

Hamlet Act 1, scene 3, 78.82

The thought expressed by Vic is that there should be some heightened sense of gratitude if one is dealing with a moral person and 'offering the hand up' and a hand-out. But Twain echoed the Bard on this topic as well:

If you pick up a starving dog and make him prosperous, he will not bite you. This is the principal difference between a dog and a man.

- Pudd'nhead Wilson

Steve Ellison writes:

When my children were 5 and 3, we hiked across the Golden Gate Bridge. There had recently been a freak accident in which a small child had somehow fallen through the small gap between the bottom of the railing and the sidewalk to her death. There were plans to replace the railing with one that went all the way down to the sidewalk, but the work had not been done yet, so I was keeping a close eye to make sure the children did not go too close to the railing. While my attention was diverted in this direction, I was almost caught off guard when the 3-year-old climbed on top of the one-foot high barrier between the sidewalk and the speeding traffic.

T.K Marks writes:

I, too, have walked across that bridge on numerous occasions. I'd walk over to Sausalito and take the ferry back. A spectacular stroll. One is still struck mid-span by the ease at which a despondent person could reach their goal. The curiously low railings prompt one to macabre thoughts. Who was the civil engineer involved with this project, Derek Humphry?

Stefan Jovanovich answers:

The answer is Charles A. Ellis. Joseph B. Strauss did everything he could to claim credit for it (Strauss was to architects and engineers what Douglas MacArthur was to the Army and Navy - even when he was wrong, he was right - just ask him). Ellis reworked Strauss' initial proposal for a cantilevered suspension bridge - which would have been the mating of the Forth bridge with a ropewalk - and produced the design one sees today. Ellis did almost all the actual work - the calculations required for the computation of stresses, the specifications, contracts and proposal forms - singlehandedly, working non-stop for 2 years. After Ellis completed the work but before the final designs were submitted to the Bridge District's Board for its review and final approval, Strauss fired Ellis. There was no mention of Ellis in any report by Strauss, including the final report upon the bridge's completion in 1938. Ellis was the equal of Louis Sullivan, and like Sullivan he spent half his working life in total obscurity, unable to get any further commissions. Moisseiff gets credit for the development of deflection theory; but, as events proved (see "original bridge" section of Tacoma Narrows bridge), Ellis was the person who fully understood the necessary relationship between span length and flexibility. He is literally the father of the modern suspension bridge and the engineering theory behind it.

Bill Rafter comments: 

There was a psychology professor that published a study showing that the vast majority of Golden Gate jumpers took the leap on the side facing the city (facing East) rather than the ocean (West) side. The article then attempted to theorize why this might be the case, and he concluded that it was an attempt by the jumper to say goodbye one last time. Nice thought, but it totally ignores the reality that it would be damned hard to jump on the ocean side as that pedestrian walkway is almost always closed.

It must be particularly interesting to be on the bridge when one of the big carriers goes under, as they have to time it with low tide to clear.

Aug

29

One can certainly use levels or changes in the price of gold to trade equities indices (i.e. SPY as opposed to gold mining stocks for example).

However that same person would have more success if he used the "volatility" of the price of gold to trade those same markets, at least since 1990.

That condition is not unique to gold.

Aug

24

My suggestion [for understanding market inter-relations] is to set markets against each other and then look at how they react to a common metric. What you will find is that such an exercise yields valuable timing information. What many perceive as the most difficult part (choosing the metric) is often nothing to worry about. That is, almost all of them work, such that the news of markets turning is writ large across the landscape.

The first consideration however is to compile the various markets as assets in which to invest. That is, instead of using yields, one must use prices as it is prices by which they compete. The best trick I can pass on is for the game theorist to start by looking longer term and then shorten up. Think years and quarters rather than intraday.There's more if there is any interest.

Rocky Humbert writes: 

One notes that "real" interest rates have backed up about 40 bp in the past week, and gold is responding in kind. Eddy Elfenbein is one of several people who have postulated a relationship between Gold Prices, Real Interest Rates, and Gibson's Paradox. Correlation is not causation of course — but his model has been working brilliantly. Read about it here.

It's also a good moment to brush up on Gibson's Paradox which notes that interest rates follow the price level and not inflation (when operating on a gold standard). According to what I've read about Gibson (which is very little) , everyone from Larry Summers to Milton Friedman accept the existence of Gibson's Paradox … but noone seems to agree on the underlying theory.

Just a quick and dirty note: Eddy Elfenbein's model says that for every -1% (annual) move in real interest rates, gold compounds upwards by 8% (annual). So back of the envelope, a 50 basis point rise in real yields "should" clip gold by 4 or 5 percent or so … and amazingly that's what happening. Now … all I need to do is PREDICT where real interest rates will be next week…

Jul

19

This is a medical/physics & math article that I believe has implications for we speculators. The counterintuitive point is that viewing data through a somewhat murky filter can actually give you a better picture that viewing that data directly. Looking at data through filters is essentially what specs do when they look at moving averages, point-and-figure representations, Heiken-Ashi, data clouds or any of the numerous tools available.

I know of no other compact optical system that combines such high resolution with a field of view that large," says Mosk. He hopes to see a hybrid system that combines his resolution with Choi's speed and field of view. Ultimately, he says, the technique could improve surgeons' views of what to cut during keyhole surgery. "Light scattering may seem detrimental to imaging, but in fact a scattering system can make an almost perfect lens.

Jul

3

Yesterday after the market close I put on my bathing trunks and went to take a swim in the ocean. On my short walk I was surrounded by perhaps 50 dragonflies. That didn't bother me in the least as I know dragonflies do not bother humans and that they eat black flies and mosquitoes that do bother humans. The west wind that we have had for days brought in the flies and mosquitoes, but also their predators. Well here I was in the middle of the swarm, and it occurred to me that I was being used by the dragonflies as bait. That says a lot about their intelligence, which would also be indicated by their exceptionally large eyes. It made me wonder if I have ever been used as bait by other market participants, perhaps with less mutualism in mind.

May

18

Does the incessant parade of illegal/insider trading, government manipulations, etc, of smart Ivy grads evidence the difficulty of getting rich in markets, or simply that dishonesty and greed is pervasive at all intelligence levels?

Gary Rogan writes:

It's probably evidence of both, but also of the illusion that highly successful people often seem to have of being invulnerable to normal negative forces, such as being punished for attacking hotel maids or being revealed for having a secret "love child" while running for the Governorship of California, or having an easily identifiable affair while running for the presidency. 

Bill Rafter writes: 

Don't the B Schools all have required ethics classes? Come to think of it, doesn't the industry regulators also require ethics classics?

Rocky Humbert writes: 

The United States has an incarceration rate of 743/100,000 population.

The New York City's financial industry employees 344,700 employees.

If the pro-rata incarceration rate for Wall Streeters were at the national average, there would be 2,561 Wall Streeters in the Big House right now. Or, with 35,400 employees, 263 of these people would be Goldman Sachs employees.

Since neither of these facts are true, the inescapable conclusion is that Wall Streeters are either more lawful than the national average (or they have better defense lawyers).

QED

May

12

UPDATE:

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
                                                        Up
   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.

Apr

27

Umberto Eco wrote a great essay about how when new products start they are used first by high end users, and then gradually diffuse to the masses so that by time the masses use them, the marginal utility keeps reducing and the first users that got real value out of it stop using them. He points to such things as railroad use and cell phones as examples.

We have see how IPO's prospectuses follow this model with info in it being completely worthless as they have to go through so many hoops that it becomes merely a boiler plate to reduce the settlements in class action litigations when the case is settled.

One notes now the apparently standard thing in financial statements "cautionary note regarding forward looking statements".

I note in a company like Rimm 30 cautionary notes including "difficulties in forecasting quarterly results" and "regulation certification and health risks". My goodness, there was a time when management statements could actually convey useful information that had a high marginal revenue.

Could we attribute this syndrome to crony capitalism or flexionism or just a natural outgrowth of the law of diminishing marginal utility? 

Rocky Humbert writes:

While the chair's assertion that disclaimers have proliferated since the passage of the PSLRA is correct, there is scant evidence that management statements ever have consistent predictive value w/r/t either the organic performance of the business or its market valuation — over a reasonable investment time period. See wikipedia on the Private Securities Litigation Reform Act.

One reason for this is that companies which are performing well have no need for management cheerleaders or CEO soothsayers; the market will eventually figure that out on its own. In fact, the worst companies are the ones where the CEO is front and center (giving "upbeat" guidance) when things are rosy, but then when things turn challenging, release 8-K's on Friday afternoons using terms such as "exogenous factors" and "one-time adjustments" (and the CEO is nowhere to be seen.) Citing Philip Arthur Fisher's Rule #14: "Does the management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur?" It's a rare company that does an IPO or secondary when business is sickly (the exception being banks which sell stock at the behest of regulators.) Hence the entire IPO process can be viewed as a possible violation of Rule #14.

On a related point, one notes that INTC stock (which was mentioned recently by Dr. P) has a compound annual return since 1982 of about 15.6% per year (versus 11% for the S&P). During the same period, AAPL stock has produced a 17.5% compound return. Yet, right now, INTC has a 10x p/e and AAPL has a 17x p/e. Both of these companies have demonstrated good long-term organic growth, RoE, product innovation, and impressive market dominance. Yet, if Mr. Market would reward Intel with only a market multiple, it's return-to-shareholders would blow away Apple — demonstrating once again that Mr. Market's valuation at any given moment dwarfs every other factor for a profitable enterprise. I submit that it's folly to attribute this irrefutable statement to crony capitalism or flexionism or the law of diminishing marginal utility. The blame should be place squarely on the market participants who continue to make the same mistakes (such as buying INTC at a 70x p/e on 3/1/2000) but shunning it at a 10x p/e on 3/1/2011. 

Ken Drees writes:

Consider the cell phone and its recent tracking news out of apple– or police being able to plug a device into your cell phone and download all your data from it– the high end user will now need tech applications to shield their privacy and will demand a next generation product that the masses do not have– a private communication device. The cycle keeps moving forward. Maybe a self destruct feature will come on the scene.on the subject of mumbo useless jumbo in fin states. Is not persistency of litigation like ants digging into the timepiece to blame for the creeping destruction of worthy information?

Bill Rafter writes:

In looking to eliminate stocks in mergers or merger talks I cannot always get that information as quick as I would like. Sometimes I have to resort to looking at the individual stock's news headlines. Before I even get to the news about the merger I see the inevitable: "The law office of Dewey, Cheetham and Howe launches an investigation into possible breaches of fiduciary duty by the Board [of the company]…"

That, I contend, is why you don't get useful information.

An Anonymous Commenter writes:

I recently read an article that the author was try to further disgrace a Euro based company whose board member had made a remark at a meeting referring to "the weaker sex". The article told of the various ways, non business groups and political active parties tried to protest these remarks. However while raising a good smoke screen; the parties complaining were inefficient and did not understand business. Has any body done a study on the stock price of a company whose leadership made non PC remarks? Could it actually increase the price, due to the signal of boldness and management willing to think outside the box? Would not such a study have been quoted in these articles that hold a company up to ridicule? Could such a study have been done but be not published due the opposite than hoped for results?

Apr

26

There has been discussion both recently and historically concerning the relationship of stocks and bonds. Indeed the Daily Speculations website this year started color coding the days on the calendar based on the different movements of those two basic assets.

Much of the discussion concerning this subject has been oriented around "counting". While I value that approach I must point out that the yardsticks by which stocks and bonds are measured in such analysis are of different lengths. Specifically, those markets do not open and close at identical times, which means the daily recording of their respective changes may not actually reflect their movements when they were contemporaneously open. If the daily recordings are not exactly representative, then counting those recordings in the hopes that the errors will "all come out in the wash" may not be the best approach.

Changes (as opposed to levels) are the appropriate data to study. But because of the different time periods, a period other than daily would be more representative of their respective actions.

Instead of counting the daily changes, I have been following the moving correlation of those markets. Whereas most investment professionals are of the belief that stocks and bonds are essentially opposites, we have found otherwise. For example, if you were designing a most bullish environment/setting, I believe that would be when both stocks and bonds were rising. That is, you had a positively trending stock market and declining interest rates. That can be easily modeled by a moving correlation of the two and a positive slope of their prices. Here's a chart (weekly data) of exactly that:

If it doesn't show up well, here is a link.

As you can see, periods of positive moving correlation and positive slope tend to be good times to be long equities. More importantly however is that price collapses are easily seen as periods when that best condition does not exist. The worst condition is when stocks and bonds are both declining. But the other two "not best" conditions reflect the standard (macroeconomic) business cycle and have interesting trading implications all their own. All of this can be non-subjective and can be tested. We have found it to be statistically significant. Furthermore, I show it here on a weekly chart for convenience, but the data is daily and should be watched daily.

I would posit that Daily Specs could find this an interesting area of study. For years my shop had used this as an important part of avoiding trouble, basically to tell us when to play in equities and when not. We only abandoned it when we found something better.

Some further comments/tips:

For bonds I used the DJCBTI because it is price-based and not expiring every six months. It is also third-party. I could make my own bond index, but then open myself to the charge of jury-rigging the results. N-values are hugely important. But adapt, don't optimize N-values. Also you will have to consider what level of moving correlation is significant (i.e. a positive value of .01 is somewhat of a yawner).

Bill Rafter, MathInvest

Kim Zussman writes:

Using TLT for bonds and SPY for stocks (2002-present, including divs), checked weekly return for stocks after prior weeks which were either (bonds, stocks) up up, up dn, dn up, dn dn, vs zero:

Variable    N      Mean     StDev   SE Mean      95% CI             T
BUSU      113   0.00165  0.0164  0.0015  (-0.0014, 0.0047)      1.07
BUSD      139   0.00156  0.0363  0.0030  (-0.0045, 0.0076)      0.51
BDSU      139  -0.00022  0.0213  0.0018  (-0.0038, 0.0033)   -0.13
BDSD       60    0.00519  0.0242  0.0031  (-0.0010, 0.0114)    1.66
 

Apr

24

Very interesting article on Galton:

One, two, many: The prehistory of counting

The Victorian idea that "primitive" tribes can't count has cast a long shadow over efforts to understand the origins of mathematics

LOOKING back, Francis Galton would call it "our most difficult day". It was 4 March 1851, and the young English explorer was beginning to appreciate the obstacles confronting his attempts to map out the Lake Ngami region of south-western Africa. Struggling to navigate a narrow ridge of jagged rock, his wagon had "crashed and thundered and thumped" while his oxen "charged like wild buffaloes".

