May

7

 In the current cycle, the derivatives boom, the ascent of London as a capital base, and China/Petro-sovereigns as enormous players have weakened the Fed's ability to understand, let alone influence, events.

I happen to believe that derivatives' stabilizing influence (via risk distribution) is a good thing. Self-interest is likely, in the short term, to make China and other sovereigns play nice.

But the days of Pax Federalis are fading into history, and we are headed into new seas that will offer a different mix of opportunities and risks.

Jeff Sasmor asks:

So at some time in the future will we no longer wait with bated breath for the Fed's interest rate decisions, or its Minutes releases?

Will the markets eventually discount the Fed's effect, at least to some degree? That sounds like the consequence of the idea behind George's essay.

George Zachar replies:

The Fed's influence, at the moment, is waning.

Perhaps the ECB will supplant them as the global marginal rate setter. Perhaps China will start treating the capital markets the way Putin is now treating Estonia. Perhaps the Fed will grow a pair and re-seize the initiative. Perhaps gold will re-take its former place at the center of the monetary universe.

I don't pretend to know where this cycle will lead, but I am keeping my eyes and my mind open.

May

7

 When I worked in Hong Kong from 1990-1995 I witnessed first hand the great emerging market bubble of the early 1990s. At the time, paying any price for anything that had exposure to China, India, Russia or Brazil was OK, because the present value of the money everyone was going to make from four billion new consumers the world over was an almost incalculable figure. Alas, we all found out that it was going to take more than six months to set up shop in China and India to manufacture and sell our widgets to all of these eager new consumers, and the frenzy died down.

We are now about 15 years down the road. The economic progress in China over the past 15 years is something the world has most likely never seen. India, which Jim Rogers always accurately pointed out was a complete mess, has completely overhauled its cities, transportation systems, and infrastructure. Capitalism has taken hold and goods and services are exchanging hands at a ferocious rate.

Despite this being arguably the most robust economic time in the history of our planet, sitting at my desk listening to market pundits and looking at my favorite sentiment indicators, all I seem to find is global equity bearishness. The Commitment of Traders report released yesterday shows a net short position for speculators in the S&P 500 futures for the first time since November 2005. On Bloomberg, look at AAIIBEAR Index AAIIBULL Index HS which shows the spread between bears and bulls to be heavily weighted to the bear side right now, even as market indices approach or break through all time high levels. It is a common for these indicators to be so skewed, but only after market declines, not at new highs.

In asking myself why, I think back to a passage from EdSpec describing the experiences of Victor's relatives after the crash of 1929 when they lost quite a bit of money. It seemed that even more disastrous to them than the money they lost was the opportunity they missed over the next 50 so years because every time the market rallied they wanted to sell so as not to get caught up in the next crash, With the memories of the Internet bubble and subsequent crash still fresh the latest batch of Wall St. participants, its seems likely that this same psychology is what is dominating the scene right now.

May

7

I recently found this article on Science Daily about the effects of sleep deprivation on competent decision making. It suggests that:

… sleep deprivation can adversely affect a person's decision-making at a gambling table by elevating the expectation of gains and making light of one's losses following risky decisions. 

May

7

 There are many positive aspects of insurance and annuities to consider, most of them revolving around peace of mind, at a price (usually a high price).

I have several senior citizen clients that are in annuities that are loaded with living (income) and death benefit guarantees. These benefits are quite pricey when you break them down. Really not worth the price, and people like Jane Bryant Quinn always vilify them, and rightly so. Most of them are mis-sold by salesman (who happened to have passed a Series 6 or 7 exam) to clients who don't understand them.

However, there are some benefits that need to be considered. I have clients that love the annuities I have them in (I use strictly no-load annuities (truly no-load, no-load in and no-load out, complete liquidity). These annuities allow them to stay in the markets when they otherwise couldn't stomach any volatility whatsoever. It's really just a peace of mind thing for them. I could get them a higher return if I managed their assets directly, but in reality, they wouldn't invest in the stock market if it weren't for the guarantees.

So the bottom line for me with annuities are this: Don't use them unless you really need the guarantees associated with them or if you plan to hold them for at least 8-12 years (the break even point between tax deferral and eventually ordinary income vs. paying capital gains tax as you go).

Life insurance is a complicated subject. If clients need "income protection in the event of premature death," then they need low-cost term insurance. They can get it over the Internet or through a good insurance broker.

A lot of salesmen try to sell insurance as saving vehicles. This kind of life insurance is 95%+ garbage (just as 95% of annuities are garbage). Don't fall for this pitch unless the person recommending it is a real planner who knows what he's doing and is using a stripped out no-load or low-load policy. And If they take this route, then they need to do a maximum funding/minimum face amount policy that doesn't violate the MEC laws. You want to make sure that the contract is not a MEC (Modified Endowment Contract). Furthermore, they need to make sure the contract offers zero interest loans (sometimes called a "wash loan"). And they need to be sure that they can afford to make the deposits that they commit (under a max funding/min face scenario).

Henry Gifford adds:

Once upon a time an annuity was an arrangement where a person paid money to an insurance company, typically a lump sum, and in exchange received periodic payments for life, sometimes starting immediately, sometimes starting at a future date.

The insurance company could use actuarial tables to determine that they were promising an income stream that on average, with interest figured in, was worth less than what they were selling it for. The same tables could be used to show the customer that if he lived longer than the average for a person in his category, he would receive a payout worth more than he had paid in. Thus for the customer it was similar to joining a pension arrangement, where people dying early subsidize those who lived longer, and all participants could be guaranteed income for life.

Things are not that simple any more. "Annuity" is now used to describe a dizzying array of products, few of which guarantee anything for life. Finding a simple description now is I think not a realistic goal.

Ray Humbert contributes:

The moving parts from an insurance company's perspective: mortality, interest, lapses, expenses and profits and taxes. It's all based on the probability of surviving (both actual and as a policyholder), and the time value of money. The buyer buys because his time of death is a tail risk tragedy and he is willing to pay more for less risk — a risk premium. But the real kicker is that any death benefit is generally tax-free and any cash surrender value also accumulates tax-free.

In general it is best to have the most complete underwriting that your health can support without getting "dinged." You want to be in the "pool" with the healthiest, least likely to die people to save mortality cost. Generally people like to pay a level premium, but this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value. Whole life has cash value, which has a margin of safety for the insurance company, so they often share some of the "good experience" in a dividend. Universal life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load,", i.e. an surrender charge.

One of the frustrating things is that investments by insurance companies are highly regulated, and crazily taxed. Hence, it is hard for a insurance company to get you "efficient frontier" returns. If they are taking the investment risk, the regulators see it as there duty to make sure they do things conservatively, to protect very long term policyholders. But like most regulations, the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from tough regulations. Further, any time taxes are involved, everyone wants more than his share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have "tax-free accumulation." A deferred annuity is a tax-free build-up of a savings which you can latter "annuitize" (make it an income stream) which can be a set period, or for life, or a combination of guaranteed payments for X years to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly).

May

7

One question is whether stock price relationship to some moving average has any predictive value, in that stocks show negative correlations in shorter time periods, tested trending and reversal as a function of moving average.

SPY weekly closes (since 1993, with dividends) were categorized as above or below 20 week moving average (as of that week). Then, looked at mean week returns following up or down weeks, for cases when stocks were above or below 20w MA:

  weeks
               after up  after dn
above MA -0.0006    0.0053
below MA  0.003      0.005

The relationship between the mean returns of these weeks shows better in ANOVA 95% CI's:

Individual 95% CIs For Mean Based on Pooled St Deviation

Level       N      Mean    StDev
+———+———+———

all wk ret724      0.00221  0.02129                 (—-*—–)
dnwk ov   187    0.00534  0.01720                       (———*———)
dnwk und  129   0.00447  0.03023                  (———–*———–)
upwk ov   331   -0.00063  0.01738     (——-*——-)
upwk und   72    0.00273  0.02656        (—————*—————)
+———+———+———+———
                                             -0.0030    0.0000
0.0030    0.0060
 
Note that weeks after down weeks are slightly higher than all weeks. There is little difference between weeks following down weeks, irrespective of current 20w MA relationship (dnwk ov, dnwk und). But interestingly, during periods when stocks were above 20w MA, weeks following down weeks were higher than weeks coming after advances:
 

Two-sample T for upwk ov vs dnwk ov

N     Mean   StDev  SE Mean
upwk ov  331  -0.0006  0.0174   0.001  T=-3.8
dnwk ov  187   0.0053  0.0172   0.0013
 
This suggests that when stocks are above (some) moving average, rather than trending up after advances, there is stronger reversal of declines. Of course the choice of moving average and return period will likely influence outcomes.
 

May

7

 If there is one reason the market has doubled in the past four years, aside from the creative power of entrepreneurialism, its intrinsic ability to earn a return that is mutually beneficial to the public at 10% a year, and the earnings yield interest rate yield differential, it's the reduction in capital gains and dividends taxes instituted by the current US administration in 2003. Thus, I note with interest that the new president of France, Nicholas Sarkozy, claims that the vote in his favor is a mandate for cuts in the Service rate. This offers the same prospect for advances in French entrepreneurial activity as it did in the US.

When I was chief finder for thousands of acquisitions over 20 years, I could tell that the after-Service amount that owners received was the key to every transaction and that nothing was a greater motivator to them then the difference between capital and ordinary gains, with preferences truly crucial. However, the US cuts of 2003 are scheduled to sunset in 2010, and most politicians don't realize how important an incentive the rate is. The easiest way to kill an economy and a stock market is to let rates increase. This, according to Albert Jay Nock, is the Roman way of inevitable destruction and despondency. And I have found in my own studies that there will be much incentive to create despondency and destruction in 2010 by public officials acting in their own self interest, as predicted by the public choice theorists, who gain so much when the number dependent on redistribution is increased merrily as the economy sinks into revulsion.

Thus it's a great countervailing signal in France today, and perhaps it will serve as an offset to the coming revulsion in 2010 if public choice theory predictions in the US come true.

Louis Vincent Gave adds:

There was actually a lot of good news in this French election, beyond Sarko's obviously encouraging result.

Good News #1: The complete implosion of the far left. The communist party only did 2%. So they will have very little legitimacy in calling on strikes and blocking the whole country as they did in 1995 when Ch-Irak tried to reform the pension system. Better yet, the communist party could now go broke as it did not make the 5% of the vote necessary to get public funding as a political party … it couldn't happen to a nice bunch of people.

Good News #2: This dismal score for the left occurred when the participation in the election reached OECD records (close to 85% of people voting). Very encouraging for democracy.

Good News #3: the National front of Le Pen is basically imploding and may not survive the retirement of its charismatic (but completely nuts) leader.

Good News #4: The Socialist Party is, this morning, starting to tear itself to shreads looking for the reasons as to why they have lost the third presidential campaign in a row.

All in all, a lot to be happy if you are French and reform minded right now.

Jeff Sasmor notices:

07:24 TASR TASER: Sarkozy wins election; $100-120 mln order could drive $4.00 in incremental value per share - Merriman (9.53 )

Merriman notes Sarkozy was elected to a five-year term. Firm ests that the opportunity in France is worth as much as $300 mln in revs to TASR assuming the purchase of a TASR and TASR Cam for each of the 250,000 police officers in the Police Nationale and Gendarmerie Nationale. Firm says according to what TASR mgmt has last heard, a Sarkozy victory could mean the near-term purchase of 100,000 TASERs, which they est that could represent up to $100-120 mln in revs.

May

7

For FOMC meeting periods, checked SPY daily returns for 5 days up to, and after, FOMC day itself. Here is ANOVA comparison of these days, with FOMC labeled as 0:

Ah, there is no way to profit kindly, frugally from the herd, sigh. Some predators become greater, and greater, and smarter and smarter. That's a law of nature. And from their point of view, all the rest is the herd. All the flesh tastes the same.

One-way ANOVA: -5, -4, -3, -2, -1, 0, 1, 2, 3, 4, 5

Source   DF         SS         MS            F      P
Factor   10  0.0003095  0.0000309  0.97  0.475
Error     99  0.0031609  0.0000319
Total   109  0.0034704

S = 0.005651   R-Sq = 8.92%   R-Sq(adj) = 0.00%

Individual 95% CIs For Mean Based on Pooled Standard Deviation
                             

Level N       Mean    StDev  ——-+———+———+–

-5     10   0.000714  0.0053           (———*———)
-4     10   0.000842  0.0051           (———*———-)
-3     10   0.000843  0.0039           (———*———-)
-2     10   0.001315  0.0053             (———*———)
-1     10   0.002249  0.0033               (———*———-)
0      10   0.004365  0.0084                     (———*———-)
1      10  -0.000143  0.0056        (———-*———)
2      10  -0.001150  0.0063      (———*———)
3      10  -0.000653  0.0038       (———*———)
4      10   0.000466  0.0032          (———*———)
5      10  -0.002264  0.0088  (———-*———)
                                      ——-+———+———+–                                      -0.0035    0.0000    0.0035    0.0070

Pooled StDev = 0.005651

 
All 5 days leading up to FOMC day, and FOMC itself (and especially) have positive means, but starting the day after things go down.

The current "conundrum" is that all news is greeted with a rally (as is every drop), and we passed 1500 + near all time new hi on the S&P. Friday's jobs report reaction of a rally is interesting because though it suggests low inflation, it also hints at slowdown.

May

7

 Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. (Alston Mabry)

This study is fundamentally flawed. Clearly it takes a pessimistic viewpoint. 'Investors got taken'. Only the conservative buy and hold crowd can make money. It forgets one simple thing - for every buyer there is a seller. (Philip J. McDonnell)

I may be wrong, but I understand the last sentence as "for every loser, there is a winner" and vice-versa. The problem to me is that the numbers are not at all the same.

OK, at a given moment T1, the number of buyers/sellers (or winners/losers) W1/L1 is exactly the same (with amount multiplication). OK, at the next moment T2, the number of buyers/sellers (or winners/losers) W2/L2 is exactly the same. But the worry is that there is an overlap between W2 and W1. All winners at T2 are not losers at T1 (and the reciprocal). Some winners win again. They win more than they should. (And the reciprocal). And this process continues. The overlap becomes smaller and smaller, but it doesn't vanish. It becomes like a Dirac point, a singularity, a top predator. Rarely do those top predators give their money back.

There is no symmetry. There are many more losers than winners. I find this study completely consistent with the fact that the markets are very Paretian. As far as I recall there is no symmetry between the P/L of big players. There are not enough big players losing the amount of money gained by the other big players. So, where are the big players big gains coming from? The money can only come from the rest of the players, those who cannot manipulate, do not have any edge, etc. The more unarmed people, the "small" players.

The markets are up x% those last years, but this x% performance is very far from being equitably shared between all players.

