Aug

26

Those bonds last week should have had a little dip and that quiet strength is a sign of another wave of money about to flood equities again. All measures I keep, the valuation regression, which is only 14% over–nothing for a bull run, that relationship of short rates and earnings, the yield curve itself, breadth and confirmations, and the broader economic measures, the duration-balanced treasury rate continuing to drop (how about that 30 year?) all point to nothing but strength everywhere.

Looking at Drudge the past 24 hours, any market-related news is very negative. As hard as it may feel to pile in, it doesn't get much easier than this, folks.

Only 2 measures (really, super-measures for a market run-up) aren't going off here (and oh, if only they would!). One, proprietary that I only speak of with a select group, the other, that 20 year constant to linear between the 10 and 30, which is flirting at 5 bps over, and could invert pretty quickly here perhaps.

Just close your eyes…do what's hard here now, and get long. Ask yourself, "Do I want to go through my entire life as a weenie?"

Aug

20

In 2015, there was a very pronounced seasonality around the 3rd Friday of the month, where the market would ramp higher going into both quad-witch options expiration, and non-quarterly expiration, and then mean revert lower post expiration. J.P. Morgan had a couple of strategies that provided exposure to such options expiry momentum and it's subsequent mean reversion. Of course, this Friday's August expiration saw the market sell off the day before opex, and close unchanged on Friday. This is very similar to what happened during May opex of this year, when the ES sold off ~3% two days before expiration. While I'm not quite certain what the market will do next week, ES rebounded strongly the week following options expiration back in May.

As Kolanovic explained, the reason a broader selloff did not ensue is that none of the triggers for systematic selling were breached. Momentum stayed positive, bonds rallied and almost totally offset the equity selloff, and vol targeting strategies had already reached leverage caps at higher levels of volatility than those reached on that day. Options positioning going into May 17 was benign and long gamma, and as is often the case, moves are reverted when there is positive gamma exposure.

Bonds are once again negatively correlated to spooz, offsetting falling equity prices, and today's vol levels have only increased commensurate with May 17th's levels, however current VVIX:VIX is substantially higher than back in May, and momentum has turned negative. September options open interest is skewed toward puts in the current trading range with large pins at the 2400 and 2350 levels.

The stuffed cabbage appears to be falling apart, and there is no shortage of potential explanations as to why: trumpeachment, tax reform delay, balance sheet reduction, fed tightening, and if there were to be a selloff this Monday–renewed bellicose dialogue between the Kim and the Donald over war games.

P/C ratios continue to be bearish, and don't show signs of being overbought. A post-expiration move below 2425-20 on Monday would take dealers further short gamma as expired hedges are rolled forward boosting volatility. A test of 2400 in the ES then seems likely where a break below, might not be bought. The 'world' is leaning against that level, and recent statements imply the Fed may not be as inclined to be a buyer, as they have been in the past.

The powers that be seem determined not to allow gold to build value above 1300, however the $/yen is on the precipice, and further domestic conflict would pare it's price and support rallies in gold and treasuries. In any case triple bottoms (usd/jpy) and triple tops (gc) never hold.

Jim Sogi writes: 

Last weekend they paid a nice premium for taking the risk of holding their goods over the weekend. Always risk, and that's what they pay for.

Ralph Vince writes: 

Don't know if we'll see that tomorrow, but volatility is certainly telling us (very strongly) this is not the correction it seems most are looking for yet.

I still think we challenge the all-time highs first, and, very possibly, go into another strong up leg this Autumn on the inevitable tax cut legislation. The big bull–from wherever you begin looking at it from, March 09, Nov 2012, or, as I see it from January 2016, is far from over. And that means higher highs before it is.

I can be long and wrong but not short and wrong on the timing of all of this. But I'm quite certain we're going right back up to those all time highs here, just not so sure about tomorrow.

The bull market in bonds takes a breather this week.

Aug

19

 A great read:

"Turmoil in Quant Land: A hedge fund's candid view why strategies that were once working regularly mysteriously stopped working"

J.T Holley writes: 

The Law of the ever changing. The rudder is still the objective standard. Just try a little bit harder.

Use the objective but become more subjective while using the objective as a ruler.

Count. Then count again. Count some more. Die counting.

Adam Grimes writes:

A broad question on this topic.

Thinking about volatility, I understand how selling vol can depress implieds. This is obvious and if there's an ever-present offer on volatility (e.g., from banks selling for "yield") this would have an impact on pricing of those derivatives… but am I correct in thinking that there's no mechanism whereby this can actually effect realized volatility? And if realized volatility were higher (it obviously has not been) then the mispricing of those derivatives would be clear and the sellers would be crushed. We also could not have a situation where pricing of implieds comes dramatically apart from realized vol for an extended period of time because there is a day of reckoning on most of those instruments.

I can easily understand how buying and selling might, for instance, erode cycles or seasonality in the underlying and would quickly erase arbs, but I don't see how buying and selling pressure in a derivative can affect realized volatility. (Again… just to belabor the point… impact on implieds is obvious.)

I could imagine being a very deep-pocketed seller of vol and then operating in the underlying to dampen swings there, but it would seem that I would quickly magnify my risks to unacceptable levels without any assurance that I'd be able to accomplish what I was trying to do.

Am I missing something here, or is there a missing piece to this low vol puzzle in general? 

Ralph Vince replies: 

Adam, YOU'RE not missing ANYTHING. The notion that too many sellers of options dampen implied vol., if it were true, would create a wonderful opportunity to buy options, which, ultimately, reflect outcomes consistent with the historical vol over the period the options have been held. That is to say, the actual outcome of price distributions between the day I buy the options and the day the expire is, datum est, a function of the historical vol over that time window.

Ultimately, like a psychotic mistress you cannot shake, implied and historical can never be too far away for too long.

anonymous writes: 

Yes, this piece seems to be catered towards those whom are subscribers or clients of the author. I like to think that longevity in systematic/quantitative strategies relies on creativity and flexibility more than a fundamental understanding of statistics or arithmetic.

As Chair said "don't try to make money the same way twice".

If too many people are only focused on selling vol because that has been the main source of alpha over the last 3 years, then it would seem reasonable to expect those same actors to see heavier drawdowns and volatility being pushed like a hydraulic press into over leveraged players. A more prudent observer would find a way to take advantage or quantity some of these "irregularities".

Zubin Al Genubi writes: 

A couple of questions remain unanswered: Why has volatility been so low?

Other questions: why is inflation so low with such low rates?

Won't some of the old strategies start to work again once this low vol regime ends?

Personally I don't even bother to trade the low vol. Better to travel. 

Paolo Pezzutti writes: 

The concept of ever changing cycles is always valid. Competition on a set of inefficiencies exploited by more and more actors reduces gradually the edge. It has always been like this. The issue is that no edge is given and working forever. Innovation and research can never stop. One has to continue counting, find new regularities , dismiss those who do not work any more. An area of research in this regard and discussed in the paper is how to exploit the growing sector of passive investing and etfs. What are the new regularities that these growing actors are creating for the speculators to exploit and profit from? 

anonymous writes: 

They didn't take on enough risk, it's THAT simple.

What a pile of yadda yadda, "We don't really know why things didn't work as well as they had in the past, but we've fixed it because we have a lot of smart people working for us."

A failure-justifying amphigory, and fails at that too.

anonymous adds: 

Managers have to have a story to tell, especially when they under-perform the benchmark. The negative effects of index funds and ETFs is a pretty common part of the story these days. I am very skeptical because, from the cheap seats, it seems that if you took all the passive money and gave it active managers, they would wind up in aggregate holding the same positions as the passive funds held, only minus bigger fees. Following that logic, one consequence of passive investments would be higher markets because more of the customers' investable funds actually reach the market rather than being siphoned off by intermediaries. Which means that intermediaries will need to find new ways to siphon off funds.

Aug

17

If not today, then tomorrow…don't be shut out.

Gary Phillips writes: 

2475.00 appears impenetrable, at least until after opex Friday. If $/yen was to further take it on the chin due to Trump backlash, which looks likely, then gold should break higher and take out the round at 1300.00 while bonds tag along for the ride. Thinking 2440 in es before 2480.00.

Ralph Vince writes: 

Maybe so, Gary. BUT…there's no danger until the big indexes hit new all tie highs first, which is inevitable in the next couple of days.

anonymous writes: 

This is good, selling off into the open. Prime chance to add for another charge at new all time highs here. We are hitting a cycle low in this Thurs/Fri area, maybe even at it right now, and some intermediate stuff that is deeply oversold.

Aug

16

Volume gave nothing yesterday. It’s a good sign Monday will continue through today, and the 20 constant mat convexity is only 3 1/2 over linear.

It should be a stronger day in the end than the open might indicate.

Kim Zussman writes: 

So how will we know when the 8 year old “buy the dip” (slightest, shortest, before you blink) trading strategy will stop printing exponential bitcoin?

Ralph Vince writes: 

Everyone is waiting on “the dip”, and more than that in numbers are the grumblers who are and have been short or not aboard at all.

It’s the 1980s, but on steroids this time. Giant transformations - far bigger than reactionary politics - were in place a year ago and are just beginning to manifest.

Like the man on the loudspeaker at the trotter track says, “Do NOT get shut out.”

Jul

19

It looks to me as though the high is about in here. Maybe a drop of 5-10% over a period of at least a few weeks. All of this in the context of a very powerful bull market that will carry for at least the next 4 or 5 years (with fits and starts, decades) driven by lower rates, lower unemployment and low inflation in a world fast transforming on the energy and transportation arenas.

Anatoly Veltman writes: 

I only glance at the charts, and I see no difference between the 2007 topping action and the current chart juncture. So to me it looks more like agreeing with Ralph about no charting reason to hold Long here, but also not anticipating reasons to look for Long any time soon. What was that about "lower rates"??

Paolo Pezzutti writes:

Charts are useless. Your perception can be biased by what could look like specific formation. I think we should discuss the possibility of a top based on a more scientific and measurable approach. It's been years since we've heard about analogs with past topping formations and distribution patterns. Sooner or later stocks will move to the downside anyway.

anonymous writes: 

If we are in an analogous market to 2007:

Have we had any "warning shots" similar to Feb. 27, 2007 in which the underlying weakness of credit markets began to be evident? Is there reason to suspect that commodities are at bubble levels, or that a commodity bubble may form as in 1H2008, in divergence from the trajectory of earnings growth and equity prices? Are quant funds blowing up, indicating a sudden change in historical relationships between markets?

Ralph Vince writes: 

Giant bull market in bonds for the past 35 years.

I KNOW I'm not smart enough to call the top in that one. There's no great insight on my part, I'm just sticking with the bass line here, and that brings us to a 1 big-handle on the thirty constant mat.

Larry Williams writes:

The bearish Cassandra's on bonds miss the point. The Fed can't raise rates much here in a struggling economy. 2% GDP growth looks like about it based on velocity of money and credit. The Fed has to stop using Phillips Curve model.

Jul

10

I find it to be a much different game involved when managing a big winning position than dealing with any size losing position. Sometimes the market moves render even the best trading plans moot, either side, win or lose. The Mistress broadly encourages one to abandon reason and science, imploring one to trade in an emotional, "seat of the pants" mode. The mistress tends to endow a winner with self doubt and adds a double dose of hindsight just for kicks. She messes with confidence levels, tries to decrease humility, increase hubris, and whispers in your ear some small suggestions, that if followed will cause personal ruin. It is important to note that the mistress is fastidiously equal opportunity, sowing discord among winners and losers alike, and all at the same time.

Losers are easy to deal with…..get rid of them quickly, learn whatever lesson is presented, and move on. It's the very rare big winners that are most perplexing….there's not much material out there on how to deal with them.

Thoughts?

anonymous writes: 

Jeff writes: "I find it to be a much different game involved when managing a big winning position than dealing with any size losing position."

I agree with this statement.

And why might that be? Is it because we have trouble keeping positions open — that is, "cut your losses and let your winners run" is much easier said than done. Or might it be that we suffer from a personal guilt/insecurity that subconsciously believes we don't "deserve" to have an big winning position? (See: Prospect theory). Or perhaps it's more mundane: a lack of strategic tactics and discipline.

Whatever the reason, it's what I call a "quality problem" — so long as one doesn't believe that "no one ever went bankrupt taking a profit." Taking small losses and small profits is a surefire way to bankruptcy.

Julian Rowberry writes: 

How many times a year do you have to cut losses? How many times a year do you have to manage a big winner?

anonymous responds: 

The Pareto Principle states that, for many events, roughly 80% of the effects come for 20% of the causes. But in fact, if one is trying to beat the S&P500, it's much more concentrated than that. According to Cliff Asness, each year for the past 20 years, the top 10 stocks have accounted for about 45% of the total gains. (There are different ways to calculate this — but the gist is the same: if you are long-only and own a concentrated portfolio, then owning those few winners is absolutely essential. It's left as an exercise for the reader whether this is one and the same with the so-called Momentum Effect.)

Similar phenomena occur in commodities…

This underscores the difficulty — perhaps even futility — of calling "tops" and "bottoms." This isn't a recent phenomenon either. I've seen some studies that show the most outsized gains occur in the final stages (so-called "blowoffs") of markets. So if you are trying to beat a benchmark (which is the most intellectually honest way to invest), then the only way to explain away those missed gains is to (a) pick a different timeframe for the benchmark and/or (b) couch things in terms of "risk-adjusted" returns or (c) pick a modest, absolute return benchmark. 

Raph Vince writes: 

Je me regarder.

There is absolutely nothing to consider here on this question but to further muddy the answer, and the only way to arrive at the answer is to first solve the fundamental, personal reason as to why you are here.

What are you seeking to do? This is true whether you are looking to trade Cook Co GOs, Natural gas futures or at the cheapie blackjack tables in Biloxi.

What are you trying to do? what is your criteria? And if the answer is simply "To make money," or "To make more money than ybidyblibidyblamgozoo," then you are among the deluded masses who will part with what you've brought in this in only a matter of time.

The single clearest denominator between those who loose what they have and those who do not is that the latter know, very clearly, and with respect to risk and timeframe, what they are doing here. Whether you're playing cards at the caddy shack or venues higher up the food chain. Once a person goes through the rough the honest and realistic self-evaluation, given their abilities, of what they can do and seek to do given their personal limitations, can they then attempt to answer such questions as posed on this thread.

Galen Cawley writes: 

I have found that piecemeal exits work best based on three different mechanisms: first, your personal utility curve (this can and should be programmed), second, a bayesian updating of the premise of your original entry, and finally, pure market action (some sort of trailing stop). The first type of exit is based on your psychology but has the beauty of not being made in the heat of the moment. The second type is logically based on your methodology, and the last one lets the position run as long as the market dictates (which can certainly escape the logic of your particular system). Occasionally, I'll give in to discretion by throwing a virgin into the volcano, e.g. selling a one lot during a runaway market, or liquidating a small portion after persistent daydreams of fantastically extrapolated returns, knowing and hoping that I'm usually wrong.

anonymous writes: 

The problem with getting out of trade too early, is "you don't know what you had until it's gone". In other words, you fail to realize the true value of the trade, until you're out. In essence then, it comes down to a problem of "recognition". One must be able to identify and acknowledge if a trade is simply a random move, or if the market has crossed some threshold; and one has been presented with the opportunity to take full advantage of "the move". At times, the argument is logical, intuitive, and almost compelling. But, at other times, the process can defy logic, be counter-intuitive, and render one doubtful. Of course, with the exception of a post trade analysis, one never knows for certain if their assessment was correct; so one attempts to eliminate bias and doubt, and reduces everything to past experience and probability.

Jim Davis writes: 

Are big winners really that rare? What’s
rare is holding long enough to capture the ‘big’. Of course, it’s
easy to hold everything you own as long as you don’t mind the many
backsliders from highs.

How many sold their beloved Bitcoin or Etherium at prices that today look like zero.

Jul

1

After a week of low volume two weeks ago, last week was highly volatile and erratic. It coincided with the advent of a new intern in the office. During the day, we don't talk much but as the market gyrates we try to quantify many different regularities. In the last 5 minutes of trading the market swung back to the lows before a holiday and a shortened day of trading before the first day of the month with gold, bonds at low, and the S&P who knows where. The moves raised a number of queries. And I realized that to a new intern and a outside observer it sounded very much like we were inmates in an insane asylum. It reminded me so much in retrospect of the idiot savant that the collab and I met at the baseball hall of fame who came up to us, and recited the batting averages of every player on every team from 50 years ago.

Anatoly Veltman writes:

I realize that one thing hasn't changed: institutions need to be invested. But other than that one thing, every other market make-up and mechanism has changed due to globalization, algos (especially HFT) and the incredible successful CBs experiment of 2010's with long-lasting zero-cost of all major currencies.

So that would mean to me that pre-2010s patterns are unreliable. And if one follows only a few years of pattern, then the problem lies with different placement within economic and election cycles, as well as most recent hacking waves. Which leads me to believe that the only constant is a CHANGE, and patterns that still CAN be relied on need constant adjusting of sorts…

In conclusion, I venture say that institutional investing has grabbed an oversize share (of course at the price of individual investing). Thus, given my introductory sentence, I have recently expected a Bull phase to last as long as it is - and then switch over to a lasting bear phase to wipe out 50-80% of the preceding gain. Now in that sense, not much change from 2007/2008 grand pattern - except for the exchange execution mechanics (with politicians dominating haphazard rule changes). So yes, lots of fun ahead for the intern.

Ralph Vince writes: 

The relentless move continues throughout the Summer, the majority waiting on the sidelines, assessing the virtues of each thumb, and the litany of those who should know better who all were looking for a top at various points up.

Yes, things are overvalued by most metrics. It's a bull market. That's how they go, have people forgotten this?

We've gone from a market of fear and disbelief, to merely one of fear now - a dangerous environment for weak stomachs as we have seen the past six weeks. The kind of market that wants to shake out those who are and have been aboard, and tempt those who aren't with a certain legerdemain only Mr. Market could do so as to get those who want to get aboard, unable to by crossing their feet and getting their weight going the wrong way.

Voir venir as mom would say.

anonymous writes: 

"Wait and see."

Anything to make us think it's no longer a bull market. Quick, volatile drops in speed and magnitude like we saw this past week, or long, slow, drawn-out affairs where new highs haven't been seen for months, yet still within the context of this bigger, overarching, fear-driven bull market.

Jun

18

 How much bad news was there last week with the market refusing to go down?

If 1 millionth as much good news came and the market didn't go up, every commentator would be saying the market is in the worst shape ever because no good news will budge it. But not the reverse.

There must be consternation and frowns at the marbled corridors of the Governors. They tried so hard to knock it down.

Reminds me of the Union Club on fifth avenue in the 1950s where the members sat at the windows looking down at fifth avenue and frowned at the women wearing mini skirts et al.

Ralph Vince writes: 

It reminds me of when I was an adolescent, and work was at Cleveland's food terminal, and the old kraut I worked for set starting time at 5 am sharp.

The endless ghetto lay between the job and my bed and the only way there was with my thumb. The jungle would always be hopping at that hour, kids out riding their bikes, etc. I would go through there like a ghost, and disregard any danger, trying only to be ready for it.

This market is identical, and calls for absolutely the same, exact, unflinching mindset. The same exact thing.

May

29

 I am asked by a son for tips on how to be a good trader. Here's a good start. Ask yourself be4 you trade:

1. Have you tested it?

2. Is it already in market?

3. Are you getting in over your head?

4. Are you trying to make money the same way many did yesterday?

5. Are you shorting stocks and going against the drift?

6. Are big things happening in related markets that could domino over?

7. Is there much fear in the market before the next announcement thereby giving you an opportunity to come in before it?

8. Are you paying too much implicitly in vig, rake in terms of how big a profit you are going for relative to your vig, rake bid asked spread?

9. Are you playing someone else's game, like trying to make a 1/10 of 1% profit on your trade in the next hour while high frequency taking 100 mill a day?

10. Is something bad e.g. sickness happening in your family that will prevent you from proper decision making?

11. Can you afford to lose?

12. Did you stop to test, consider all these things before you traded or did you just make a reflex kind of trade?

13. Is liquidity going to be reduced shortly so you're playing mah jong against a group of experts with little chance of beating them?

14. Do you have a backup position with most of your assets long stocks?

15. Have you had sex recently good or bad and is it influencing your decision the wrong way?

What would you add or subtract from this?

Ralph Vince comments:

Along the lines of 11, can you handle the worst thing that can happen (and along the lines of 13, this event should include the notion that there will be no liquidity, which will haunt you in the quietest moment of the night.)

I would also add: "What's your time horizon on all of this–on this trade and how many of these?" Ad infinitum is an answer here, but there should be a reason for that answer, not as a default.

Once both of these two questions are answered, unequivocally and clearly, a trader can address the most important question, in my opinion, which answers the "how much," but is approached by answering the pinnacle of questions all traders must answer, which is "what are you trying to accomplish within this given time frame?".

Jeff Watson writes: 

Do you really know and understand the game being played that you are trying to join? Are you aware that there are always games within games that might have a totally different, secret, set of rules?

Are you under the delusion that grains are "easier" because they seem to move slower and with less violence than the metals, oil, spus, etc?

Are you in good shape financially and physically?

Have you developed an aversion to losing money?

anonymous writes: 

Focus on process over outcome. It's not whether you make the shot, but whether it was a good decision to take the shot.

May

6

 2 posts for plenty of thought:

"Did you know? The world population growth rate peaked in 1962/63 and has been falling to about half of what it was since then"

Children per woman, total fertility rate, 1955-2015

Ralph Vince writes: 

Who knows how quickly we will populate Mars, and how soon this will begin (these things come on much faster than anyone anticipates).

I posit tht population growth is a function of bounds, both economically, culturally, and geographically. When the hottest thing for a young person to do is move to Mars and start life, given the seemingly boundless opportunity out there, the picture will change dramatically, and these ancestors of ours will look back at such articles with amazement and a touch of humor.

Apr

25

Aka how to get in the news:

"Elliott Wave investor Robert Prechter says a Depression-like shock is coming"

Stef Estebiza says: 

"As I've explained here, Elliott Wave theory says public sentiment and mass psychology move in five waves within a primary trend, and three waves in a counter-trend."

Maybe the book is interesting, but Robert Prechter was very wrong in the past with his elliot theory. After the recent change that has seen rivers of money only for some, rates to zero and the central banks traders on the markets, I doubt that we can talk about investors, psychology and the public. The only mover of the market is the orchestrated national deficit > QE whatever it takes… 

Ralph Vince writes: 

Prechter himself is but a symptom of what is going on– this all-over asive,"low frequency," fear, as I have been talking about, and that is it biggest driver of prices here. This is not the "breath-stuck-in-your throat, 2008 kind of fear." Rather, a constant low frequency, ubiquitous background fear pervading everything.

Fear not only sells but it is both contagious, and it is relative. It has become so pandemic that we don't recognize how fear-motivated our actions are (and I contend it certainly IS manifest in the markets). Look at the rise on gun sales, the blue glove swarms, bike helmets, bottled water, political reactions (much of the "green movement" itself is fear-motivated), fear of losing people's jobs, credibility, etc.

Finally, fear, like volatility itself, though it can come on very quickly, dissipates slowly. This is WHY bull markets persist, and why the majority are never aboard early on succumbing to the contagion of fear.

This is the bass line guys, the bass line to what's goin' on in the world and hence capital markets as well, and if you listen to just the base you'll move just fine.

Russ Sears writes: 

It is with trepidation that I will disagree with both Larry and Ralph, but I must in principal. The "opposite" of optimism from belief in the individuals working together is not technical analysis, nor is it fear…those are but symptoms of the opposite of the force of human progress and wealth creation. No, the opposite is betrayal of the individual. It is when the markets thought were working for the good of their "team", turn out to be for example taking huge loans and buying lumber land in Canada, or helping individuals fill out mortgage loans pretending that these are same standards as the past, or perhaps at a higher level some branch of government that is to be "by the people for the people" is scamming the people or outright demanding more from the people. Yes there are the dot com bubbles and the East India Tea bubbles but these are not caused by over optimism of the human spirit, rather it is from a clear understanding the enormous progress in wealth creation is about to be made… which do occur… but just not how when or where the market was expecting.  

Apr

20

 QE is over, it's back to the same old money creation we've had for centuries — an idea which has actually levered the resourceful potential of man.

Your going to see a car drive in front of you as you stand on the curb, and it will be sans driver.

Your going to see a man in a drone, in a park, lift off the ground.

These things are here, and united airlines isn't in the game. Or any of the others for that matter.

And faster than you can gobble un croque monsieur, they will collide in a 3d, computer controlled "roadway," obsoleting cars and every minor roadway, parking lot and driveway,and traffic jams will be viewed as lice infestations of the past.