To make matters worse, Galton had little faith in his local guides from the Damara tribe, who appeared to lack even an understanding of basic arithmetic - a situation Galton found "very annoying". He recounts that having established an exchange rate of one sheep for two sticks of tobacco, he handed four sticks to a local herdsman in the expectation of purchasing two sheep. Having put two sticks in front of the first sheep, the man seemed surprised that two sticks remained to pay for the second. "His mind got hazy and confused," Galton reported, and the transaction had to be abandoned and the sheep purchased separately.

As further evidence of the apparent ignorance of the Damara, Galton wrote that they "use no numeral greater than three" and that they managed to keep track of their oxen only by recognising their faces, rather than by counting them. At a most inopportune time for his expedition, Galton seemed to have stumbled into a world without numbers.

To a modern reader, these tales in Galton's 1853 Narrative of an Explorer in Tropical South Africa seem little more than pithy anecdotes that reflect his prejudices as a gentleman of the growing Victorian empire. (His preoccupation with the supposed inferiority of other peoples persisted in his later work in eugenics.) Within 10 years, however, those same reports of primitive innumeracy were being used by the finest scientific minds of Victorian Britain to glimpse the savage condition of prehistoric humans.

Read the full article here. 

Victor Niederhoffer writes:

This seems wrong to criticize Galton. What am I missing? 

Steve Stigler writes: 

Vic,

The author is a 1st year PhD student at Princeton who isn't even working on Galton, and writes carelessly without knowledge. See his bio. He looks bright but has a lot to learn.

Apr

20

What would be the correct way of running a multiple correlation to check this theses that a major part of the Rsquared comes from the DXY? Run one with it and one without it and see the R squared. Perhaps not enough. How much of the variation is explained by DXY amongst a bouquet of "relevant" variables.

Perhaps I am trying asking too many questions in a single one. Quants on the list will perhaps not mind tossing me out of the kitchen table with just a few strokes of their insightful knives.

Bill Rafter writes:

What would be the correct way of running a multiple correlation to check this theses that a major part of the Rsquared comes from the DXY? Run one with it and one without it and see the R squared. Perhaps not enough. How much of the variation is explained by DXY amongst a bouquet of "relevant" variables.

Perhaps I am trying asking too many questions in a single one. Quants on the list will perhaps not mind tossing me out of the kitchen table with just a few strokes of their insightful knives.

Mar

17

So is the consensus now among us non flexions  that the radiation danger is merely exaggerated 100 fold so that technology in the US will be set back 30 years, and government intervention will be lubricated for the next 4 years to deal with the crisis which seems so much worse to the US than the Japanese and IAEA? This is not meant to diminish the magnitude of the tragedy in Japan, but merely to wonder if we believe that the subsequent dangers have been much exaggerated for flexionic profit?

Anatoly Veltman writes:

Yes, of course. One thing to be sure about is that T.Boone Pickens' funds will start getting ahead, as Natural Gas projects (like gradual highway infrastructure to facilitate filling-up vehicles, especially trucks and such) should finally be given light-of-day.

Bill Rafter comments:

"Never let a crisis go to waste."

Jay Pasch writes:

Buy the clashing of bearish cymbals, and sell the euphoric opposite…

Kim Zussman ironizes:

Buy the clashing of bearish cymbals, and sell the euphoric opposite in flat/choppy markets. If markets ain't flat or choppy, don't buy and sell 'em. 

Steve Ellison writes: 

No doubt it was my poor judgment, but from the perspective of operating a specialty line in panics, the moments of panic in the past week in the S&P 500 seemed too brief and ephemeral to go all in. The changes since the earthquake were:

3/11 +11.7
3/14 -10.7
3/15 -15.2
3/16 -21.4
3/17 +14.9

There were three moderately large down days in a row, but for perspective, the S&P 500 futures are still up 1.5% year to date. Only for the briefest of moments did they trade below the 1247.9 year-end close of 2010.
 

Mar

16

What is the geophysics of thinking that more natural disasters are more likely now that the earth quake has occurred?

Kim Zussman shares:

Read this article.

Rudolf Hauser writes:

Another factor to consider is the shifting of the magnetic poles. This is reportedly associated with violent swings in weather and more earthquakes and volcanic explosions. Apparently there has been a marked acceleration in the rate of shifting in the past few years. Some question whether this might be the cause of recent weather extremes and geological activity. Since such shifts occur only every half million years or so we obviously have little idea of how they progress. If this is a real reason for concern it is an issue far more immediate and important that the global warming fears.

Pitt T. Maner III writes: 

There have been suggestions of a connection with renewed (regional?) vulcanism.

The last eruption of Mt. Fuji , for instance, occurred 49 days after the previous largest earthquake in Japanese history.

Another Japanese volcano has resumed activity but cause/effect from the March 11 quake may be tenuous.

The volcano, Shinmoedake, is famous for standing in as the villain's secret rocket base in the 1967 James Bond film, "You Only Live Twice". 

Bill Rafter comments: 

Earthquakes and volcanism are simply different manifestations of the goings on of plate tectonics.

Read this article from New Sceintist: "The megaquake connection: Are huge earthquakes linked?".

Feb

24

From the description on the NY Public Library's site:

Darwin's Disciple, George John Romanes

Thursday, March 3, 2011, 1:15 p.m.

Stephen A. Schwarzman Building, South Court Auditorium (Map and directions)

Fully accessible to wheelchairs

George John Romanes (1848-1894), best known today to the intellectual community for founding the Oxford University lecture series still bearing his name (1891), was a major figure in the history of biology for his advocacy of Darwinian evolution as well as his contributions in animal physiology-discovery of a nervous system in invertebrates-and in animal behavior-recognition of the ability of animals besides humans to reason. But perhaps Romanes's greatest legacy is the support he gave Darwin when it was most needed.

After publication of Darwin's Origin of Species in 1859, Darwin and his work was under attack almost from the outset, not only by the religious establishment but also by scientists offended either by the theory itself or by its primary mechanism, natural selection. Darwin and his theory needed support from other naturalists, and Romanes became a strong advocate for Darwinian evolution in the decade preceding Darwin's death in 1882, and the years before his own death in 1894, thereby filling the vacuum left by evolutionists who disagreed with Darwin on the mechanism by which species evolve.

A former Writer in Residence in the Library's Wertheim Study, Joel S. Schwartz is Professor Emeritus of Biology at the City University of New York, where he served on the faculty for forty years. His scholarly interests have focused on nineteenth century natural history, on the development of natural history, and on how maritime exploration stimulated discovery in the natural sciences. He has published numerous papers and delivered many talks on Charles Darwin, Alfred Russel Wallace, Thomas Henry Huxley, and other eminent Victorian naturalists. His book, Darwin's Disciple: George John Romanes, A Life in Letters, was published July 2010 by Lightning Rod Press at the American Philosophical Society. Currently, he is Contributing Editor of the Darwin Manuscripts Project, based at the American Museum of Natural History.

Feb

6

What is Different This Time?

 This chart illustrates one of the problems with the equities market of late. The [unnamed] variable shown was a model of consistency up until September 2010, and then started behaving less reliably. The data represents actual transactions (all of them), but would be unknown to most practitioners. Thus it is not the case of a variable being followed by so many that it becomes second-guessed and thus unreliable.

For what it's worth, this is NOT one of our decision variables.

Bill Rafter is president of Mathinvestdecisions.Com, a quantitative investment firm.

Jan

25

Here is a fascinating "CIBOARD" series from the St. Louis Fed.

Mr. Krisrock writes:

It's clear that inventories are peaking and that seasonals can't account for the extreme cold weather and the probability of a weather slowdown in European and North American sales which the Russell2000 underperforming the Dow may demonstrate…so the need to borrow cash right now is high with inventory raw material costs rising in many items. Right now there are many similarities to 2007 patterns, including the rising volatility in stat arb fund counter funds. Finally, there is high likelihood of higher ranges in the week after a democrat delivers a state of the union. With the market above its 50 and 200 day MA, theories of 1220 gold and lower crude are making the rounds…

Jan

7

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.

Dec

31

UPDATE 1/31/2011:

Contestants Summary:

- 31 Spec-listers contributed to the 2011 Investment Contest with "specific" recommendations.

- Average 4 recommendations per person (mean of 4.2, median and mode of 4) came in.

- 6 contestants gave only 1 recommendation, 3 gave only 2 and thus 9 out of the total 31 have NOT given the minimum 3 recommendations needed as per the Rules clarified by Ken Drees.

- The Hall of Fame entry for the largest number of ideas (did someone say diversification?) is from Tim Melvin, close on whose heels are J. T. Holley with 11 and Ken Drees with 10.

- The most creatively expressed entry of course has come from Rocky Humbert.

- At this moment 17 out of 31 contestants are in positive performance territory, 14 are in negative performance territory.

- Barring a major outlier of a 112.90% loss on the Option Strategy of Phil McDonnell (not accounting for the margin required for short options, but just taking the ratio of initial cash inflow to outflow):

- Average of all Individual contestant returns is -2.54% and the Standard Deviation of returns achieved by all contestants is 5.39.

- Biggest Gainer at this point is Jared Albert (with his all in single stock bet on REFR) with a 22.87% gain. The only contestant a Z score greater than 2 ( His is actually 4.72 !!)

- Biggest Loser at this point (barring the Giga-leveraged position of Mr. McDonnell) is Ken Drees at -10.36% with a Z Score that is at -1.45.

- Wildcards have not been accounted for as at this point, with wide
deviations of recommendations from the rules specified by most. While 9
participants have less than 3 recommendations, those with more than 4
include several who have not chosen to specify which 3 are their primary recommends. Without clarity on a universal measurability wildcard accounting is on hold. Those making more than 1 recommendations would find that their aggregate average return is derived by taking a sum of returns of individual positions divided by the number of recommends. Unless specified by any person that positions are taken in a specific ratio its equal sums invested approach.

Contracts Summary:

- A total of 109 contracts are utilized by the contestants across bonds, equity indices (Nikkei, Kenyan Stocks included too!), commodities, currencies and individual stock positions.

- The ratio of Shorts to Longs across all recommendations, irrespective of the type of contract (call, put, bearish ETF etc.) is 4 SELL orders Vs 9 Buy Orders. Not inferring that this list is more used to pressing the Buy Button. Just an occurence on this instance.

- The Average Return, so far, on the 109 contracts utilized is -1.26% with a Standard Deviation of 12.42%. Median Return is 0.39% and the mode of Returns of all contracts used is 0.

- The Highest Return is on MICRON TECH at 28.09, if one does not account for the July 2011 Put 25 strike on SLV utilized by Phil McDonnell.

- The Lowest Return is on IPTV at -50%, if one does not account for the Jan 2012 Call 40 Strike on SLV utilized by Phil McDonnell.

- Only Two contracts are having a greater than 2 z score and only 3 contracts are having a less than -2 Z score.

Victor Niederhoffer wrote:

One is constantly amazed at the sagacity in their fields of our fellow specs. My goodness, there's hardly a field that one of us doesn't know about from my own hard ball squash rackets to the space advertising or our President, from surfing to astronomy. We certainly have a wide range.

May I suggest without violating our mandate that we consider our best sagacities as to the best ways to make a profit in the next year of 2011.

My best trades always start with assuming that whatever didn't work the most last year will work the best this year, and whatever worked the best last year will work the worst this year. I'd be bullish on bonds and bearish on stocks, bullish on Japan and bearish on US stocks.

I'd bet against the banks because Ron Paul is going to be watching them and the cronies in the institutions will not be able to transfer as much resources as they've given them in the past 2 years which has to be much greater in value than their total market value.

I keep wondering what investments I should make based on the hobo's visit and I guess it has to be generic drugs and foods.

What ideas do you have for 2011 that might be profitable? To make it interesting I'll give a prize of 2500 to the best forecast, based on results as of the end of 2011.

David Hillman writes: 

"I do know that a sagging Market keeps my units from being full."

One would suggest it is a sagging 'economy' contributing to vacancy, not a sagging 'market'. There is a difference. 

Ken Drees, appointed moderator of the contest, clearly states the new rules of the game:

1. Submissions for contest entries must be made on the last two days of 2010, December 30th or 31st.
2. Entries need to be labeled in subject line as "2011 contest investment prediction picks" or something very close so that we know this is your official entry.
3. Entries need 3 predictions and 1 wildcard trade prediction (anything goes on the wildcard).

4. Extra predictions may be submitted and will be judged as extra credit. This will not detract from the main predictions and may or may not be judged at all.

5. Extra predictions will be looked on as bravado– if you've got it then flaunt it. It may pay off or you may give the judge a sour palate.

The desire to have entries coming in at years end is to ensure that you have the best data as to year end 2010 and that you don't ignite someone else to your wisdom.

Market direction picks are wanted:

Examples: 30 year treasury yield will fall to 3% in 2011, S&P 500 will hit "x" by June, and then by "y" by December 2011.

The more exact your prediction is, the more weight will be given. The more exact your prediction, the more weight you will receive if right and thus the more weight you will receive if wrong. If you predict that copper will hit 5.00 dollars in 2011 and it does you will be given a great score, if you say that copper will hit 5.00 dollars in march and then it will decline to4.35 and so forth you will be judged all along that prediction and will receive extra weight good or bad. You decide on how detailed your submission is structured.

Will you try to be precise (maybe foolhardy) and go for the glory? Or will you play it safe and not stand out from the crowd? It is a doubled edged sword so its best to be the one handed market prognosticator and make your best predictions. Pretend these predictions are some pearls that you would give to a close friend or relative. You may actually help a speclister to make some money by giving up a pearl, if that speclister so desires to act upon a contest–G-d help him or her.

Markets can be currency, stocks, bonds, commodities, etc. Single stock picks can be given for the one wildcard trade prediction. If you give multiple stock picks for the wildcard then they will all be judged and in the spirit of giving a friend a pearl–lets make it "the best of the best, not one of six".

All judgments are the Chair's. The Chair will make final determination of the winner. Entries received with less than 3 market predictions will not be considered. Entries received without a wildcard will be considered.The spirit of the contest is "Give us something we can use".

Bill Rafter adds: 

Suggestion for contest:

"Static" entry: A collection of up to 10 assets which will be entered on the initial date (say 12/31/2010) and will be unaltered until the end data (i.e. 12/31/2011). The assets could be a compilation of longs and shorts, or could have the 10 slots entirely filled with one asset (e.g. gold). The assets could also be a yield and a fixed rate; that is one could go long the 10-year yield and short a fixed yield such as 3 percent. This latter item will accommodate those who want to enter a prediction but are unsure which asset to enter as many are unfamiliar with the various bond coupons.

