# Glucosamine Chondroitin and the Statistics Thereof, from Charles Pennington

I'll just throw this out.

Intuitively, I suspect that if a fraction X gets better on a placebo, and if a fraction Y (which could overlap with X) gets real physiological benefit (as determined the by the deities), then the fraction that will REPORT being better would be something like sqrt(X^2 + Y^2). (The "reasoning" is that the real effect and the placebo effect are probably uncorrelated and therefore "add" in an orthogonal way, like the Pythagorean theorem.)

So if X is 0.6 and Y is 0.4 then 72% of people in the study would say they were better.

Of course this won't be valid if X^2+Y^2 gets close to or exceeds one.

Anyway, if that formula is right, and if 40% of people really do benefit as determined by the deities, then we'd see 72% reporting that they're better, which is not much more than the percent that "respond" to the placebo, 60%. So it's probably hard to smoke out an effect, even if it's kind of big.

## anonymous writes:

Before any marathon or ultra, you hang around in the corral of runners waiting to go, (towards the back. towards the WaaaaaAAAaay back, with the jockeys, fat ladies, kids dribbling basketballs) and ask practically ANY old guy if they take it, they will tell you affirmatively. I've done that at least dozens of times. Then look around at who has had a knee replacement and is in that category. No one.

Now that does not mean that the prevalence of old guys running marathons now (whereas two or three decades ago you didn't see that, may be a function of fad, but I remember old guys who ran two or three decades ago stopped running– almost all of them because "their knees couldn't take it anymore," or they "wore out their knees.") is a result of G&C consumption, or the fact that there are so many more older people running now, the fad effect.

There is a tendency to mock anecdotal evidence such as this– but our entire lives are spent accumulating anecdotal evidence and attempting to draw conclusions, from what we consume, what the "best" route to get to a certain destination is, what time we ought to wake up, to how we trade, etc. Everything we do in life is an attempt to solve an optimization problem based most often on a statistically insignificant number of data points.

## David Lillienfeld writes:

First, I'm a physician and among my areas of expertise is the evaluation of drugs (pharm, not abuse). If you want to use anecdote, then you must have little use for regression to the mean. Anecdotes are subject to publication bias, small numbers, inadequate control of bias, among others. It is human nature to work off of anecdotes. It is also misleading.

Based on anecdote, radical mastectomy would still be the standard of care for breast cancer. Based on anecdote, rehab after a heart attack would consist of sitting on one's butt for six months "for healing." Based on anecdote, there are any number of medications one might use for treating pulmonary fibrosis. They actually don't do much. None of them. Based on anecdote, laetrile would be the nectar for cancer. Guess what—it isn't. So if you want to run on anecdote, go right ahead. But don't be surprised if your results are random, because that's what's happened in medicine based on anecdote. It's the reason why evidence-based medicine has emerged from the shadows. And don't forget that regression to the mean. Relying on anecdote goes right up there with physician self-treatment of disease. BTW, my uncle treated himself for a heart attack. Wrote the orders for morphine (it was 1960). Managed to kill himself with an overdose. In the hospital.

Second, vitamin C has been looked at for any number of diseases. For the common cold, there's lots of hedging by the Cochrane Collaboration, but I'd hardly call it something where they see compelling evidence—at least for the common cold. Linus Pauling may have thought he was onto something. He was brilliant, some would say he was a genius. That doesn't give him a pass on evidence. Ronald A. Fisher believed cigarette smoking wasn't—couldn't be—a cause of lung cancer, and he was mystified by the increasing mortality rates from it. The same was true for Jacob Yerushalmy. There's a fellow in San Francisco, generally acknowledged as brilliant (he may even have a Nobel) who maintained that HIV wasn't the cause of AIDS. Genius isn't immunity from being wrong. Conjectures in science, even from geniuses, need evidence to be considered worthy of incorporation into the corpus of scientific knowledge.

I had two good friends, Bill Cochran (he of Cochran's Theorem and Abel Wolman talking at a symposium on the history of epidemiology. Cochran observed that "Evidence is a bitch." Wolman replied, "At least evidence is visible. It's the non-visible things that will get you every time." Wolman made his reputation in sanitary engineering (as it was then known) on figuring out how to get sufficient chlorine into tap water as to kill the cell present in it while maintaining that water's potability. Threats that weren't visible was his stock in trade, so to speak. But these were philosophies of science, not specific research questions.

Third, the pharmacokinetics of vit C do not suggest that more is better, ie, always gives a higher serum concentration.

Sorry about the length of this message, but it's worth noting that saying, "Guessing is a capital crime, and if you engage in it, you will lose your capital and become a criminal." I wish I could remember who said it. Can't though.

## Ralph Vince writes:

I don't disagree with you (more specifically, I'm not qualified to disagree with you on this even if I were inclined to), however, as infants we learn to speak, and before that even, in our earliest life hours, we learn to learn by optimization based solely on the sparse data set of anecdotal evidence.

It's a platform that has certainly served us well, should not be disparaged, but rather ought to be acknowledged as perhaps not always best when other determination making platforms are available.

Properly done full squats are excellent for strengthening knees (assuming no preexisting damage, only weakness). One of the surprising things I've found since starting powerlifting 4 years ago, is that a lot of 'knee pain' can be corrected through better mobility (ie, stretching). New power lifters of all ages typically have to work on hip and ankle mobility before they can successfully squat. Once you have the mobility issues corrected, building strength is a matter of patience and diligence.

My wife, a RPh, thinks it MAY help, because it does seem to increase the lubricant on the joints.

However, firstly, this effect takes 2-3 months of use to develop this effect, The placebo effect is much more immediate. And most users think it works much quicker than the measurable effect to the body.

Secondly, it may simply be self selection, since as Jim and others suggest. Those willing to stick to taking 3-5 large pills a day are usually the ones willing to exercise. Diet also effect it.

Thirdly, many drugs help cause the desired response to the body, but create other problems to produce that effect. For example lowering cholesterol, but also side effect of lower calcium/electrolyte for the heart. (this is why I avoid supplements in general)

Fourth, it is not a "cure" but a MAY prevention future flare-ups, it MAY mask the symptoms. And people with arthritis have various rate of deterioration. Hence, needing a large group to determine if it helps.

With this said, many doctors and pharmacists do recommend using it.

# The Problem with Target Funds, from Charles Pennigton

Scott, what do you see as the the problem with target funds? Is it that they just hold too much in stocks?

I do see that AAATX, which is a 2010 target fund, does continue to hold about 50% in stocks. So they're putting someone who retired in 2010 and may be 65 or 70 years old into a 50% stocks portfolio. Indeed, that's a higher percentage than I would have expected. Is that the point that you're making, Scott? What do you think the percentages should be?

## Scott Brooks writes:

To Charles and anyone who wants to read this: Prepare for a long missive.

Target date funds have a multitude of problems…I'll hit on a few.

First, they give retirees a false sense of security. A sense that they're being taken care of by these big firms that "know what they're doing".

So you see retirees who have most of their retirement tied up in investments (as opposed to pensions) still living with an accumulation portfolio (i.e. still trying to get big returns) who think they can pull 5% - 10% per year off their portfolio because they've got a portion of their assets in a target fund.

Look at what happened to the target funds from 4Q07 - 1Q09. Most of their assets get hammered by 30% - 60%.

So you have a retiree who has spent the last 2 or 3 decades in an accumulation mode with an accumulation style portfolio and now they've got to make the shift to a distribution mentality and distribution portfolio…..and they don't want to do that…they think they can still keep investing like they always have in the past. They still want to see their portfolio grow like it did in the 90's or like it did from 1Q03 - 4Q07, or like it did from 1Q09 - present.

They forget the downturns as they become further and further removed from the downturns (00, 01, 02 are a distant and almost forgotten memory and 08 is almost forgotten as well).

But they "kinda know" that they should (maybe) get a bit more conservative, so they bite the bullet and put a chunk of their portfolio in a target date fund and leave the rest in their accumulation style portfolio.

Then when another downturn hits like 00, 01, 02 or 08, they'll see their portfolio meltdown 40%, 50% and in some cases more. They'll find that their target date fund (maybe) didn't lose as much, but it still went down 30% - 40% (maybe more).

Now what?

As much as a volatile market helped them in the accumulation phase of their lives (i.e. via dollar cost averaging), pulling money OUT of the portfolio to live on (kind of a reverse dollar cost averaging) hurts even more than DCA'ing helped them.

The drag/strain of a withdrawal stream on a portfolio is bad enough, but when we have downturns like we've experienced over the last 15 years, it can be devastating.

So basically, my first gripe is that Target Date funds give a false sense of security to retirees and pre-retiress (and believe me, I see it every single week) that they are not more conservative and the TDF portion of their portfolio is safe.

My other gripe is that Target Date funds have a problem with competition. When things are going well, (as they have for the last 6 years or so), people start to get antsy because of the lower returns of the Target Date funds. So eventually, after watching their friends get higher returns (sometimes substantially higher), people start to migrate out of the TDF's.

TDF's know this and they want to not only keep their current clients, but they want to attract new investors as well. So they have to "juice" the returns a bit by holding a bit more stock than they otherwise should. For example Charles made the comment about the 2010 TDF holding 50% stock and 50% bonds for clients that are ostensibly 65 - 70 years old.

Based upon "conventional wisdom" and "rules of thumb" (assuming you accept that claptrap), doesn't 50% stocks seem a bit high?

And if you're smart enough to see thru that line of BS (i.e. 100 - your age = % of stocks you should hold) you'll also notice that investing in bonds (especially right now) is not really a "risk decreasing move". Is anyone naive enough to think that interest rates are going to stay down forever? When they do start going up, we all know bonds probably aren't going to like that very much and I feel safe in summarizing that stocks won't like it either.

Yet people believe that 'ole line of horse manure sold to them by the "big mutual fund companies" that the TDF's are going to take care of them and that they've decreased the risk in their portfolio by making the switch to XYZ fund companies TDF group.

But what if interest rates never go up again? Are holding more and more bonds a safe way to go now? Well, the old phrase "you can't get there from here" comes to mind. By that I mean with interest rates so low, the bonds aren't yielding enough to make them worth the risk associated with the "butt kicking" that may some day come if interest rates go up.

But back to my earlier point about the TDF's having to "juice" their returns to help quell capital outflows while also attracting new money in. If interest rates stay low they've got to increase their stock holdings just to keep the peasants happy. So they decrease bond positions and increase stock position. So basically, even if interest rates stay low, the TDF managers just become part of the parade of people that are helping to build the next bubble (the next bubble being whatever the fund managers are investing in to get good returns that eventually will come crashing back to earth someday)

Look, I'm not telling anyone on this list anything they probably didn't know already. We all have a basic understanding of how markets and economies work.

But the average guy out there, Johnny and Sally Lunchbucket DOES NOT HAVE A CLUE!

They have little or no pension. They do have SS.

But what they've got is a nest egg in their 401k/403b/457/IRA/Roth/etc. And that nest is a LOT of money (at least to them).

Here's an example of what I see.

Couple aged 65 has:

\$250,000 in an IRA

\$100,000 in a TSA

\$100,000 in an 401k

\$150,000 in a brokerage account

\$40,000 in the bank (I don't count bank "cash" money in my financial planning equations. This is "emergency fund" money that gives them "peace of mind" knowing they can get to it).

They've got \$3,000/month of SS (between the two of them) coming in They've got \$2,000/month of pension (between the two of them) coming in Therefore, they have a total of \$5k/month coming in each month for them "to live".

When one of them dies (usually the husband in most cases), they are going to lose the lessor of the two SS and lose \$500/month of pension income….but that's another problem to discuss on another day.

The problem they have is that (while both of them are alive) \$5,000/month is not enough for them to enjoy the life they've worked 40 years for to have in retirement. They need an additional \$1,000/month. So they need \$6,000/month "to live"

They also want to have an additional \$10,000/year "to have a life" (go on cruises and other trips, help the grandkids when needed, etc.).

So far, this seems pretty doable, right? Between the \$1,000/month (\$12,000/year) "to live", and the \$10,000 they need "to have a life", they only need to "withdrawal/strain" their portfolio for \$24,000/year (or 5.8%/year). They seem like they're in pretty good shape right?

Yeah, they're fine as long as 2008 doesn't come along again and knock their \$500,000 nest egg down by 45% to \$275,000 (Which is what will happen to them even if they own a TDF's). (And yes, I know their total nest egg is more \$640,000, but bear with me for a moment and I'll account for the rest of the money in short order)

Now, when 2008 or 2000/2001/2002 happen again, they either have to drastically change their lifestyle or very much run the risk of running out of money. Maybe they just curtail their lifestyle for the 5+/- years that it takes for the market to recover. But at age, 65, how many "5 year curtailments of lifestyle do you want to take"? You don't have much time left and you certainly don't want to waste any time waiting for the money to come back.

So what SHOULD they have done?

Here's what I would do for them.

I'd take \$240,000 and put it into a private pension annuity (yeah, I know we all hate annuities, but bear with me here). That is going generate for them a guaranteed monthly income of AT LEAST \$1,000/month (keep in mind that is the guaranteed minimum….it could be higher). I would almost certainly use a fixed indexed annuity (don't fall for the variable annuity and it's "potentially" higher returns game here…remember, in retirement it ain't about the gain, it's about the losses).

I would then take \$260,000 and put it into a mix of low and moderate risk private money managers who focus on risk management (i.e. decreasing beta by 50% - 80%) so that I can generate for them the \$10k they need to "have a life".

Now, what have I done.

I've guaranteed that this couple is going NEVER run out of money because they have their pension, social security, and private pension annuity. So, at the very least, they have the peace of mind to know they'll, at least, be able "to live".

Since I'm using low/moderate risk money managers and properly allocating their investments over multiple asset classes, they have a very high probability that they'll continue to get their \$10k/year of money "to have a life".

Also, if the private money managers only continue to perform at 80% of the level they have in the past, we'll also be able to offset the ravaging effect of inflation on their spending power over the ensuing years.

Now, if you've done your math, you've noticed that I still have \$140k of money left over in their portfolio. What should I do with that.

Well, now we've got to take care of the other big problem that plagues seniors…..Long Term Care.

But who wants to pay for a LTC policy that could (and likely will) skyrocket in price over time.

So what I do is take \$100k and I put it into a Life/LTC Combo policy that qualifies under IRC 7702 and 101c. This is a hybrid life insurance policy that allows you to use the death benefit for LTC (you can usually access up to 2% of the DB/month for to pay for LTC).

They both end up with a policy that has (give or take) approximately \$250,000 of DB on each of them, that guarantees that the internal premiums can never go up (this is very important for LTC which is NOTORIOUS for massive premium increases), pays them a decent interest rate on their money in the plans (keep in mind that the interest they pay you is usually eaten up by the cost of the insurance but the benefit of this is that it allows you to pay for the premium with pre-tax dollars while still enjoying the benefits tax free), and the policies can be shared by each other (i.e. if the husband needs nursing care and uses up his entire \$250,000, he can then dip into his wife's LTC plan and use up her \$250,000).

I would then set them up with an attorney who would make sure that they have a good trust in place with proper POA's (health directive and POA for asset management) and also put together a Medicare Trust for them so that they only need to really worry about LTC for no more than 5 years after the trust is set up.

That leaves \$40k of money that they have in the bank. That money stays right where it is. That's the amount of money THEY NEED to have the peace of mind that they've got an emergency fund handy that they can get to by driving down the street to their local bank. This is important the Lunchbuckets to have easy access to this emergency fund money…..JUST IN CASE.

Then, I would meet with the Lunchbuckets at least once per year (usually more like 2 - 4 times per year). My staff would call them at least monthly, they would get a monthly newsletter from me, and I would make sure that they attended at least 2 - 6 client events (dinners, client appreciation events, etc.) so that I CAN MANAGE THEIR EXPECTATIONS AND THEY CAN ALWAYS SEE THAT I AM PROACTIVELY DOING EXACTLY WHAT WE SAID WE WOULD DO AND THAT THEY ARE STILL ON COURSE TO ACHIEVE THEIR GOALS AND THAT THEY DON'T START TO GET ANTSY ABOUT WANTING HIGHER RETURNS OR GET TOO SCARED WHEN THE MARKET MOVES AGAINST US. I MAKE SURE THAT THEIR CLIENT BINDERS ARE UP TO DATE SO THEY CAN EASILY REFERENCE THEIR GOALS AND CLEARLY SEE THE PROGRESS WE ARE MAKING TOWARDS THEIR GOALS.

At this point, it's all about managing expectation and being there for them when they need me.

Now, after all this, let me remind you that we're not talking about sophisticated people here. We're still talking about Johnny and Sally Lunchbucket. But everything that I've laid out above (may) seem(s) like sophisticated planning…..AND IT IS….to the Lunchbuckets.

But the Lunchbuckets don't know about this stuff. All they know is what their Edward Jones broker (who has them in the same things he did when they were in the accumulation phase of their lives….and, quite honestly, sells the same crap to all his clients because he makes a higher commission by selling "certain" products) or their UBS broker, or their Wells Fargo broker or their "regional brokerage firm" broker, or their cousin who sells insurance and mutual funds (all of whom have the same conflict of interest issues that the Edward Jones broker has) has told them. And what they've been told by these "professionals who were smart enough to pass a series 7 exam" (which you don't have to be very smart to pass) is the is the same failed BS claptrap that they've been told for years….except it's been repackaged to fit the times…..i.e. repackaged as Target Date Funds (or some other equally slimy crap).

And the next time the market corrects, the Lunchbuckets are going to get HAMMERED…..and they're going to be told by their broker to "stay the course", "hold on, it will come back", "we gotta take the lows and the highs".

But the Lunchbuckets won't like that. They'll feel a gnawing sense of anger and an increasing pit in their stomach as they watch their portofolio melt down further and further and further. And they'll get angrier and more desperate as the market starts to recover and their portfolio doesn't recover as quickly because:

1. They sold stuff near the bottom in a panic or

2. Their broker got scared and put them in more conservative investments (you, now high sell low) or

3. Or they kept making withdrawals on the way down and had to sell more and more shares just to get the same amount of money and now they don't have enough shares to facilitate continued withdrawals and allow the portfolio to recover, or

4. Maybe they believed the Vanguard BS or their broker was lazy and they ended up with TDF's. TDF managers that are now in a panic because they didn't protect their investors at all and so now they all of a sudden want to get more conservative to show that they're at least doing something, even though it's "too little, too late" and they end up buying high and selling low.

I've been typing for some time now and I think I've gotten off on more than a few tangents and strayed from the original question about why I have a problem with TDF's.

What it comes down to for me, in a nutshell, is that TDF's are just a gimmick put forth the financial services industry to gather assets by telling investors a new twist on the same old line of BS that the financial services industry has been spewing from their lying mouths for years.

The Lunchbuckets used to get pensions managed by professional and prudent companies (usually insurance companies were the best at this) and they knew that between their pensions and SS, they were going to be able "to live' in retirement.

Now, the Lunchbuckets don't get enough (or any) pension and they have to figure out how to take care of themselves. Their pension has been replaced by a large barrel of cash in the form of 401k's/IRA's/403b's/457's etc. that the Lunchbuckets are woefully unable to handle themselves…..so they get preyed upon by the predators and scavengers who infect the financial services industry.

Now, some of these scavengers and predators are naive' and ignorant about the havoc they are reeking upon the lives of those that they call clients. They are just following the company line and doing what they are told by their "superiors and bettors that are higher up the food chain". Some of the scavengers and predators figure out the harm they are doing (or they are willfully ignorant), but are so addicted to the lifestyle and the money (where else can a schmo go and make ball player money?) that they rationalize what they are doing so they can stand to look themselves in the mirror or face their wives and children.

That is, in part, the problems I have with Target Date Funds…..target date funds are just a symptom of the many problems that plague the financial services industry.

## anonymous writes:

Nice work, Scott. Your clients should be grateful that you're doing this kind of thinking for them.

I guess I'd say there's nothing intrinsically wrong with the idea of "target date" funds, but Scott's saying that 1) these funds remain too heavily weighted in equities as the target date approaches and passes and 2) they often allocate reactively in a "CYA" kind of way.

I agree that annuities should play a role in most people's retirement finances, but I would need a pro like Scott to wade through the annuity world–they're complicated. I also came to the same conclusion as Scott regarding long term care insurance, which seems like a "heads we win / tails you lose" kind of deal for the insurers. Packing it into life insurance seems promising, though again, I'd want someone like Scott who is honest and immerses himself in this stuff to help me figure it out. ￼

# Man Bites Dog: the Yale Professor is Bullish on Greek Stocks, from Charles Pennington

Seems like a good idea, and so I bought some GREK at 10.71 this morning.

I wrote to the professor to ask if the model that called for the buy on Greek stocks is publicly available. Haven't heard back yet.

I became a Shiller skeptic after reading an article of his that had what I think was a serious statistical error. His thesis was that market valuations fluctuate "too much". To prove it, he compared each year's valuation with the then present value of the forward earnings, known retrospectively over the following 50 or so years–I'll call that number the "retrospectively known present value" or "RKPV". Sure enough, he found that market valuations fluctuated much more than the RKPVs. He correctly pointed out that if a predictor (the market valuation) has a bigger variance than what's predicted (the RKPV), then the predictor clearly has room for improvement.

The problem though is that he only had on the order of 100 years of data to work with. Since each RKPV involved about 50 years, he effectively had a non-overlapping sample size of around 2 — so small as to be meaningless.

In 1932, people thought the RKPV would be very low. It turns out that they were wrong. But if we had 1000 years of data to play with, it might turn out that the next "1932" event will indeed be followed by a super-low RKPV, perhaps even lower than the market's valuation. So we don't know enough to conclude that the market is irrational.

The Chair has pointed out that Shiller made a similar mistake in his "CAPE" analysis. He'd have roughly 100 years of data, which sounds good, but his CAPE predictor looked back 10 years and predicted forward 10 years, so the non-overlapping sample size, again, was only around 10. Shiller would claim the CAPE was good at predicting the 10-year forward return, The Chair, however, did a little snooping and showed that it was in fact bad at predicting the forward 1-year return, getting the sign wrong even. It's kind of implausible to claim that one has a predictor for the year 2024 return, but it can say nothing about 2015. So that further suggests the CAPE results are an artifact of small sample size.

It's possible I've missed something, but these seem like novice errors. It made me suspect that it's a little easier to get the Nobel Prize in Economics than in Physics or Chemistry or Biomedical Sciences.

# Debt Graph, from Charles Penningtom

May 13, 2014 | 1 Comment

Have you seen this interesting graph of debt/GDP ratios of the G7 countries since 1946.

It's puzzling to me that in 1946, UK had 270% debt to GDP, and US and Canada had >100%, while at the same time Germany, Japan, and Italy had almost no debt.

I'm sure the allies didn't want another Versailles, but still this seems like an extreme outcome.

Germany, Japan, and Italy also had almost no assets. Their currencies were worthless, hence no debt. I'm guessing that the same phenomenon occurred with the Confederacy as the end of the war approached.

## Stefan Jovanovich retorts:

David's answer is - alas - a muddle. The currency and the debt of the government of the Confederate States of America was officially worthless after the surrender at Appomattox. (Read Section 4. of Amendment XIV of the U.S. Constitution.) So were Germany's debts, currency and laws after the formal surrenders signed by the remaining German General Staff officers with first the Americans and British and then the Soviets. Germany, like the Confederacy, literally disappeared. That is why the line for Germany beginning in 1945 is flat at 0 until the reconstruction loans that were part of the Marshall Plan took effect in 1948. What is interesting is the other flat-line - the one for France. The Vichy French government never formally surrendered; one of deGaulle's marvelous bits of arrogance was to assert that Vichy itself was not a government and could have no recognition. Somehow that also became the rule for the debts of the Third French Republic (I don't know exactly how) as well. After the war, their debts, like those of Vichy and Germany, seem to have legally vanished. When deGaulle took charge after the Normany landings he was meticulous about asserting that he represented the Provisional Government of the French Republic (GPRF), not the Third Republic. Yet somehow the financial assets of that Republic - specifically the gold on deposit with the Federal Reserve bank - were "saved" and became the property of the new Fourth Republic that came into existence after deGaulle resigned in 1946. Italy, which had overthrown Mussolini and signed an Armistice with the Allies, and Japan, which retained its Imperial Rule, both continued to exist as governments; their debts were restructured but not officially abolished.

FWIW, Charles, I don't think the the parts of the graph that deal with the immediate aftermath of WW II have any meaning. They are another attempts to put prices on things for which there is no market. The statistics for the U.S. GDP during WW II are another example. As Higgs and others have pointed out, the "recovery" of the U.S. economy in WW II cannot, in any sense, be measured in dollars. We know what the U.S. "spent" but that money cannot be considered an "investment"; the factories had no value except to make things that only governments would want to buy and this was at a time when all the governments of the world, except the U.S., were broke.

# Heart Disease Dramatically Reduced, from Charles Pennington

April 27, 2014 | 2 Comments

This blog post gives some very stunning data on "coronary heart disease", which I assume means "heart attacks". Supposedly the rate of death per year per 100,000 people has gone from over 500 in the 1970s to 20 now. People just stopped dying from heart attacks.

What's up with that? Is the data misleading in some way? Has coronary heart disease started getting re-classified as something else? (And for that matter, isn't "coronary heart disease" redundant?)

Seems like a good topic for Dr. Lillienfeld.

## Dr Lillienfeld responds:

A few thoughts:

First, the commentator in the link should not be confused with the UNC ob-gyn epidemiologist David Grimes.

Second, coronary heart disease, in which atherosclerosis is present in the coronary arteries supplying blood to the heart musculature, differs from valvular heart disease (in which one or more valves malfunctions and needs to be replaced) and other manifestations of heart disease. Syphilitic heart disease referred to in the blog is, I think, a reference to dissecting thoracic aortic aneurysms, which used to be a major problem in the US, but with control of syphilis, it's declined in occurrence.

Third, as for the main issue, there has been a substantial decline in CHD mortality in the US and in the UK. The peak in the US was in 1968 and in the UK, 1970. Stroke mortality has similarly declined. There are lots of questions as to what is actually taking place in the population—is it better treatment? is it reduction in exposure to risk factors? We know that there's been a significant reduction in risk factor prevalence—smoking rates have declined from 60% or so in the US to 20%. (The impact of the e-cig boom isn't clear as yet). There have been significant reductions in air pollution, especially in the small particulate portion, and the consumption of a fat/cholesterol-based/laced diet has also declined.

Hypertension has come under control (though in the early 1980s, with budget cuts in public health clinics, hypertension control lessened, and for a period of about 8 years, stroke incidence went up). Oral contraceptive use—a significant factor in heart attacks in younger women and also strokes—have reduced their estrogen content (we're now on the 3rd generation), and with that reduction, the associated risk of a heart attack or a pulmonary embolism has declined, too. (There's parts of this story in Foundations of Epidemiology 2nd edition and 3rd edition), but we didn't include it in the first edition—that was much of a lung cancer-cigarette smoking focus.

So far, so good. Except that the decline began in the US in 1968, just after the role of oral contraceptives in heart disease in young women was discovered (and before any reductions in estrogen content had been undertaken). (By the early 1970s, something like 60% of American women under the age of 50 had used oral contraceptives for at least 18 months; it was a widely used medication-especially among women who smoked—and smoking acted synergistically with oral conceptive use in increasing the risk of a heart attack. Hypertension control was introduced into the US during the 1960s. It would be difficult to say that it was widely prevalent by the end of the 1960s. During my residency in Minnesota in the mid1980s, we undertook many different ways to get everyone in the population screened for hypertension, and we know we didn't succeed nearly enough to suggest that there was effective control of high blood pressure in the population. In any case, control of high blood pressure really took hold only after the decline began. (It has had an impact—on chronic kidney disease; it has reduced hypertensive renal failure significantly. And since Medicare covers the expense of dialysis, the use of those anti-hypertensives has saved a lot of money. Whether Medicare should have ever covered the cost of chronic renal failure, much as whether it should have covered coronary bypass surgery, is a matter of contestation.)

Similarly with blood lipids. Cholesterol levels have declined, but the impact of the statins (the effects of which have been shown in a number of randomized trials) would have been felt only since the mid 1990s; lovastatin wasn't even introduced in the US until the late 1970s, and atorvastatin (Lipitor) wasn't until 1997. In other words, the big three risk factors for heart disease—blood lipids, smoking, and high blood pressure—have declined, though lagging the decline in mortality. Then there's Europe. Smoking in Europe did not decline nearly as much, nor as fast, as in the US. I don't know about the extent to which high blood pressure control occurred in Europe, but I doubt if it was any faster than in the US. Yet the decline took place to the same degree as in the US.

Ah, I hear you say, that's because it's the result of better treatment. All that money wasted on disease prevention programs. Except that the data supporting that contestation are as out of sync with the decline as were the risk factors. Many cardiologists have declared that the decline is a demonstration of the impact of all the coronary care units built during the 1960s and 1970s. CCUs were the crowning jewel in many academic medical centers. There were high tech and they were effectively black holes for money. Despite many efforts by epidemiologists to subject CCUs to randomized trials, cardiologists insisted (much as psychiatrists were doing at the same time) that to deny access to the CCU to any patient meeting criteria for admission to the CCU was unethical. But CCUs were an American creation. The UK and much of the rest of Europe didn't build them until the decline was well underway. That build-out wasn't completed until much of the decline had happened. The same is true for coronary bypass surgery and the use of stents.