But it will take some forward-thinking and planning here. Wasting a trillion-dollar is rebuilding these roads, airports, etc. on an infrastructure plan, is not the equivalent social investment as building the interstate system in the 19 fifties was. This would be a trillion dollar simply to maintain that which we currently have, when the future is about to take an Abrupt turn. That's where we are to be funding things with public monies, as that's where the enormous multiplier in terms of social benefit derived from money spent will be seen much as it was when we built the interstate system originally. To spend that money an existing infrastructure which will soon become obsolete, is equivalent to porkulus, on a diluted scale.

Victor Niederhoffer writes:

Mr. Vince makes a subtle point that I think he means. The most valuable thing in the world is a person. They can make tremendous contributions that all can benefit from. Julian Simon is very good on providing statistics for this. And it is no accident that standards of living are so highly correlated coterminously with population like during the industrial revolution. As to which causes the the other, it's mute.

Ralph Vince adds: 

It is a bad bet to bet against the likes of Jonas Salk. But for every Jonas Salk, how many others of equal insight go untapped throughout their lives?

The population of the earth in 1960, five years after his vaccine was announced, was about 3 billion. It is now 250% of that. For every Jonas Salk of 1960, we would expect 2 1/2 of them….and for every untapped Jonas Salk….2 1/2 of those as well.

And virtually every varlet and their harlot(s) who are not the equivalent of Salk posses some sort of potential to add to the cumulative progress.

Why would you bet against the resourcefulness of man? All bear markets, since the invention of the hand axe, have been short-lived compared to their bullish counterparts, and every single market top over those millennia have been exceeded (save for 3/1/2017…..yet).

To bet against the resourcefulness of man is silly, ultimately futile, and it requires one to time things perfectly. It is a far easier proposition to load up long as when things are selling off, and manage your powder to see it through to the next new highs.

David Lillienfeld writes: 

Two thoughts:

1. There's lots of infrastructure spending to be done to support some of the newer technologies to which you refer. And it's beyond broadband. Just air traffic control alone could use a shot in the arm (well, more actually). There's also the reality that people like to physically move. And the way the society is configured, tire's no doubt that will figure out ways to do so as efficiently as they can within whatever infrastructure exists. Until motivations like sex or control disappear (which seems unlikely in the life span most of us associate with being on the face of the good earth), keeping the existing infrastructure going will also have its benefits. The interest in sex, for instance, isn't disappearing anytime soon, especially among those in their teens, who will do just about anything to get away from the clutches, eyes and ears, of their parents. That takes infrastructure.

2. I recall at the 1964 World's Fair, there was the ATT building in which there were picture phones with an assurance that certainly within 20 years, they would be omnipresent. Didn't seem to work that way. Ditto GM and the future of transportation. I've heard about the new technologies coming into use for more than 5 decades. Yes, the technologies do make it into use. But it takes a lot longer than anyone at first thought likely. Remember commercial supersonic aviation? I don't think it was ever fiscally viable. The story of how RCA came to dominate wireless communications is a case in point. Eventually, the new technology did triumph, but it took longer than anyone had considered likely.

Plank's law comes into play and is part of the explanation, inertia and lack of understanding of the potential of the new technology is another. Remember Amazon in the 1990s when it was starting to hit at sales at Books a Million and the other retail outlets? It still took 15 years for Amazon to practice its hegemony—which represented the triumph of the net over physical bricks and mortar. And even now, Amazon is putting up bricks and mortar. Isn't the internet supposed to displace such things?

anonymous writes: 

Sure trucks and jumbos full-o-junk and folks crossing oceans will still be needed.

But technology gets here in less than half the time anyone ever thinks it will.

And if we're going to spend 1-2 trillion on infrastructure, rebuilding existing assets will not pay off the way they paid off when they were first built; that's only a little better than giving it away to teacher's unions and far-lefty organizations. The electronic infrastructure for tomorrow's transportation would be a much wiser investment than rebuilding existing infrastructure.

J.T. Holley writes: 

Bruce's "Glory Days" lyrics give a beginning of explaining why throwing money at fixing all the decrepit bridges in Pittsburgh is a bad idea.

Now I think I'm going down to the well tonight
I'm going to drink to I get my fill
And when I get old I hope I don't sit around thinking about it
But I probably will
Yeah, just sitting back trying to recapture
A little of the glory of, well time slips away
And leaves you with nothing mister but
Boring stories of glory days

That is all that throwing 1 trillion is going to produce. Eventually just "boring stories". It's just to pacify the unions, steel, and cement industries. The Rust Belt vote will be needed in the future. Hats the only forward looking that is taking place.

Apr

19

It is a bad bet to bet against the likes of Jonas Salk. But for every Jonas Salk, how many others of equal insight go untapped throughout their lives?

The population of the earth in 1960, five years after his vaccine was announced, was about 3 billion. It is now 250% of that. For every Jonas Salk of 1960, we would expect 2 1/2 of them….and for every untapped Jonas Salk….2 1/2 of those as well.

And virtually every varlet and their harlot(s) who are not the equivalent of Salk posses some sort of potential to add to the cumulative progress.

Why would you bet against the resourcefulness of man? All bear markets, since the invention of the hand axe, have been short-lived compared to their bullish counterparts, and every single market top over those millennia have been exceeded (save for 3/1/2017…..yet).

To bet against the resourcefulness of man is silly, ultimately futile, and it requires one to time things perfectly. It is a far easier proposition to load up long as when things are selling off, and manage your powder to see it through to the next new highs.

Apr

4

 Europe and emerging markets are the favorite topic of all in the coming months. Osmotic pressure?

Ralph Vince writes: 

But Stef, why screw around with those markets when the US is in a monster bull market — bigger than anything seen in over 50 years, or maybe in modern times? The US and the earth may have de-linked, and the US is, at least, a sure thing. We are in SUCH a raging bull market it's silly. This may be MORE than 1982, and the reason I am certain of it is because EVERYONE is SO RISK AVERSE. A planet of absolute weenies now.

I had some stooge tell me the other night, as I went to our myself a glass of tap water from the faucet of a friends condo here, "I only drink distilled water." Are you f***ing kidding me?

A bike helmet society. Since 9/11 and the crash, everyone is insanely risk averse. "The Presidents first priority is to keep Americans safe!" has been a common theme. That appears NOWHERE in the US Constitution btw, and I'm certain its framers - who were individually certified badasses, would laugh at such a statement. If you step outside of the day, if you transcend the era we are in and look at the bigger picture, it;s clear that never have so many people, been so motivated by fear in my lifetime. Maybe in 1938/9 people in Europe were, maybe in the Spring of 387 they were, Do you think this is not manifesting in the markets? Does anyone think that fear has dispersed yet?

Youth is steeped in it, and now, must be conditioned, only trough painful, firsthand experience to NOT be so risk-averse. The markets have never accommodated everyone, why would it be different this time around? Yes, there will be fits and starts and sputters, but the next 20 years are up and up and up and it doesn't matter what happens politically–this is bigger than politics, but is the market's reaction to one-sided human emotion.

J.T Holley writes: 

I completely agree with you Ralph. Having been a Father of three, Athletic Coach, and Boy Scout Leader I can tell you that there are two generations of folks that would rather be risk averse and maintain a lower standard deviation with their lives than take even the surest of bet!

The only other generation that might have had more fear would be that of the 1950's after WWII. That generation or slice of generation were the ones who did bombshelter drills, got under desks at school, and were spoon fed propaganda. They feared total nuclear annihilation. That eventually faded.

Ralph Vince writes: 

We're finally seeing what we "feared" for a long time, that all this inflating would result in a giant asset-bubble. This is now manifesting, but nowhere near to the degree it would to be commensurate with the size of the inflating that occurred.

If people are risk averse, the late-boomers, people my age, mid 50s to early 60s. simply want to be able to hobble into "retirement." They are not taking any risks. The younger set has been programmed NOT to seek risks. People of wealth are and have been hunkered down for a long time. Bank prop desks are dissolved…so very few are taking serious risks in the equity of assets–an endeavor the vast majority of people think is about finished for a variety of weak, small minded reasons.

Kim Zussman writes: 

Ralph I admire your optimistic enthusiasm. So much, in fact, I would like to adopt you as my brother (along with a select group of spec listers)!

I somewhat get the point about pervasive fear. But as a devil's advocate (and I'm not particularly bearish):

1. There could be even more fear, including the acute variety, just thinking about risks involving N Korea, Iran, Russia, ad nauseum
2. Dems will do everything they can to stop the president from executing his pro-growth agenda, though he has and will continue to get some of it via executive order
3. Related to #2 (and to some extent with the same motives), the Fed is in tightening mode
4. Protectionism and withdrawal from international trade might not be good for many company's earnings
5. To the extent one cares about valuation, stocks aren't particularly cheap here
6. VIX has been quite low and spikes are smashed apace. Long time since 10-20% "correction"
7. Boomers are retiring and they can't eat their stocks. Many might be inclined to lock in asset values, but who will buy them?

You may point out these and other fears are bullish, and I agree. But we don't have anything like the fear of 08-09 that resulted in over a 3X - 9 year gain (and probably won't again in my lifetime).

Would you suggest all-in, or scale-in on dips?

Ralph Vince responds: 

Kim, my response to your points is below: 

1. There could be even more fear, including the acute variety, just thinking about risks involving N Korea, Iran, Russia, ad nauseum

This is already baked into the market.

2. Dems will do everything they can to stop the president from executing his pro-growth agenda, though he has and will continue to get some of it via executive order

Very likely they will do all they can to obturate things. But as I said, this saturnine, fearful sentiment is what drives markets, and it;s the same mechanism we saw, for the same reasons as in 09. Except the fear - at a deep and cultural level, has remained as an ocean of cash has been pumped into the system — still out there. The ascent of Trump merely gasoline on this deep, prolonged, over-arching cultural shpilkes.

3. Related to #2 (and to some extent with the same motives), the Fed is in tightening mode

At the short end. Mr market is telling us a differetn story at hte long end, where the free market for credit occurs. I'm looking for a 1 big handle on the thirty within a year.

4. Protectionism and withdrawal from international trade might not be good for many company's earnings

You're talking a zero sum game by definition. It may not be good for some, but people will still buy light bulbs.

5. To the extent one cares about valuation, stocks aren't particularly cheap here.

They aren't expensive either, the relationship being (earnings ^2 ) / ln(long rates). By this (linear) measure they ARE quite failry priced indeed, and at the 1 big handle on the denominator, well….

6. VIX has been quite low and spikes are smashed apace. Long time since 10-20% "correction"

And where SHOULD Vix be? Is the pre-November historical level……..is that same level where it should be? Everyone for months has been looking for Vix to spike. It will, of course, at SOME point,as stocks too will correct beyond a few percentage points, at SOME point.

As an aside — perhaps looking at outright vix levels is deceiving us, just as looking at absolute interest rate levels deceives us. Perhaps vix, like interest rates, should be looked at for the character of its term structure, rather than absolute levels? (and further, vix exhibits the character, ie.e the manner in which it moves, which is very similar to monthly unemployment — not that they move together, they do not, but they move with similar personality)

7. Boomers are retiring and they can't eat their stocks. Many might be inclined to lock in asset values, but who will buy them? We haven't seen Dr. Greed enter the picture yet. How many guys do you know well past retirement who love to take a spec on things? Boomers aren't going to leave this game en masse — where will they get a return?


You may point out these and other fears are bullish, and I agree. But we don't have anything like the fear of 08-09 that resulted in over a 3X - 9 year gain (and probably won't again in my lifetime).

We have similar fear today, and, just like 08-9, it is deep and culturally ingrained, far beyond the mere fear of capital market corrections. The difference is we've been further steeped in it, and the markets have continued higher, stoking hte fear further. By every metric, gun sales, political banter (on all sides, favoring "safety!") etc., we are a culture in a sort of tenebrous, deep fear, which has persisted well beyond a decade and a half now — I contend it is so deep and so ingrained that we aren;t even aware of it.

Would you suggest all-in, or scale-in on dips?

Timing dips is for dips who think they can. Why piddle when things are just going to keep making new all-time highs? Just buy and buy and keep buying. Come up with more money and buy some more. Add and add and ultimately cause yourself to have a bigger stake in it which has naturally averaged in. If you want you can protect it very cheaply for about 1-2% /year.

Mar

30

One sees that everything is topsy turvy with the service reform that repubs are now pointing to. Apparently the agrarian reformers have put a framework in place where a new plan must be revenue neutral or else it has to subject to whatever non-reconciliation is. To the layman that means it's a lot easier to get a revenue neutral plan in. Washington loves that because gov spending won't be decreased. But the fly in the ointment is that any proposal to reduce service rates will generate enormous increased revenues through growth and compliance and proper business activities rather than those designed to reduce payments to the service. Supposedly the "non partisan" budget office made the congress agree that there can't be dynamic scoring. So the Lafferian correlation between reductions in service rates and growth can't be taken into consideration. Thus, the whole thing has an improper foundation, a twisted acorn that must grow into a twisted oak. I've found that all things built on improper foundations eventually crumble.

Rocky Humbert writes: 

Since taking office, I count that to-date, Trump has eliminated over 90 government regulations; some of which are very significant and positive from an economic growth perspective (if one is inclined to view the cost/benefit ratio of such regulations as high).

Rocky wonders whether Vic has any hot water in his Connecticut manse. Why? Because he always seems to have a bucket of cold water at the ready.

Ralph Vince adds: 

And further to Rocky's point comma it is estimated that these regulations costing economy about to trillion dollars a year. That's one eighth of our economy. Cut that in half reduce half of these regulations and you see an immediate 6% bump in GDP. In my case I have spent over 150 hours in the last month simply wrestling with the regulations caused by Dodd-Frank. Those who oppose the president on the political scale to sew an ideological grounds but in the nuts and bolts world of trying to get anything done and America the regulations are stultifying.

That 6% bump in GDP is before any kind of multiplier is put on it. Can again go back and look at any of the great social programs have been started and worked successfully in America from Social Security to Medicare to Medicaid they all coincide with double-digit GDP growth, something I personally and looking for between now and January of 2019. Taking a machete to the Jungle of regulations anyone trying to start or run a business or even so much as take out a mortgage has to contend with, as the numbers illustrate goes a long way towards getting his towards that double-digit growth, and possibly then some type of healthcare plan in America. People have been flying to this putting the cart before the horse.

Kim Zussman shares the article: 

"How to Engineer a Trump Boom"

Cut taxes, deregulate, build roads, bridges and airports—and don't start a 1930-style trade war.

By ROBERT J. BARRO

Stefan Jovanovich writes: 

Mr. Barro is looking through the large end of the historical telescope. Trade wars only occur when countries are already having shooting wars; they begin and end when one country loses all its money. The 20th century's "trade war" began in 1914 and only ended in 1945.

What "explains" the 1920s is that the one country in the world that had any money - the United States - decided that it could afford to accept other countries' central banks' valuations of their domestic currencies. What explains the 1930s is that Herbert Hoover and Franklin Roosevelt both agreed that the way to solve the collapse of the Wall Street credit bubble was for the U.S. to join the rest of the civilized world and undertake its own default on its domestic currency.

When economists now say that countries can inflate their way out of their debts, they are referring to the magic of the defaults of nearly all the international loans issued after the Great War. No one got paid back because the valuations accepted for the initial loans (mostly from the U.S.) were as fictional as the current Venezuelan exchange rate; and the Americans decided that having the U.S. Treasury own all its citizens' money was the ideal way to revive American credit exchanges.

Academically trained economists insist on treating political economy as a science, yet they believe, without evidence, that international trade was "free" after World War I. They see a world without quotas, currency controls and imperial preferences after 1918 as a kind of mystic vision that is true regardless of any actual facts. They believe this version of history with even more fervor than LDS believe in the story of Joseph Smith and the golden plates. The Mormons, God Bless Them, consider their gospel a matter of faith; Professor Barro and his colleagues must pretend that it is all somehow Reed Smoot's fault.

Mar

13

The article "Seeking the Latest Fear Trade" on p. B2 of the weekend WSJ describes the efforts of volatility pioneer NYU Stern School Prof. Menachem Brenner to derive an actionable gauge of ambiguity, to complement VIX.

Ralph Vince writes: 

Fascinating stuff. I am searching for a cached copy. Think of the rich complexity of a listed product, the spreads and just mere sentiment expressions something like a listed product on such a creature would afford.

Mar

4

 Qiji Jim Zhu [bibliography ] has very pronounced, chiseled facial features as is often the case with men of Northern Chinese genetics, features that further seem to augment the aggressive way he assails the blackboard. He is physically fit for a man 20 years his junior as he attacks the chalkboard in his office to his audience of another gifted mathematician and myself, who has no business in their company, only the good sense to know it.

It is an explosion, a seemingly violent yet joyous expression, and with both men, this seems to be the case even though I think it is lost on them. I witness in awe, trying to absorb and understand the math as it is "carved" into the board, trying desperately to keep up.

Zhu attacks the board, aggressively, pausing not even to take a breath, his voice losing the race with the symbols he agressively carves into the blackboard with harsh, audible slashes and bangs. He begins to run out of blackboard space, and without skipping a beat in the slashing and banging of his chalked hand and accompanying voice, begins to erase ahead of where the chalk is going with his bare other hand. The expression visually, audibly, is as aggressive as any entirely serious Chinese gambler visiting Vegas, and he finishes abruptly, throwing his shoulders and head back as his hands come forward as he turns to us now smiling, the rapture of his expression only now evident to us.

Stani Maier-Paape [bibliography ] stands, walks toward the board, chalk in hand, rolling his head about his neck as he approaches, exactly as a very relaxed boxer approaches his opponent at the start of a new round, tapping his gloves as he rolls his head, the way such a boxer might do before coming into range of his opponent. He is in no hurry whatsoever, as though time no longer exists - he is lost in the moment, in his mathematical expression, and I notice his near-accent-less English now returns to a very German-sounding accent, which the man caught up entirely in what he is focused on is seemingly oblivious to.

He stops between each line, each phrasing, turns to his small audience and makes certain they are with him (me, in particular), in stark contrast to his Chinese counterpart, both men recognized from childhood in their respective countries as prodigies of mathematics, their contrast very evident and enigmatic to me.

I had the pleasure of being invited to meet with these two at Western Michigan University late this past week, and it was difficult for me to focus on the mathematics — as it is meeting any great man, where you are lost absorbing their persona, inadvertently, at the expense of trying to understand their expression of their mastery of their field.

As with most things in life, I found myself wondering what I was doing there, and "Hey, I gotta find a way to stay here," overwhelmed by the joy in their work, and how just being in the vicinity of that joy, is a drug in its own right. I felt like I was at "Baseball camp," where those of pedestrian existence get to spend a few days on the field with the big leaguers.

Feb

28

 Just as "The Big Short," debuted one month before the low last January, (the moral lost on almost all who saw it was that the story wasn't about anyone who caught the short side of the '08 crash, a drop of about 7,700 dow points, or about 56%, but the big long that followed– the dow rising 14,370 + points since then, or a gain of about 222% of what the drop was) I saw an ad on television featuring a commedienne I find highly offensive touting pastel-colored jeans.

It's very interesting to begin seeing these cultural reflections of bull market.

It will be very interesting to see if a musical wins best picture further buttressing this. And that's something I plan to learn in the morning.

Musicals are more of a bull market phenomena, and certainly La La Land is the antithesis of the pervasive, dark-themed movies of the recent past.

Feb

13

Amazing consonance of about 150 stock markets on my Bloomberg screen, all but Kenya is up with the median being about 5%. With the wealth of so many tied to stock markets in one way or another, many people must be feeling much happier and secure than in previous times.

Ralph Vince writes: 

The backdrop, at least for US equities, is 1982 - on steroids. A runaway market in its nascent stages (I see no end in sight from my indicators–in fact, my main intermediate term indicator, for the foreseeable several weeks, is still overSOLD).

99% of everyone I speak to or hear is looking for a top, a pullback, increased volatility–yet for those fully invested, it's been ripe for establishing defense–inexpensive hedges, etc…

The backdrop is certainly not one that could be characterized as "frothy." Yes, the decennial pattern of years ending in 7 would call for some type of serious selloff along the road here this year. If so, I don't see it on my radar screen yet. Frankly, if someone is in this business, and not very seriously long and have been throughout the past 12 months, they have no business in this business.

Feb

13

A friend asked me, "What in your opinion is the thing or things that makes markets rise upwards the most?"

I think it's a pretty straightforward answer, and all three factors have shown high correlations, at least for the last 5,000 years, to the price of ownership of any private property:

Population
x Change in man's upward progress
x Available stores of wealth (the aggregate amount of money)

The value of equities expressed as a line with respect to time, ever increasing as the factors comprising it ever-increase, about which the value at the moment fluctuates relatively mildly about.

Jan

30

While everyone is in a lathered-up blather about executive orders and screeching, we gotta keep our eyes on the ball. I for one can't get sucked up into political noise when there's money to be made.

Nearly everyone I speak to is looking for three things:

1. A pullback in equities.
2. Interest rates have bottomed and will now approach more historically normal levels.
3. Volatility is bound to increase in the coming months and perhaps years.

And the degree of which I am hearing this makes me quite certain none of these are in the cards. Tomorrow may be a great day to sell equities, shorter term, on any strength. The month of February should be, by my reasoning, a gentle, sane chop with an upward bias, in a bigger, grander, continued bull market. As far as rates go–I don't know, but I am surprised at the lopsidedness of sentiment regarding #2, above. But as the late kid from another (classier, as it were!) suburb of Cleveland used to say, "Don't fight the Fed."

Jan

9

VIX opens Monday at new lows; but chart seems VERY BULLISH. What say you?

Ralph Vince responds: 

I'm looking at the yield curve in constant maturity treasuries, the 10 year duration on out, which tells the tale of the market's health — it's currently very bullish shape. When the 20 yr yield > 30 yr yield or a big concave point at about the 20 year duration, I'll get worried.

Volume hasn't given us a short term sell here yet….

Three week plurality of NYSE Most actives has still not gotten oversold………..since way before the election.

Quality spreads in the credit markets starting to give it up, very bullish for equities, and the shape the big indexes on the charts is verrrrrrrrrrry.

Vix may see little spikes here and there, but I think this [stock market]  is a runaway train, and I think it's going to blow everyone apart who gets in it's way for a while. This is the perfect backdrop, everyone trying to call a top, everyone THINKING sentiment is too bullish, people's thinking all occluded from politics and the dyspepsia therefrom.

This is a runaway train.

Dec

21

 I thought this was a good article:

"Ray Dalio says read Ayn Rand to understand Trump's economics. Here's what that means"

Jeff Watson writes: 

Ayn Rand's "Virtue of Selfishness," contains many nuggets of wisdom IMO. It has roughly influenced the blueprint and road map of my life. A big lesson it taught me, among many other things, was that it is good to put myself first. Here's a copy of it.

Ralph Vince writes: 

I find her books (and I have not read "Virtue of Selfishness") hollow. It speaks of the effects and actions, I find, without the driving force, the motivation (save, except for vague notions of "profit," or "doing something worthwhile," or good, or improving things). It could be that I've missed those things in what of hers I have read. I think, however, it may be because it is an interpretation done by a woman, Rand herself.

By this I mean the following. It is vital that a man find his over-arching purpose in life, and find it before he is thirty, the single, solitary purpose that is the reason he lives his life, his telos.

Yes, taking care of family and other "obligations," and "responsibilities," one must live up to in life must be addressed, but aside from that he must find what he is here to do. His number one priority as a man is to find his purpose in life, his destiny, and pursue it with all he has outside of his responsibilities and obligations. (And it is on this point that modern education fails males, and it is on this point that inner city youths are left, abandoned to life).

Until a man has found this out, he should not commit to something, a job, a marriage, a city, etc. A man's purpose must be something he is crazy passionate about. Yes, a man can know success and/or monetary gain without ever figuring this out, yet it is the discovery of his telos that is where he draws his energy, and his joie de vivre, absent which, he is merely existing, merely a slave. It provides something he can do for the rest of his life, and make a living at. It provides something he would do if he were "retired." This is the ultimate form of success – getting paid to do what he loves to do and never having it feel like work. (This is why people so envy pro athletes, because they have found this at a young age). A man needs this to be happy.

Finding what he is meant to do with his life makes him powerful.

It is my belief women follow an entirely different existential path than this. I do not claim to know what that is, I am merely an outside observer, but it is a fallacy perpetuated by an ideology devoid of terrestrial and important motivations to assume genders are the same or even mirror images of each other - there is an inexplicable mystery involved that an outsider can never know. Rand was such an outsider, and as deeply as her writings resonate on the topics she wrote of, I say they are hollow as they seem to perceive what I have pointed to here as an outsider, which, to the world of males she necessarily was (and, in fairness, her works could never have been written by a man, else they would have, and that provides a unique perspective and beauty to hers).