"Rebalanced" entry: A collection of up to 10 assets which will be rebalanced on the last trading day of each month. Although the assets will remain unchanged, their percentage of the portfolio will change. This is to accommodate those risk-averse entrants employing a mean-reversion strategy.

Both Static and Rebalanced entries will be judged on a reward-to-risk basis. That is, the return achieved at the end of the year, divided by the maximum drawdown (percentage) one had to endure to achieve that return.

Not sure how to handle other prognostications such as "Famous female singer revealed to be man." But I doubt such entries have financial benefits.

I'm willing to be an arbiter who would do the rebalancing if necessary. I am not willing to prove or disprove the alleged cross-dressers.

Ralph Vince writes:

A very low volume bar on the weekly (likely, the first of two consecutive) after a respectable run-up, the backdrop of rates having risen in recent weeks, breadth having topped out and receding - and a lunar eclipse on the very night of the Winter Solstice.

If I were a Roman General I would take that as a sign to sit for next few months and do nothing.

I'm going to sit and do nothing.

Sounds like an interim top in an otherwise bullish, long-term backdrop.

Gordon Haave writes: 

My three predictions:

Gold/ silver ratio falls below 25 Kenyan stock market outperforms US by more than 10%

Dollar ends 10% stronger compared to euro

All are actionable predictions.

Steve Ellison writes:

I did many regressions looking for factors that might predict a year-ahead return for the S&P 500. A few factors are at extreme values at the end of 2010.

The US 10-year Treasury bond yield at 3.37% is the second-lowest end-of year yield in the last 50 years. The S&P 500 contract is in backwardation with the front contract at a 0.4% premium to the next contract back, the second highest year-end premium in the 29 years of the futures.

Unfortunately, neither of those factors has much correlation with the price change in the S&P 500 the following year. Here are a few that do.

The yield curve (10-year yield minus 3-month yield) is in the top 10% of its last 50 year-end values. In the last 30 years, the yield curve has been positively correlated with year-ahead changes in the S&P 500, with a t score of 2.17 and an R squared of 0.143.

The US unemployment rate at 9.8% is the third highest in the past 60 years. In the last 30 years, the unemployment rate has been positively correlated with year-ahead changes in the S&P 500, with a t score of 0.90 and an R squared of 0.028.

In a variation of the technique used by the Yale permabear, I calculated the S&P 500 earnings/price ratio using 5-year trailing earnings. I get an annualized earnings yield of 4.6%. In the last 18 years, this ratio has been positively correlated with year-ahead changes in the S&P 500, with a t score of 0.92 and an R squared of
0.050.

Finally, there is a negative correlation between the 30-year S&P 500 change and the year-ahead change, with a t score of -2.28 and an R squared of 0.094. The S&P 500 index price is 9.27 times its price of 30 years ago. The median year-end price in the last 52 years was 6.65 times the price 30 years earlier.

Using the predicted values from each of the regressions, and weighting the predictions by the R squared values, I get an overall prediction for an 11.8% increase in the S&P 500 in 2011. With an 11.8% increase, SPY would close 2011 at 140.52.

Factor                  Prediction      t       N    R sq
US Treasury yield curve      1.162    2.17      30   0.143
30-year change               1.052   -2.28      52   0.094
Trailing 5-year E/P          1.104    0.92      18   0.050
US unemployment rate         1.153    0.90      30   0.028

Weighted total               1.118
SPY 12/30/10               125.72
Predicted SPY 12/30/11     140.52

Jan-Petter Janssen writes: 

PREDICTION I - The Inconvenient Truth The poorest one or two billion on this planet have had enough of increasing food prices. Riots and civil unrest force governments to ban exports, and they start importing at any cost. World trade collapses. Manufacturers of farm equipment will do extremely well. Buy the most undervalued producer you can find. My bet is
* Kverneland (Yahoo: KVE.OL). NOK 6.50 per share today. At least NOK 30 on Dec 31th 2011.

PREDICTION II - The Ultimate Bubble The US and many EU nations hold enormous gold reserves. E.g. both Italy and France hold the equivalent of the annual world production. The gold meme changes from an inflation hedge / return to the gold standard to (a potential) over-supply from the selling of indebted nations. I don't see the bubble bursting quite yet, but
* Short gold if it hits $2,000 per ounce and buy back at $400.

PREDICTION III - The Status Quo Asia's ace is cheap labor. The US' recent winning card is cheap energy through natural gas. This will not change in 2011. Henry Hub Feb 2011 currently trades at $4.34 per MMBtu. Feb 2012 is at $5.14. I would
* Short the Feb 2012 contract and buy back on the last trading day of 2011.

Vince Fulco predicts:

This is strictly an old school, fundamental equity call as my crystal ball for the indices 12 months out is necessarily foggy. My recommendation is BP equity primarily for the reasons I gave earlier in the year on June 5th (stock closed Friday, June 4th @ $37.16, currently $43.53). It faced a hellish downdraft post my mention for consideration, primarily due to the intensification of news flow and legal unknowns (Rocky articulated these well). Also although the capital structure arb boys savaged the equity (to 28ish!), it is up nicely to year's end if one held on and averaged in with wide scales given the heightened vol.

Additional points/guesstimates are:

1) If 2010 was annus horribilis, 2011 with be annus recuperato. A chastened mgmt who have articulated they'll run things more conservatively will have a lot to prove to stakeholders.

2) Dividend to be re-instated to some level probably by the end of the second quarter. I am guessing $1.00 annualized per ADS as a start (or
2.29%), this should bring in the index hugging funds with mandates for only holding dividend payers. There is a small chance for a 1x special dividend later in the year.

3) Crude continues to be in a state of significant profitability for the majors in the short term. It would appear finding costs are creeping however.

4) The lawsuits and additional recoveries to be extracted from the settlement fund and company directly have very long tails, on the order of 10 years.

5) The company seems fully committed to sloughing off tertiary assets to build up its liquid balance sheet. Debt to total capital remains relatively low and manageable.

6) The stock remains at a significant discount to its better-of breed peers (EV/normalized EBITDA, Cash Flow, etc) and rightly so but I am betting the discount should narrow back to near historical levels.

Potential negatives:

1) The company and govt have been vastly understating the remaining fuel amounts and effects. Release of independent data intensifies demands for a much larger payout by the company closer to the highest end estimates of $50-80B.

2) It experiences another similar event of smaller magnitude which continues to sully the company's weakened reputation.

3) China admits to and begins to fear rampant inflation, puts the kabosh to the (global) economy and crude has a meaningful decline the likes of which we haven't seen in a few years.

4) Congress freaks at a >$100-120 price for crude and actually institutes an "excess profits" tax. Less likely with the GOP coming in.

A buy at this level would be for an unleveraged, diversified, longer term acct which I have it in. However, I am willing to hold the full year or +30% total return (including special dividend) from the closing price of $43.53 @ 12/30/10, whichever comes first. Like a good sellside recommendation, I believe the stock has downside of around 20% (don't they all when recommended!?!) where I would consider another long entry depending on circumstances (not pertinent to the contest).

Mr. Albert enters: 

Single pick stock ticker is REFR

The only way this gold chain wearing day trader has a chance against all the right tail brain power on the list is with one high risk/high reward put it all on red kind of micro cap.

Basic story is this company owns all the patents to what will become the standard for switchable glazings (SPD smart glass). It's taken roughly 50 years of development to get a commercialized product, and next year Mercedes will almost without doubt use SPD in the 2012 SLK (press launch 1/29/11 public launch at the Geneva auto show in march 2011).

Once MB validate the tech, mass adoption and revenues will follow etc and this 'show me' stock will rocket to the moon.

Dan Grossman writes:

Trying to comply with and adapt the complex contest rules (which most others don't seem to be following in any event) to my areas of stock market interest:

1. The S&P will be down in the 1st qtr, and at some point in the qtr will fall at least

2. For takeover investors: GENZ will (finally) make a deal to be acquired in the 1st qtr for a value of at least $80; and AMRN after completion of its ANCHOR trial will make a deal to be acquired for a price of at least $8.

3. For conservative investors: Low multiple small caps HELE and DFG will be up a combined average of 20% by the end of the year.

For my single stock pick, I am something of a johnny-one-note: MNTA will be up lots during the year — if I have to pick a specific amount, I'd say at least 70%. (My prior legal predictions on this stock have proved correct but the stock price has not appropriately reflected same.)

Finally, if I win the contest (which I think is fairly likely), I will donate the prize to a free market or libertarian charity. I don't see why Victor should have to subsidize this distinguished group that could all well afford an contest entrance fee to more equitably finance the prize.

Best to all for the New Year,

Dan 

Gary Rogan writes:

1. S&P 500 will rise 3% by April and then fall 12% from the peak by the end of the year.
2. 30 year treasury yields will rise to 5% by March and 6% by year end.
3. Gold will hit 1450 by April, will fall to 1100 by September and rise to 1550 by year end.

Wildcard: Short Netflix.

Jack Tierney, President of the Old Speculator's Club, writes: 

Equal Amounts in:

TBT (short long bonds)
YCS (short Yen)
GRU (Long Grains - heavy on wheat)
CHK (Long NG - takeover)

(Wild Card)
BONXF.PK or BTR.V (Long junior gold)

12/30 closing prices (in order):
37.84
15.83
7.20
25.97

.451

Bill Rafter writes:

Two entries:

Buy: FXP and IRWD

Hold for the entire year.

William Weaver writes:

For Returns: Long XIV January 21st through year end

For Return/Risk: Long XIV*.30 and Long VXZ*.70 from close today

I hope everyone has enjoyed a very merry holiday season, and to all I wish a wonderful New Year.

Warmest,

William

Ken Drees writes:

Yes, they have been going up, but I am going contrary contrary here and going with the trends.

1. Silver: buy day 1 of trading at any price via the following vehicles: paas, slw, exk, hl –25% each for 100% When silver hits 39/ounce, sell 10% of holdings, when silver hits 44/ounce sell 30% of holdings, when silver hits 49 sell 60%–hold rest (divide into 4 parts) and sell each tranche every 5 dollars up till gone–54/oz, 59, 64, 69.

2. Buy GDXJ day 1 (junior gold miner etf)—rotation down from majors to juniors with a positive gold backdrop. HOLD ALL YEAR.

3. USO. Buy day 1 then do—sell 25% at 119/bbl oil, sell 80% at 148/bbl, sell whats left at 179/bbl or 139/bbl (whichever comes first after 148)

wildcard: AMEX URANUIM STOCKS. UEC, URRE, URZ, DNN. 25% EACH, buy day 1 then do SELL 70% OF EVERYTHING AT 96$LB u http://www.uxc.com/ FOR PRICING, AND HOLD REST FOR YEAR END.

Happy New Year!

Ken Drees———keepin it real.

Sam Eisenstadt forecasts:

My forecast for the S&P 500 for the year ending Dec 31, 2011;

S&P 500       1410

Anton Johnson writes: 

Equal amounts allocated to:

EDZ Short moc 1-21-2011, buy to cover at 50% gain, or moc 12/30/2011

VXX Short moc 1-21-2011, buy to cover moc 12/30/2011

UBT Short moo 1-3-2011, buy to cover moc 12/30/2011

Scott Brooks picks: 

 RTP
TSO
SLV
LVS

Evenly between the 4 (25% each)

Sushil Kedia predicts:

 Short:

1) Gold
2) Copper
3) Japanese Yen

30% moves approximately in each, within 2011.

Rocky Humbert writes:

(There was no mention nor requirement that my 2011 prediction had to be in English. Here is my submission.) … Happy New Year, Rocky

Sa aking mahal na kaibigan: Sa haba ng 2010, ako na ibinigay ng ilang mga ideya trading na nagtrabaho sa labas magnificently, at ng ilang mga ideya na hindi na kaya malaki. May ay wala nakapagtataka tungkol sa isang hula taon dulo, at kung ikaw ay maaaring isalin ito talata, ikaw ay malamang na gawin ang mas mahusay na paggawa ng iyong sariling pananaliksik kaysa sa pakikinig sa mga kalokohan na ako at ang iba pa ay magbigay. Ang susi sa tagumpay sa 2011 ay ang parehong bilang ito ay palaging (tulad ng ipinaliwanag sa pamamagitan ng G. Ed Seykota), sa makatuwid: 1) Trade sa mga kalakaran. 2) Ride winners at losers hiwa. 3) Pamahalaan ang panganib. 4) Panatilihin ang isip at diwa malinaw. Upang kung saan gusto ko idagdag, fundamentals talaga bagay, at kung ito ay hindi magkaroon ng kahulugan, ito ay hindi magkaroon ng kahulugan, at diyan ay wala lalo na pinakinabangang tungkol sa pagiging isang contrarian bilang ang pinagkasunduan ay karaniwang karapatan maliban sa paggawa sa mga puntos. (Tandaan na ito ay pinagkasunduan na ang araw ay babangon na bukas, na quote Seth Klarman!) Pagbati para sa isang malusog na masaya at pinakinabangang 2011, at siguraduhin na basahin www.rockyhumbert.com kung saan ako magsulat sa Ingles ngunit ang aking mga saloobin ay walang malinaw kaysa talata na ito, ngunit inaasahan namin na ito ay mas kapaki-pakinabang.

Dylan Distasio comments: 

Gawin mo magsalita tagalog?

Gary Rogan writes:

After a worthy challenge, Mr. Rogan is now also a master of Google Translate, and a discoverer of an exciting fact that Google Translate calls Tagalog "Filipino". This was a difficult obstacle for Mr. Rogan to overcome, but he persevered and here's Rocky's prediction in English (sort of):

My dear friend: Over the course of 2010, I provided some trading ideas worked out magnificently, and some ideas that are not so great. There is nothing magical about a forecast year end, and if you can translate this paragraph, you will probably do better doing your own research rather than listening to the nonsense that I and others will give. The key to success in 2011 is the same as it always has (as explained by Mr. Ed Seykota), namely: 1) Trade with the trend.

2) Ride cut winners and losers. 3) Manage risk. 4) Keep the mind and spirit clear. To which I would add, fundamentals really matter, and if it does not make sense, it does not make sense, and there is nothing particularly profitable about being a contrarian as the consensus is usually right but turning points. (Note that it is agreed that the sun will rise tomorrow, to quote Seth Klarman) Best wishes for a happy healthy and profitable 2011, and be sure to read www.rockyhumbert.com which I write in English but my attitude is nothing clearer than this paragraph, but hopefully it is more useful.