Bill Rothstein looked at this issue (to a degree) in his book (http://www.amazon.com/Public-Health-Risk-Factor-Revolution/dp/1580461271). Bill got into quite a heated discussion when he presented his first paper on the subject at the 2012 American Association for the History of Medicine meeting in Baltimore (esp with Bruce Fye, who I think is still at Mayo), and more recently at the 2013 meeting in Atlanta with Henry Blackburn (from U Minnesota). Henry's compiled his own online history of cardiovascular epidemiology (http://www.epi.umn.edu/cvdepi/people_list.asp), but at least when I last spoke with him late last year, he had no response to Rothstein.

Frankly put, no one understands the decline, and to suggest that statins and the like had little contribution to it doesn't make sense given the extensive clinical trial data showing significant effects. Lipitor can reduce the blood lipid level by a third, for instance. The only thing everyone agrees on is that there was indeed a decline. Maybe it's lots of little contributions, except that the lag times don't concord with that explanation, either.

I hope that helps.

## Charles Pennington writes:

Yes, that was masterful, seriously. I am still digesting it. Thanks!

If you still have energy left, I would also like to know about the left hand side of the curve–the enormous accelerating increase that took place from 1910 (when the rate was very close to zero) through the 70s. Was that at least partly a reporting/diagnostic issue — that they just didn't recognize this mechanism of death in 1910?

## David Lillienfeld replies:

Let's start with what we know and work from there. We know that by the 1960s, there were many heart attacks occurring in the US male population—women would catch up in a couple of decades (yes, Benson and Hedges had it right, just in the additional context of disease as well as social conventions, occupational opportunities, and so on). The phrase "He had a coronary" was part of everyday discussions. For a middle-aged American male, having a heart attack was almost a part of life's passages, much like one's first love, marriage, children, and so on. Heart attacks were diagnosed by EKG until the 1960s, when wide-scale availability of serum chemistry analyzers in medical laboratories facilitated the development and use of elevations in different enzymes as indicative of a heart attack. At the same time, the idea of a "silent MI," as it was called, was developed, in which some myocardial tissue died from a mini-heart attack that did not cause sufficient pain or shortness of breath to cause the individual to present to a physician. That's how we came to know that there were a lot of heart attacks in men during the 1960s (which is not to suggest there wasn't lots of heart disease in women, too).

How did we get to the point of having so much heart disease in the first place? Heart attacks have been known as a distinct clinical entity for a long time. In Major's Classic Descriptions of Disease (I think I have the second edition, but I can't find it immediately), the credit for the first observation of a heart attack is given to Adam Hammer, a physician in St. Louis, who published the description during the late 1870s. Angina pectoris, as a distinct entity, would await William Osler, but I don't remember the date. It was later than Hammer.

During the first part of the 20th century, there's general agreement that the majority of cases of heart disease were rheumatic, ie, sequelae to a case of rheumatic fever; specifically, there was damage to the heart valves. (While there was some controversy about the diagnosis of rheumatic fever and what might be its cause up until the 1940s, when T. Duckett Jones put forth a standardized set of criteria that have served since as the basis for making the diagnosis, the cardiovascular effects were accepted as such back by the turn of the century.) While there are some controversies outstanding about how exactly rheumatic heart disease develops, its clinical diagnosis can be made with assurance using the medical technology and skills available in the early part of the 20th century. It seems unlikely, then, that there were many heart attacks misdiagnosed, unless one posited that there were lots of silent heart attacks. I don't know of anyone putting forth that idea, though.

Two big factors weighed on the population's health during the turn of the century—better nutrition and, for reasons not well understood, a declining frequency of active tuberculosis. The two may be coupled, but again, that's controversial. Suffice it to say that American diets included many dairy products, providing a source of animal-based fats. This was the "anti-tuberculosis diet" of the early 20th century. It provided sufficient calories that even in the presence of an active case of tuberculosis, the patient was not literally consumed by the infection (this is why TB was known as consumption). The problem was that that same diet was also fantastic at creating fatty plaques the lumens of the coronary arteries (other arteries too). As the population became wealthier, consumption of meat and processed dairy goods increased. Concurrent with that was an increase in the prevalence of smoking. Prior to 1900, there wasn't nearly as much smoking as there was in the mid-20th century. And the vast majority of that smoking was among men. The incubation period for smoking on heart attacks is much shorter than dietary fat or hypertension. WW2 didn't help matters—the cig cos gave the cigs out free to soldiers—a whole generation hooked on smoking.

Hypertension is a little more challenging. No one's really sure when it really did first appear. Until the 1950s/60s, increasing BP with age was considered OK.

The bottom line is that there was a confluence of factors, all of which were increasing at the same time—a trifecta if you will. Or a perfect storm.

# Kids and Video Games, from Charles Pennington

This article tells a story of the positive consequences of banning video games in the household.

It rings true to me.

They're addictive, and any skill that a kid might pick up can't be generalized to much of anything else. A lot of unpleasantness occurs daily when you tell your kid that it's time to stop playing–and so putting "limits" on their time is not a great solution.

Of course the games can be of practical use to a parent if he wants to de-activate his child for some period of time, but maybe they will turn to books if the games are out of their lives.

Agree, disagree, or is this too obvious to even discuss?

# Yuan Thoughts, from anonymous

February 28, 2014 | 1 Comment

The purpose of this post is to stimulate discussion about an important market development. It's not a prediction.

I believe that one of the most widely accepted memes in the financial markets over the past several years has been that the Chinese Currency was/is undervalued, manipulated and would not go down and must eventually go much higher. The fundamental arguments for this were the persistent balance of payments surplus, purchasing power parity, competitive advantage/cost, political pressure, the history of currency movements in places like Japan, relative growth rates and growth potential; monetary base; and the list goes on and on and on. In fact, I can't find any credible opinion to the contrary. (A couple of summers ago, Bill Ackman made a big PR splash buying "cheap" calls on the HK dollar predicting an inevitable and massive revaluation.)

Over the past few weeks, the Yuan has reversed course and started to decline. It has had a violent and 3 sigma decline in the past 3 days. The story is that the Chinese authorities are encouraging a "wider trading band."

I am not offering any predictions here. But it is striking that the impulse move is in the down direction, not the up direction … all the more so, when the universally accepted truth is that the Yuan can only rise.

Is this just a counter trend move? Or is something bigger going on? If the Yuan starts declining instead of rising, what are the second order effects on other markets? If this is more than a counter trend move in a secular bull market for the Yuan, then I believe there are some very important implications. Unfortunately, I'm not smart enough to know whether the supposition is true and/or what the second order effects may be.

A good place to start thinking about this might be historical analogs. What are the historical analogs? And when does the perma bull Yuan story get stopped out?

## Alston Mabry writes:

I agree. With all the issues out there on shadow banking, credit bubble, CBOC actions, ghost cities and shopping malls…who actually knows what's going on? If anybody "knows', it's the market itself. Once China frees up capital controls, import controls and currency controls and becomes relatively transparent accounting-wise…then the RMB will move on economics…mostly. But right now there are so many "shadow issues" in play that it's hard to assess the situation other than on a short-term trading basis.

## Richard Owen writes:

Disregarding the background 'China story' which is the key determinant of the secular factors (eg, do you believe China is massively insolvent or not, does it matter), when currencies are 'newly' brought to market (in the sense of being a new regime, if not a new currency), they often trade off initially. Domestic holders want to diversify and foreign buyers have no structural reason to accumulate inventory, thus have a 'show me' attitude on price. And since fx is a short duration asset, nobody is holding for the carry and a trend begets itself. Or to put it another way, as yuan trading is liberalised, does the marginal holder likely want to diversify out of existing stock more than a foreign holder wants to get into? Comparables are perhaps the euro introduction, where despite a hugely profitable convergence carry on long bonds, even underwritten by the ECB discount window, it initially sold off. Perhaps more analogously, when South Africa empowered its blacks, the Afrikaans community thought the end was nigh (as some chinese entrepreneurs do now) and began liquidating everything and selling into offshore currencies. They misread the situation, however, and the sandtown community provided a bid to the Afrikaans. My friend's uncle bootstrapped a working mans savings into a billion by buying the real estate liquidation, putting in newly arriving AAA multinationals as tenants and riding the yield curve down from teens to single digits.

## anonymous writes:

In the face of 2008 downturn, the Chinese government created more money than was done by the ECB or the Fed. The shadow banking system carried on making new loans to reestablish the housing bubble. Based on that slice of data, the RMB should not be rising against other foreign currencies, but falling.

Yes, trade surpluses are supportive to a currency, but China's big trade surplus with the US is balanced by some trade deficits with sources of raw materials, and production machinery, so that their trade surplus overall is not as big as with the US. The foreign direct investment into China has been very high as has the Carry Trade where borrowing in low interest rate countries like Japan and buying higher rate Chinese Treasuries, was profitable and gained even more as the RMB rose. This looks to be reversing and is thus a negative for the RMB and is big at maybe a half trillion dollars of hot money.

The image is of the Chinese government suppressing the currency to keep its exports growing and doing so by buying US Treasuries, and that was also pushing the image higher. But Chinese people are buying gold for safety, indicating that they have seen government spending and do not have confidence in the RMB. I think a downward spike in RMB could be followed by more selling if Carry Trade unwind becomes big. But PPP and Trade surplus will limit the move eventually, IMO.

## anonymous writes:

I also agree, (Chinese financial reporting is awful) but the assertion that we can know many outside variables from the US\$ of the equation is very important. (Current account surpluses and deficits bear many similarities to double-entry accounting, in that aggregate balances in one direction or another should balance each other out.)

I submit that the current state of Chinese property and credit markets bear many similarities to what Hyman Minsky termed a "deviation amplifying" mechanism in his Financial Instability Hypothesis.

However, if asked how it will play out, my tendency is to say that at some point over the next few years, they are at substantial risk for a debt deflation. Personally, I'd have a tough time convincing myself to be short a deflating currency.

## Charles Pennington writes:

OK, here's an "N=1" kind of study…

Back in mid/late 2011 the Swiss franc ("CHF") was strengthening violently against the Euro, with the Euro almost going down to parity with CHF. Then the Swiss stepped in to weaken the CHF and forced the Euro back up to 1.2 CHFs. The Euro sat there, pegged at 1.2, but everyone feared that the risk was that the Euro would fall below 1.2. Instead the Euro ended up moving higher against the CHF in mid-late 2012 and 2013. Very similar to Rocky's China story.

Since mid 2012, EWL (the Swiss market etf) is up about 55% and FEU (the EuroStoxx etf) is up about 40%. EWL is probably a bit less volatile than FEU (though I didn't check), so EWL's gain is yet more impressive.

So the N=1 conclusion is that you should buy Chinese stocks.

# Janet Yellen’s Humor, from Victor Niederhoffer and M. Chuprin

The Chairman of the Fed is known for her wit and wisdom. One thought it useful to memorialize some of her wit on a continuing basis. We hereby inaugurate a compilation of her "Sublime Jokes" so as to gain gravitas from her the same way her colleagues and supporters in the press who always admire her sense of humor.

Please feel free to augment this list with other examples of her hilarious remarks.

## Janet Yellen's humor:

1.

But even as she pushed for more aggressive policies to deal with the financial crisis [of 2008] and the economic downturn, Ms. Yellen also displayed an ability to disarm her critics with a sort of gallows humor, even in the darkest days. "In the run-up to Halloween, we have had a witch's brew of news," she said to the laughter of her colleagues, before quickly apologizing for her sarcasm.

2.

As a forecaster, Ms. Yellen was at something of an advantage. She was based in California, where some of the earliest signs of distress appeared. In a lighter moment, she joked that the problems were not just in the collapsing housing market.

"East Bay plastic surgeons and dentists note that patients are deferring elective procedures," she said to laughter, according to a transcript of the meeting on Sept. 16, 2008.

"The Silicon Valley Country Club, with a \$250,000 entrance fee and seven- to eight-year waiting list, has seen the number of would-be new members shrink to a mere 13," she said to more laughter.

But she also was looking for clues anywhere she could find them. In June, she told her colleagues about employees at her bank who "had their home equity lines slashed."

"One has deferred a planned home renovation project as a consequence," she said. "If that is happening to them, I can only imagine how hard it must be to get a loan if you have a merely average credit rating."

"Sales of cheap wine are soaring," Yellen reported to the Fed on March 8, a week before Bear Stearns collapsed

3.

Yellen, unlike Greenspan or a pre-2008 Bernanke, is probably the last person you'd hear repeating one of Reagan's favorite jokes: "The nine scariest words in the English language are: 'I'm from the government, and I'm here to help.'

Yellen is humorous. In the recently released transcript of the Dec. 16, 2008, FOMC meeting, she said: "An accounting joke concerning the balance sheets of many financial institutions is now making the rounds, and it summarizes the situation as follows: On the left-hand side, nothing is right; and on the right-hand side, nothing is left."

This morning I began the process of picking out items of praise from
the link below, but it's lunchtime now so I'll have to adjourn for
awhile.

She's ultrasmart but also ultramethodical

Yellen was not ordinary, even as valedictorians go.

Yellen is inclined to ask probing questions and to be interested in people even as she grapples with abstract ideas.

Yellen
revealed not so much a combative personality as someone prone to get to
the point and to avoid becoming too proud of her own intellect.

wanting to think through problems from every angle and with an open mind.

brilliant and a hard worker,"

"I don't think she ever just got along on brilliance."

Her thorough, skip-no-detail approach will be tested in the years ahead

Arguably no individual will have more influence over financial conditions for American families.

"The Fed is the only game in town,"

For
Yellen, that will mean navigating a difficult course from the moment
she occupies the head chair in the Fed's ornate conference room in
Washington: trying to move the economy toward more solid growth while
also backing the central bank off its stimulative policy of holding
short-term interest rates at zero. This will affect everything from
unemployment to inflation to stock market portfolios.

One of Yellen's challenges will be to defend the notion that the Fed serves all the American people

even Republicans don't doubt she has the résumé for the position.

Her career path has led her from prominent teaching positions to varied roles in the Federal Reserve System.

Some have called her the best qualified nominee ever.

Yellen will be the first woman to head America's top financial policymaking post.

Although
Yellen has said in the past that she hasn't felt discrimination during
her career, finance remains a male-dominated realm in America. Her
elevation carries both substantive and symbolic importance.

"every time a glass ceiling is broken it sends a signal that government is more inclusive"

Yellen
once accompanied her parents on a transatlantic summer cruise. A
highlight for Yellen, then in high school, had to do with learning about
rocks. A geologist on board, thrilled to meet a young person with a
keen interest in his field, presented her with a trilobite fossil.

She
the fossil..to her personal stash, Yellen loaned it to the biology lab
at her school so that others could learn from it, too.

Exploration was a kind of family trademark during her time growing up

The melting pot of New York City was itself a kind of global microcosm of arts, sciences, and culture…Yellen took it all in.

[family outings] included plays, concerts, or science lectures

Yellen's
youth wasn't all about igneous rocks and high-brow culture…one of
those concerts that they went to featured a young songwriter coming out
of the folk tradition, named Bob Dylan.

Yellen was a "very normal kid." "We would talk for hours by phone" about typical subjects such as boys, clothes, and "who said what to whom."

"the real gift to teenage girls like Janet and me was the way we were treated by our teachers, our parents and our peers." Instead of being beholden to gender stere­otypes, "[w]e were expected to take charge, just as our mothers and grandmothers did when men went off to war."

Yellen was an all-around scholar who, with encouragement from her parents, took an advanced-course track through middle school, allowing her to enter high school as a sophomore and graduate a year ahead of her peers.

Her prowess with language arts propelled her toward the editor in chief role at [the school newspaper]… yet her self-profile revealed her to be fascinated by science and math.

She was fun-loving and showed a ready wit

she said she enjoyed reading philosophy

also seemed to exhibit an unusual degree of discipline.

"She did lots of things, and she did them all really well,"

"What stood out to me was intentionality, purposefulness, a determination not to be better than others but to be the best she could be."

Yellen wasn't one to put on airs

Staff economists remember her eating with them in the bank cafeteria.

But she was motivated to achieve.

An unsigned editorial in The Pilot at the close of her senior year (Yellen believes she wrote it but, 50 years later, can't be sure) urged a do-something outlook that her own life embraced: "Be curious! Wonder why the sky is blue, what fire is, why peace-loving nations feud … but wonder about something!"

headed off to college at Pembroke (then the women's college at Brown University) in Rhode Island. Economics quickly drew her in. "She was totally smitten" after her first course, Grosart says, recalling the excitement Yellen shared when returning home on a break.

Graduating with highest honors led to the opportunity to do doctoral work at Yale University, followed by a rare invitation from Harvard University to start teaching there before she had landed a job anywhere else.

Yellen's career had begun its upward arc.

• • •

In 1977, Yellen met George Akerlof, another rising star in the field of economics. It was essentially love at first seminar.

"We liked each other immediately," Mr. Akerlof writes in an autobiographical sketch. "Not only did our personalities mesh perfectly, but we have also always been in all but perfect agreement about macroeconomics."

The scholar spouses shared an interest in mysteries related to unemployment.

Akerlof's and Yellen's academic lives have been centered around the University of California, Berkeley, where he won a Nobel Prize and she taught for years at the Haas School of Business.

Family interests over the years have included cooking, hiking, tennis, and travel. Yet their dinner table discussions, Yellen acknowledged in 1995, might not be that interesting to an outsider (typically revolving around economics).

The home environment was stimulating enough that Robert Akerlof, their son, chose to enter the same field and now teaches at the University of Warwick in England.

When Mr. Kohn's team of staffers would present economic briefings to the board, Yellen almost invariably seemed to be the one who homed in on the key issue.

"She would find the central point in the briefing, sometimes the central weak point in the briefing. I was often surprised, especially at first," says Kohn, who later held the vice chair role that Yellen would eventually occupy.

It was surprising in part because the other six got to comment or raise questions – starting with Chairman Alan Greenspan – before she, as the newest member, could utter a word.

Kohn's view of Yellen is echoed by Ted Truman,..he recalls similar signs of a sharp intellect.

Yellen's job was to take notes for the whole class, because Professor Tobin wanted the students to be free to listen and discuss. "They were very elegant and careful notes," Truman says, "and they became classics"

• • •

All this may make it sound as if Yellen is a superwoman – someone who crunches numbers about the American economy while wearing a cape. She isn't.

She often prefers to speak from prepared notes rather than spontaneously, which some see as a sign of preparation and precision and others see as too programmed. The best shot one Washington gossip news report could take was to chide her for – horrors! – wearing the same outfit to both her confirmation announcement and her confirmation hearing.

Yet she does draw criticism for where she might lead the Fed.

Her confirmation vote, on Jan. 6, was 56 to 26 – the narrowest margin any Fed nominee has ever been approved by. All the "no" votes were cast by Republicans.

Yellen's history at the Fed shows her to be more pragmatic than ideological. It also suggests she can be tough and persuasive when she wants.

# HPQ and Today’s WSJ, from Charles Pennington

January 23, 2014 | 1 Comment

WSJ today has an article that's critical of companies that do big share buybacks. It features quotes from Chanos, who says he's shorting some of the buyback companies. Much of it seems wrong to me.

HPQ is cited as an example of a buyback disaster — "if only" HPQ had just invested in real opportunities instead of those buybacks. I thought though that HPQ's problem wasn't the buybacks, but the high-priced acquisition of a software company that turned out to be fraudulent. Obviously they would have been much better of if they had used that \$15 billion to buy back shares.

The main target of the article though is IBM, which seems like a particularly bad choice. IBM's earnings have grown by a factor of 3 over the last 10 years while its share count had dropped 35%. Furthermore, IBM is one of the few companies to have reduced its share count even during the 2008/2009 period–the count went 1385, 1339, and 1309 million in years 2007, 2008, 2009.

## anonymous writes:

I think your analysis is quantitatively accurate, but the typical bottoms-up analyst has a much shorter lookback period than you do, 5 years at most, and with good reason.

The fact of the matter is that IBM has had extremely low/negative "organic" revenue growth for several years. The CSFB analyst has made the most consistently cogent representation of this argument, and "FCF conversion attributable to shareholders" (FCF post-financing, post-M&A) has been ~70% of earnings and falling … and FCF conversion has deteriorated every year since 2009 as a fundamental analyst/PM myself (of internet stocks).

I would never use a lookback beyond the current management team, and probably 3 years or less. I suspect Chanos keeps an extremely close eye on FCF conversion combined with -ve organic revenue growth, and sees aggressive corporate buybacks within a rapidly deteriorating fundamental backdrop as a form of management corruption, in which management chooses to invest excess capital in juicing their own stock options, instead of reviving the company's longer term prospects. This is endemic of "blue chip" tech conglomerates that no longer know how to generate organic growth.

I am not quite as familiar with HPQ but i strongly suspect it's a similar thesis.  I was totally bewildered by Buffett's decision to load up on IBM in 2011 as were a lot of people who covered IBM. It violated every one of Buffett's own rules.

Side comment: since Chanos is compensated on "negative alpha" instead of absolute return (i.e. if the market is +20% and Chanos's short portfolio is only 10% against him, he is "up 10 percent on the year") he has the luxury of fighting these longer-term wars against these kinds of companies.  It's very hard to fight a stock that's buying back 10% of their float per year, which probably makes them more attractive to shorts who can take a longer view.

## Gary Rogan writes:

Stocks (or rather companies) that can't go organically but don't shrink are like perpetual bonds, but with an upside option in that someone can buy them for the cash flow. At the right P/E they can make a lot of sense.

# The Sage’s Billion \$ Offer, from Charles Pennington

Table below gives the odds.

Columns:
–prediction accuracy (assumed to be the same in every game)
–odds of getting it are "1 in X "where X is shown in column 2)

50% 9.2E+18

60% 9.5E+13

66% 2.3E+11

75% 7.4E+07

80% 1.3E+06

90% 763

95% 25

(Example: if you're 95% accurate, then the probability of getting all 63 games correct is 0.95^(65) = .0394 = 1/25 )

# Value Line Replicability, from Charles Pennington

It's fairly well known that Value Line's Ranking System hasn't been working all that well over the past decade, but a separate question is how reliable are Value Line's self-reported performance numbers, and how achievable they are in live trading. It's easier now to answer that question because since 2004, there has existed an etf, ticker FVL, that holds the 100 rank 1 Value Line stocks, equal weighted, with quarterly re-balancing.

The table below gives the annual returns of FVL (taken from Morningstar), along with the returns of rank-1 stocks as reported by Value Line. Value Line reports the results for both "allowing changes each week" and for "allowing annual changes", and these two options are shown in separate columns. Because FVL re-balances quarterly, it can't be expected to match either of these two options exactly.

The table shows that FVL is tracked reasonably closely with both of Value Line's self-reported performance. FVL's annual average return of 4.6% is just a bit below the two self-reported averages of 6.0% and 4.7%, which is in line with what you'd expect based on management fees, trading costs, etc. (Year 2012 is an odd duck — VL's self-reported return of 17.2% for "allowing annual changes" is a bit of an outlier.)

This finding shows that Value Line's self-reported results can be matched fairly closely in the real world.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

### Jan

#### 2

It was in July 13, 2012, more than a few months ago, when Specs were voicing concerns about Facebook, including that it was valued at an "astronomical" amount, and daughters were reporting their friends were getting bored with it. FB was at \$31 then; it's at \$55 now. It must be very bullish for a stock if kids are getting bored with it.

## Jim Sogi writes:

I'd agree with the Professor. Just because it's not in style with kids doesn't matter. When Boomers and Grandmas use it, it's become very successful and more likely to last than a fad. I use FB to stay in touch with kids and friends in a nice way. It's a better tool than email in many ways as a killer app. There are flaws, and they are making it worse, but the idea is the same.

# Recent Articles, from Victor Niederhoffer

Recent articles seem to indicate that the stocks with the greatest short interest perform significantly worse than random. The meme used to be the opposite. An example of changing cycles? Or all consistent with capital asset pricing model with volatility in a up versus down market?

## Charles Pennington writes:

Most of those studies don't include the cost of borrow. Ruger (ticker RGR) currently costs about 74% annualized to borrow. If you sell it short, it might go down, but it better go down in a hurry if you want to make any money. If you're long, you should haggle with your broker and get him to pay you some of that 74%.

# One Has Been Watching Youtube Videos on Footwork, from Victor Niederhoffer

September 9, 2013 | 2 Comments

One has been watching youtube videos on tennis footwork with a view to improving Aubrey's squash game. Many videos talk about moving in to the ball rather than waiting. Apparently this is the secret of Federer's footwork with his walking step which just means, as far as I can see, hitting every shot as if it were an approach shot. Paul Gold has a series of 4 steps that he recommends. Using the eyes to watch the ball, and getting into an athletic position, taking a split step on every shot to take a proper first step, and getting to the ball with big steps pushing off the opposite foot to where the ball is going.

I wonder if these steps have a value for market people. Get prepared before the day with the proper equipment and study deciding whether you wish to buy or sell and which ones adjusting your trade level and size with the proper current volatilities and market movements and announcement. Trading and then preparing for the next shot…

## Alston Mabry writes:

The trading analogy for me is that I find myself in two basic modes: (1) reactive, waiting to see what's going to happen next, or (2) predictive, identifying what I think are the highest-probability paths over the next X time period, defining what I will do in each case and preparing for that action.

On the morale side, it's easy for lack or preparation or a losing trade to push me into mode (1); whereas getting back into mode (2) takes preparation, focus and discipline.

## Anonymous writes:

Related to the preparation stage of the game, it is interesting to pontificate about how many moves ahead board game players and sportspeople think and how the speculative game can be improved by adding this type of thinking.

I played basketball up to a fairly high level ( I played center for my state) and in that sport one only tried to anticipate one move ahead (to try and steal the ball or make the rebound).

My limited experience in tennis and squash leads me to think that the best in these games have time to think perhaps two moves ahead (Chair may have a view on that given that he has been known to hit the occasional hard squash ball just above the tin).

I read that chess and checkers players may think many moves ahead — perhaps all the way to a game's conclusion given an opponents error (or good move). Distinguished personages on this list might add meat to this point?

So, how many reactions ahead in the markets…? My various quantitative approaches likely have a substantially shorter holding period than most on the list so the following needs to be filtered by this fact:

* In terms of prediction, I have not been able to produce consistent alpha from any method that looks more than two steps ahead or behind (Market A's move effects Market A's future as well as Market B's future and Market A&B's move effects the future of Markets A,B & C)

* I guess one can also look at this in terms of degrees of freedom- more than 3 or 4 is probably too many. (Or to quote Arnold Zellner "…KISS….Keep it Sophisticatedly Simple)

* It might be a reasonable generality that the more steps ahead (or back) you look the longer needs to be your time frame.

Back more directly to Tennis & basketball. As a center in basketball I had two things to do in preparation. These were to be fully stretched out to jump high and to be completely focused on getting the ball to my pre- chosen team mate. When rebounding you have to commit before the shooter fully raises his arms. In tennis, the unbeatable ground strokes are often those hit on the rise — as it were. In both cases you have to anticipate to hit the perfect stroke or 'deny' the shooter.

The same in markets I think.

This comes back to being ready — obviously.

## Pitt T. Maner III writes:

I would wonder if there are specific training or virtual simulators (software) for traders that would be useful to identify and improve weak areas in preparation, execution, timing, psychological tendencies, etc.

For athletes and racquet players the analogy might be some type of virtual practice such as Virtual Tennis Academy where there would be actual analysis of footwork and stroke production in slow motion using attached sensors. With eventually perhaps some type of instant feedback (ie. sound, vibration) to cue the practicing player on what he or she is doing right.

Film analysis is becoming important in tennis as well.

A recent article, for instance, suggests that improvement in cognitive abilities in older persons is possible through the use of computer games:

"Commercial companies have claimed for years that computer games can make the user smarter, but have been criticized for failing to show that improved skills in the game translate into better performance in daily life1. Now a study published this week in Nature2 — the one in which Linsey participated — convincingly shows that if a game is tailored to a precise cognitive deficit, in this case multitasking in older people, it can indeed be effective."

The world of quantified self programs appears to be ever expanding. Why not financial and sports feedback too?

## Charles Pennington writes:

I tentatively have a theory that players stand way too far back to receive serve. One of the most awkward serve receives is a high backhand. But if you stand up close to the service line, perhaps halfway between the service line and the baseline, then you know that the ball is going to be bouncing nearby, and you can try to catch it low before it gets above your shoulders. If things go as planned, you'll punch the ball back and make the server have to scramble for the ball with little time to spare. However, I haven't really had a chance to try this out against a big server.

## Anton Johnson writes:

It is a joy to watch the masterful footwork of an accomplished base thief.

The speedster, with orders received, his eyes fixed on the pitcher, quickly side-steps, while never crossing his feet, feeling his way to tease the 12' danger zone. When sensing the pitcher suddenly whirl, with his weight biased to the left, he must cross right foot over left, to initiate the saving dive, and avert the embarrassment of a catastrophic pick-off.

However, when the enemy is committed, and with armed help at the plate, with explosive power he crosses left foot over right to continue the fight, knees powering forward, to slide just under the tag, to win the battle to own second base.

# Emerging Markets in the Dumps, from Charles Pennington

This is just a "gee whiz" observation, but emerging markets are really in the dumps. EEM (the big emerging markets ETF) is only about 10% above its 2011 low, while SPY is up about 50% over the same period.