Dec

8

 We must ascribe to President Trump that which is his contribution and that which is not. Employment has been accelerating the past two months, the yield curve has steepened, and warnings (on the s&p500) are up 1.6% since late Aug.

Is that Trump or Obama who deserves credit. Nevertheless, 50 bln is 30 bps bump in God, before accounting for the fact that is is 100 bln effect (it is akin to an export towards GDP, while 50 bln in goods need not be shipped), 50,000 jobs, and the multiplier effect on the above. So let's call it a solid 30 bps to GDP, not a bad day's work for any President.

I measure employment from eight different, what I believe to be non-redundant sources, so as to flesh out a fuller, clearer picture than if I relied on only the monthly number, or weekly jobless, though I do incorporate those 2 as part of the 8. 

I DO show employment not only picking up, but accelerating to the upside now, since late August (along with earnings, steepening 90day-30yr Fed curve) and the other "perfect storm," conditions I saw in pace for the beginning of the bull run of the century, which I have every reason to believe, barring human craziness, we are now in the very early throes of (and as I said on another list, a simple amex floor p&f chart gives a dow minimum count on the current run to 20,500). But I think this is the beginning of a multi-decade bull run that will go far beyond what anyone imagines - in equities in gdp, in employment, and in lower rates (yes, rates continuing the relentless, long-term decline amid skyrocketing asset prices).

None of this can be attributed to Trump, the conditions existed before Trump, regardless of who was elected (and I don't really care who is elected, I care about making money). However, if we dissect the numbers of what is happening, as I pointed out, something like the Softbank announcement yesterday is worth 30-60 bps bump in GDP — that would be attributable to Trump. A 15% corp tax rate, and the 300-600 billion that would bring in (read about 1.75-3.5 % bump in GDP) not to mention the multiplier effect, jobs created, etc.

I think political ideology can cloud our thinking and obfuscate opportunity oftentimes. I didn't care for Reagan (1986 amnesty, creating the atrocity we now contend with today, doing away with privacy in banking, bearer bonds, etc, war on drugs, violating checks and balances with Nicaragua, and worst of all, in my book, not putting the total kibosh on the Chrysler bailout, which I said then was a very bad precedent, proven in 08-09) and there are things about Trump I don't like, but all politics aside, this is 1982 on steroids now.

Nov

28

 Readers of the Dailyspec who follow the trend should note the French presidential primary result:

From the WSJ:

Francois Fillion, a former prime minister who compares himself to Ronald Reagan and Margaret Thatcher, resoundingly defeated Bordeaux Mayor Alain Juppe in the runoff [election] primary Sunday, garnering 66.5% of votes.

Just two weeks ago, polls had shown Juppe, a centrist with bipartisan appeal with a comfortable lead.

Fool me once. Shame on you. Fool me twice. Shame on me.  Fool me three times, shame on the pollsters and media.

Scott Brooks writes: 

The pendulum is swinging hard away from the leftists.

Soon the non-leftists will screw things up and it will swing the other way.

The left (including the MSM) are like cockroaches…..not even the nuclear bomb of Trump can wipe them out.

Ralph Vince writes: 

I think we're witnessing something bigger than a pendulum swinging — I think we're watching a major, glacial, cultural shift going on now, around the planet large than politics, where the last vestiges of the last century are being slowly self-lulled into extinction, and many other things going on.

I think the "ZIRP minus minus" world, the survival of the ending of easing, and other "perfect storm" factors are colliding to make for an explosive rise in asset values sans a corresponding rise in rates, that may persist for decades.

The greatest free-market transference of wealth in human history is already upon is for those willing to assume risk, to be followed by legions of those who must assume ever-greater risk. Never has there been such powerful feedback and driving mechanisms that have fallen into place.

And as I've said here, I think most people are on the wrong side of this, which further buttresses the case. As I mentioned yesterday, the "Snowflake" generation (who I regard as the new "greatest generation") are modern-day Spartans of productivity, trained in it from birth. I have infiltrated their camps, I have gone in and worked with them for months at a time, wanting to learn this-or-that (and getting paid to o it) telling myself that when I leave, I leave knowing what they know (oh, yes indeed this coerced humility from me!) and I walked out the doors with heir brains in mason jars, amazed at their work ethic, embarrassed by my own in comparison. Every preceding generation had "no such thing as dumb questions," but theirs.

What an engine, what a perfect storm, what a cultural cusp we are upon.

Nov

28

 The so-called "snowflake" generation works much harder than we boomers did, is more educated, lives in their parent's basements and doesn't know what 4% growth looks like. They are extremely efficient, and put the rest of us to shame. When this gets going, for real, it's really going to cook.

A little kindling from someone who knows how to do it now, a 15 corp tax rate and the great repatriation, among many other factors, many of which were going to occur regardless of who was elected (the ultra-strong market, having not clinched with the termination of QE, the sideways, bear-market-in-time since 2014, the ocean of money which must seek risk to meet liabilities, etc.) but Trump would be fastest on the (inevitable, ultimately) repatriation (which, even at current spending and receipts levels, puts us at a balanced budget for the year of the repatriation, the first time since 2000), and trade (which is directly accounted for in GDP. 170 billion less in annual balance of trade outflows is 1% added to GDP, before the multiplier effect, which is X-fold in addition to this!) and we are at the start of what will ultimately be the bull of our lifetime, and likely outlive many of us. So whereas the markets and economy were bound to perk up, I thought Trump could get it going posthaste. (Plus, I like what he said about women.)

The snowflakes deserve a rocking economy, and will be fueling it.

Oct

31

 This is a paper by Victor Haghani of LTCM fame on bet sizing observing and analysing how people place bets on a coin flip that is biased to come up heads 60% of the time.

Ralph Vince writes:

It's a very interesting paper, and to many might be surprising. A couple of comments:
1. It assumes someone's criterion in wagering on this is to maximize what someone makes. This is certainly not the case in capital markets, where (the rather nebulous) risk-adjusted return is king, specfically: "Optimal F: Calculating the Expected Growth-Optimal Fraction for Discretely-Distributed Outcomes"

2. Even what the authors and Thorp himself claim are the amounts to wager so as to maximize expected gain, their answer is not quite aggressive enough! The amounts the refer to are asymptotic, as the number of trials ever-increases. The author himself points to a horizon of 300 plays in half an hour, and the actual optimal wager (which would, int hat time period, yield a greater return than the authors or Thorp point to) is slightly more aggressive, and can be determined from the above paper.

Not trying to toot my own horn (it needs no tooting, and besides, my horn will do a lot, but tooting it won't do) but the paper is inaccurate on these two points.

Jim Sogi writes:

Thank you for the interesting article. The other night at our band practice, the bass player's wife, who works at a public school, asked me if I was taking my money out of the market. She had heard a number of people were worried about the election and a market drop if either candidate was elected. I told her the market would probably go up, though it might jump around a bit. I thought that was interesting. Its an example of the public doing the wrong thing, for the wrong reasons. It reflects peoples fear about uncertainty about the election. It helps explain some of the market action recently. 

Rocky Humbert writes: 

Mr. Sogi's anecdote and conclusion is a textbook example of Confirmation Bias — which is the tendency to search for, interpret, favor and recall information in a way that confirms one's preexisting beliefs or hypotheses.

To wit: On what basis does Mr. Sogi conclude that the bass player's wife represents the "public" — as distinct from Mr. Sogi himself being the "public" ??!!

How the stock market will perform over the next 30 or 60 days has very little to do with the study of a coin that is heavily loaded to land on heads. At best, the stock market's performance over the next 30 days is only slightly better than 50:50. 

Alston Mabry writes: 

Just had to do a quick sim of their betting game.

Oct

24

 I am quite certain stocks lift off here, immediately, and the beneficiaries are those who are long before the election should she win. It's going to be very hard to step into it once it goes for most who aren't in beforehand. We're on the long road to 1% long rates and similar numbers for unemployment according to my calculations.

As for the election, Trump lived to fight another day when everyone reacted in seeming horror to what he said about accepting the election results. He was so pathetic at the last debate, and the spotlight shifted, to his fortune, as a result of his "horrifying(?)" statement. As Pat Buchanan, who bears the furrowed brow I recognize and expect of all those who have tortured by Jesuits, puts so poignantly in his most recent column:

"The establishment is horrified at the Donald's defiance because, deep within its soul, it fears that the people for whom Trump speaks no longer accept its political legitimacy or moral authority."

I don't think this election is a foregone conclusion or can be measured anymore than we can know what a jury's verdict will be at this point. As difficult to predict as the market may be, it is a much simpler calculus than this election.

Oct

24

Rate Hike?

The trend has been for lower rates since the early 80s. It is precisely the "zirp minus" world that is one of the factors (the biggest factor) that will drive things farther and longer than anyone dreams. This condition has persisted far longer than anyone ever expected, and as I;ve said before, all money must now seek risk - and that exists in equities, private and public, real estate and "wild things" (art, sports teams, etc).

The world has been soaked in cash, so much so that there is seemingly no demand for it, and the pensions hunger grows evermore desperate each year.

What is too high a PE when the alternative is a certain loss? The world has changed, profoundly, as a result of this, and I would speculate it may get even stranger. For example, to be long equities is to be short volatility, and vice versa, and that relationship too, is not as cast as the sun rising in the East. That relationship too could flip.

Adaptation is the first rule of survival. Look at the hedge fund industry.

Oct

17

 Regardless of who wins this election, this market is going to rip to the upside — and I can be quite certain of that without even looking at the numbers, just the very tentative nature of nearly everyone around it. I've smelled this dish cooking before, and so have a lot of folks on this site. I don't know who is going to win this, but I do know that a 500 bln stop (not even flip) in the hemorrhage of balance of payments translates into an instant 3% GDP growth, and the multiplier effect on that puts us at 1965 growth, or even Truman-era growth. I was fortunate, in the 1980s and latter half of the 90s, anyone who showed up on time with their shoes on did pretty well. I had some lucky breaks too, which didn't hurt (and, as I have said repeatedly, and bears repetition for no one's sake other than my own perspective — "Anything that I may have has been given to me.").

But nothing has gone anywhere since the Spring of 2001. It would be wonderful to see growth in double digits, or just robust, 80s-90s style for the morass of all these millennials. People teasingly refer to them as "Snowflakes," but I have proactively and of my own volition gone out of my way in the past since 2007 to get into their heads, to work alongside them — not your typical snowflakes but snowflakes of all varieties. For all the negatives said about these kids (which I do not disagree with!), they are a much harder working, industrious, adaptable and far more pleasant gang than we boomers were. And for exactly them, I hope they get a break here and get the the change they deserve, and the economic growth they can use.

Stefan Martinek writes: 

Ralph,

The whole 2014, maybe the first part of 2015, you mentioned multiple times the issue of liquidity, the risk of a huge crash, structural liquidity problems, ETFs, etc. Do you consider all that is over? I always thought that the trend in equities (from 2009) will take some time to reverse, that there will be some chopping on the top before the next up move. I never tested this, but the chopping for another 1-2 years would look proportional, beautiful, expected… Of course growth will resume at some point. I thought that maybe market needs to take back some easy money generated in the last decade before going forward.

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

A few observations on this thread.

First, perhaps because of its nature, Dailyspec tends to look for the cause of many social phenomena in financial terms. In our discussions, Mr. Haave suggested "that while the Southern states get more benefits those benefits go predominantly to the minority that votes democratic." Mr. Aiken's thoughts illustrate exactly why: "NY and IL are 'red states' outside of NYC and Chicago, respectively…" I can't speak for NY, but "ethnic demographics" are the key driver Big D majorities in IL…I have no idea how to quantify, or define, the effect of "cultural indices."

Mr. Hauser added a vital insight in suggesting that "many elderly move South in their retirement years" and, by extension, while their benefits add to the states' totals, it does not necessarily translate into democrat votes. I am one of those "expats" and can say with some certainty that we have had a marginal impact.

But several very important issues are either overlooked or avoided to explain why these states remain in the red column. First, and most important, many in the current (and, more than likely, continual regime) have quite boldly and heavy handedly attacked the religious foundations of many individuals in these states…certainly enough to swing the vote.

Second, gun control is no minor issue. Its rare to find a resident in my part of the state who doesn't own both a shotgun and a deer rifle…their purposes, though, are concentrated on bringing down consumable game and/or eliminating non-human varmints. Though many own pistols, their numbers are dwarfed by the many in our larger cities who use them for quite different purposes.

Third is education or, more specifically, the make-up of the curriculum and the content of the mandated text books. Many of today's parents and grandparents are now, after a significant amount of published and broadcast news, aware that they have received a less than adequate education. When school prayer was outlawed they were upset, but, over time, grudgingly came to accept it. However, when the study of Islam was made part of required courses, things became (and remain) a point of relentless debate.

Other points of contention which aren't appreciated outside the immediate area, but which lead many to the red side of the spectrum are the "elite" dictates discouraging, eliminating, or outlawing the Confederate flag, tobacco farming, soft drinks, fried food, salt, and "dipping."

Individually, these may seem to be trivial matters and, in many cases, "settled issues." Big mistake. Taken together, these represent stark examples of big government going well beyond its mandate. It took the Tea Party to underscore this and galvanize the voters…not just here but in other states as well. The current Democrat platform offers them nothing of substance and can do nothing to alter this situation.

Will things change? Sure they will. Despite a growing number of home schoolers and charters, an overwhelming majority of young students remain classroom captives in a system that has essentially replaced much that shaped western civ with new age agitprop.

But there will always be a remnant and as surely as all grand socialist experiments fail, this, too, shall pass.

Andy Aiken responds: 

It's tricky to quantify in toto, but consider a simple variable: married vs. unmarried. There is a stark difference in party ID and voting behavior between the two subgroups, all else being equal.

Aug

29

 "Why can’t we see that we’re living in a golden age?: If you look at all the data, it’s clear there’s never been a better time to be alive" by Johan Norberg

Jeff Watson writes: 

There's huge money in doom and gloom.

Ralph Vince muses: 

A person should live each day of his life with the same mindset, the very same attitude of savor and gratitude for every minor thing, as if he got out of jail that morning.

Or, as the Old Frenchman himself would say, "If you have the same address as a thousand other guys, you don't have a lot going on."

Alston Mabry writes: 

Pessimism is a strategy. People who have learned, usually from childhood, that they cannot act on their most important impulses use pessimism as a way to devalue what they deeply believe they are not allowed to want.

Bill Rafter adds: 

Just a minute…

As we all know from trading, if you want to increase your profitability over time the most effective strategy is to limit losses. Possibly related to this is the result of several studies attesting that fear is a greater motivator than greed, buy a factor of 3 to 1. Furthermore, we all look at prices and know both instinctively and historically that those prices will not be constant over time. They may be higher or lower, but not the same. Thus, pessimism is historically justified, profit-saving and possibly life-saving.

But to want to trade these markets for profit, one also has to be optimistic, often excessively so in light of bad experiences. You need both.

Jim Sogi writes: 

Jeff is right. Television causes pessimism. Don't watch TV. I haven't had TV for 47 years. It's not only the content. It does something to the brain. It's harmful. 

Stefanie Harvey writes:

Exactly. Television, especially US news television, is the poster child for confirmation bias. 

anonymous writes: 

Many good reasons for worry exist. If you're not worried, you're not paying attention. All of the worries stem from something completely nobody talks about in polite company: population explosion. In 1804, the world's population was 1 billion. In 2012, it topped 7 billion. It's projected to reach 9 billion in 2042 — within my son's lifetime.

True, Paul Erlich got it wrong when he said we'd all starve by the end of the 1970s– but go back read his book. Then reflect on how much different life is.

All those people are unsettling policymakers, with these results (and they are what's secretly worrying us):

Unspoken Fear #1: War. Today's empire builders are intent on grabbing resources; nuclear weapons are in too many hands.

– China: rich and populous; thanks to the free-trade break we gave them in the 1970s, they've created a war machine and ready to go for our jugular.

– Islam: implacable and populous; we have spent trillions trying to establish a decent government, and the area keeps morphing into an empire that despises us and all we stand for; they want their old empire back, be it from Baghdad or Istanbul.

– North Korea: Our strategy is, "Let's all ignore that man in the corner, and maybe he'll quiet down."

– Russia: ruthless, and intent on restoring the empire of Rus.

Unspoken Fear #2: Dystopia.

– When people don't have honest work, nothing good can come of it. In America alone, 94 million people are out of the work force. We're not being honest about the impact of robots and artificial intelligence. It's this fear that gave Trump the nomination, not that he knows what to do with it.

Unspoken Fear #3: Central government that keeps growing.

– Confronted by the population explosion, the elites have decided that the masses must be controlled and pacified. This political philosophy shows up in the fear of liability for anything fun, in subsidies, in central banking. We see sledgehammer policy-making, from FDR to Obamacare.

– And the educated love it! Calls for authoritarianism are the norm among socialist youth, aging hipsters, authors and "educators" at all levels.

These memes and unspoken but rational fears show up in pop music, with its ugly pounding overamplified brutalist mindlessness; in contemporary academic music, with its screams and jaggedness; in art, with its sneering cynicism; in architecture, with its boxy Stalinist aesthetics.

It shows up in the piggishness of the powerful, with Hillary Clinton the prime example. The rich expect multiple homes in idyllic spots, bodyguards, private jets; the poor suffer in overbuilt, crowded, noisy, polluted cities.

I happen to be an optimist, and always see the glass as half-full. Please note I am not prescribing anything; for one thing, it's gone too far. Nor do I think that going to Mars will help.

Russ Sears writes: 

First, human super-cooperation is built on trust. To evolve as a group, a high percentage of that group must be trustworthy for the compounding effect of the prisoners dilemma to work. As the group grows too big, it becomes too easy for a individual to feign cooperation. Hence the need for creative destruction and for power being placed in the smallest sized group necessary. It has always been easy to look at the big groups and see the corruption and assume that they are in control of the long term future. But the truth is they are dinosaurs and will lose out to the small but wise group/ businesses that still operates at the human individual trust one another level and are quite hidden from the spotlight, because of size. But these time and time again raise the tide for all.

Second, personally, it is too easy to dwell on the jerks that simply can ruin it for everyone but that fall into everyone's life. They can ruin many nights even if as a rule I try to avoid them. A single jerk can derail my perspective and keep me up at nights and easily crush my spirits if I let them. I found the best antidote for me is to turn the tables if I start thinking of the jerks and think instead of those in everyone's life that have blessed them with love, grace and patience. I think of my Dad's second wife, caring for a dementia patient at home for 13 years and weeping tears of love on his passing, the coach that helped me, the friend that's always there, etc. I try not to let the jerks own my mind rather than those loving, lovely (my spouse), good and virtuous people in my life. This also goes with those news makers, politicians and on the dole.

Aug

17

 Based on the timing indicated, he must be significantly underwater at this time. That assumes he has not thrown in the towel by now: "Soros Doubles His Bet Against S&P 500 Index"

John Bollinger writes: 

The interesting question for me is: Why is he advertising this now?

Peter Tep writes: 

Good point, John.

Sounds like he is releasing the hounds, so to speak.

Did the same for his short Aussie dollar trade some years back and also his long gold position–get long, get loud.

Jeff Watson writes: 

The more important thing is, who cares what the Palindrome says he does. Whenever anyone who's purportedly a big player discloses his supposed position, I look at his motives with a big grain of salt.. People bluff in the markets as much as they bluff at final table of the WSOP. It's all a mind game, and while one should take in what the opponent says, keep in mind that their disclosure is not for your benefit and it could be a bluff. A good lesson is to look at announcements like this and try to find tells….they exist. Nobody ever discloses their position(real or fake) to the media to be altruistic and benevolent. The sad thing is that many people(retail investors, CNBC watchers etc) believe in the good will of the Palindrome and the Oracle to the small investor. Those same unknowing investors are the pilchards that are eaten by the sharks.

anonymous writes: 

"keep in mind that their disclosure is not for your benefit"

That is a key. Even if it is true it is still not for our benefit. For example "they" cover while "we are riding a growing loss waiting for the idea to play out. Our entry was their exit. The flexions/greats/insiders see angles we can't, if we listen regularly our account balances will be eaten. 

Petr Pinkasov writes: 

I struggle to see how in 2016 it's even intellectually sound to present Q as another 'dagger on the steering wheel'. It's hard to quantify the intellectual capital that investors are willing to pay 50x earnings. 

Alex Castaldo writes: 

Exactly. What is the Q ratio for AAPL, how many factories do they own and how much are those factories worth in the marketplace? (Rhetorical question). The Q Ratio is a statistic from another era, when John D. Rockefeller built oil refineries bigger than anybody else's or when Mr. Ford bragged about his new River Rouge plant. It has limited value in many businesses today.

Another smaller point: the proposed tail hedging strategy is designed to break even if the S&P declines by 20% in a calendar month. In the last 30+ years (367 months) this has happened on only one occasion (October 1987). It is quite a rare event. Would you do this tail hedging all the time? I am not convinced that the numbers work when you consider that every month you are paying for put options.

 Alston Mabry writes: 

Doing some searching, I ran across this on FRED:

Nonfinancial Corporate Business; Corporate Equities; Liability, Level/Gross Domestic Product

Cheap-seat question: I know what GDP is, but I'm not sure about "Nonfinancial Corporate Business; Corporate Equities; Liability". Is that simply adding up the liabilities side of the ledger for public companies? Actually, it peaks Q1 2000, so it must involve market capitalization.

But it does peak Q1 2000 and Q3 2007. Of course, ex ante how do you know it has "peaked"?

Ralph Vince writes: 

All measures from an era when there was an ALTERNATIVE to assuming risk — that alternative now is to assume a certain loss, or, at best, a large rate markets exposure for the (slightly) positive rates at the longer durations.

This is an ocean of money that is coming through the breaking dam. It likely will go much farther and for much longer than anyone ever dreamed. Imagine the unwinding of the government-required-soviet-style Ponzi schemes like Social Security, which, at some point must start affording for self-direction to provide an orderly unwinding. Not only from the natural bookends of life expectancy, and pushing out the book ends to where too few could expect to ever collect from it, but the pressure from below in a runaway market for self-direction. This too will fuel the hell out of this run and make it last much longer than anyone dreams of.

Every equity that yields a dime has greater value than the certain loss; every wigwam that provides shelter too, from investing in the ingredients of pizza in Pulaski to Poontang in Pyongyang, all the wealth of the world must come out of the shadows and find a risk — and this creates a self-perpetuating feedback that is something we've never seen.

This is the move that comes along once in a century at best, and we're already starting into it. The measures of the world of positive rates (which may not be seen for a long time) I do not believe are germane to the world today.

Jul

25

Will someone tell Shiller and his followers that p/e's must be considered relative to interested rates. The value of an annuity growing at g is 1 + g /(1 +i) times a factor or two.

Ralph Vince writes: 

Thank you. Anyone who doesn't accept this isn't in the present moment, which is the most inflective moment in finance in my lifetime so far, and few moments in history with more opportunity and peril.

Interest rates are where they are on the planet because there is cash in such ample supply no one is willing to pay a damn thing for it.

Sitting on it, not exposing it to risk, is to expose it certain loss.

Anyone getting their mailboxes stuffed with all kinds of institutions begging them to borrow money?

This money must find propositions of some degree of risk, or it loses with certainty, every equity, every damn wigwam out there, everything is starting to shake and we've never been in a situation where a FACTOR of cash, a FACTOR that is measured in significant digits, is coming downstream.

Alex Castaldo interjects:

Excuse me but… If we receive one dollar a year from now, (1+g) dollars 2 years from now, (1+g)^2 the next year and so forth… and we discount at the rate i, then the present value of this growing annuity is  (1+i)/(i-g)

Jun

6

 "The economic consequences of a Donald Trump win would be severe"

by Lawrence Summers

On June 23, the UK will vote on whether to remain in the EU. On November 8, the US will vote on whether to elect Donald Trump as president. These elections have much in common. Both could lead to outcomes that would have seemed inconceivable not long ago. Both pit angry populists against the political establishment. And in both cases, polling suggests that the outcome is in doubt, with prediction markets suggesting a probability of between one in four and one in three of the radical outcome occurring. It is interesting to contrast the way that financial markets are reacting to these uncertainties. The markets are highly sensitive to Brexit news: the pound and the British stock market move with every new opinion poll. Analysis of option pricing suggests that if Britain votes to leave the EU, sterling could easily fall by more than 10 per cent and the British stock market by almost as much. It is widely believed that the uncertainties associated with Brexit are consequential enough to affect the policies of the US Federal Reserve and other major central banks.

It would in all likelihood be economically very costly for Britain to leave the EU and would raise questions about the future cohesion of the UK. It would also threaten London's role as a financial centre and curtail British exports to Europe.