The more I think on it, the more I see the Paretian laws governing so many aspects of the biological world, just as the math/graphic illustration of (for instance) Henri Laborit's great work/experiments on rats.

I may be wrong, but I'm not at all stressed by the herd. I feel no great danger coming (directly) from this side. But I'm stressed by the big players, those who are very good, very sharp, the top predators. And need a lot of flesh to survive. They may either kill me directly like a rabbit under a harvester, or push the gnu herd in such a way I'll be trampled on.

May

7

 Something happened this week in the National Basketball Association that has never happened in the history of the sport. A number 8-seeded team defeated a number 1 seed in a best of 7 series. There were several instances in the past, where the lowest seeded team defeated the highest seed, but this was in a best of 5 series. It had never happened in a best 7 series up to now.

The Golden State Warriors finished the regular season at 42-40 and the Dallas Mavericks had a regular season record of 67-13 and a road record of 31-10. The Mavericks had a 17 game win streak and 3 streaks where they won at least 12 games in a row. The Warriors had to win the final game of the regular season just to make the playoffs. The Mavericks came in to the playoffs with one of the best records in the history of the NBA. They were led by their MVP Dirk Nowitzski and were set to return to the finals, which they appeared in last year only to lose to the Miami Heat in six games. The Warriors were just fortunate to make the playoffs.

The Warriors won the series in 6 games and sent the Mavericks back the lone star state a very humbled and very beaten team along with their flamboyant and outspoken billionaire owner Mark Cuban.

This got me to thinking. What was the decisive factor in the series? What was it that tilted things in the favor of the Warriors? I am sure there are many theories and views floating around on this subject. So I thought I would weigh in with my thoughts.

Was it because their 66-year-old coach, Don Nelson had a personal score to settle? After all, he coached the Maverick just two years removed and was replaced by current coach Avery Johnson. Was it that Stephen Jackson had something to prove. He was one of the players who was involved in the worst fight in sports history when he was a member of the Indiana Pacers and was traded to the Warriors. Was it because they dominated the Mavericks in the regular season series and thus had confidence going into the playoffs?

I am sure those who know far more about the game of basketball than I can give a statistical and analytical analysis why the Warriors won. They can throw out the concept of match-ups and strategy, perhaps luck, officiating and a host of other tangible and intangible factors that came into play. This is of course very plausible.

I submit they won because they had nothing to lose. They looked like they had fun in every single game. They played with energy and enthusiasm and at times with reckless abandon. They looked like young kids running up and down the court. There was no doubt that they were the team that displayed the most confidence and showed no great tension at crunch time. .

The Mavericks just looked like they were worried much of the time. And when it came to critical junctures of games, they just came up short.

I share this story as I feel that there is a lifetime of lessons in this one event that we can learn from. That maybe just maybe, at the end of the day and the series that many times it comes down to the fact that the team that wins just has more fun along the way.

I would like to hear others' personal stories about just having fun making the difference between winning and losing. And maybe not even winning but coming out ahead and leaving with a personal feeling of accomplishment.

Stefan Jovanovich writes:

Somewhere in the archives is a video clip of Chili Davis, one of my favorite Giants players, snapping his bat over his thigh while walking away from the plate after striking out. What is amazing is not the strength it takes to do that but that Davis did it without breaking stride. He left the pieces behind him while continuing his walk back to the dugout. Even when he was angry, Davis played loose.

As a reminder that baseball should never be more than a game, Davis used write 70 on the end of each of his bats in indelible marker. "I do that," he said, "to tell myself only use 70% of my strength when I swing. 110% is a guaranteed pop-up."

May

7

 Charles Darwin once wrote, "Each living creature must be looked at as a microcosm–a little universe formed of a host of self-propagating organisms, inconceivably minute and as numerous as the stars in the heaven." (from David Lamb)

I have taken this quote to heart, especially in my trading. Each individual trading program, like my own, is formed "of a host of self-propagating" variables. Although, I must add, that every trading system is nowhere near as complex as that of a cell, let alone a colony of cells. But trying to find parallelisms in biology and trading seems like a good exercise.

For instance, the foundation of one trading system is to quantify and qualify three basic variables: time series, volume, and price. But found in each of these variables are a slew of possible dependents based on the action of the other dependents, hence making them interdependent. What makes one hedge fund buy 10,000 long contracts of the 30-year t-bond, while another fund is willing to sell them? What about spread trading and how does this affect the overall movement, if the often talked about Lobagola is experienced much of the trading days? Is it possible to understand the reasons of such things? Is it even necessary?

In order to understand how the human tongue works it is necessary to delve deep into the inner workings of the tongue. For example, the bumps on the surface of a tongue are called papillae, which control our taste buds. Taste buds provide information about the taste of food being eaten. The human tongue has about 10,000 taste buds, and each of these taste buds is formed of clusters of about fifty cells. Should one want to change, enhance, or get rid of a particular taste bud, the comprehension of the cells that make up the taste bud, and how they interact with each other is probably necessary in order for any manipulation to take place.

Perhaps asking the right questions, as so many on the spec list has stated, is the most important exercise one can do in any field of endeavor. Perhaps I need to start with the absolutes, the unchanging variables, in the field of trading. In a conversation between Albert Einstein and Count Harry Kessler, recorded by the latter, Kessler asked him if relativity applied to atoms.

Here is what was recorded in Kessler's journal:

"Einstein said no: size (the minuteness of the atom) comes into it here. So size, measurement, greatness, and smallness, must be an absolute, indeed almost the sole absolute that remains, I said. Einstein confirmed that size is the ultimate factor, the absolute that cannot be got away from. He was surprised that I should have hit on this idea, for it is the deepest mystery of physics, the inexplicability and absoluteness of size. Every atom of iron has precisely the same magnitude as any other atom of iron, no matter where in the universe it may be. Nature knows only atoms, whether of iron or hydrogen, of equal size, though human intelligence can imagine atoms of varying magnitude."

So, what are the absolutes of trading? In this highly competitive endeavor, due to my lack of knowledge and experience, I have found very few absolutes. If one or two constants can be properly qualified does this provide a sound foundation to entering/exiting positions, while taking into consideration the law of ever-changing cycles?

May

7

 Here is a nonsensical list from the billowing bag bloviating in Omaha.

There were no audio or video recordings allowed of his comments so much of this is hearsay. This is reminiscent of a Skull and Bones meeting or at the very least a Shriners' cabal.

  1. It will take four CEOs ultimately to do the job of one Buffett because of the complexity of his job, and at least three CIOs because of the vast complexity of his job.
  2. Don't try to do what he does; don't piggyback on Berkshire's investing. Don't buy the same stocks. See above.
  3. Forty-six billion in cash looking for a home for the money but finding a whale to land unlikely.
  4. Looking for deals abroad. Evidently U.S. offers little appeal.

These great and powerful comments were made after he paraded into the arena like Julius Caesar upon entering the Roman Coliseum.

Victor Niederhoffer remarks:

The latest emanation from Omaha is truly pathetic and fin-de-siecle'ish. The Sage says he is truly able to make a large acquisition and is looking for a big one. It's exactly as in The Old Man and The Sea when the little boy says that after 93 days without a catch, the old man is due for a big one, and the old man tries not to make the boy cry. The idea that buying yet another company to add to the 63 the Sage already owns is good is against all experience of conglomerates, practical and theoretical. And the desire of the old man to see the lions again, to make the big one, one that he might have to borrow 30 billion for, makes me want to cry out that imposture and falsity abound.

Steve Leslie adds: 

One final addendum to the ministrations from the noxious noisemaker from Nebraska and the attendant effluvium is that he and his buddy Billy Gates fellow Board member, played a game of table tennis against a young Chinese champion never scoring a point and sat down and played a game of chess afterwards.

Nuff said.

May

7

There are two issues. One is description of reality. The other is math.

I have just finished the book "Understanding Scientific Reasoning" by Giere, Sickle and Mauldin. It is shedding some light on the first issue. This book has two main parts:

- Theoretical Hypotheses
- Statistical and Causal Hypotheses

Throughout the book, it is made clear that science doesn't pretend to describe any form of absolute reality, out of Plato's cave, but rather to produce approximate models of world phenomena. It is also made obvious that science is not something static, but rather an always-evolving process.

Reading the first part of the book is enough. The second part about statistics is less interesting. The authors somewhat fail to make it clear that statistical hypotheses are a subset of theoretical hypotheses. Perhaps the reason why the authors are devoting so much of their book to trite statistics is that this subject is difficult for their students. Anyway, the first part is great and providing the following summary for any scientific process:

                                      fit/no fit
REAL WORLD      —————————–

—-    MODEL
         
         |                                                                |
         
         |                                                                |
         |                                                                |
observation
reasoning/calculation
experimentation                        with experimental setup
         |                                                                |
         |                                                                |
         |                                                                |
        V
V
     DATA           <———————————–>   PREDICTION
                               agree/disagree

There is a "real world" from which data is observed. There is a model describing part of the real world. From the model, a prediction about real world data is derived. The prediction must agree with the data in order for the model to be deemed fitting. A statistical model is nothing but a model expressed in statistical terms, e.g., "real world population is normal". Its predictions are what samples should look like if said model is true. The authors are providing a city map analogy. A map is a model of a city, not the city itself. It makes predictions: "Street A is intersecting Street B". These predictions can be checked by walking in the city; that is collecting real world data.

The terms "models" and "hypotheses" are used interchangeably, because they are one and the same thing. A model can be one hypothesis or a collection of hypotheses. "Hypothesis" makes it even clearer that science is not pretending to touch the essence of whatever the "real world" is.

The book is not dealing with the second issue, mathematics. We can ask ourselves where does math fit in?

So far, the description of scientific processes has not involved math. It doesn't need to. Science doesn't need math. Science has but one constraint: to be grounded in logic. Logic can be deployed in math, but also in language, that is rhetoric, or in graphical illustrations, drawn following strict rules.

Compare these 3 versions of Newton's Law of Gravitation:

1. Plain English

"Any two objects exert a gravitational force of attraction on each other. The direction of the force is along the line joining the objects. The magnitude of the force is proportional to the product of the gravitational masses of the objects, and inversely proportional to the square of the distance between them."

2. Graphical (assuming proportions are respected in the drawing)
______________ r _________________

F -F O—————————-o M m

3. Mathematical

F = g * M * m / r^2

One can see immediately the huge advantage of mathematics: Concision. Economy of space. Economy of ink. It is entirely possible to deal with science in plain English without a single formula, but books would be at least 20 times weightier.

Mathematics are a concise lingua franca. But everything written in the language of math can be rewritten in any human language or in the form of graphical descriptions / geometrical figures; think Chinese ideograms or Egyptian hieroglyphs.

The reason why mathematical descriptions do not correspond to the real world, is that they are used in the process of scientific discovery, which itself never applies to the real world, only to the formulation of hypotheses about this world.

May

7

My colleague Tyler Cowen calls this phenomenon "the great blowing sound."

6 May 2007

Editor, Washington Post
1150 15th St., NW
Washington, DC 20071

Dear Editor:

Alan Blinder worries that as technology opens up pools of low-wage labor in poor countries, the gains to American workers from free trade will be slow in coming ("Free Trade's Great, but Offshoring Rattles Me," May 6). He forgets that the world's stock of capital expands quickly to take advantage of profit opportunities.

If American workers today produce enough output to justify their high pay, any transfer of capital from America to China or India opens up profit opportunities for new investments in America. Skilled, motivated workers in a commercial environment of secure property rights will not long remain unexploited by capitalists.

Want evidence? Foreign direct investment in the U.S. from Latin America was $87.3 billion in 2004 - 114 percent higher than 1999's figure of $40.8 billion.

Sincerely, Donald J. Boudreaux Chairman, Department of Economics George Mason University 

May

7

"Tomorrow Never Knows" by The Beatles
(there's more beyond the lyrics…)

Turn off your mind, relax
and float down stream
It is not dying
It is not dying

Lay down all thought
Surrender to the void
It is shining
It is shining

That you may see
The meaning of within
It is being
It is being

That love is all
And love is everyone
It is knowing
It is knowing

The Fab FauxI'd be willing to bet that anyone who was at least a teenager when JFK was shot remembers where s/he was when s/he heard about it. I was in Mr. Pinataro's French class in J.H.S #59 in New York City. The announcement came over the PA system. I can visualize it as if it was yesterday.

How many people who are in my age group (~5.6×10^3) remember where they were when they first heard a Beatles song? I do. I was in my homeroom in J.H.S. #59, wearing trend-setting, tight, iridescent-green pants (hot stuff), white shirt and a tie. Someone had on 57 WMCA-AM (which is now 'New York's Christian Radio,' to my surprise when I just checked). That's where I first heard the Beatles.

Tonight I went to a benefit at McCarter Theatre in Princeton NJ that featured a band called "The Fab Faux" - they're a Beatles Tribute band; supposed to be the best. It was really amazing! No, they didn't come out dressed in Sergeant Pepper outfits, rather, normal clothes. But they really were into recreating the music. They kept changing the guitars that they were using to better reproduce the original sounds. Highly recommended!

But you know, I have heard these songs SO many times that for the first half-hour or so, the pattern matcher in my brain heard every difference, every note that was different, every timing discrepancy. My wife said that I looked spaced-out. After a while I was able to ignore it and have fun.

I've often felt that the brain evolved as the ultimate pattern matching engine. How else can I recognize a song from the first note? See the predator, hear the noise, recognize the visual/aural pattern, flee, survive, reproduce.

Pass along the trait of good and quick pattern matching in your genes. Millions of years made us able to drive without perishing, cross a busy Manhattan street without getting run over, play tennis or chess, appreciate and/or play music; so many, many things, including, in my opinion, trade. I can't believe there isn't some instinct involved.

I wonder how that works as you age. Why is it that the music we grow up loving in our youth becomes mostly all we want to listen to? Do we run out of memory? Are there co-related patterns of music and experience that can't be dislodged? When I was listening to the Beatles my parents said it was garbage - why didn't I like to listen to Frank Sinatra? Why can't I get into the Fallout Boy, My Chemical Romance, and 'Emo' music that my kids love? I don't think it's 'crap' but I can't get into it. Although I finally have a greater appreciation for Sinatra and big-band music.

So the song remains the same - is that dangerous? This weekend I have read articles in various magazine about 'sell in May…' and similar. The intraday news service I use has been warning 'keep an eye on your longs and consider taking profits. So my expectation is that there will be some sort of a gap-down on Monday morning that will reverse up; I'll probably be wrong.

I think that it was in Chair & Collab's Practical Speculation that we learn about how when a certain pattern emerges and is recognized by everyone, it will shift and/or change. Excuse the misquote if I didn't get it exactly right. I've always taken this to be valuable advice.