Tim Melvin writes:

Ah the years end prediction exercise. It is of course a mostly useless exercise since not a one of us can predict what shocks, positive or negative, the world and the markets could see in 2011. I find it crack up laugh out loud funny that some pundits come out and offer up earnings estimates, GDP growth assumptions and interest rate guesses to give a precise level for the year end S&P 500 price. You might as well numbers out of a bag and rearrange them by lottery to come up with a year end number. In a world where we are fighting two wars, a hostile government holds the majority of our debt and several sovereign nations continually teeter on the edge of oblivion it's pretty much ridiculous to assume what could happen in the year ahead. Having said that, as my son's favorite WWE wrestler when he was a little guy used to say "It's time to play the game!"

Ill start with bonds. I have owned puts on the long term treasury market for two years now. I gave some back in 2010 after a huge gain in 2009 but am still slightly ahead. Ill roll the position forward and buy January 2012 puts and stay short. When I look at bods I hear some folks talking about rising basic commodity prices and worrying about inflation. They are of course correct. This is happening. I hear some other really smart folks talking of weak real estate, high jobless rates and the potential for falling back into recession. Naturally, they are also exactly correct. So I will predict the one thing no one else is. We are on the verge of good old fashioned 1970s style stagflation. Commodity and basic needs prices will accelerate as QE2 has at least stimulated demand form emerging markets by allowing these wonderful credits to borrow money cheaper than a school teacher with a 750 FICO score. Binds go lower as rates spike. Our economy and balance sheet are a mess and we have governments run by men in tin hats lecturing us on fiscal responsibility. How low will they go Tim? How the hell do I know? I just think they go lower by enough for me to profit.

Nor can I tell you where the stock market will go this year. I suspect we have had it too good for too long for no reason so I think we get at least one spectacular gut wrenching, vomit inducing sell off during the year. Much as lower than expected profits exposed the silly valuations of the new paradigm stocks I think that the darling group, retail , will spark a sell-off in the stock market this year. Sales will be up a little bit but except for Tiffany's (TIF) and that ilk margins are horrific. Discounting started early this holiday and grew from there. They will get steeper now that that Santa Claus has given back my credit card and returned to the great white north. The earnings season will see a lot of missed estimates and lowered forecasts and that could well pop the bubble. Once it starts the HFT boys and girls should make sure it goes lower than anyone expects.

Here's the thing about my prediction. It is no better than anyone else's. In other words I am talking my book and predicting what I hope will happen. Having learned this lesson over the years I have learned that when it comes to market timing and market direction I am probably the dumbest guy in the room. Because of that I have trained myself to always buy the stuff that's too cheap not to own and hold it regardless. After the rally since September truly cheap stuff is a little scarce on the ground but I have found enough to be about 40% long going into the year. I have a watch list as long as a taller persons right arm but most of it hover above truly cheap.

Here is what I own going into the year and think is still cheap enough to buy. I like Winn Dixie (WINN). The grocery business sucks right now. Wal mart has crushed margins industry wide. That aside WINN trades at 60% of tangible book value and at some point their 514 stores in the Southeast will attract attention from investors. A takeover here would be less than shocking. I will add Presidential Life (PLFE) to the list. This stock is also at 60% of tangible book and I expect to see a lot of M&A activity in the insurance sector this year and this should raise valuations across the board. I like Miller Petroleum (MILL) with their drilling presence in Alaska and the shale field soft Tennessee. This one trades at 70% of tangible book. Ill add Imperial Sugar (IPSU), Syms (SYMS) and Micron tech (MU) and Avatar Holdings (AVTR) to my list of cheapies and move on for now.

I am going to start building my small bank portfolio this year. Eventually this group becomes the F-you walk away money trade of the decade. As real estate losses work through the balance sheet and some measure of stability returns to the financial system, perhaps toward the end of the year the small baileys savings and loan type banks should start to recover. We will also see a mind blowing M&A wave as larger banks look to gain not just market share but healthy assets to put on the books. Right now these names trade at a fraction of tangible book value. They will reach a multiple of that in a recovery or takeover scenario. Right now I own shares of Shore Bancshares (SHBI), a local bank trading at 80% of book value and a reasonably healthy loan portfolio. I have some other mini microcap banks as well that shall remain my little secret and not used to figure how my predictions work out. I mention them because if you have a mini micro bank in your community you should go meet then bankers, review the books and consider investing if it trades below the magical tangible book value and has excess capital. Flagstar Bancorp(FBC) is my super long shot undated call option n the economy and real estate markets.

I will also play the thrift conversion game heavily this year. With the elimination of the Office of Thrift Services under the new financial regulation many of the benefits of being a private or mutual thrift are going away. There are a ton of mutual savings banks that will now convert to publicly traded banks. A lot of these deals will be priced below the pro forma book value that is created by adding all that lovely IPO cash to the balance sheet without a corresponding increase in the shares outstanding. Right now I have Fox Chase Bancorp (FXCB) and Capital Federal Financial(CFFN). There will be more. Deals are happening every day right now and again I would keep an eye out for local deals that you can take advantage of in the next few months.

I also think that 2011 will be the year of the activist investor. These folks took a beating since 2007 but this should be their year. There is a ton of cash on corporate balance sheets but lots of underperformance in the current economic environment. We will see activist drive takeovers, restructures, and special dividends this year in my opinion. Recent filings of interest include strong activist positions in Surmodics(SRDX), SeaChange International (SEAC), and Energy Solutions. Tracking activist portfolios and 13D filings should be a very profitable activity in 2011.

I have been looking at some interesting new stuff with options as well I am not going to give most of it away just yet but I ll give you one stimulated by a recent list discussion. H and R Black is highly likely to go into a private equity portfolio next year. Management has made every mistake you can make and the loss of RALs is a big problem for the company. However the brand has real value. I do not want town the stock just yet but I like the idea of selling the January 2012 at $.70 to $.75. If you cash secure the put it's a 10% or so return if the stock stays above the strike. If it falls below I' ll be happy to own the stock with a 6 handle net. Back in 2008 everyone anticipated a huge default wave to hit the high yield market. Thanks to federal stimulus money pumping programs it did not happen. However in the spirit of sell the dog food the dog will eat a given moment the hedge fund world raised an enormous amount od distressed debt money. Thanks to this high yield spreads are far too low. CCC paper in particular is priced at absurd levels. These things trade like money good paper and much of it is not. Extend and pretend has helped but if the economy stays weak and interest rates rise rolling over the tsunami f paper due over the next few years becomes nigh onto impossible. I am going take small position in puts on the various high yield ETFs. If I am right they will explode when that market implodes. Continuing to talk my book I hope this happens. Among my nightly prayers is "Please God just one more two year period of asset rich companies with current payments having bonds trade below recovery value and I promise not to piss the money away this time. Amen.

PS. If you add in risk arbitrage spreads of 30% annualized returns along with this I would not object. Love, Tim.

I can't tell you what the markets will do. I do know that I want to own some safe and cheap stocks, some well capitalized small banks trading below book and participate in activist situation. I will be under invested in equities going into the year hoping my watch list becomes my buy list in market stumble. I will have put positions on long T-Bonds and high yield hoping for a large asymmetrical payoff.

Other than that I am clueless.

Kim Zussman comments: 

Does anyone else think this year is harder than usual to forecast? Is it better now to forecast based on market fundamentals or mass psychology? We are at a two year high in stocks, after a huge rally off the '09 bottom that followed through this year. One can make compelling arguments for next year to decline (best case scenarios already discounted, prior big declines followed by others, volatility low, house prices still too high, FED out of tools, gov debt/gdp, Roubini says so, benefits to wall st not main st, persistent high unemployment, Year-to-year there is no significant relationship, but there is a weak down tendency after two consecutive up years. ). And compelling arguments for up as well (crash-fears cooling, short MA's > long MA's, retail investors and much cash still on sidelines, tax-cut extended, employee social security lowered, earnings increasing, GDP increasing, Tepper and Goldman say so, FED herding into risk assets, benefits to wall st not main st, employment starting to increase).

Is the level of government market-intervention effective, sustainable, or really that unusual? The FED looks to be avoiding Japan-style deflation at all costs, and has a better tool in the dollar. A bond yields decline would help growth and reduce deflation risk. Increasing yields would be expected with increasing inflation; bad for growth but welcomed by retiring boomers looking for fixed income. Will Obamacare be challenged or defanged by states or in the supreme court? Will 2011 be the year of the muni-bubble pop?

A ball of confusion!

4 picks in equal proportion:

long XLV (health care etf; underperformed last year)

long CMF (Cali muni bond fund; fears over-wrought, investors still need tax-free yield)

short GLD (looks like a bubble and who needs gold anyway)

short IEF (7-10Y treasuries; near multi-year high/QE2 is weaker than vigilantism)

Alan Millhone writes:

Hello everyone,

I note discussion over the rules etc. Then you have a fellow like myself who has never bought or sold through the Market a single share.

For myself I will stick with what I know a little something. No, not Checkers —

Rental property. I have some empty units and beginning to rent one or two of late to increase my bottom line.

I will not venture into areas I know little or nothing and will stay the course in 2011 with what I am comfortable.

Happy New Year and good health,

Regards,

Alan

Jay Pasch predicts: 

2010 will close below SP futures 1255.

Buy-and-holders will be sorely disappointed as 2011 presents itself as a whip-saw year.

99% of the bullish prognosticators will eat crow except for the few lonely that called for a tempered intra-year high of ~ SPX 1300.

SPX will test 1130 by April 15 with a new recovery high as high as 1300 by the end of July.

SPX 1300 will fail with new 2011 low of 1050 before ending the year right about where it started.

The Midwest will continue to supply the country with good-natured humble stock, relatively speaking.

Chris Tucker enters: 

Buy and Hold

POT
MS
CME

Wildcard:  Buy and Hold AVAV

Gibbons Burke comments: 

Mr. Ed Seykota once outlined for me the four essential rules of trading:

1) The trend is your friend (till it bends when it ends.)

2) Ride your winners.

3) Cut your losses short.

4) Keep the size of your bet small.

Then there are the "special" rules:

5) Follow all the rules.

and for masters of the game:

6) Know when to break rule #5

A prosperous and joy-filled New Year to everyone.

Cheers,

Gibbons

John Floyd writes:

In no particular order with target prices to be reached at some point in 2011:

1) Short the Australian Dollar:current 1.0220, target price .8000

2) Short the Euro: current 1.3375, target price 1.00

3) Short European Bank Stocks, can use BEBANKS index: current 107.40, target 70

A Mr. Krisrock predicts: 

1…housing will continue to lag…no matter what can be done…and with it unemployment will remain

2…bonds will outperform as republicans will make cutting spending the first attack they make…QE 2 will be replaced by QE3

3…with every economist in the world bullish, stocks will underperform…

4…commodities are peaking ….

Laurel Kenner predicts: 

After having made monkeys of those luminaries who shorted Treasuries last year, the market in 2011 has had its laugh and will finally carry out the long-anticipated plunge in bond prices.

Short the 30-year bond futures and cover at 80.

Pete Earle writes:

All picks are for 'all year' (open first trading day/close last trading day).

1. Long EUR/USD
2. Short gold (GLD)

Short:
MMR (McMoran Exploration Corp)
HDIX (Home Diagnostics Inc)
TUES (Tuesday Morning Corp)

Long:
PBP (Powershares S&P500 Buy-Write ETF)
NIB (iPath DJ-UBS Cocoa ETF)
KG (King Pharmaceuticals)

Happy New Year to all,

Pete Earle

Paolo Pezzutti enters: 

If I may humbly add my 2 cents:

- bearish on S&P: 900 in dec
- crisis in Europe will bring EURUSD down to 1.15
- gold will remain a safe have haven: up to 1500
- big winner: natural gas to 8

J.T Holley contributes: 

Financials:

The Market Mistress so eloquently must come first and foremost. Just as daily historical stats point to betting on the "unchanged" so is my S&P 500 trade for calendar year 2011. Straddle the Mistress Day 1. My choice for own reasons with whatever leverage is suitable for pain thresholds is a quasi straddle. 100% Long and 50% Short in whatever instrument you choose. If instrument allows more leverage, first take away 50% of the 50% Short at suitable time and add to the depreciated/hopefully still less than 100% Long. Feel free to add to the Long at this discretionary point if it suits you. At the next occasion that is discretionary take away remaining Short side of Quasi Straddle, buckle up, and go Long whatever % Long that your instrument or brokerage allows till the end of 2011. Take note and use the historical annual standard deviation of the S&P 500 as a rudder or North Star, and throw in the quarterly standard deviation for testing. I think the ambiguity of the current situation will make the next 200-300 trading days of data collection highly important, more so than prior, but will probably yield results that produce just the same results whatever the Power Magnification of the Microscope.

Long the U.S. Dollar. Don't bother with the rest of the world and concern yourself with which of the few other Socialist-minded Country currencies to short. Just Long the U.S. Dollar on Day 1 of 2011. Keep it simple and specialize in only the Long of the U.S. Dollar. Cataclysmic Economic Nuclear Winter ain't gonna happen. When the Pastor preaches only on the Armageddon and passes the plate while at the pulpit there is only one thing that happens eventually - the Parish dwindles and the plate stops getting filled. The Dollar will bend as has, but won't break or at least I ain't bettin' on such.

Ala Mr. Melvin, Short any investment vehicle you like that contains the words or numerals "perpetual maturity", "zero coupon" and "20-30yr maturity" in their respective regulated descriptions, that were issued in times of yore. Unfortunately it doesn't work like a light switch with the timing, remember it's more like air going into a balloon or a slow motion see-saw. We always want profits initially and now and it just doesn't work that way it seems in speculation. Also, a side hedge is to start initially looking at any financial institution that begins, dabbles, originates and gains high margin fees from 50-100 year home loans or Zero-Coupon Home Loans if such start to make their way Stateside. The Gummit is done with this infusion and cheer leading. They are in protection mode, their profit was made. Now the savy financial engineers that are left or upcoming will continue to find ways to get the masses to think they "Own" homes while actually renting them. Think Car Industry '90-'06 with. Japan did it with their Notes and I'm sure some like-minded MBA's are baiting/pushing the envelopes now in board rooms across the U.S. with their profitability and ROI models, probably have ditched the Projector and have all around the cherry table with IPads watching their presentation. This will ultimately I feel humbly be the end of the Mortgage Interest Deduction as it will be dwindled down to a moot point and won't any longer be the leading tax deduction that it was created to so-called help.

Metals:

Short Gold, Short it, Short it more. Take all of your emotions and historical supply and demand factors out of the equation, just look at the historical standard deviation and how far right it is and think of Buzz Lightyear in Toy Story and when he thought he was actually flying and the look on his face at apex realization. That plus continue doing a study on Google Searches and the number of hits on "stolen gold", "stolen jewelery", and Google Google side Ads for "We buy Gold". I don't own gold jewelery, and have surrendered the only gold piece that I ever wore, but if I was still wearing it I'd be mighty weary of those that would be willing to chop a finger off to obtain. That ain't my fear, that's more their greed.