What I find surprising is that US and global markets and financial policymakers seem much less sensitive to "Trump risk" than they are to "Brexit risk". Options markets suggest only modestly elevated volatility in the period leading up to the presidential election. While every Fed watcher comments on the implications of Brexit for the central bank, few, if any, comment on the possible consequences of a victory for Mr Trump in November.

Yet, as great as the risks of Brexit are to the British economy, I believe the risks to the US and global economies of Mr Trump's election as president are far greater. If he is elected, I would expect a protracted recession to begin within 18 months. The damage would be felt far beyond the United States. First, there is a substantial risk of highly erratic policy. Mr Trump has raised the possibility of more than $10tn in tax cuts, which would threaten US fiscal stability. He has also raised the possibility of the US restructuring its debt in the manner of a failed real estate developer. Perhaps this is just campaign rhetoric. But historical research suggests that presidents tend to carry out their major campaign promises. The shadow boxing over raising the debt limit in 2011 (where all participants recognised the danger of default) was central to the stock market falling by 17 per cent.

Ralph Vince writes:

What is not addressed is the question of what would be the economic consequences (and contrary to Dr. Summers musings, let;s keep it something measurable, like GDP growth) of another negative 100-500bln/yr in further deteriorated balance of trade over the next several years?

Are we willing to suffer another 2.5-3% drag on YoY GDP growth?

John Floyd writes: 

Yes, as with another winner of the John Bates Clark award in the year prior the reasoning leaves much out and is ingrained in a certain hue. Nonetheless I find the tack interesting as we approach UK referendum, FOMC, US elections, Italian referendum, etc. in the coming months and the potential impact and opportunities in markets. Not quite up to Patton's statement to Rommel, but along the same battle lines.

Ralph Vince replies:

Agreed.

This is a period that is a serious test of traders and nerves now, more so than the usual, more than the past four or five hours at the bridge table. With this hand, it gets particularly interesting now, for those who haven;t dozed off and know what the t the contract is now.

anonymous writes: 

As an extension to this line consider that one of the key tools in forecasting Bernanke’s reaction post 2008 was knowing his previous writings and statements as well as direct words including something very close to “a Japan type situation will never happen on my watch”.  To that line of reasoning consider and read Yellen’s work at SF Fed on the US economy and the influence of housing, etc. and I think that is a good roadmap to her speech today and actions coming in the future.

Mar

28

What is the difference between the "smart-beta" index built around "momentum factor" (offered by Russell or some other index provider) and a trend-following CTA? It seems to me like a lot of smart repackaging (trend-following is now called momentum since more academic research is about momentum, trading is now asset allocation, etc.)….

Aside of fees, of course :-)

Ralph Vince writes: 

All trading systems can be represented as indexes. (even your simplest, go long here, flat there, short here, has aggregatge weightings of 1, 0,1 on the various positions — cash always 1-position weight).

All portfolio models, can be represented as indexes.

So

Trading Systems ~ Portfolio Models ~ Indexes (~ representing "equivalent to")

It's a matter of packaging.

And further building on this edifice scratched in the walls of my darkened cave….

And all long positions ~ short put + long call of same series.

And all of this occurs within the hyaline manifold of leverage space, which readily explains things that are often not so evident on the surface (such as why a short etf will have a long-term downward drift, as well as all leveraged ones, just as with any form of portfolio insurance) and on and on and on and on.)

Rocky Humbert writes: 

Ralph articulates this well.

I would add one point:

We know as a logical syllogism that the overall return from an entire market (to all participants) is the overall return from an entire market. Putting aside the mark to market paradox, if I were the sole market participant and I owned the entire market, then my return would be the intrinsic market return (i.e. cash flow, profits, dividends, etc). And if there were two market participants, then the intrinsic return is shared between those two participants. Again, mark to market paradox notwithstanding, just as it is impossible to squeeze blood from a stone, one cannot produce a total return that exceeds the intrinsic market return. The only question therefore is how to allocate the return — which, beyond the intrinsic return, resembles a zero sum game. (Some people here call the intrinsic return, "drift", but it is really dividends, retained profits, etc.)

An academically pure index must capture the entire market's intrinsic return. And it would do that by owning the entire market capitalization of that market. The S&P500 doesn't do this exactly — the index owners exercise nuance and discretion — and that process might give some opportunities to the smart-beta crowd. That the S&P is market cap weighted further gives rise to the mark to market paradox (i.e. the starting point when one purchases the entire market cap).

But if one could actually purchase a piece of the entire market on the day of the market's creation — and own it until the end of the world — that investment will produce a return that will, after taxes and expenses — beat holding any given smart beta strategy for the same duration. This is a purely theoretical point — because during any given holding period, some particular smart beta strategy will surely outperform. Again, it's a mark to market issue. So the goal is to figure out which one will and which one won't. (Assuming that this is possible!)

So yes Virginia — there is a pure index. But it is theoretical ideal.

anonymous writes: 

I used to trade and develop "smart beta" strategies back at the fund.

I don't think there is an established "this is smart beta and this is not," but I can tell you as to what people expect. The momentum strategies are a bit different than typical CTA trending strategies (not using crossovers for example). Instead momentum is tracked by other measures such as relative performance across sectors and going long/short the best/worst performing ones.

The implied idea of smart beta, which is not exclusive to CTAs, are the other benefits of using these strategies amongst others in a way that utilizes portfolio construction or a dynamic weighting strategy (like monthly rebalancing on vol).

The goal with smart beta is to not produce alpha outright, but to accept that the majority of alpha has been "sapped" and you are now using diversified strategies that have a known cyclical alpha. This is where you get into gray area but I differ the two by saying:

alpha means the sharpe significantly deteriorates as others discover the method smart beta means the sharpe has already significantly deteroriated, but because it has, you can more easily predict the regimes in which they work/don't work. For example, AQR's paper: value and momentum everywhere discusses the idea that momentum (continuation) and value strategies (mean-reversion), tend to have negative correlations, albeit both strategies have lower sharpes (0.4 to 0.7).

anonymous writes: 

Assume, all flows as dividends etc produce an intrinsic market return of zero over some point. Trader A loses 10. Trader B gains 9 (dont forget the vig). Ok till this syllogism its a zero sum game

Next,
A sold at 100, B bought at 100.
A stopped out at 105.
B stopped out at 95.
There must be a C or a CDE.. and so on and so forth.
Still sounds like zero sum. 

But if over a length of time some stay in the game, majority keep dropping out. Then it becomes a series of zero sum games.

Next, If A,B,C,D,E…. et al become very large numbers then its a zero sum game between those who stayed in the game up to the point the non participants came in. This also explains the Lobogolas.

Market therefore is a variable sum game. People vary their exposures, they vary even their presence for prolonged periods of time. No one rides an investment bus permanently the way sage does. Normal people buy stocks with an "intention" to sell at some point.

The drift in equities is explicable by a fact that it is the only asset class where reinvestment in growth occurs. For Indian equities I have had calculated in the past it mimicks the curve of (1+GDP growth)*(1+inflation). Perhaps true for other markets too. Given in the long run supernormal profits dont exist, its the ability of businesses to pass on inflation to their customers that produces the drift in their cashflows and thus stock prices. 

Mar

24

 As Mr. Vince knows better than anyone, the variance of a sum is equal to the sum of the variances. I believe the market ecosystem works its magic each day of the week to do its damage and make the public lose more than they have any right to lose every day of the week without regard to levels or rest.

Ralph Vince replies: 

Which, by extension, we would expect the one-trading-day-variance from Friday to Mon to be the tamest of the five, consistent with your results, but not proof that weekends don’t matter.

If you could trade on Sat or Sunday it would be expected to get out of line compared to what we see from Friday come Monday, yes?

Victor Niederhoffer comments: 

The NYSE and many of the Asians I believe used to trade on Saturdays, and the changes on Sat were very small relative to the other days. I believe it’s because there is not as much damage that the collectivists do over the weekend.

Ralph Vince comments: 

When NYSE was open on Saturday, wasn’t that only half-day sessions? Us millennials know nothing of those bygone days.

Victor Niederhoffer writes: 

In the good old days, trading continued well into the evening at the fifth avenue hotel and the curb.

Anatoly Veltman writes:

Just got back from Seafire grill and I see this about the good ol’ days. Among other things, in my 1980’s better days, gold was only offered during Shabbat by HK dealers, and only a couple of hours. One memorable curb occurred after the Friday Oct.13th, 1989 Comex close. Late that Friday, following the UAL deal collapse, stock futures closed basically limit down. Gold futures that were closing full 1.45h earlier, didn’t discount any of that. I stared down a dozen screens, so I was anticipating SP technical troubles way ahead of the field. I kept soaking up gold offers all day - yet the darn contract barely edged up. My partner on the floor, who among others had no concept of what might have been transpiring with the stock market, kept a better tally: “we’re about 1,000 lots over the initial margin requirement!”

So going into COMEX closing sequence, I tell him: “We have no choice. Announce the offer of 1,000 lots, but please - no locals. Just keep yelling out “1,000 or nothing!” Don’t hit any partials.

No one took’em… An hour after COMEX close a good bank friend calls: “I heard you had some. Any market?” I give him .5% above Comex settle, he says buy’em, I say “1 bar mate”, he says “appreciate”. Half hour later he says “Aron is looking, help me out” (that’s Goldman). I give him 1% above settle, he says buy’em, I say 1 bar mate, he says “Wise. Appreciate”…And then HK quotes 1% higher and .5% wide - and no trade till Sunday…So Sunday night Sydney opens to a 1% higher bid, which I hit for my remaining 920 extra lots - and they’re thanking me! My broker calls Monday morning: “Any wire coming in?” I say you’ll hate me, but no wire; here is my 1,000 offsetting EFP shorts, I’m no longer your problem, made a quick million in the closed market, sorry mate, HOW ARE YOU DOING! He says “appreciate your concern; lots of accounts really fxxxup” I say sorry, not a freaking soul wanted them during COMEX, I be damned. He says don’t do it too often, and you owe me dinner… Guess what: I never got to buy him that dinner. Despite SP opening limit-down Monday, COMEX traded back down around Fri settle. My 920-lot Sunday opening sale was apparently passed around in Asia and thru Europe like a hot potato, with no one caring about the stock market again, like on Friday. I be damned… 

Mar

1

The edge in part related to the vig would be reduced to 0 if there were just 1 or 2 trades a day in  markets. Which time would be best for a non-flexion, non-top-feeder, i.e., the public, to trade if they wished to maximize their wealth?

Andrew Goodwin replies:

Mutual funds have had one price per day in most cases. It has proven difficult to keep various sharpies out of securities markets whether these markets price continuously or just once per day. The names and tactics change.

Ralph Vince comments:

You're referring to the most illiquid of times - which correspond to violent selloffs, not so much sleepy, pastoral markets. The most recent in memory was the open of 8/24/15.

Feb

17

I thought this was an interesting opinion piece from David Deutsch who has some creative ideas in physics theory:

"Probability is as useful to physics as flat-Earth theory"

Gibbons Burke writes:

String theory, or more particularly, M-theory, which represents a current SWAG (Scientific Wild-Assed Guess) at the grand-unifying-theory-of-everything, requires some eleven dimensions to make it all work out.

Our mortal finite deterministic mental capacities can wrap our space-time evolved brains around four or five, with instruments perhaps a few more.

Perhaps randomness is how we get a handle on behavior which defies rational explanation in our four-dimensional flatland of what seems to be the 'natural' material world; if there are eleven or more dimensions, then perhaps what seems random for us has rules beyond our ken which govern the dynamics of the other invisible, shall we say, 'super-natural', dimensions.

Ralph Vince writes: 

I think people are missing the point of the article Dylan puts here. The author of this simple piece is discussing things that are right in my ambit, what I call "Fallacies in the Limit." The fundamental notion of expectation (the probability-weighted mean outcome), foundational to so much in game theory, is sheer fallacy (what one "expects" is the median of the sorted, cumulative outcomes at the horizon, which is therefore a function of the horizon).

To see this, consider a not-so-fair coin that pays 1:-1 but falls in your favor with a probability of .51 The classical expectation is .02 per play, and after N plays, .5N is what you would expect to make or lose for player and house, as the math of this fallacious approach - and I say fallacious as it does not comport to real-life. That is, if I play it on million times, sequentially, I expect to make 20,000 and if a million guys play it against a house, simultaneously, (2% in the house's favor) the house expect to make 20,000

And I refer to the former as horizontal ergodicity (I go play it N times), the latter as vertical ergodicity (N guys come play it one time each). But in real-life, these are NOT equivalent, given the necessarily finite nature of all games, all participants, all opportunities.

To see this, let is return to our coin toss game, but inject a third possible outcome — the coin lands on its side with a probability of one-in-one-million and an outcome which costs us one million. Now the classical thinking person would never play such a game, the mathematical expectation (in classical terms) being:

.51 x 1 + .489999 x -1 + .000001 x - 1,000,000 = -.979999 per play.

A very negative game indeed. Yet, for the player whose horizon is 1 play, he expects to make 1 unit on that one play (if I rank all three possible outcomes at one play, and take the median, it i a gain of one unit. Similarly, if I rank all 9 possible outcomes after 2 plays, the player, by my calculations should expect to make a net gain of .0592146863 after 2 plays of this three-possible-outcome coin toss versus the classical expectation net loss of -2.939997 (A wager I would have gladly challenged Messrs. Pascal and Huygens with). To see this, consider the 9 possible outcomes of two plays of this game:

outcome

0.51                     0.51    1.02

0.51             -0.489999    0.020001

0.51             -1000000    -999999.49

-0.489999            0.51    0.020001

-0.489999    -0.489999    -0.979998

-0.489999    -1000000    -1000000.489999

-1000000            0.51    -999999.49

-1000000    -0.489999    -1000000.489999

-1000000    -1000000    -2000000

The outcomes are additive. Consider the corresponding probabilities for each branch:

product

0.51          0.51                 0.260100000000

0.51          0.489999          0.249899490000

0.51          0.000001          0.000000510000

0.489999   0.51                  0.249899490000

0.489999    0.489999          0.240099020001

0.489999    0.000001          0.000000489999

0.000001    0.51                 0.000000510000

0.000001   0.489999           0.000000489999

0.000001    0.000001          0.000000000001

The product at each branch is multiplicative. Combining the 9 outcomes, and their probabilities and sorting them, we have:

outcome             probability         cumulative prob
1.02              0.260100000000    1.000000000000
0.999999       0.249899490000    0.739900000000
0.020001       0.249899490000    0.490000510000
-0.979998      0.240099020001    0.240101020000
-999999.49    0.000000510000    0.000001999999
-999999.49    0.000000510000    0.000001489999
-1000000.489999    0.000000489999    0.000000979999
-1000000.489999    0.000000489999    0.000000490000
-2000000    0.000000000001    0.000000000001

And so we see the median, te cumulative probability of .5 (where half of the event space is above, half below — what we "expect") as (linearly interpolated between the outcomes of .999999 and .020001) of .0592146863 after two plays in this three-possible-outcome coin toss. This is the amount wherein half of the sample space is better, half is worse. This is what the individual, experiencing horizontal ergodicity to a (necessarily) finite horizon (2 plays in this example) expects to experience, the expectation of "the house" not withstanding.

And this is an example of "Fallacies of the Limit," regarding expectations, but capital market calculations are rife with these fallacies. Whether considering Mean-Variance, Markowitz-style portfolio allocations or Value at Risk, VAR calculations, both of which are single-event calculations extrapolated out for many, or infinite plays or periods (erroneously) and similarly in expected growth-optimal strategies which do not take the finite requirement of real-life into account.

Consider, say, the earlier mentioned, two-outcome case coin toss that pays 1:-1 with p = .51. Typical expected growth allocations would call for an expected growth-optimal wager of 2p-1, or 2 x .51 - 1 = .02, or to risk 2% of our capital on such an opportunity so as to be expected growth optimal. But this is never the correct amount — it is only correct in the limit as the number of plays, N - > infinity. In fact, at a horizon of one play our expected growth-optimal allocation in this instance is to risk 100%.

Finally, consider our three-outcome coin toss where it can land on it;s side. The Kelly Criterion for determining that fraction of our capital to allocate in expected growth-optimal maximization (which, according to Kelly, to risk that amount which maximizes the probability-weighted outcome) would be to risk 0% (since the probability-weighted outcome is negative in this opportunity).

However, we correctly us the outcomes and probabilities that occur along the path to the outcome illustrated in our example of a horizon of two plays of this three-outcome opportunity.

Russ Sears writes:

Ok after a closer look, the point the author is making is scientist assume probabilities are true/truth based on statistics. But statistics are not pure math, like probability, because they are not infinite. Therefore they can not detect the infinitely small or infinitely large.

But the author assumes that quantum scientist must have this fallacy and do not understand. Hence he proposes that thought experiments or philosophical assumptions of deterministic underpinnings of physics must hold and should carefully supercede statistical modeling. Hence denying the conscious mind any role is creating a physical world outside itself.

So basically the author accuses others of not understanding the difference between the superiority of probability over statistics. So he tries to use pure thought to get pure physics devoid of the necessity of consciousness to exist. Perhaps he does not confuse the terms himself. It would be better written however, if he used the terminology a 1st year probability and statistics student learns. 

Jim Sogi adds: 

I believe that the number and size of trades at a price, or the lack of density at that price lead to certain gravitational effects. The other somewhat unknown are the standing orders at those levels but the orders and trade density are related.

Jan

11

 Common thoughts among the masses:

Invest in bricks and mortar, you will never lose your money. Invest in banks, whenever a bank has collapsed? Buy oil. It can only continue to rise in price, considering the peak oil, etc…

Ralph Vince writes: 

Banks?

Yes I did, starting in the summer of 08…buying and buying and buying and hotel room trauma in zero degree NR US city pacing at 4 am to meet margin call by 10…

My last position, Corus Bancshares, I saw print a 56 cents from a hot dog stand TV in Sarasota in the Winter of 09, and I knew my 55 cent limit was filled, my last position, exited with a profit — about enough to pay for my lunch that day after all of that!

I learned the hard way — banks aren't brick and mortar– they are bags of air, just as industrial companies are a web page with a picture of their parking lot on it, and some CNC drawings that are being used to make the product in Indonesian machine shops.

Nov

30

What kind of moving average of the last x days is the best predictor of current and future happiness, and how does this relate to markets?

Anatoly Veltman writes: 

The widespread misuse of MAs concept is what gives it bad name. 90% of testers and users look at crossovers, and the remaining 10% look at break of MA from above or below. All wrong

The only proven way to apply MAs from trend-follower stand point is to look at nothing else but SLOPE. (Trading Days) Is 14-day MA sloping upward? If so, then is 30-day sloping upward? If so, then is 50-day sloping upward? If so: then Shorting is forbidden! Mirror test may save you from disastrous bottom-picking.

Bill Rafter writes: 

I beg to differ. There is no way the "average of the last x days is best predictor…" It by definition is at least a coincident indicator and more likely a lagging indicator. BTW the same can be said of the SLOPE of the last x days.

However, you can construct a leading indicator by comparison (difference or ratio) of the coincident to lagging indicators. For this newly created leading indicator, there tends to be a lot of false signals, due to random market action. To guard against that you need to have very smooth coincident and lagging inputs. Making them smooth also makes them more lagged, but that will not hurt you as you are not going to look at them outside of a difference or ratio, which will be quite forward-looking.

The real problem is that investors want to identify a static x. In doing so they are insisting that the market be modeled by x periods. Well, the market doesn't always feel like cooperating. At times the market may be properly modeled by x periods, and at other times by x+N, in which N can assume a wide range of positive and negative values. The solution is to first identify the exact period over which the market should be modeled for the coincident valuation. And then go on from there. Rinse, repeat.

Russ Sears writes: 

This would be a good question to ask the trading expert psychologist Dr. Brett.

It seems that with the same brain imagery he uses is being used in the study of the science of happiness.

While I am no expert I have read Rick Hanson, PhD book "Hardwiring Happiness"/ It has been awhile since I enjoyed this book, my summary of it is "focus on the life/good in the present. Placing things in context to how it has brought you to this moment, then enjoy the moment is enjoying life."

Presence seems to be the buzz-word in studies of contentment and psychology of success. Being aware of all your inputs, your feelings and recognizing them as part of life, then celebrate living. Presence gives you the fulfillment in your life needed to be loyal and disciplined enough for what is working well in your life. Thanksgiving is a day built on this idea, But presence also gives you the courage to turn things around, admit things are not as you want, and gives you Hope for the future. Happiness is more about living your life, being in control, then it is circumstances. Some of my happiest times have been after running hard for over 2 hours exhausted after 26.2 miles, cold and totally and dangerously spent but knowing I gave it my all.

So I would suggest that MA, trend following, momentum, acceleration, nor death spirals nor reversion to the mean, value investing should not ever be the "key to Rebecca", rather judge them in the context of everything else. Some days "the trend your friend" other days "the sun will come out tomorrow". 

Brett Steenbarger writes: 

It's a really interesting area of recent research. It turns out that happiness is only one component of overall well-being. What brings us positive feelings is not necessarily what leads to the greatest life satisfaction, fulfillment, and meaning. I suspect the market strategies that maximize short-term positive emotion have negative expected return, as in the case of those who jump aboard trends to reduce the fear of missing a market move.

Ralph Vince writes: 

Too many times in life I've found myself in darkened parking lots with a small gang of characters who intend me harm, and saw how the pieces would play out enough in advance enough to get out of it, or at least to realize there was only one, very unpalatable way out of it.

Shields up.

Too many times in life, I've had an angel whisper in my ear with only a few hours or seconds to spare to keep from being robbed blind by people I made the mistake of trusting.

Too many times in life I've paced in some anonymous hotel room, wondering "How the hell am I going to do this once the day comes?"

Too many margin calls have had to be met.

Far more times than I would care to, I've found myself confronted with the proposition of having to throw boxcars to survive, and I find myself, yet again, with that very proposition in a life and death context.

Only someone who really loves the rush of the markets, could enjoy wanting a given market to move in a specific direction. I've come to the conclusion it's far better for me to set up to profit from whatever direction things move in on a given day. Those that dont move in a manner so as to profit from this day, will tomorrow, or the next day, or the day after that… I need to just show up on time with my shoes on, collect on that which comes in today, sow the seeds today for taking profits on something at some future date. It's not difficult, and a lot more satisfying.

There's enough episodes in life we need boxcars to show up, and yeah, "Baby needs a new pair o'shoes."

Victor Niederhoffer writes: 

I like all these untested ideas about moving averages but my query was of a more general nature. What kind of moving average, perhaps its top onion skin an exponential average, is the best predictor of human happiness. I.e. if you are happy yesterday and unhappy the day before, are you happier or sadder. I mean vis a vis the pursuit of happiness, not markets, although the two are related I think.

Alexander Good writes: 

My answer would be a medium term moving average works best - about 6 months. We're naturally geared to notice acceleration not speed. After accelerating happiness, it's virtually certain to decelerate which we would have a heightened awareness of. Thus a 5 day moving average would have too much embedded acceleration and deceleration to yield a good outcome.

I would also say 6 months is a good number because there's a fear of 'topping out'. I.e. if you're at the peak happiness of the past 5 years you might get afraid of a larger mean reverting move. 6 months is short term enough not to be victim to noticeable accel/decel, but not too long to be subject to such existential thoughts that lead to unhappiness. 2 quarters is also a good timeframe for evaluation of back to back 3 month periods which seems like a relevant timeframe to most people professionally.

My meta question would be: does measuring one's happiness with a moving average make one more or less happy? 

Theo Brossard writes: 

I would pose that happiness would exhibit similar behavior with market volatility. Short-term clustering (which makes exponential average a good choice, if you are happy today chances are you will be happy tomorrow) and longer-term mean reversion (there must be some thresholds defined by values and time–you can't be very happy or unhappy for prolonged periods of time).

Jim Sogi writes: 

A good way to study this is to rate and record your happiness each day. Also record your acts: exercise, diet, work, family, vacation, tv, meditation, etc. Over time you can correlate the things you do that make you happy. You could correlate day to day swings as Chair queries in a univariate time series.

Oct

14

 When I meet with prospective clients and talk to them about their portfolio, I ask multiple questions to determine their tolerance for risk.

Three questions I ask are:

"How much money did you lose in 2008?"

"How long did it take for your portfolio to recoup those losses?"

"Was that loss a lot of money to you?"

I've pretty always asked a version of those questions (i.e. prior to 2008 I asked about the same questions about the tech bubble).

As we all know, the market took a massive hit in those years and loses were rampant and widespread.

When I asked those questions in 2009 - 2013 people would regale me with tales of how much they lost (40%, 50%, 60%+). Even people that held a lot of bonds "for safety" spoke of the losses they experienced.

Almost everyone spoke of how many YEARS it took for them just to recover their losses (most took 5 years just to get back to even).

And almost everyone would talk about how the loss they experienced was a LOT of money to them and they'd rather never experience that kind of loss again.