According to Morningstar, the P/E for EEM is 10.4, vs SPY at 15.4. Price to book is 1.3 vs 2.2 for SPY.

Seems like a reasonable deal to me and reminds me of the Nikkei when it was in the doldrums and only Rocky was interested. (And Dan Grossman as well.)

# So Much For the Marquee Mutual Fund Managers, from Charles Pennington

August 9, 2013 | 1 Comment

It would be nice if you could just put your money in mutual funds managed by established, well-regarded front-men and outperform the market.

I was recalling a discussion on the spec-list literally 10 years ago in which a Lister advised that if you want to know when/what to buy, then just take a look at what Mason Hawkins, Bill Miller, Marty Whitman (all of whom manage mutual funds available to the retail investor), and a few other names (all of whom managed hedge funds unavailable to the retail investor) were all doing and imitate them.

At that time, Hawkins, Miller, and Whitman all had great reputations. Furthermore, if you were to read an interview with them, they could make very compelling cases for the stocks that they owned.

What happened to their mutual funds over the next ten years?

I think it's important to separate their "alpha" returns from their "beta" returns, and this is something that can be done very easily at Morningstar.com, where they conveniently provide, for the past 3, 5, 10, and 15 years, each mutual fund's alpha and beta.

Here's a table.

columns:

Marquee investor / mutual fund ticker / 10-year alpha vs S&P / 10-year alpha of fund category vs S&P / fund category

Mason Hawkins / llpfx / -1.77% / -0.36% / large blend

Bill Miller / lmvtx / -6.16% / -0.36% / large blend

Marty Whitman / tavfx / 0.47% / 1.06% / MSCI EAFE

So let's take a look. Mason Hawkins' fund LLPFX's alpha was -1.77%. That means that given his beta with the S&P 500, his fund returned -1.77% less than it "should" have. Now his fund is in the "large blend" category. We should consider whether his negative alpha came about just because he was in "large blend" stocks, and they just had a bad 10-years. In fact it turns out that "large blend" mutual funds had an alpha of -0.36%. So that could explain some of Hawkins' negative alpha, but not all. He under-performed.

Similarly Bill Miller's fund LMVTX had an alpha of -6.16%, not good by any measure. His fund is also in the "large blend" category, so that only explains -0.36% of his large negative alpha.

Marty Whitman's fund TAVFX had a positive alpha of +0.47% vs the S&P. But he's in the MSCI EAFE (basically "international / developed world") category, which itself had a positive alpha of +1.06%. Foreign stocks happened to beat US stocks, and that more than explains Whitman's positive alpha to the S&P.

So all three of the marquee mutual fund managers mentioned 10-years ago by a Lister (who himself is very knowledgeable and experienced) failed to add any risk-adjusted extra goodies, and in fact they took something away from what you should have gotten based on the market risk that you took with them.

I've always enjoyed reading intelligent analyses of individual stocks, but that's probably something I should do just for fun, not with any expectation that it will make money.

## Gary Rogan writes:

Bill is a gambler who bets huge on things he can't possibly know with any degree of certainty. He is very smart so usually his bets pay off. He is still a wild gambler who given enough time will blow up, or at least lose a lot of capital.

Buying a lot of inexpensive stocks with stable fundamentals when they are down, either relative to their historical valuations or to typical long term average ratios of P/E or P/S, in multiple areas, is still gambling like everything else, but a much more stable form of it that's not likely to blow up unless the market blows up and you can still beat the market.

# Breastfeeding, from Charles Pennington

August 2, 2013 | 2 Comments

A news article from yesterday's WSJ reports on a new study from Harvard that purports to demonstrate that breastfeeding enhances a baby's IQ by about 4 points, and that the effect has been isolated from other confounding variables. A pet peeve of mine is that as usual I don't have access to the original publication, which covered research that very likely received some form of funding via my tax dollars. Anyway, just from the news account, I am skeptical.

The study "followed 1,312 babies and mothers from 1999 to 2010..and then tested the children's intelligence at ages 3 and 7"

OK. Well I read elsewhere that:

"A large number of studies have suggested that low [omega fatty acids DHA and ARA] might be associated with problems with intelligence, vision, and behavior. Children fed standard formulas may have IQ's 5-9 points lower than breast-fed babies, even after correcting for other factors."

and that:

"until 2002, [omega fatty acid additives including DHA] were not present in the infant formulas available in the United States".

The new Harvard study covered 1999-2010, but the kids were assessed at age 7, so I assume that means that the kids' birth dates ranged only from 1999 to 2003. Therefore, essentially all of the formula-fed babies in the study were getting formula without the DHA and other additives that were added in 2002. So shouldn't I expect their IQs to be "5-9 points lower", simply because they were using pre-2002 formula? If so, that renders the study irrelevant and unnecessarily alarming to parents today who aren't able to breastfeed for whatever reason, and who are using today's omega-enhanced formulas (which is the only thing that is available anyway).

If that objection is somehow mistaken, then I have further skepticism about how ~1000 cases could be an adequate sample size, given what they need to show.

If they look at IQ vs only a single independent variable — breastfeeding — then it's pretty clear that their "N" is adequate. On a "back of the envelope" basis, I think they're claiming something like a 13% correlation between breastfeeding (measured on a continuum from no breastfeeding it all to >1 year of exclusive breastfeeding) and IQ, and I believe that a sample size of just a few hundred would be adequate. The measured correlation have something like 1/sqrt(N) ~ 3% standard error, much smaller than 13%.

However, they claim to be able to isolate the effect of breastfeeding from other confounding variables. The biggie is the mother's own IQ, which is highly correlated (50%?) with the baby's IQ, but also with breastfeeding, since smart moms on average are more likely to breastfeed. I hope that some statistics experts can help on this, but I do have the impression that it's notoriously difficult to isolate the effects of independent variables when they're strongly correlated with each other. Again, it would help if the original paper were accessible to the public, who probably paid for part or all of the research and have a real practical need to understand the results.

# Review: The Outsider, a Memoir, from anonymous

I recently read Jimmy Conner's book The Outsider, a Memoir.

Although a little sugary– too much mama this and mama that, wife this, wife that– and if you can get past the tedium of the same old guys going out to party– Jimmy and Nastase did this, Nasty did that– the book is down right unremarkable, however it was interesting to follow the birth and growth of popular tennis.

When I mentioned to two different people that I was reading this book the quick item brought up was that Jimmy married Chris Evert, right? Well, they were engaged, an item. Conners was chasing her around the tour when she was 17. He mentioned that her Mom was always around and that Chris was heavily guarded. He never married her but married the 1977 playmate of the year. He professes to not have been a drug guy ever and a non-partier until he basically hit his life long goals of winning wimby and the US open.

A few items I think you would be interested in:

His grandmother and mother trained him from a youth (St. Louis area), as did his grandfather some. His father was around but was overshadowed by the ladies of the home who nurtured him. His mom was a good tennis player and taught him a solid game. He did not do well in school.

His grandfather made him jump rope. Jimmy would have to jump for some period of time without a mistake or the stopwatch got reset. Jimmy would ask how much time and grandpa would say 10 minutes, then grandpa would change his mind after seven minutes and say, no let's do 20 minutes. This would mess with his mind. Grandpa would sometimes walk around close or behind Jimmy when he was jumping to make him feel rattled–if he made a misstep he would have the clock restarted. This in reflection was done to make him ignore distractions.

His coach, Pancho Segura–from wiki here: Pancho "Segoo" Segura, born Francisco Olegario Segura on June 20, 1921, is a former leading tennis player of the 1940s and 1950s, both as an amateur and as a professional. In 1950 and 1952, as a professional, he was the World Co-No. 1 player. He was born in Guayaquil, Ecuador, but moved to the United States in the late 1930s and is a citizen of both countries. He is the only player to have won the US Pro title on three different surfaces (which he did consecutively from 1950-1952).

Pancho to me was very interesting and I would like to read more about him. He would draw up a game plan for Jim on napkins before each match. Conners had a solid game and was able to form a strategy that basically shielded him from the adversary's strong points.

Conners had OCD which came out in his behavior after winning Wimbledon. He would bounce a ball endlessly and not be able to pick it up and toss it up to serve, or he would have to check the locks on his windows and doors before going to bed multiple times, drive from the hotel to the game location at a certain time and with exactly the same route. In those days no one knew what OCD was. He just dealt with it.

He was and most likely still is an action junkie. He gambles and loved the playboy clubs. He would bet on himself to win tourneys. It was legal to do so.

He won 109 event championships, his enemy of sorts was Johnny Mac who knocked him out of first in world ranking.

He was a tenacious player, a fighter, a little guy who had to scrape for everything. He had slips of paper in his shoes outlining concepts to think about from his grandma when it was break time between sets.

The trading/life related item was when he first won his Wimbledon title. He said he was mentally in tennis nirvana. Pancho (genius move in my opinion) took him the next morning over to a local children's cancer ward for half a day to talk with and entertain the children who were suffering. He said his cloud 9 turned into a cloud zero as he saw what was really important. We can all use this lesson reminder in some form or another.

I share your thoughts on the Connors book. "Unremarkable" is a good one-word description. Autobios by Agassi and McEnroe were real page-turners, though they didn't always make the authors seem like admirable people.

The opening parts of the Connors book, which cover his childhood and family, are quite interesting, but after about the half-way point the book loses my interest. He mechanically lists results from tournaments after his prime that no one will remember. He spends several pages on the traits and personalities of the 4-5 dogs that he owns. Who cares?!

Also it's kind of a stretch for him to call himself an "outsider". He was an outsider to the tennis world as a child in East St. Louis, but by the time he was a teenager he was surrounded by LA celebrities and had Pancho Segura as his coach.

# The Myth of the “Secular” Bear Market , from Victor Niederhoffer

February 4, 2013 | 3 Comments

The professor once performed a beautiful study to see if all the turning points that one could retrospectively select

to be short and long a la birinyi who shows almost 5 times the market drift by getting in and out of the bear and bull markets with 20% being a fuzzy base line , —– and he found it completely consistent with randomness. It was a model of what a good study should be. Perhaps he will share it with us again, or at least tell us the drift.

## Richard Owen writes:

That would be great to see. It is definitely one of the most mumbocentrically diverse areas of asset analysis and a firm and incestuous friend of the buy and hold debate. The more important corollary to the depressing corollary would therefore be that successful investing is almost entirely about the quality of your liabilities? Would a Japanese salaryman wealth manager with the Professor's report in hand have been able to maintain a career? If not, would he have been right to get a copy of Taleb out to console himself?

## Charles "the professor" Pennington writes:

I have kind of forgotten how that went, but I will see if I can find it.

There was a study of something kind of along those lines from Big Al and/or Kim Zussman not so long ago that was very compelling, covering dozens of possible trading strategies, but only one or two could thread the needle and do better than random.

## Russ Sears writes:

Not as rigorous as the Professor's, but I did a back of envelope study of the Dow from 1900 to 12/31/2012. Not including dividends, just the index.

There were 20 beginning of the years where the Dow was less than it began 10 years (of course these have overlapping decades).

What do do if you retrospectively find yourself in a "Secular Bear Market"?

The next year change in the dow average +14.35% min - 23.5% max 59.6% stdev of 21.1%. Whereas the overall was 4.7% and stdev of 20.9%.

Likewise the next ten years change based on roughly 20% steps of prior 10 years (again overlap) This only covered 1910 to year end 2012 since I needed 10 year periods before and after. There were 2 years 2008 and 2009 that the decade prior was negative, both had positive next years. But we do not know what it will be in 2018 and 2019 so they were not included. Here the overlap does matter since the next 10 year periods are not independent.

Count  group avg Range for Group    Next 10 years  Range for group

19     -16.8%     -49.7%       1.4%     108.5%      -3.6%     271.7%
19      16.9%       2.0%      33.0%      82.0%     -39.0%     238.8%
19      60.2%      35.4%      98.1%      95.8%     -15.1%     240.1%
19     137.9%      98.5%     169.4%      75.2%     -39.8%     323.4%
18     240.9%     172.7%     323.4%      96.8%     -49.7%     317.6%

## Richard Owen writes:

Very kind and thoughtful work! Apologies to be very dumb: what periods do the five groupings of 19 counts represent? And group avg [col 2] (I would have thought trailing? But the premise is those periods were negative?) The "excluding divs" heuristic so common for stock analysis is, I guess, one reason why we need King Dimson so badly.

## Russ Sears writes:

The period in the five groupings in the next decade. Hence, may double, triple or more count some years. It takes some time for the "past decade" to move into another grouping.

## A Warning that Engendered the Discussion from Victor Niederhoffer:

Please don't write more as you have threatened about "secular bull markets" or "secular bear markets" that can only be described in retrospect and have no predictive significance, and are mumbo jumbo and depend on random selected starting and ending points and would only lead our fine readers to wallow in absurd, unhelpful charlatanism.

# A Post, from Victor Niederhoffer

November 27, 2012 | 2 Comments

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.

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.

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.

# Facebook Numbers, from Charles Pennington

FB premiered in Value Line recently, and here are the round numbers, as I understand them:

Market cap: \$40 billion

"Working Capital": \$12 billion

I think the "working capital" is mostly cash, but I'm not sure. It went from \$3 billion last year to \$12 billion this year, so it sounds like cash from the IPO.

Enterprise value around \$30 billion.

They had revenues of \$5 billion and "operating margins" of about 30%, so it sounds like they would have earned \$1.5 billion pre-tax, but instead they earned roughly zero because they had >\$1 billion in "variable compensation costs" for their 3,000 employees. I.e. it sounds like employees got bonuses of >\$300K, on average. I'm not sure why "variable compensation costs" are not consider a cost of "operating" when calculating "operating margin".

Value Line says their revenues will be about \$13 billion by 2015-2017, and the operating margin will be 50%. That sounds like there will be \$6 billion of profits pre-tax on this enterprise value of \$30 billion, but again, will the "variable compensation costs" chew that up?

# Cold Cures, from Charles Pennington

May 24, 2012 | 2 Comments

I've had a terrible head cold for the past week, and it's made me think about what a weak approach the world takes to the common cold. Doing a little wiki search you'll find that people are out of commission for something like 2 weeks per year. Tens of millions get poured into some cancer drugs that are viewed as successes because they increase life expectancies from one month to three months. But when you go to the pharmacy for your cold, 80% of what you see is junk, and what's not junk is just barely. (I'm making up a lot of the actual numbers in this post, but you get the idea.)

Here's a rundown on some of the pharmacy items:

Long-last 12-hour nasal decongestants, inhaled (like Afrin): This stuff works for awhile and provides actual relief, but 1) it doesn't work for 12 hours–more like three, and 2) they tell you you can only use it twice per day and up to a maximum of three days. OK, well I'll just have to make sure my cold only lasts three days! If you consider how people treat the warnings about drugs like crystal meth, I would imagine that a lot of people use Afrin for longer than three days and more than twice per day and don't get badly hurt. The CVS pharmacist kind of hinted that that was the case. But on the other hand, I don't want to get a permanent stopped-up nose and Afrin addiction.

Short-last nasal decongestants, inhaled (like Neo-Synephrine): These are supposed to work for 4 hours, but of course they don't. There are scattered hints that they don't pose much dependency risk, but the label says otherwise–use no more than once every 4 hours and not for more than 3 days.

Oral pill nasal decongestants — phenylepedrine — These don't do diddly. I discovered this on my own, but later the pharmacist told me that everybody pretty much knew it.

Oral pill nasal decongestant — pseudo-ephedrine — For these, you have to go to the pharmacist and show your drivers license so that they can check that you're not making crystal meth. Usually I don't want to go to that kind of trouble, but word on the street is that phenylephrine, which is the new pseudo-pseudo-ephedrine, like the one that Mother gave Alice, doesn't do anything at all–you have to get the REAL pseudo-ephedrine. Anyway, I got some 12-hour slow-release capsules of pseudo-ephedrine. They seemed to have some slightly helpful effect, but not nearly enough to give comfort.

"Nite-time" stuff — There are literally dozens of varieties of this at CVS including multiple store-brand versions of the same thing. They're all equal to Tylenol+Phenylephrine (useless) + Dextromethorphan HBr + Chlorpheniramine Maleate. The Dextro… is described as a "Cough Suppressant" and "Chlor…" as an antihistamine. I know what Tylenol and Phenylephrine are. I don't really understand the last two drugs, but I think their real purpose is to put you to SLEEP. That's not the worst thing in the world, but they only last for about 4 hours or so. So then I wake up at 3am and want some more, but I worry about taking more because I've been reading that it's easy to overdose on Tylenol and mess up your liver.

Various Zinc stuff, acidophilus, Vitamin C — I already pretty much know that Vitamin C doesn't work, since I already take a lot of it, having read Linus Pauling's book years ago, but I still get plenty of colds, and they last a good, long time. It's possible that some of the other stuff could work. The typical story is that one study showed good results in 1996, but it had some kind of flaw in its setup. Of the remaining studies about half showed something good and half got nulls. Well gosh, 1996 was 16 years ago, and we're talking about alleviating the common cold, which keeps the entire world out of commission for two weeks per year. Why in the heck doesn't somebody do the definitive study? Meanwhile, I have the option of paying the toll to what I suspect are charlatans.

I read about a real company called Biota in Australia that supposedly has something that pretty much cures the common cold, though it's not on the market yet, and it will be very expensive and perhaps only available to asthmatics [I will apply to become one]. However, in the best of circumstances I can't imagine the FDA approving something like that in less than two decades because it will be argued that since nobody dies from the common cold, it's fine for us to just suffer.

I'd be very interested to hear helpful tips.

## Leo Jia writes:

Prolonged exposure to negative psychological states such as fear, tension, anxiety and etc, which seem to be inherent but unconscious to most traders, can make one's immune system weak. The immune system is key in fighting cold and other abnormalities in the body. Best things to me that help strengthen the immune system and alleviate negative senses are physical exercises combined with meditation, Yoga or Zen practices. For me personally, playing the violin helps a lot also as the dedicated playing puts one into a concentrated mental state that can be close to meditation.

## Victor Niederhoffer writes:

To what extent do we catch most of our colds from the classmates of our kids at school or our coworkers at work? Is one of the great advantages of home schooling aside from the fact that the kids don't have to spend every weekend with a wasteful birthday party, that they are healthier and don't catch colds as much? And similarly for work at home.

## Bill Egan writes:

We homeschool six children. The kids tend to be less sick than the kids of my colleagues at work. Ours still manage to contract a sufficient number of plagues from other kids in our homeschool network, the YMCA, choir, etc.

# Briefly Speaking, from Victor Niederhoffer

May 24, 2012 | 4 Comments

The average American trader is basically insecure due to among other things a 120 point continuous drop. In other words, just from waiting around for that plain little market to go into the gold today, a trader could develop a cold.

# Neck and Neck, from Rocky Humbert

I just noticed that the S&P dividend yield is now virtually identical to the 10-year treasury yield.

Photo finish?

## Charles Pennington writes:

Mr. Rollert was pointing out to me that the yield on German 2-year bonds is now 0.09%, about equal to that of Japan's and lower than the incredibly low US 2-years at 0.29%. That kind of sneaked up on me. That German 2-year yield fell through last summer/fall when the crisis was in full gear, but even in October it had only gotten down to ~0.5%. Now with stocks up massively, it's fallen to 0.09%.

# How to Undo One’s Education?, from Leo Jia

April 10, 2012 | 4 Comments

I remember having read somewhere about the philosophy and objective of the modern education. It originated from the industrial revolution when disciplined, organized, and time-abiding people were needed to work in unity. Farmers were quite opposite and were not suitable for the new era. So then the modern education system was created to serve this very need. The actual knowledge or skills it taught were quite secondary.

I think up to today the education systems worldwide have all inherited the original purpose and still have not deviated much from it. They all stress that students think and behave uniformly. Psychology has long been promoting that we human have all lost large part of the creativity and originality of our childhood due in big part to the education we get. It seems quite true that the more school education one gets, the fewer outlier ideas he could come up with.

I believe that in order to be oneself and to live one's own valuable life, one needs to somehow undo some of the school education, and release the fixation on the mentality. There are more real things to learn for the benefits of ourselves and on ourselves. Fortunately also, trading permits us and requires us to be ourselves.

The book Crazy U is very good.

Here's an amusing passage from it on legacies at Harvard, and on the contortions that the school goes through in order to avoid telling anyone anything useful about their admissions.

The setting is an informational meeting for prospective Harvard undergrads with the Director of Admissions:

(Condensed version below is from this site:

A Chinese parent stands up and asks:

“What do you mean?”

“How many of class are legacies?” he said. “Their parents went to Harvard.”

“Oh, I don’t have that information,” she said. “I’m not sure we even keep that information.”

Just a guess, then, the man persisted.

“I wouldn’t want to guess.”

“So you have no way of knowing?” he asked, with exaggerated incredulity. “The numbers don’t exist?” His wife, short and stocky, stood next to him, staring at the dean. Their son bowed his head and closed his eyes.

“Legacy is just one of many factors that Harvard considers,” the dean said. “I like to say, ‘legacy can help the wounded, but it can’t raise the dead!” She laughed uncomfortably but the father and mother still stared.

“Answer the question,” another father called out.

“Maybe I can get that information for you afterward,” she said, twisting one hand with the other. She moved one foot backward.

“Come on,” said another parent, with just a hint of insurrection.

She was quiet a moment before surrendering. “If I had to say,” she said, “thirty, maybe thirty-five percent.”

There was a shock before the murmuring began. The number was hard to square with the egalitarianism of the video we’d just seen. The number suggested the traditional Ivy League primogeniture.

Another takeaway that I had from the book (and this is not original; e.g. Steve Sailer has suggested something like this) is that society has a need for more TESTING. Instead of studying once for an SAT, kids and adults should have the opportunity to study and be tested on subject matter throughout their lives, and they should have the option of posting their scores publicly. There is much testing that's more or less pass/fail, on basic things, like the Series 7 or the bar exams, but there is room for testing for higher levels of accomplishment and creativity. For mathematics, for example, one could have the option of taking an N-hour exam similar to the Putnam. Programmers could take language-neutral tests in which they tackle coding problems. It seems like there could be a market for much more testing. The benefits arise both from "signalling" AND from the fact that people could truly build their skills by preparing for the tests. So it's not just about how to divide the pie, but also about making the pie bigger.

One puzzling thing — the book mentions that it has become more or less illegal to test prospective employees, yet I keep reading about the spontaneous tests of creativity that Google and other elite techie companies give to their applicants. How do they get away with it?

# EPA to Announce Another Rule Affecting Coal, from Carder Dimitroff

March 28, 2012 | 1 Comment

From Politico's Morning Energy:

The EPA today will announce its greenhouse gas rule for new power plants, advancing a regulation that - if upheld - promises to change the way the U.S. gets its power.

The proposed standard would generally require that new power plants emit carbon dioxide at a rate comparable to or better than natural gas-fired power plants, which emit about 60 percent less greenhouse gases than coal plants.

In essence, that means that new coal-fired power plants will have to capture their carbon dioxide emissions - either for storage or, in many cases, to send the CO2 to oil and gas drilling operations where it can be used to help extract fossil fuels.

But the rule also includes a phase-in period, sources knowledgeable of the rule say, so that coal plants that are ready to build may move forward. The impending announcement was first reported Monday by The Washington Post.

Carbon capture is not a practical option. This rule will be the end for coal and it will also put an end to simple cycle gas turbines. This proposed rule seems to put the US in a box; reducing the capacity of base loaded power plants at the same time reducing peakers. If upheld, I don't see how this will end well.

## Gary Rogan writes:

From the summary:

"The EPA in 2009 found that by causing or contributing to climate change, GHGs endanger both the public health and the public welfare of current and future generations."

Another offering to the false god.

## Ron Schoenberg writes:

If the loss of Arctic ice, the decline in glaciers, the unprecedented extreme weather events such as eight serious droughts in the last ten years in Texas, tornadoes in January, the last decade's global temperatures being the hottest on record, the accelerating increase in sea level, unprecedented wildfires in Russia and other parts of the world, unprecedented droughts and floods in Australia, unprecedented insurance claims due to weather, if all of this fails to convince you of the seriousness of climate change, what would it take to convince you?

Like the mythical frog in the pot slowly being brought to a boil, you might get cooked if you fail to see what is happening. I'm genuinely interested, what would have to happen for you to decide that you needed to jump out of the pot? I'm not asking you to agree that it's happening. I'm not asking you to say there's a pot being brought to a boil. I'm just asking what would have to happen for you to admit that climate change is actually occurring.

## Stefan Jovanovich responds:

Of course, the climate is changing; that has never been the question. The debate has been over 2 issues: (1) the loss of individual liberty for people who will have unelected authorities regulating the details of their lives in the name of "saving the planet" and (2) the cost to the poor and ordinary (sic) people of the world who will need the energy produced by fossil fuels if they are to have any hope of seeing their children become secure enough to afford ecological sensitivities.

The central fact of the climate (formerly known as "global warming") debate is that there are no longitudinal data sets for terrestrial temperatures that can be cross-checked much before 1780; for sea temperature the records are not available globally much before the 1870s. All the other "facts" on offer - the hockey stick, etc. - exist only in mathematical models. The first rule of any prescriptive science is "do no harm". The cures offered in the name of "saving the planet" will prevent people in most of the world from ever getting drinking water as potable as the stuff people have in their radiators right now (excluding the anti-freeze). Without the pumps fueled either by oil, gas or coal-powered electricity and the plastic piping, there is simply no way. Fortunately, people seem to be much more aware of the choices than they were when the Brave New World was first put on offer at Kyoto.

It's worth noting that the most prominent physicists (as opposed to "climatologists") who have actually waded into this issue have tended to be on the skeptical side. These include:

Ivan Giaver (Nobelist)

Will Happer (heavy hitting Full Professor at Princeton)

Freeman Dyson (Feynman collaborator who probably should have gotten the Nobel for work they did together)

These guys were already so prominent when they spoke out on this issue that it was impossible to blackball them, but younger, less powerful scientists would risk being shunned if they spoke out–as the Climategate emails demonstrated.

## Gary Rogan writes:

Yes, the increase in atmospheric concentrations of CO2 is an undeniable fact.

And yes, the consequence of adding more CO2 into the atmosphere is unknown.

100 ppm is one molecule in 10,000. Try to visualize 10,000 of anything and think about the effects of adding 1 to it. Conversely, if it has 3 of something, than adding 1 more could be significant. Yet we hear that other participants in that 10,000 are really important, like water and methane molecules. The oceans are also exceptionally important in both diluting and releasing CO2.

Every time I hear about some "unique" phenomenon I can visualize many other "unique" phenomena of unknown provenance or importance. Unique phenomena don't prove anything, especially if one side is highly motivated to tie these unique phenomena to the outcome they seem to be highly interested in for good or bad reasons.

Many are convinced that this is obviously true. I believe this is utter nonsense because of the political circus and evidence of fraud that surround it, but it certainly is not as implausible as many totally faith-based things because people really are releasing carbon into the atmosphere in significant quantities. All I ask for is from some predictive ability of this line of thinking before I agree that bankrupting whole industries and impoverishing millions if not billions is called for. "Can't you see, it's all around you" is not enough for me.

# 9 Lessons from Squash and Markets, from Victor Niederhoffer

It's amazing how smart the public is, and how ridiculous all the experiments of the expert's breakfast friend are that duplicitously show how irrational the public is when confronted with contrived situations with deceptive self serving to the academics answers. They always sense when someone knows what he's talking about and pay attention as they did to my lessons from hard ball squash, giving more responses than any other of my posts except the one about Lady Gaga and what she can teach us about the idea that has the world in its grip.

Okay, I have to give some more lessons from the one thing I know about.

7. Never hit a soft drop shot. The opponent will be able to get there near the end of a game and kill it. It's especially bad near the end of a game, when the opponent will run for anything, do or die. Lobs are sure losers near the end of a game also for the same reason. Don't ease into your positions. You'll only get filled when it breaks out, and that's the only time that the opponents will certainly have the weather gauge. And don't arabesque into trial positions in small markets just to get your feet wet as the Pelicans at the top of the pyramid will always eat your bait, as they don't allow outsiders to dine at their expense, especially when the resources are limited.

8. Don't try to win the point with the same shot over and over. Your opponent knows when they run you up to the front right, on your rightie forehand that you are going to hit it cross court. If you happen to catch the perfect angle so that your opponent can't intercept it, and belt it down the backhand wall, for sure it was luck or he'll try harder the next time and you will lose the point. Always be ready to return the straight drop to the right side wall down the wall instead. Please don't try to make money from the market the same way two times in a row. How foolish do you think the adversary is to allow you to take his chips twice in a row. He was only setting you up for the big kill. Most people have a very good memory of what happened the last time, especially if it was a vivid loss. They are so angry that they will put their resources against you the next time, without hesitating to take billions of bail out money which they have received, or use costless loans from their past, current or future cronies at the Fed to go against you.

