# Bathtub Theory of Markets, from Phil McDonnell

February 28, 2008 | 7 Comments

When taking a bath one of the better ways to circulate newly added hot water is to swirl the water in the tub. One hand paddles backwards, the other goes forward and a giant wave soon circles the tub. At any given moment there is a limited volume of water in the tub. The goal is to circulate the water around to each point in the tub equally.

Our friend Sushil Kedia has posited that the Indian market leads the US market. Perhaps this is an application of the bathtub theory. To test this we might wish to look at simple correlations between INP, the Indian ETF, and SPY, the S&P 500 ETF. If in fact the Indian market leads we would expect that there wold be significant correlations at some lag. Following are the recent correlations of the INP with SPY at various lags:

Notably, five of six are strongly negative and the sixth is insignificant at 1.2%. So it would seem that the globe is a giant bathtub and that water does slosh around it in a non random manner. But if there is correlation then we know that a predictive regression model can be developed.

Using only lags 1, 3, 4, 5 & 6, our regression model has an overall correlation of 24.9%. All of the coefficients are negative, mostly in the neighborhood of -.04. The regression constant is -.001, reflecting the recent weak market behavior. Effectively what this says is that when money flows out of the Indian market it tends to go into the US market over the next six days or so. The converse is valid as well, in that if money goes into the Indian market it will come out of the US in the next six days. In any event the bathtub theory works reasonably well for the Indian - US markets, with India leading.

# Bathtub Theory Part II, from Phil McDonnell

February 28, 2008 | 1 Comment

The Bath Tub Theory is based on the premise that there is a fixed amount of water (money) in the tub at any given time. In the earlier piece we saw that money flowed from Indian stocks to the US with about a 5 to 6 day lead time. However at the core of any reasonable such theory the money must be returned. Just as the wave travels to one side of the tub it must also swirl back to the first side as well because the amount of water is relatively constant for any short period of time. So does the theory hold up and allow the money to return from the US to India?

To answer this question we only need to look at correlations between SPY and INP but, this time, with the SPY etf leading. Following are the correlations between the two with a lag of 5 and 6 days.

lag correlation
5 -10%
6 -18

A regression of the two lagged variables shows an overall correlation of 22%. We also note that the correlations and their respective regression coefficients are negative. This indicates that money flows out of the US and into India as expected by the Bath Tub Theory. For what it is worth the prediction for INP on Monday is a loss of about 1%. But be careful. The standard error for the model is about 3.9% so the prediction is well within one standard error. Over the last 95 days the chances of a successful prediction have been about 58% so its a little bit better than a coin flip.

# Inflation? from George Zachar

February 28, 2008 | 1 Comment

Ever so slight, but upward, revisions in the price series.

By the way, the uptick in initial claims seems to have been due to funky seasonals around the President's Day holiday.

Silver is approaching \$20. Can \$1000 gold be far behind to complete the markets' inflationary grand slam (after \$100 oil, \$1.50 euro)?

# Skilaufen, from Alston Mabry

I don't ski, but I do like to watch it on TV. And just about everybody I know is at Big Bear or Whistler or some such right now. Which makes me think of skiing as a market analog. You take the chair to the top, and that's the overnight gap up/down. And then you slalom back down the slopes. And there are bunny runs, and intermediate runs, and those black diamond runs — I've hiked them in summer, and man, some of them are way, way steep. Each class of run has a certain risk/reward ratio. You gotta know what you can handle and what might wipe you out. And when the pros do it at the World Cup level, they use every bit of leverage they can get.

## David Wren-Hardin recounts:

Along with knowing what your limits are, you have to know what run you're actually on. I went skiing last week at Snoqualmie pass in the Cascades east of Seattle. I'm an intermediate skiier, and have never skiied west of the Mississippi or anything as big as Snoqualmie. I was there with a friend, and we headed up to the top, intending to take a blue trail (intermediate) across the top to some blues down the left side of the mountain. The top of the mountain was engulfed in cloud, but we headed off to the left, looking for signs of the trail down. Soon the trail was hemmed in on both sides by trees, then went off to the left. It looked a little steep, but we obviously had gone as far as we could. Off we went. Bam, I went down and slid down almost 200 yards. One ski joined me at the bottom, the other was two thirds of the way up. My friend lost one ski altogether.

Ski patrol came along, and helpfully went to the top and brought my ski down. Meanwhile my friend found his. As we brushed our egos off, we asked ski patrol "Just what did we go down?" "Oh, that's Free-Fall, a black diamond (expert)."

When it cleared up, and we could see where we went wrong, it became even more laughable. The trail we meant to follow was broad and clear. But in the fog, we had drifted left, hitting a fairly small clump of trees at the top of the diamond runs. But with our view obscured by fog, our unfamiliarity with the slopes, and our preconceived notions of where the trail we were looking for was, we launched ourselves down a trail that was much beyond our abilities. For what it's worth, during the entire rest of the day, I didn't see a single person go down Free-Fall.