Now, let's flash forward to 2015……And it's a completely different story.

When I ask them how much they lost in 2008, the majority of people say, "I really don't lose much". Some will say "I lost maybe 10% - 15%".

I am hard pressed to find a single person who lost any money worth mentioning.

Further, when I ask them how long it took them to gain back their losses, I hear things like, "Oh, maybe a few months, I really didn't lose much to begin with" or, "I think it took me maybe a year or a year and half".

When I ask them if the loss was a lot of money to them, I hear things like, "Oh, I really don't know, it was no big deal."

What's my point of mentioning all this to the group?

I know for a fact that the rank and file people of the world (the people that I deal with) lost a lot of money in the 4Q07 - 1Q09 housing debacle. I know this because they told me so and they told me they were scared and and that it took them 4 - 6 years just to get back to even and that they lost a LOT of money….more than they were comfortable with.

And now……..they've all forgotten.

Out of sight, out of mind.

All they see (again) is the magnificent rise in the stock market and they all just know that it's not likely to ever correct again in any appreciable way, and if it does, it doesn't matter….it will come back in a very short period of time.

Yes, I know this is anecdotal, but I can tell you that this is based on hundreds of interviews with prospects over many years.

And yes, the story I've written above applies exactly to the experience I had when I interviewed prospects from 2003 - 2007

They all experienced great losses in 2000, 2001 and 2002 that were beyond their comfort zone that caused sleepless nights…..and as time went on, the losses became smaller and smaller and the time it took for the losses to recover became shorter and shorter and the pain they experienced became less and less.

I think a line of lyrics from Paul Simon's "The Boxer" are appropriate here: "A man sees what he wants to see, And disregards the rest."

Ralph Vince writes: 

Great post Scott, thank you.

I'm astounded by this same thing. If you took everyone in early '09 who were upset that they didn't liquidate their 401k plans, etc., the percentage of those who have now is very, very small. Especially in a ZIRP world.

Sep

15

 From the 1960s-1982 the Dow stayed in a range between 600 and 1000, with several 40% swings. Then came the great bull market.

Is there any reason why we might not return to such a range for 20 years or more? We are off all time highs, but with quite the penumbra around 1950s. Also, it's been a bull market for 7 years.

anonymous writes: 

In real terms (adjusted for inflation) from the peak in 1966 to the bottom in 1982, that was a 75% decline in the value of the Dow, and a 29-year trough before a new high was made. The decline from 1929 to 1932 by comparison was 85%, also with a 29 year valley before the 1929 peak was surmounted.

Ralph Vince writes: 

Yes, but in August of 1982, you KNEW the lid was coming off.

On Friday the thirteenth, after a languishing bear market, things jumped. It had a different feel to it. By the next Tuesday, the 17th, it was off to the races.

I remember it well. It was a complete change in market character from what had been going on for several years before it (at least since the Summer of 1980, and August of 82 was profoundly different than that even).

My point is, you didn't have to be a contrarian to know something big was just getting going. It came in with bang,

We live in an era where damn few remember — if anyone ever knew — how to read a tape, the pace of whats coming across the Electro-Lux. I've tried to catalog this in terms of patterns of volume bars. If you go back and look at the Friday, August 13, 1982, it occurred on a low volume bar turnaround — v. bullish (assuming a descent into it).

But the real tell came later — the 18th, a high volume bar day, the end of the short term runnup, On the 18th, the DJIA dropped a small amount, on very heavy volume, marking the high that day as an interim high that should hold for a few days. Not only did the market blow through that, showing extreme strength, but the coup de grace was the following week when the market continued higher on very high volume. Often, a single bar making a high on high volume markets an interim high (there are fine points I am not mentioning here), or, even stronger still, if there is a few bars in between and another high on high volume. But a series of 3 or more bars, on very high volume, where the market continues to grind or grind higher, is very, very bullish.

There was a confluence of factors leading up to that — negative sentiment, bank failures, bankruptcies, etc. amid an environment of declining energy prices, falling rates, technological breakthroughs (as evidenced by Ipos in the 18 months leading up to it — Apple, Genentech, etc.) the pc was in its infancy , Apple was talking about "Lisa," the mother of Mac, there was by many people's accounts, a political climate favorable to business.

There are perhaps many similarities to today, and many differences. I suppose it could happen, could happen in the coming months (look at the advances in cancer treatment, and I don't think we've even begun to feel the effects of the technological advances afforded by a true, coast-to-coast high speed network drones and mass transport, or even the productivity created asa result of the handheld devices most of us use today). But if it's anything like the last, great bull market, it come in with a roar, and I would expect it to be evidenced by inexplicably high trading volume that generally persists.

anonymous writes: 

I miss the noise those Trans-Lux jets made, with those funky fluorescent black lights and those little colored pegs. They were crude, but effective. The bars around the exchanges all had jets so you could have a drink and still see the prices, real time. Nobody minded in those days if a broker went down to the bar for a quick one or three as long as they were good earners. The Germans, Irish and Italians were the ones who went to the bars for a quick one during market hours……..the Jews at the CME always wanted to maintain decorum and control, and never show public intoxication…..the drug of choice for the Jews was cocaine and naturally they didn't drink like the Germans/Irish, and the lack of good drinking establishments around the CME was evidence enough. The bars around the Merc were never legendary like the ones at the CBOT like Broker's Inn, Sign of the Trader, Trade Inn, and Alcotts around the corner. Those bars were in a league of their own and the back stories of what went on in those establishments would be worthy of Runyon or Hemingway. I have sources that have the 1970's Russian Grain Deal being worked out at a back table of the Broker's Inn. Whether or not this event occurred and is verifiable, I wouldn't say it would surprise me. I've seen 20mm tonne cash grain deals done on the back of a napkin and with a handshake.

Steve Ellison writes: 

It took the S&P 500 7 years to regain is 2000 high, but it could not hold that level for long. It was not until 2013 that the S&P 500 again reached its 2000 high, so we already had a retrospectively-defined trading range for 13 years. I have a hunch that the next "great bull market" is already here. The so-called millennial generation in the US is larger than the baby boom generation. I keep noticing things about this decade that remind me of the 1980s, including a commodities bust and concurrent strength in the US dollar and US stocks.

Stefan Jovanovich writes: 

Steve gets my vote. Part of what happened in the 80s was the destruction of previously secure franchises. Mr. Walton's stores destroyed thousands of local "downtown" merchants who had enjoyed distribution monopolies in the villages and towns of what became known as flyover country. Even as AT&T decides that satellite streaming of NFL football games is worth $3200 a customer, the kids are growing up wondering why anyone would be so stupid as to subscribe to a service whose ability to provide programming on demand is as ancient as a Betamax recorder.

anonymous writes:

But where can rates go, Steve? Or perhaps it isn't the direction of rates, so much as their absolute values?

The other big element that concerns me is not the systemic liquidity problem (which we had a taste of on 8/24) but that volume has been tapering off throughout this run up from the 09 bottom.

Sep

14

 On my last haircut before moving, I gave my regular lady a $100 tip on a $17 haircut (applause line here?). That small gesture brought her to tears. She is a very interesting older woman. I've enjoyed talking with the past few years. She knew I worked in investments/trading and asked if I had any ideas for her. I asked about credit card debts and she told me she just cashed in 25K of an IRA to pay down 25K of credit card debt, yet already had accumulated 2K since then and was getting in the hole again. I might invite her down to do some murals in my kids room, and perhaps do some studies on trees (She is an artist who made a living cutting hair for the last 40 years).

The point is (perhaps? At least the relevant one?) is the deadly financial problem of never having working capital that provides the flexibility that keeps one off the spike of usurious interest.

This lady had been sold on long term investments (by her branch XYZ big box bank) in high fee mutual funds with perhaps at best a 5% yr expected value over the long term, while paying off 25% interest rates on credit cards. The scams run on the lower middle class or working class are obscene.

And it is not income. Clearly if these folks can pay these obscene high interest rates, they can afford much more than they have. The problem is that they never understood the idea of having "working capital". I told my friend that her best investment is at least 6 months of living expenses in the bank. As basic as it is, and at such a low margin for error that standard that is, for many it is an alien concept. Her recent issue was a car repair that blew up her budget and started the credit card problem again. With no working capital plus compound interest against, it is like a giant pit metaphorically with wood spikes and lions at the bottom to gobble one up.

So in trading and investing, how can we use this idea? Victor has taught "never get in over ones head" as one of the key tenants of speculation. So how do we manage our cash in our speculations, investments, life's "issues" to have the flexibility to seize opportunities and avoid pit of being bent over a barrel–while still getting a solid return.

Scott Brooks writes: 

The problem is deeper than that.

The people that Ed is referring to don't have the mentality to accumulate wealth and get rich. They are sold on the "here and now" mindset. They go into debt to satisfy the here and now. Something will always come up that will prevent them from succeeding. The only thing they are really good at is coming up with PLE's (Perfectly Legitimate Excuses) to justify their failures.

They are defined by their failures.

anonymous writes: 

Especially with respect to this site, I would wonder the data and testing behind those assertions. Otherwise, one might consider them to be presumptive, elitist, and uncharitable, with mean-spirited implication. But for the grace of god….

Ed Stewart writes: 

"presumptive, elitist, and uncharitable, mean-spirited"

Yes but who cares. I'm guilty of most those things at most times. Is time preference the essence of trading? That might be a more interesting question vs. my original one. Can it be quantified? I think so, as a hypothesis generator. Does it work better than other thought models?

Russ Sears writes: 

Sorry, I disagree Scott. Ed is correct, it's a matter of education and coaching. Have a plan, believe in the plan, stick to the plan.

The average working poor Josie is not a loser. It's the average bank has learned they are more valuable dumb and paying fees than smart with small accounts. The stats say that the fees are several hundred dollars per person in the USA. So some are paying several times that. The banks have the average poor working single parent or mom in a snap trap that they can't figure how to unsnap and lift the door.

The first thing I tell kids is that you need a minimum of $1,000 in emergency cash preferably $2,000. Have a garage sale, stop buying lottery tickets, no gambling, stop buying new clothes, stop cable, and stop smart phones, etc until you have that emergency fund. Also budget, if you can't fix the budget to the pay, downsize housing, get roommates, no car, bus, pay for car pool, whatever it takes to have a workable budget. Then save for the 3 to 6 months expenses in a cash account ready for a big expense. Only then should you invest.

Most people in this problem don't have anyone they can trust to give them the advice and perhaps the tough love they need to stop living in denial. The truth is the banks want the poor.

What does this mean for "investors". Frankly I think most investors have it wrong. It's not so much managing your risk as it is managing your cash flow first, then manage your risk. You can take a lot of equity risk if your investment horizons 20 years out.

Also the lesson to investors is just because someone is in the best position to give you advice and would make some money off you if they gave you that advice, it doesn't mean they will give you the advice that's in your best interest when it conflicts with their best interest. Their best interest is CMA (cover my …) by silence or sin of omission. Then it's to make more money by selling what gives them the most profit to "cover" you like payday loans.

anonymous writes: 

The thing I practice (and I don't know if it adds any edge that can be computed) is to always take some off after a good run. No mater what, be it trading, investing, bonus, etc. Never spend it all–or even most of it. Put it away for when SHTF, because as day follows night, it will…

Andrew Goodwin writes:

A major part of the problem is the thinking that makes the credit limit on credit cards equivalent to ones own money.

For my part, I will never willingly stop at a gas station that has two prices for gasoline with one higher for the credit card user than for one paying cash.

In a world where there are card rebates on gasoline, what is the point of acting responsibly with credit when those who did not act responsibly get subsidized by those who did. The dual pricing also serves to support a cash economy against the public interest.

Peter Grieve writes: 

I feel that I am unique on this site as having been in this hairdresser's situation for most of my life (Hello, Peter). Obviously this is not due to a lack of economic education or upbringing. I feel that the factors include a lack of skepticism regarding my own appetites, a lack of faith in the future, a certain immediacy in response to the world. These are traits associated with immaturity, to which I confess. Of course this leads to tremendous inefficiencies, even when viewed from a purely hedonistic perspective, but it does have its compensations.

I do not regard Scott's comments as elitist, presumptive, uncharitable, or any of that baloney. On the contrary, I find the the use of the word "uncharitable" to be condescending. I do not feel that people in my position are a fit object of charity.

Everyone has their irrationalities, and they are often incomprehensible to those who do not share them. Scott's words are simple, honest truths, which many people (including me) would benefit by internalizing to a greater degree.

Stefan Martinek writes:

It is good to have an emergency cash for at least a decade; locked, untouchable for trading or similar. The rest can be at risk. And after MF Global steal from client accounts (is Corzine still free?), I think it is prudent to keep as little as necessary with FCM. In case of a brokerage failure, the jurisdiction matters (Switzerland is preferred, the UK is too slow but ok, then Canada, and the last option is the US broker).

Ralph Vince writes: 

Stefan,

I entirely disagree; emergency cash has a shelf life which is very short, and our perspective warped as we are speaking in terms of USD. Being the historian you are, you know full well how quickly that cash can be worth nothing. (And again, a many of our personal experiences here would bear out, money is lost far quicker than it can be made).

A bag of air on hand is good for one breath.

People are taught that "saving" is virtuous, borrowing a vice. I would contend that we have crossed to Rubicon in terms of the notion of stored value — no more able to contain that vapor than we can a bottle of lightning. The circulation brought upon by a zirp world, turning all those with savings into the participants at a craps table, the currency being used the product of a confidence game, among the virtues to be taught to tomorrow's youth is that of creating streams of income — things that provide an economic benefit their neighbor is willing to pay for, as opposed to a squirrel's vermiculated nuts.

"Stored value," is a synthetic notion we have accepted and teach as a virtue. It has no place in nature, it is a synthetic construct, one that is not scoffed at in the violent, life-and-death world of fire and ice. Young people need to be taught the fine distinction between the confabulation of "storing value," and that of using today's fruit to generate tomorrow's.

Stefan Jovanovich adds: 

From the other Stefan: I agree Ralph. "Stored Value" is another part of the economist dream that platonic ideals can be found. Money is and always has been one thing: the stuff you could voluntarily give to the tax man that would make the King find another excuse for throwing you into the dungeon. The gold standard did not change that; it simply gave the citizen a chance to make the same kind of unilateral demand on the government. It is hardly surprising that the fans of authority and "government" hate the Constitutional idea of money as Coin. How can you have a permanently elastic official debt if the citizens can ask for payment in something other than a different form of IOU?

However, Stef does have a point. Having a hefty cash balance is a wonderful gift; it gives you the time to figure out your next move. The sacrifice is the absence of leverage; the gain is having literally free time.

Scott Brooks comments: 

There are a lot of companies out there that take advantage of them and the bad advice they were given from their parents. Banks certainly do. Then you've got insurance companies and brokerage firms selling them crap products as well.

But that doesn't hold water in today's society with Suzie Orman and others like her being nearly ubiquitous on the airwaves and net.

These people live beyond their means. Plain and simple.

Yes, they lack education, but even with education available, they don't take advantage of it. They are just doing what they were taught as kids. For far to0 many of these people, as long as they've got enough money for their 1-2 packs of cigarettes/day and their quart of Jack/week, they go and live lives of quiet desperation, hoping that they don't lose their jobs and are lucky enough (i.e. like not spending money on stupid stuff is "luck") to pay off their debts by the time they are in their early/mid-70s so they can live out their remaining few years (if they even make it that long) on social security.

I know. I grew up with these people. I know how they think. But for grace of God (as was mentioned earlier), I might have been one of them. But for some reason, I was blessed with gray matter that works, and I saw the error of those ways, and I was able to get out.

Ken Drees writes: 

I knew a guy–lost touch with him over the years–who exclusively dealt with hairdressers and salonists. He sold variable annuities to them since these people had no retirement plans given to them from the salon owners. I believe in his mind that he was doing them a service–and I really do not know the quality of his products–but at a glance I saw them as mutual fund annuity hybrids that came from heavy fee fund families. He was a tall, dark and handsome gent and he would actually get entire staffs of salon ladies to invite him in after hours for a group meeting/financial planning discussion presentation.

He always said that business was brisk! 

Jim Sogi writes: 

When young friends ask me, how should I invest, I give them a simple asset allocation model based on ETFs or Vanguard and an averaging model. Invest x% of your paycheck off the top each time. Doesn't matter how much really.

Russ Sears writes: 

 Scott, since this is the DailySpec let us bring a little science into the discussion, even if it is social science.

Where we differ is not what is causing the hairdresser's problem. It is in what can be done about it that I differ. I believe you can coach people to delay gratification. I coached kids that never did homework before and got "D's" and "F's" during a summer and by fall the kid was an "A" or "B" student. You probably owe a hardy thanks to the coaches in your life.

Perhaps the greatest social science finding has been the "marshmallow experiment" done at Stanford. They did test on 600 4 year olds telling them if the child did not eat a marshmallow for 15 minutes after they left, they would get a second marshmallow. 1/3rd of them made the whole 15 minutes, a small percentage ate it immediately after the others had waited various amounts of time. They followed up on these kids several time in the last 40 years. Just about every way you can think of to define success was highly correlated with the time the 4 year old delayed gratification: SAT score, college/HS graduation rate, credit scores, long term committed relationships, contentment etc. And almost any way you can define failure was inversely correlated: jail time, high school.

The correlation was stronger than IQ, social economic status at 4 years old. In other words even the dumb poor kid that delayed gratification was happy/content/successful 40 years out. He may not be making much but he is happy with it.

For a humorous view of this experiment reproduced: Joachim de Posada: Don't eat the marshmallow! 

Sep

2

In the past six years, we have basically seen two phenomena in stocks: 1. etf growing use, and 2. share buybacks. My theory is that these two forces combine to totally drain liquidity from the stock market. The general downward trend in volume is the proof, also probably explains persistent small upward march of stocks, and the tendency for "corrections" to be much more like "flash crashes."

With one, we have something like robotic superfunds who accumulate mass quantities of stock and hold, rebalancing based on volume in the etf. With two we have drastic reductions in float.

A bear market in that environment will bring a certain violence and toxicity never seen before. Down days are almost forced to be large. So when we talk about a bear and months of down days, it will probably be something truly awful. Etfs will dump stocks on a reduced float market that is largely composed of funds anyways.

The size of the exit is determined by volume and float. Door is getting small…

Ken Drees writes: 

This article explains ETF mechanics well.

Almost as important for the ETF are the authorised participants, or APs, which act as marketmakers. The APs, most of which are banks, help to keep the share price of the ETF close to the value of the underlying assets. Imagine that one big investor in an ETF with, say, a 10% stake, wanted to sell its holding in a single day. There might not be ready buyers for such a large holding, causing the ETF to fall to a price below the value of the assets it owns.

To avoid this, the APs act to balance supply and demand. If the ETF is expanding (more people want to buy shares than to sell), then the AP puts in an order to the fund manager for a block of new shares, dubbed creation units, in the ETF. In return, it transfers a bundle of securities, based on the index the fund is tracking, to the manager (this bundle is known as the creation basket). If the ETF is shrinking (more people want to sell than to buy), then the AP sells creation units to the fund manager and receives in return a bundle of securities known as the "redemption basket".

The AP can also keep the price of the fund in line with its assets through arbitrage. The asset value of the ETF is published on a regular basis during the day; if the price of the ETF is higher than its underlying assets, then the AP (or any big investor) can sell ETF shares and buy the underlying assets. If the price is lower, they can buy ETF shares and sell the assets.

The AP can also keep the price of the fund in line with its assets through arbitrage. The asset value of the ETF is published on a regular basis during the day; if the price of the ETF is higher than its underlying assets, then the AP (or any big investor) can sell ETF shares and buy the underlying assets. If the price is lower, they can buy ETF shares and sell the assets.

So how might this process go wrong? One obvious danger might be the role of the APs. If they fail to make a market in the security, then the price could get out of kilter with the asset value of the fund. Alternatively, they might go bust in the middle of the creation or redemption process, which takes three days to complete. That might leave the ETF short of the shares needed to top up the fund (and match its benchmark) or the cash to pay its investors.

anonymous writes: 

Larry, your analysis seems reasonable. I'm curious if you or other folks here think the lack of liquidity applies more generally than just the stock market (e.g., in the banking and currency markets). See for instance:

"Into The ‘Dollar’ Run Now More Than Illiquidity?"

"Volatility As ‘Money’; Or Really Rising Vol As Anti-Money
"

Ralph Vince writes: 

And the fact that leveraged and short ETFs must move stock exponentially with a drop in prices. That is to say, the more the underlying securities in the ETF drop in price, the more shares must be sold and this is not — a a drop of 2d takes more than twice as many shares to be sold as a drop in 1d. This would seem not such a big problem except that it is likely to occur during times of vacuous liquidity. 

Aug

10

 Since the situation may well be worse than this data suggests, my question is how can China maintain 5% growth this year, never mind 7%. Or will the economy hit a wall?

Ralph Vince writes: 

It is not like our economy at all. Whereas we panic over QE this or that, there the government owns everything. It can go on forever.

Jul

31

 1. How many times have you taken a position in a market and had it moved against you, and then got out pursued by a debacle only to find that the market moved in your favor 9 or the next 10 days? Please quantify the situations and see if you can take the other side. Monday, July 24 spu????!!!!!

2. The Senator loves to find a market hitting a new x day low I believe at near the open and then going above some level (I believe the previous close or some such) as a great opportunity to buy. His Japanese acolytes took furious notes and wished to make him a national icon for this. How can it be quantified for individual stocks and markets?

Ralph Vince writes: 

#1 occurs ONLY when one has stops in the market of interest. Otherwise, it just doesn't happen that way– I am Cain (the market sees me, yes, me, there, in the shadows and trying to hide anonymously in the crowds).

I have to turn away, walk away in these situations, and look back at some as-yet unknown future point. "I'll be at the Coyote Motel, with it's missing light bulbs and wax bars of little soaps and the maids that never show. I will be eating cheese and day-old Reubens and watching the markets (now pointing with my index finger) and I will return when you can act like a lady."

May

23

 David Lillienfeld writes:

Last year, Tim Melvin posted a classic piece about Memorial Day. It brought me to tears then, and it did so this morning when I went through it again. It is some of the most eloquent writing I have seen about Memorial Day, and it's a shame that it hasn't received more notice outside of this site than it has to date—it certainly merits it.

Tim Melvin writes:

They call to you this weekend. From Flanders Field, from Normandy, Khe San, Gettysburg, Concord and Lexington, the Chosin Reservoir, from the hull of the Arizona, and from all the hundreds of thousands of resting places marked and unmarked they call to you. The call to you from the depths of the Pacific and the jungle of Asia, from the deserts of the American Southwest, from the fields and cities of Europe, from Cuba, from around the world they call you with a request this weekend. Remember me.

Remember who I was and the hopes and dreams I willingly laid upon the altar of the great American experiment. Remember that like you I was once flesh and blood and I gave that up to secure a portion of the American Dream and secure essential liberties at home and even for people around the world. You may not have agreed with the rational for some of the conflicts we have ensnared ourselves in over the centuries and I am not even sure I fully understood it. But our nation called and I answered. Liberty carries a price tag and I paid it for you. Remember me.

War is an idiotic human endeavor and I wish we never had to go engage in such a wasteful exercise. But at times throughout history it has been necessary for good men to take up arms to secure our freedom from tyranny and defends ourselves against expressions of pure evil and hatred. When such times have arisen I have taken arms and defended the freedom and liberty in which I believed and for which all humanity years. Remember me.

Do not remember me with tears and sadness. Pray solemnly and shed tears if you must but that it is not my preference. Remember me in a violent celebration of all that is America. Take your families to the seashore and frolic as man has done since we merged from the sea. Go out on your boats and go as fast as you can over the waves with the winds of a free land and a free people blowing back your hair. Fire up your grill and invite the neighbors up for food, drink and laughter. This is why I laid down my life. Not so you would cry for me but so you could enjoy your life and your family, your loved ones and friends. Remember me in the laughter and joy of being alive.

Hear me in the sound of loud music coming from a dock bar. Hear me in the growling of a stock car engine taking a green flag or the whine of Indy car hitting 200 mph on the backstretch. Hear me in the laughter of a child skipping in the surf or running through the sprinkler in the back yard. Hear me in the chatter of friends around a BBQ pit. Hear me in the swell of an orchestral pop concert on a wide meadow as the sun settle over the land. In all the joyous raucous noises of being alive, hear me and remember me.

 See me in the flag unwinding in the breeze. See me on the baseball diamond, the soccer pitch the basketball court. See me at the bar with my friends raining a glass to good times gone by and still to come. See me in the smile of your wife, your girlfriend or male equivalent thereof. See me in the hammock beneath the tree taking a slow summer nap. See me in all the moments and times of that make life special. See me and remember me.