Long lithium related or raw if such. Technology demands such going forward.

Energy:

Long Natural Gas. Trading Day 1 till last trading day of the year. The historic "cheap" price in the minds of wannabe's will cause it to be leveraged long and oft with increasing volume regardless of the supply. Demand will follow, Pickens sowed the seeds and paid the price workin' the mule while plowin'. De-regulation on the supply side of commercial business statements is still in its infancy and will continue, politics will not beat out free markets going into the future.

Long Crude and look to see the round 150 broken in years to come while China invents, perfects, and sees the utility in the Nuclear fueled tanker.

Long LED, solar, and wind generation related with tiny % positions. Green makes since, its here to stay and become high margined profitable businesses.

Agriculture:

Short Sugar. Sorry Mr. Bow Tie. Monsanto has you Beet! That being stated, the substitute has arrived and genetically altered "Roundup Ready" is here to stay no matter what the Legislative Luddite Agrarians try, deny, or attempt. With that said, Long MON. It is way more than a seed company. It is more a pharmaceutical engineer and will bring down the obesity ridden words Corn Syrup eventually as well. Russia and Ireland will make sure of this with their attitudes of profit legally or illegally.

Prepare to long in late 2011 the commercialized marijuana and its manufacturing, distribution companies that need to expand profitability from its declining tobacco. Altria can't wait, neither can Monsanto. It isn't a moral issue any longer, it's a financial profit one. We get the joke, or choke? If the Gummit doesn't see what substitutes that K2 are doing and the legal hassles of such and what is going on in Lisbon then they need to have an economic lesson or two. It will be a compromise between the Commercial Adjective Definition Agrarians and Gummit for tax purposes with the Green theme continuing and lobbying.

Short Coffee, but just the 1st Qtr of 2011. Sorry Seattle. I will also state that there will exist a higher profit margin substitute for the gas combustible engine than a substitute for caffeine laden coffee.

Sex and Speculation:

Look to see www.fyretv.com go public in 2011 with whatever investment bank that does such trying their best to be anonymous. Are their any investment banks around? This Boxxx will make Red Box blush and Apple TV's box envious. IPTV and all related should be a category that should be Longed in 2011 it is here to stay and is in it's infancy. Way too many puns could be developed from this statement. Yes, I know fellas the fyre boxxx is 6"'s X 7"'s.

Music:

This is one category to always go Long. I have vastly improved my guitar playin' in '10 and will do so in '11. AAPL still has the edge and few rivals are even gaining market share and its still a buy on dips, sell on highs empirically counted. They finally realized that .99 cents wasn't cutting it and .69 cents was more appropriate for those that have bought Led Zeppelin IV songs on LP, 8-track, cassette, and CD over the course of their lives. Also, I believe technology has a better shot at profitably bringing music back into public schools than the Federal or State Gummits ever will.

Other:

Long - Your mind. Double down on this Day 1 of 2011. It's the most capable, profitable thing you have going for you. I just learned this after the last 36 months.

Long - Counting, you need it now more than ever. It's as important as capitalism.

Long - Being humble, it's intangible but if quantified has a STD of 4 if not higher.

Long - Common Sense.

Long - Our Children. The media is starting to question if their education is priceless, when it is, but not in their context or jam.

Short - Politics. It isn't a spectator sport and it has been made to be such.

Short - Fear, it is way way been played out. Test anything out there if you like. I have. It is prevalent still and disbelief is rampant.

Long - Greed, but don't be greedy just profitable. Wall Street: Money Never Sleeps was the pilot fish.

I had to end on a Long note.

Happy New Year's Specs. Thanks to all for support over the last four years. I finally realized that it ain't about being right or wrong, just profitable in all endeavors. Too many losses led to this, pain felt after lookin' within, and countin' ones character results with pen/paper.

Russ Sears writes:

For my entry to the contest, I will stick with the stocks ETF, and the index markets and avoid individual stocks, and the bonds and interest rates. This entry was thrown together rather quickly, not at all an acceptable level if it was real money. This entry is meant to show my personal biases and familiarity, rather than my investment regiment. I am largely talking my personal book.

Therefore, in the spirit of the contest , as well as the rules I will expose my line of thinking but only put numbers on actual entry predictions. Finally, if my caveats are not warning enough, I will comment on how a prediction or contest entry differs from any real investment. I would make or have made.

The USA number one new product export will continue to be the exportation of inflation. The printing of dollars will continue to have unintended consequences than its intended effect on the national economy but have an effect on the global economy.. Such monetary policy will hit areas with the most potential for growth: the emerging markets of China and India. In these economies, that spends over half their income on food, food will continue to rise. This appears to be a position opposite the Chairs starting point prediction of reversal of last year's trends.

Likewise, the demand for precious metals such as gold and silver will not wane as these are the poor man's hedge against food cost. It may be overkill for the advanced economies to horde the necessities and load up on precious metals Yet, unlike the 70's the US/ European economy no longer controls gold and silver a paradigm shift in thinking that perhaps the simple statistician that uses weighted averages and the geocentric economist have missed. So I believe those entries shorting gold or silver will be largely disappointed. However in a nod to the chair's wisdom, I will not pick metals directly as an entry. Last year's surprise is seldom this year's media darling. However, the trend can continue and gold could have a good year. The exception to the reversal rule seems to be with bubbles which gain a momentum of their own, apart from the fundamentals. The media has a natural sympathy in suggesting a return to the drama of he 70's, the stagflation dilemma, ,and propelling an indicator of doom. With the media's and the Fed's befuddled backing perhaps the "exception" is to be expected. But I certainly don't see metal's impending collapse nor its continued performance.

The stability or even elevated food prices will have some big effects on the heartland.

1. For my trend is your friend pick: Rather than buy directly into a agriculture commodity based index like DBA, I am suggesting you buy an equity agriculture based ETF like CRBA year end price at 77.50. I am suggesting that this ETF do not need to have commodities produce a stellar year, but simply need more confirmation that commodity price have established a higher long term floor. Individually I own several of these stocks and my wife family are farmers and landowners (for full disclosure purposes not to suggest I know anything about the agriculture business) Price of farmland is raising, due to low rates, GSE available credit, high grain prices due to high demand from China/India, ethanol substitution of oil A more direct investment in agriculture stability would be farmland. Farmers are buying tractors, best seeds and fertilizers of course, but will this accelerate. Being wrong on my core theme of stable to rising food/commodity price will ruin this trade. Therefore any real trade would do due diligence on individual stocks, and put a trailing floor. And be sensitive to higher volatility in commodities as well as a appropriate entry and exit level.

2. For the long term negative alpha, short term strength trade: I am going with airlines and FAA at 49.42 at year end. There seems to be finally some ability to pass cost through to the consumer, will it hold?

3. For the comeback of the year trade XHB: (the homebuilders ETF), bounces back with 25% return. While the overbuilding and vacancy rates in many high population density areas will continue to drag the home makes down, the new demand from the heartland for high end houses will rise that is this is I am suggesting that the homebuilders index is a good play for housing regionally decoupling from the national index. And much of what was said about the trading of agriculture ETF, also apply to this ETF. However, while I consider this a "surprise", the surprise is that this ETF does not have a negative alpha or slightly positive. This is in-line with my S&P 500 prediction below. Therefore unless you want volatility, simply buying the S&P Vanguard fund would probably be wiser. Or simply hold these inline to the index.

4. For the S&P Index itself I would go with the Vanguard 500 Fund as my vehicle VFINXF, and predict it will end 2011 at $145.03, this is 25% + the dividend. This is largely due to how I believe the economy will react this year. 

5. For my wild card regional banks EFT, greater than IAT > 37.50 by end 2011…

Yanki Onen writes:

I would like to thank all for sharing their insights and wisdom. As we all know and reminded time to time, how unforgiven could the market Mistress be. We also know how nurturing and giving it could be. Time to time i had my share of falls and rises. Everytime I fall, I pick your book turn couple of pages to get my fix then scroll through articles in DSpecs seeking wisdom and a flash of light. It never fails, before you know, back to the races. I have all of you to thank for that.

Now the ideas;

-This year's lagger next year's winner CSCO

Go long Jan 2012 20 Puts @ 2.63 Go long CSCO @ 19.55 Being long the put gives you the leverage and protection for a whole year, to give the stock time to make a move.

You could own 100,000 shares for $263K with portfolio margin ! Sooner the stock moves the more you make (time decay)

-Sell contango Buy backwardation

You could never go wrong if you accept the truth, Index funds always roll and specs dont take physical delivery. This cant be more true in Cotton.

Right before Index roll dates (it is widely published) sell front month buy back month especially when it is giving you almost -30 to do so Sell March CT Buy July CT pyramid this trade untill the roll date (sometime at the end of Jan or begining of Feb) when they are almost done rolling(watch the shift in open interest) close out and Buy May CT sell July CT wait patiently for it to play it out again untill the next roll.

- Leveraged ETFs suckers play!

Two ways to play this one out if you could borrow and sell short, short both FAZ and FAS equal $ amounts since the trade is neutral, execute this trade almost free of margin. One thing is for sure to stay even long after we are gone is volatility and triple leveraged products melt under volatility!

If you cant borrow the shares execute the trade using Jan 12 options to open synthetic short positions. This trade works with time and patience!

Vic, thanks again for providing a platform to listen and to be heard.

Sincerely,

Yanki Onen

Phil McDonnell writes: 

When investing one should consider a diversified portfolio. But in a contest the best strategy is just to go for it. After all you have to be number one.

With that thought in mind I am going to bet it all on Silver using derivatives on the ETF SLV.

SLV closed at 30.18 on Friday.

Buy Jan 2013 40 call for 3.45.
Sell Jan 2012 40 call at 1.80.
Sell Jul 25 put at 1.15.

Net debit is .50.

Exit strategy: close out entire position if SLV ETF reaches a price of 40 or better. If 40 is not reached then exit on 2/31/2011 at the close.

George Parkanyi entered:

For what it's worth, the Great White North weighs in ….
3 Markets equally weighted - 3 stages each (if rules allow) - all trades front months
3 JAN 2011
BUY NAT GAS at open

BUY SILVER at open

BUY CORN at open
28 FEB 2011 (Reverse Positions)
SELL and then SHORT NAT GAS at open

SELL and then SHORT SILVER at open

SELL and then SHORT CORN at open
1 AUG 2011 (Reverse Positions)
COVER and then BUY NAT GAS at open

COVER and then BUY SILVER at open

COVER and then BUY CORN at open
Hold all positions to the end of the year

WILD CARD
3 JAN BUY PLATINUM and hold to end of year.

RATIONALE:

. Markets to unexpectedly carry through in New Year despite correction fears.

. Spain/Ireland debt roll issues - Europe/Euro in general- will be in the news in Q1/Q2

- markets will correct sharply in late Q1 through Q2 (interest rates will be rising)

. Markets will kick in again in Q3 & Q4 with strong finish on more/earlier QE in both Europe and US - hard assets will remain in favour; corn & platinum shortages; cooling trend & economic recovery to favour nat gas

. Also assuming seasonals will perform more or less according to stats

If rules do not allow directional changes; then go long NAT GAS, SILVER, and CORN on 1 AUG 2011 (cash until then); wild card trade the same.

Gratuitous/pointless prediction: At least two European countries will drop out of Euro in 2011 (at least announce it) and go back to their own currency. 

Marlowe Cassetti enters:

Buy:
FXE - Currency Shares Euro Trust

XLE - Energy Select

BAL - iPath Dow Jones-AIG Cotton Total Return Sub-Index

GDXJ - Market Vectors Junior Gold Miners

AMJ - JPMorgan Alerian MLP Index ETN

Wild Card:

Buy:

VNM - Market Vectors Vietnam ETF

Kim Zussman entered: 

long XLV (health care etf; underperformed last year)
long CMF (Cali muni bond fund; fears over-wrought, investors still
need tax-free yield)
short GLD (looks like a bubble and who needs gold anyway)
short IEF (7-10Y treasuries; near multi-year high/QE2 is weaker than
vigilantism)

Dec

29

Apropos of this derivative-centric world, I'll never forget the first time I was asked, "what might happen if there were a crash UP?"

Bill Rafter writes:

There were "up crashes". During the flash crash in May there were some thinly traded ETFs that had big range days with the activity being on the upside. I believe that was because they were involved in some long/short strategies such that when the holder dumped the long side, he covered the short ETF driving it up. 

Dec

16

Let me call this a literary digression so as not to run afoul of the prohibition on political proselytization:

Perhaps what I am about to say will appear strange to you gentlemen, socialists, progressives, humanitarians as you are, but I never worry about my neighbor, I never try to protect society which does not protect me – indeed, I might add, which generally takes no heed of me except to do me harm – and, since I hold them low in my esteem and remain neutral towards them, I believe that society and my neighbor are in my debt.

Spoken by the title character of The Count of Monte Cristo. Chapter XV The Breakfast.

Stefan Jovanovich writes: 

Dumas the elder and Auguste Maquet were probably the most successful literary collaboration ever. Maquet was a prodigy of historical study; he was a professor at the Lycee Charlemagne at age 18! He did the historical research, plot outlines and character sketches– what Hollywood would call treatments– and Dumas wrote the scripts. They were also a wonderfully sensible division of labor. Dumas who was already a celebrity was the name author; Maquet and he split the royalties. Maquet was a much better investor. He died rich.  Dumas– in the great tradition of spendthrift geniuses– was always on the edge of bankruptcy.

The back story for the Count, who is really Dumas himself, is that Dumas and his son (Traviata is based on the son's play) both suffered scorn, sarcasm and insult for being what would now be called "black". The Count's view of "society" is very much that of the outsider looking in. "Life itself is an exile. The way home is not the way back." (Colin Wilson)

Dec

16

Payroll tax receipts are a very good surrogate for jobs. The data is daily with a 1-day lag. It is reported by the Treasury rather than the BLS, and is NEVER revised. It does have the disadvantage of being presented raw rather than seasonally-adjusted, a fact which keeps many from considering the data. The series tends to lead the unemployment numbers (which are the opposite side of the coin) by some four to five weeks. All of the above is a repeat announcement. Now the news: At this time the growth/slope of that data is decidedly negative, almost to the point of being scary in our opinion. This is not what we expected and put it out as a word of caution. Of course, remember that the economy is not the market.

Scott Brooks adds:

Two anecdotal observations:

1. My insurance brokerage clients and insurance industry clients are reporting that their workers comp premiums are down and not coming up.