9. Please learn from racquetball and jai alai how to hit a proper backhand. The swings of the racquetball players on the backhand, very nicely memorialized by the Hobo are infinitely better than the squash swings. They have 5 separate torque in there to give it exponentially more power than the placid Philadelphia, old boy English swing. And the Philadelphia swing is 10 times more powerful than the ridiculous backhand that the old Harvard players were taught in the hard ball game with the slice backhand with hardly any backswing, and no torque at all. I shudder at how high a % of the games I lost came because of the weak Harvard backhand I was taught and was too foolish ever to change, possibly because the only one that could beat me was Sharif. Martie Hogan's backhand in racquetball was a thing of beauty and since that time, it's been improved upon every 3 years or so by the next generation of racquetball players. Pedro Baccalo had the best backhand in squash which he learned from jai alai, and he could hit it 5 times harder than any other player because of all the torques in it. Learn from these improvements instead of watching the placid, effete swings of all the old time squash players and as far as I can see, the current crop of Internationalists. Okay, for crying out loud. The best lessons in markets and any field come from the borders where it meets another field. You'll learn more about markets from studying checkers or ecology or statistics or sports betting than you will from all the books on markets combined. Study the greats in other fields, e.g. Bronstein, or Armstrong or the Globetrotters to see the secrets of winning in markets.

## The first six lessons:

I often get asked to talk to kids about the good old days of squash when you could make a point with a sharp angled shot and a long point only lasted 30 seconds. At a recent occasion talking to Hopkins kids I tried to relate the lessons of squash to wider endeavors. While doing it, I found myself in a dream world where flashes from markets, life, business, and school, circled around, crossed over, and fed back on each other. Since this is the one subject I know about, I thought it might be useful if I turned the tables and tried to think of the lessons that I learned from squash and how it relates to markets.

1. The game is always changing. Who would have thought that hard ball squash would now be as dead as squash tennis, or court tennis. There were once 2,000 court tennis courts in France before the revolution, but now say 10 in the world. There were once 10,000 hard ball squash courts in the world. Now, hardly any as they've all been converted. The markets you are trading now are likely to be very different from the ones you'll trade in 25 years. The rules and equipment will have changed. Electronic speed and international standards will replace manual method. I find it hard to believe that the things I traded 10 years, ago, foreign exchange, bonds, options, are no longer viable for me. How many others will find this out to their cost if they don't prepare for it.

2. The officials, the rule making body, the association in squash, will always be like most such associations a body devoted to maximizing the power, perks and profits of the officials. Time and again, they stood in the way of professional play on the grounds that it would weaken the amateur spirit of the game, the English way of stiff upper lip, poverty for the serfs, and noblesse oblige. If you wanted to be successful in squash, it was very important to stay in the officials' good side so that they wouldn't keep you out of the good spots and good tournaments, as they so often did to me and Gardner Molloy, and countless others. If you want to be successful in the markets, be sure that the rules are not stacked against you. That you will not receive margin calls so that the officials can take the other side against you, that the members will not be able to get the edge on you thru access to unlimited capital, flexionism, and self serving decisions like those that arise when you go to arbitration on an Exchange, where the referees, and judges are invariably chosen by the exchange itself. How can you expect them to rule against their friends and cronies.

3. Counting and record keeping are crucial. A good squash player, should know exactly where the ball will land, when he hits any shot, given his current position on the court, the angle of the wall he aims for, and the velocity of the shot. You could work it out by geometry given starting with the angle of incidence equaling the angle of reflection. Very few players take the trouble to figure it out, or even think about it. How many good market players don't know what the expected volatility is on their trades given how fast and the direction it's been going in the past?

4. The first blow is half the battle. The player that gets ahead by 2 or 3 points is inordinately likely to win the game. The importance of a good start and good preparation are paramount. Bronstein once waited 2 hours before deciding on his opening move while the clock was running. The first blow in markets is still crucial. The expectations are much higher when the first x minutes are up compared to down.

5. One of the keys to winning in squash is never to stretch. When you stretch you can't hit a hard shot, and you're limited in where you can hit it, so you're opponent can always anticipate perfectly where the shot is going. The other side is that you should always take the extra step so you'll be in position to hit any shot. It's so enticing to stretch because it saves you the step and enables you to get the ball in play but so certain to lose to losing. How many time do you stretch in markets. Put on too big a position, take a regularity that only has happened 3 of the last 5 times and run with it? How often do you end up leaving yourself vulnerable to an adversary who knows exactly how extended you are, and come into full force against you? Certainly one of the worst errors in markets.

6. I could never figure out why Sharif Khan had a winning record on me. He was sure to make at least 5 errors a game, and had a weak backhand that turned over the ball whereas I could go a whole match without making a single error. Then I realized he was the only person that could make 7 winners a game against me, where the ball bounced twice before I could touch it. Then I realized that what he did was to take every shot on the half volley. He worked off my power so that the ball came back at a higher velocity. He also didn't give me time to set up to return the ball. Most important though, by violating the stricture we had learned to wait and make the opponent commit, he prevented one from anticipating his shot and tucking in to retrieve it. Since that time Agassi and even the more loathsome sportsman Connors have pioneered using the half volley in tennis to beat players with much better equipment than they in tennis. Nowadays it's de rigeur in tennis.

Taking it on the half volley in markets means not waiting until the afternoon to put your positions on, not waiting until every market that 's a pilot fish for your market is in the right direction, not waiting for the announcements to reduce your uncertainty. If you want to speculate you have to speculate. Only the house can wait and grind you to oblivion. Taking it on the half volley in markets is getting in way before the pivot has occurred, way before the trend has changed. It's the secret of success of great players in racket sports and markets. Come to think of it, it was the secret of success in handball also.

The old time handball players are so much better than the current ones. Why? For one they hit the off the wall with deadly precision. Artie had a fantastic off the wall shot, and somehow his football killed arm was able to miraculously get back to its youthful vigor when he hit it. He always said that Ralphie Adelman was the best because he could hit everything off the wall for a killer. I now see that Martie Hogan is espousing standing in front of the service line on each shot in racket ball as the key to success there. Some day someone will teach the handball and racket ball players of today that the off the wall killer is key in games and markets.

## Chris Tucker writes:

Point 5 is the similar to using power tools as I mentioned in "On Taking Down a Tree":

Never extend your reach beyond what is comfortable. Using a tool at more than arms length puts you in a position that prevents you from reacting quickly if something goes wrong. It puts undue stress on you and the tool. It removes whatever leverage you have on the tool. It also prevents you from "feeling" properly through the tool. When using a power tool you receive signals about the material you are cutting and the nature of the stresses on that material. You can always tell when a branch is about to go if you are listening carefully to the tool. That feedback is denigrated by reaching too far or by using only one hand.

When developing skills you must, occasionally reach beyond your current level. This is different from overextending your reach. But it is important to do so incrementally as overstepping your bounds too egregiously can result in devastation and trauma. Taking small steps into new areas or higher intensity or greater complexity allows you to learn while remaining close to your comfort zone. Yes, you have to reach in this sense, but you want to do it in such a way that you don't destroy yourself in the process. When you push yourself in this way you also expand your comfort zone and your skill set. This can be the translated into taking on larger size, increasing leverage, having more trades on at one time, or introducing new instruments to your repertoire.

I think Ari would say, "you should set goals that are constantly reaching further, but attainable, then gradually keep moving forward. If you have a stumble then pause and evaluate why. If you set a goal too far out of reach you may be faced with disappointment at not getting it".

## Charles Pennington writes:

Steve Sailer has a nice illustration of the problem with some of Kahneman's questions.

Apparently the following background information is NOT supposed to convince you that Jack is more likely to be an engineer:

"Jack has a B.S. degree from Purdue. At work, Jack wears a short-sleeve button-front shirt with a pocket protector full of mechanical pencils, just like most of Jack's coworkers on his floor. Jack always wears a tie clasp to keep his necktie from getting smudged by the blueprints when he leans over a drafting table. Jack's favorite line from Shakespeare is, "The first thing we do, let's kill all the lawyers." In fact, that's the only line from Shakespeare he knows. Jack wanted to name his firstborn son Kirk Spock, but his wife wouldn't let him."

From Forbes' "Five Leadership Lessons from James T. Kirk" (applies to lone wolves and markets as well) :

“You know the greatest danger facing us is ourselves, an irrational fear of the unknown. But there’s no such thing as the unknown– only things temporarily hidden, temporarily not understood.”

“One of the advantages of being a captain, Doctor, is being able to ask for advice without necessarily having to take it.”

“Risk is our business. That’s what this starship is all about. That’s why we’re aboard her.”

“Not chess, Mr. Spock. Poker. Do you know the game?”

“‘All I ask is a tall ship and a star to steer her by.’ You could feel the wind at your back in those days. The sounds of the sea beneath you, and even if you take away the wind and the water it’s still the same. The ship is yours. You can feel her. And the stars are still there, Bones.”

# Buddy Fletcher, from anonymous

March 3, 2012 | 5 Comments

His particular skill lies in devising vertiginously complex "hedges" to insure minimal loss if stocks decline while maintaining maximum profit potential if the stocks rise. His audited annual returns for the last five years have averaged over 350%, and on some days during that period his tiny firm has accounted for more than 5% of the trading volume at the New York Stock Exchange. A safe estimate would put his personal wealth at somewhere around \$50 million.

There are many alarming items there — the Madoffian hedging so that really you can't go wrong while you're making 350%, the 5% of the NYSE trading volume (EdSpec observed that there are several hundred tiny firms that each control 5% of NYSE trading volume).

## Charles Pennington writes:

I thumbed through the section in Buddy Fletcher in the Jack Schwager book Stock Market Wizards (excerpts can be found under Google Books), and he has what at first seem to be some reasonable ideas for making money:

–arbitrage between the different tax needs of U.S. and overseas clients, especially the treatment of dividends

–some kind of option arbitrage that exploits the mismatch between option prices that involve a risk-free interest rate and clients who have to pay a relatively high commercial interest rate to borrow

Now those seem like reasonable germs-of-ideas, but surely they'd have very limited capacity, and surely they'd become widely known pretty quickly. They don't seem consistent with the 1996 New Yorker article description:

"His audited annual returns for the last five years have averaged over 350%, and on some days during that period his tiny firm has accounted for more than 5% of the trading volume at the New York Stock Exchange."

## Humbert Humbert replies:

An astute colleague explains that the fancy options ideas described by Fletcher in Schwager's "Stock Market Wizards" sound like nothing more than ways to take advantage of the cheap access to capital that he had from his firm. If the bank let him borrow to trade and pay below-market interest rates, then he could make money just by buying a money market fund. The fancy (and almost riskless) "box " options spreads that he describes probably served the purpose of a money market fund.

# Fortune Favors the Boastful, from Charles Pennington

February 29, 2012 | 9 Comments

Msn.com doesn't seem to have an archive of Vic and Laurel's articles from the early 2000s, but I was fortunate enough to have made copies of them. Now I'm curious to know how some of their stock picks and pans did over the intervening 10 years or so.

I decided to take a look at a January 2002 article, "Companies that speak softly carry big profits". The theme of it was that perhaps firms with mild-mannered, self-effacing CEOs might outperform boastful firms that say "We're Number 1!" Vic and Laurel were bullish on the "Modest 10" and bearish on the "Boastful 13". Their subsequent performance is given below.

8 out of 10 of the "Modest 10" firms saw positive total returns on their stocks between then and now, led by Electrolux (ELUX), with a 321% return. The average return was 67%. That's not too bad.

Of the "Boastful 13" firms, 10 of the 13 saw negative returns, including 3 that lost at least 90%. To repeat, 8 of 10 of the Modest 10 were winners; 10 of 13 of the Boastful 13 were losers. Nevertheless, in terms of average return, the Boastful 13 won out over the Modest 10. One of the Boastfuls, Priceline.com, gained 1,454%! That drove the average for the Boastful 13 up to 107%, beating the average for the Modest 10.

Priceline's indiscretion that put them in the Boastful 13 was to proclaim that "Priceline will reinvent the environmental DNA of global business..[and produce]..a totally different form of energy". (Did Shatner write that?) Vic and Laurel had sought companies that said "We're Number 1", but they reasoned that even though Priceline's pronouncement didn't match that exact wording, it was still fairly boastful, and I agree.

Here are the details:

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

# Yet Still More on Risky vs. Non-Risky Stocks, from Charles Pennington

Here's a little more commentary on the issue of high vs. low beta stocks, to be appended to these links:

In those links I argued that the apparent under-performance of high beta stocks is illusory, and that the current popularity of low-volatility stock strategies is unjustified. High beta stocks have actually done fine over the past dozen years or so in terms of their appropriately risk-adjusted performance as measured by "alpha".

For a little more insight, I plot below the compound total return of \$1 invested in the S&P 500 index ETF, ticker SPY, along with the return of \$1 invested using a margin account, with a leverage of 2 to 1. The margin account position is re-adjusted to 2 to 1 at the end of each calendar month, and interest is charged to the account at the rate of the 3-month t-bill rate (which is significantly less than what a real investor would have to pay).

The 2-1 margin account is the true benchmark for a portfolio of beta=2 stocks, and we see that the 2-1 margin account did poorly over the full period, turning \$1 into \$0.96, with much undesirable sound and fury, while the unlevered SPY turned \$1 into \$1.36. Any real-world margin account would have to pay more than the t-bill rate — a reasonable guess is 2% more per year, which would have further degraded the leveraged account.

So if your high beta stocks seem to have done poorly over the past 12 years, much or all of that is due the market itself and their heavy exposure to it.

That could all be different over the next 12 years, and if you're the type who wants 2-1 exposure to the market, there's no evidence to suggest that an un-levered portfolio of beta=2 stocks is a bad way to get it.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

# Low Beta Vs. High Beta Stocks Again, from Charles Pennington

January 31, 2012 | 1 Comment

After writing two pieces for DailySpec (Link1. Link2.) I've become a little bit obsessed with the topic of low beta vs high beta stocks.

I reported there and confirm here that:

1) high beta, high risk stocks tend to look bad in studies of their compound growth, i.e. what would happen if you kept 100% of your portfolio there, but that

2) they actually look fine in terms of their "excess return" or "alpha", which is the proper (according to the "Capital Asset Pricing Model") way to measure returns on a risk-adjusted basis

Here's the expression used for "alpha" or "excess return":

alpha = R - Rf - beta * ( Rspy - Rf) ,

where R is the % return of the stock, Rf the percent return over the same period of a "risk free" asset (read "T-bills"), and Rspy the return of the S&P 500 index ETF ticker SPY.

The universe used here is the 500 largest market cap US-domiciled stocks, trading on either NYSE or Nasdaq, selected at the start of each calendar year in the study. The list includes tickers that have since vanished one way or another, whether by bankruptcy, merger, or other event.

In order to characterize the dependence of forward alpha on trailing beta, I measure, for each month, the correlation (sometimes called the "information coefficient") between each stock's alpha/excess return and its trailing beta, measured over the trailing 250 trading days. The results are shown in the attached table. With measurements for a bit less than 500 stocks each month (I exclude stocks with share prices less than \$5 and stocks without a trailing 250 trading day history), the statistical uncertainty in the measured correlation is approximately 500^(-1/2), or 4%. Data ranges from May, 2001 through December, 2011 — 128 months.

A word about signs and magnitudes: the table shows correlation between forward alpha and trailing beta, so a negative sign for a given month would indicate that low beta stocks had outperformed. Regarding magnitude, I'd say that the one would require a magnitude of at least something like 10% for the effect to be meaningful and "actionable".

The table shows that the average of the 128 monthly correlation measurements is -0.5%, with a t-score of -0.3. This is most definitely a null result. So over this period, high and low beta stocks did, on average, roughly what the capital asset pricing model / "efficient market" theory would predict.

—–Also attached is a plot of the cumulative sum of the monthly correlations. When the cumulative sum is decreasing (increasing), that means that low (high) beta stocks are outperforming. The plot snakes around but in the end doesn't go very far. Low beta stocks do very well over the ~2004-2005 window, but then give it all back and more from 2008-2009. (It may be surprising that high beta outperformed low beta over the very bearish 2008-09, but first, remember that we're talking about risk-adjusted "alpha" here, and second, during 08-09 saw 50-ish percent declines even among not-so-risky stocks.)

So I don't think that the enthusiasm for low-risk, low volatility equities, as seen in the popularity of ETFs like SPLV, is deserved. It makes more sense to buy the whole market, SPY, and be tax-efficient. If you want lower volatility, then just buy less of it.

.

.

.

.

.

.

.

.

.

.

.

.

.

.

# Review of The Romantics, from Charles Pennington

I finally got around to seeing "The Romantics" this weekend, watching it on Netflix streaming cable.

I would have thought that it would have a lot going against it for me. It's aimed at women, a "chick flick". Also it's a reunion flick in which old friends from college get together later, and I can think of any number of such movies– "The Big Chill", "The Secaucus Seven", "Four Weddings and a Funeral", "St. Elmo's Fire"– that I didn't like. To my surprise, though, I found "Romantics" to be fun to watch. It was funny, interesting, and kind of thought-provoking.

Usually my problem with the college reunion flicks ("Big Chill", etc.) is that I don't like the feeling I get, that the movie kind of assumes that my worldview will be fairly compatible with the groupthink that's accumulated among the reunioners, and I feel that the movie is trying to pull me in, slowly boiling me like a lobster. Somehow "Romantics" avoids that fate. Many of the snark reviewers focused on their dislike of the characters, and I can't disagree with them on that. Tom, the groom, flits back and forth between Laura, his supposed true flame, and Lila, his security blanket. He seems kind of dim-witted. Lila is forgiving beyond any bounds of decency. Laura is "self-absorbed", as the snarkers say, because no ethical concerns ever stop her from going ahead with what she thinks will fulfill her. But it doesn't make sense to judge the movie on the character of the characters, and maybe the fact that I didn't particularly like the characters helped me keep my objective distance, so I didn't feel like the boiled lobster. By no means was the author setting up any of them as model citizens–it's about the ambiguity of where they're going to take their lives.

Anyway, I give it a thumbs-up. It kept me interested and absorbed, and it's more memorable than most movies out there.

# More Cheap (Apparently) Stock Tidbits, from Charles Pennington

December 22, 2011 | 1 Comment

The Dec. 12 Barron's, page 32, lists some big cap stocks that have big cash holdings.

I list them in a table below, along with Value Line projections for 2012 earnings, and an "adjusted" P/E–the (price-cash)/earnings, which makes sense if you sort of assume that the cash earned nothing.

column labels:

ticker / cash per share / price / 2012 earnings from ValueLine / (price-cash)/earnings

msft   \$7    \$26   \$2.80  7
csco   \$8    \$18   \$1.45   7
goog   \$129   \$630   \$40  12.5
orcl     \$6     \$29   \$2.42    9.5
jnj     \$11     \$64   \$5.25    10
pfe    \$5      \$21   \$1.60    10
aapl     \$87   \$395  \$32.50   9.5
cvx     \$10    \$103   \$13.10  7
wlp     \$53    \$65(!)  \$7.70   1.3
amgn     \$19   \$61  \$5.50  7.5

As has been observed here before, stocks are pretty cheap these days.

On the subject of AMGN, one of my first posts on spec-list was "Amgen in P/E Stratosphere", ca 2004 or so. Though having no local insights about the stock, the then high P/E ratio was subsequently rectified in the denominator. (and has remained range-bound in Russian fashion since).

Presumably high-flying growth stocks either become value with dividends (also see MSFT) or debubblize (also see HOV, AMD, etc.

# A Logic Riddle (Heads You Lose, Tails You Lose), from Rocky Humbert

Real interest rates are back near their recent record lows (5 year TIP= negative 1.2%; 10 Year TIP= negative 0.15%); and gold's recent behavior is once again consistent with these facts. Riddle me this, Batman:

If I buy a 5-year TIP at a negative 1.2% real yield, and hold it to maturity, that means I am certain to lose 1.2% of purchasing power over the next five years. BUT: Were I instead to short a 5-year TIP at a negative 1.2% yield, and hold the short to maturity, does that mean I am certain to make 1.2% of purchasing power over the next five years? And, how can BOTH of these statements be false?

Private riddle for The Chair:

What do Galton, Batman, and Robin have in common?

The Riddler's False Notion:

Robin: Holy molars! Am I ever glad I take good care of my teeth!

Batman: True. You owe your life to dental hygiene.

## Sushil Kedia writes:

Logic Riddle is a misnomer for what is truly a contradiction. The presentation has a contradiction. In life, in markets there are no contradictions. Allow me to quote Ayn Rand from the Atlas Shrugged, "If there is a contradiction, check your premise".

Rocky, your logic is based on inflation remaining what it is right now the same also during the maturity and at the point of maturity of the 5 year TIPS! Market is not pricing that! Market is pricing inflation will come down! That's all. Check the premise, there are no contradictions.

Purchasing Power is a good term to help create this contradiction. Purchasing power will be Cash in your hand on day of maturity Divided by (1+inflation)^5 if I take the Annualized realized inflation readings. Realized Inflation readings five years from now will be known only then.

## Rocky Humbert responds:

Dear MisterMeanor:

2. That means it's possible to have not only a negative REAL YIELD but it's also possible to have a negative NOMINAL RETURN! (So much for the risk-less treasury market.

4. Your statement "Market is pricing inflation will come down! That's all. Check the premise, there are no contradictions" is 100% UPSIDE DOWN. There is little justification for locking in a negative 1.2% compounded real yield UNLESS you have no alternative investment that does better. You need an inflation assumption of RISING INFLATION not falling inflation due to the way these seasoned bonds behave.

I reckon, back of the envelope, north of 3.8% compounded CPI…. is required to have these TIPS beat the bullet 5 year … and even then you still lose 1.2% of purchasing power (compounded) per year. If you want to bet on disinflation/deflation, you would short these bonds at 105 with an inflation factor of 226/220 with abandon, and buy 5 year bullet bonds to term.

Batman just ended. The Flintstones are on now.

## Charles Pennington writes:

That's a very nice riddle.

These bonds trade dearly I think because there aren't many other competing foolproof CPI inflation hedges.

Obviously if you short the bonds AND hold the short sale proceeds in cash, you are at risk of losing money. You short \$1 million in bonds and hold the \$1 million proceeds in cash. The bonds could go up in nominal terms by a factor of ten to \$10 million. Meanwhile your short sale proceeds sit there in cash, still just \$1 million, and when you cover, you lose \$9 million. That's a loss in any terms.

Of course, if you could use your short sale proceeds to buy something that tracks the CPI without the built-in "negative carry" that the TIPS have, then you'd have a perfect arbitrage. But such a thing doesn't exist.

(Does it?)

A 1 year bond is four three month bonds.

A three month bond is a treasury bill financeable for cash as legally defined by the government at the rate set by the federal reserve.

If ex ante you knew that rate, let's say it would be zero for the next year, then if the one year note traded at 1 percent, there would be risk free arbitrage in buying the note (because the note is defined as acceptable collateral to get cash without exception at the overnight rate, it is perpetually fungible).

But all of this is true because arbitrage needs a unit that you're left with at the end, say for example cash, to make the calc.

I will not solve the last part of your riddle yet Rocky.

Let me ask, can the fair value of cash, the unit of account in arbitrage, which is merely the desire to lend known resources today for unknown future wants x years from now, change?

I don't want to lend at these rates.

I'd rather just have the money in the bank.

But if you know the money in the bank is guaranteed to earn zero shouldn't you buy the bonds and finance them at zero?

And if you know that the nominal bond is priced on the arbitrage condition above, and you believe that inflation will be three percent,t hen if you short the bond and earn the overnight rate risk free, and buy the tip and pay the over night rate risk free,and you hold these positions to maturity, since they are both fungible for cash, then you are guaranteed to earn the difference between future CPI and the ex ante break-even, which is an unknown variable free to take any value.

If you had an opinion on the future rate of inflation you could express that view only because of the other variable being priced to remove arb.And the riddle you speak of which seems to be, why would you commit ex ante to a negative real return can be answered by saying arbitrage of the other instruments demands that only the break-even and not the real rate is solved for by the buyers and sellers in the tips market.

Then What is the real rate set by? That is a very tricky question. The answer is in the above, but not obviously.

## Duncan Coker writes:

I believe selling the 5 year Tip and buying the 5 year bond would do better than 1.2% (anti negative real rate) and would actually capture the inflation rate of around 2%. Empirically if you convert them to zero coupon for calculations then sell the 5 year tip around 105, buy the 5 year bond at 95, this makes for a compounded return of around 2%, 10 profit, holding to maturing. But then again there is a reason I don't trade bonds much.

I think of tips only in term of the real yield. It would take a very unusual set of circumstances to get me excited about investing in a situation where I can earn a negative real return. These bonds, if I recall all have CPI floors built into them so persistent deflation while sapping a bond of its built in inflation accretion can't turn the redemption figure below par. Each bond has a different sensitivity to the built up inflation component depending upon when issued. This is because the bond pays the same real coupon and the principal balance is adjusted by prior CPI (riding on a train so can't look up)

Certainly these bonds are one of the only high quality ways to hedge inflation. There are a number of global ways to do this but France, etc. Have bigger issues.

So what can happen when you short one of these. I wonder for those who can obtain info what the cost to borrow for the short is here. Obviously the overnight reinvestment is not a plus here.

Seems like I should expect to earn the real yield in this case which is a depreciation toward par but what is my short cost?

## Tyler McClellan responds:

I set up my example clearly.

The reason the thirty year bond cannot be arbitraged to short term rates is very simple. There is no way to credibly make the claim that short term rates will be X for thirty years. There is no institution that can impose the stick. I put very little weight on all the other things. Its the fact that short terms rates could be radically different in the future that generates the volatility not the other way around. Long bonds are very convex and thus this is a major reason they should have a lower yield, offsetting the term premium.

Your examples about LTCM and MF Global are meaningless. Their assets were never fungible at 100 percent leverage for the overnight rate. The Fed conducts monetary policy by making cash and bonds of certain maturities exchangeable for each other at certain overnight rates. To compare this to MF global where the bonds are explicitly not instantaneously fungible with cash (euros) is very odd.

Your example about RV strategies in fixed income is a good counterpoint to the limits of arbitrage. I agree that a one year rate 29 years forward is not subject to the same laws of arbitrage as other instruments. This is for a simple reason. The one year rate 29 years forward is not something that is dynamically set in the market by participants trading until equilibrium. It is an artifice of other things that are traded in this manner and thus it "falls out" of other asset prices.

In general arbitrage is the mechanism by which the sum of views in the market derive their equilibrium condition. You have to have a variable that reflects some view for arbitrage to do heavy lifting. I cannot arbitrage a one day interest rate 17.75 years forward for the simple fact that there are no views on that variable and thus it is merely an artifice that arises from the ecology of the market.

As for mingling "real and nominal". You do not understand your own analysis. The market already believes that we will have about 2% inflation and is nonetheless holding cash at 0%. So the accepting of negative real returns ex ante exists in many markets as a necessary fall out of accepting other variable. To say that this comes from the TIPS market is strange. All the tips market does is allow people to have differing views on the future rate of inflation. Everything else is determined by much more liquid (and therefore likely to be subject to arbitrage pricing) markets.

You will get negative real returns (your vaunted guaranteed decline in real wealth (a phrase that I dont understand)) ex ante in either the nominal or the TIPS market. If you reread what you wrote, you will understand this has nothing to do with TIPS.

As for your last question. You already understand the answer rocky. You get more than PAR day one for being short the TIP.

If you

1) take all those proceeds and reinvest them at the fed fund rate at the future path

2) and if inflation is equal to the breakeven-rate

3) then you will lose the real value of the capital lent to you at exactly the same rate that the market says the real value of the capital lent to you must go down ex ante.

Put another way,

If

1) you must earn the nominal return priced in the market,
2) experience the inflation rate priced into the market,
3) and deposit your funds at the monopoly price set by the FED,

then you are indifferent between the two outcomes and are guaranteed to earn the same negative return. Which is of course why there is a market. All of which i wrote a long time ago as a explanation for why it might make sense to be short tips but if an only if you could tell me why based on your estimate of the above three variables. Any speculation on the real rate is meaningless, it is not a variable one can have a view on outside of the above (if and this is a key assumption, cash money from the fed reserve is the unit of account you wish to sum all the steps across. Its very possible the real term structure of other commodities is different)

## Rocky Humbert responds:

I will address your many points more specifically when I have some time. But I will make a very simple observation (which you ignored)….which has to do with the interactions between inflation and tax policy and the zero interest rate boundary problem.

Let's assume a simple Taylor rule and that the fed sets overnight funds at inflation+100 basis points. Let's further assume a marginal tax rate of 30%.

Case I) Let's assume that inflation is running at 5%. Then fed funds is 6%. Then my after-tax nominal return = 0.7x 6% = 4.2% and my after-tax real return is negative 0.8%.

Case II) Let's assume that inflation is 2%. Then fed funds is 3%…and my after-tax nominal return = 0.7×3%= 2.1% and my after-tax real return is positive 0.1%.

Case III) Let's assume that inflation is NEGATIVE 2%. Then fed funds is 0% … and my after-tax nominal return = 0%, but my after-tax real return is positive 2%.

This is a clear example where real after tax returns behave in counter-intuitive ways…. and so the apparent negative return on TIPS might have less to do with inflation expectations per se, and more to do with the tax effects…. (or more succinctly, an investor in Case III above would be willing to buy a tip that has a negative 2% real yield and would be indifferent to case II, where the same TIP has a +100 real yield.) Just a thought

## Tyler McClellan writes:

Very true. I once worked with Paul McCulley on the tax implications of same. As you never posed that as a question I didn't address it.

I agree with your points and thing it is a modest contributor the the current equilibrium pricing.