Remember me best in living well. Think of me when you are passing around the steaks and steamed crabs. Remember me as you sip the cold gin and tonic in a sweaty solo cup under a shade tree. Think of me in the fisszt of a beer bottle opening, the fizzing of soda pop in a glass, the shaking of a martini, the pop of a cork, and the tinkle of ice. Remember me in the sounds of the party of life.

I do not want you to remember me in solemn sweaty ceremonies and pompous parades of politicians. You do not need to go to the cemetery to remember me for I am not there. I am at the beach, the ballgame and in the backyard. I am at the lake, on the boat and fishing on the riverbank. Do not remember me simply because I died. Forgetting to duck or being ordered to charge impregnable positions is a crappy legacy if you ask me. Remember me because I lived and I died protecting your right and ability to live and experience all the joys and madness that is life.

I am not merely a dead soldier who died in the service of his country. I am all the things that were made possible by freedom gained and protected. I am Mark Twain, William Faulkner and Hunter Thompson and all the words written by the geniuses spawned in the America. I am the music spawned among a free and talented people. I am Robert Johnson, Miles Davis Liberace and Ted Nugent. I'm all the great scientists and inventors that have graced this land. I am Edison, I am Feynman and I am Ford. I am all the great athletes born in the towns and cities of this nation. I am Mantle. I am Unitas. I am Jesse Owens and Jim Thorpe. I am every greatness achieved by this nation born in a sea of blood and protected by rivers of it over centuries. Do not mourn me for the time has past for that, but remember me.

Remember me for I am also the future of this great nation I died to build. Remember me as you live, as you build as you work and as your create. Remember me as youprotect my legacy from the charlatans, thieves and idiots who make up our political class. Remember me when you refuse to cede personal liberties I died for to those who have good intentions and bad ideas. Remember me when you take chances and reach for your dreams and ideal. Remember me when you refuse to participate in limiting freedom or opportunity based on skin color, sexual preference or genital make up. Remember me when you dream, when you achieve and when you celebrate. These are things for which I died and for which I would be remembered.

My voice calls to you today. Life, love, laugh dream, build achieve. Do this in remembrance of me.

Happy Memorial Day. Remember me.

Stefan Jovanovich writes: 

 Memorial Day used to be Decoration Day — the day when the graves of soldiers were draped in flags — and there was no official Federal date. In Gettysburg it was held on November 19, the day the cemetery was dedicated. In the South it was on various dates in the Spring. It was never, ever a day for speeches until the official South decided that the soldiers graves should be part of a general uprising to justify the Rebellion — the same political movement that gave us official segregation; at that same time - the late 1880s — the states began legislating official holidays for Decoration Day, they also made Jefferson Davis' birthday a state holiday. What we now observe dates only from WW II, and the date itself was fixed in the 1960s. It is strictly a Cold War ritual that has been revived for the war against unspecified terrors.

I hope Tim finds an equilibrium somewhere between thinking that everyone who ever died in uniform as a hero and believing war is everywhere and always to be considered the worst of all things. I hope everyone enjoys the ceremonies today. If I don't, it is not out of disrespect for what people have done. I don't like official remembrances for the same reason Grant hated parades; they tend, by their very nature, to be organized lies.

They allow the people in the reviewing stands to preen and they present a picture of order that is the very last thing that wars ever are.

The truth is that some wars are worth their awfulness and some are completely stupid. The people best qualified to judge are the ones who have done the fighting; as with so many other things in life, those who know the most are the very ones who don't say much. There are exceptions, like Professor Sledge:

"War is brutish, inglorious, and a terrible waste… The only redeeming factors were my comrades' incredible bravery and their devotion to each other. Marine Corps training taught us to kill efficiently and to try to survive. But it also taught us loyalty to each other - and love. That espirit de corps sustained us."

"Until the millennium arrives and countries cease trying to enslave others, it will be necessary to accept one's responsibilities and be willing to make sacrifices for one's country - as my comrades did."

anonymous comments: 

I differ…greatly.

I preface by saying I have not served in the services nor in a war.

Yet I've known many…young, naive or foolish men who have answered the call. Many didn't believe in the cause and thought their superiors to be idiots. Yet they stayed and fought. I respect and remember that loyalty, and buy dinner or drinks for them and their family when I come into contact with them. I do it out if loyalty and not guilt. They upheld their end of the bargain. The least I can do is acknowledge them.

These are not the she-men that appear to surround me, those who talk about shat should be done yet are never there to do it. They have loyalty to no one.

There are pieces meant to rouse the animal spirits and conscripted ranks. I felt Tim's piece wasn't a call to enlist as other pieces.

The generation of Vietnam castigated those who were drafted and required to fight. That double bind or catch-22 has always bothered me. There's a similar thinking in DC now, where you are encouraged to break laws and obey them simultaneously.

One if the primary social contracts is to take care of your own. Tim's piece echoed that sentiment. The Chair demonstrates it too, as do many on the list.

In the Catholic Church, there are many celebrations of saints. I have learned, not having been raised Catholic, that many saints were far from perfect. There was a similar idea in his piece. Monday isn't a celebration of personal perfection or success in war. As Tim writes, it is recalling the guy who once sat in the empty chair at our table.

Semper Fi et Ductus Exemplo. 

Ralph Vince writes: 

There is nothing more inadvertently dangerous than a young man.

There is nothing more potentially vicious than a woman on her own.

One must tread carefully around these. 

Apr

15

 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.

Jim Wildman comments:

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.

Russ Sears adds: 

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. 

Feb

13

 This article "14 Ways An Economist Might Say 'I Love You" seems appropriate for the day. Personally, I'll go with an orchid. No lines, no trumped up cost. (The line on 86th used to go from 2nd Avenue over to Lex before turning south for 1+ blocks back when I was living in Manhattan. And a dozen red long stems was $44. Ouch.)

Gordon Haave writes: 

The best move to make on Valentine's Day is the single red rose, presented elegantly. That way it looks like you put some thought into it to make it special when really you are just trying to save money.

Ralph Vince writes: 

But you don't just give it to her. Now, is where the REAL thought has to happen and the magic transpires. But most men can't figure that out.

anonymous writes: 

The technique I have had great success with is to engineer events so that it looks like I was not thoughtful, had no plan, forgot, etc. This causes a growing sense of letdown and frustration, which of course seems a counter-intuitive intent. The key is in the swing to euphoria that can occur from this low level. When it is discovered that rather than "forgetting", you had instead been very thoughtful and utilized foresight well in advance (the opposite of what had previously lead to her sinking feeling), the elation can be intense on the lady's part, which leads to a very solid return from the male perspective. I think in the markets, you often get this same euphoric reaction after a test lower has cleaned out the stops– nowhere to go but up.

Feb

4

 Here's a quick list of what I came up with but I hasten to add I know nothing about football.

1. Don't try to be tricky. The members are too enabled.

2. Slow but steady wins the race. Don't go from long to short in one day.

3. Stick with the drift. Bonds and stocks have a drift.

4. Be calm and steady. Stay away from exotic and barrier options and all prop things in markets.

5. Regression fallacy is ubiquitous. The last pass to Butler was good. Don't think it will work again.

6. Don't try to make money the same way two times in row.

7. Stay with the quants. You would think that sabermetrics would tell the right way.

8. Never force your opponent to hit a good shot. They set up a play that allowed Butler to reach it.

9. The cobbler should stick to the last.

10. Don't over strategize. Stick with winning.

anonymous writes: 

If nothing else (not being much of a sports fan), Monday morning analyses often emphasize (to me) the existence of the recency bias, or in wikipedian terms, the serial position effect.

The likelihood that the end of the game last night actually had one of the worst play calls ever is actually fairly low. I suspect that lots of decisions poorer than that one have been made in the past. Similarly, there seems to be a longstanding tendency that when the public is surveyed about their opinion of the quality of presidents' administrations in recent history, the current office holder nearly always is at one extreme or the other.

Ralph Vince writes: 

39 F Curl X-back up. Montana through that to win the 89 Super Bowl. The ball was on the 9 yard line with 39 seconds to go. It was a pass right up the middle, in the back of the end zone however, when the more obvious play would be to throw it right at the goal line, by the sidelines — that would have been much harder to intercept, and if you came up short, there was time to finish it. That up the middle pass left Cincinnatti time to try one last flailing attempt, but, most importantly, it is the kind of pass that led itself to being picked-off.

But no one second guesses the plays the worked, or the fact that every play mismanages the clock one way or the other. You never get top tick.

Andrew Goodwin writes: 

Point 9 of the Chair indicates that one should stick to what one knows. The "last" is a form that shoemakers use.

The Seahawks failed in not sticking to their "last." Their footmen were capable and the excessive trickery failed in the pass call.

The right play was run to Lynch on foot instead of to pass. Let the star who got you to the endgame be the one of who fails. You can pay him less next time even if you lose the game.

Point 8 contains the concept of never cornering the opponent in order to avoid his making a brilliancy. That encapsulates a wonderful ambiguity –Never answering but always provoking thought and sometimes provoking profitable action.

Dan Murphy adds:

It was, indeed, the worst play call in Super Bowl history for the following reasons:

1. The Patriots were almost certainly incapable of stopping Lynch from getting one yard if aligned directly behind Wilson. They were by some metrics, the worst team at stopping runs on 3rd or 4th and short this season, and Seattle the best at picking up those yards on the ground with Lynch. There was one key 3rd and 1 earlier where the Pats stopped Lynch in the Red Zone…but that is only because the backside OT pulled on the read-option and the unblocked DE (Ninkovitch) ran the play down from the backside. Straight ahead man-on-man blocking and there is little chance NE prevents a touchdown (maybe 25%) …give them two chances and the probability of success is probably over 90% (and there was a remote chance of a 3rd play with a quick time-out if the first attempt failed)

2. The explanation of “it was being done to run time off the clock” was as dumb as the call itself. An incomplete pass runs no less time off the clock than an unsuccessful run AND if the Patriots were desperate to stop the clock (it would have been running on a failed rush but stopped after an incompletion) they would have been forced to use a time-out (although seems unlikely that they would have called time-out given that they didn’t use one to stop the clock at :50 after the first Lynch run). What would have been a reasonable explanation was “We wanted to make sure that we had three chances to score instead of two.” At least there is some logic to this. With two failed runs and only one time-out, they might not have gotten off a 3rd play before the clock expired. By passing on 2nd down, they had the potential to throw an incompletion, fail by rushing on 3rd down, and then get a last play by calling time-out.

Regarding the throw itself ..as anybody who has watched a lot of Tom Brady over the years can tell you …the safest place to throw that ball is ankle high.. where only your guy can get it. The problem with that is Russell Wilson is 5'10? and therefore throwing in the seams can be dangerous from the perspective of tipped / batted balls. Throwing the ball between the #s from the pocket is his weakest point as a QB … yet another reason why this play call was a disaster.

Personally, I thought the Patriots were going to win the SB from the pre-season…finally Belichick had the personnel to play his kind of defense on a high level (for the first time in nearly a decade), although I’ll admit I didn’t feel too good about this prediction with 30 seconds left in the game.

anonymous writes: 

Caution: Professor Phil will probably disagree with most or all of this.

Even the very best major league hitter can only cover (at most) half the hitting zone for any one pitch. He can, if he is Altuve or Posey or any of the other dozen or so HOF quality current players, cover the entire plate side to side and 90% of it up and down (hence, "high" and "low" ball hitters) with his stance and swing. But, at the speed and spin that good pitchers throw, even with 20/10 vision and complete concentration he can only cover half the plate. So, the challenge for the hitter is where to look and, for the pitcher, to do a reverse Wee Willie Keeler. Sabermetrics "works" in the same way that the having a legal tender convertible to a fixed weight and measure of gold works; it offers a yardstick that is not political. Where sabermetrics fails is in the details of a particular contest; probabilities cannot forecast a game any more than the Constitutional dollar standard could predict the credit markets. 

Feb

1

Finance professors teach their students that diversification is the only "free lunch" they can get. Recently, I looked at eight market groups (period 1995-2014). High correlations within individual groups could be expected. More interesting is what is happening on a wider scale over time. I recall that media were writing around 2008 that the "free lunch" is gone and that all markets behave like one big correlated monster, like Dracula. Between 2007-2012 we could see increased numbers, but recently we moved back to the normal. I have attached a figure for the year 2014 (server did not allow more pictures - 100k limit; for those who are interested all data can be found here).

Ralph Vince comments: 

Correlations have NO relevance in allocation decisions — they are not only not constant, they don't address the relationship properly (as a copula does). Using the latter, one see the effect of those oddball days of immense danger, and can then craft their allocation strategy accordingly. Straight correlations tend to mask this.

Stefan Martinek replies: 

I agree Ralph. I like things balanced between equities, fixed income, currencies, and commodities. We can ignore Markowitz + half Chicago. But it is still interesting to see where we are now in comparison to history and whether things somehow degenerate.

Jan

23

All the testing I have done on stops indicates they work exactly as you would expect. They reduce risk and they also reduce expected return. Sometime they reduce the return to breakeven or negative in which case its better off just not to trade. In other cases they eliminate bankruptcy risk and allow for some return, but not the expected return you get without stops. It seems to fit right in with EMT, CAPM and practical ideas on markets regarding risk and return. If you are selling disaster risk, you expect to be paid for it.

Ralph Vince writes: 

Or, expressed in terms of their effect:

Total Return = (A^2 - V)^(Q/2) - 1

Where A = Average return per trade (expressed as a multiple, i.e. 1.0 + return)

V = Variance in the A's

Q = total number of A's

When stops reduce V more than they increase A^2, it pays to use them.. I suggest conducting tests on this, it is far more revealing (in terms of the distribution of the A's) then meets the (rolling) eye(s) when looking at the simple equation.

Jan

5

 For those with a bloomberg professional terminal, "live" bitcoin prices are now available. The symbol is XBT <CURNCY> <GO> … so we can now run all of those essential analytics.

But standing in the way of this analysis is the fact that the forward, interest rate parity, etc. pages are all blank. Because they don't exist….

VCCY <GO> is the "virtual currency monitor" page.

Henrik Andersson writes:

Rocky, I found a way for you to short Bitcoin. btcjam.com is a peer 2 peer Bitcoin lending web site. If you sign up under the alias 'RockyHumbert' I promise to help fund the loan provided you pay a decent rate….

Rocky's Ghost writes:

Rocky will be heading back to the Northwest Territory shortly, but before he departs, he wants to give a shout out and thanks to Henrik for what Business Insider ranks as the single worst investment of 2014. Bitcoin declined from about 800 to 314 over the course of the year (which is even worse than Rocky's daughter's Mattel stock which she owns for the "long run". )

If Rocky were going to make a similar bet for 2015, it would be to buy calls on UUP. Wishing everyone a happy and healthy 2015.

1. Trade with the trend.
2. Ride winners and cut losers.
3. Manage risk.
4. Keep mind and spirit clear.

Ralph Vince writes:

Interesting post indeed. I have no predictions for 2015, other than to put as much as I can behind my trading. As there is more than one way to skin a cat, in reading Rocky's Ghost's post (and I admire his market acumen as I do his physical self) I would amend his four points, most interestingly, as follows:

1. Trade as though the data is entirely random and fat-tailed (RG :Trade with the trend.)
2. Always be taking profits (RG :Ride winners and cut losers.)
3. Manage risk. (RG: Manage risk.)
4. Shake it - but don't break it (RG: Keep mind and spirit clear.)

Point #3 bears repeating.

anonymous writes:

Some Seykota additions:

#5. Follow the rules.

#6. kKnow when to break rule #5.

Dec

23

 American Exceptionalism. I have always hated that phrase and the perverse doctrines that accompany it. The American Constitution is remarkably exceptional; one wishes it were still followed. But the idea that we Americans were born or (equally bad) become endowed with some special grace is one that makes me look for the Exit sign in the hall every time I hear it.

It also reminds me of the disastrous presumption that infected so much of the period that Stern writes about and led to WW I.

Ed Stewart writes:

I notice that every time I start believing that I am an exceptional trader (like I did a few weeks ago), a large loss is near at hand. Best to curtail commitments at the hint of that feeling– the opposite of what the feeling suggests to do.

Gary Phillips writes: 

Success is more destabilizing emotionally than failure.

Ralph Vince writes: 

Failure is absolutely necessary–in fact, nothing is more necessary, in all aspects of life.

For one, it teaches the individual not so much not to do what caused the failure, but how to regroup, reassess and recover from failure. The lesson of failure is about what you do afterwards.

Many things in life require failure. No one learns, say, to lift a lot of weight, to solve a differential equation, or do a backflip on pavement, without failing many, many times. There is no may to accomplish many things in life without enduring the requisite and many failures required.

Jeff Watson writes: 

Failures teach you much more than successes which can lull you into complacency and hubris (like when you have 10 successes in a row). But you must attention pay attention to and analyze the failures inside and out. You have to ask yourself "why?". Ralph hit the nail on the head with his post.

Ralph Vince replies: 

The 13-year-old boy looks around the gym, struggling to lift pipsqueak weight. Failing.

I point to all the old smellies, putting up ungodly amounts of weight.

"You see those guys - every one? Every one of them failed at every increment, every 5 pound increment between what you are failing at and lifting what they lift and they failed at every increment over and over. That had to keep trying, eventually, sneaking up on it. Failure, repeated failure, is part of the process."

Dec

17

 In Codes of the Underworld: How Criminals Communicate, he mentions that since criminals find it very hard to communicate directly they often take their signals from vivid events and happenings like in The Godfather which is their favorite (by the way, Puzo had never met a gangster and wrote the book completely from transcripts). They adopt the language and the styles and the activities.

The top feeders in our field have a similar problem. They can't communicate their actions directly as they would be front run and also the public would not be able to weaken and succumb to give them good fills. So they wait for vivid events like today to do their stuff, first clearing the action to make sure there are no others around to intercept their messages. The horse's head was yesterday, but today FOMC was the massacre of bears.

Ralph Vince writes: 

The best bridge is played before the first trick is.

Orson Terrill comments: 

What about the ECB signaling that next year is when they'll stimulate. Was that a "FOMC, we know you're tightening to some degree soon, and this time we want to lag behind in the interest rate cycle, to get a relatively weaker currency"?

Nov

4

 I admit I have difficulties separating myself from the monkeys.

During trading strategy development, most of the time I have found that a 'good' strategy by many criteria can't actually beat out the performance of the random trades by monkeys. So the question is what constitutes intelligence? Is performance the sole criterion that separates intelligence from non-intelligence? If not, what else? What can make me say, "ok monkeys, I can't beat you in performance, but this thing makes me much more intelligent than you"?

Marion Dreyfus writes: 

Monkeys' investments are hypothetical; no one has really actualized this hoary supposition. Your trades are measurable and real.

Et voila la difference.

Ralph Vince writes: 

Because you think too much.

No joke.

You look for an "edge," i.e. an asymptotic probability weighted mean that is > 0.

The monkey - he doesn't. He does not posses that great big brain that leads him to believe in the delusions (see previous line) that you do.

He is only concerned with a finite time horizon, one play (get the banana! Don't worry about the small probaiblity of a chock, get the banana), in his case. You, on the other hand, have used your big brain to lure yourself into thinking you will be around tomorrow, something you take for granted.
 

Oct

7

If you're working a limit and miss the fill by 1//2 a point, and you then go to market when it's 5 away so to get the position on, the price will hit your original order limit. And of course if you don't go to market, you'll miss the trade of the year. You can put your lunch money on it.

Ralph Vince adds: 

This comports to one of a family of distributions named after Maurice Tweedie , who classified a group of distributions, incl. Pareto, as comporting to:

Variance(x) = a * ExpectedValue(x)^p, where the constants a>0 and p>=0

The various distributions that are classically known occur at certain values for p (e.g. p==2 for Pareto), which is of no consequence but what IS of consequence is that this basic form is where we see so much occur in so many events market-related, insurance-related, weather-related, etc.

Oct

6

 So much–once again–for moneyball.

Kansas City-9

Oakland-8

Ralph Vince writes:

Baseball is certainly a game where you truly need at least a 7 game series to determine who is the better team. Unlike, say, football, where in most games, the better team wins, that margin is much, much smaller in baseball, given the nature of the game (truly, a game of inches…and bounces…and breezes, and tiny margins that decide the day).

Don't take my word for it, however. We can compare major league baseball, to say, basketball, where the percentage of time the better team wins, given the nature of basketball vs baseball, is higher than baseball. Here is the data for all 7-game playoff series from 1905-2013:

1905 - 2013

Series Baseball Basketball

1-0        62.7     77.3

2-0        82.7     93.7

3-0         97       100

2-1        71.1      82

3-1        84.6     96.3

3-2        69.8     85.9

So, series 3-2 we see that in baseball, the team that is up 3 games to 2 games has taken the 7-game series 69.8% of the time vs basketball's 85.9% of the time. Clearly, basketball dominates baseball in this metric, and further evidence that the outcome of any single baseball game reflects who the better team is less frequently than most other sports.

Stefan Jovanovich comments: 

In baseball the "best" team is the one that actually wins in the post season, not the one that has the "better" stats during the regular season; that is, as the coach said, "why they play the game" and why the game, which can be counted so easily, still eludes the precision that sabermetricians have promised.

What makes baseball relentlessly unfair is that the advantage that "better" teams usually enjoy - home field - counts for the least. Of all the major sports, baseball is the one has the lowest "home field" advantage - 52-48. What makes the game doubly unfair is that the "inches" even out, just as they do in the racquet sports; and the referees cannot easily, as they often do in football and basketball, decide the game.

For those of you who have not read Moneyball, the reason for my snarky reminder of the final score (Kansas City-9, Oakland-8) was that the Royals won the game by doing precisely what Master Beane has argued against - they stole bases and sacrificed - and the A's got their 8th run by doing exactly the same thing.

Sep

15

 Shades of Galton….

Excerpt:

In his fourth-floor lab at Harvard University, Michael Desai has created hundreds of identical worlds in order to watch evolution at work. Each of his meticulously controlled environments is home to a separate strain of baker's yeast. Every 12 hours, Desai's robot assistants pluck out the fastest-growing yeast in each world, selecting the fittest to live on, and discard the rest. Desai then monitors the strains as they evolve over the course of 500 generations. His experiment, which other scientists say is unprecedented in scale, seeks to gain insight into a question that has long bedeviled biologists: If we could start the world over again, would life evolve the same way?

Stefan Jovanovich writes: 

The absence of time's arrow is fascinating. The "fittest" compete in a world where the rules are constant and invariable - "meticulously controlled" - while everything we know says that the rules are always changing in ways that even we brilliant humans fail to predict. Still worse for the purposes of experiment, the rules sometimes instantly and violently, even as they obey all of our entirely predictable laws of physics.

Ralph Vince comments: 

This has nothing to do with "fitness," and everything to do with randomness.

Take X scenarios. At each discrete point in time, they branch into one of these X scenarios, such that after Q discrete periods, you have X^Q branches.

Your "expectation," (not in the classic sense) is the sorted median outcome (whereas the classic sense expectation is the probability weighted mean outcome, and I contend that in the limit, i.e. as Q->infinity, they converge *).

About this sorted mean outcome (at QP0, in the paper this thread pertains to) there is a vast region of similar-outcome branches. It sounds to me as though this experiment has lass to do with evolutionary "fitness" and more to do with artifacts of expectation in finite time.

I am working on a proof of *, but working on it with respect to continuously-distributed outcomes (as opposed to discrete "scenarios") as well as continuous(though fininte) time, rather an discrete increments of time to Q.

It is a struggle.

Mr. Isomorphisms adds: 

This may not be what you're looking for in proving *. But the other day I worked out that you can exploit the "soft max" identity (seen in tropical geometry and elsewhere) to get analytic formulae for the median, third-from-top, etc. (only with log base ∞) which might get you where you need to go.

max = log_t ( t^a + t^b + t^c ), t going to infinity

min = log_t 1/( t^-a + t^-b + t^-c ), t going to infinity

second_max = max( {a,b,c} - max({a,b,c}) )

With recursion you can get all the way to the middle. (Now since we've turned the median into a continuous function we can take derivatives, which I haven't simplified or played around with since I realized one can do this. But I don't think that relates to your * — just hoping the method would.)

Steve Ellison comments: 

Regarding Shane's original question, yes, there is a phenomenon known as evolutionary convergence. Isolated areas with similar conditions often have similar life forms that developed independently. For example, cacti originated in the Western Hemisphere, but there are plants that originated in Eastern Hemisphere deserts that also store water and have spiky exteriors.

Gary Rogan writes: 

Clearly there are niches in the environment, just like there are in the economy, the market, the arts, sports, etc. It seems self-evident that a species that thrives on a Pacific island is likely to be different from a species being able to survive in the Arctic or at the bottom of the ocean. Not having "a single, cannibalizing species inhabiting the planet" only speaks to the niches in the environment not some complicated problem with evolution.