2. My small business clients that are hiring are reporting that they are having a very difficult time hiring at the lower end of the pay scale. They simply can't compete with unemployment benefits that are paid for doing absolutely nothing. People would rather earn slightly less money without the hassle or expense associated with actually working.
 

Aug

20

I read an article "How Venice Rigged The First, and Worst, Global Financial Collapse" by Paul Gallagher. Whaddya think?

Bill Rafter summarizes:

Skimming the article one gets the opinion that the author blames most of the 14 Century economic failures on Venetian bankers rather than on the Black Death. 

Victor Niederhoffer writes:

We must hear from Stefan on this subject to get the truth, the whole truth and nothing but. 

Stefan Jovanovich commentates:

I am feeling damn near invincible this morning having had Susan's corn meal and flour drop bisquits for breakfast (also the 10-year old boy cat's favorites) so I am going to pretend that this opinion offers what Vic requested– "the truth, the whole truth and nothing but the truth". I have read Charles Lane's book , and I do know something about the period because my own faith comes closer to what is now called the Eastern Church than any other Christian sect; and I have always been curious about its fate. As Bill tactfully suggests, perhaps Black Death had something to do with the decline in European population that the essayist blames on those awful Italian bankers. The later Crusades and the mere Hundred Years war (which, together, had relative costs greater than WW II and the Cold War combined) may also have played a part. Blaming the bankers for the decline in food production that began around 1300 also seems more than a bit of a stretch. The farmers themselves thought that the end of the Medieval Warm Period was a more likely cause.

The author is right: there was a credit bubble. But like our most recent ones the bubble rose out of a dramatic reduction in the real prices for the things people lived by (computing for the tech bubble, household and home improvement goods from Asia for the consumer/real estate bubble). The rise of the Italian city-state bankers came from the dramatic declines in the costs of transportation and protein. (Archaeologists are finding that around 1100 Europe relatively suddenly went from eating freshwater fish to cod and other salt-water species.) These changes came from developments in naval technology and an outbreak of relative peace. The Italian bankers couldn't have been able to cheat poor King Edward if they hadn't had the means of getting themselves and their gold to London and back quickly without risk of having the Vikings waylay them.

The bubble continued and then broke because events moved against people and then as now, the bankers kept their mansions but most of them lost the better part of their fortunes.The essay assumes that there was ONE GIANT FINANCIAL VILLAIN without which the rise of benevolent national governments would have continued and everyone would have lived in peace and prosperity. This essayist blames the Venetians; others have blamed (who else?) the Jews. What is indisputable is that the bankers kept better books and minted more honest coin than the governments they lent to. How that allowed them to "control the Mongol Empire" and switch legal tender from gold to silver and back again remains unexplained. But, then, so does the modern notion that the Great Depression and the rise of the Nazis were mostly a function of the New York Fed's misadventures with the money supply.

The costs in blood and treasure of WW I, the influenza epidemic and the Tokyo fire and earthquake and the Mississippi Flood of 1927 were entirely incidental. What made people stretch so far for yield that they were willing to invest in match monopolies in the 1920s is the same cause that brought people to do serial refinances with the Bardi, Peruzzi and Venetian banks. Events had left most of them without the incomes they had come to expect so they borrowed and risked more and hoped to make it back when the weather changed and they won the next war.

Phil McDonnell adds:

I have to side with Bill Rafter on this. Arguably the Bubonic Plague may have begun in Europe when the Mongol Golden Horde laid siege to the nearby Genoan city of Kaffa in 1345. The siege was only broken when the Mongols were too badly stricken with the plague and forced to go home. Within a couple of years one third of Europe had died.

I think Plague and Mongols invaders would have a strong chilling effect on trade. Conversely, a banking panic cannot cause the Plague.

Steve Ellison comments: 

One of my pet peeves is the overuse of impenetrable equations in
peer-reviewed finance publications (and I think I'm pretty good at math;
I can still occasionally help my son with his calculus homework). To
cite a recent example, it would not seem to require calculus to explain
that spending on durable goods falls faster in a recession than other
spending.

Russ Sears replies:

Mr. Falkenstein's argument should be applied to all modeling, not just economic modeling. Even in a field with time tested product pricing models as actuarial science, I have found time after time that to truly add value, you must ask "where is the model blind spots?" People drove a convey of trucks through the MBS model's blind spot in pricing and ratings. And if left to their own devices FASB mark to market models would have driven all of us to a great depression. As I said at the time, (see A modest Proposal to the SEC)

They were blind to a liquid assets that can quickly turn illiquid and have huge liquidity premium on a mark to market model.Exploit the loopholes, and if nobody ask if this is simply a blind spot that you are exploiting, you will look great on paper like AIGFP… for awhile…until it become apparent that your resource allocation has a divide by zero error in it.

Modeling and regulatory modeling in particular, have replaced the central planner of the failed communist system.

Jul

15

The professor's wifeOne wonders if anyone out there saw any activities that bore the badges and emblems of inappropriate behavior out there today so that one can maintain my side of the discourse with Mr. Humbert. One noted a strong weakness in the last minute. Could that be the interference with the advantages of the closing prices of JPM and GOOG announcements from the flexes? Or was it more likely yet another wife (or significant other) of a professor from an ivy league university just using her knowingness for her hedge fund as in the free market reform expenditures they conduited, monopolized and discharged their debts in court thereto? Any help you can give me in this continuing discussion so that I can hold my own with my friendly adversary who apparently sees the best in all his former bosses and their colleagues would be appreciated.

Rocky Humbert states his position:

I am not an adversary of The Chair (friendly or otherwise). I simply question why, if the game is as rigged as he suggests, does he continue to participate– especially when more than 70% of the daily volume is attributable to high-frequency computer-generated algorithmic activity– which by its very nature must be a zero sum game. 

Nigel Davies writes:

I think someone will continue professional participation in a game as long as one believes that money can be made. Now there was always cheating in chess tournaments via the throwing of games for prize money and/or title norms, but this didn't stop the better players making money, especially because tournaments had external sponsorship.

But what happened after the Berlin Wall came down is that the bus loads of former Soviets both flooded the market and simultaneously increased the amount of cheating. All but 'elite', non bus-loaded chess events lost their prestige (and thus their external sponsorship) and forced the early retirement of 'professionals' starting with the relatively unsuccessful and gradually working upwards.

Could such a phenomena happen with markets? Very possibly, as once the game starts to get rigged and randomised the weaker pros plus passing wannabes will get driven out, reducing liquidity and making it harder for those who are left to remain. They might not feel the effect at first but the game would become increasingly unplayable.

In this light some early protestations about rigging are sensible as they just might help stop the rot. The creaking gate tends to get oiled and all that.

Nick White responds:

Re: "why bother?"

For myself at least, I would argue that it's a bit like in football.

A running back tries to get through the line and the secondary to make the play and score….most of the time he will get flattened or maybe gain small yardage. Every now and then he'll get creamed, or worse, fumble it to concede a TD to the other side. But - the opportunity to score comes from trying to find that little crease in the D to break into daylight. And so it is with us.

To know where those creases may open up on a given play, the player needs to study the film, know the schemes, know the players they're up against and the tells those players give out ( I recently watched an "America's Game" NFL film about the Patriots; on the other side of the ball, one of the coaches remarked how much they were looking forward to defending against a particular OL because this linesman gave up, without fail, whether their play was going to be a run or a pass by the stance he took at the line: if he was in a two-point, i think it was for the run, and three-point stance for the pass.)

So, there it is….it can be a tough game to play against the ebb and flow of noise; no one doubts that. But the key seems to be (no matter your trading stripe) to put yourself in the best position to find a crease, know the circumstances under which they are likely to occur– and then nail it for all it's worth.

Rocky Humbert adds:

But extending the metaphor, The Chair seems to be suggesting that (1) the referee is corrupt; (2) the other team's blockers are carrying brass knuckles; (3) the clock runs faster when you have ball possession; and worst of all, the Professor's Wife paid off the laundry guy to not-wash-out the bleach from your jock strap. Shall we still play a game?

(It didn't end so well for Mathew Broderick.)

Nick White writes:

I'm no conspiracy theorist. Maybe there's collusion and coercement. Maybe there isn't. I'll never know. I console myself that if I stick to my plans, I hopefully won't have much reason to care. I can only play my game, and (like you, Chair and others) play it staunchly by the rules.

I'm just pragmatic about the potential for shenanigans where there is a competition and money is the prize. To build in some redundancy into my bold assertions I'll try and give some allowance for 1-3. Four is more problematic…that's just going to hurt.

With the current running of the Tour de France, I'm sure there is much we can learn about systematic cheating and cover-ups.

Bill Rafter adds:

The fix or edge was always so, and is so now, but the markets and players have changed.

Many moons ago when my partner and I were active commodities traders (before they were called futures) we made a lot of money in certain markets. Our favorite venues were eggs, cocoa, bean oil and meal. For some strange reason we had the ability to ascertain the fix, but only in those markets. What interested us what that the egg market was clearly a rigged game, but the bean products seemed to be the essence of fair markets. Also of interest was that we could not get any edge in other obviously fixed markets such as bellies (and a tip of the hat to a certain former and future flexions cattle broker and her signiflexiant other). In the case of eggs we had strong evidence that it was the delivery particulars, and delivery also seemed to have an effect on the other markets we could play favorably. Delivery is very much the bailiwick of those in the know.

Fast-forwarding to today's equity markets we suspect that HFT is having a strong effect. Overall share volume had dropped precipitously from the highs of several years ago. It has recently returned to a decent level. But how much of that recent volume increase/recovery is HFT? If it is, then some part of the activity beyond 1-minute bars (or 5-minute bars) is going to be inefficient. For HFT should make the market more efficient in the shortest run, but ignores the forest for the trees.

We ourselves like the presence of HFT as it tends to give us better executions. And we prefer that the giants (e.g. Giant Squid) play in that shortest time frame. Someone has to take over the specialist functions, and better it be the well-capitalized firms. But anyone trying to compete in that time slot is going to have a lot of competition. And should one of the giants discover an opportunity in which THEY had limited, if any, big player competition, watch out. That is, a giant with the room to run a table most certainly will. And if the giant has a dealer at every table, sooner or later one is going to present such an opportunity. That in theory could have happened under the specialist system, but the specialists were constrained from doing so. No such constraint is in place now. The bailiwick of those in the know at this time is the HFT universe. Expect to be taxed by the bailiff.

May

19

1. Can anyone come up with ANY justification for retail parties' engagement in High Frequency Trading?

Russ Herrold writes:

Sure. First would you mind please:

1. Carefully defining: High Frequency Trading

2. Explain if you consider the taking of profit from a market to constitute an adequate 'justification'.

Bill Rafter writes:

Let me deal with them in reverse order:

If a market is inefficient such that a profit can be made by doing a trade to capitalize upon the inefficiency, the trade performs the simultaneous jobs of creating liquidity and reducing inefficiency (and making a profit).

Given that, it makes no difference whether the trading is high frequency or not high frequency.

By the way, I have no dog in this hunt, being a long-only equities trader who tends to hold for a minimum of 2 days.

Apr

29

Inigo v. WestleyThe Princess Bride Swordfight Scene shows a gentlemen's prelude, and how concealed ambidexterity can be a secret weapon, but can also backfire.

You will see Inigo Montoya very chivalrously allowing the Dread Pirate Roberts, aka Westley, to catch his breath after scaling a sheer cliff wall before beginning their swordfight.

Then as concealed ambidexterity is applied and revealed by both fencers one after another, the tables turn and turn yet again. But really the chivalrous Spaniard's eventual loss was sealed the moment he allowed Westley to clamber up over the cliff edge.

Chivalry, malevolence or (unjustified) pride in one's abilities?

Chris Tucker adds:

"The Princess Bride" is a movie that Aubrey simply must see. I love this movie; so do my kids. We find ourselves quoting Inigo at work frequently. "I do notta suppose you coulda speed things up?" or "I'm going to do him left-handed" or "You know what a hurry we're in!" or "It's the only way I can be satisfied" or "Inconceivable!" or "You keep on using that word. I do notta think it means what you think it means." Mandy Patinkin is priceless!

Bill Rafter adds:

"Never try to outwit a Sicilian," and "Do I have to get a new giant?"

Russ Sears writes:

My high school aged daughter tells me it is quoted all the time around her clique. Quoting it is the inside joke/ litmus test for those with verbal IQ versus those clueless.

Apr

25

The currently available data for M2, a slightly broad definition of money supply, show continued restrictive behavior. That restriction may be caused by the Fed, or it may simply be a lack of willingness of banks to lend. Regardless, the outcome means that inflation is not a risk in the foreseeable future. If anything the risk is for deflation if this continues.

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

Apr

18

the matrixRead this article on Random Matrix Theory: the deep law that shapes our reality.

Bill Rafter comments: 

This is a good intro article. I appreciated this part:

But when Bouchaud's team applied Marcenko's and Pastur's mathematics, they got a surprise. They found that only a few of these apparent correlations can be considered real, in the sense that they really stood out from what would be expected by chance alone. Their results show that inflation is predictable only one month in advance. Look ahead two months and the mathematics shows no predictability at all. "Adding more data just doesn't lead to more predictability as some economists would hope," says Bouchaud. 

Apr

14

Here is a useful index of physical commerce in the U.S.

Bill Rafter reviews it:

That is interesting–an index based upon diesel purchases by long-haul trucks. They show you the charts, and to a small extent they are interactive, but there does not seem to be any back data available. If they want any recognition, they should put the data out there so the number crunchers can have a go at it. If it's worthwhile, the number crunchers will make it highly desirable.

It has certain distinct advantages:

It's based on thousands of real free-market transactions and not surveys.

Generally not revised.

Monthly with a two-week lag.

Has the potential to be more frequent with even less lag. Note U.S. treasury tax data is daily with a 1-day lag.

Because it is gathered (and presumably binned) locally, it could be used to track cross-border movements. There's not a whole lot of forex risk between USD, peso and C$, but the near-port area transactions could be of use with overseas forex risk.

Potential problems:

Long-haul truckers are very efficient in their avoidance of expensive diesel, taxes of which are state-based. So there's some potential for distortion.
 

Apr

8

Suddenly my "buy" list has a large number of companies which have never graced the list before. They are property and casualty insurers. Although they have sufficient capitalization, their volumes are too small for me to get involved. Does anyone know why they would be in favor?

Dan Grossman writes:

B RVolumes too small for you to get involved… You must be quite a heavy hitter, trading millions of shares.

I don't know what you mean by in favor, but because the insurance companies held mostly bonds, including mortgage bonds no one knew the value of, they were beaten down to very low levels, below book value, PE multiples of four or five. Now bond valuations are normalizing, and I guess the insurance stocks are returning to reasonable levels.