## Philip J. McDonnell writes:

I think one point that has not really been made in this discussion is that TIPS are paid back at the greater of inflation adjusted value or par. This means that they have an implied deflation protector built in.

It is like a deflation put which has intrinsic value in and of itself. In many ways we are in a deflationary environment caused by the great credit bubble unwinding throughout the world economy.

I just scanned the riddle discussion. It seems to me that the reason you can't make money shorting TIPS is like the obviously idiotic action of shorting dollars in dollars. Let's say you decide to short a million dollars, and sell it to someone for a million. That's what shorting is, and yet you are in exactly the same situation as you once were.

If TIPs are losing purchasing power against a basket of commodities, but dollars are losing it faster, if you short TIPS you get something that loses purchasing power even faster than TIPS, hence no gain. If you could find a way to get paid for your shorted TIPS with a basket of commodities, and there is high inflation, you can buy them back with fewer commodities, so you make a profit.

# Fed Model-Related Tidbit, from Charles Pennington

From page M49 of this week's Barron's:

The median price/earnings ratio of the 30 Dow stocks using 2011 consensus estimates is 12.3; using 2012 estimates it's 10.8.

NOT A SINGLE STOCK in the Dow 30 has a p/e greater than 20, whether using 2011 or 2012 estimates.

Meanwhile the 10-year is yielding 2.18%.

# Market is Stuck in a Coupled Differential Equation with Obama, from Charles Pennington

I think the dynamics of the market now are the following:

If the market goes down a lot, then people become convinced that Obama will lose, and so the market recovers.

If the market goes up a lot, then people worry that Obama will survive the election, so the market goes down again.

These ideas explain (in retrospect, of course) the range-bound market over the past couple of months, with typical daily swings of 30 or more points, yet bound within the range (until today) from 1100 to
1200.

The equations are:

dM/dt = epsilon1 - k1 * dO/dt

dO/dt = -k2*dM/dt +epsilon2

M = the market level
O = perceived probability that Obama will win
epsilon1 and epsilon2 are "noise" k1 and k2 are positive constants

# Risk Free Assets, from Charles Pennington

If yields on all treasuries of all durations are going to zero forever and ever, it seems possible that a bubble could develop in the Falkenstein-ish safety stocks, the Proctor and Gambles, the Pepsis, the Philip Morrises–anything that has a 2-3 percent dividend yield that's expected to grow slowly with minimal risk and minimal connection to the economy.

## Kim Zussman writes:

Relatedly, what exactly is a risk-free asset?

# More on High and Low Beta Stocks, from Charles Pennington

September 9, 2011 | 2 Comments

Here's more on risky vs non-risky (more precisely, high beta and low beta) stocks, following up on a previous post.

There is a very nice set of data on Eric Falkenstein's website www.betaarbitrage.com. The data gives monthly returns, going back to 1962, on stocks grouped according to beta. I've used that data along with data on market returns and interest rates from other sources.

I looked at two (overlapping) date ranges. The first is from 1993 to present. That range was chosen since it coincides with the lifespan of the S&P 500 etf SPY. The other range chosen was the past 10 years / 120 months, from 8/31/2001-8/31/2011.

The results of this study are summarized in the following table.

There is only one fairly anomalous finding–a Lake Woebegone effect–in that all beta groupings had positive alpha and out-performed SPY. That is interesting, but is nothing more nor less than an artifact of the fact that the S&P "equal weight" 500 index outperformed the standard "cap weighted" index over these periods.

If we compare within the different beta groupings, we find a great big null result, a result consistent with expectations of the "Capital Asset Pricing Model". Neither low, medium, nor high beta stocks excelled or under-performed the others in any statistically significant way. For the past 120 months, the average monthly alphas of the beta=0.5, 1.0, and 1.5 groupings were, respectively, 0.37%, 0.21%, and 0.40%, each with standard error of about 0.2%. That's a tie in statistical terms.

For the 1993-present period, the alphas were 0.27%, 0.06%, and -0.06%, giving the edge to the low beta (beta=0.5) stocks, but with standard errors in the readings that are comparable with the differences, so again it's a statistical tie.

Reiterating points that I made in a previous post, I think that the returns of risky stocks get a bad rap. First, it's not appropriate to use geometric average returns, which unfairly penalize volatile stocks. A real-world investor can re-balance his portfolio periodically if he feels his market exposure is too big or too small. Second, with risky stocks, you don't need to invest as much money to get the same market exposure, so risky stocks should be credited in some way for the interest on the money that you didn't need to invest. The Capital Asset Pricing Model term "alpha" takes care of these problems in an elegant and logical way.

Technical details:

–Monthly returns data are taken from Eric Falkenstein's site www.betaarbitrage.com, specifically from the "beta=0.5", "beta=1.0" and "beta=1.5" portfolio data supplied here.

Eric writes: "The beta portfolios here target a forward looking beta. Using historical daily data, for the most recent period, but monthly for data prior to 1998, I create portfolios filled with stocks that have the betas closest to 0.5, 1.0, and 1.5."

–Monthly alphas are calculated as follows: alpha = (return - return_riskfree) - beta*(return_s&p - return_riskfree)

–For return_s&p I used the monthly total returns, taken from MarketQA, of the S&P ETF ticker SPY.

–For return_riskfree I used the 13-week treasury bill index (ticker ^IRX on Yahoo Finance) as measured at the start of each month.

# No Email Say Docs, from Dan Grossman

In a survey of doctors on a website I follow, 80% of responding doctors answered no way would they allow their patients to email them.

This was the response I posted:

To the 80% of responding docs who say "No way": If you wonder why many patients develop major hostility to doctors' office procedures and to doctors themselves, and why the public is happy to stay silently on the sidelines while the government and insurance companies take over control of doctors' working lives, could it be that doctors (who for 100 years had control of their practices and refused to make them patient-friendly and efficient) have failed to enter into the 21st century? And regard it as perfectly acceptable to impose inefficiency, frustration and wasted time on patients by not letting them communicate with the doctor but requiring them to make an office appointment (probably 3 or 4 hours with travel to and fro, long office waits, etc) for every question or matter?

I see nothing wrong with a doc charging for email or telephone time. Those patients wishing to use email or telephone should be willing to pay the time charge, regardless of whether such charge is covered by insurance. But if our profession continues to lord it over patients by refusing to allow them what every other profession and all of modern life does, doctors will deserve what they get in the way of government and insurance oversight and regulation.

## Charles Pennington writes:

Chiming in, that is a pet peeve of mine. What other profession won't take email? Lawyers, dentists, accountants, etc. all communicate by email, of course. Doctors make it even worse by making you communicate with them only via a voice-mail maze that begins with "If you are a physician, press 1; otherwise, your call is very important to us so please remain on the line…"

I'm with the doc's here.

When the tears are flowing, everyone says they are willing to pay, but without getting into the business of FIRST AND AT THE ONSET, having a Retainer Agreement, unilateral right to draw it down upon presentation of statement, Mandatory Arbitration clause, deposit for fees in the Trust Account, all one does is lay a background for a fee dispute complaint or malpractice counterclaim to a suit to collect those fees. It's not gonna happen as a general practice. The doc is caught between the rocks of patient desire for immediacy and convenience; the professional obligation 'not to miss' something that in hindsight seemed obvious; and the fact that insurer reimbursement for web and email oriented 'treatment' lag.

Having had poor service (breaches of patient confidentiality, outright prevarication by nursing staff, and failures of delivery of test results repeatedly and after specific instruction) in the care of a wound, all since May of this year, from the standpoint of the patient, I want there to be a formal paper trail (not email; not call center notes in some database, forgotten and closed; not some other ephemeral media) … a well drafted letter explaining the issue, a file CC, and a cc to the supervising agency (hospital system privacy officer, nursing board, 'authorized provider' certification entity), and an equally formal response (or in its absence, proper escalation on my part).

Unreasonable, I know, but progress is made on the backs of unreasonable people.

The same goes for lawyering. If a client cannot keep and will not pay for an office visit, or meeting at other venue of their choice, to permit the open-ended probing that proper representation requires, they won't be MY client very much longer, as I cannot properly represent them.

## Alex Forshaw writes:

The fact stands that interacting with doctors is a pain in the ass from the second you enter the door. They do not face nearly enough competition. There is no bigger beneficiary of protectionism in the entire country. The lack of competition has meant they face no evolutionary pressure. I hate "socialized medicine" as much as anyone but US doctors are as much culprits in their own demise as the tort bar and all of doctors' other favorite bogeymen.

In my conversations with doctors, I've been told the potential legal and regulatory liabilities risked by patient email contact are vague and large, leading them to simply shun the practice.

## Phil McDonnell writes:

Regular email is not a secure medium. Privacy regs hamper a Doc's ability to use email. Most will call you on the phone and/or write a letter with results. That is why expensive software with encryption is required that often the smaller practices cannot afford.

## Gordan Haave responds:

Sure that's what they say. But it's BS. How is the fax or telephone somehow more secure than email?

If the issue is confidentiality, why is it that Lawyers will email you but not Doctors?

There is one other group that won't send emails: The IRS.

I am in the middle of a personal and business audit, and you can't email the IRS. It's very inefficient.

To me this is just further proof that Dr's collectively are not the saints they claim to be, but rather just a cartel that uses wildly inefficient systems to extract rent's from consumers.

## Dan Grossman writes:

I am surprised that a few otherwise highly astute Speclisters so easily accept doctors' excuses for refusing to permit email. As a service to the medical profession and to our country (and in time for inclusion in the President's speech tonight as a new regulation under the Patient Protection and Affordable Care Act), I have drafted and present below a few simple groundrules that a doctor can require a patient to accept as a prerequisite for emailing him.

"A Patient wishing to email Doctor must indicate his acceptance of the following:

1. Complex or detailed matters require an office visit. This email is for minor procedural, scheduling and prescription renewal matters.

2. Doctor will attempt to look at reasonable numbers of emails as time permits but because of his busy schedule cannot commit to read or deal with every email. Any information Patient wishes to convey with certainty must be conveyed by other means.

3. Emails are not secure and should not include sensitive personal information. They will not necessarily be presevered or included in Patient's medical file or record.

4. Patient agrees to pay \$20.00 for each ten minutes or part thereof Doctor spends reading or dealing with emails from Patient, regardless of whether the amount is reimbursable to Patient by his insurer. Medicare and Medicaid Patients unfortunately are not eligible to use this email since such programs do not permit email charges. (Doctor regrets this and asks that you please take up such inefficiency with the Government rather than with him.)"

With regard to 3, doctors or their office assistants can instead spend 15 minutes setting up free encryption, as others on the List have already pointed out.

Cheers,

Dan

# The Power of Electricity, from Tim Melvin

August 31, 2011 | 1 Comment

How I have missed you. It occurs to me after a few days without power that nothing in our modern world works without electricity. I suspect power generators are much more valuable than the market gives them credit for.

## Henry Gifford writes:

Electricity is priced in a strange way, and generally thought by many to be heavily subsidized.

Roughly described, the utility company is guaranteed a % return on investment, so once a wire or power plant is paid back, it is "a sunken cost" and carried on the books as worthless.

Residential customers pay only for buying and transporting electricity they use, and for political reasons pay nothing for unused infrastructure. This is a little like telling a taxi to wait by your door all year because you might want to go someplace on New Years Eve, or you might not want to go anyplace, but you won't pay the taxi to wait at the curb all year.

"Commercial" customers pay a "demand charge" for the infrastructure capacity that is available 24 hours 365 days per year, but only fully used for a few minutes per year, often in the late afternoon in the summer, when everyone else wants it. The demand portion of the bill can exceed the electricity buying and transporting charges, and indeed many companies are in the business of helping large users shave their peak demand, sometimes by shifting it to a non-peak time.

One example is the 20+ companies in the US that manufacture ice storage tanks. Customers with large air conditioning loads make ice at night, when their demand is lower, then use the ice for cooling during the day, reducing their peak (daytime) electricity use.

## Charles Pennington clarifies:

We're categorizing water in three ways: drinking water, washing/cleaning the body water, and flushing-the-toilet water.

Sam's Club Diet Lemon-Lime Soda is a pretty good go-to for the washing/cleaning the body water. It's cheaper than most bottled water, and because it's "Diet" it has no sugar and is good for washing your hands. I guess it's not optimal for brushing teeth, but it won't be for long, I hope.

# Wisdom of John Wooden, from Victor Niederhoffer

August 31, 2011 | 4 Comments

John Wooden lived 99 2/3 years and is considered by many to be the greatest coach in history. His teams at UCLA won ten of 12 national championships, 88 games in a row, and he was a 3 time all American in college, once sinking 134 foul shots in a row. His players loved him and he developed several systems for success. After reading his book published shortly before what would have been his 100th birthday on October 14, 2010, I figured I could learn much from him.

Here are some of the things I learned. He kept good records. His father gave him a note card with suggestions. He attributes much of his success to his father. His father gave him 7 suggestions to follow and he has tried to live up to it every day of his life. Be true to yourself. Help others. Make each day your masterpiece. Read good books. Make friendship a fine art. Build for a rainy day. Be thankful for blessings each day. I liked better what his father gave him in three rules: Don't whine. Don't complain, don't make excuses.

He loved teaching. And I like the little fellow poem that guided him in his relations with his 3 kids and his students.

A careful man I  want to be
A little fellow follows me
I dare not go astray
for fear he'll go the self same way
I cannot once escape his eyes
What he sees me do, he tries.
Like me he says he's going to be.
The little chap who follows me.
He thinks that I am good and fine.
Believes in every word of mine
the base in me he must not see
the little chap who follows me
I must remember as I go
Through summer's sun and winter's snow.
I am building for the years to be
that little chap who follows me.

He was married to his college sweetheart Nellie for 60 years and she came to every game he coached. Apparently he never earned more than 50000 a year, and he often turned down jobs that would have paid him much more because he had given his word and he never wished to tell a lie.

His pyramid of success is famous. It has at the bottom hard work, friendship, loyalty, cooperation, and enthusiasm then goes up to self control alertness action and determination. Then fitness skill term spirit poise confidence personal best.

How would I apply these things to markets? I like the never complaining and never boasting. The hard work, and loyalty and enthusiasm. The attributes of the pyramid of success would seem to be good for any activity.

His humility is a good model for all who wish to achieve success. He didn't have his hand out for money and went beyond the dollar and the clock The fact that he was such a good player must have made him a great coach. Apparently he had every minute of every workout planned. And he insisted on it being a team game rather than a forum for a star. I guess that's a bit easier when you have Alcindor and Walton on your squad.

I would have liked to know more about his day to day life and how that suited him to live to 100 and be loved by so many. Certainly the philosophy of life must and the pyramid of success much have had much to do with it.

He took losing very well, and always felt sorry for the teams that he beat.

I can't find anything that needs much improvement in his life as a model for a teacher, father, or speculator.

## Charles Pennington writes:

I thought the Chair disliked cooperative games like soccer and (I presume) basketball. What's the story there?

## Fred Crossman writes:

Never did I want to call the first time-out during a game. Never. It was almost a fetish with me because I stressed conditioning to such a degree. I wanted UCLA to come out and run our opponents so hard that they would be forced to call the first time-out just to catch their breath. I wanted them to have to stop the running before we did. At that first time-out, the opponent would know, and we would know they knew, who was in better condition.

He never called a time out at the end of the game either. Sat there with his program rolled up most of the game for he believed UCLA was better prepared mentally, too. His players knew exactly what to do. Confusion and pressure at the end of the game was their ally.

# Risky vs. Non-Risky Stocks, from Charles Pennington

July 26, 2011 | 2 Comments

How has beta been working lately?

Attached is a graph of the compound growth since 1999 of \$1 dollar invested in each of five "pentiles" of S&P 500-like stocks, sorted according to each stock's trailing beta. (I will specify the technical details more precisely below.)

.

.

At first glance, pentile 5, the high beta stocks, looks like a disaster. After 12 years, it's at break-even, and that's after suffering enormous white-knuckle drawdowns of almost 90%. The other four pentiles all show an annualized compound returns of 6-8%, all with lower volatility.

So are high beta stocks a big disaster? Recently the idea has emerged that low risk stocks offer superior performance, or at least risk-adjusted performance, than high risk stocks. Eric Falkenstein wrote a great book (Finding Alpha ) and writes an ongoing blog on the broad theme that risky assets don't have the pay-off that they should, and recently some institutional offerings of low volatility stock portfolios have emerged, such as the Powershares Low Volatility S&P 500 ETF.

The results presented here seem at first to support the thesis that low risk stocks are the way to go, and that high risk stocks should be avoided. However, if you take a closer look, these results turn out to be in close agreement with the "Capital Asset Pricing Model" ("CAPM", the model of beta) and more broadly, the efficient market hypothesis.

Briefly, the reasons that high beta stocks have the illusion of underperforming are:

1) Because of their high volatility, their geometric compounded returns sharply lagged their arithmetic returns. That's not a fair comparison with low beta stocks, though, because an investor does not need to invest as many dollars in high beta stocks to get the equivalent market exposure. With a lower dollar exposure, the geometric and arithmetic returns would approach each other.

2) Because an investor doesn't need to invest as much money in high beta stocks to get the market return, he can use the remaining money to earn the risk-free rate — and that benefit is not properly credited to risky stocks in a simple plot of their compound returns.

Both of these issues can be assessed and addressed by analyzing data with the standard CAPM formula:

R - Rf = beta * ( Rspy - Rf) + alpha

where R = return, Rf is the risk-free rate, Rspy is the market return (which I take to be the return of the S&P 500 ETF SPY), and alpha is what efficient market purists would call an "error term", representing the amount by which the return was above or below what it "should" have been. From our point of view though, alpha is the out-performance or under-performance that we're trying to measure. Our question is, "Do high beta stocks have negative alpha?". The short answer is that they don't (or at least they didn't from 1999 to now).

Here is a summary spreadsheet of the statistics.

The annualized alphas for pentiles 1 (low beta) to 5 (high beta) were 3.3%, 3.5%, 3.3%, 4.8%, and 5.5% respectively.

The reader may be very surprised that ALL the alphas are positive, which is sort of a "Lake Woebegone" effect. That's equivalent to the fact that the "equal weighted" S&P 500 index out-performed the traditional cap-weighted index over this period.

In any case, the alpha for pentile 5, the highest beta pentile, was 5.5%, the highest of any pentile. Pentile 1, the lowest beta pentile, was tied for the lowest alpha, at 3.3%. So from that point of view, the highest beta stocks were the best performers of all, despite having the worst compound annual return. To be fair, the annualized volatility of pentile 5's alpha was also the highest, and the ratio of pentile 5's alpha to the volatility of its alpha (which is equivalent to the Sharpe ratio of pentile 5, hedged with an appropriate short position in the S&P 500 index) was the lowest, so from that point of view pentile 5 was the worst performer (and pentile 4 the best).

We shouldn't over-analyze which of these alphas is the best, though, because within statistical error, they are all the same. The statistical error for the alphas of the pentiles are all about 2-3%, except for pentile 5, which has a 6% statistical error. The alphas themselves range from 3.3 to 5.5, and so the inescapable conclusion is that within statistical error ALL PENTILES WERE ABOUT THE SAME in terms of their alpha.

So my soapbox message is that the performance of high beta stocks may look terrible at first glance, but you've got to correct for the fact that you don't have to hold as much of them to get your market exposure. Don't penalize them by using geometric returns, and make sure to credit them for the interest you'd earn (or the margin interest that you wouldn't have to pay) because you don't have to hold as many dollars' worth of them.

TECHNICAL DETAILS:

1) This study used a database (MarketQA) that I believe to be free of survivorship bias

2) The 500 stocks used in the study are not the actual S&P 500
components. At the start of each calendar year, I selected the 500
largest market cap US domiciled stocks, trading on either NYSE or Nasdaq.

3) On each trading day the 500 stocks (excluding any that were trading
at less than \$5 per share as of the previous close) are sorted into 5
pentiles based on their total return beta with SPY. Beta is calculated for each stock based on the prior 250 trading days of close-to-close moves.

4) The daily return of each pentile was calculated as an equal-weight average of the daily returns of the (roughly) 100 stocks in each pentile.

5) The daily risk-free rate used is taken to be the 3-month treasury bill yield index (divided by 252, assuming 252 trading days per year). It averaged 2.6% over the period of the study, but it ranged from zero (currently) to values much greater than the average.

6) The daily alpha for each stock is calculated as alpha = (R-Rf) -beta * (Rspy - Rf). The alpha for each pentile is calculated as the equal weight average of the alphas of the (roughly) 100 stocks in the pentile.

7) "Annualized" alphas for each pentile is 252 times the average of the daily alphas. There were 3,154 trading days. Annualized standard deviations of the daily alphas of each pentile is the square root of 252 multiplied by the standard deviations of the daily alphas of each pentile.

# Thoughts on HP, Eastman Kodak and IBM, from Charles Pennington

July 24, 2011 | 1 Comment

I interviewed for a job at HP once about 20 years ago. Back then at least, they had a lot of divisions that were more or less silo-ed, trying to be profit centers on their own. If that's still what they do, then it would be a pretty good situation for doing spin-offs and that sort of thing.

Eastman Kodak. By chance, I was thinking about EK day or two ago and about how easy it is to be wrong. In 1997 I was visiting China. I looked around and tried to think about how the emergence of China and how it might play out in investment themes. My best idea, I thought, was that as Chinese consumers moved up in the world, one of the first things they would want would be film to take pictures of their children. So I thought that already beaten down EK might be a good investment. The WSJ reported the other day that EK's bonds are falling away to zero now. It's believed that they could default in as soon as a year or two.

On the same page in the WSJ there was an article about IBM's booming earnings, three-something billion in the most recent quarter. Yet another "insight" I had long ago was that IBM could never make much money after the mainframe business died. When that was happening, the stock was way, way down, and Gerstner took over, and I'm pretty sure it's been a good-to-great investment ever since. Even now, I don't really understand what they "do", and how they make \$3 billion a quarter doing it. I read that they make a lot on consulting, but anybody can do consulting, and it sounds tough to even gross \$3 billion on that, let alone net.

# The Best Selling Books of All Time and Markets, from Victor Niederhoffer

The enclosed list of best selling books of all time  is an excellent indicator of popular culture I think, and should have interesting market applications. How would one dig down into that, and do you think or do you think it's not applicable?

## Steve Ellison writes:

The first thing I notice is what a diverse list it is. The Lord of the Rings is a fantasy book. Think and Grow Rich is a self help book. There are conventional novels, children's books, religious books, and even a book about science by Stephen Hawking.

Who'd have guessed that A Tale of Two Cities is the best seller (single volume) of all time? I didn't even know it was the best-selling Dickens novel, which apparently it is by a factor of 20, since no other Dickens novels appear in the list. That's very surprising; am I misinterpreting?

## Stefan Jovanovich writes:

No misinterpretation here. ATOTC was so wildly popular in the U.S. - like all Dickens' writings - that people in New York and Boston and Baltimore (? not absolutely certain about that one) literally waited at the dock for the packet to arrive from England with the latest installment. One reason Dickens disliked America and Americans is that some of our enterprising ancestors are known to have bought a copy of the latest serial, set it in type over night and had reprints out on the street the following morning for sale - at, of course, a suitable discount from the price of the legitimate copies.

Tale of Two Cities was also the last book that "Phiz" illustrated. Starting with The Pickwick Papers, Dickens has written "monthly parts" that were sold as part of a serial publication. (It literally revolutionized British publishing.) The serials were close to being graphic novels. Robert Seymour, George Cruikshank, and George Cattermole all did illustrations. Hablot Knight Browne (1815-1882) — "Phiz" — did the ones that are best remembered. When Dickens began self-publishing in his own weekly periodicals, Household Words and All the Year Round, Dickens fired his friend as chief illustrator. The parallels with Walt Disney are interesting.

## Pitt T. Maner III writes:

In digging down a bit one sees that 3 of the authors, with over 100 million copies sold, are buried within a couple of hundred miles of each other in England (within a shared cultural environment) and that some of their literary themes had connections with class or race distinctions and warfare /murder (Dickens–French Revolution, Tolkien–races of mythological creatures, Christie– see wiki article on And Then There Were None (which originally had a different title and is about murderers from different classes being tricked into meeting on an island and being tricked in some cases into bumping each other off).

There is a whole series of study devoted to the Chinese book Redology and (having not read it), " Dream of the Red Chamber" appears to involve issues of class mobility.

Tsao Hsueh-chin, the author of A Dream of Red Mansions, lived between 1715 and 1763. His ancestral family once held great power. As such, he led a wealthy noble life in Nanjing as a child. When he was 13 or 14, the family was declining and moved to Beijing, where life took a turn for the worse. In his later years, he even led a poor life.Drawing on his own experience, Tsao Hsueh-chin put all his life experiences, poeticized feelings, exploratory spirit and creativity into the greatest work of all time - A Dream of Red Mansions. Drawing its materials from real life, the novel is full of the author's personal feelings filled with blood and tears.

A Dream of Red Mansions is a novel with great cultural richness. It depicts a multi-layered yet inter-fusing tragic human world through the eye of a talentless stone the Goddess used for sky mending. Jia Baoyu, the incarnation of the stone, witnessed the tragic lives of "the Twelve Beauties of Nanjing", experienced the great changes from flourishing to decline of a noble family and thus gained unique perception of life and the mortal world. Revolving around Jia Baoyu and focusing on the tragic love between Jia Baoyu and Lin Daiyu and Xue Baochai against the backdrop of the Great View Garden, the novel portrays a tragedy in which love, youth and life are ruined as well as exposes and profoundly reflects the root of the tragedy – the feudal system and culture.

Found here.

Terrible things can happen if you leave the rich and powerful unchecked and unpunished… is that close to the themes that may be partially beneath the success and appeal of the above best sellers of all time.

The meme being that it will be back to the dark ages of murder and mayhem on earth if government social services are the least bit underfunded and the rich continue to not pay their fair share.

## Dylan Distasio writes:

I thought it might also be worthwhile to look at bestsellers by decade. There is a course on 20th century American literature that has been kind enough to share their materials with the interwebs. The full list by decade for the 20th century is at the below link and is worth checking out.

## Pitt T. Maner III comments:

In my first paid job as a 12-year old library aide, Agatha Christie made shelving a pile of returned books easy– her works constituted 10% of the pile and were quickly put back with little effort to the same spacious shelf location. I remember reading "Jaws" then, a book hugely popular at the time.

It is doubtful, however, that the Palm Beach socialites checking out multiple Christie books each week would ascribe her popularity to the "Burkean paradigm".

The following is a piece on Christie from a self-described "Wilsonian". Perhaps an example of reading into things a bit too much…the retrospective reasons for success when starting with a point of view.

Her work conforms to Burkean conservatism in every respect: justice rarely comes from the state. Rather, it arises from within civil society – a private detective, a clever old spinster. Indeed, what is Miss Marple but the perfect embodiment of Burke's thought? She has almost infinite wisdom because she has lived so very long (by the later novels, she is barely able to move and, by some calculations, over 100). She has slowly – like parliament and all traditional bodies, according to Burke – accrued "the wisdom of the ages", and this is the key to her success. From her solitary spot in a small English village, she has learned everything about human nature. Wisdom resides, in Christie and Burke's worlds, in the very old and the very ordinary.

# When Comparing a Current Price, from Victor Niederhoffer

In comparing a current price to something 10 years ago, it is instructive to consider the correlation of a part to a whole the correlation of ( x1+ x2 + x3 + x4 + x5 + x6 + x7 + x8 + x9 + x10) to p when the x's are uncorrelated with each other. If the correlation of x10 to p is negative then the average correlation of the other 9 x's to p must be positive, surprisingly so. And good to calculate. The correlation between the first quarters earnings and the whole years earnings is of the order of 50% assuming randomness and uncorrelation.

I had many old men very angry with me when I pointed out this fallacy in Green and Segall's and Myron Schole's work that showed that first quarter earnings were not predictive of the whole years earnings. It meant that the next 3 quarters were highly negative correlated. The same defect is relevant to the chronic bear's work, and when I took the liberty of pointing this out to him, he demurred and apologized and said something about the stochastic calculus, a trick he tried on Andy Lo with similar absurdity.

## Charles Pennington writes:

I suspected that this tale had grown a bit tall with age, but here is a link to the first page of a 1966 article by Green and Segall. On that first page they do say that they can't seem to prove that the first quarter's earnings are helpful in predicting the annual earnings.

# Drilling to the Earth’s Mantle, from Pitt T. Maner III

Drilling to the earth's mantle and the Mohorovičić discontinuity was pursued by the USA back in the late 50s and early 60s under the name Project Mohole and then attempted by the Russians on the Kola peninsula in the 70s and 80s. Thoughts of drilling to the earth's mantle to find out what is there are being revived.

1) from a national geographic article:

It may not be a journey to the center of the Earth, but it could be the closest thing yet.

Scientists are planning to drill all the way through the planet's miles-thick crust to Earth's deep, hot mantle and retrieve samples for the first time. The samples, they say, would rival moon rocks for sheer scientific import—and be nearly as hard to get.

"That has been a long-term ambition of earth scientists," geologist Damon Teagle told National Geographic News. But a lack of suitable technology and insufficient understanding of the crust have long tempered that ambition."

2) Check out a second article in April 1961 Life magazine written by John Steinbeck during his time on board CUSS 1 at the start of drilling for Project Mohole.

The best place to drill, Teagle said, is in the mid-ocean,
because that's where Earth's crust is thinnest—only about four miles
(six kilometers) thick, versus tens of miles deep in continental
regions.