Ralph Vince adds: 

Perhaps we DO, in effect, have one, cannibalizing species, depending on how broad the field of view of our lens of examination.. How many animal life forms on the planet have but one eye? "Evolution" having eliminated that not-so-robust construction in all earthly environments. Is our notion of "species," which we believe to exhibit a vast array of life forms, only show us carbon-bases life forms with, at most, five senses. In that sense, is a penguin so much different from a scorpion from a human being? The notion itself of "food chain," with such biochemically similar life forms, is, in effect, an exercise in cannibalism. 

Gary Rogan writes: 

Since the evidence points to life arising or being successfully introduced to Earth just once, it's not surprising that we only have carbon-based life forms. And just because a scorpion shares a lot of genes and proteins with penguins doesn't mean they are of the same species, simply based on the definition of the word: to be so classified they'd have to be able to interbreed. I'm now no longer sure what the point is, but hopefully "descent with modifications" is not in question.

Ralph Vince clarifies: 

My point simply put, is that I don't find "evolution," or "Survival of the Fittest," an adequate model, i.e. a panacea for how life arose and differentiated (to the restricted sense that it has) on earth. I find it too simplistic of a solution, believe there are likely many other explanations (all of which are, in a limited sense, true, similar to the wave/particle properties of light) and am interested in any other explanations (there is not a debate here, aside from one which I don't believe you ascribe to of "Fitness" being an explanation for all life on earth).

For example, (to the best of my knowledge) every living thing seems to fit somewhere into the food chain. Perhaps there is an overriding-yet-undiscovered mechanism requiring this as a license for life on earth? (And if not, why not? A stupid question, unanswered, is still an unanswered question. I believe evolution seems to explain so much that we use it to explain where a different mechanism may be the driving one, yet, occluded by the seemingly-obvious-to-us explanation of "fitness"). Evolution is a powerful explanation, but it does not explain everything.Not that I have a problem with "fitness" as a driver here — clearly it is, so I am not at odds with you there (though I am not so sure life was introduced on earth only once, again, viral and fungal life is a difficult leap from living cells). So I simply wonder of what other driving mechanisms are at work here that we are unaware of.

Gary Rogan writes: 

Ralph, as it's generally hard to prove a negative, especially in open-ended complicated situation, I can't argue that there are other forces at work. As for fitting somewhere on the food chain, all carbon-based life forms eventually get weak and if not eaten at that point die. Weak or dead concentrated proteins and other valuable chemicals present too rich and too easy a food source not to be consumed by something, so this particular point doesn't instill a sense of wonder in me, but perhaps there is more to it than meets my eye.

We should keep in mind that on the average over any appreciable number of generations every existing species or otherwise categorized collection of biological creatures has almost exactly one descendent per individual, otherwise within a short span of time the group's mass would exceed that of the planet or conversely disappear. Therefore available resources present arguably the highest hurdle on the success of species, but as Hamlet said, "There are more things in heaven and earth, Horatio, than are dreamt of in you philosophy."

Ed Stewart writes: 

Speaking of the food chain, I think the concept of the tropic level has some serious application to the markets, as I the chair documented in his first book. Might be particularly good model to analyze the impact of various stimulus measures - what level the stimulus directly stimulates, then who feeds on that level directly and indirectly for investments opportunity.

anonymous writes: 

There are no marsupials above the Wallace Line above Australia. Below there are the myriad odd and strange life forms in Australia. It was a function of geology creating distinct eco zones and separate paths of development of life forms.

Sep

2

 How many of the rich were in the lower quintiles like What's App which recently sold for 18 billion to Facebook and the owners were on food stamps the previous year. Is that bad for a society to provide such opportunity and for the mobility between classes to increase or should we be like England where once you're in one class you can never move to another.

Richard Owen writes: 

I am unsure if its really true that class barriers exist to any greater degree in the UK than the USA, other than perhaps in the mind or money of the classes themselves. A bit like Mr. Cosby's riffs to African Americans: don't perceive barriers for yourself. As my friend staying at the Knickerbocker club and being variously harassed for his attire, decorum and guests the other week reported "a certain strain of New Yorker could surely teach the British a thing or two about snobbery." Sure, we have a Conservative government with a disproportionate number of Etonians in it, but when one becomes Prime Minister, one tends to reach for trusted friends and fellow travelers. And being an Etonian is not a vote enhancer. Annunziata Rees-Mogg was asked to reframe herself Nancy Mogg for the purposes of election PR. The USA does not seem short of its own political dynasties and classes.

Ralph Vince writes: 

The chair's example of WhatsApp I believe is the exception more so than the rule.

The churn at the higher stratas sees parties leaving unexpectedly. Those arriving, arrive slowly, believing they will be there forever.

Vast sums of money are lost in a day, a minute or the blink of an eye. You see this principle play out at the baccarat tables and the markets. The new arrivals, the beneficiaries of money-begetting-money for protracted periods, often generations. 

Mr. Isomorphisms writes: 

Regarding the very long timetables, I admired both the diligence/ingenuity of Gregory Clark and The Economist for publishing that the surname "Micklethwait" has enjoyed a run of good luck, when its chief editor is John Micklethwait (graduate of Ampleforth College, and later Oxford). Miles Corak also earns a mention in that Economist piece. A short list of Americans from expensive high schools includes Dan Ellsberg, Charles Coker, Thruston Moore, Glenn Close, Adlai Stevenson, Cosma Shalizi, but not Dan Einhorn. 

Stefan Jovanovich adds: 

If you do any serious searching of genealogical records, you discover 2 things:

1. Longitudinal searches of census data by county locations, including the immediately adjacent ones, show limited "social mobility" because the people who stay where they are born and whose children stay there are largely content with their lots in life. This is one reason America scores better than Britain in the 19th century; the people who stayed in Britain were ok with their lives where as, in America, nearly everyone was moving around, even if many of them eventually came back to "home".

2. The people who leave are the ones who become very rich, by local standards, or flat broke or need to get away from the law. The very rich tend to move to the places where they can be with their financial equals (so the Rockefellers abandon Euclid Avenue Baptist Church and become Episcopalians in New York) and the flat broke know they have better chances getting help from distant relatives than from local ones (a great deal of the Northern migration of freed slaves and, even more so, their children follows that pattern). The need for people to get away from the local sheriff hardly needs explanation.

The Harvard study deliberately ignores #1 and #2. "We assign children to commuting zones based on where they lived at age 16 – i.e., where they grew up – irrespective of whether they left that CZ afterward." The study also makes no adjustments for relative costs of living as a discount factor in gauging incomes. A child who migrated from Charlotte to San Jose gained 50% in gross income during the study period; but he or she gained no wealth with the added income compared to a child of lesser social mobility who stayed back home.

There is one other fact of human nature that you learn from reading the ancestry searches people have done: Everyone with any pretensions finds a way to trace their ancestry back to European royalty, even if the parish records stop 300 years or more before the connection is made.

Aug

4

Crossing I-10 to the South is a most liberating sensation.

Jul

31

 Birds of a feather flock together includes people and dogs. Today a young Utah tourist, part of a new American wave to strike paydirt at the ayahuasca mecca of the world in Iquitos, Peru, was surrounded by four grimy youths flashing knives at his breast and throat. The scene was at Gang Corner where I've been attacked on each seven previous nights at the same hour. My assaults have not been by uprights, but by dogs dressed in the local people's clothes, with snapping canines in the yellow lamplights. The Salt Lake man had just stepped out the tenth annual International Shaman's Conference at a ritzy hotel at 11pm and walked a hundred steps to Gang Corner, on the fashionable Rio Amazon malecon, when the knives flashed. The waterfront Belen youths surrounded and demanded his knapsack, knowing it contained the tourist's valuables of camera, laptop and maybe a few dollars. They would be surprised to discover the victim's U.S. passport.

Why hadn't I been robbed at the same corner at the same time by the same two-legs gang? Perhaps the snapping circle of dogs each night dissuaded them, but more likely they knew the exact hour the Shaman's conference dismissed and lay in wait for the first unsuspecting tourist. Having a passport stolen presents a Catch-22 of needing to prove one's identity to a U.S. Consulate, and coughing up a hundred bucks without credit cards that usually accompany the theft, as well as paying for two weeks hotel in wait (unless a harsh expedite fee is paid). Since the nearest embassy is in Lima, the Salt Lake man went to the airport today in hopes of boarding without identification, and then 'throwing his feet' in Lima on the Consulate's doorstep. Fat chance.

This poor man's misfortune was my stroke of luck, and I took the tip to the police station. I must find an equalizer. This is because I must walk past Dog Corner nightly from the last day's activity here at the Cyber internet to my hotel. The sycophantic policemen urged me to take matters into my own hands by purchasing a $20 mace spray that shoots a 15' stream like a squirtgun that will 'stop a charging beast'. They instructed to aim for the chest, not into the wind much like a urination, and the spray will splatter and dispense temporarily blinding and inducing respiratory distress. The recipe is tear gas and peppermint. Then, they smiled, bring the predators turned prey to the cop shop and they'd beat them for a song. So, I got the mace.

An equalizer is required whenever a smaller person faces a larger, or armed, or group of thugs. During twenty years of world travel I have never carried a weapon for two primary reasons: it ups the blood ante of any altercation, and it cancels the mental rehearsal of the manly art of self-defense. My former equalizers have been fast shoes and quicker hands, with a swifter tongue. However, now I required something more concrete at Gang Corner. The ordinary doorstop on skidrow hotels is a baseball bat, in Manhattan the world squash champ used to jog through Central Park at midnight brandishing a squash racket, I would prefer an oversized modern racquetball racquet for the lighter swing weight, on the rails the standard is a 7" railroad spike, but now the answer was protective spray. I can take it in checked luggage to USA where it's also legal, yet in California the net weight must not exceed 2.5 ounces. A squirt reaches twice as far as an arm and knife.

The reason for my concern is that if I get stabbed it would be more hapless than the Salt Lake tourist. The protocol is that the foreigner is taken to a hospital, he is patched, but not allowed to stay if he cannot afford the bill, and on leaving is met by the immigration police to check documents and explain why a tourist can't afford a hospital stay. I couldn't pay it because of a defaulted loan before this trip to a former acquaintance. The mace is an insurance policy tonight, as I venture out to Gang Corner.

Ralph Vince writes: 

Weapons & Women….

I like the idea of a mace-style spray like that. First off, regardless of whatever anyone thinks they are capable of in terms of defending themselves, one thing is for certain, when there is more than one assailant
– and absolutely when there are more than two — you need a weapon (personally, I carry at least two anywhere, depending on the local laws as well as the context. A genteel dinner party is different than a late-night, city walk. Everyone should carry at least two, non-redundant weapons).

One of the main concern with any weapon is its range. A rifle ught be good at 100 yards or longer, a handgun from 40 feet on in. A knife, only out to about arms length (but deadly in that range). Some weapons have to be swung (bats, tire irons, batons, etc.) meaning they have to be moved in a plane
– get outside that plane and you're safe, and the plane is almost always primarily vertical or horizontal, and with a very finite range. Not only is the far extent of that plane finite, in close it is of no use. So an aluminum bat might look very imposing, but sternum-to-sternum, it's quite useless as well. The sooner you can get sternum-to-sternum, or out of the plane of that thing, the sooner you can stuff them with it or be high-tailing it away (In fact, any of these swinging-style weapons are a poor choice becuse they are plane-restricted, have a finite range in both directions, have to be chambered, etc. They do not hide well, and you can usually be quite certain any loogan carrying such a weapon has only THAT weapon. When you see the guy on walk with the golf club to fend of a loose dog, you can be quite certain he is, for all intents-and-purposes, unarmed).

Spray, is like a gun the the sense that it's range is beyond the reach of your assailants arms and legs, and works sternum-to-sternum, and hides well. It's a nice weapon provided you have something else you can get to from any practically any position.(I onceu asked a postman, with sun-cragged skin from too many years of Florida delivery, if he ever had to defend himself against vicious dogs with the can of mace at his side. He mentioned how it works well against bees in the mailbox, and vicious dogs but that you "Gotta get it right in their eyes." Maybe spraying the chest works with people but I'm not so sure about dogs!)

As we get a little older, even though we may think otherwise, we ar arme a LOT slower than a young person, andwith far less wind than a young person. The best young person fighter can perhaps take on two at once — someone older, beyond more than one assailant, you absolutely must have a weapon to have a chance. In other words, when you know you are going to be accosted by more than one person, make up your mind that they are going to be needing an ambulance here. It's SO much easier when you really WANT to hurt someone in those situations.

The most important thing to remember when being confronted by more than one assailant is that nobody really wants to be harmed. You want to plant in their mind that there's a chance things may not go right. Put some doubt in their mind that they may not get away without harm. The only reason people do bad things is they think they're going to get away with it and not be harmed. So how do you do this? They are reading your body language. They are checking you out to see if you can defend yourself — specifically, to see if you're tuned in to what is happening and if there's a reasonable chance you might hurt them.

So don't look to intimidate, and don't get all huffy & puffy. Make eye contact (You are not making eye contact, per se, but rather looking at their sternum. Solid eye contact is a challenge and you are not in as good a position to "see," specifically their lead foot which will always, ALWAYS move at you when the go to grab or strike you) with your potential enemies, in a non-emotional manner.

Marion's remark is very wise. Just as I take the incandescent light for granted and the flush toilet, so too do Western women very often (because we are accustomed to) take their individual safety for granted in an historical context. We have come to assume that is how things are when in fact, this is reltively new in human existence, and hasn't yet reached many parts of the world. When you're with a woman in a bad situation, bad people are MORE likely to come after you (a woman with you is akin to your being a wounded animal in the wild — it is viewd as an impediment to your being able to effectively defend yourself). You have to be more prepared, more ready to hurt people who are a threat in those situations.

A woman who is armed has at least a chance of inflicting harm and getting away if unaccompanied. The best situation, is to be accompanied and armed as well — Bo's idea of mace is a great weapon in the battery of weapons someone ought to have.

Marion Dreyfus writes: 

When I was traveling solo in Peru, I frequently chafed at having to stay in after dark if I did not have a bunch of fellows to go out with, since I never usually call it a day until it is very very late, especially when I am a-traveling. One time high in the hills, I asked a few men I vaguely knew if they would accompany me out for a late look around the town. All were tired and did not want to risk a strange place at night.

One woman thought us silly, trying to find compadres for the walk. An attractive 20-something, she took her backpack on her back and left for her own town investigation. She returned in an hour, a wreck, crying hysterically, her clothes a mess, her hair disarrayed, dirty and unconsolable: She had been accosted by 3 or 4 men, her backpack was taken, her passport and all her money was gone, and she was fortunate she kicked up enough of a fight not to be raped. She spent the next days desperately trying to get her passport replaced, not doing anything else in Peru.

I was glad that I had not ventured out alone that night. Later in the week, I rose very early and flagged a small cab, directing him to go further up the mountain. I wanted to check on a statue that someone had pointed out to me, one he said had been given by muslims to the town in gratitude for something or other in the early 1940s. We went to the statue, 6 am, as the sun was rising, and I studied the plaque at the foot of the statue, though it revealed little that was of use to me. I reboarded the same taxi and returned to the hotel/inn, before most people had even risen for breakfast.

But traveling in such places, if I am not with several men, I do not venture out. All well and good to be a tough and adventure-seeking female, but the rest of the world does not necessarily appreciate our independence: They read a female alone as an opportunity for free money, free unbidden sex, and free harassment fun. Or worse.

One of the reasons I canceled my trip alone to Yemen, where women have simply disappeared if they did not travel in a dense group.

Jul

3

 I've spent the last week in Sacramento, and the week before that in San Francisco. Two things caught my attention that seem like ticking time bombs no one is talking about: sub prime auto (and other non-mortgage) loans and interest rate resets on mortgage rate resets from 2010—leading to lots of houses about to be foreclosed on. I heard a bit about these two from individual perspectives. I don't know, though, how large these two may be. Anyone know how big the sub prime auto loan market is now?

Victor Niederhoffer writes: 

In my 55 years in wall street, there is always a month when there is something bad happening. From 1954 to his helpful passing for those who refrained from buying during his incessant and invariable weekly bearishness, one can merely look at the king of pessimism's column to find the bearish thing of the month– a very helpful thing for the bulls as it creates unnecessary fear and selling. After his passing, there was our friend the bearomoter who consistently found bearish things. This will save one from having to look through every days newspaper which I'm told is much easier now that you can look at it in the net and don't have to use microfilms any more, although I have not had the pleasure of doing this yet. However, Doc Lilienthal often has very helpful pessimistic things he's noticed, and the ticking time bombs mentioned above are a helpful substitute for the bearomoter with the elegant equestrian partner.

Gary Rogan writes:

But overall it seems like examining any individual piece of news, positive or negative, is pointless with respect to predicting the future market direction.  If it's out, it's already in the market, and the vast majority of them are too small to affect the market in any predictable way anyway.  Certainly something that is known by someone will affect the market, but knowing what it its among the thousands millions of candidates doesn't seem worthwhile.  The good doctor seems to have an idea that the market needs an excuse to do something.  I don't know if it does, but short of a sudden outbreak of a major war that one can't predict anyway or some well-known employment of Fed news that everyone knows, it seems pointless to look at news as a guide.

Ralph Vince writes: 

I would point to any short which shows US Equity prices and US recessions, and I would argue that US GDP is relevant when it is contracting for multiple quarters, and we should bear in mind the 1st qtr predictions, none of which were as negative as the final number came in at, and consider we have second quarter preliminary right around the quarter.

anonymous writes: 

Auto loans are not backed by the feds, while most home loans are, thus I expect fallout from the sub prime auto loan market will not get the same attention in the media or in Washington that home loan foreclosures will get.
 

Jun

4

The Mankiw Model has a great history for predicting where the weekly fed funds rate should be, using inflation and unemployment (two inputs which have enjoyed a tremendous track record in trading short-duration rates for many years).

The model started going off the rails about two months ago, and now calls for fed funds, currently at .09 to be at nearly 2.00. The data is on a tab in the weekly Barrons data I track in excel for on my website under the "links" tab there I believe. The tab on excel is found by hitting the F5 key.

anonymous writes: 

Ralph, I could not get the link on your website to work. The Mankiw model (from his blog) is reprinted below for interested readers:

WEDNESDAY, JANUARY 11, 2012

The Liquidity Trap may soon be over.


About a decade ago, I wrote a paper on monetary policy in the 1990s (published in this book). I estimated the following simple formula for setting the federal funds rate:

Federal funds rate = 8.5 + 1.4 (Core inflation - Unemployment).

Here "core inflation" is the CPI inflation rate over the previous 12 months excluding food and energy, and "unemployment" is the seasonally-adjusted unemployment rate. The parameters in this formula were chosen to offer the best fit for data from the 1990s.  You can think of this equation as a version of a Taylor rule.

May

28

 To what extent can Pascal's principle where a change in pressure is transmitted undiminished to all parts of an enclosed liquid or gas system, whereby a small change in force on a narrow area can move a much larger force on a larger area as used in car lifts or construction machinery, be applied to markets in certain situations? Is this a useful question?

Stefan Jovanovich writes: 

The Chair has asked a question that I cannot answer so I will add to my stack of irrelevant comments. What is called the Industrial Revolution was neither. Metal working and large scale enterprise were not new things. The Arsenal at Venice and the Royal Navy's yards with Brunel Sr.'s block carving automatic lathe did not need the "invention" of the steam engine. It was the discovery and application of the paradoxes of fluid dynamics that created our modern world — first steam, then gases and liquids generally.

Gary Phillips writes: 

Mauboussin likes to talk about the market as a complex adaptive system and critical points where large scale reactions are the result of small scale perturbations, the implication being that causality can be difficult to identify because it is often very subtle.

Traders tend to focus on multiple and ubiquitous agents that may not drive price, but do support their directional bias, while ignoring potential outcomes with low probability that may be driven by hidden or obscure agents. Same with systems with too many degrees of freedom and over fitting.

Gary Rogan writes: 

I often think of the market as a Pascal system or a school of fish. How do all the stocks know to move the similar direction?

Ralph Vince writes:

In the context of fluid dynamics, Gary's question leads to the (near inescapable) conclusion that the movement of stocks prices, in this context (with an isomorphism to 3D space of the varioius stocks) is characteristic of the flow WITHIN the de/compressing cylinder itself, under varying states of compression at varying times.

A study of hydraulic flows would show that fluid flow within the cylinder itself is not uniform, and is also a function of various degrees of pressure.

From this we could create such a model.

Gary Rogan responds: 

It is kind of like that, but it's almost like there are local agitators within the cylinder. This morning provides a perfect example that I can see in my own stocks. Some joint venture news in MDLZ, one of the Kraft spinoffs has provided positive agitation to the food stocks, and more so to the specifically beverage stocks, and less so to the consumer non-durable stocks. This agitation is somewhat sticky in that when the market first rose for whatever reasons and then fell likely on Yellen's remarks, these stocks seemingly have experience a smaller sensitivity to the market had the important news not occurred. It's like a decompressing cylinder with small local explosions/collapses.

Ralph Vince adds: 

 Matter in the expanding (i.e. decompressing) universe may be a better model?

But it still boils down to a feed back loop where the output of one becomes the input for the next ( in one case amplifying and in the other dampening).

Gary Rogan writes: 

That's an excellent analogy and something I've been reading a lot about! It's not perfect but likely productive.

Immediately after the Big Bang the small world was pretty uniform. But then quantum uncertainty fluctuations have added a small pattern to the Universe that was the progenitor of what we all see today. In addition sound-like wave resonated within the Universe leading to the spectrum we still see in the microwave radiation today. Gravity has dramatically amplified the initial quantum fluctuation leading to the truly observable local pattern of galaxies, stars, and planets. And of course all the following star formations, collapses, and explosions created all the heavy elements as well reshaped the local structure of galaxies. Plus there is all the dark matter and dark energy (dark pools?) that exert gravitational and expansionary forces that can only be guessed at by their effect.

Craig Mee writes:

From the back benches, I think the problem may lie in measuring the change in volatility, since under no news conditions, the environment may be ideal, for example, after news releases in Europe mid morning before the states come in. After that though, it may be difficult to separate cause from effect. 

Jim Sogi writes: 

Might a small amount of money pouring into something like gold or oil or wheat move the entire market? The canary principle might be at work rather than Pascal's causal function, and there may be a lag, complicating the relationship.

anonymous writes: 

 The use of finite-volume methods in sell-side modelling suggests it is a useful question. Market cap is a "squishy" concept of volume, as it can change when prices rise and fall. Book value is less squishy but still far from rigid.

Imagine a directed graph of trade flows among several companies, forming a trade network. Suppose there is a bottleneck somewhere. Destroying this link might be more disruptive than destroying other links.

My father used to talk about one of his coworkers who whirled about his organisation with fingers in every pot. This individual did much more than his job description suggested. When he left the organisation many projects across departments floundered.

The Allies' North African campaign of WW2 was meant to attack a "pressure point": Rommel's petrol supplies. Paraphrasing ER: "The bravest man can do nothing without guns, the guns can do nothing without ammunition, and neither guns nor ammunition are mobile without petrol."

I would also use the metaphor of joint-locks in jiu jitsu. Consider the manifold of configurations of your opponent's feet, knees, hips, shoulders, elbows, wrists, fingers. Applying pressure (vector) to the wrist and fingers in most of these configurations will not move the opponent's feet or hips. Joint locks find the configurations where a small force in precisely the right direction will cause the opponent's feet and hips to move a lot.

Saving the geekiest example for last: in George Lucas' fantasy world, certain Jedi Consulars are able to, with sufficient meditation and magic, see "shatter points" in a situation–precisely the kinds of vulnerabilities that will spread and multiply force to a wider area.

May

26

 I'm reading one of the best training books I've ever read for training for endurance sports, which they define as almost any sport lasting more than two minutes. Training for the New Alpinism: A Manual for the Climber as Athlete House, Steve, Johnston, Scott. They draw on many studies from high level Olympic athletic training and physiology.

Technical physiological detail supports their theory. In a nutshell to train for endurance sport, duration as opposed to intensity is key. Building up an aerobic base where you can exert yourself without hard breathing is key to to building mitochondrial mass, capillaries and appropriate ST muscle fiber which builds endurance. High intensity is not a short cut, and can lead to a decrease in endurance and performance. Cross fit is an example of high intensity.

There is no shortcut. It takes long hours building a base for endurance. The effect builds over years.

Larry Williams writes: 

I would add to this discussion that endurance does not win races. The winners are the fastest runners, skater's bikers, etc.

When the marathon running aspect of my life began I was doing 100 miles a week, ran 50 milers and all that but could never qualify for The Great Marathon; Boston, as I had to post a 3:25 at a sanctioned race to qualify. I was then running 4 hour marathons, and while I could run all day that was not enough.