Scott Brooks writes:

I deal a bit in the insurance world and I have to say that this baffles me. Insurance brokerage firms that I deal with are hurting big time. Premiums are down as small businesses (which insurance brokerage firms have as clients) continue to layoff, not hire, and generally decrease payroll.

Maybe their revenues are down, but their margins are looking better, but I find that hard to believe since every P&C guy I know is busting his butt to bring on as many new clients as possible and bidding as low as possible to "buy" the business. The problem is that their competitors are doing the same to them.

Vince Fulco comments:

A few I follow remain at a healthy discount to book value (WTM, CNA) and I've been wondering when the rising tide would lift these ships–  since other industries are being given the benefit of the doubt that conditions are normalizing — and when would some of them get credit for adequate portfolio management and improving pricing and underwriting activity. Loosely speaking, a properly running P&C company can trade from .9-1.3x book and when the punch bowl really overflows, multiples of 1.5-1.8x are possible. Still plenty of room vs. normalized valuations. Why it has taken the crowd until now to really start bidding them up, I remain puzzled particularly vs. underlying corporate performance. It would seem the investors wanted to wait the half life of the bond portfolios to ensure no more problems as most run short duration portfolios.

Secondarily, there had been concerns within the industry about six months back that the Obama administration would go after the Bermuda-domiciled ones doing biz in the US for a bigger tax bite. That seems to have fallen by the wayside for now. Talking my book as I've owned WTM off and on for the last seven years.

Ken Drees adds:

The big question is since these insurance companies were screwed by their debt holdings, took writeoffs and have muddled through — some with Tarp but most P&C did not get Tarp — where do these companies park their cash now? They used to make money in the derivative leverage through the bond kingdom — outside of normal operational gains through underwriting. What is the risk of their holdings now? I don't see many stock buy backs from these guys and I don't see dividend rates that have gone up — both factors here would show that companies would rather pay out earnings or reinvest in themselves. Will they be able to ring the registers as normal through the bond markets? 

Kim Zussman replies:

At a recent lecture by a business law attorney, the take-away message was "everyone needs business practices liability insurance." He went through a litany of litigations; violations of overtime laws, rest-breaks, bonuses not being factored into overtime calculations, performance reviews, extensive paper-trailing, s_xual harassment (including a married doctor who had relations with a woman six times before hiring her, then continuing to pursue her on the job).

In an environment of increasing regulation/litigation, empowerment of little old ladies in lieu of rich guys, and increasing taxes, the deductible expense of increasing insurance coverage could make sense — even though lining pockets of bureaucrats and their legal co-conspirators.

Phil McDonnell asks:

Vince, I have a question. For CNA the ratio of receivables to revenue is about 100%, for wtm it is about 75% (by eye). That would correspond to 12 and 9 months worth of receivables they are owed by their customers. Are their customers really the slowest payers in the world or am I missing something? 

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

Vince Fulco responds:

Not sure where you are looking but the largest receivables on the balance sheet from the last few years relates to business they've reinsured with others. WTM management is generally more risk averse than their peers and is inclined to cede segments of their business to better define their upside/downside. These arrangements have truing up terms, conditions and times which make the receivables ratio more lumpy than an ordinary industrial concern. The mix of biz between them and CNA is probably another factor.

If you are speaking specifically to 'insurance and reinsurance premiums receivable', they've been 21-22ish% of revenues for the last few years. I have no specific answer for that but it doesn't seem out of line if we think of the balance sheet as a point in time.

Mar

26

Painting by Rubens

The yogis say our true nature is joy.  When we're laughing and truly having fun, perhaps that's when we're most being ourselves - and not the product of something else. G.P.

It is easy to be jocular and personable when things are going well, but you get to see who you really are when things are going badly. The energy required to maintain interpersonal facade is redirected toward survival. The market is a very good mirror. And a very bad one.

Bill Rafter adds:

Who you really are is very much like a stock in Portfolio Theory. The good side is the rate of return, but most compare that with the additional information of the standard deviation of the returns.

Similarly a person should be measured along the same lines. The person who is happy go lucky most of the time but occasionally has bouts of violent anger is not as desirable a friend as one who is relatively constant but with lesser high points.

Each person responds differently to stimulus. And as with stocks it is the bad side that is most important. Someone who is in a funk for a long time has the risk of getting clinically depressed, with physiological damage to the synapses.

Ken Drees comments:

I always liked the saying that "not all great companies are great stocks". Forgot who coined that one–maybe from the Livermore books that I have read. Meaning that the stock of the good company may not act or behave well for speculation. In general, it is interesting how stocks are given human qualities by specs.

Alex Castaldo replies:

Forget about Livermore. The first to warn about confusing good companies and good stocks was the late Peter Bernstein in the Harvard Business Review in 1956.  The idea was followed up by many people, including Solt and Statman (1989) and most recently Richard Bernstein .  

Kim Zussman generalizes and extends:

Galton weighed in on this, with five big personality traits: Openness, Conscientiousness, Extroversion, Agreeableness, and Neuroticism (OCEAN) In modern times, add Yeswecannyness, Islamocapitalist, and Amelanotaxophile.

Mar

22

parabolaAn interesting and scholarly article on basketball angles and spins in the Washington Post, kindly sent my way by Dan Grossman of Florida, indicates that physics calculations show that the angle with which a shot is thrown influences its accuracy. The gist is that the higher the arc, the greater then chances it will go through. Also, the higher the height the ball is launched from, the greater the margin of error on the shot, and the greater the success. Taking one thing with another, a launch angle of between 45 degrees and 55 degrees seems best.

Angles have played a big role in stock market technical analysis. The most influential angles are those derived from the work of W. D. Gann who believed that when price breaks through an angle of 30, 45 or 60 degrees from a previous low to previous high, a continuation in direction of the break through was possible. As to how to compute the previous low or high, where it should start, where it should end, and what the time scale should be — why, that's why there are 1.4 milion entries on the subject of Gann angles with most concluding that they have been superceded by more sophisticated tools in these days of modern computers.

Being one to believe that taking the pencil to paper might help to find regularities, I computed some subsequent prices moves for the last 15 years for daily, weekly, and monthly prices. I looked at the angle between the two last moves of an index. For monthly prices, I looked at the subsequent moves following the moves in the previous two months. For example I looked at the moves in January and February to predict March. For weekly moves, I looked at the two previous weeks to predict the third week. For exampe the first and second week of the month to predict the third. For daily moves, I looked at the previous two days to predict the third. For example, Monday and Tuesday to predict Wednesday. The angles formed could be computed by using trigometric identities to compute the adjacent angles and noting that the sum of the three angles is 180 degrees. Here are the results:               

subsequent period   prior     previous    expectations   number of obs

monthly                    +         +                       4                53

monthly                    +         -                      -4                 41

monthly                     -         +                      7                 40

monthly                     -          -                      -6                33                                                                                                              

weekly                      +         +                      -2               185

weekly                      +         -                       4                186

weekly                       -         +                      -3               189

weekly                       -         -                        1               147          

daily                        +         +                      -0.7             952

daily                        +         -                       -0.5             898

daily                        -         +                        0                904

daily                         -       -                          1    744                                                                                                          
                                                                                                

The many regularities that this table reveals are a good start to find angles that are useful for success in shooting for profits in markets. 

Bill Rafter offers:

If there is some mystical or otherwise relationship of price to time, it would perforce need to dictate the scale of the price charts for any angles to describe that relationship. In earlier times graphs and charts were drawn in pencil on standard graph paper, such as 10 x 10 to the inch. If everyone kept the same charts in the same scale, an argument can be made (i.e. the self-fulfilling prophesy) for various angles, Gann or otherwise. However the person who used a scale not similar (in the geometric sense of the word) to the standard scale would have different points of intersection with respect to the same angles as the standard scale. Fast-forward to today and we find computers rescaling charts to fit on the visual page to the extent that no longer is there a standard scale. So at the very least, there can no longer be a self-fulfilling prophesy. Whether there is a price-time relationship, I do not know. But the next time I see Master Yoda I will ask him.

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

Jim Sogi writes:

One of the problems is asymmetry. Contrary to symmetry theory, the markets are not symmetrical. It makes the Gann ideas or other symmetrical equations inaccurate. This includes normal distributions.

Sushil Kedia comments:

A few years ago Mr. Sogi had written a review of a book from a publisher in Australia providing co-ordinate geometry treatments of the Mathematics of the Divine Ratio. The Chair and Dr. Castaldo too have written about the applications of polar co-ordinates to transforming prices to study appropriately, thereon. Perhaps a number of ideas from that book could be applied to produce suitable transforms and then fitments to the effect of say treating the rate of drift as equivalent to an angle of zero or one would provide perhaps some worthy examinations of the other standard angles as 1/3rd or 2/3rds (pi/12 or pi/6) etc.

Jim Sogi replies:

Why is it that the last few weeks, the price followed an upper and lower line so well as moving mechanically upward? It has kind of broken that recently, but it seems more than random things the mind puts together like a taking patterns out of random dots. I've graphed random series and seen the so called trends, but they don't seem as linear. And it seems to continue for days and weeks.

On the subject of the negative time idea Rocky talked about earlier, and since it's spring now, a look at our Gregorian calendar shows the inaccuracies in the counting system. Assume as a mind experiment that the market operates on absolute time. Given an inaccurate Gregorian system, at times the measurement of absolute time might appear to jump or reverse at various adjustment points. See the wikipedia entry on Julian Day Calculation and on the accuracy of Gregorian Calendars.

Pitt T. Maner III writes:

John WoodenThe discussion on shooting angles in basketball reminded me of one of John Wooden's favorite ideas which is to use the backboard or "glass".

Within days of implementation of this new 'back' board, players found that they could gauge the angle and use this new tool to their advantage to make shots. The problem today is that players have either forgotten or never learned its full advantage. Arguably the most successful coach of his era and probably of all time, UCLA Hall of Fame Coach John Wooden was renowned for teaching his players to use the glass both in the post and especially off of fast break transition. Coach Wooden's teams won 9 straight NCAA Titles (10 in 11 years) a feat unparallel before or since in collegiate basketball. Coach Wooden believed that if his players practiced making 5-10 foot bank shots at the 45 degree angle off the break and could make them at a rate of about 75-80% these shots were nearly as good as getting a lay-up. For those young players that missed the opportunity to see the great UCLA teams they were almost always successful in transition. Probably the single greatest scoring performance ever in an NCAA Championship Game was by UCLA's Bill Walton’s 21 for 22 field goal shooting performance against Memphis in the 1973 title game. Bill Walton’s' patented move was the up and under using the glass.

I have found that it is possible to use the target square on the backboard to advantage when shooting free throws and banking shots in instead of trying to get a "swoosh" each time. Having a visual target behind the "bucket" seems to help.

Banking in shots, however, is probably best used (like Wooden suggests) when shooting from the sides in basketball. Wooden believed in playing percentages and when a basketball hits the backboard it has almost a "second" chance of going in as opposed to hitting the front or side of the rim or completely overshooting or undershooting the mark. I think the coach would have preferred a sure layup over a dunk any day—and how many times has one seen a sure dunk pop out when thrown down with too much force when a layup would have scored two.

Not quite sure what a market analogy would be for a backboard–perhaps some type of straddle where you can make money on the continuation of the angle in either direction?At any rate one of the fun aspects of the NCAA basketball tournament is getting a chance to see various styles of play and the leveraging of seemingly higher risk approaches. The Cornell–Kentucky game on Thursday night, for instance, if it stays close, could be an example of excellent, confident outside shooting and defense vs. more pure interior power, younger talent and athleticism (and good outside shooting too). But as they say, you can "live and die by the 3-pt. shot".

Mar

8

It happened.

For the first time in over two years the year-on-year growth in payroll tax receipts is positive. That is, the somewhat less negative jobs news that has been circulating is not phony. In the past we anecdotally observed some identical anomalies in both these data and the BLS jobs data, and the BLS anomalies lagged the Payroll Tax data by about five weeks. That makes us believe that no matter what happens to future payroll taxes, the BLS numbers will be positive for the next month or so. Certain politicians will take credit for it, and there will be a bullish tone to the stock market.

N.B. We do not use these data to trade the stock market, but think they're valuable nonetheless.

Mar

1

For what it's worth, here are representations of the velocity of money, which is defined as the nominal gross national product divided by the money stock.Velocity tends to tank in a recession and recover thereafter.

Ken Drees replies:

Since arrow mzm = s&p, money base is non confirmation? Should not all three walk together?

Feb

26

I'm looking for some new/better ideas on how to calculate the vig in ETFs, versus the vig in futures, versus the vig in the physical.

Bill Rafter replies:

Not all ETFs are taxed identically. Specifically the inflation-averse would be warned that GLD is set up as a grantor trust and not as a 1940 Act fund. Profits in GLD are taxed as collectibles.

This points out that "structure matters". For example if you own an ETN (note) rather than an ETF (fund) you are subject to counterparty risk. Some people have chosen to gloss over the distinctions and refer to them all as ETPs (products), and that homogenizing tends to mask the counterparty risk. For example, LEH had issued a few ETNs whose owners are now waiting in line with all of LEH's other creditors. Barclays is the counterparty on INP (ETN representing India), which presumably would be okay. But why take the chance when you can buy EPI, the Wisdom Tree offering which is a true ETF?

How do you find these things out? Read the prospectus, something very few do anymore.

Nick White writes:

Deep and mysterious are the secrets that one can behold if they are willing to brave the legalese, break out pad and paper and delve into these sometimes fantastically structured products.

Rocky Humbert comments:

There were/are a whole load of those ETNs out there — additionally, the IRS issued a ruling about a year ago that changed the tax treatments for the currency ETNs. Currently, some of the narrower futures are under scrutiny by the IRS, and some foreign (unregulated) futures don't qualify for Section 1256 at all. Another example of the hazards of the ETFs are also the changing CFTC rules regarding position limits — which caused the UNG and USO to diverge from their NAV. At one point the UNG was trading at a 19% premium to NAV. If one is short the ETF, one cannot redeem the position, so there is no theoretical limit on how far the premium could go. In contrast, if you buy the ETF at a discount, you can always redeem it and close the arbitrage to the underlying. 

Feb

26

There is a very big "shoot the moon" increase in the Base.

Bud Conrad comments:

Here is a chart from St Louis Fed of Monetary base

Bill Rafter adds:

Terse: a big increase in money stock (money supply). That would normally tend to be inflationary, but BSB just yesterday told us there is no inflation. (And he was correct.) Typically the Base tends to grow at an exponential rate in the low single digits. However with the banking rescue programs there was an astounding 100+ percent increase from Sept 08 to Jan 09, and another big increase from Aug 09 to Dec 09, and now we are at it again.