Is there some simple explanation of how we even know how thick the
earth's crust is and what's below it when we've never drilled through it
before?

## Pitt T. Maner replies:

It's the depth at which the seismic velocity changes probably due to a compositional change to periodotite type minerals with perhaps some changes due to temperature regimes.

So the only samples that geologists have to look at from mantle depths were brought to surface enclosed in magma as xenoliths.

Other than that there are probably lots of questions as to what will be
found and whether the mantle differs from location to location in
composition.

One question they hope to find out is how deep life extends below the earth's surface.

A lot has been learned since I studied Geology 29 years ago.

# Notes from the Field, from Alan Millhone

Dirty tables. I'm at a place I like for a Boli and the place is busy. I dislike seeing dirty tables and the seats not cleaned. To me for a food business to maintain an edge over the competition they need good food and a clean place to dine.

This place is individually owned. Watching the girl now cleaning tables and chairs with the same rag! Also note our local Panera has the same table and seat issues. Panera and our local free standing Chick Fil A use two cloths for tables and chairs.

Likely all of this has Market implications when an investor chooses a restaurant stock to purchase.

Sincerely,

Alan

## Charles Pennington responds:

I almost always try to hit restaurants when they're not crowded. I'll grab lunch at 11am or 3pm, or I'll get dinner at 5pm or 9pm. It's a great strategy, except that always, always,always there is someone sweeping the floor while I'm eating. I try to cover up my food, but there's really no way to protect it from small pieces of airborne debris. I understand that restaurants are in a quandary–they have to sweep sometime, but I wish they'd come up with a better solution.

Also Alan is very fortunate to have a Chick-fil-a in town. The Chick-fil-a people should invade the northeast and show everyone how it's done. When I was a kid, Chick-fil-a was mostly a mall destination, but now they are also a highway exit destination. I'd drive an extra hundred miles if it would get me to a Chick-fil-a, where I know the place is going to be clean and they're going to treat me with wonderful courtesy.

# Peter Lynch stocks from “Beating the Street”, from Charles Pennington

February 17, 2011 | 3 Comments

Back in 1992 I read Peter Lynch's book "Beating the Street". It's a fun book to read; he explains how he came to recommend ~20 stocks in that year's Barron's "Roundtable". As the years passed though I kept noticing that stocks that he had recommended were falling by the wayside. One of them, Sun TV and Appliance, was a retailer in Columbus, Ohio, where I was living at the time, and not too many years after the recommendation, Sun crashed and burned. Similarly I noticed bad things happening to Supercuts, which he recommended, and more recently Fannie Mae and GM both fell to zero-ish levels. So I've long suspected that overall his picks might have been sub-par, or a disaster, even.

Today I finally got had the time and energy to test it. I know this is breaking the rules, but please refer to the attached spreadsheet, only 10 kB. The spreadsheet shows Lynch's 18 stocks (I excluded one stock because it traded in London and another because it was a "Class B" share, and I couldn't figure out what ticker to use in my database) and their tickers as of 1/31/1992.

Many, actually most, of the stocks did not continue as going concerns until today; they were either acquired, bankrupted, or whatever. I believe that my database (MarketQA) does a reasonably good job of giving my a terminal value, but beyond that I didn't attempt to find out what happened to each stock.

So the spreadsheet has a column for "months as a going concern", i.e. how long the stock lasted after 1/31/1992 until it was acquired, bankrupted, or whatever. Stocks that survived until now have lived for 229 months. The next column, "\$1 grew to" tells you how much money you'd have if you invested \$1 and held until the firm ceased as a going concern. The last column gives the compound return over the period as a going concern.

Lynch didn't do badly at all. The average stock grew \$1 into \$4.24. On average the stocks "lived" for 141 months as going concerns, and I did not give Lynch any credit for reinvesting the moneys after stocks died off. However there was an enormous variation among the stocks. Five of the 18 stocks lost more than 90%, but four multiplied your money by a factor of 10 or more.

The big winners were in the thrift / S&L stocks–on average they grew \$1 into more than \$8, and without them the average performance of the remaining stocks is not impressive.

Lessons? I guess these results give a pretty good feel for the wide variation in returns of individual stocks over long periods. It may also be surprising that stocks have such finite lifetimes, even when they work out well–e.g. First Essex turned your \$1 into \$20 before it fell off the radar about ten years ago, presumably after being acquired. Lynch himself always emphasizes that the occasional "ten bagger" can make up for a lot of sins elsewhere in the portfolio, and that definitely played out with his picks.

(If you can't handle spreadsheets, here it is as text, but I have no idea whether it will format properly for you.)

ticker as of 1/31/1992    company name    months as a going concern    \$1 grew
to    compound annualized return while a going concern
GH    General Host    72    \$0.80    -3.6%
PIR    Pier 1 Imports    229    \$2.88    5.7%
SBN    Sunbelt Nursery    74    \$0.03    -44.7%
CUTS    Supercuts    57    \$0.72    -6.7%
SNTV    Sun TV and Appliance    82    \$0.03    -40.0%
EAG    Eagle Financial    75    \$6.34    34.4%
FESX    First Essex Bancorp    145    \$19.57    27.9%
GSBK    Germantown Savings Bank    35    \$3.67    56.1%
GBCI    Glacier Bancorp    229    \$12.70    14.2%
LSBX    Lawrence Savings Bank    229    \$10.54    13.1%
PBNB    People's Savings Financial    66    \$3.97    28.5%
SVRN    Sovereign Bancorp    204    \$1.03    0.2%
TLP    Tenera L.P.    139    \$0.00    -42.8%
GM    General Motors    226    \$0.01    -23.7%
PD    Phelps Dodge    182    \$10.64    16.9%
CMS    CMS Energy    229    \$1.74    2.9%
FNM    Fannie Mae    229    \$0.04    -15.5%
COGRA    Colonial Group    38    \$1.67    17.6%

average    \$4.24

## Steve Ellison writes:

The median stock turned \$1 into \$1.70 and had a 4.4% CAGR. I got similar results when I checked stocks suggested by Jim Collins in Good to Great. A small number of big gainers made the portfolio as a whole above average. Maybe there is a lesson here.

If you study Mr. Lynch's results much of his success was a result of playing the mutual thrift conversion game. His fund had deposts in just about every mutual thrift in the country so he could buy the conversion offering. Almost universally these stocks were HUGE winners. That game is very much back to life today as new regs are pretty much forcing many thrifts to convert…..most can be bought after the offering at a still sizable disocunt to tangible book value.

## Charles Pennington writes:

Of the four "ten baggers", two would have gotten stopped out at very disadvantageous (roughly break even) prices…

I would have guessed that those conversions had limits on how much stock a customer could buy, and with those limits in place, how could they make a dent in the performance of a large fund?

According to the Cramer book ("Confessions.."), which is very entertaining, much of the good performance of his fund was also due to holding thrifts, but he almost went under when redemptions threatened to force him to sell those very illiquid stocks.

Apart from the initial "pop" after a conversion, I don't see why thrift stocks would continue being cheap. Isn't this a very well-known idea, given that I've heard of it?

## Victor Niederhoffer writes:

Now the professor is going to compute the market value of the individual stocks and tell me that the average market value of the ones that went down 100% at inception was not different from the average market value of the ones that were 10 baggers and kept him from reading books.

## Charles Pennington responds:

The Chair's point is that most of the 10 baggers mostly started out as impossibly-small-to-buy stocks, and that is correct. Here are the 10-baggers and their market caps in January 1992:

First Essex (FESX) \$21 million
Glacier Bancorp (GBCI) \$32 million
LSBX \$12 million
Phelps Dodge (PD) \$2.6 billion

The only non-micro cap is Phelps Dodge.

Here are the January 1992 market caps of the stocks that lost nearly 100%:

SBN \$60 million
SNTV \$109 million
TLP \$30 million
GM \$19.9 billion
FNM \$17.7 billion

## George Coyle writes:

Food for thought since I don't have access to data, certain funds and firms have size restrictions on what they can buy due to position sizing, liquidity, etc. It would be interesting to see if stocks which crossed over a given level in market cap (\$100mm, \$500mm, \$1bb) subsequently saw inflows or outflows by virtue of qualifying as new investments for bigger buyers or being kicked out by virtue of falling below an acceptable cap level. Also, there are legal filing consequences of holding positions over certain sizes so I imagine patterns exist which are very real as firms alter position sizing to avoid regulatory filings (and ultimately position size disclosure on a non-quarterly basis). It is a bit of a momentum study meets the analysis below but with a legal/fund guideline slant. I believe Factset tracks historical cap sizes with some reasonable degree of accuracy/frequency but I no longer have access.

## Phil McDonnell writes:

To throw a few stats on the table I am posting links to some work done by Eric Crittenden. He is a momentum quant with BlackStar Funds. He argues that trend following must work because long term stock distributions have very fat tails. He also argues that the negative fat tail implies that stop losses must work. One of the charts shows a huge right tail of three baggers or better. Another shows that all gains come from 20% of the stocks.

I have had the chance to review several of his studies in progress and Crittenden seems to do it right. He uses total returns and avoids obvious pitfalls like survivor bias etc.

## Charles Pennington responds:

It seems kind of silly that they take this indirect route — "lots of big gainers and lots of big losers, therefore use stop losses". Why don't they just test the performance of some simple stop-loss rule? Jason proposed a trailing stop of 50%. That sounds ok to me. Then, whenever you're stopped out, use the proceeds to buy an equal weight (cap weighted) of the remaining stocks. Does that outperform or under-perform the equal-weight (or cap weighted) index?

# Drug Stocks In This Week’s Barron’s, from Charles Pennington

February 16, 2011 | 2 Comments

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

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

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

## Vince Fulco writes:

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

## Bill Humbert writes:

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

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

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

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

Check this out. Some data on the drug industry:

Figure A: # new drugs by year

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

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

Figure B:

Pfizer R&D spend

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

## Alston Mabry writes:

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

## Dan Grossman writes:

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

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

## John Tierney writes:

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

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

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

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

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

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

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

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

Guess I sort of agree.

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

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

# Casual Observation of Yield Curve, from Charles Pennington

The slope of the yield curve between say 0 and 2 years has soared since October, the 2-year yield going from ~0.35 to ~0.85 with short term rates still zeroish.

Seems like that's discounting an awful lot of hikes by the fed over the next year or two.

This is bait to see if Rocky will tell me what it means.

## Victor Niederhoffer responds:

Before the erudite polymath sets us straight, I can tell you that it means the expected average of the funds rate for the next 2 year is 1.70%

## Rocky Humbert takes the bait:

Last April, the 2 year note reached 1.11 (0.85% last). So, we're still about 30 basis points below last April– which incidentally was a great time to short stocks and buy bonds… One obviously wonders whether we'd be 30 - 50 basis points higher right now but for the QE2 ??

Vic is correct, but there's a nuance because the mean is different from the path. The last six Fed Funds futures from June 2012 to Jan 2013 predict fed funds at between 1.00% and 1.83%; and the front of the Fed Funds strip Feb11 to Feb Sep 11 all have Fed funds between unchanged So the "steepness" is mostly in the back contracts. That is, Mr. Market believes that the fed will not move until late 2011 or early 2012 at the earliest. And then it will tighten 200 basis points fairly quickly. I think the market is consistent with Pimco's most recent stated view…

It's really hard for me to get excited about a 2 year note at 0.84% when the CPI is running at more than double that. And, the MIT Billion Price Project is predicting an accelerating CPI over the next few months.

# 10 Rules for Betting Football, from Jeff Watson

January 18, 2011 | 3 Comments

I came across a good article from Chris Maloney listing ten rules for
betting with a bookie.  Substitute a few words and the list could be

From Rule 3:

"There is probably no better bet in sports than playing an underdog at home," Moseman says. "Teams play inspired ball at home. Slim underdogs regularly win outright. Big underdogs often find ways to cover the spread and they rarely give up toward the end of a game in front of the home crowd."

Are the sports betting markets so slow moving and dumb that you can make money doing something as simple as this?

# The FOMC Announcement, from Charles Pennington

The FOMC announcement did nothing to moderate the extremes in yield curve steepness that Rocky was talking about. Here are the moves from 2pm to 3:30pm (EST) in some bond futures:

put
FV (five year) +8/32
TY (10-year) -3/32
US (30-year) -2 24/32
UB (ultra) -4 19/32

Very roughly speaking, TY should move roughly twice as much as FV, and US roughly twice as much as TY, but obviously that's not what happened.

I think the FOMC gets a little thrill out of being able to say "I like the five-year today" for no reason and then push a button and blast it upward. Buckley's first 100 names from the Boston phone-book would do a better job, and a true market would do even better than that.

# One of the Greatest Errors, from Victor Niederhoffer

October 4, 2010 | 4 Comments

One of the greatest errors people make is to think that the level of good or bad economic or earnings news is related to future stock market performance. Always the market is anticipating the future, and the market now has in its sights the election, the coming increases in service rates, and all else.

It is interesting to contemplate a graph of the DJI and its 10% continuous rise in September and relate it to Iowa bets on the outcome of the November election with its steadily decreasing blue line and increasing red line graphed below.

## Ken Drees writes:

The idea that the market is a seeing creature, very blind short term but correct and on target 6 months out really has been taken for granted as an old sharp cutting saw. So what is the market seeing now 6 months out? In April when the market was topping–what did that market see for this October. Thereby in March of this year when the market was moving up–it forecasted the best September in 70 years?!

I really don't get this, but actually am programmed to believe that somehow the market sees things that the crowd doesn't. Now we are told that the market sees a republican victory and stoppage of anti-business actions–maybe the start of repeals against major programs, or at least old fashioned gridlock. What is the best way to use the market as a "seeing" tool?

## Gary Rogan writes:

Everywhere I turn I read about how the liquidity injections by the Fed are what's really pushing the stock market higher. How would one go about separating the effects of the extra liquidity from the anticipatory ability of the market?

Also, since correlation does not imply causation, could it be that some of the same underlying causes that result in high liquidity also result in the increased republican takeover. For instance:

High Unemployment -> More Liquidity to Spur Employment -> Higher Stock Market

High Unemployment -> Higher Republican Chances

High Unemployment -> Lower State and Federal Revenues -> More Need To Borrow -> More Need for Low Interest Rates -> Higher Liquidity -> Higher Stock Market

…-> More Need To Borrow -> More Dissatisfaction with High Debt -> Higher Republican Chances

… -> More Need To Borrow -> Lower Dollar -> Higher Stock Market in Today's Dollars

High Unemployment -> Higher Mortgage Defaults -> More Government and Fed Intervention to Prevent Defaults -> Higher Dissatisfaction with These Efforts -> Higher Republican Chances

… -> More Need To Borrow -> Higher Concern with the Stability of the System -> Higher Gold Prices -> Higher Stock Market to Maintain Some Parity with Gold

This can go on for a while, but I think the point is clear.

It would be alarming that the public apparently trades so poorly, but I've never actually met anyone who was a member of the public, so likely the losses are not significant, and whatever they are, surely they are compensated by all the winnings at poker, for I have not heard of a single soul who loses at that game.

## Mr. KrisRock writes:

Has anyone seen "my old friend" Gold…he was supposed to top out like the way "gut feel" counting Russian said it would…unfortunately, Ben Bernanke's actions have made the Russian feel like he's not welcome at the FED…happiness in when you don't fight the FED but unlike the public who are buying GOLD hand over fist, the PROS always know right.

Conversely, perhaps it's us "professionals" who are the ones who trade poorly, like I did a week ago last Friday going long the entire grain complex, only to get blasted on Monday and Tuesday. Or, like some of us who play poker, people like me who play six games at a whack on six screens on Pokerstars, losing at 5 of the games. Those losses, plus the vig, the mistakes, and the admitted waste of time and talent are the real crime.

# DC: Worst of All, from Victor Niederhoffer

September 20, 2010 | 2 Comments

Worst of all was a trip to the Jefferson Memorial which is riddled with apologies for the ideas behind the Declaration, appeals to the adolescent nature of Jeffersons' longing for the Arcadian days when the Saxons lived harmoniously in the forests with representative government, and the naivete of his ideas that out of of their own bounteousness and munificence, the original Americans came here without any assistance from the English and thus no revolution was required to reclaim what was rightfully theirs and ours from the beginnings.

In a Zacharian your own man thing, Ellis, the chief contemporary biographer of Jefferson, and the only such book for sale in their book shop,  joins the Jefferson as racist, slave master, father of the black Illinois Jeffersons from the Hemmings union camp, a view memorialized in all the written material around the exhibit that would make Jefferson small.

And indeed all of Washington today it would seem is designed to show the need for redistribution and the great unworthy gulf between the rich and the poor, and that is why the Great Mall outside the White House is unfit for civilized occupation as it is completely taken over with bums and the homeless —the idea being to show you the great gulf, ( especially when the homeless are not using their cell phones and blue-tooths as they were on my visit).

Another approach to Jefferson is that he is an "enigma", as in the liner notes to Ken Burns' documentary:

"Revered as the author of the Declaration of Independence, the most sacred document in American history, yet condemned as a lifelong owner of slaves, Thomas Jefferson remains the enigma that is America."

He wasn't much of an enigma. He wrote and advocated eloquently and at length for the cause of limited government, but that needs to be whitewashed.

I was walking the streets of Charlottesville some years ago with my children and came across Nock's Jefferson in hardback. Paying only a buck for it and it being in great condition I felt like I had a precious gift in my possession. It proved that and more.

There are to many things to list about Jefferson that I've learned through studying the Enlightenment, hours of History credits, and reading Notes and a couple of biographies, but here are a few:

1) He technically didn't own his slaves. They were purchased through levering mortgages or notes. He couldn't free his slaves if he wanted to.

2) It is amazing how such a public figure made himself such an "anonymous man" in all aspects of his life that he could.

3) Upon the death of his wife he burned all of their shared writings.

4) When addressing his daughters on choice of dresses to wear he said "Wear what all the other girls are wearing, if you want to be different then do so with your thoughts and mind". I'd like to find the source for this paraphrased quote if anyone knows, it's just stuck with me over these years.

# Fishing for Input from Jovanovich, from Charles Pennigton

September 4, 2010 | 2 Comments

I saw this written about Churchill:

When Churchill entered the inner Cabinet as First Lord in 1911, Britain was first nation on earth and ruler of the greatest empire since Rome. When he left in 1945, Britain was an island dependency of the United States:

"..he schemed constantly behind closed doors agitating for war at every opportunity.

"He was also a first rank opportunist. Supported nationalizing industries when he thought he might be able to run them. switched to Hayek when out-socialized on the left.

"Switched political parties numerous times.

"Lots of bravado about being tough when losing his empire and sending boys to their deaths, if that is an admirable trait.

"There wouldn't have been Nazi's in the first place if not for his (and others) role in Versailles. He lived for war. wanted war at every turn, and it cost Britain her empire."

Can Mr. Jovanovich give his opinion?

## Stefan Jovanovich obliges:

Churchill's disastrous military mistakes as CIC– Gallipoli, Narvik, even Singapore– all had the same source: he was determined to avoid any repetitions of the "meat-grinder" of the Somme. Churchill's fascination with "wonder weapons" and "special executive" missions came from his hope that these alternatives to conventional warfare could offer an escape from the unavoidable truth about wars fought between opponents who will not cut and run.

The European continent has had a history of warfare that is unmatched by any place else on the globe. That is– in the end– probably the best explanation for how some soggy islands, river deltas, and dry mesas produced world empires; the inhabitants were constantly tinkering to build better weaponry.

To take that tradition of strife and then say, "Oh, an unfair (sic) peace treaty and a bad choice for gold-sterling exchange rates is the explanation for Hitler, Stalin and Mussolini" seems to me more than a bit of a stretch. If you are going to blame peace treaties for the continuation of the Western Way of War, you have to look to the treaties of the 1870s.

Treaty of Frankfurt

Treaty of Berlin

# A Modest Proposal: CPI Futures‏, by Charles Pennington

August 3, 2010 | 1 Comment

This is a shout-out to all the futures exchanges: How about a contract on the Consumer Price Index? There is a wide dispersion of opinion on what CPI will be in the months and years to come. There are plenty of pundits predicting deflation and roughly an equal number predicting Zimbabwe-style hyperinflation. Many people feel a need to hedge against inflation. They would be natural buyers, and they'd probably lose money most of the time in the hopes of making a killing someday. As opposed to S&P futures, where just about all the trading is in the front month, for CPI futures the volume would likely be distributed over several years forward. There are already successful contracts on Fed Funds that have that feature (not to mention natural gas and some other commodities).

CPI is announced once a month, at 8:30AM. Futures contract settlement dates could be set on those announcement dates. A reasonable contract size would be \$10000 for full CPI percentage point. Maybe the January 2013 contract would be trading at 4.5% now. If someone went long and then the January 2013 CPI measurement turned out to be 5.5%, then he'd make \$10000 per contract. That's pretty simple. How about it? Maybe one of the more nimble exchanges, such as the CBOE Futures ( http://cfe.cboe.com/ ), will pick up on this.

## Rocky Humbert responds:

As I've written previously, the current 10-Year TIP may not be a good measure of inflation over a short time horizon — because it's structured to capture the CPI over a ten-year holding period and is path dependent. Using a *constant* maturity 10-year TIP may exaggerate this effect. If you use a 2-year or 5-year TIP, you may find that it produces more accurate inflation forecasts for short-term horizons.

There's tons of academic literature on predicting CPI — if you Google-Scholar the subject, you can spend weeks reading the papers and building your models. Monthly changes in CPI have been nominally small over the past decade (although big in percentage terms), and it should be fairly easy to predict the CPI out a month or two — but becomes incrementally more difficult for each subsequent month. I've dubious of the investment value of knowing next month's CPI — but I would love to predict with confidence whether the CPI is going to be either consistently negative or consistently over 3.5% next year this time. That could be extremely useful — whereas a CPI between those two bounds shouldn't matter much.

As of this writing, the 5-year tips "breakeven" CPI is 1.38% and the 10-year tips "breakeven" CPI is 1.77%.

# Tennis Notes, from Charles Pennington

July 20, 2010 | 3 Comments

Here are a few tennis notes to myself, following up on a match that I lost 6-0, 6-0 on Friday. Hope springs eternal.

–Whatever the virtues and drawbacks of the backhand slice, I need to have one when I'm in a defensive situation. However, my slices too often end up being either high floaters or direct dispatches to the bottom of the net. In retrospect, I think I need to close up that racquet face. Federer's slice (video on subscription site www.tennisplayer.net) uses just an ever-so-slightly open face. Tonight I was practicing with a nerf tennis ball in the basement, and that does seem to improve things.

–I have ongoing indecision about whether to try to hit forehands with the Western/semi-Western grip or with a Continental, McEnroe style. The Continental grip seems so relaxed and smooth, with my body motion so in tune with the swing. (See McEnroe vid) My stroke with a western grip too often feels like a flail, and I sometimes frame it. I can't even get a good mental image of what the western forehand "should" feel like. The Continental shot, however, is difficult if the ball is high, and furthermore my coach tells me that it doesn't have as much on it. The Eastern grip is sort of in-between these two alternatives, so it should be a reasonable compromise, but for whatever reason, I tend to hit the ball way too high, and out, with it.

–Sweat! Despite using a sweatband, towels, and brand-name overgrip, my palms was profusely sweaty, which did nothing for my confidence. After the match I bought all the anti-sweat paraphernalia that I could find– the Prince Grip Plus Enhancer, a Gamma Tacky Towel, and a rosin bag. I don't yet have any data on whether these will help.

–The Serve. The serve was problematic. Oh heck, it was awful. The serve is the hardest shot of all. The crazy thing is that the ball is above your head, but you need to hit it with topspin. Often the textbooks say things that can't possibly be correct, such as "Hit the ball at the highest point of your racquet's arc." At the highest point in its arc, the racquet's vertical component of velocity is zero by definition, and so you'd never impart any topspin to the ball if you did that literally. Several times during my tennis life I got to the point of having a good or even very good serve, but if and when I ever stopped playing for even a few weeks I always lost it and had to totally, painfully rediscover it.

Two interesting points…it seems grip is foundational to everything. What's the starting grip in the market? Could we call it approach (ie, quant, fundamental, ta etc)

Second point: in the link for Winning Ugly, Google Books also recommends Michel Foucault– an interesting suggestion, though not as oblique as it first seems. I presume this association comes from the foundational premise that if one wishes to improve their game, one must first prove the ball actually exists.

The more frightening recommendation was "Marxism and Psychoanalysis". Either the algorithms need some serious tweaking or the programmers have a sense of humour.

I believe your "market grip" is your capital relative to your ability to defend it; hence, the ghetto slang word "grip," what you're holding of value which Dr. Dre, for one, intends to take by "jacking little homies for they grip." But that's just one man's interpretation, obviously.

# A Thought About Falkenstein’s Ideas, from Charles Pennington

July 16, 2010 | 2 Comments

Eric Falkenstein is the author of an excellent book, Finding Alpha, and of a website.

One of his big insights is that in the real world the relation "return ~ risk" is often not obeyed. He cites many examples, but a representative example is that risky stocks (whether high beta, high volatility, high idiosyncratic volatility, or whatever) have not historically outperformed less risky stocks. I'm thinking that one possible explanation for this is that when you own risky stocks, you sort of get an implied put option "for free". The market makes you pay for that put option by giving you a lower return on the riskier stocks. Here's an example to make it clear:

Suppose investor A buys the whole market, with beta=1, and gets an average return of 10% with a standard deviation 25%. Investor B instead puts just 20% of his money into a diversified portfolio of high beta stocks, with an average beta of 5. He puts the rest of his money into a "risk-free" investment, and for simplicity, I will assume that the risk-free rate is 0%. What return should investor B expect on his stocks? Well, the conventional academic view is that his stocks should have an average return of 5 times that of the market, or 50%, with a standard deviation of 125%. Since B has only 20% of his money invested, his expected average portfolio return would then be 10%, with standard deviation 25%, the same as A.

The problem though is that B has a safer portfolio than A. B has a "floor" on his losses–he can lose at most 20% of his capital. He effectively has a put option that's 20% out of the money. How much is that worth? Well, to get a ballpark understanding, a put option on SPY, expiring 1 year out, 20% out of the money, is currently going for about 6% of the SPY share price. So in a fair world, maybe B's expected portfolio return shouldn't be 10%, but rather 4%, to reflect the idea that the market makes him cough up 6% to pay for the virtual put option that he owns.

If that's all true, then beta=5 stocks should have expected average returns of 20%, not 50%, and a standard deviation of 125%.

This is only a semi-quantitative explanation, but the point is that when you own higher beta stocks, you're implicitly getting an implied put protection relative to lower beta stocks. If the market is efficient and makes you pay for that put, then the returns of the high beta stocks would be reduced as compared to what you'd otherwise expect.

Disclaimer: For all I know, probably some academic has already thought through all this and demonstrated that it's incorrect and/or insignificant, and if that's so, then maybe someone can set me on the right path.

## Stefan Jovanovich shares:

An earlier contribution from Eric Falkenstein– David Hakes' story about the risks of publication regarding the subject of risk:

When we submitted the paper to risk, uncertainty, and insurance journals, the referees responded that the results were self-evident. After some degree of frustration, my coauthor suggested that the problem with the paper might be that we had made the argument too easy to follow, and thus referees and editors were not sufficiently impressed. He said that he could make the paper more impressive by generalizing the model. While making the same point as the original paper, the new paper would be more mathematically elegant, and it would become absolutely impenetrable to most readers. The resulting paper had fifteen equations, two propositions and proofs, dozens of additional mathematical expressions, and a mathematical appendix containing nineteen equations and even more mathematical expressions. I personally could no longer understand the paper and I could not possibly present the paper alone. The paper was published in the first journal to which we submitted.

## Lars van Dort writes:

I'm not sure I have much to contribute to the main question your post raises (why is the relation risk-return often not obeyed?), but I must say I was intrigued by your example. I felt it must be flawed, but it took me quite a while to see why.

Let's consider the investment in stocks of the portfolio of B, which has an average return of 50% and a standard deviation of 125%. The following could be one of the possible return distributions, from which these numbers are derived:

-100.0%
-50.0%
-38.5%
-25.0%
0.0%
50.0%
150.0%
213.5%
250.0%

Average return = 50%
Standard deviation = (pretty close to..) 125%

We see that the worst possible result is -100%, more would not be possible for stocks anyway. Because B has invested 20% of his total portfolio in stocks and 80% risk-free against a 0% return, his worst possible total return is -20%.

We now have to decide what return distribution to assume for the portfolio of A (average return 10%, standard deviation 25%). There are two options.

Option 1:

We take the possible returns from above and divide them by 5:

-20.0%
-10.0%
-7.7%
-5.0%
0.0%
10.0%
30.0%
42.7%
50.0%

Average return = 10%
Standard deviation = (pretty close to..) 25%

Or any other distribution with a worst possible return not lower than
-20%. In this case, the portfolios of A and B can both not lose more than 20%!

Option 2:

We do allow for a worst possible return for A of lower than -20%. However, in the equivalent distribution for B this would lead to a worst possible return for B's stocks of lower than -100% (because x5). This is not possible for stocks, but even if we imagine other assets that can take a negative value, this would have the consequence that B's total portfolio loss is no longer capped at -20%.