Once we began doing speed work on the advice of a Kenyan runner who, while running with I asked, "What do I have to do", was given the simple answer, "run faster".

So off to the track we went for speed work and that on— top of endurance— got us to 4 Bostons, one with Ralph V.

There is a difference between completing a race, triathalon, etc and wining. Winners are fasters and work very hard to gain speed.

Seems like this applies to the markets in some fashion but I'm too slow to put that all together.

Anatoly Veltman writes: 

We're always taught that staying in the game is the key, because that's your prerequisite to catch the once-in-a-lifetime move. But then again, ascribed to palindrome: it's not whether you're right or wrong; it's how much you have on when you're really right! 

Larry Williams adds:

It's that delicate balance between spend and endurance– above average performance and staying in the game— in our game it seems. At times I have had speed in trading, competition, and like all in this list we have endured, but getting both at the same time still eludes me.

Buffet only has endurance.

Anatoly Veltman writes: 

I don't think Buffet only has endurance. He'd been given valuable chunks on silver platter.

Gary Rogan writes: 

 It seems like being given valuable chunks came after 1990, when he was already a billionaire. He made his first million in 1962, and a million was worth a little more back then. Perhaps someone has the goods, but it doesn't seem like he built up his fortune early on on anything but taking advantage of available opportunities. Early on the opportunities were not flexionic, but later on they got to be that way more and more. He will do or say anything to make a buck, but was he given or did he take what he saw?

As for only having endurance, it would appear based on his objective net worth that in acquiring wealth endurance matters more than speed, unlike marathons.

Rocky Humbert comments: 

Mr. Rogan makes a key point which should be underscored. The tortoise beats the hare in investing because of the law of compounding.

In a marathon, the objective incremental value of the runner's speed at mile #2 is the same as at mile #22. That is, the marathon result is a simple sum of the time used for each mile.

In a lifetime of investing, the incremental value is different at year #2 versus year #22 … because net worth is a geometric series due to compounding.

There are many subtle aspects to this — the effects of volatility on the compounding, and the effect of a bankruptcy in year #1 versus year #22, etc.

Lastly, to the extent that one believes that there is a random/luck/chance is a factor, the turtoise will do even better than the hare.

Ralph Vince writes: 

Good points Rocky (ever-prescient, except in matters matrimonial and matriarchal, in my humble opinion). In reading what you wrote though, the following question comes to mind (and I am unable to answer it, perhaps you or someone with a more sports-physiology knowledge can — my interest here in in the mathematical function pertaining to…).

There is not difference in benefit accruing to the marathoner by a given speed at mile 2 versus mile 22. However, is there a tradeoff a cost, involved between running wither of these faster that would indicate a particular strategy as being more preferable than another? I know individual marathoners may have a different take on this, I'm more concerned with the actual physiological function however.

anonymous writes:

Overall fitness requires strength, speed/agility, and flexibility.  The mental component is extremely important as it is the brain that gives the signals to the muscles to act.  If there is no deep reserve, or lack of strength, the brain senses this and pulls back autonomic functions.  Motivation however allows the brain to tap the reserves of strength and endurance in times of need.

Each individual has different training requirements.  Many a sport trainer or coach has found this out the hard way.  Each individual reacts to training in different ways at different times in the training regime. 

Training actual changes the body and brain functions.  Mitochondrial cellular mass actually increases, as does enzyme production and along with muscle mass and function. 

Recently I started logging my training efforts in a quantitative manner.  Very helpful.

Overtraining is a common problem.  A typical cure is to increase training, but it is counterproductive.  When you feel tired, cut back, or rest.  Your body is telling you something.
 

May

26

I found this blog post on game theory very interesting.

"Game Theory Is Really Counterintuitive":

Every now and then, I hear someone say that game theory doesn't tell us anything we don't already know. In a sense, they are right—game theory is a methodology, so it's not really telling us anything that our assumptions are not. However, I challenge someone to tell me that they would have believed most of the things below if we didn't have formal modeling.

Stefan Jovanovich writes: 

People often take aggressive postures that lead to mutually bad outcomes even though mutual cooperation is mutually preferable.

Even if everyone agrees that an outcome is everyone's favorite, they might not get that outcome.

Neither of these "insights" (sic) is a discovery that goes against intuition; children learn these lessons the first time they bring a toy to a "sharing" event with other toddlers.

Ralph Vince writes: 

Game theory is the study of what makes us tick, which means we step out of ourselves, observe our own behavior.

The danger with this is that we then draw conclusions about ourselves along the lines of our acting more intelligently than we previously thought; we ascribe to reflexive intellect that which is likely simply mere instinct.

And I would add at this juncture (and perhaps this bears consideration on every thread) intelligence which outsizes one's humility is a prescription for delusion. The smartest hamster on the planet is still just a hamster. 

May

12

 I found this 1926 paper "On Being the Right Size" by J. B. S. Haldane quite fascinating.

To the mouse and any smaller animal it presents practically no dangers. You can drop a mouse down a thousand-yard mine shaft; and, on arriving at the bottom it gets a slight shock and walks away, provided that the ground is fairly soft. A rat is killed, a man is broken, a horse splashes.

Gary Phillips writes: 

That reminds me of Billy Eckhardt's comments on bet size…

If you plot system performance against bet size, you obtain a curve in the shape of a rightward-facing cartoon whale, going up in a straight line before dropping dramatically.

He said: "Trading size is one aspect you don't want to optimize: the optimum comes just before the precipice. You want to be at the left of the optimal point, in the high zone of the straight curve."

Ralph Vince comments: 

Not altogether true.

Expected growth-optimal bet size is a function of horizon, i.e. how many plays or periods.

For one period with a positive probability-weighted expected outcome (what most refer to as the misnomered "positive expectation") the expected growth optimal bet size is 1, one hundred percent.

As the number of periods approach infinity, this diminishes to the asymptote at what I refer to as Optimal f (not "Kelly," which is subset of Optimal f).

But all that is f we are discussing expected growth-optimal as criterion.

In capital markets, the criterion is often to maximize the risk-adjusted return, which occurs in the region between the inflection point less than the peak, and the point where the curve's tangent has the highest slope, which is greater than the inflection point, but less than the peak. These two bounding point for risk-adjusted return optimality are, as with the peak itself (and, as I hope I have convinced in another, previous post, the actual "expectation") a function of horizon.

May

7

 Over a decade ago, when I was speaking to VC guys (I think most of the private equity universe is in the losing money business. I am in the making money business, so we were unable to get anywhere) and how what these guys saw as the application of my creation — things like a better voice tree, or other imbecilic applications (Siri being about the best one out there yet, but even that is a far cry), I would pull my hair out in frustration. Even the world's largest transactional law firm, whose head told me "I don't know if there is a market for it, but if there is, we can market it," could not be penetrated to see the applications. And it occurred then to me– and we are seeing this manifest — that the replacement of humans by machine is happening very, very incrementally, almost imperceptibly, as opposed to an abrupt "leap" as I believe Turing had hoped.

Ultimately, dumb people are still cheaper than smarter machines, and ultimately, the investment required to make this a reality won't be decide by people, but by the machines themselves.

May

6

 In honor of Ralph who has occasionally pointed out that if risk is actually assessed the way financiers claim it is, we would never get on a plane, here is a list of activities that seem to me to have uncompensated risk embedded in them.

I have heard too many stories of each of the below, from friends, media or books, such that I would be reticent to engage in them. Can anyone add to the list, and am I being a chicken?

I was prompted to think them through by reading that Kirk Douglas nearly died twice in small planes/helicopters and twice on the set of action movies.

Horse riding

Cycling on roads

Small planes/helicopters

Motor car racing

Action movie sets

There was a line in the Ayrton Senna documentary where, in response to the accusation that he drives recklessly, Senna says "if you see a gap and you do not go for it, then you are no longer a racing driver." Sadly Senna died at age 34.

Charles Sorkin writes: 

That's more a question about decision making, as opposed to whether or not that flight improves my well-being (by getting me to a destination, and by possibly being enjoyable.)

If the risk was known to be that high, then clearly the distress associated with being on that plane (the marginal cost) would largely offset any benefit from flying. That would not be the case if the flight was in the same risk category as, say, that risk that we take when crossing the street.

Ralph Vince responds: 

Charles, I should have been clearer — the cost associated with a negative outcome on the plane, let's assume, be certain death. And my proposal on this is that being sane men, nothing is worth that in terms of risk assessment (I understand there are outliers — love of country, say, or certain death withing a finite x periods even in the positive outcome, but those aside for simplicity here) and that we get on a plane (or even cross a street) not because the risk is so low relative to what we might obtain (the risk of death being always too high a price to pay), but rather because we "expect" the positive outcome. In the limit, to continue crossing the street, to continue getting on planes, as the number of trials approach infinity, the probability of dying by such approaches 1. But in the very limited, finite space of our existence — say, x thousand flights in a lifetime — we don't "expect" a disaster, we expect, rather, to "get away with it."

And I think this notion of "getting away with it," is necessary to our survival, and we make and have been making decisions along these lines from the beginning, and the same type of assessment perhaps is present in how we trade (or, perhaps ought to be).

Take, for example, a famous big hitter commodity trader of yore who claimed that 90% of his profits came from 10% of his trades. Now, to be able to "expect" to be aboard on of those trades means you would mathematically have to sit through between 6 and 7 trades till you could have "expected" to have had one of those 10% of his big winning trades.

May

5

 I have seen many of your posts finding trading wisdom from so many other disciplines. I think they are valuable. Here is a relevant one relating to Roger Federer. "Roger Federer May be More Machine than Man". It is not current and you may know this piece already, but fyi. All the best, Fred Rickey.

Victor Niederhoffer comments: 

Very interesting consistency stats for Federer. But is it good or bad to be that consistent in trading?

Vince Fulco writes: 

As our august surfers on this site have remarked often, i am coming around to the view that trading is more like surfing. Have to watch a number of opportunities pass by until one is right for you then take the risk and stay flexible for the inherent churn, back and forth, sturm und drang caused by the newer HFT players, news/tape bombs and the over-reactors. The minor undercurrents will push you around for no apparent reason. It is as much knowing and developing one's ability to cope as it is having a strong market opinion.

Richard Owen writes: 

A Fed that never delivers surprises? I guess there's also the question of whether the stats are consistent only for Federer, or if this is typical of pro players?

Ralph Vince writes: 

Consistency, if it is the equivalent of variance = 0, is, to my way of thinking, certainly something beneficial to the trader. Given that variance, contrary to the generally-held notion that it is somehow (at least an aspect of) risk, is actually a diminishment of returns (i.e. variance is negative average return), then clearly you want as little of that as possible.

Apr

22

 I have been thinking about what could be a good set of criteria to measure trading (strategy) performance for individual traders.

The criterion of average return divided by the variance of the returns seems to have its shortcomings. One reason is that some large positive returns can cause the variance to go up resulting in an indication by the criterion that the performance deteriorates. But some large positive returns are good to have.

Other criteria like Sharpe ratio seem more suitable for institutions.

I think using properties of the linear regression line of the cumulative return curve might be a better choice.

Two useful properties are the slope and the "width" of the linear regression line. By "width" I mean the deviation of the cumulative return curve around the linear regression line.

A good performance should have high slope on the one hand. And if we do not consider reinvesting profits, it should have narrow "width" around the linear line.

So then the value of slope/width seems meaningful.

If we take the linear regression line as a risk free benchmark, then this value may be very similar to the definition of Sharpe ratio, but practical for individuals.

Would anyone please comment on the pros and cons of this, or any other better ways to measure performance.

Alexander Good writes: 

Great post!

I think it makes sense to measure linearity of PNL and convexity separately so I agree with you that R sq is a good one to employ. I am curious how width differs from the strategy's std though…

One thing that you can do as a cheap proxy is median return * sqrt(252)/std return and then for skew then have a (rolling max peak to trough draw down)/(rolling max peak to trough draw up).

You can benchmark your strategy vs. bonds, the S&P and a traditional 60-40 mix or your other strategies. It's very hard to beat a vol weighted portfolio of stocks and bonds so it's a good benchmark in my humble opinion assuming you're trading your PA and you don't have large retirement holdings. I assign different weights to skew and median return depending on my portfolio construction.

In portfolio construction you'll often find things with strongly positive skew have good inverse correlation to market PNL series and are typically 'long vol' (idea ripped off AQR's value and momentum everywhere).

Trending strategies frequently have very positive skew (momentum) whereas mean reversion tend to have skew that looks like the S&P (value). So if I'm net long beta my marginal utility of doing trending models is higher whereas if I'm net short I tend to size up mean reversion strategies.

Would be curious to know what other people are using/ how other people think about this/ if they have good papers on the subject. 

Leo Jia writes: 

Aren't they different?

std of returns has this term: (Ri - mu)^2, where mu is the same for all i's.

The width has this term instead: (CRi - Vi)^2 where Vi is the value on the linear regression line at time i and is all different across all i's.

Alex Castaldo writes: 

Personally I just like to look at the equity curve visually, and it is not difficult to store large numbers of graphic files in a folder and quickly "flip" through them by hitting a key on the computer.

But for automated evaluation Leo's two criteria (slope of regression, and "width around the regression" (which is also called the SEE or standard error of estimate.in regression textbooks) make sense to me.

However I know there are many other criteria that have been proposed. There is one with a foreign name that I think starts with "v" but that I can't remember. I am sure some people here know what I am talking about, it was much blogged about 2 or 3 years ago.

In looking for it I accidentally googled another measure of equity quality, the k-ratio , that believe it or not has 3 different versions.

Any other ways to measure equity curve "quality"?

anonymous writes: 

As with many things involving non linear information, my experience suggests that one must mix, blend or combine different 'quantities' to form a unique and proprietary time series.

For example, some form of 3D 'curve' that combined the three quantities return, AUM & volatility that gets thicker as AUM in the strategy grows and changes colour as volatility of returns increases perhaps… 

Ralph Vince writes: 

percent of 6 month periods underwater
percent of 1 year periods underwater
percent of 2 year periods underwater

percent of time at equity highs
percent of time within 1% of equity highs
percent of time within 5% of equity highs
percent of time within 10% of equity highs
percent of time within 20% of equity highs

I have all of these programmed up in javascript which you can peruse at lspindexes.com and click the "compare" tab. 

Apr

14

Bloomberg news picked up this article. I am not endorsing the paper, its methodology nor its conclusions. But counters should heed the underlying message. Especially Kora. I find it surprising that he doesn't look at the multiple comparison issue nor cite Bonferroni etc, but rather prefers to ask the question, "what is chance that a backtest generates a great result by chance." He argues that if you use 10 backtests, you are very likely to find a strategy with a Sharpe Ratio of 1.6 which is over-fitting: "Pseudo-Mathematics and Financial Charlatinism: The Effects of Backtest Overfitting on out–of-sample Performance" by David H. Bailey, Jonathan M. Borwein y Marcos Lopez de Prado z Qiji Jim Zhux, April 1, 2014

What good is a hypothesis that cannot be disproven? A Cautionary Tale (In Memory of Ross Miller)

1. Kora observes: Y = Fn(X) with a significance of T.

2. Kora raises a small amount of investment capital based on the expectation of this stochastic function alone. She gives no consideration to dynamic or causal or other exogenous relationships or intellectual or information edge.

3. Kora produces excellent performance as Y= Fn(X) as predicted.

4. Kora raises a massive amount of investment preformance after establishing a track record.

5. After raising a large amount of capital and collecting substantial management and incentive fees, something happens and Y <> Fn(X), and the clients suffer horrendous drawdowns. The fund shuts down and the total net amount of loss dwarfs the net amount of gains.6. The SpecListers say, "The probability of this was extremely small. But it is an example of Bacon's Ever Changing Cycles." Rocky says, "This is a example of bad science because any utility of the observation Y = Fn(X) without a casual understanding is limited to and qualified by, the ability to anticipate the onset of a changing cycle. And if the scientist can correctly anticipate the onset of a changing cycle, then this meta-hypothesis is vastly more important than the functional hypothesis.

Unfortunately, this is a recursive paradox, because the ability to anticipate the onset of a changing requires the ability to anticipate the onset of a changing cycle of a changing cycle, and then the onset of a changing cycle of a changing cycle of a changing cycle … and this continues ad infinitum OR UNTIL spec partiers go home to bed — whichever comes first."

Jordan Neumann writes: 

I admit not to have fully read the paper — I searched for the word transaction cost but did not find it, yet it makes finding a profitable strategy much harder than it seems.

Isn't this a problem with statistics in general? How does this differ from using thousands of drug candidates to find a drug? We still don't know why Advil works, but I take it anyway based on the statistical evidence. When quants believe that earnings or margins or insider trading affect prices, I would say that the economic justification is far from random.

There is a recent series of news articles that disparage quantitative analysis, just as several quant funds suffer for a few bad years. I would think that everything moves in cycles, and this might be the bottom.

Hernan Avella writes:

Mr. Rocky offers some valid questions to the counting battalion. However, I'm afraid his argument suffers severely from the straw man problem. It assumes that one can't have an approach that incorporates: logic, an economic framework, money management rules and counting. Even more. As you move up in the frequency spectrum, the economic framework becomes optional (useless).

The real question is (for med/long term speculators). If you incorporate all the said components in your approach, can you quantify your success per component?

Ralph Vince writes: 

Kora,

Yes, in my humble opinion, more money is to be made on the assumption of EMH (the cost of being wrong in this regard is less).

Stefan Jovanovich writes:

The test of the reality of a market is whether or not there are prices for quantities exchanged in actual transactions; and the market itself is sufficiently profitable that dealers are willing to pay for the rent and other costs of keeping the lights on. Market failure happens all the time; a trade disappears because other markets have swallowed the action or the inter-mediation itself is no longer handled by bid-ask. Even now more than a century and more after they disappeared you can find the remnants of "corn exchange" buildings throughout Britain; dealing in grain continues but it is no longer handled by open outcry involving dealers and farmers within half a day's train travel of a regional hub.

Markets are efficient in the way that engines are efficient in that they work. They are inefficient in the sense that there is wasted energy, some or much of which can be the result of insider manipulation and general fraud. The debate is over numbers matter - the economics of the companies and the world of money as a whole, the prices themselves and their patterns, the numerical indices of sentiment; for that question there is no absolute answer, nor should there be. Larry Williams, the R-Man, the Watsurf, RPH and many, many others can all be right - and wrong. And, in that sense, markets are permanently inefficient because, even among people to whom Morgan would have assigned a perfect grade for their financial character, the only final word comes when the market itself disappears. 

Apr

8

1) First, some thoughts on the question "what would happen if everyone lived off capital?"

If people saved, rather than spent, every dollar they earned, it would initially slow down the velocity of money. Likewise if no one ever spent savings, it would initially slow down the velocity of money. Rather than maximizing immediate consumption, people would be savers first, then very frugal consumers.

However, in both these cases the slack would be picked up in either the business sector, or the government sector, since there is now have an over supply of savers looking to invest capital. This would, of course, lower the risk, as the companies would not have to jump too high a hurdle to make interest payments. When do you think government would likewise only spend capital?

The recent financial crisis could be thought of as the opposite case where everyone thought they could leverage and overspent. This increased the risk as savers willing to lend disappeared. The money given to the flexions' banks to save them, could be thought of as printed money put in a lock box called deleveraging. Hence an increase in the quantity but a slowing of velocity of money and a risk of deflation.

2) Now for some strategies for preserving capital. The idea is to be a saver first, a consumer second.

Lets assume we invested $1,000,000 in Vanguard's index fund in April 1987. And any week we ended up with more than $1,000,000.00 we withdrew the excess. Below I list the 52 week amounts withdrawn (assuming 364 day years, 364 = 7*52). While the average $138,000 seems generous, about top 5% of earners, it would still give you many years in a row of $0 withdrawn in the 2000's. But if you think these booms and bust are systematic, then a better strategy would be to only withdraw in any one year a set amount, and save the rest for those lean $0 years. The next 2 columns shows how much you would have withdrawn if that set amount was $125000 annually. The withdrawals come from from $1 million invested in stocks excess earned, first, and then, if needed, from the amount stuffed under the mattress (not literally, of course, but previously set aside as neither consumed nor invested in stocks) . The amount invested in stock is kept at $1 million, the excess not spent in any year is mattress padding for future years.

You can see that during the bounteous years of the 1990s, you could have set aside over $1 million without compounding to cushion those upcoming lean years.

(Note: fiscal years ending in April)

Rocky Humbert writes: 

Mr. Sears' approach towards capital withdrawals is nominal, not real. So in an environment of 10% inflation and a risk free rate of 10%, he would be shrinking the real value of his corpus as he withdrew 10% on average. Conversely, in a deflationary environment, with rates at zero, he would not be consuming at all even though the corpus of his portfolio would be growing in real terms. The reality is that inflation has been averaging between 2 and 3% for the last decades and that destroys the corpus over a lifetime.

This wealth illusion associated with inflation/money printing is prevalent among both retirees and working folks. It is an insidious behavioral bias and I believe affects both consumption and economic activity. The bias is one reason that deflation is a drag on medium term growth.

Ralph Vince adds: 

I believe inevitably governments, a century or several hence, will live off of their own capital, part of a social-evolutionary process.

A structured dismantling of future liabilities (undoing the mega-Ponzi Social Security in the US, for example, in an orderly manner through generational taper with newcomers to the job market putting 100% in self-directed, those leaving the job market, 0% self-directed) and would other future liabilities to a sustainable level, and some time later, to a level of easy sustainability would allow an ultimate sinking fund of future government liabilities, eventually reaching a level of self-sustainability.

At which point, one would HOPE taxes would end, unless the Catholic Church model is employed.

Stefan Jovanovich writes: 

Everyone does live off of investment (I think this is what Russ means by "capital"). The one correlation that seems dismally robust is that, in spite of all efforts to "distribute" (sic) wealth, only the ratio of private investment to people working determines how high someone's pay can go. If there is low "capital" investment, people make very little; if there is high "capital" investment, they make much more. People instinctively know this; it is the reason we all have our eyes drawn to to displays of physical grandeur and, in the days of the gold standard, bank lobbies always had marble. But, since we live in the age of alchemy (the nominal wealth illusion the R-Man notes), "income" becomes more important than savings.

Ed Stewart writes: 

Stefan doesn't it matter how savings are deployed. Savings productively deployed in a way that increases output of goods and services increases total wealth (and if such capital is up per head, wages) but not all savings are equal in this regards. Savings deployed to fund a make-work project via government debt represents consumption. I question if in general, savings used to help another party pull forward consumption on net represents consumption and not savings, just redistributing wealth from shortsighted to farsighted — if that makes sense (??).

Russ Sears writes: 

Once again my e-mail's brevity and my poor writing causes some confusion. The "mattress" strategy was meant to be humorous, not literal. Implying you have many options as to how you use the "savings" to hedge inflation. This strategy was meant to illustrate how to take equity risk while still withdrawing a decent amount for consumption. $125000 is a decent amount in today's dollars to live off, but in 1988's dollars that was very high living, perhaps near top 1%. In the example, the amount withdrawn could easily be slowly increased for inflation, with interest earned on the savings or less savings. The bigger problem I have with my own example is what do you do if you retire/need money at the start of long term $0 return to $1,000,000 capital amount. But let us go over some inflation options:

1. Put savings back into equities…I believe, (only my opinion), this may be a good option if money keeps being put into the system due to low or negative inflation and hence likely low interest rates as we currently see. But, this also leaves you more open to risk of inflation killing the equity markets or long term bear markets in general. However, looking back long term equities returns should beat inflation if next 100 years is like last 100 years.

2. Put saved money into a long term bond fund. This could handle mild inflation, as long as it stays mild.

3. Put money initially into short term fund then as inflation gets "high" switch over to long term bond fund as inflation kicks up. But this leads to when is inflation "high" (10% seems to be Rocky's boggy). Perhaps the answer is when it starts killing equities returns because the market is worried about it. Then if you think this is the case start putting "more" of the savings into long term funds. You'll have to decide what "more" speed is and if inflation is "the cause" for poor equity returns.

4. A combination strategy.

How to invest for inflation is a tough subject which such a simple "living off capital" strategy was not meant to answer. I hope the above shows sufficiently that a disciple approach to withdrawals. even if adjust for some inflation is better than simply going with the wealth effect and spending as earned from equities. But in the end you are going to have to decide for yourself, what you think inflation will do and when it will do it. And then execute it. But at least a disciplined approach to withdrawals give you much more flexibility and with it a chance to meet this challenge.

Finally the reason "capital" was chosen instead of "investment" was to signify an investment that is somewhat dependent on a stable "monetary" base for entry and exit. As opposed to a more direct investment in human capital or even property which may out last a government and may more likely be inverse related to inflation.
 

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