Right now we're in sort of a no-man's land. There are a lot of conflicting bits to think about. People have been getting really used to the pattern of buying the dips. There've been huge short squeezes, especially recently. What is the song we are about to hear? Will it be All You Need is Love?

Scott Brooks adds: 

Could it be that we associate the music with fond memories?

The worry free days of youth, the hot balmy days of summer with our friends playing the neighborhood, the blustery days of winter with our friends in school, or maybe a birthday party.

I can't help but think of Mo-Val Summer youth camp, whenever I hear "Indian Summer" by Poco, or my first make out session with Cheryl C. from Mexico, Missouri (yes, I still remember her name) on the dock at camp Mo-Val while the song "More Than a Feeling" played in the background.

Put on Sammy Hager's "Turn up the Music" and I'm back cruising with my buddies on the Lindbergh Ave. to Tesson Ferry loop.

Starland Vocal Band's "Afternoon Delight" reminds me of baseball practice with dad coaching the team. We always came in first place!

Van Halen's "Runnin' with the Devil" was in the cassette 8-track on the way to football practice.

Of course, every time I hear "Sister Christian", I think of the time I pulled out into traffic and smashed into by another car.

But I'll take the good with the bad. It's all the memories that make up my life.

May

7

 Krakatoa, by Simon Winchester is a fascinating account of the social and scientific world in 1883 and the impact of the explosion of the volcano of Krakatoa. He is a geologist and explains the history of the idea of tectonic plate movements, which is standard knowledge now, but dismissed then as nonsense, like many new scientific theories.

One theory is that Krakatoa ushered in the global age that is now driving financial assets. The explosion sent shock waves through the air that traveled around the earth 7 times and registered on the many barometers in London! The tidal wave registered on tide meters 7,000 miles away. The particles created spectacular sunsets around the world for months and lowered temperatures. It was not Krakatoa that caused the many crop failures but another explosion that turned summer into winter.

The then recent telegraph and the new cables allowed the news to travel within days around the world leading to the realization of the importance of world events. A man named Reuter used pigeons to dispatch news from Europe to London to be the first to convey news of interest and financial importance. With that edge he was able to expand subscription to his services.

In the Heart of the Sea, The Tragedy of the Whale Ship Essex, by Nathaniel Philbrick, is a heartbreaking account of the attack by a sperm whale against the Essex, its sinking, and the devastating 87 days at sea in small whale boats and the suffering and struggle of the diminishing crew. As with many tragedies, though perhaps precipitated by some random event, a series of miscalculations, errors of judgment, both before and after led to creating a much worse situation.

In the case of the Essex, it was an older ship and the owners may have skimped on some repairs leaving it weakened structurally allowing the whale to stove its sides. The new young captain through bad sailing allowed a knockdown near the beginning of the voyage leaving them short of whaleboats. They were unprepared for a sinking.

After the sinking, rather than head for the Society Islands a few hundred miles away as the Captain first decided, he succumbed to the opinion of the mate and crew to go up wind, thousands of miles to South America. This example of poor leadership resulted in suffering and death. The horrific plight of the starving sailors on the small boats and who survived and who died and why in the social order gives much food for thought. It is notable that Captain Pollard eventually sunk a second ship by crashing it on a reef. Was it random? Bad luck? Or something else at work. The story reminds me of the feelings of a trader stuck in a bad trade or drawdown, starving for days and weeks and months on end but eventually making it back. Some even go on to live out their lives, but for some reason, the characters in this book seem to attract the plague of the fates. In this case, were correlation and causation related? That is an important question.

The Essex was the basis for Melville's, Moby Dick, which leaves off as the Essex horror continues. Interestingly, Melville was a commercial failure as a writer and had to work the docks during his life. As an aside, I have a fried here who taught us the hundreds of knots and lashing to lash a traditional sailing canoe who looks just like Quequaig with the tattoos and the top knot and is a seaman of the highest order and speaks of his death. He has tattoos on his back and head which mark where his life force will exit at his death.

May

6

 Vic says, "Be direct," in market analysis. "Study the thing directly, not some derivative. Studying the most simple things leads to the most robust ideas even in complex systems."

Taking a "be direct" approach to understanding a market occurrence is certainly a benefit. Individuals incorporating this practice as a piece of her "overall" information collection strategy tend to have a reasonable understanding of market causality.

Moreover, individuals attempting to use a be direct approach, in isolation, should take heed. Susceptibility to manufactured events and disinformation increases dramatically as the number of credible sources decline. Entities conveniently provide information hoping that people will "take their word" and not be objective thinkers. This situation hardly advances our own self-interest and makes informed decision-making nearly impossible.

Perhaps, people could analyze a market occurrence in the most direct fashion available, making notes of their initial reaction and potential course of future action. Placing scenario one on hold, cross-reference that information with as many creditable sources as possible. Timeliness should be a concern because over-referencing might decrease the advantage time sensitive information provides. Throughout this process the information's creditability and relevance will be established.

Combining enhanced qualitative analyses with quantitative "know-how" will invariably lead to more informed, if not better, decision-making.

As for the aforementioned Mr. Koch's postulates? I must have dozed off during the lecture highlighting his work regarding microorganism causality.

As a librarian, I relish the journey of acquiring hard-to-find information. Feel free to contact me if you'd like a list of websites, books, and articles related to the art and science of effective information collection.

May

6

What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns. Ilia D. Dichev, University of Michigan at Ann Arbor, Stephen M. Ross School of Business

This abstract came by way of the New York Times, via Dr. Mankiw's blog. 

The existing literature typically does not differentiate between security returns and the returns of investors in these securities; usually implicitly, these two concepts are assumed to be the same. However, the returns of stock investors depend not only on the returns of the securities they hold but also on the timing of their capital flows into and out of these securities. This paper suggests a new and more accurate measure of stock investors' historical returns, which involves dollar-weighting of the returns and properly reflects the effect of investors' timing. Theoretically, the essence of dollar-weighted returns is that they value-weight both the cross-section and the time-series of returns. In practical terms, dollar-weighted returns are computed as internal rate of returns (IRRs) from investment projects in which initial market values and contributions from investors (e.g., stock issues) enter with negative signs, and distributions to investors (e.g., dividends, stock repurchases) and final market values enter with positive signs. The empirical results indicate that aggregate dollar-weighted returns are systematically lower than buy-and hold returns. The annual difference is 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and averages 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. These results have implications for the debate on the equity premium, for the literature on long-run returns following capital flows, for building successful investment strategies, and others.

May

6

 Green tea is good for you, but only if drunk in moderation. While the polyphenols in green tea are credited with preventing heart disease and cancer, it seems they can cause liver and kidney damage if consumed in very large quantities, a review of studies into the toxicity of polyphenols has shown.

"People shouldn't be too alarmed by this, but those taking supplements may experience problems," says lead author Chung Yang of Rutgers, the State University of New Jersey.

He stresses that up to 10 small cups of green tea a day is fine. Problems are likely in people who take supplements, which can contain up to 50 times as much polyphenol as a single cup of tea.

May

6

A day at the tracks: I took these photos at Woodbine racetrack earlier today. I used an Olympus DSLR E1 fitted with Leica lenses.

May

6

How did the market change post the 2/27 bear-fake? One aspect is follow-up responses to up or down days. SPY day returns (w/div) were used to compare returns for days following drops and rises. Here is the result from 2/27 to the present (inclusive):

Two-sample T for after dn vs. after up

           N     Mean    St Dev     SE Mean
aft dn  15  0.00160  0.00859   0.0022  T=0.0
aft up  31  0.00160  0.00597   0.0011

There was more than twice the number of up days as down, and returns following both were positive, with means identical (after down had higher standard deviation). For the 48 days prior to 2/27 there was a somewhat different pattern:

Two-sample T for after dn pre vs. after up pre

                N      Mean     St Dev       SE Mean
aftdn pre  24  -0.00152  0.00892     0.0018 T=-1
aftup pre  24   0.00050  0.00499     0.0010

Here there were equal up and down days (close to long-term pattern), and unlike post 2/27 response to down days was also down.

Comparing all days post 2/27 and 48 pre-2/27 shows that the recent period also has a higher (NS) mean:

Two-sample T for post 2-27 vs. pre 2-27

                 N      Mean     St Dev      SE Mean
post 2-27  46   0.00160   0.00683   0.0010 T=1.45
pre 2-27    48  -0.00051  0.00722   0.0010

Thus the rise since 2/27 came from:

1. More up days than down
2. Higher mean return of all days
3. Reversal of down days rather than continuation

May

6

 I have been watching the Queen on the news and her day-to-day visits to the US. Her last visit was in 1956. The Queen has one of the finest collections of rare stamps. On occasion she will lend certain portions of this vast collection to World Philatelic events. She has been afforded the honour of collecting stamps and also having her likeness printed on many stamps. I wonder what she thinks about our new inflation proof US forever stamp. Speaking of stamps, our current 39-cent stamps go up a few pennies this month! Is the forever stamp a good investment over the long haul?

Henry Gifford writes:

Regarding the "forever" stamp vs. inflation, I have a narrow definition of inflation: the lowering of the value of money.

If the price of hamburgers goes up after an epidemic of hoof-and-mouth disease reduces the supply of beef while the demand does not change, the price increase probably reflects an increase in the value of beef. This is not inflation. Describing it as "beef price inflation" is a mishmash of two factors.

True, the factors cannot ever be separated any more than anyone can say with certainty why a stock goes up in price. But inflation can, and I think should, be used only to only describe a lowering of the "price" or value of money. I once started a collection of the various and conflicting definitions, and the wide variety of points supported by changing the definition to suit the situation, but was quickly overwhelmed.

Suffice to say that I think the most honest definition is the simplest: a lowering of the value of money. With regard to the stamps, if the value of delivering a letter does not change, buying "forever" stamps is a hedge against inflation, sort of like holding dollar stocks (39 cents of dollars) while also repeatedly buying call options on the price of the dollar, with the price of the calls equal to the opportunity cost of not investing the money elsewhere.

As the price of delivering a letter is simultaneously taxpayer subsidized and a protected monopoly, the actual value and its change over time is hard to judge, much less predict, as there has been no actual price data available since the government monopoly was started. The excuse was that it was necessary to thwart spying during the Civil War. Changing technology since then makes it hard to judge the change in value.

May

6

 The all seeing eye could find many regularities, lessons, and things to test in the gyrations of the markets in the last week. Let's start with a descriptive one. What a fantastic 10 minutes of trading in the S&P futures from 3:55 to 4:05. It went down to 1507 looked like it would head back to 1502 where it started the week, then closed at 1514, a six year high, very close to the all time S&P index high of 1515. What a beautiful recap of the whole week in 10 minutes.

The main regularity that everyone misses is that the S&P been up 23 out of 26 days now, and this puts it in a completely different camp.

It is close to the all time high and it just broke the round number of 1500. I tried to give the numbers when it broke, but the regularity is clear in that a path that's goes up 75% of the time, steadily from 100 to 1500 with dividends constantly being taken out, is obviously a very good one. Normally there is a 75% likelihood that it will go up through a round number of 100 before falling through a round number of 100, given that the last 100 breakthrough was up also.

All the declines are clustered around a positive run of 1 breakthrough, or negative runs. After a positive run of 2 or more breakthroughs the conditional chances of a rise are say 85%, and after a positive run of 3 or more the conditional chances of a rise are say 90%.

Another regularity is the moves in the year following a positive run of 2 or more round number breakthroughs. Also, there is the likelihood of achieving an all time high when we are within 1% of the previous all time high. Another regularity is the likelihood of an up move after a big decline on the previous Monday. I could go on, but there are enough grists for the mill that I can stop.

The big mistake that people have made is the change in tactics that is usually necessary after a big decline . Nelson would say "forget about the maneuvers go right at them" and I would like to say that to all my people. It is hard to change horses and tempo though.

The whole rise stands on the shoulders of the February 27th move, and the fact that the bears had to make a disruptive, totally shocking move to try to keep down an incredibly bullish market. Whenever it looks the faintest like there is bearishness again, this is the time to go right at them, but it is hard to test that.

Another regularity is that all the papers are saying that the public has not believed this rally. That they are waiting for the pull back to occur, and that only eventually, if you do not get the pull back, will the market go up. This was confirmed, that "only 35% of the public is bullish this month." and after an up month this is completely unprecedented.

Another regularity is that the sports team owner effect was very helpful .A bunch of useful idiots, typified by the fake Dr., the ghost, and the seasonatarian (who strangely are invariably on the same side), use recurring patterns based on small numbers and infinite numbers of implicit hypotheses, to come up with their useless forecasts. Of course, no matter how wrong or ambiguous these bears' predictions are, they are always able to later interpret what they have said as correct, fooling those of us who do not keep close records.

In the fake Dr.'s case, he used the fact that over the last ten recessions the average duration was six years, and the inversion of the yield curve in 45 of eight times had a small correlation with economic change. In the ghost's thing, he used the fact that near the end of February, the sage usually tries to say something bearish in his annual report so that he seems like he is much more moral and ascetic than we are. Of course the ghost was wildly bullish at the time, in the heat, calling for all to root for the next fake key level of 1474, but then when the market went down, all of a  sudden the previous forecast he had been bearish.

Of course the non-falsifiable forecasts, "I was bearish but then bullish, and I mentioned a level, without regard to whether it was going to gap up from there or down from there" are ridiculous. It is amazing to see how easy it is to dupe people with non-falsifiable forecast like this. This is probably the main fault with modern predictions, and it is shameful when the progenitors like to boast about their success.

Another regularity was the way the weekly financial columnists, who has been consistently bearish for 40 years, including the last 10 months when he got back again after a hospitalization and the S&P has risen from 1250, finally said the previous week that the stock market rise had no reason or sense behind it and he did not know when it was going to end. But he was for sure that when it ended it would follow the same rapid path on the downside that it did on the upside, presumably going down to the Grossian Dow 5000.

It was amazing to see that the weekly columnist did not write last week. You would think he would be ashamed of the worst record in history, but indeed he was replaced by another weekly columnist who loves to say that the woes of the dollar are about to beset us, (if this is woe, give us more), and calls his column 'Bubble 2.1'.

A horse from the same stable is the sell in may and go away meme. That is as bad as the January barometer in its multiple comparison effect.

There are numerous other regularities, and I have received a stream of hateful emails from chronic pessimists, some of which I have alluded to above. One feels that there is a giant battle of the optimists versus the pessimists being played out, where the Grossian disciples are the big universities, and the expert is giving his tour — all in their last throes of desperation trying to maintain their facade of rectitude against the backdrop of their terrible harmful.