The reason there has not been inflation is that this expansion has not gone anywhere beyond the (big) banks. If you look at other versions of the money stock such as M2, you see that there has been no such increase. In fact, M2 has been showing contraction relative to its long-term target. It will be most interesting to see the M2 numbers to be released today. A big increase in M2 would make the case that inflation is finally coming. No increase in M2 would state that we are just getting more of the same, specifically that the Fed has been putting money out to the big banks (at zero interest) and then allowing them to simply leave that money on deposit with the Fed (at interest). This process is just a subsidy to the banks.

The important question to me now is why the latest increase? Are the banks in further trouble? Does this anticipate more trouble, say with commercial real estate?

Given the colossal increase in the Base, some of it will bleed through to M2, which probably explains the current increase. However note that M2 is still below its long-term growth rate (what I call the fit or target), so effectively practice (as opposed to policy) continues to be restrictive.

At some point "somethin's gotta give": The Fed could start taking down the Base. They probably will just reverse the policy of paying interest on deposits left with the Fed. At that point the banks will return much of their borrowings back to the Fed. Some of them may not, and choose to start pushing commercial loans out the door. Then you will start to see increases in M2 and the earlier increase in the Base will become inflation. That at present is the only reason why I watch this data.

Mick St. Amour comments:

Bill, this proves my theory that fed is fighting deflationary forces given contraction in lending and collapse in monetary velocity. Given we are in balance sheet recession, reflation of assets/collateral values is main goal of central banks everywhere. It is key to stoking animal spirits in the markets and in real economy. I suspect this provides tailwind for asset classes such as equities and commodities.

Rudolf Hauser comments:

It might be worthwhile to remind readers of what the demand for money is in a non-inflationary economy. It is the amount of money people in the aggregate wish to hold (emphasis on hold, not spend) plus that needed for transition in transactions (the amount involved that is held up by the clearing process) in an environment of just real growth or decline. That applies to both high-powered money (the monetary base) and measures such as M2. If that amount is not provided banks will attempt to increase reserves by reducing investments and loans. Paying interest on reserves increases the banks demand for reserves (excess reserves), as does increased caution on their part. You will only get M2 to grow if banks are more aggressive in investing and lending. Since there are no longer reserve requirements on (M2-M1) all of the reserves related to this are excess reserves. If the Fed were to stop paying interest on reserves a bank could profit from such reserves by buying 3 month or probably even 1 month Treasury bills as long as the return were in excess of their processing costs since the reserves used to buy those securities is zero percent financing. But to buy treasures they have to pay the buyer, which increases bank deposits, i.e., M2 (and M3). The banks cannot drain total reserves from the system– only the Fed can do that. If the Fed wants to keep excess reserves from being used it can discourage that use by raising the interest rate it pays on excess reserves. To repeat, lowering that interest rate only leads to more rapid monetary creation-something that I suggested would be desirable here to accelerate M2 growth to a rate that does not drive us into another economic down-leg in a few quarters from now.

Feb

8

Dr Rafter

There is an upcoming article in TAS&C (April 2010) by David G. Hawkins that deals with modifying Price Volume Trend Indicator, a 1980 variation of Granville's OBV indicator. The article is chart-based rather than statistics-based, but there are a number of talented readers who could correct that, should they wish. The article references two contributions to TAS&C by Larry Williams (2000 and 2004). What is interesting to us is that he overlays a linear-scaled indicator onto a log-scaled price, recognizing that most indicators behave linearly while equity prices do not. We had long noted that, but never thought of superimposing the one chart onto the other.

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

Feb

2

Volume, from Jim Sogi

February 2, 2010 | 2 Comments

Interesting drop in volume on today's up move in ES:

2010-02-01, 1896011
2010-01-29, 3068079
2010-01-28, 3052088
2010-01-27, 2634603
2010-01-26, 2449263
2010-01-25, 2080292

The old TA theory is that an up move on low volume is weak, and a down move on increasing volume is strong, but it doesn't prove out scientifically.

Sushil Kedia comments:

A homegrown theory I developed borrowing on the Chair's applications of the concept of struggle to markets interprets volume as a struggle for price discovery. Extending this with memetics, a higher volume indicating a higher struggle for price discovery meme implies an ongoing persistence of the meme. So, within any time frames or patterns or noise, if you perceive a meme then interpreting lower volume as lesser struggle tilting towards consonance and thus implying a fading meme comes by. This way of looking at price and volume relationships does lead to several testable ideas getting the gut feel closer to science.

Bill Rafter writes:

The only use we have found for volume is as a surrogate metric for volatility. Indeed S&P volume and VIX have very interesting relationships. However the standard TA mantras that  (a) volume “confirms” price and (b) volume-weighting indicators makes them better, have not been confirmable.

Here is an excellent graphic I prepared relevant to volume.

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

Kim Zussman writes:

Here's another check. SPY daily returns (c-c), with volume traded, 1993-present, were used to check for big up days = >+1% (0.01). Then calculated relative volume (RV) as:

(today's volume) / (average volume prior 5 days)

Then compared next day's return for two cases; if it followed a big up day which had low RV (RV<0.8) or a big up with high RV (RV>1.3):

t-Test: Two-Sample Assuming Equal Variances

                       low RV      hi RV
Mean               0.0010    -0.0015
Variance          0.0002    0.0002
Observations        151    146

Pooled Variance    0.0002
Hypothesized Mean Difference    0.0000
df    295
t Stat    1.5263
P(T<=t) one-tail    0.0640
t Critical one-tail    1.6500
P(T<=t) two-tail    0.1280
t Critical two-tail    1.9680

Jan

25

(Caveat: easier said than done)

SPY monthly returns (1993-present, with div) were checked for a normalized proxy of intra-month range = (H-L)/C. The series was then ranked by range, along with corresponding monthly returns. These monthly returns were multiplied for the entire 17 year period, which gives a total return of 3.35 ($100 became $335). This was then repeated after successively skipping first the highest range month, then second, all the way to skipping the highest 100 range months. This allowed evaluation of the effect of being "out of market" on final compounded return - whether or not the high range months were up or down.

The graph below shows the effect. Cpd return is the green line, which rapidly increases by skipping (and investing in "cash" = multiplicative return of 1.00) the highest range several months, and continues to outperform B/H up to 100 months skipped. Range of skipped months is plotted in red; for scale on this graph multiplied X10 (eg, range of 0.34 shows as 3.4).

Here are the compound returns, successively skipping the top 20 range months, with dates:

Date             ret       H-L/C     CPD
10/01/08    0.83    0.34    3.35
11/03/08    0.93    0.29    4.01
07/01/02    0.92    0.24    4.31
09/04/01    0.92    0.21    4.68
03/02/09    1.08    0.20    5.10
02/02/09    0.89    0.19    4.70
08/03/98    0.86    0.18    5.27
09/02/08    0.91    0.17    6.14
01/02/09    0.92    0.17    6.77
10/01/98    1.08    0.17    7.38
03/01/01    0.94    0.17    6.83
10/01/02    1.08    0.16    7.23
10/01/97    0.98    0.15    6.68
01/02/08    0.94    0.15    6.85
09/03/02    0.90    0.15    7.29
08/01/02    1.01    0.15    8.14
04/02/01    1.09    0.14    8.09
03/01/00    1.10    0.14    7.45
04/03/00    0.96    0.14    6.79

In fitting with decline = volatility, only 6/20 biggest range months were up.

Steve Ellison writes:

Using Dr. Zussman's results as a starting point, since I am not very good at determining the monthly range before the month begins, I checked what would happen if one skipped the month after a month with a high range. SPY total return including dividends from the end of 1993 to the end of 2009 was 3.14, for an average monthly return of 1.0060. If one held cash in all months following a month in the top 10% of ranges to date, and held SPY in all other months, total return would have been 1.98, with 140 months in the market and 52 months out. Average monthly return would have been 1.0049.

Since the end of August 2007, however, the average monthly return following a month with a range in the top 10% of historical values has been 0.9707, while the average monthly return of other months has been 0.9992. Thus, substantially all the losses of the last two years occurred in months following months of very high ranges.

Example:

                         90th
                                pctile
 Month ending   H-L/C   H-L/C Position Return
    9/30/2008    0.18    0.13     in     0.9058
   10/31/2008    0.35    0.13    out   0.8349
   11/28/2008    0.30    0.14    out   0.9303
   12/31/2008    0.12    0.14    out   1.0098
    1/30/2009    0.18    0.14     in     0.9179
    2/27/2009    0.19    0.14    out    0.8925
    3/31/2009    0.21    0.14    out    1.0833
    4/30/2009    0.12    0.14    out    1.0993
    5/29/2009    0.08    0.13     in     1.0585
    6/30/2009    0.08    0.13     in     0.9993
    7/31/2009    0.13    0.14     in     1.0746
    8/31/2009    0.06    0.14     in     1.0370
    9/30/2009    0.08    0.15     in     1.0354
   10/30/2009    0.08    0.14     in    0.9809
   11/30/2009    0.08    0.15     in    1.0615
   12/31/2009    0.04    0.16     in    1.0191

Rocky Humbert asks:

Is this study and its results more than a reflection that (historically) a higher VIX → lower return?

Bill Rafter comments:

VIX is simply one form of volatility. It is logical to assume that some of the other forms may lead VIX, and that those may be causative and have predictive value. If they have predictive value for VIX and VIX is coincidental with declining equities, then you have something on which to build.

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

Oct

26

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

Oct

6

B RafterAs previously mentioned, we track three monetary aggregates and their deviation from target (based on a historical fit).

The triptych presented here is the progression from the Base to MZM to M2 reflecting a decrease of Fed control and concomitant increase in shadow banking control.  (N.B. I have shortened the charts to get them on the same page.)  The progression also shows that the Base is extremely expansionary while M2 is actually restrictive.  That is, Money Supply as defined by M2 is restrictive in the current depression.  The liquidity provided by the Fed is not filtering out to the population at large but being used to rebuild bank balance sheets.

This scenario (assuming it persists) has implications for recovery and inflation.  That is (in our opinion) neither is likely to happen soon.  But you can draw your own conclusions.

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

Vince Fulco adds:

As a additional resource, this Fed paper delves quite clearly into why excess reserves are not necessarily inflationary both due to their composition and interest payment policies created specifically for the post-crisis period.

Why Are Banks Holding So Many Excess Reserves? [PDF, 380kb]
Todd Keister and James McAndrews
Federal Reserve Bank of New York Staff Reports, no. 380, July 2009

Aug

14

The Fed has the most control over the Monetary Base, less control over MZM and even less over M2.  Interestingly the Base has doubled with the Fed’s activities, but those activities have had a much reduced effect on MZM and almost negligible effect on M2.  This means that the extra money is being held on deposit by the banks (helping their bottom lines).  With no bank-lending-created expansion of money, any inflationary or bubble argument is diminished.

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

Steve Ellison recalls:

I feel like I have seen this movie before. In the early 1990s the banking system was in trouble, and the Fed's actions were considered ineffective — "pushing on a string". The next phase was the jobless recovery, in which Bill Clinton was elected on the platform of "it's the economy, stupid" 18 months after GDP growth turned positive. As late as the fall of 1993, Barron's ran a cover story on efforts to rescue homeowners with negative equity. This entire period was a great time to own stocks. It wasn't until the economy was unmistakably strong that the stock market ran into trouble in 1994.

Bill Rafter adds a picture to his comment:

I refer you to this graphic that will illustrate the point.

As you will see, M2 is below its target rate of growth. That’s contraction from a monetary policy standpoint. That means no inflation.

What would happen if there was an increase in bank-lending-created money? Well, what do you get when you increase a fiat money stock without an increase in goods and services? Increases in prices; loss of confidence in the currency.
 

May

11

PhilAAA rated bonds are the best corporate bonds available. BAA represent a somewhat riskier class of such bonds. So, using St. Louis Fed data monthly (series AAA and BAA) it might be instructive to look at the yield spread between the two bonds versus the monthly returns of the Dow Jones average. The yield spread was calculated as BAA - AAA yield from 1928 to the present. The spread is currently near historically high levels and thus seems especially relevant now. One way to think of the yield spread is as a measure of fear in the bond market or as a measure of the current availability of credit to riskier corporations.

The following correlations are for the yield spread lagged n months ago. Zero lag is the concurrent relationship. To be significant at the 5% level, two tailed with n =1000 the correlations should be above 6.2%.
Lag    correlation
12     0.054331609
11     0.060955747
10     0.05292927
9      0.039778526
8      0.035184767
7      0.01231181
6      0.000377968
5      0.004196862
4      0.008836528
3      0.027029827
2      0.043577867
1      0.030773782
0     -0.03036919

But what is interesting is that they are all positive at the various lags. In other words if there is a credit crunch indicated by a larger yield spread, then stocks subsequently go up. This is not what one would have expected.

Suppose one were able to obtain a newspaper for the yield spread over the next 12 months (in the future). Well the correlations between the Dow and the future yield spreads were as follows:

Lag   Correlation
1    -0.112798121
2    -0.126495119
3    -0.124710641
4    -0.096857777
5    -0.107535598
6    -0.112776958
7    -0.117648043
8    -0.10364356
9    -0.117856956
10    -0.134941986
11    -0.137242692
12    -0.148479036

They are all negative and statistically significant. Again not what was expected.

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

Charles Pennington asks:

Is this summary correct:

1) High (or rising?) yield spread predicts excess positive returns for stocks in the future, though not statistically significant and 2) Rising stocks predicts narrower than average yield spreads in the future?

If so, then why would you find item 2 to be "not what was expected"? I would have expected that rising stock prices would lead to lower yield spreads, as you observe.

Also, it sounds like you've used "levels" rather than "moves" for the yield spread. I would think that the yield spread is something that moves around on a fairly slow time scale, and that there would be a lot of serial correlation in its level from month to month. That would explain why the second set of 12 numbers are all about the same.

Phil McDonnell responds:

Your first and second points are correct.

It has long been held as common wisdom on Wall St. that yield spreads indicate credit conditions, and that widening spreads predict stock market problems. In this case stocks seem to predict yield spreads. As always you make a good point. I did use levels in the yield spread only, percent changes in the Dow. It is probably worth looking at the changes as well.

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

Bill Rafter adds:

This number was down to a -349 and has now risen to -259. Above -270 it took out the post-LEH, post-TARP periods, meaning that the credit problems associated with those events have been rendered old-news by recent behavior. It's nice corroborative information but not actionable, in my opinion.

More important than this is that the "dumb" money is still short, and still shorting the rally.

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

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