But what if we take a distribution for A with a worst possible return of lower than -20% AND a distribution for B's stock returns with a low of -100%. In this case (and here comes the point), for all the values to still add up to the mentioned average return and standard deviation, one or more of the other possible returns in the distribution of A would have to be higher, compared (x5) to B.

So, when one wants to argue that in this situation B's portfolio includes a put option because his losses are limited, along the same lines one would have to argue that A's portfolio includes a call option, because his possible returns are also relatively higher. Although I'm not sure how to prove this, it seems logical to assume these options need to have the same value.

The numbers of the example can be changed, but I believe a reply as above can always be given.

## Tyler McClellan writes:

My quick thought is that this is not a good way to think of it.

The idea is to look at the marginal preferences of people with the same portfolio set.

In your example the relevance is not between the two portfolios you list but between what stocks the person with 80 percent in cash should chose for the remaining 20.

But I also suspect you are on to the correct way of getting insight about this, which is to show that the distribution of portfolio preferces is very correlated to specific holding within a category (for example maybe the person that owns risky stocks is highly likely never to own other stocks), such that a dynamic similar to what you describe does in fact happen. (best I can describe it is that the category of people to drive this relationship away by buying the now theoretically mispriced stocks is not big enough to overwhelm the people that continue to want volatile stocks and cash, or some other asset such as you suggest).

## Rocky Humbert shares:

There are many ways to look at this; however using a high beta subset of the index has elements of a self-referential paradox and must be avoided.

One thing to recognize is that REAL and NOMINAL interest rates greatly influence the result. In an environment of very high real and nominal rates, and low stock market volatility, one can buy a five year zero coupon bond and use the discount to buy calls on the s+p with no principal risk. At the extreme, one could achieve full index replication with no principal risk, and I'd argue that this would be the perfect baseline for analyzing the issue.

## We are honored to receive a message from Eric Falkenstein:

I appreciate Charles mentioning my name!

I think you can create such arbitrage only because the standard CAPM assumes lognormal returns, and for lognormal returns, only the first two moments (mean and standard dev) matter. So, parceling out put options is like saying there are different relations between how stdevs relate to max drawdown due to 'non-gaussian' transformations via leverage, distinctions that by definition are irrelevant within the framework of the canonical CAPM and its derivatives.

Many people, including Markowitz at the inception of the CAPM, have pointed out that returns may have important higher moments–skew, kurtosis, see here on my web site for references. Indeed, Fama did a lot of work on this in the 1960's (see my blog ),and his take-away was that these adjustments merely make second-order, intuitive changes to the base model–complications without much real add. However, downside skewness may be going thru a revival, as Cam[pbell] Harvey (editor of the JoF and mainstream finance archetype) actually  mentioned  in comment section of my blog that skewness preferences could explain a lot of these negative volatility-return empirical findings.

As they say in China "Speak of Cao Cao and Cao Cao arrives."

# Double Faulting, from Pitt T. Maner III

July 2, 2010 | 1 Comment

Double faulting is one of the most discouraging aspects of tennis. Watching Djokovic double fault the 2nd set away (and to end up losing the match) this morning during a tiebreaker against Berdych in the Wimbledon semifinal match shows that even the number 3 player in the world can feel pressure, fear and nerves on a critical point. Giving away points to an opponent after working hard is extremely aggravating and mentally difficult to overcome.

The tennis serve is very dependent on a good, consistent ball toss–it is so easy to get the wrist involved and throw the toss in all directions and to lower the head (anticipating the return of the serve) during the serve and serve into the net. It's almost better to serve long and try to add more spin than it is to dump a serve into the net. It is also important to think positive thoughts and not tighten up–that little voice in the head can easily lead you to a double fault.

Regular cues and ball bouncing rituals can be helpful.

It's shame though to lose a match due to choking or self-defeating behavior, and you don't see it that much amongst the top pros, but when it happens it is a hard thing to get out of the head. And more particularly when your nickname is "Joker" the press has an easy rhyming headline to use to remind you of your past failures.

RE: it is also important to think positive thoughts and not tighten up.

This is SO absolutely true, and SO difficult to really define–that being loose, yet in a controlled pace without any real slack on the line. This is vital to performance in anything, be it tennis, fighting…or even thinking through problems. The Old Frenchman would say, "C'est toujours la meme chose," (It's always the same thing).

Think of anytime you've ever choked at anything– the aforementioned mental and physcial state was absent. Think of ANY fight you've ever been in. They always, ALWAYS tighten up, succumbing to fear and adrenaline.

I think pro athletes really understand this, and not just in the individual sports like tennis or golf, but even when these guys are shooting foul shots in basketball. Learning that mental groove is worth more than all the years one can spend in school I think. It's the kind of thing that one learns only by doing it, learned only through the prompting of pain and discomfort until it is found.

Learning things any other way is not really learning.

The serve has got to be the most non-intuitive and difficult-to-learn shot in tennis. Whenever I look at slow motion video showing the trajectory of the racquet, I am amazed that it's possible for a human to do it.

Here's a video of McEnroe serving, showing the fundamental steps–the weight shift, the toss, the swing of the racquet, and the line call argumentation.

## Nigel Davies writes:

I wonder if the frequency of this kind of mistake may increase in proportion to a player's muscle mass. The 'nerves' might be a simple chemical equation.

# Is Checkers a Solved Game? from Charles Pennington

June 18, 2010 | 3 Comments

I was having a discussion with a colleague on the topic of Chess vs. Checkers. Somewhere I had the impression that Checkers had been "solved" –that it is ultimately an elaborate version of tic-tac-toe, i.e. there is a well-defined correct move to make in every situation. Chess though is different, as I understood it–there is no known correct way of playing in every situation, either because it can't be known in principle or because the computers just haven't found it yet. Can someone set me straight on this topic? (Background: I haven't played chess or checkers in over 30 years, but I am quite good at tic-tac-toe.

## Nigel Davies weighs in:

As I understand it there is no 'solution' as such to either game and that with checkers in particular it is quite easy to make it considerably harder by playing on a larger board and with more pieces (one can also play 'big chess', though this looks somewhat artificial to my eye). With regard to board games being 'computer proof' it's also worth checking out Shogi and (especially) Go where computers are still rather mediocre compared to the best humans.

From the point of view of educating children all of these games are wonderful in that they can teach the young to falsify their own ideas. In order to play 'well' one must find out what's wrong with a move before playing it on the board.

One major consideration in the choice of game might be the number of opponents to be found. In the West at least I believe this is where chess shows to advantage.

Hope this helps.

## Pitt T. Maner III writes:

Dr. Schaeffer wrote an appreciation of one of the best checker players ever, Marion Tinsley, who actually liked the challenge of facing a computer (nicknamed Chinook).

After Chinook's first game against Tinsley in 1990, we started analyzing the game. Tinsley began recounting the history of the line we played, recalling games he played in the 1940's! The move sequences flowed easily from him without hesitation, sometimes annotated with the name of the opponent, date or place where the game was played! 1947 was as vivid in his memory as if it were only yesterday. The second facet to his play was his incredible sixth sense. A glance at a position was sufficient to tell Tinsley everything he needed to know. For example, in 1990 Chinook was playing Tinsley the 10th game of a 14 game match (won by Tinsley 1-0 with 13 draws). I reached out to play Chinook's 10th move. I no sooner released the piece when Tinsley looked up in surprise and said "You're going to regret that". Being inexperienced in the ways of the great Tinsley, I sat there silently thinking "What do you know? My program is searching 20 moves deep and says it has an advantage". Several moves later, Chinook's assessment dropped to equality. A few moves later, it said Tinsley was better. Later Chinook said it was in trouble. Finally, things became so bad we resigned. In his notes to the game, Tinsley revealed that he had seen to the end of the game and knew he was going to win on move 11, one move after our mistake. Chinook needed to look ahead 60 moves to know that its 10th move was a loser. In my experience with tournament chess and checker players, the sixth sense is experience. It is well-known how intensely Tinsley studied the game, analyzing anything from a Grandmaster game to a game between novices. His uncanny ability to know good from bad and safe from dangerous, is the direct result of all his hard work. Strong chess players have the same ability, but perhaps it is not quite as evident as it was with Tinsley .

## Nigel Davies writes:

Seems like we get a whisker away from quite deep philosophical questions. My personal belief is that the goal of 'replacing humanity' in the cause of 'efficiency' is a deeply flawed one. It always feels to me like the attempt to show that computers can 'play' these games much better makes our attempts at self-improvement appear futile, an idea which many people will buy into. Is it too fanciful to suggest that they represent a 'greater goal' of being looked after by machines whilst humans have mindless 'fun'? Nigel Davies

## David Hillman writes:

This is not unlike giving up the warm, tactile sensation of the paper page in a book for the slick plastic of a Kindle, or the daily newspaper's beautiful scent of cheap pulp and ink replaced by the netbook's display. The aromas of silicone and polymers do not mix as kindly with the scent of espresso wafting on the morning air. My own livelihood is derived from computer-based industrial productivity and efficiency systems, but my life is kept on a yellow legal pad with a #2 pencil. Balance, always balance. To paraphrase Queen, "we need it all and we need it now." The Deep Blue's, Chinook's, etc. may be wondrous, but there is simply no mineral nor petrochemical-based substitute for the hug of a happy child, for the lap of a caring spouse upon which to lay one's head at the end of a bad day, or for the twinkle in a grand-master's eye across the chessboard when he mates you in 6 moves.

## Nigel Davies responds:

I don't think it's the same thing David. An analogy with having a kindle versus a book would be to play chess against a human via your PC. Having computers do the playing and trying to demonstrate their 'superiority' is more like having them write the books, and purportedly do it more efficiently than humans; fewer words for the same meaning perhaps, 'War and Peace' reduced to 10 pages.

## Chris Tucker agrees:

I agree with you completely Alan, my point is just that programmers are not out to replace us completely (yet, anyway), but they are out to codify decision making. Games are a good place to do this because the rules and possible moves are very limited, even though the number of possible outcomes can be astronomical. The arena is structured and they can test and validate their ideas within this framework. The idea of game playing is much deeper, philosophically, (as Nigel suggests) than most care to admit. I will leave that bit for you two to explore. Machines that can replace the humanity of squaring off with an opponent do not exist, there are simply too many levels of interaction there.

## Nigel Davies replies:

Chris, there is no decision making in the programs or any attempt to replicate human thinking, they simply use brute force to analyze all the possibilities (with chess slapping in a primitive evaluation function) and the mathematical limitations of the games enable them to get away with it and 'win'. Perhaps when they started out the intention was to create 'artificial intelligence', but I don't see that this claim can be maintained given the route they have taken. Looks like an ego driven attempt to 'beat mankind' of the type which enables a car to go quicker than someone on two legs.

## Dave Bacon addresses the original question:

I believe Checkers on a standard sized board has indeed been solved. The reference is Science, Sept. 2007, Vol. 317. no. 5844, pp. 1518 - 1522.

“Checkers Is Solved” Jonathan Schaeffer, Neil Burch, Yngvi Björnsson, Akihiro Kishimoto, Martin Müller, Robert Lake, Paul Lu, Steve Sutphen

The game of checkers has roughly 500 billion billion possible positions (5 x 10^20). The task of solving the game, determining the final result in a game with no mistakes made by either player, is daunting. Since 1989, almost continuously, dozens of computers have been working on solving checkers, applying state-of-the-art artificial intelligence techniques to the proving process. This paper announces that checkers is now solved: Perfect play by both sides leads to a draw. This is the most challenging popular game to be solved to date, roughly one million times as complex as Connect Four. Artificial intelligence technology has been used to generate strong heuristic-based game-playing programs, such as Deep Blue for chess. Solving a game takes this to the next level by replacing the heuristics with perfection.

# From the Dept of Child Rearing, from Charles Pennington

June 11, 2010 | 4 Comments

The following is not a rhetorical question; I genuinely don't know the answer. The 12 hours of school, music lessons…sports programs–is that really what's going to be best for these kids?

There seem to be fewer and fewer pre-scripted routes to success these days. Alan Corwin wrote about highly skilled database programmers who found themselves obsolete. Medicine has gone from being very cushy to modestly cushy. (A few pathways that might still exist: 1] do well academically/go to law school/ become partner at law firm, 2] get a government job, or 3] be nice to your very wealthy parents) Increasingly you have to invent yourself.

So what happens to regimented and highly educated kids when they grow up? They can hit a passable forehand, play some of Beethoven's piano sonatas, and do integrals (on Matlab), but they grow up and find that what they really need out there is something that's unique, which they don't have. Most of the successful people that I know personally had unstructured lives as children, and they had to figure out for themselves what to do with all that time. Most unsuccessful people though had the same situation! That's why my question is a real one, not a rhetorical one, one in fact that I'm facing with my own children.

## Scott Brooks writes:

Having an unstructured life as a child equating into success as an adult depends on your upbringing, parental guidance, and environment. I saw a lot of my friends growing up living unstructured lives because of single family households (mother couldn't do much more than work to support family), alcoholism of one or more parent, or other factors.

I think a lot of these kids would be much better off if they were in a structured environment that allowed them freedoms most of their day (12 hours or more), at least 6 days a week.

The problem is that the kids who need this environment are stuck in some kind of a governmental system whereby the teachers unions control the environment. I believe that is what has lead us to being a country of non-thinking sheeple and is destroying our children today.

## Jeff Rollert writes:

Improv is the best training I've had, and I use the trapped time in the car to make the kids do it. Doesn't matter if it is story telling, music, jokes, etc.The only consistent skill I've seen in life that doesn't get obsolete is on-the-fly storytelling.

This is an important question and one that has great significance for the future. Recently I've come across more and more articles regarding this cohort and their predicaments.

The recent spike in student loan defaults has highlighted the fact that many of our "highly educated kids" have gone deeply into debt. Unfortunately, many have been highly educated in specialties that offer little opportunity to secure a wage sufficient to pay off the debt and live in a manner to which they've become accustomed.

In many of these households, the parental unit(s) have also taken on substantial debt to provide the education; unfortunately, their 401Ks and pension plans have been whacked by the market, and chances that junior will be offered a comfortable, all-meals-provided, rent-free existence dwindle daily.

I recently re-read "The Grapes of Wrath" for a discussion group. There was some conversation on whether current events could lead to a re-run of those days; it was suggested that our many undocumented immigrants would supplant the equally powerless and under-educated Okies. I suggested, however, that while both groups presented problems for their times, our well educated but un- or under-employed youth could present a significantly greater one.

During my lifetime it's been rare that major anti-establishment protests have been led and peopled by the under-classes…the poor rarely had enough time or resources to be regular participants or prisoners. Those movements were conducted by an educated but unhappy coterie that was rarely underfed or unqualified for well paying positions. Tomorrow's protest leaders could well be both.

Another disturbing element in this education scam is the adult re- education programs being offered and underwritten by the Feds and the States. There's heavy emphasis on computer skills, auto repair, finance, education, business admin, accounting, and nursing - fields in which there already exist many unemployed but experienced professionals, and others which have little future.

I can appreciate Dr. Pennington's concern. Of my three sons, only one appears to be moderately secure. All are now in their forties, so options are limited and not very promising. For my grand-daughter and grand-son (I have one of those now), I have major concerns as I feel they, too, are being offered yesterday's curricula for yesterday's jobs. Will they be tomorrow's Joads?

## Stefan Jovanovich writes:

We already have Steinbeck's world here in California; but the traffic is heading east away from the state. The only people driving to our state are the people behind the wheels of the empty rental vans. (I urge List members to check out the differential rental rates to and from California.) People here are literally packing up and heading out because there is no work; and they know there will not be any.

Not to argue with John but the "anti-establishment protests" in American history have never been led and peopled by the underclasses. The Homestead strike was by the best-paid steel workers who were protesting the hiring of cheaper immigrants who spoke languages other than English. The Reuthers, the founders of the UAW, were skilled machinists; so were the auto workers who staged the sit-down strikes in the 1930s. The poorest workers - the blacks, the hillbillies - had already been laid off. The Wobblies my grandfather knew were skilled miners who had learned their crafts in the European mines before coming to America; the "scabs" (sic) were the Mexicans and poor white Southerners. Now, riots - like the Rodney King uproar - are another thing; then, the underclass comes out to smash windows.

# Golf Questions Answered by a Physicist, from Charles Pennington

April 21, 2010 | 3 Comments

I was recently asked by a golfer:

Here's a basic physics question for you. One golfer's clubhead speed is 100mph at impact with the ball and 105mph immediately after. He has an accelerating swing. Another golfer has 100mph clubheadspeed at impact but only 95mph immediately after. He has a decelerating swing. Assuming everything else is constant (type of ball, wind speed, etc), does one drive go farther than the other?

The question is a surprisingly hard one, and I've thought about this kind of question in tennis as well. Here are two extreme scenarios that are easy to understand:

1) If the club (racquet) is much, much, much heavier than the ball (hitting a golf ball with a sledgehammer), then the speed of the club is all that matters.

2) On the other hand, if the club (racquet) is much, much lighter than the ball (hitting a bowling ball with a badminton racquet ), then the speed prior to collision hardly matters, and all that matters is how much you shove through during the actual collision.

In any sports/ bat/ ball/racquet situation, you're always somewhere in between the two extreme scenarios described above because that's the best way to design the bat/racquet/club. (It is analogous to having your car in the right gear for the speed that you're driving.) So there's not any simple answer except that it's somewhere "in between". It's neither 1st gear nor overdrive, but something in between. You need high speed, but also a somewhat "firm foundation". (A quibble — it will be absolutely impossible for the swing to be moving faster immediately after compared to immediately before. [I'm modeling the club-ball collision as essentially instantaneous.] Would require you to apply an infinite torque or force or whatever applied by the golfer to the club.)

This seems an obvious application of the basic principle taught to someone learning how to hit a baseball: follow-through on your swing for a better hit. It must be the case that an accelerating swing in baseball, golf, tennis or anything else will impart more force (for a longer movement of the ball), because the moment of contact is longer than instantaneous.

## Sushil Kedia writes:

You have to make an assumption that the movement of the club is following a harmonic motion as in a pendulum. Highest Kinetic Energy at the point of equilibrium and zero at the extremes. Acceleration will have to be negative from equilibrium onwards.

Case 1:

Velocity of the club after impact > velocity of the club before impact: This will be possible only when the point of impact is reached before the point of equilibrium.

Assume mass of the ball is B and the acceleration it achieves on impact is A1. Then the amount of force transferred in this case is B*(A1)^2. Since there is an equal and opposite force it exerts on the club. The net acceleration of the club at the point of impact will be calculated by adjusting the existing harmonic form of the kinetic energy equation MINUS B*(A1)^2.

If this value is 105 mph it only tells us that without knowing the length of the club AND NOT just the effective weight (Center of gravity adjusted leveraged weight for the length of the club) it would be impossible to know at which angle the impact happened.

So either it is not possible for this to happen of there is inadequate data for comparison since you mention everything else is constant.

Case 2:

Velocity of the club after impact < velocity of the club before impact: Without knowing the acceleration of the ball at the point of impact (which can be estimated by estimating the values of friction, time before which the ball stops and the distance traveled) it is not possible to calculate the net force transferred by the club into the ball at the point of impact. EVEN if one assumed that the impact happened after the equilibrium point was reached on the trajectory of the club swing. It is worth mentioning here that the swing of the club would HAVE TO HAVE A NEGATIVE acceleration beyond the point of equilibrium else it is not the point of equilibrium.

So, in both cases 1 and 2 the assumption of everything else is constant is a situation of inadequate data. If however the question is implying that the club hit both the balls at the same angle, then the question is a trick and does not have a solution.

## Stefan Jovanovich writes:

Here is a link to a fascinating site called batspeed.com — the most comprehensive study of the baseball swing on the web.

There's no way to solve this problem theoretically–only experimentally–but there is a good theoretical framework to think about it. You model it as a totally elastic head-on collision between a mass M moving with speed V and a mass m (the golf ball) moving with initial speed 0.

In that case, the final speed of the ball is:

v = V*(2M)/(M+m)

and the final speed Vf of the "club" (*) is

Vf = V*(M-m)/(M+m)

(Note that this is always less than V, and could even be negative, e.g. if a golf club hits a bowling ball.)

The problem is, what do we use for M? Do we use the mass of the club? The mass of the golfer who's connected to the club? The mass of the earth, which provides some friction so that the golfer doesn't slide backwards?

There are some simplifying cases:

If M>>m (sledgehammer hits golf ball), you'll see that the equation reduces to v=2V, i.e. the ball will fly off with twice the initial speed of the club.

If M<<m (feather hits golf ball), then the equation reduces to v~(2M/m)V.

The only way to find out the value of M is to do an experiment: get a real golfer, measure his (pre-collision) swing speed and the speed of the ball, and then use these equations to find the golfer's "effective M". A golfer who braces himself more and has a solid stance might have a bigger effective M than a golfer who uses a more floppy, wristy swing–but he also might have a lower V, so his shot might end up with less speed.

# Delicious BBQ in Yankee Territory, from Jeff Watson

I do reckon I found a gem of a BBQ place and had to go all the way to Fairfield, CT to find it. A good friend, and fellow spec, took me there to prove the Northeast has BBQ that will stand on its own — and he was right. He was quite apprehensive in trying to score a good fix of BBQ, as I'm known for being very tough to please and rather discerning.

Jeff Watson, surfer, speculator, poker player and art connoisseur, blogs as MasterOfTheUniverse.

## Charles Pennington weighs in:

I heartily agreed with MOTU about Popeye's, but I dissent on Wilson's. I've been there a couple of times, most recently with my wife. We got indifferent service, prices about three times that of a good Southern place, and mediocre food. Also they won't even give you a fountain coke with ice — they'll only let you buy a 12 ounce can if you're nice. It's also small and has not very good seating. There is a place called Bobby Q's in Westport that is pretty good, and there are plenty of places in Manhattan that are fantastic, though expensive. Bottom line though is that whenever I head down South I'm bowled over by the quality, low prices, and plentitude of the 'cue. Most recently I enjoyed Shane's in Atlanta. It's a chain, but it's great.

# MOTU and Popeyes, from Charles Pennington

February 27, 2010 | 2 Comments

It has come to my attention that MOTU has a strong buy on Popeye's fried chicken:

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

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

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

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

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

## Alston Mabry writes:

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

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

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

Rating a few Manhattan Popeye's:

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

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

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

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

# Andy Murray, from Charles Pennington

February 1, 2010 | 12 Comments

It's frustrating that Andy Murray is one of the top few tennis players in the world right now. There is not much about his strokes or his strategy that's distinctive or interesting. His only distinction is his on-court personality — he scowls and sometimes swears after every error that he makes, as though his expectation is not to make any errors throughout the match. Federer, by contrast, treats his errors as an expected part of the game. His face shows no negative emotions; it looks like granite.

Everybody who gets to number one in tennis has some kind of distinctive flair. They never get there by doing everything like everybody else, just a little better. I hope Federer gets a more interesting opponent in the next three majors.

# Distribution of 52 Week Price Changes, from Phil McDonnell

January 6, 2010 | 1 Comment

Below is a graph of the distribution of 52 week price changes for stocks tracked by Google. To me the interesting part is the distinctly bi-modal shape. Some companies are doing well in the last 52 weeks and the mode of the right hand side is about 66%. But others are clearly struggling and the mode on the left hand side is -21% in an otherwise up year.

The valley in the middle is centered around unchanged.

.

## Charles Pennington responds:

I'd think the left-hand peak is just an artifact of the fact that Google used the wrong horizontal axis — they should have used ln(Pf/Pi) (where Pf=final price; Pi=initial price), rather than percent return — which they would have known if they had read "Optimal Portfolio Modeling" by Dr. Philip J. McDonnell.

# A Terrible Splendor, from Victor Niederhoffer

December 17, 2009 | 5 Comments

Picture the all-seeing eye looking down on the crucial third match of the 1937 Davis Cup with the two best players of the world, Don Budge and Baron Gottfried Von Cramm playing, with the greatest of all time, Bill Tilden, in the stands rooting for his beloved German student, along with Barbara Hutton the Woolworth heiress, deeply in love with Gottfried and showing it at every shot as her second husband gets more and more furious, as Europe prepares for war, Germany recovering from hyperinflation, homosexuals and Jews gradually being stripped of their property and lives, and fighting for their lives on and off the court. It's two all in sets, extra games, and Von Cramm has volleyed a sharp angle 10 feet wide to Budge's weak forehand on the Wimbledon grass with the Queen's interlocutor in the royal box trying to restrain his enthusiasm for the German royal's victory, and stock market volume is way down because they're all following the match on the radio with Al Laney from The Tribune broadcasting.

"Take a rest," Tilden had told his very good friend. "I can't," Von Cramm answered. "I'm fighting for my life." As the players walked to the court, Von Cramm had been called back to take a call from the Führer. "We're counting on you to win… or else." Men of homosexuality, like Von Cramm, in those days were being sent to concentration camps and Cramm had been outed by the SS already. In addition his mother was half Jewish and Jews had been forbidden to practice any profession, including finance, as well as having their businesses and money confiscated. (However, they apparently were able to take out 7% of their money upon proper application). Thus Von Cramm really meant it that he was playing for his life.

That's the backdrop for this entertaining and well researched book by a man who loves tennis but doesn't play the game, and weaves the story of the match into the backdrop of the culture of tennis, arts, and economics during the 1930s. Along the way, we learn the true story of Von Cramm's gentlemanly behavior with the linesmen (he liked to thank them for their vigilance in calling his foot faults, and never corrected a linesman, and always called the ball down on himself). The sexual preferences and vices of all the Davis Cup players of the era. "Budge apparently was often three sheets to the wind, but Tilden never drank. "I'll have a Tilden" was the way the French ordered water in those days. The tragic story of all their deaths, the nitty gritty of the home economics of all the players (Tilden was always broke even though he was the highest paid athlete of his day — he insisted, like me, on picking up all checks), and many anecdotes about the tennis players of that era. Very entertaining and revealing. (Part 1).

Here is a video of the Don Budge backhand.

This particular backhand looks "flat" to me — not too much topspin.

I think that the reason that the topspin backhand was considered so difficult a few decades ago is that most everyone used a grip that was too "open". It was too much of a wrist-balancing act to keep avoid netting or skying the ball.

Last night I was watching a 1980 US Open Borg-McEnroe match on the Tennis Channel. McEnroe's backhand was very unsteady. Usually he hit weak slices. It is amazing that he could hit topspin at all, since he used the same grip for both backhand and forehand.

Tennis has evolved since that time and the modern day rackets allow you to play with a lot more topspin. However for a recreational player nowadays, it is maybe wise to flatten out the stroke since there is less effort in the shot and strain on the body. But in order to do that you need to have a feel for the ball. It is much more complicated to play with an open grip. Spin is what gives less of a margin for error and also creates bigger problems for the opponent. McEnroe had the best hands in tennis. When I watched him play last year out at the Long Island Tennis club it was amazing. He is able to control each ball and put it within six inches of the line 90% of the time.

# Medical Question, from Charles Pennington

I'm looking for some clarity about the issues of immunity, allergies, etc. Possibly this question will reach a reader with expertise.

In my college biology class, about 26 years ago, the professor explained that we've all got antibodies to "everything", but the antibodies only multiply themselves to large numbers when the body is attacked by an invader. At the time I asked the professor, "what's everything?", and the professor answered only "everything". I wanted to follow up and ask if "everything" included anti-neutrinos? Buicks? But there were >100 other students in the lecture, and anyway I don't think the professor really knew the answer. (Maybe the answer is "proteins"?)

What about foods? There has been much recent publicity about allergies to gluten, protein(s) found in wheat. Presumably gluten in included in "everything", and so everyone should have antibodies to it. Why then do some people react to gluten, multiplying the gluten antibodies up to big numbers, while others don't?

More broadly, since "everyone" has antibodies to "everything", why is that in only some people an allergen is treated as an invader?

## Mr. Justa Guy replies:

Your professor was indeed correct, we all do have antibodies against virtually everything, or at least everything proteinacious. That is because of (i) continual recombination, and (ii) ongoing mutation.

Antibodies are made up of two heavy chains, and two light chains. Each heavy chain and each light chain have a unique specificity for a particular target (aka antigen). There are three genes which contribute to the specificity of each heavy chain, or light chain, called the variable (v), diversity(d) and joining (j) regions. There are multiple (ie dozens) of different V regions, dozens of different D regions and a few different j regions. This number is constantly increasing because of somatic hypermutation. One heavy chain made up of a specific combination of V, D and J chains, and one light chain made up of a different combination of V and D chains are made by one particular B cell. Mathmatically this diversity allows for tens of thousands of different antibody specificities. The presence of somatic hypermutation where one amino acid (there are 26 amino acids) is mutated with each round of cell division allows for a virtually infinite total number of antibody combinations, which in principal will include antibodies specific for every possible antigen (except perhaps Buicks).

Lets take the case scenario of a B cell that makes an antibody against influenza. In the case of the flu, a naive B cell which is specific for flu, is activated when it encounters flu antigen (either vaccine or flu virus). This causes the B cell to proliferate and make different kinds of antibodies, starting with IgM and IgD, and then maturing into either IgA, IgG, or IgE which help with either defense at mucosal surfaces, in the blood, or in causing allergy. Ultimately the activated B cell makes daughter cells of memory B cells, or plasma cells whose job it is to produce large amounts of antibody.

That is a short version of how it works.

There are many excellent intro level immunology texts, one of my favorite is by Janeway. They can provide a much more detailed explanation.