The counter that doesn't count, and the decision maker who doesn't look at the costs and benefits of decisions both have a message of anti-individualism that will cost institutions like the one that I went to, and its chief rival, the 30-130's and all their ilk, so many trillions in opportunity cost in the future.

As I am not totally bak to the hitting box yet, I will have to stop here, and not test all the meals for a lifetime written about above, as well as the many meals for a day that those willing to take out the pencil and paper could adduce.

May

6

 Does anyone understand how the gears and levers of insurance and annuities work? For me, it's a MEGO subject that I'd like to understand better. Is there a good web reference, or can someone write a brief essay that outlines the moving parts?

For instance, what are the real economic aspects life insurance products (whole/term/universal)? I vaguely understand some or all of them involve embedded optionality (since the pay-in of premia is fixed in advance) especially wrt interest rates. Is there a quick analysis of the form "product X includes embedded long-bond optionality that the buyer typically pays 2 vols vig on"?

And how best to jumble together all the tax/risk/return/optionality aspects, without doing deep financial engineering? I'd love to have a brief (but informed) soundbite I could pass on to friends/family who ask me about such things, believing (erroneously) I'm knowledgable.  

Russ Humbert responds: 

The moving parts from a insurance companies perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. Its all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer, buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax free and any cash surrender value also accumulates tax free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value which has a margin of safety for the ins. comp. so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load" I.e. an surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for a insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as there duty to make sure they do things conservatively, to protect very long term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly)

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Anon: 

The moving parts from insurance companies' perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. It's all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax-free and any cash surrender value also accumulates tax-free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value that has a margin of safety for the insurance company, so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load", i.e., a surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for an insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as their duty to make sure they do things conservatively, to protect very long-term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly).

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Henry Gifford:

The importance of the "lapses" part of the above description is what was apparently behind the commotion last year when investors were reported to be buying old people's policies from them before they died. What the investors apparently figured out was that the expected number of policies that "lapsed," that is, the policyholders didn't keep up the payments and thereby forfeited the benefits, enabled the insurance companies to promise rather large payouts. The investors planned to maintain the payments on 100% of the policies until the people died, thereby getting handsome returns. 

May

6

 It's hard to test the overnight fat finger of fate bar on the jobs, but like the clearing fire, like the probing action, they seem to have a clearing function. Last year there were a few of the night spikes ups and the subsequent follow through. A lot of brush has grown between here and 1527 cash SPX in the last five years, but the function of the futures seems to be to probe, peek a light in the darkness ahead, clear away the brush for the main army which follows behind. I can't see how the army will not push through the short distance.

With only 500 stocks in the S&P to absorb a global glut of productivity, industriousness, striving, youth, inventiveness, and of the world, These are 500 of the best, systematically weeding out the losers, and it seems that there is much upward pressure and bias on those precious assets. Look around and see how crowded it is everywhere you go, and how prosperous and well fed everyone seems. Consider the linear rise in prices inexorably higher even to the point of exponential rise. Remember the 80's, the late 90's. Bears are trapped, break outs up, every dip bid back in a rush.

Consider the new highs in the Dow and the proximity of the S&P highs, current daily multiyear highs, the breakdown of many old systems and cycles. It's easy to say and see after it happens, but in practice its a very difficult environment when moving to and into new ground, and the old rules no longer seem to work so well.

May

4

 Just got home from an evening at the historic Smoot Theatre and was entertained for two hours by a wonderful one man show performed by Hal Holbrook . This is his 53rd. consecutive year for his remarkable show. Out of the theatre program tonight, Holbrook's biography takes up two full pages. He was born in Cleveland in 1925 and his life story is remarkable.

I remember seeing him in Magnum Force opposite Clint Eastwood . I met him in person a few years ago in the waiting area of LAX. We were going back to Ohio and he was headed to do his one man show in Chicago. We rode on the plane together and I often thought I would love to see him perform as Mark Twain one day.

He kept us enchanted this evening and one could smell the aroma from the black stogie he on occasion would light and puff while telling tales. His comments that he made about life in his time are just as relevant today.

His appearance tonight in Parkersburg, WV, was part of a fundraiser put together by the Ohio Historical Society to benefit the restoration of the National Historic Landmark towboat W.P. Snyder, Jr. that resides along the banks of the Muskingum River in Historic Marietta,OH. The Snyder is the sole surviving steam-powered, 'pool' type towboat in America, and one of only three steam-powered towboats still in existence.

The Smoot Theatre was sold out tonight and I had a great time hearing about a great writer, as told by a great actor!

May

4

 In recent days I have begun to explore the category-based tuning feature of my car's XM radio. (I'm a big fan of XM.) This feature enables one to tune linearly between categories rather than station numbers and it remembers the last station that one was listening to in a category.

Categories are things like "Rock," "Dance," "Hits," "Decades," etc. The proper tuning of stations in category mode requires that one decide on a favorite station within the category that will come on automatically each time. Choosing a station can be tough, either because there are so many contenders — I currently have the 70s as my favorite decade, but I could switch to the 80s at some point — or because there are so few.

A most problematic category is "Christian," which is mysteriously sandwiched between "Hits" and "Rock." While several categories include X-rated fare, for some reason no such choice is available for Christians. Oddly, there is a Christian rock station — odd because everyone know that the underlying beat of rock music is designed for fornication. After contemplating the dilemma of which Christian station to program in without making an explicit decision, I moved on to the "Rock" category. I always have it tuned to "Lucy," the station of classic alternative music, a seemingly contradictory concept. By some miracle the song that was playing was The Pixies 's "Monkey Gone to Heaven." I see the makings of an alternative Christian station. With REM 's "The End of the World as We Know It," Peter Gabriel 's "Your Eyes," and XTC 's "Dear G-d" for starters, there should be an abundance of tunes to choose from.

Must we wait for an XM/Sirius merge to bring us a "Bar Mitzvah and Wedding" channel so that I can hear the music of my youth? Hora or bunny hop, anyone?

Stefan Jovanovich replies:

For what little it may be worth, given what "everyone knows", the Christian women out here in California prefer blues. They think rock music's beat is just another enticement for the men to indulge in what Sarah Jessica Parker's character once described as "jackrabbit s-x". Rock and roll's origins are from rockabilly, which was and still is the ultimate American dance music. Dancing was clearly designed as a path to other things, of course, but as the Georgia Satellites so wonderfully put it, with the women worth chasing the road to fornication always includes a pit stop at the church. 

Stefan Jovanovich replies:

For what little it may be worth, given what "everyone knows", the Christian women out here in California prefer blues. They think rock music's beat is just another enticement for the men to indulge in what Sarah Jessica Parker's character once described as "jackrabbit sex". Rock and roll's origins are from rockabilly, which was and still is the ultimate American dance music. Dancing was clearly designed as a path to other things, of course, but as the Georgia Satellites so wonderfully put it, with the women worth chasing the road to fornication always includes a pit stop at the church. 

May

4

There is an idea that's pervasive, that has become conventional wisdom in much of the academic and hedgefund community — it is that there is a tendency for the stocks that have been outperforming over the past 3-12 months to persist for the near future in their outperformance. A main source of the idea is the academic papers of Jegadeesh and Titman, published in the mid 90s (Rev. Fin. 1995, Vol 8, 973-993).

This idea, or at least the simple interpretation of it that I test here, has not been working well in recent years among large cap stocks.

For the years 1997-2006, I considered S&P 500 component stocks at year end, requiring a share price (the price as it stood at the time, unadjusted for splits) greater than $10. I calculated the median trailing 1-year return for the qualifying stocks, then separated them into two portfolios, the "Leaders", an equal-weighted portfolio of stocks that had a trailing 1-year return exceeding the median, and the "Laggards", with 1-year returns less than the median. Then I looked at the forward 1-year returns for these portfolios, and for "Hedge", which is "Leaders -Laggards". Here are the portfolio returns by year:

Year  Leaders    Laggards   Hedge
1997     33         26           7
1998     21          7          14
1999     17         12           5
2000      2         25         -23
2001     -5         10         -15
2002     -9        -15           5
2003     30         51         -21
2004     20         16           4
2005     15          6           9
2006     16         18          -2
       
avg      14         16          -2
stdev    14         17          13
t-score   3.1        2.9        -0.4

So the Laggards actually won by a narrow margin.

Maybe there are other circumstances where the Leaders beat the Laggards. Perhaps they do so for small cap stocks, which I haven't tested here. Don't fall prey, though, to the idea that they win pervasively, consistently, or by a wide margin.

Kim Zussman adds:

Prof. Pennington's results fit with the recent literature, including the new article The Disappearance of Momentum by Hwang and Rubesam, that suggest rumors of the death of momentum are not exaggerated, notwithstanding that Jegadeesh's construction was high-low deciles, not halves.

Over the past 10 years, buying stocks based either on momentum or reversion worked equally well. Now, where are those darts?
 

May

4

Backtest , a new R package I've been exploring:

The backtest package provides facilities for exploring portfolio-based conjectures about financial instruments (stocks, bonds, swaps, options, et cetera). For example, consider a claim that stocks for which analysts are raising their earnings estimates perform better than stocks for which analysts are lowering estimates. We want to examine if, on average, stocks with raised estimates have higher future returns than stocks with lowered estimates and whether this is true over various time horizons and across different categories of stocks. Colloquially, "backtest" is the term used in finance for such tests.

May

4

 Every businessman needs a well-defined plan of succession for his affairs, both while he is living and when he dies, including:

1. Legal paperwork, in order for the inevitable. This includes wills, powers of attorney, living wills, health care surrogates, trusts. Location of paperwork. Lists and possibly personal introductions of personal lawyers, accountants, bankers, financial advisors, insurance agents, physicians. If one does nothing else but read one book this year, read a book on this subject. It will be time well spent. Many legal documents are available from legal software companies and others for do-it-yourselfers, but if not comfortable with this, go to the next level and solicit the assistance of paralegals and ultimately lawyers.

2. Contingency plans for temporary illness. Well-defined and orderly chains of succession for businesses. Check writing, bill paying, decision making, proper names on bank accounts, money deposits, trading authorizations, access to offices and homes. Location of important documents for tax purposes and documentation.

3. Business continuation plans for after death. Purchase agreements, Buy sell agreements and insurance, legacy transfer, Order of succession. Grooming of successors.

It is critical to address these issues while one is of sound mind and body. And it is very important to revisit this theme quarterly, semi-annually or annually, contingent upon personal situations and business growth.

May

4

 Charles Darwin once wrote, "Each living creature must be looked at as a microcosm — a little universe formed of a host of self-propagating organisms, inconceivably minute and as numerous as the stars in the heaven."

I have taken this quote to heart, especially in my trading. Each individual trading program, like my own, is formed "of a host of self-propagating" variables. Although, I must add, that every trading system is nowhere near as complex as that of a cell, let alone a colony of cells. But trying to find parallelisms in biology and trading seems like a good exercise.

For instance, the foundation of one trading system is to quantify and qualify three basic variables: time series, volume, and price. But found in each of these variables are a slew of possible dependents based on the action of the other dependents, hence making them interdependent. What makes one hedge fund buy 10,000 long contracts of the 30-year t-bond, while another fund is willing to sell them? What about spread trading and how does this affect the overall movement, if the often talked about lobagola is experienced much of the trading days? Is it possible to understand the reasons of such things? Is it even necessary?

In order to understand how the human tongue works it is necessary to delve deep into the inner workings of the tongue. For example, the bumps on the surface of a tongue are called papillae, which control our taste buds. Taste buds provide information about the taste of food being eaten. The human tongue has about 10,000 taste buds, and each of these taste buds is formed of clusters of about fifty cells. Should one want to change, enhance, or get rid of a particular taste bud, the comprehension of the cells that make up the taste bud, and how they interact with each other is probably necessary in order for any manipulation to take place.

Perhaps asking the right questions, as so many on the spec list has stated, is the most important exercise one can do in any field of endeavor. Perhaps I need to start with the absolutes, the unchanging variables, in the field of trading. In a conversation between Albert Einstein and Count Harry Kessler, recorded by the latter, Kessler asked him if relativity applied to atoms. Here is what was recorded in Kessler's journal:

"Einstein said no: size (the minuteness of the atom) comes into it here. So size, measurement, greatness, and smallness, must be an absolute, indeed almost the sole absolute that remains, I said. Einstein confirmed that size is the ultimate factor, the absolute that cannot be got away from. He was surprised that I should have hit on this idea, for it is the deepest mystery of physics, the in-explicability and absoluteness of size. Every atom of iron has precisely the same magnitude as any other atom of iron, no matter where in the universe it may be. Nature knows only atoms, whether of iron or hydrogen, of equal size, though human intelligence can imagine atoms of varying magnitude."

So, what are the absolutes of trading? In this highly competitive endeavor, due to my lack of knowledge and experience, I have found very few absolutes. If one or two constants can be properly qualified does this provide a sound foundation to entering/exiting positions, while taking into consideration the law of ever-changing cycles?

May

4

 Mathematics does not correspond precisely with the real world. It gives an unnatural sense of precision that does not exist. The equals sign is a good example of a basic fault with math. Take 1=1 which seems simple, but in the real world nothing is equal to another thing, and nothing is the same as something else. Everything differs from everything else in some manner, in small details, in space, in time. Nowhere in nature or the real world will you find a line, a circle or a point. Zero is convenient for computations but zero does not and cannot by definition exist. This problematic from a philosophical standpoint.

Math may be useful as a model to help predict or understand but has basic flaws that are often overlooked at the users peril. The remarkable advances due to math cannot be denied, but from the realist's view, the discrepancies loom large. From this discrepancy creeps in random results present in the real world.The Mathmatician argues that calculus and limits, and statistical procedures account for this real world fuzziness, but the idea of limits and central limits can be ways of shortcutting by creating a simple model to represent a much more complex process and cramming it into a little figure which remains black, non transparaent and unexplained.

The mathmatician argues, "Who are you, untrained philosopher who never studied math, to say this." Point granted, but the analysis stands.

The bright side of statistics is that it attempts to measure the discrepancy between the line, the curve and the real world and in the process captures some information about the real world and its deformities exhibited as randomness.

May

3

Today's break through the 1500 level by the S&P index is the first break through of a round number since Nov-17-2006 (1401.2). It is also the seventh consecutive movement upwards through an hundred level without a fall through an hundred level since Nov-01-2002 (900.96).

A chart of the S&P shows a relatively continuous movement up from 100 in 1980 to 1100 in 1998, then a little backing and filling, and then a rise to 1500 (3/22/2000). This was then followed by a precipitous decline back to 800 (7/23/2002).

This raises all sorts of questions about randomness, continuity, tendency for long runs, the drift, and gravitation.

We thought we'd start by looking at a few of the more obvious ones.

SPX Index Daily Data, 100 point box size

Date Reference Close Dist. frm Ref. Move
   1/2/1980        105.76    
 11/21/1985   100  201.41  101.41   UP
  3/23/1987   200  301.16  101.16   UP
 12/26/1991   300  404.84  104.84   UP
  3/24/1995   400  500.97  100.97   UP
 11/17/1995   500  600.07  100.07   UP
  10/4/1996   600  701.46  101.46   UP
  2/12/1997   700  802.77  102.77   UP
  7/2/1997   800  904.03  104.03   UP
   2/2/1998   900 1001.27  101.27   UP
  3/24/1998  1000 1105.65  105.65   UP
  8/31/1998  1100  957.28 -142.72  DOWN
  11/2/1998  1000  1111.6   111.6   UP
 12/21/1998  1100 1202.84  102.84   UP
  3/15/1999  1200 1307.26  107.26   UP
   7/9/1999  1300 1403.28  103.28   UP
   8/9/1999  1400  1297.8  -102.2  DOWN
 11/16/1999  1300 1420.03  120.03   UP
  3/22/2000  1400 1500.64  100.64   UP
  4/14/2000  1500 1356.56 -143.44  DOWN
  7/14/2000  1400 1509.98  109.98   UP
 10/10/2000  1500 1387.02 -112.98  DOWN
 12/20/2000  1400 1264.74 -135.26  DOWN
  3/12/2001  1300 1180.16 -119.84  DOWN
   5/21/2001  1200 1200 1312.83  UP
   7/6/2001  1300 1190.59 -109.41  DOWN
   9/7/2001  1200 1085.78 -114.22  DOWN
  9/20/2001  1100  984.54 -115.46  DOWN
 10/25/2001  1000 1100.09  100.09   UP
  6/21/2002  1100  989.14 -110.86  DOWN
  7/18/2002  1000  881.56 -118.44  DOWN
  7/23/2002   900   797.7  -102.3  DOWN
  7/30/2002   800  902.78  102.78   UP
  10/7/2002   900  785.28 -114.72  DOWN
  11/1/2002   800  900.96  100.96   UP
  6/16/2003   900 1010.74  110.74   UP
 12/29/2003  1000 1109.48  109.48   UP
 12/14/2004  1100 1203.38  103.38   UP
  3/15/2006  1200 1303.02  103.02   UP
 11/17/2006  1300  1401.2   101.2   UP
   5/3/2007  1400 1501.31  101.31   UP
TODAY  1500      

We noticed a tendency for UP's to be followed by UP's (and vice versa) so we tested this with a two by two contingency table (previous move listed at the side):

Transition Matrix
=================

  UP DOWN
UP 19 7
DOWN 7 6

Fisher's exact test p=0.19

Although the tendency is there, it does not seem to be statistically significant.

 Bruno Ombreux writes:

A classic runs test yields the same p-value in the 2-tailed case. The one-tailed test has obviously half the p-value. That's 0.097, which, as Tukey would say, "is leaning in the right direction". That's not significant but warrants further exploration.

I have a few questions:

- In these cases, is it legitimate to use a one-tailed test? After all, we suspected UP was followed by UP.

- We are testing on the data used to formulate the hypothesis. It is not good practice but in such a long-term study, there is no choice, is there? Not enough data.

- Aren't we wasting our time anyway, UP followed by UP just being an artifact of the positive drift everybody already knows about? What I mean is that the whole exercise is assuredly non-predictive but raises an interesting philosophical question: one-tailed or two-tailed?

Runs Test

Data: S&P Standard Normal = -1.301, p-value = 0.193 alternative hypothesis: two-sided <==> non-random

Data: S&P Standard Normal = -1.301, p-value = 0.097 alternative hypothesis: less <==> trending

May

3

 Driving down Washington Boulevard here in Belpre I noted the local Speedway has just boosted their regular gas to $3.19. I hear on the news that fears are mounting that Iran may mine the Straits of Hormuz, and thus oil could approach $100.00 per barrel and gasoline might reach $5-6 per gallon. This will affect all of us to some degree. All of this may benefit my overall health as I am a bit too heavy and will begin to walk a little more. My walking and others who do the same might have a direct correlation to the Market! I will need a pair of good tennis shoes and if enough of us walk and buy shoes those companies will benefit and so will their stocks.

On saving fuel: The other night on the news a tip was given for saving some gas. Instead of going through to get that favorite Big Mac, it was recommended you park your car and go inside and get your carryout order. You will be saving fuel by not idling in line and get in some walking to boot. Others I am sure have their own tips to share.

Henry Gifford adds:

There are approximately two meaningful ways to save gasoline used to operate a car. One is to keep the tires inflated to the correct pressure. This is widely overlooked, and can save money and gas. The other way is to replace the air filter when it gets dirty, which saves the energy used to suck air through a dirty filter.

Otherwise, other than turning the engine off when possible, as described below, very little else can be done. The energy profile of a car is basically fixed the day it rolls off the assembly line.

Approx. 28% of the fuel is typically used while idling at red lights or in very slow traffic, when the overall efficiency is essentially zero. Gas/Electric hybrids avoid this, which is one of the ways they save fuel.

May

3

I would be really grateful for answers to the following …

  1. When there is a sudden increase in demand for an ETF do the managers have to buy the constituents and thereby push up the price of those so that the EFT's price continues to reflect that of the constituents?
  2. Is this different from a closed-end fund?
  3. Is the price of an ETF a function of sudden changes in volume in the same way that the price of a typical share is influenced by sudden changes in volume?

David Wren-Hardin explains:

  1. An ETF is just a container for a basket of stocks. I'm not sure whom you mean by the manager. If you mean the trust, the trust holds the stocks, but doesn't have to do anything if people buy ETFs on the open market. If people are buying an ETF, though, and a specialist or marketmaker sells them, he will typically hedge with the underlying basket or with the equivalent future. So the buying pressure is passed on. But no one has to buy the underlying.
  2. I believe it's different, because ETFs can be created and redeemed. You can hand the trust the basket of stocks and get ETFs, or you can break up your ETF and get the basket of stocks back. Potentially, the number of ETFs is limited only by the amount of underlying stock in the open market. Mismatches in demand can lead to impaired rebates of ETFs for those who are short, especially around dividend times. Clearing firms will then sometimes create ETFs to ease the impairment for their customers. Or customers will create ETFs themselves to cover it.
  3. The short answer is yes. The ETF and its underlying stocks trade as an arb, and changes in demand quickly move back and forth between the two universes.

Kevin Depew adds:

From the iShares Web site:

iShares ETFs are traded like stocks on an exchange where investors buy and sell them just as they would any other publicly traded security. And because iShares ETFs trade like a stock, investors can benefit from features like intraday pricing and trading, the ability to place stop and/or limit orders, and the opportunity to sell iShares ETFs short.

Like other exchange-traded securities, iShares ETFs will trade subject to a bid-ask spread. Spreads may fluctuate in response to supply and demand forces, overall market volatility, and other factors ? in other words, the same factors that influence the prices and spreads of stocks. But unlike stocks, the ETF's creation and redemption process not only helps to minimize the bid-ask spreads, but may also reduce the premiums and discounts that can develop between the iShares ETF market price and the Net Asset Value (NAV).

ETFs are very different from closed-end funds. A closed-end fund's shares are fixed, which is why they frequently trade at a premium or discount to NAV. Although they both trade on an exchange, the ETF shares can be created and redeemed throughout the day.

Also, it's important to get a handle on the composition of ETFs. The Biotech HLDR, with fewer than 20 members, is two-thirds weighted in AMGN and DNA. On the other hand, IBB, with more than 150 members, is only about 12% weighted in AMGN, has no exposure to DNA. That's a significant difference for two funds labeled Biotech. David Wren-Hardin replies:

Kevin makes a great point. HOLDRS were invented by Merrill Lynch, and unlike other ETFs from the Spyder family (SPY, DIA, XLE, et al.), they never rebalance, and their composition does not change unless a company is taken over or goes bankrupt. That's why AMGN and DNA have taken over the BBH, as opposed to IBB, which is rebalanced from time to time.

In addition, it's more costly to create/redeem out of a HOLDR than a SPY, It costs $10.00 per 100 HOLDRS to create or redeem, That works out to a dime a HOLDR share, a pretty hefty premium. SPY, on the other hand, is a flat $3000.00 charge. The minimum creation unit is 50,000 shares, so that's only six cents, 40% cheaper already. But its $3000,00 for 50,000 or 5,000,000, and at that level the fee becomes a much smaller cost.

Also, HOLDRs pay their dividends straight through. If INTC goes ex-dividend, the owner of the SMH gets the dividend the same day as a regular INTC owner, minus a touch since fees are taken out of the dividend stream. Spyder products and their ilk accumulate the dividends over time, and pay it out quarterly.

Art Cooper remarks:

An excellent resource is Russell Wild's Exchange Traded Funds for Dummies.

Dean Parisian remarks:

I bought into the ETF story early on. So far so good with the love of my financial life, RSP, the Rydex S&P Equal Weight ETF, doing what it is supposed to do.

But all is rosy neither in love nor in the financial markets. I'd like to think I was hoodwinked in shares of USO, the United States Oil Fund. Contango has pinned me down so far, can backwardation bail me out? The fund manager said I should have read the prospectus better.

May

3

 I have been thinking a lot about the important problem of establishing cause and effect, since Nigel Davies brought up the topic earlier in the week.

It seems like the more complicated systems become, the more difficult it is to establish cause and effect relationships between different phenomena. Physicists often say that two phenomena are "associated", when they don't dare establish a cause and effect relationship.

But the science that really has a problem with this is biology, which studies extremely complicated systems (remember that there are more cells in your body than there are stars in the Galaxy, and each cell is quite complex). Perhaps more biological thinking would do us good, rather than the physics-like thinking often used in market modeling.

In the germ theory of disease, for example, it is very difficult to establish the mechanism by which the germ actually causes the disease. And the mere presence of the germ in large numbers is not enough to establish cause and effect. The germ may be an opportunist, taking advantage of the diseased state to increase its numbers.

Anyway, around the turn of the last century an attempt was made to make criteria for establishing this kind of cause and effect. One scheme was called Koch's postulates. Here they are in their original form:

Koch's postulates are:

1. The microorganism must be found in all organisms suffering from the disease, but not in healthy organisms.

2. The microorganism must be isolated from a diseased organism and grown in pure culture.

3. The cultured microorganism should cause disease when introduced into a healthy organism.

4. The microorganism must be reisolated from the inoculated, diseased experimental host and identified as being identical to the original specific causative agent.

I'm sure my fellow Specs can find holes in this scheme. But can we establish our own postulates for cause and effect in markets? Of course we can't "introduce" and "culture" market phenomena (much as we would like to). But maybe some other kind of formal scheme would provide food for thought.

Nigel Davies adds: 

This seems like such a good analogy. For example there are recurrent conditions in which the sufferer has occasional outbreaks of the disease.

In considering outbreaks of a market disease there might need to be the presence of germs plus some trigger factor such as 'stress'. Even then there are no guarantees.

Bill Egan writes:

Tylenol (acetaminophen or paracetamol) is the #1 cause of fatal liver failure. It produces minor effects on the liver at the recommended dosage levels (4 grams per day in adults). Fatal liver damage (zone 3 necrosis) can happen with as little as 10 grams per day. The safety margin is a mere 2.5x between pain relief and death.

Most drugs are metabolized by enzymes in your liver, so that they can be excreted more easily. Acetaminophen is not an exception. Five percent of acetaminophen is converted to a reactive metabolite that will bind to liver cells and kill them. This is normally prevented by the body's anti-oxidant defense system, a molecule called glutathione, which binds to reactive molecules and thus prevents them from causing damage. Should your glutathione levels be low (not eating right, alcoholic, sick, etc.) you will be more susceptable to damage caused by the reactive metabolite of acetaminophen because your glutathion levels will be lower than normal. Should you ingest a bit too much acetaminophen, you rapidly exceed even the capacity of the normal levels of glutathione to prevent its damage. It is like a step function.

What market mechanisms act to prevent routine damage? What is the tolerance limit beyond which they are overwhelmed? (This is a violation of Koch's postulate #1 but it is chemical not biological.)

May

3

 What happens the year after a new closing high on the S&P if there has not been a record high close for at least a year?

Since 1950 there have only been 11 examples.

Despite what many will undoubtly say when S&P closes above 1527, it looks safe to get back into the water.

Date      Close    next year
2/14/95  482.55  31.58%
7/26/89  338.05   6.72%
1/21/85  175.23  18.33%
11/3/82  142.87  17.42%
7/17/80  121.44    8.90%
3/6/72    108.77    5.66%
5/4/67      94.32    5.18%
9/3/63      72.66  12.69%
1/27/61    61.24  11.74%
9/24/58    49.78  13.60%
3/11/54    26.69  31.62%

May

2

 The route by which I take my son to school got me thinking about the distances between two points.

If I take the most direct route it means negotiating a road packed with cars and little likelihood of a 100% legal parking opportunity. Unpleasant and stressful to say the least.

On the other hand, there's another road running parallel which is connected by a footpath; only a few parents park there. Now getting to this other road is not quite as straightforward either. By the most direct path it means crossing a busy road. So the most efficient route once again means taking a slight detour so I can join the busy road with an easy left turn (bear in mind that Americans, Frenchmen and Germans drive on the wrong side) and then leave the main road with a right.

Thus we have left, left, 2nd right, left, left, 1st right, park, walk left through an alleyway and right out of the alleyway rather than left, left, 2nd left, right, 1st right. Route 2 is more direct but is ultimately less efficient and more costly.

This conclusion got me thinking about the wiggles in markets; why does the market move in such an indirect and apparently inefficient way? It seems that it could be because of the traffic, which makes me realize that passengers might find it as difficult to guess the S&P's eventual destination as any of my passengers might guess mine. Unless I tell them of course.

May

2

I found a nice paper combining items of interest to the Daily Speculations: chess and statistics. Most of it is directly applicable to markets.

May

2

 I was recently asked how we could make Daily Speculations a better prediction market, and Mr. Andres the questioner, pointed out that we tend to be bullish. As I have said many times, we base this on the 10,000-fold returns that have been experienced over the last century so this is not without strong foundation.

This question started me thinking about the importance of asking the right questions, and I had the following hasty thoughts which may have a little value:

I think I know how I could make the site much worse and in the process make it a much better prediction market — by asking the wrong questions. That is the most important part of proper speculation. The other way I could make the group worse is to encourage ideas that have a bearish bias.

I could encourage the dissemination of useless information — the kind that every one else reads. Also, I could feature the predictions of people whos views are completely random or have a negative correlation with the future, (everything they say seems so reasonable and it would make us all lean in their tending to be wrong direction).