## Jeff Sasmor writes:

Recently there has been much publicity about allergies to gluten, protein(s) found in wheat. Presumably gluten in included in "everything", and so everyone should have antibodies to it. Why then do some people react to gluten, multiplying the gluten antibodies up to big numbers, while others don't?

But Gluten Intolerance, also known as Celiac Disease isn't an allergy — it's an autoimmune disease; gluten sensitive enteropathy.

My older daughter has it… so I learned more about it than I ever wanted to know.

That is where it get more complex.

In order for B cells to maximally proliferate, they require "help" from another cell, the CD4 T cell. The CD4 T cell that helps a given B cell is specific to that same antigen. When CD4 T cells recognise antigens, it is done in concert with recognising another class of molecules called MHC class II, which is what defines self. So If a CD4 cell recognises an antigen but does not see MHCII, it is non self, and the CD4 cell helps coordinate the immune sytem to attack the non self antigen. If the CD4 cell recognises antigen, but also sees MHC II, then it is self and the CD4 cell is prevented from proliferating, and so it does not supply the necissary "help" to the B cell so that the B cell cannot proliferate to produce antibody.

Celiac Sprue is felt to be a food intolerance, where antibodies are produced that also react with self antigens expressed in the small bowel. In essence the antibodies are reacting against self, and so Sprue ( and many other diseases - eg lupus, rheumatoid arthritis etc) are circumstances where the process of tolerance ( breifly outlined above) to self antigens fails.

## Riz Din responds:

As Justa Guy says, it's all about finding one's optimum dose. Unfortunately this is very difficult to do with vitamin D, as official lines are quite wishy-washy.

In order to get to where you want you first have to know where you are, and having a vitamin D blood serum test has to be the best first step in this direction. After spending a long summer outdoors I had my blood taken and my level came in a rather pitiful 63 nmol/L. It isn't woefully inadequate, though it does fall in the 'insufficient' zone. I shudder to think what my winter reading would have been. My doctor simply recommended a multi-vitamin tablet of all things as a solution, which is not wise as many of the other vitamins can be toxic at much lower multiples of the RDA. I'll eventually get retested to make sure I'm not at an risk of toxicity from vitamin D supplementation (currently taking 1000IU a day), but I think this is close to impossible on the existing dose.

From (a rather wobbly) memory, I understand the benefits for many conditions (bone fracture risk, etc) really kick it at the slightly higher doses of 800IU upwards, and also that the negative effects are very rare and tend to occur at extremely high doses, except for people who display a particular sensitivity. For my mother, who is also taking supplements, vitamin d has bought significant improvements. For me however, I haven't experienced anything beyond stronger nail growth, but I guess that's the point.

My 'vitamin d' bookmarks folder is on another machine, so I've put together a few interesting links for people who want to dig a little deeper (see below).

- Dr Holick is a significant figure in the field of vitamin D research and he is also the most recent winner of the Linus Pauling Award. His UV Advantage website contains links to articles, videos, interviews, etc . I know the site looks a bit cheesy, but this guy is pretty well respected.

- On the issue of life extension, a recent study of lymphoma patients found that 'Patients with deficient vitamin D levels had a 1.5-fold greater risk of disease progression and a twofold greater risk of dying, compared to patients with optimal vitamin D levels after accounting for other patient factors associated with worse outcomes.' Pretty impressive stuff.

- The Institute of Medicine is reviewing the daily reference intake recommendation for vitamin D. Their work is ongoing but if you follow the link and click on 'presentations' in the 'other resources' section on the right, you can download presentations from people who attended the workshops (Holick is among the names).

- An AJCN Editorial from 2007 states: 'The balance of the evidence leads to the conclusion that the public health is best served by a recommendation of higher daily intakes of vitamin D (3). Relatively simple and low-cost changes, such as increased food fortification or increasing the amount of vitamin D in vitamin supplement products, may very well bring about rapid and important reductions in the morbidity associated with low vitamin D status.'

- An older AJCN review article looked at toxicity levels and reported 'Throughout my preparation of this review, I was amazed at the lack of evidence supporting statements about the toxicity of moderate doses of vitamin D. Consistently, literature citations to support them have been either inappropriate or without substance.'

The author presents this insightful graph and comments that 'The serum 25(OH)D concentration is maintained within a narrow range (Figure 2Go), {approx}75–220 nmol/L across vitamin D supplies from 20 µg (800 IU) to the physiologic limit of 250–500 µg (10000–20000 IU)/d. The most reasonable explanation for this kind of relation is that there are homeostatic control systems to regulate serum 25(OH)D and to buffer against variability in vitamin D supply. … Beyond the vitamin D supply limit, which is comparable with that attainable with sunshine, there is a classic rise in the dose-response curve. The sharp rise reflects the introduction of vitamin D and 25(OH)D at rates that exceed the capabilities of the various mechanisms to regulate 25(OH)D.'

# Whither Japan? from Dan Grossman

December 11, 2009 | 4 Comments

I used to do a lot of business in Japan and I think very highly of Japanese businessmen (unfortunately they rarely include women at high levels). They have an industrious, highly intelligent population, are very interested in business, and a good base as the second largest economy in the world.

It is a great mystery to me why they (and their stock market) have not done better in recent years and I have never seen any good explanation of it. Okay, they had a bubble that burst, government policies that were not great, and they have an aging population. But so what? They had plenty of opportunity to recover on their own in spite of whatever the government has been doing. (BTW their government policies could not be any worse than our current ones, so if government policies are the test, we're in big trouble.)

Has anyone seen or can anyone give a decent explanation of why Japan has lagged?

## Ken Drees writes:

1. LDP party out of power after 55 years.

2. Exports and profits slumping via USA trade like others Asian exporters.

3. Big(gest) holder of USD denominated debt.

4. Aging populaton (nothing new), but 81 billion spending package just announced, more internal stimulus to follow?

5. Need to diversify their surplus holdings like others (China, Brazil, Russia, et. al.)?

6. New party administration playing a little differently with USA — recent Obama trip no real results, prior to that some grumblings about USA debt, etc.

7. Japan equities — bottoms in 1998, 2003, 2009 — skewed symetric reverse head & shoulders – or just bumping along the bottom?

8. Will need to strengthen export markets everywhere and keep USA markets open and profitable. Japan's growth lies with its neighbors if USA doesn't fix itself.

9. Yen carry trade over, yen rising — conflicts with strategic direction that exports and export profits need to be robust.

10. Zugszwang-lite Japan — any small move doesn't change game for the better. Are there any good moves available?

How will the new party lead? If they cannot rope in the yen to improve exports can they stimulate spending via QE and weaken yen at same time? Or is this approach too slow and meandering? There seems no real strong moves available unless global imbalances happen first and allow Japan countermove possibilties. Japan seems still to be unable to escape via its own power.

Is Japan getting tired of being tired?

A broad-brush explanation is that the Nikkei got way out of line with other world markets and has spent the past 20 years returning to normalcy.

The Japanese price to earnings ratio was "well over 100" in the late 80s, and now it's 33 (reported by today's Financial Times), still higher than the US at 22. Earnings for the S&P are up about 2-3 times over their level in 1989, and perhaps the Nikkei's are as well, but if the P/E fell from, say, 200 down to more normal value of 33, a value much more in-line with other world markets, well, that explains a lot.

The Chair will rightly point out that this is retrospective, descriptive, and not predictive, that Japan's interest rates are (or at least were) lower, that the accounting may be different. Also, Mr. Grossman doubtless already knows all these figures, so he is looking for a better explanation, which I don't have.

Country-stock could be like "best company" studies, showing admired firms under-performing the rest. Presumably established/successful companies/economies have less upside than currently dire situations. And more downside?

## Vince Fulco replies:

1. Shareholders — very far down the societal list of all stakeholders in the corporate world. The stock market is generally considered more for gambling (no jokes Dr. Z!)

2. Much heavier reliance on debt financing (too much) due to roots in maibatsu/keiretsu structure whereby a conglomerate's banking branch handles all the financing needs

3. No Carl Icahn or Guy Wyser Pratte influence to shake up entrenched mgmts and unlock under-utilized assets. The quote is 'the nail which sticks up gets pounded down'. A few have tried over the years but are usually labeled degenerates or cowboys and run out of town one way or another.

4. Years of very low ROI, white elephant projects by the government, to keep happy important constituents of the LDP (the old group in power) such as construction and the mob — i.e. the bridge to an island with 50 people on it, which we almost got in Alaska a few years back.

5. Legacy obligations which haven't been addressed but simply kicked down the road as we've emulated so well in the last 12 months.

## Ken Drees responds:

Vince, Kevin, Kim and Charles have all provided excellent observations as to Japan's inbred entrenched-ness, inabilities to move, and relative over valuations. Also, the idea that is was the once high flyer status albatross, so all these past behaviors are in the rear view mirror, yet they continue to taint the view of Japan as an old has-been power country. But change agents may now be inside this yesterday/today paradigm. So far Palindrome's reflexive reinforcement of trend is still in force. The malaise continues. Will some new change agent surface? Will the reflexive reinforcement finally be breached.

The early elements for a change exist. To bet on a new bullish Japan is a long shot. But how much money can be made betting the field? Tax policy can be repealed, monopoly/hands in hands can be abolished, small investors can be made more ownership level. All the levers to lift the old dead stump and turn it over are at the ready. Or is this a dead end due to lack of will? Is Japan a stunted growth, never ever to leave off-broadway? If a global imbalance rises up, will Japan change tack and ride out on a new wind? I am watching Japan, if only since they since they are shackled to the USD. Maybe the impetus for change is at hand. This new administration in Japan — what do they owe the US?

## Stefan Jovanovich replies:

The Japanese are certainly not hidebound where their Navy is concerned. They are the dominant sea power in their part of the world. From the folks at StrategyPage.com:

"Japan is currently the second largest naval power in the Pacific (after the United States), with a total of 32 destroyers, nine guided-missile destroyers, and nine frigates. The older Tachikaze-class guided-missile destroyers are being replaced by the new Atago-class destroyers. Japan also has 16 modern diesel-electric submarines. The Chinese navy is larger in terms of ships. They have 25 destroyers and 45 frigates. However, of these 25 destroyers, 16 are the much older (than Japanese equivalent) Luda class. Most of the frigates are the obsolete Jianghu class ships. China has 60 diesel-electric submarines, but most of them are elderly Romeo and Ming class boats. China's Han class SSNs (nuclear attack subs) are old and noisy. In terms of modern vessels, China is not only outnumbered, but the Japanese ships spend more time at sea and the crews are better trained. The Chinese are also at a disadvantage when it comes to naval air power. Most of China's naval fighters are old. They have a growing number of modern J-11s (a copy of the Russian Su-27) and the Su-30MKK. Japan is almost at parity in terms of numbers (187 F-15J/DJs and 140 F-2s to 400 Chinese J-11/Su-30MKKs). Japan has better trained pilots, although China is trying to close that gap as well."

The attention to detail and sense of duty of their workforce is amazing, and the public infrastructure in Tokyo is of a very high quality — certainly better than Boston, DC, New York or the Bay Area. Tokyo is much bigger than all these four areas. It makes New York seem small.

It's not entirely clear to me why their equity markets haven't done better, but the "obvious" explanations of long term multiple contraction and shrinking internal aggregate demand seem to be correct.

I believe GDP per capita in Japan has been rising all along at the same pace as in the US since 1989, so it isn't as if quality of living in Japan has been frozen at 1989 levels. From what I can tell walking around the streets, they still enjoy a comparable standard of living to anywhere in the OECD, and have an unemployment rate (whatever that means in Japan) of 5.0%

Some investors are expressing great fear about the debt given the large amount maturing in the coming 12 months that is held by citizens, as Yishen writes, and given it has "no foreign demand, no domestic savings, structurally declining tax receipts and savings due to demographics, etc." Any views on this?

The top line numbers for the country are stagnant, but the per capita numbers don't look so bad. Japan might have a ton of public debt, but most of it is yen denominated and some 3/4 of it is held domestically by its own citizens.

## Dan Grossman writes:

1. Based on the two-decade decline in average Japanese stock PEs from 200 to 33, why shouldn't average US stock PEs decline further from the current 22 if government policies following bursting of the bubble are equally ineffective in the US as they have been in Japan?

2. If since 1990 the U.S had avoided illegal and legal immigration anywhere near the extent to which Japan has, the US unemployment rate would probably also be 5%.

Please look at slide 14. Japanese valuations at the of 1989 were incredibly high, add to that a lengthy deleveraging process on the corporate side and leveraging (debt to GDP has tripled) on the government side and you also have anemic economic growth.

## Vince Fulco writes:

Here is fascinating article in the WSJ re: a foreigner helping a small japanese village manage the downside of the demographic slowdown. One wonders how much more pervasive this sclerotic 'no change' attitude really is…

There's a nice column by Lisa W. Hess in the Dec. 28 Forbes about investing in Japan.

She claims that small cap companies are even more undervalued than large cap, and recommends buying the Topix rather than the Nikkei.

# Speaking of Value Line, from Kim Zussman

Here is a description of the studies I am doing on Value Line. FVL is an ETF which uses the Value Line timeliness system. Instead of using VL service to pick stocks individually, you can own FVL and obtain VL returns (of course other screens could be applied).

Using daily closes of FVL and SP500 ETF SPY, I did a linear regression:

For each day's change in SPY (X), what is the same day's change in FVL (Y). The actual equation for this line is:

FVL = - 0.000109 + 0.791 SPY  (Y = alpha + beta*X)

The regression does a least-squares fit of a line to the data (minimizing the sum of squares of errors in Y direction), and the slope and Y-intercept of this line describes how FVL's daily change is related to SPY's.

The slope ("beta") of 0.8 means that when SPY goes up 1%, on average FVL went up 0.8%, etc.  The intercept alpha) shows, on average, whether FVL gives higher or lower daily return than SPY, by checking where the line crosses when SPY is zero.

Both slope and intercept are tested for statistical significance (assuming error residuals are normally distributed), that is whether they were likely to have occurred by chance alone.

(Better descriptions welcomed)

Here is the study:

FVL; Value Line timeliness ETF.

From inception in 2003, regressed daily return of FVL vs SPY:

Regression Analysis: FVL versus SPY

The regression equation is
FVL = - 0.000109 + 0.791 SPY

Predictor        Coef         SE Coef        T      P
Constant   -0.00011       0.00023    -0.48  0.630
SPY          0.79111        0.01640    48.24  0.000

S = 0.00906282   R-Sq = 59.3%   R-Sq(adj) = 59.2%

>> Conclusion: alpha (with respect to SPY) for FVL is negative, though N.S.  Beta is 0.8, and highly significant.

A scatter diagram is also available.

## Charles Pennington writes:

For my curiosity, could you (if convenient) try reversing it and regressing SPY vs the VL fund, for comparison?

## Kim Zussman replies:

No problem, Charles. Here's what happens when you reverse the independent and dependent:

Regression Analysis: SPY versus FVL

The regression equation is
SPY = 0.000173 + 0.749 FVL

Predictor       Coef    SE Coef               T      P

Constant   0.0001734  0.0002204   0.79  0.432
FVL          0.74920      0.01553       48.24  0.000

S = 0.00881953   R-Sq = 59.3%   R-Sq(adj) = 59.2%

Analysis of Variance

Source            DF       SS       MS        F      P
Regression         1  0.18099  0.18099  2326.84  0.000
Residual Error  1599  0.12438  0.00008
Total           1600  0.30537

# On Andre Agassi’s book, “Open”, by Victor Niederhoffer

November 18, 2009 | 4 Comments

I was planning to review Agassi's autobiography but he shows himself as such a loathsome character on every page that I don't wish to waste the time before finishing A Terrible Splendor, an excellent book by someone who doesn't know anything about tennis, but does tell some great anecdotes along the way, and evinces the pathos of Tilden and Von Cramm in a heartfelt way. I always thought that Agassi was a terrible sport, and a spoiled good-for-nothing and people would try to dissuade me and say he's changed — but I see my views were correct. I wish I could see as clearly to the bottom line in markets as I can in racket sports.

## Charles Pennington responds:

It was an enjoyable book, and I like to watch him play, but it's true that almost everyone who comes up in the book, except for his current inner circle, gets panned in some way or another:

1. Pete Sampras gives miserable tips to cabbies, luggage handlers, etc, and makes you feel like one of them when he wins.
2. Michael Chang is sanctimonious, takes God to be on his side in his tennis matches.
3. Jim Courier, after beating Agassi, went out for a jog to demonstrate that Agassi didn't even tire him out.
4. Boris Becker blew kisses to Brooke Shields during his match with Agassi in order to tick him off.
5. Brooke is superficial, talks only about things rather than ideas.
6. Nick Bolletieri can't be taken seriously as a coach.
7. Andre's dad tormented him with tennis.
8. Jimmy Connors is a mean SOB, walks around like Julius Caesar.
9. Andre's grandmother has a hideous wart on her nose.

# First Scandal in Agassi Book — Jeff Tarango Cheated Him at Age 10‏, by Charles Pennington

November 11, 2009 | 16 Comments

I got the new Agassi book and have now read the first chapter.

The first chapter tells of his match at age 10 with Jeff Tarango (who also later became a touring pro, controversial for his bad temper). With the score tied 4-4 in the third set tiebreaker, Agassi hits a backhand winner that's three feet inside the lines. Tarango "bows his head and seems to cry…" [Tennis Week story]. "Now he stops. All of a sudden, he looks back at where the ball hit. He smiles. 'Out,' he says," writes Agassi. "I stop. 'The ball was out!' Tarango yells. This is the rule in the juniors. Players act as their own linesman… Tarango has decided he'd rather do this than lose and he knows there's nothing anyone can do about it. He raises his hand in victory. Now I start to cry."

Overall, you definitely get your money's worth if you want dirt dished. Again, writing of his childhood, page 39: "My father's mother lives with us. She's a nasty old lady from Tehran with a wart the size of a walnut on the edge of her nose…" I also once read the Tatum O'Neal autobiography, which is tangentially connected to tennis because of her marriage to John McEnroe. Agassi is scoring high on the scandal-meter, but he won't be able to touch that one.

# Dow Ten Thou, from Victor Niederhoffer

October 17, 2009 | 5 Comments

What would a weekend be without my noting that Mr. Dow crosses back and forth over magic 10000 gravitational level six times on Friday, as was guaranteed to happen.

I note a different Isaac Newton effect as pump prices rise in the last ten days. I read in morning's paper an inside trader hedgie arrested. I feel as a sheer novice it is scoundrels like him who moved the Market to ten thousand and not a solid economy; as to foreclosures we have yet to see the true picture. This coming Winter will be a very cold one and demands will be made on natural gas and ole Reddy Kilowatt. People will use their cash for food and fuel and home utilities and holiday retailers will suffer.

## Alston Mabry takes out pencil and paper:

The Dow first crossed 10,000 on 12 March, 1999. The first open above 10,000 was 19 March, and the first close above was 29 March.

Looking at all Dow days from 29 March, 1999, to present and calculating how far in points each close is to its nearest round thousand, produces the following stats:

Total days: 2657

Mean distance in Dow points from nearest round thousand: 265.46

Histogram (using 25 point bins):

bin//frequency//%totaldays

0-25 112 4.22%
50 122 4.59%
75 104 3.91%
100 119 4.48%
125 132 4.97%
150 135 5.08%
175 105 3.95%
200 124 4.67%
225 144 5.42%
250 115 4.33%
275 126 4.74%
300 135 5.08%
325 140 5.27%
350 116 4.37%
375 131 4.93%
400 156 5.87%
425 168 6.32%
450 156 5.87%
475 157 5.91%
500 160 6.02%

Looking again at this histogram, one can total the bin %'s in different ways:

distfromround / %totaldays

.   0-250 45.6%
250-500 54.4%

.   0-125  22.2%
125-250  23.4%
250-375  24.4%
375-500  30.0%

## We are honored to receive this communication from Prof. Charles Pennington:

Benford's Law gives expectation frequencies for the first digit of a numerical quantity that's thought to be uniformly distributed logorithmically over several orders of magnitude. The Dow has varied by about 2 orders of magnitude since 1928. Here's its distribution along with the Benford's Law prediction:

columns:
first digit / frequency of occurrence in daily Dow 30 prices /
expected frequency from Benford's Law

1 35.0% 30.1%
2 12.5% 17.6%
3 6.3% 12.5%
4 4.7% 9.7%
5 3.7% 7.9%
6 5.5% 6.7%
7 6.1% 5.8%
8 14.2% 5.1%
9 11.9% 4.6%

(There were 20,352 observations.)

So there are "too many" 1s, 8s, and 9s, and not enough 2s, 3s, 4s, and 5s. Because of the serial correlation in the daily prices, it's not obvious (to me) whether this is statistically significant, but over history the Dow has spent some extra time hanging around near the powers of 10.

## Victor Niederhoffer bypasses Benford's Law in his evaluation:

Yes, it seems significant. There were 45% within 250 points and the standard error expectation was 25. So the deficiency of 130 is five standard errors from expectation.

## Alston Mabry follows up:

I broke the Dow into non-overlapping 250-day segments and counted the number of times within each segment that the Dow had an 8- or 9- handle. Chart of the results (click on All Sizes [magnifying glass] to see large version).

Conclusion: the big skew is there from the mid 1960s into the early 1980s.

# Speaking Briefly of Tennis, from Charles Pennington

Some high quality youtube of Fabrice Santoro vs Julien Benneteau. Benneteau won the match, but he had to win each point three or four times before Santoro would let go.

Santoro might like the new two-handled NaturalTennis racquet promoted by a pro doubles team, the Battistone brothers, who bought the patent for it.

## Victor Niederhoffer remarks:

That tennis is among the most beautiful match of racket sports I've ever seen. Reminds me a bit of a fantasy match between Evonne Goolagong and Althea Gibson. Or Vic Herskowitz playing Martie Decatur in handball or Jeff Hunt in squash versus Sharif Khan. amazing that Santoro can hit so well considering he can't move well. And neither has much of a serve or overhead which must have been their undoing.

## Murali Mys agrees:

Santoro is a magician. He wields the racquet like a wand. He will be missed — 2009 will be his last year on the ATP tour.

Santoro… Amazing touch and feel, plus, he loves the sport. I dig watching him. Actually, a rerun of a 2005 Masters Doubles Championship was just on Tennis Channel. Great tennis; four guys at the net, ping, ping, ping, lob volley, wind sprint, lob, overhead smash for the point. Santoro was a gift to tennis, I hope he comes back in a year or two, heck he's only, what, 36?

## Don Chu extends:

Another Magician of the Court was the Moroccan, Hicham Arazi. With his dexterity, body coordination and rubber wrists, his touch and feel has to be amongst the best of any era. He could do so many amazing things with that racquet, admittably some of which had little to do with the game of tennis. Alas, his lack of a robust mental game, temperament and a complete game, was too much to overcome even for a wizard with his kind of body-alchemy; many times the Magician was reduced to Court Jester.

# NFL Football Statistical Study, from Charles Pennington

September 30, 2009 | 10 Comments

Evidence is accumulating that football, at least at the professional level, is causing dementia and other cognitive problems among retired players.

"..the Michigan researchers conducted a phone survey in late 2008 in which 1,063 retired players — those who participated from an original random list of 1,625 — were asked questions on a variety of health topics. Players had to have played at least three or four seasons to qualify. Questions were derived from the standard National Health Interview Survey so that rates could be compared with those previously collected from the general population, the report said.

"The Michigan researchers found that 6.1 percent of players age 50 and above reported that they had received a dementia-related diagnosis, five times higher than the cited national average of 1.2 percent. Men age 30 through 49, for whom the national average is 0.1 percent, showed a rate of 1.9 percent, or 19 times that of the general population.

"The paper itself questioned the reliability of using phone surveys to assess prevalence rates of diagnosed dementia, as did several experts in telephone interviews. For example, some of those affected might not be reachable; then again, N.F.L. players may have greater access to doctors to make the diagnosis, and so on."

The study already seems compelling. There could be some promising ways to test the idea further and learn more, such as measuring the dependence of cognitive problems on:

– years played
– self-reported number of diagnosed concussions over football career
– height and weight at retirement
– "safety" of position played, as rated by some independent source.
(e.g. punter and kicker would probably be rated safest)

Obviously this may cause some worries among high school and college players. One can hope that the problems don't really kick in until the play reaches the weight and speed level of the NFL.

## Victor Niederhoffer generalizes:

The study the Professor alluded to reinforces my long held belief that soccer is an evil sport, and the body is not meant to be banged up, especially the head, and that this causes early death and dementia. In addition to the heading shot, which must be involved on at least a third of all goals, I find soccer objectionable for my kids because kids with no other means of recreation or occupation play it from the day they are born, and by the time they compete with Americans who have to go to school and develop other interests, they are much too good for the Americans to compete against . Also, I hate that you can't play it without great effort after you graduate from college so it's not a life long source of recreation. My father Artie always said, whatever you do, don't let your kids play football. And I would add soccer and boxing.

## Jordan Neuman opines:

I always thought that the rise of soccer in the suburbs over the last generation was just an extension of liberal politics because everybody can play. If someone has no talent they just stick him on defense. (I am speaking of school kids, obviously at higher levels of play this does not apply.)

On the other hand when my kid is pitching, he is on the stage. When he is throwing good strikes it is beautiful. When he gets lit up you have to tip your hat to the hitter (also on his personal stage). I always thought all those volumes expended on "America is baseball" were wasted, and most are. But there is a reason that baseball is a uniquely American game.

## Ryan Carlson digresses to his favorite sport:

One of the many reasons why I find hockey to be such an honorable sport is that cheapshots and any unsportsmanlike conduct is dealt with through "the code" that such behavior has to be answered through fistfights. The code serves as a check and balance for problems to be addressed quickly and so liberties aren't taken when the ref is looking the other way. An entertaining book for those interested is The Code: The Unwritten Rules Of Fighting And Retaliation In The NHL

## Scott Brooks continues:

Having grown up a big St. Louis Blues fan and overall general hockey fan, I watched more than my fair share of hockey. We had season tickets to the Blues when I was growing up in the 1970s. My dad ate at a restaurant by his work that was frequently attended by Blues players. Dad was on first name basis with such greats as the Plager Brothers, Garry Unger, Bob Gassoff, Noel Picard, Chuck Lefley and many others.

Watching the dynamics of hockey growing up, it was clear that every team needed at least one good enforcer. This was the guy that would go out and beat up whoever on the the other team "breached protocol". If someone smashed into the Garry Unger (the Blues main scorer back in his day), he'd have to deal with one of the Plager Brother or (even worse for him), Bob Gassoff!

My father knew Plagers and Bob Gassoff and would tell me regular stories about what nice guys they were — but on the ice, holy cow! They were animals!

Pound for pound, there was no tougher, meaner group of hockey players ever to step on the ice than those Blues teams in the early/mid 1970s. The Plager Brothers were two of the toughest men ever to play in the NHL. And the best pure fighter to ever step on the ice was Bob Gassoff!

Bob Gassoff was the ultimate enforcer. Even the Plager Brothers — easily in the top 25 best fighters to ever step on the ice in the history of the NHL — would defer fights to their teammate Bob Gassoff.

Of course, there is always the image in my mind of the Blues going up into the stands fighting with the crowd in Philadelphia (a city known for its toughness).

And of course, there is ultimate showdown in the history of the NHL: Bob Gassoff vs. Tiger Williams as to who was the toughest man in the NHL. Both coaches agreed in advance to not let the players on the ice at the same time. But with around three seconds left in the game (and the game already won), there was a dead puck face off. The coaches put Gassoff and Williams on the ice at the same time. They lined up next to each other in the circle, looked directly into each others eyes, nodded to each other and proceeded to drop their gloves and go at it!

What a spectacle! After the fight, Bob Plager grabbed a bloodied Bob Gassoff and skated him around the ice holding his hand up like a referee does for the victorious prize fighter. Gassoff had won the ultimate hockey battle!

I think the markets would be a lot more interesting if we could have enforcers. If someone squeezes you out of your position too many times, you just send over your equivalent of Bob Gassoff to let him know he'd better not do that anymore!

## Stefan Jovanovich reassures:

The most important question to be asked about getting smacked in the head is "where?". The upper forehead and the forward peak of the skull can take a severe impact without any damage; the same blow to the temple will kill a person. There is no question that football players and professional boxers have problems with dementia from the repeated blows to the temple. Vinh Tu's beefy coach was an idiot and bully. The first lesson in learning how to head a ball is teaching the kid to watch the ball into his/her forehead, and the best way to teach that lesson is to have two kids soft-toss the ball back and forth, as if they were playing pepper.

There is very little risk of head injury in amateur boxing; if it is properly worn, the head gear protects the temples and the upper jaw – the two places where you can get hurt.

What is stupid about the design of football head gear are that the helmet is allowed to float; compare the design to military headgear where the webbing and the helmet are cross-braced so they move together.

## Tom Marks is skeptical:

A humble postulate: Nearly all orthopedic and neurological injuries related to professional sports stem from the fact that eons of evolution hardly designed the human body for the unique stresses these activities put on it.

Sports-related head and knee injuries aren't going away anytime soon, especially the latter. Somebody could design a more efficient helmet, but only nature could design a knee that could better withstand the unnatural rigors of playing running back in the NFL. And there's nothing hasty about nature. It tends to deliberate long and hard.

keep looking »