Another way would be for me to encourage those who have positions to unload their views on us with the view that they could encourage us to go their way and add to the ability of them to get out better . This would really be bad because it would increase friction.

I'll have to think of some other ways to make this site a much better prediction market by making it much worse than it is, and I'd appreciate any ideas.

Vince Fulco adds:

Vic's comments remind me of a quote I read early in my career that has kept me in good stead. As I recall, the book Money Masters by John Train has an interview with the investor extraordinaire Larry Tisch. In it, he discusses the shortsightedness of the average investor and observes that "no one thinks of straw boaters in wintertime …" I've taken that phrase to heart as a constant reminder to be cognizant of the issues du jour, but it is the rare one that has not already been absorbed into market prices. 

Vincent Andres writes: 

Here are some clarifications to avoid misunderstanding due to my imprecise vocabulary (and for which I apologize):

  1. I wasn't asking how we could make Daily Speculations a better prediction market. Rather, "Could Daily Speculations make a good prediction market?" "Make" was too literal a translation from French. My meaning was "be" or "constitute," and absolutely not "become." I did not at all mean "how to make", precisely because of all the reasons mentioned by the Chair. There are zillions financial forums over the Internet which would be very good candidates. It is unnecessary to touch one of the very rare intelligence-based ones.
  2. I have always been, I am now, and will always be an optimist. It's the least one can do to thank life. So, when I speak about "noticeable bull/optimistic bias," it's in no way a critique, since I share this bias.
  3. Even if a bias is a good one, a bias remains a bias. I did just notice that Daily Speculations, being biased, is probably not a good random sample.

How do you say "comme à la prunelle de ses yeux" in English?

May

2

 Ultimately, in the game of musical chairs, there is only one chair available for the final two participants and whoever claims the final chair is the winner.

In the late 90s the stock market went on a very impressive run beginning in 1995 and continuing through the end of the century. As 1999 progressed the stocks that were making new highs began to get thinned out and the indexes, most notably the NASDAQ, had fewer and fewer stocks making new highs. It was being carried by a few big names such as Cisco, Intel, Microsoft Yahoo, JDSU and some others. Stocks were described by money managers as being "priced to perfection" and every growth manager owned the same names. This was code for "You better watch out, a day of reckoning is on the horizon." Analysts like Jack Grubman and Mary Meeker were still beating their war drums however and making strong cases for their companies using very creative reasons for owning the stock.

One public poll asked investors what return did they expect on their money going forward. The most popular responses were in the high teens. Some people thought they could expect more than 20% annual return on their money for the next 5 to 10 years through their investment in mutual funds.

This all came to a bitter end in March of 2000 and the market went into the worst slide since the great depression. Ultimately, this nadir was achieved in fall of 2002 and the market began to recover in the spring of 2003. By then major damage had been done and those who came in very late to the securities party suffered greatly. Some had lost 80% and more by investing in high-risk mutual funds like the Van Waggoner group, which bought many of the dot.coms of that era.

Now we enter a new phase of the stock market and the market has been on a 4-year climb. In the 2006 year, the S&P index was up 10 months out of 12. In 2007 it has been up 3 months out of 4 and in April the market was up 18 out of 21 days.

Where do we go from here? This question becomes more and more interesting. Unfortunately, I am not Professor Marvel and certainly not an oracle and I cannot consult a crystal ball to provide this answer. I honestly do not know. What I do know is that the music is playing in the background, and chairs are beginning to be taken away as seen by some very disappointing numbers by the homebuilders and retailers to name two.

In the business of buying and selling stocks, sometimes it makes sense to take a "Schnitzel" off the table and keep some cash on hand for the next buying opportunity. There always is another stock to by somewhere and cash just isn't necessarily a bad thing to have at times.

Somebody once said, "Money isn't everything." My response is "It is if you don't have any."

And like the old Cowboy once said, "Talk is cheap, it takes money to buy whiskey."

May

2

 Amos Bronson Alcott said, "To be ignorant of one's ignorance is the malady of the ignorant," and I believe this is the worst mistake a speculator can make, aside from asking the wrong questions and succumbing to promotion and churning.

Recently I wrote about the difficulty of steering between the Scylla of allowing pain and the Charybdis of reducing pain with the morphine drip, as you come out of the recovery room. The amazing thing about my experience with it was the 1000 systems in place to monitor and remedy. This was the one thing that the hospital was the most insistent I knew about and were in perfect operating order.

It reminds me of the advice that speculators are always given that they should constantly sell down to the sleeping point as prices go against them. It's guaranteed to give ease to the caretaker and guaranteed never to allow you to get back to using your own functions correctly. I have subsequently received some clinical backup for my views from my good friend Dr. V Hrehorovich. He is President of the Medical School of Antigua and previously ran several hospitals including Brooklyn Lutheran, which has 500,000 patient visits or so a year. He drew me diagrams to show how the pulmonary functions all even out when you use the morphine drip and it crowds out proper lung function.

I have not tested his assertion but his views based on 40 years of practice seem to me quite valuable, and a study of this subject would be very difficult with the double blindness, and all. In the writings on survival that my friend has written I see there is one thing that is totally wrong. What I didn't say was that with all the failings, with all the mistakes, all the indignities (I am reminded so much of the L'amour story, by Dr. Yak describing how I felt when I was thrust in a room with 100 other poor souls like myself, which I likened to the black hole of Calcutta), the system worked very well.

My friend was saved from a situation with a 25% risk of mortality. My doctors did a great job in getting me the right procedure at the right time, and there is opportunity to reflect on lessons rather than having a tribute to my friend at his grave.

My friend should have been much more gracious and appreciative in his writings and I will not be remiss in remedying this improper lack of appreciation in the future.

May

2

Here is an easy to digest 55 slide powerpoint presentation for the beginner, from George Zachar.

For those interested by the subject, I remember my own short page on this topic which contains other links as well. Could this site make a good prediction market? I suspect not, because of the noticeable bull/optimistic bias.

Alex Forshaw replies:

There definitely is some debate on the issue of play money markets' allegedly comparable efficacy to that of real money markets. In my opinion, Wolfers was too hasty in putting his academic imprimatur on the notion of effective play money markets. The MidasOracle group blog (to which I am a frequent contributor) is a very good prediction markets portal.

Russell Sears remarks:

As an actuary working in the insurance industry, I wonder what the hedging risk effect is on many of these prediction markets. It would seem to me that for many of the low probability, high risk events (bird flu pandemic, specific terrorist attack) especially for thinly traded contracts that the insurance premium would overwhelm the predictive effect. Further I suspect the variance of the "risk premium" due to media noise may dwarf the change in actual risk.
 

May

2

 First, "recession" stories seem to exhibit normal business cycle characteristics; the number of stories rises during periods of slow growth and recession and remains low during periods of economic expansion.

Second, recession stories seem to peak toward the end of the recession, or shortly after, and then fall sharply, which suggests that this indicator might be useful in helping identify troughs, though perhaps less so for peaks.

Third, although the two newspaper counts show a high degree of correlation (0.86), the number of recession stories that appear in the New York Times is usually larger than the number that appear in the Wall Street Journal.

This was particularly evident in the 1973-75 and the 1990-91 recessions. Finally, despite a noticeable jump in the number of "recession stories" in the Wall Street Journal in March 2007, both series remain at levels consistent with economic expansion.

May

2

"The reason for this is not that they couldn't get the parts needed to keep things operating, but the process of procuring and stocking parts was so screwed up and inefficient that they couldn't get parts in a timely enough fashion to keep things operating. So they would have huge piles of tires, far more than they needed but no brake parts for example. It's like the joke in Contact. The first rule in government procurement is why build one when you can build two at three times the price?" — T.M. Ryan on the problems of nationalized Oil Companies

When onboard my ship in the Navy we would have to take enormous amounts of time ordering supplies for various things. I remember that it took way too much time trying to match up what "normal" people call simple office products to what the Navy had named them, for instance:

In Navy-speak, "fastener" and "disposal container" mean "paperclip" and "trashcan."

The list went on and on. I was criticized for even trying to translate. My Chief told me to utilize the order manual that was given!

From Stefan Jovanovich:

For those wanting to learn more of the currently useful and useless military euphemisms, I recommend Embrace the Suck, by Col. Austin Bay. 

May

1

 If there's one overriding principle of successful market navigation, it is that survival is the most important thing of all. The market will always be there, and if you have an edge, there will be a chance to rise to your rightful place in the firmament — if you survive.

Because survival is so important, I am always on the lookout for survival lessons from other fields. One of the reasons I always read Bo Keeley's writings is that he has had at least 81 near-death experiences, and by dint of proper planning and response, survived them all.

One of the best things about the Patrick O'Brian series is that in each of his critical battles, the hero, Jack Aubrey, goes through innumerable steps to survive and minimize the deaths of his crew, often changing tactics midstream, so that what would have led to certain death instead led to a long, beloved life.

I have 100 books on survival, at least one of which is on my desk at all times. I have books on survival at sea, survival in the mountains, survival on the battlefield. The problem is that others know infinitely more about the principles of survival in such fields than I do. However, I recently had some direct experiences related to survival that gave me confidence that I might have something to add in the continuing search for lessons.

For almost three months, I have been visited off and on by a racking cough and runny nose. The symptoms were the same as the flu. I have always been very resilient to colds and flu, and I expected each day that the symptoms would disappear and that I would go on my merry way. But on Sunday, April 22nd, after a game of tennis and family activities, I suddenly found that I could not walk without agonizing chest pain. I was about to have dinner at a restaurant with a trusted companion and before the first course arrived I asked her to pay the check so we could leave. She said she would call paramedics and I told her not to. I begged her to listen to me and do nothing. I stepped outside for some air, and within 30 seconds, two fire trucks and an ambulance had screeched to a stop on Park Avenue. Despite my efforts to elude them, they wrestled me in and administered tests. I rejected their advice to come with them to the nearest emergency room, and signed a release form stating that I knew I might lose my life in the next minute.

I went home and slept. In the morning, I could not muster the energy to walk 10 yards to my trading screens to see where things were opening. Those concerned called an assortment of relatives to persuade me of the error of my ways, and there was much talk about possible heart problems — which I refuted with elegant logical and philosophical proofs and reminders that I had played sport every day for the last 50 years. Furthermore, I refused to be transported by ambulance to the indignities and travails of an E.R.

But one thing led to another, and a triumvirate of magnificently determined women tricked and manipulated me into an E.R., where a battery of tests quickly revealed that I had pneumonia and that one of my lungs had stopped working. My brother who was working behind and in the trenches the whole time, subsequently sent an article indicating that my particular condition was associated with at least a 25% mortality risk within the next 30 days, and I submitted, albeit not without further complaints, to the ministrations of doctors.

Here is what I learned about survival from my experience:

1) The worst person to make a decision when survival is at issue is the person whose life is in danger. He may be concerned about discommoding others — or the Grim Reaper may have dulled his senses. If I had not been hurried into treatment against my wishes … I won't finish that sentence.

All market traders should have a designated person to take over decision-making in their positions when survival is in question.

2) For three months, I had been subjected to extremely non-random changes in my health. This had to be a 1-in-1,000 shot. When my symptoms didn't respond to the usual remedies, I should have seen a doctor.

When a market starts reacting in a completely non-random fashion, especially when it's against you, you should throw away the databases and get down to fundamental principles. Any persistent rise such as what we've been witnessing in the stock market for the past month, or the non-random episodes that happen so frequently in the commodities and foreign exchange markets — anything that refuses to give you even one chance of a dignified exit — should be treated with the most serious consideration, as survival may be involved.

3) I was admitted as a cardiac patient. If I had gone to a cardiologist's office or a dignified heart center, I am certain that I could have talked my way out. Instead, I was put into a hellacious, poorly ventilated, noisy, crowded emergency room where I received 20 tests in an hour or two and quickly learned that the problem was my lung, not my heart.

The lesson for market people is that during a survival episode, simple routine tests or systems of the kind that brought you into the trade are no longer sufficient. What is required is a wide-ranging approach that may have nothing to do with the original system.

4) A friend of mine told me 20 years ago that the only way to get good medical attention these days is to be on the board of directors of a hospital. I don't believe that the statistics on survival for poor and rich bear this humorous platitude out, but I do think that the only way to convalesce in quiet, or to die with dignity, is to be a friend of a key board member.

Because I have some important friends, I was whisked from the E.R. into a fancy section of the hospital where it was possible to breathe and to accommodate all my well-wishers and caregivers (although I was pegged mistakenly as a diabetic and the TV monitor was programmed to show me Diabetic Channel only). Somehow the name "Soros" kept being wafted about. The powers that be may have believed that my potential contributions to mankind would be of a Palindrome-like magnitude. It was rather amusing since Soros, I believe, would have been very pleased to have me shuffle off the mortal coil at any time during the last 10 years. But such is the power of reputation.

5) One of the items listed in the Patient's Bill of Rights posted in every hospital is that you won't be discharged from the hospital until an advocate for you has pleaded your case. Apparently, the tangled web of the third-party payment system so frequently impairs the profitability of some patients that these appeals have been made a basic right.

It would be great if they had a similar system in place in the market. Cases like Amaranth Advisers and Long-Term Capital Management make clear that it is not entirely likely that you will be accorded the dignity of such checks and balances before you are discharged from your positions. At least you should understand this in advance and try to set down the terms of timing, execution and procedures by which such discharge would be made.

Another key aspect of the Patient's Bill of Rights is the protection of privacy. Apparently somewhere along the way somebody in charge realized that patients are human beings and they like to be accorded the respect in their persons that they try to maintain in their homes.

Any market trades that are not kept private are an invitation to the ruination of your financial health. The levels of your stops are too tempting to those on the other side; the wolf point at which you must pull the cord, once disclosed, may almost certainly be expected to become a target.
 
6) Most deaths occur between 2 a.m. and 5 a.m. My nurses tell me that this time is known as "the wolf hours." While many people think night nursing is a breeze, somehow everything seems to happen in those three hours. I dreamed every night that the Grim Reaper was standing by my bedside trying to entice me down into Hades, and I woke with a start each time and asked my night nurse to minister to me.

The key times to worry about your demise in a market position are approximately those same hours - the closing hours in Asia and the opening hours in Europe, the time when the final tumultuous gyrations of the e-minis seek to send you and your positions to Davy Jones' locker.

A Friend continues:


How to steer between the Scylla of wreckage and the Charybdis of certain death:

For many years, I have harbored the goal of making a citizen's arrest. People do things wrong so often, especially violating rights to life liberty and property. I felt, as Jay Gaynor said, it was every citizen's duty to take the law into his own hand and act as a policeman would in arresting the malefactors. He won the mayorship of New York on this platform.

I made that citizen's arrest, ending up paying one-eighth the cost of the policeman's heart attack, lost every decision, paid the other side's legal fees, and was out a big ace before that one was over.

I've also wanted to experience the heroic feeling of liberty in Beethoven's Fidelio prisoner chorus upon seeing the first light of day after being in prison darkness for years. I wanted to combine this with the escape that Churchill made from the Boers by walking out of the Transvaal prison in top hat and coat in complete nonchalance and then descending into the rails.

I was more successful in this pursuit today as I dressed in my normal clothing, got out my tennis racket, and strolled out of the confined prison I was in, with windows that didn't open for seven days straight, and a feeling of fetidness waiting in the wings to engulf me at every stage. All the while the doctors tried to track down someone who would take responsibility for discharging me, even though I refused their last three X-rays and blood tests. I was much more successful in this second pursuit and I made my escape to the Central Park air at 1 pm yesterday.

At taking that first breath of fresh air, I felt utter happiness, the feeling of life's rekindling itself. It was exactly the counterpart of Beethoven's prisoner's song.

I feel the same exhilaration after exiting a losing position that I feel after coming into the fresh air. I believe they are both life-enhancing acts, and should be taken much more often and earlier. However, this must be contrasted with the terrible wrongness of the morphine drip, the one thing they were sure was working,

After making my escape, I voluntarily came back to the prison, feeling like Willie Sutton, who found it so difficult on the outside because of the kinds of people he met inside and knowing that a posse of concerned parties who had done much good would be discommoded by his absence. I didn't want the extra X-rays and blood tests for a simple reason. The change in my health that might have come from any intervention resulting from the tests had an expected value of zero, whereas the costs of the pain and discomfort of the tests was quite tangible. It was impossible for me to explain the concept of the value of information to the doctors who so earnestly wanted more and more facts to base their further treatments on. Ultimately, there was an impasse and I was discharged properly and walked out a free man.


Dean Parisian writes:

Sometimes women just know best. Don't fight the tape and don't' fight the E.R. help. Fighting can seriously affect one's livelihood. Ah, hope and wishful thinking can be a wonderful thing. They can make things happen! 

Vincent Andres adds:

Yes, survival is the first point. The rest will always be there.

Resting is very important for a durable recovery. Time to fully recuperate is not lost time. I hope you'll find the time for that. Hear the wise women!

A prescription suggestion: Two weeks of cool trout or salmon fly-fishing in Ireland. Remember The Quiet Man. The place where they made the movie is really lovely. 

Jim Sogi extends:

It is good to consider one's death every day. Nothing else is more certain statistically. Would you be happy with your life if you died today? It is not morbidity; it is a celebration of what is important in life. Were you 10 times happier when your bank account grew to 10 times what it was? Were you happier to be hugged by a child? Hearing recently of a close friend's near death from appendicitis, skiing the life and death gnarly in Alaska, feeling my own mortality face to face, seeing my aging parents, makes the important choices in life loom large. Health has to be the first priority, then family. That is where the greatest wealth is, not in the bank.

David Humbert remarks:

You have learned the awful truth that hospitals are dangerous places, and to be avoided unless absolutely necessary. As a general rule, your constitutional well-being is a reasonable proxy for how you are recovering from a medical event. In other words, if you are feeling well, you are probably improving internally. Expect weariness, remember that your body's immediate response to injury of any type (surgery, infection, etc.) is to cannibalize skeletal muscle in order to obtain the protein building blocks necessary to repair tissue. This leads to an obligatory weakness that can only be overcome when the body shifts from its catabolic (breakdown) stage to its anabolic (building) stage. That occurs at a variable time but probably sometime 10-14 days after the original insult. 

Kevin Humbert adds:

“All market traders should have a designated person to take over decision-making in their positions when survival is in question.”

There is a designated person who often takes over when survival is in question, the Margin Clerk. Heed the warning! 

George Zachar comments:

In New York State, you cannot be discharged over your own objection, without the hospital jumping through onerous legal hoops.

After my father had his gall bladder removed, NYU tried to discharge him 48 hours later. He was in his late 70s, weak, and obviously needed longer to recoup. Nonetheless, the staff hectored him to sign the release, and it wasn't until I said "you will literally have to carry him out over my body, and I'm not bluffing" that they relented.

Once they saw he was going into a different insurance category as a result of my statement, the staff demeanor flipped from bean counting to healing, and all went well.

May

1

 "Couldn't you just buy a portfolio of stocks that outperformed random?" That question was posed over dinner by an individual investor who had never taken a statistics course and had no real idea of random. He also had no idea over how long one should compare the performances. But he held the belief that today's financial weather is a function of yesterday's financial weather, and in his own way was looking for a way to make it work. Individual investors believe in autocorrelation even if they don't know what it is; they do not believe in the random walk.

The question caught us off-guard because we did not know the answer. We had always compared performance to the market indices as the obvious benchmarks. We were not enamored with the idea, but as professionals we had no choice but to learn the answer.

We have taken the 500 largest capitalization stocks* and their 1-day rates of change. Then we have randomized the signs of those rates of change. For example, if stock A had a gain of 0.32 percent on a particular day, the study would for each observation randomly attribute that day's performance as a positive 0.32 percent or a negative 0.32 percent. Keeping the absolute value of the percentage change and randomizing the sign preserves the volatility of each particular stock.

We then produced 1,000 such random results for each of those stocks over the last 10 years.

Next, on a moving basis (with varying lookback periods) we compared the actual performance of each stock to its collection of random results. We then ranked each by the percentage of the actual above or below the random collection. For example, if at a given time, the actual performance of stock B was better than 850 of the 1,000 random runs, then stock B was given a ranking of 85. If, over the same period, stock C ranked 80, then stock B was deemed to be stronger than stock C. Thus the stocks were compared first to themselves and then to each other.

We then simulated trading results as follows: we purchased a collection of stocks that ranked highest on a given day, allocating funds equally. The collections varied from as few as 5 assets to as many as 50. There was no attempt to rebalance the portfolio. For example, if 3 stocks dropped off the list, then we simply divided up the sales proceeds equally to the 3 new stocks entering the list. This was to keep the strategy operationally possible. We know that total daily rebalancing is more profitable (we have tested it), but it requires transactions in every held asset every day that is onerous for all but a few professionals. The actual strategy seems simple, but is annoyingly time consuming because of the number of calculations involved.

There was no attempt to institute stops. Stocks were never "sold"; they were simply replaced. This avoided the toughest decision in investing: when to sell.

We performed this work over a number of "lookback" periods. In the link below we have illustrated results over a semi-annual period (126 market days). Since ranking over a lookback period is more reflective of the middle of the period, we were essentially comparing quarterly price performance, which we felt mimicked either actual or expected quarterly earnings performance.

If stock price behavior is random, the strategy will not perform well.

Our preference is to compare performance on a reward-to-risk ratio. That is, we take the average annual rate of return and divide that by the maximum drawdown over the period. The S&P 500 Index on a total return basis returned a 9.26 percent average annual rate of return and experienced a 47.41 percent peak-to-valley drawdown, thus its reward-to-risk ratio is .1953. However as you will see, the choice of performance yardstick is moot, as the results are totally one-sided.

Of the 46 collections studied, the average annual return was 27.39%, while the average maximum drawdown was 45.15%. The average reward-to-risk ratio of the collections was 0.6076. More importantly however, is that all of the collections bested the S&P. There was not one that underperformed the market.

Although the results are fairly uniform some vague generalities can be made, which will not be surprising: The fewer the number of assets chosen, the higher the return and more volatile the performance. The greater the number of assets chosen, the closer that performance will come to mimicking the overall market.

These are not enviable results, but they are significantly better than the market. This study raises the bar for asset rotators. Most compare their performances to a buy and hold strategy of the indices. However, now we would postulate that these are new benchmarks for an asset rotator to beat prior to claiming any expertise.

——————————————-

* The list included deceased stocks (e.g. Enron, Worldcom, etc.) to prevent survival bias. Thus at times the list consisted of more than 500 stocks.

May

1

The idea of recovery is linked to the subject of clearing. After a clearing, how long does recovery take? The measure of your fitness is the recovery rate to normal heart rate after reaching your maximum heart rate. You should be able to return to your normal rate quickly. The longer it takes, the worse shape you are.

It might be asked of your emotional health: after an argument how long does it take to regain your composure and to forgive? After illness, how long does it take to regain your normal strength? What is the best path to recovery? Rest of course, but the struggle back up the hill is always twice as hard.

This might be asked of the market, what shape is it in? How long does recovery to old highs take? It might be asked of a trader: after a drawdown, how long does recovery to new highs take? After a fire, our colleague showed recovery is especially rapid. We will see what kind of shape our market is in here soon. So far it seems pretty healty with a start at recovery.

May

1

Debt Managers Flock to `CDO Squareds' Backed by Subprime Loans 2007-05-01 13:40 (New York)

May 1 (Bloomberg) — A flurry of so-called collateralized debt obligations backed by other CDOs may be created soon to lure investors…

May

1

Some recent events have had me thinking about cause and effect, and the logic which surrounds their application. Let me explain:

 Just over a year ago a family member was diagnosed with Asperger's Syndrome. Now whilst there is plenty of denial around about the causes (people seem to go out of their way to blame vaccines etc.) it seems that the most likely one is inheritance. And since I am related and happen to be a chess grandmaster with some social 'eccentricities', fingers quite naturally get pointed.

After reading up on the condition I noticed that I had a number of traits. So I figured it might be good to get tested, which in older people is done via an interview of the suspect together with one of a close family member, in this case my sister. The upshot was a 'not guilty' verdict, it was simply impossible for the psychiatrist to establish a positive diagnosis (too much eye contact, apparent sense of humour etc.). On the other hand he thought it possible that I was somewhere on the spectrum and that had he seen me 30 years ago then I might well have tested positive.

This was quite thought provoking. Can a still existing physical condition (in this case the small matter of dodgy brain wiring) be regarded a 'cured' if the person who has it finds 'work arounds' so that any symptoms effectively disappear? The prevalent view seems to be that those who are on the spectrum are somehow 'incurable', but I do wonder about the evidence for this. First of all the hypothesis that Asperger's Syndrome means xyz traits relies on testing a sample of people who show xyz traits in the first place. This ignores the possibility that many people might have overcome the same condition so as to be undetectable. An excel spreadsheet would call this a 'circular reference', demonstrating how smart it is compared to the average humanoid.

Then we come to the confusion of cause and effect. The process through which one finds effects have particular causes may be a good way to study many things, but flaws may appear when the reverse argument is applied (ie that a cause will necessarily result in a particular effect). So if someone breaks their back and therefore cannot walk, this might prove to some that they could not possibly become, say, one of the world's strongest men. Yet Valentin Dikul did exactly that, breaking his back and then curing himself with a set of unique exercises that developed other muscle groups.

Similarly one of the word's greatest composers was in fact deaf when he wrote much of his best music. Beethoven certainly 'worked around' his deafness and possibly his Asperger's Syndrome as well (see Fitzgerald for evidence of Beethoven's Asperger's Syndrome).

I can see the very early stages of a similar process at work in my son. His difficulty with the standard way of acquiring language is being offset by an ability (not to mention determination) to remember a large number of phrases (mainly from Thomas the Tank Engine DVDs and software) and then recombine them in situations he recognises as being appropriate. The results are slightly odd at times (not to mention comical) but this work around is doing its job, he's learning to talk. I further speculate that he will learn to work around the other 'disabilities' associated with Asperger's Syndrome, including sacred cows like 'empathy' and 'humour'.

Is his method of 'working around' approved of? Apparently not. Whenever I've had to discuss his case with any 'authorities' who have been involved, they try to say that his 'understanding' needs to be developed rather than him using memory. I get the impression they'd say that Dikul had no right to cure himself either, at least not by methods that weren't approved of.

What's their problem? I think their understanding of cause and effect is flawed in that the assume the causes they know of are inseparably linked to the effect being observed. And I further suggest that one can find similarly poor linkage in things like 'climate change' in which a series of plausible relationships is being presented as proof of impending doom. It's there in markets too, lying at the heart of failed and failing models.

Why are cause and effect leading to such problems? I think it may be down to a lack of creativity, the ability to come up with alternatives. Normally creativity seems to be sidelined as nothing more than an adjunct to the analytical process (come up with an idea and then analyse it). But what if analysis is necessarily flawed if it lacks a creative element at every stage, the reason being that without the ongoing generation of alternatives, cause and effect will be assumed to be fully reversible?

Chess players here may note that Kotov's famed 'tree of analysis', in which the player first comes up with 'candidate moves' and then analyses them afterwards, may be similarly flawed. For years Grandmasters have felt guilty for being 'undisciplined' by generating new candidate moves during the analytical bit and then going back to square one. But perhaps they weren't so wrong after all.

I'm not sure if my thoughts on this are 'new' or not, at least they're new to me. Sharpening, clarification and criticism appreciated as always.

Kim Zussman adds: 

On 5/1/07, Stefan Jovanovich wrote:

One group was identified to each of their new teachers as having exceptional potential and the other as being what my recently released from high school daughter assures me is still the term for dummies -"retards".

There is also correlation between intelligence and good looks; some of which may stem from teachers and mentors affinity for cute kids and interns.

(Those hoping for something here about priests will have to settle for this)

You can see this with income/net worth also. For example we have Whole Foods and Trader Joe's markets here, which sell similar "healthy/organic" (what food isn't carbon-based?) TJ's is quite inexpensive, but WF is very high. If you enjoy retailing adventures, shop them both and you will see a clear difference between clienteles. The TJ housewives are trying, but saggy and kind of hungry-in-the-soul looking in the eyes wishing it weren't so. A lot of the WF crowd looks machina ex-Berkeley, with things still holding up well by dint of good jeans toting a perky-in-the-credit-card eager to check out.

All of which evidences that Asperger's and volitional Tourette's may still have funny jeans, especially large ones they wore as a child impersonating Jonathan Winters. 

Stefan Jovanovich says:

The women in my household (one 58, one 22) disagree with Dr. Zussman. They attribute the WF phenomenon to the trophy wife syndrome, and they remain skeptical about the correlation between brains and good looks, given what the older one knows from three decades of working in show business and what the younger concludes from having survived both high school and college. They offer the Drive Through ATM joke by way of confirmation.

May

1

Is a market that doesn't test previous highs on a breakout (over x amount of time) telling us something, therefore should we add a certain % of higher risk on its next foray into blue sky after a measured period of consolidation, if indeed it does not give us "that pullback?"

Some markets just take off and never let you get back in … maybe on ones that do this a different trading appoach is needed rather than the feeling "I've missed it."

May

1

 Whilst looking around the internet for pictures of my buddies and I on the trading floor, I noticed that Deutsche Bourse has cornered the market on Andreas Gursky's photos of exchange floors:

Also I found an old CME ad promoting the beginning of the E-mini S&Ps. My, how far has that contract come!

The CME has put out some really cool promotional stuff in the past and I'm working on a collection. When a contract would be launched or some sort of milestone was set, they'd give out buttons for everyone to wear. Stuff like, "15 minutes please" to ask traders to make an appearance where a new contract was trading and give it a shot, or such as celebrating 1 million open interest in eurodollars (it's 10 million O.I. as of yesterday), and the launch of new contracts, most of which failed.

In the 70's they put out posters and ads ridiculing the Communist system such as How Come There's No Moscow Mercantile Exchange?

"Millions of tons of potatoes, cabbage and other commodities change hands in the U.S.S.R. every year, but not a ruble's worth is traded on any futures market. In a regulated economy, the price of a head of cabbage is exactly what the government says it is –no more, no less. Does their system work? Apparently. Does it work as well as ours? You've got to be kidding."

How Come There's No Peking Duck Exchange? "Difference of opinion — openly aired — is as essential to a free economy as it is to a free society. That's why great commodity exchanges can flourish in this country and not in the People's Republic of China. You can't have free markets in a regimented society. And you can't have regimented markets in a free society."

How Come There's No Havana Cigar Exchange? "It just wouldn't work. A commodity futures market such as those that flourish in the Uniter States and other free countries simply can't operate in a highly regulated economy. Free markets — or controlled? When you get right down to it, that's probably the single biggest difference between their way and ours. Except, of course, for the standard of living."

There is also a Budapest or Belgrade ad out there but I don't have my paws on it yet.

I'm not sure if they put any promotional material out under the phrase "Free Markets for Free Men" but I'm certain the meat pits didn't let it be known their unofficial phrase was/is still? "Wide Markets for Wide Men."

One thing that makes me livid is that I was travelling and didn't know that Nick Leeson's jacket was up for auction until after it ended. To follow up, I emailed the liquidator and they said all the other Barings coats were sold as well.

While on the topic of the trading floor, I might as well plug a new book that I enjoyed recently and is an easy read, Out of the Pits: Traders and Technology from Chicago to London by Caitlin Zaloom. Another thing I dug up on the net is a 51 second youtube clip of Robert Downey Jr. on the floor of a NY futures exchange and he concludes with his opinion on the types of people who inhabit the floor.

If anyone knows of any Futures industry memorabilia for sale, please let me know.

May

1

 I recently had the pleasure of having dinner with a certain young man, Mohammad Asif at the home of a good friend. It's not often that I get the chance to sit and chat with someone of such huge potential in the world of cricket, so I was tremendously excited.
Some background first. Asif is the latest in a long line of prodigious fast bowling talent that is constantly being unearthed in Pakistan. Pakistani fast bowlers have been credited with inventing and then perfecting the art of "reverse swing." Rahul Battacharya in his book "Pundits from Pakistan" credits a version of cricket called "tape tennis" for keeping this conveyer belt of fast & swing bowling going in Pakistan. This version of cricket is played with a tennis ball wrapped in electrical tape and more often than not played on concrete. Roads, pavements, parking lots, anything will do!

During these few hours, inevitably the discussion centered around the Pakistan cricket teams' poor performance at the current World Cup in the West Indies. It was here that Asif opened up. He began to talk about the professionalism, hard work, athleticism and mental preparation of the Australian team. Australia are to cricket currently what the Jordan Bulls were to 1990s NBA. The sheer desire to win and competitive spirit that is the ethos of Aussie cricket has never existed in cricket before, certainly in the modern era that I have watched the game. They do not care if their opponents are amateurs or the next best team in the world. They want to defeat, maybe even crush them all by the same margin!

For me, hearing a Pakistani player, especially the new vice-captain of the squad, speak of admiration for the professionalism of the Aussies was like manna from heaven. Is it possible that we have finally found home grown leadership that wants to develop modern attitudes in its approach to competitive professional cricket?

This discussion lead to discussions about Chelsea, the current English Premiership champions (soccer), Michael Jordan and the Bulls and eventually, Asif said the magic word: deception! He said when he was bowling, all he thought about was how was he going to get the opposing batsman out. What would he bowl, from what angle, how did he want the ball to approach the stumps, and what was the batsman expecting. He wanted to deceive the batsman into losing his wicket and would try anything to make it happen. Now, the Chair has written numerous times on deception and its role in markets, sport and even life. But here was a guy who had worked out that it was his primary weapon in attaining success. And he's only 25. I thought about mentioning the Chair's work to him, but decided it would be too far removed from Asif's world to appreciate. Better to direct him somewhere else.

So I mentioned Hashim Khan's book "Squash Rackets: The Khan Game" a first edition 1967 copy of which my university squash coach Peter Lyman gave me in my sophomore year (the reasons are another story). Everybody from Pakistan knows the legend of the Khans, so I figured he'd cotton on immediately and I wasn't disappointed. Chapter 7-9 read like a very early version of "Winning Ugly" by Brad Gilbert. He's asked for my copy of it which I will loan to him, but I think I'll add Winning Ugly too.

I'm convinced that Asif will become a legend in the sport, not only because of his audacious ability to swing the ball, his simple and sustainable action, but also because he has already understood the game within the game. All he needs is to find 10 like minded individuals in Pakistani cricket, and we can win the next World Cup!

For those interested, the current Cricket world cup will finally end this week, and more than likely Australia will win for a record 3rd consecutive time. But the seeds of the future are being sown. What price Pakistan at the next World Cup?

May

1

 I played golf this weekend with my wife and a random twosome. On the first par 3, I hit a good shot about 6 feet away from the pin. The next guy hit it about 2 feet away. I congratulated him and told him this story:

My first hole-in-one happened just like this. I was playing with a friend and a random twosome. One of the other guys was very competitive, and he hit a shot about 5 feet away from the pin. He taunted me, saying, "Let's see you get inside that!" I calmly lined up a wedge from about 120 yds with the wind at my back, and plopped it right in the cup.

My current partner said, "That's great! You really showed him!"

Then we both missed our birdie putts and sulked over to the next tee. He said, "So you started your story talking about your first hole-in-one. How many have you had?"

"Just one so far," I replied, "But I'm optimistic."

May

1

 This might be useful to compare stock returns to contemporary art prices.

Enlarge Image A painting by cult "guerrilla artist" Banksy has sold for GBP288,000 at auction - a new record for the artist.

Space Girl and Bird, which sold for 20 times its estimate, was commissioned by Blur for their Think Tank album cover.

It was sold to a telephone bidder from the US. Earlier, a Banksy self-portrait showing an ape's face fetched GBP198,000 - five times its estimated value.

The previous record for one of Banksy's works was GBP102,000, paid for a picture of pensioners bowling with bombs.

Banksy, from Bristol, made his name with stencilled graffiti and subversive stunts in public spaces but fiercely guards his true identity.

Banksy self portrait Six telephone bidders battled it out to buy the self-portrait Another two of his pieces fetched GBP75,000 and GBP32,000 during Wednesday's sale at Bonhams auction house in London.

Bonhams specialist Gareth Williams, said: "We are delighted with today's result.

"The art market for contemporary cutting edge art is booming and Banksy's work has become part of this culture."

Charles Dupplin, an art expert from insurance company Hiscox, said buyers were "fascinated" by the artist.

"Today's auction demonstrates just how much art by Banksy has skyrocketed in value. Clearly he is an artist in huge demand.

"To have the previous record set by the artist broken twice in quick succession reveals how much fascination there is in Banksy by collectors."

The value of contemporary art had increased by more than 11% in the last year, he added.

May

1

You never hear much about the real facts when people are trying to waft a detrimental meme past you. Now that inflation is all the rage again and people are fearful that there is going to be a terrible thing happening — not sub-prime, not China, not earnings slowdown, but inflation — don't expect anyone to point out that bonds closed the month at 111.24, a 35 calendar high, and up a bit on the year.

Perhaps the adjusted deflator index for March or April of this or that seasonally adjusted economic series would be more meaningful, as well as a parsing of the forces that will beset Bernanke. It is such a pleasure to have at the Fed a real economic man, who seems truly interested in providing the backdrop for a proper growth and inflation, rather than his predecessor who was always posing and always had a hidden agenda. The fake doctor reminded me of one of the old men who sat at the club windows on fifth avenue and commented on the mini skirts and diversity walking by these days.

Note the freqeunt high fives the fed boys gave each other under Dr. Greenspan when he used to tell them that by fooling the market one way or another he was able to avert upward movement.

There are many circuits in electricity and biology where the energy and health of a system is not complete until a clearing event has occurred, (I would very much like some good examples from the specs). It is interesting to speculate if such a clearing event can be described and used predictively for market movements. I would think it worth much study.

Hint … One such clearing event occured today.

Jim Sogi writes:

On the inflation meme, I was astounded at how cheap a car went for. It seems less than they cost years ago. Cars now are bigger, better, more engine, last longer for less money. Go figure.

On clearing, forest fires are a great example. There has been a debate for years in the US Forest Service on fighting fires. The policy before was to fight all the fires. The policy cost lives and in fact made the fires later worse because the underbrush grew creating tinder. The natural fires clear out the underbrush and give way to new growth and healthier forests. The policy now is to allow more natural fires to run their course to have a healthier forest. This is true with markets. A few little fires here and there help to clear out the dead wood, leaving the healthier more vibrant life. Some forests need fires to regenerate.

On that subject of running their courses, these long bars are always of interest. My favorite biochemist studies how to attach new molecules to the molecules that they want to track and follow in the body. The ones they want to track try to hide and avoid detection. The only was to find them is to cut and that is no good. The scientists attach a "handle" or a long bar molecule sticking out of the diseased molecule. To that handle they attach something like a glowing chemical or tracking device so they can see the disease in the body without cutting. This is my layperson's simplification of a complex process, but in my mind at least describes the process. Molecules operate on a very physical level, like a key in a lock. The long bars are a kind of handles that help track the market and are good handles to tag to follow the market.

David Lamb adds: 

To add to (and hope not diminish from) Mr. Sogi's comments, I quote from a Botany textbook I received from Arizona State University.

Many viable seeds do not germinate right after they are shed from the parent plant, nor do they germinate during the following growing season. Seeds can lie dormant for many years before conditions are suitable for their germination. Everywhere that seed plants grow, the soil contains viable, ungerminated seeds in natural storage-that is, a seed bank.

Seeds in a seed bank may be dormant because of their own inhibitors, as in many desert plants. Ecologists can sometimes determine what kinds of seeds are in the seed bank of a particular habitat by removing the shrubs from a small area. When a new growing season begins, the seeds of many annual plants germinate. Such experiments simulate what happens, in part, when fire sweeps through an area. In addition to eliminating the source of potential germination inhibitors, fire also releases the nutrients contained in plants. Thus, annual plants grow abundantly in burned areas during the first growing season after a fire. As perennial plants become reestablished, the newly replenished seed bank of annual plants once again goes into natural storage until the next fire."

Seed banks that require favorable environmental conditions to germinate can be compared to the famous caneology. Some of the lesser plants that do not have strong enough roots to withstand the "heat" can be cleared out in order for those other plants, the plants that have been leaning on their canes for quite some time, to show up on the stage.

Vincent Andres writes: 

There are many circuits in electricity and biology where the energy and health of the system is not complete until a clearing event has occurred.

Some rough thoughts. I would distinguish at least 2 kinds of clearing events, based on the event's duration.

1. Long clearing events:

Biology: at the end of the day we sometimes get tired, e.g., quite unable to solve a problem. A good night sleep and the problem gets solved. I think most of the night "clearing" we use our energy for our brain/body reparation/maintenance/etc.

Mechanics: I ask a bit too much to my motorized cultivator or my chain saw. So it becomes dangerously hot and I have to give it "clearing" time in order to cool a bit.

In both above cases, the clearing event is quite long. At least it has some proportionality with the working time.

Maybe markets also need to rest or to cool.

2. Short/instantaneous clearing events:

Electrical: e.g., the soft reset or hard reset on some computers. Necessary to bring a computer out of a endless loop etc. The clearing event is very short, but this effect may be very beneficial. The computer system is rebooted to an initial state.

Biology: Sometimes our mind gets confused. A problem seems very difficult. We try many issues and none work. And suddenly in the middle of the confusion a little detail, a little connection occurs, and we understand. I believe that in fact, the understanding was already here, already present, but hidden in the confusion/drafts of the work. The clearing event is maybe the moment where we decide to wipe out the useless stuff. A clearing event may also be the recognition/awareness, of denial. It's a short instant, but it may have great consequences. But, I think it would be erroneous to believe that all occurs just during the short instant. All is already prepared. The question is "when will we look at it?"

The straw that breaks the camel's back catches our attention, but the responsibility is not the straw's. And detecting the straw is probably much more difficult than noticing that the camel is overloaded.

Maybe markets have also some trigger or revelation.

I think markets are concerned by both kind of clearing events but I'm respectfully curious about precisely which kind of clearing event you were thinking of?

"For fifteen days I struggled to prove that no functions analogous to those I have since called Fuchsian functions could exist; I was then very ignorant. Every day I sat down at my work table where I spent an hour or two; I tried a great number of combinations and arrived at no result. One evening, contrary to my custom, I took black coffee; I could not go to sleep; ideas swarmed up in clouds; I sensed them clashing until, to put it so, a pair would hook together to form a stable combination. By morning I had established the existence of a class of Fuchsian functions, those derived from the hypergeometric series. I had only to write up the results which took me a few hours."

Henri Poincare

Victor Niederhoffer adds: 

It is interesting to speculate if such a clearing event can be described and used predictively for market movements. I would think it worth much study. Hint: One such clearing event occurred today. 

David Wren-Hardin writes: 

There are many circuits in electricity and biology where the energy and health of the system is not complete until a clearing event has occurred.

The first that comes to my mind is both electrical and biological. When our nerves send a signal, it's sent by an action potential. A neuron maintains a potential difference across its membrane through the use of a Na/K pump; it pumps Na out of the cell, and K into the cell. The action potential is kicked off by a signaling event, and the gates in the cell membrane open, and Na floods into the neuron, causing a rise in voltage. The Na gates are sensitive to depolarizing events, and a positive feedback circuit ensues, where more and more Na channels open, causing a spike in voltage — the action potential.

The Na channels don't just stay open, however. After depolarization and opening, they are inactivated in a voltage-dependent manner; the very process of opening and depolarizing the cell leads to their own inactivation. Another action-potential is only possible after the Na/K gradient is re-established, and the refractory period ends. In other words, more activity is only possible after a clearing out of the activity of the previous event.

One could also see the action-potential itself as the clearing event. A large potential is built up over time, and with a seemingly small synaptic event, a cascade begins that triggers a large event.

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