# When Bridge Burning is Good, from Nigel Davies

In most pursuits it's a bad idea to burn bridges. Trading is an obvious example, if one keeps making all or nothing bets then sooner or later it's going to be nothing. Chess is like this too, the professional way of playing being to avoid leaving one's position so brittle that a failed attack means you are lost. This is why Bent Larsen liked to push his rook's pawns; an advance of this pawn rarely compromises one's position beyond hope.

There are also times that bridge burning can be good, when the bridge leads somewhere to which you never want to return. A good example is in throwing out old clothes after losing weight when retreat is no longer an option. Another is to announce to acquaintances that one is giving up the thing that lies on the other side of the bridge. Take your pick between booze, cigarettes and blondes, the statement makes it harder to go back because of the loss of face. One must, of course, mind losing face for this to work.

And this brings me nicely to the point of this email, I'm about to burn one of my own bridges with an announcement: A wonderful 30 year relationship I've had with (moderate amounts of) alcohol has recently come to an end. And I'm now left wondering why I didn't do this earlier.

## Scott Brooks replies:

When I first got into this business it was recommended that I read Tom Hopkins book "How to Master the Art of Selling". It was a very old-school book on selling (but hey, 20 years ago everything was old-school), but it did have some pretty profound advice that I decided to follow.

I'm going from memory here, but what Hopkins basically said was, "Remove all people and all things from your life that don't add value."

Then I made several decisions that I believe had an important impact on my life.

1. I stopped hanging around with a group of friends that were hoodoos
2. I gave up drinking altogether. I was never a heavy drinker, but not giving it up was symbolic to me in that it I believed it seperated me from the vast majority of people
3. I reaffirmed my commitment to not use four-letter words.

By far and away, giving up the hoodoo's was the best thing I ever did. But quiting drink and not using four-letter words is a constant reminder to myself (since most around me cuss or drink) that I hold myself to different standards, that are solely my own.

Now, I'm certainly not proselytizing my way of life to anyone reading this, nor do I look down on others that make choices that are different than mine.

## Steve Leslie writes:

To Nigel, I say, congratulations on your decision and I hope it has meaning for you beyond the physical benefits you will likely experiences.

The Outlaw Josey Wales said it best, “A man’s gotta know his limitations.”

I applaud Nigel for making a public and personal decision. I emphasize the word personal.

I agree that moderate drinking, consumption of fine food, recreational gambling, enjoying a fine cigar, or trading futures, in most cases is probably not very destructive. When it is a chronic condition when it might become a problem.

Even helping out those in need and advising others can be a noble pursuit.

Many of us are aware when this crosses the line and becomes destructive to our own lives.

For those who might not have the gift of discernment or may be too soft-hearted or gullible, it can be very helpful to have at your disposal an inner circle of advisors. It also is important to distinguish as to whom one includes in this circle. Napoleon Hill in his excellent book “Think and Grow Rich” discusses this in great detail. Others such as Tony Robbins, Zig Ziglar and Jim Rohn have also expounded the validity of such a strategy. It would serve us all well to visit Hill’s book and review his profound wisdom.

## Nigel Davies replies:

Steve makes a good point that such decisions are personal. It wasn’t meant as a criticism of other peoples’ choice to drink either moderately or immoderately. In fact one of my all time favourite quotes is by former World Chess Champion Mikhail Tal, who on learning that the Soviet authorities were going to clamp down on vodka drinking exclaimed: “The State against vodka? I’m on the side of vodka!” It was vodka that killed him, by the way, though without the vodka he might not have been able to tolerate life in the USSR.

My purpose in going public was really just to keep myself in line; making a public declaration like this really binds you to the decision. And I made the choice to quit after starting not to feel too good the morning after even moderate consumption. This sudden intolerance could be a result of having taken up Zhan Zhuang (’standing like a tree’) some months back — I’ve been advised by that such practices can produce this kind of effect. Whatever the reason I can say that I now feel better than I have done in years. And it will be a sad day if I ever build a bridge to go back.

## Jeff Watson recounts:

I used to be guilty of not burning bridges, and it cost me dearly.  I got a reputation for being a shoulder to cry on, and found myself inserted into the problems and drama of others.  This took a physical and emotional toll on myself and my family, and I finally had to cry, "No Mas!"  About 15 years ago, I made a concerted effort to to free my life of all of this flotsam and jetsam, and the result of doing so has simplified everything in my life. I got away from negative people, the ones who suck the very lifeblood from your soul.  However, I do like to listen to hoodoos, encouraging them to give their views in great detail.  Hoodoos are great fade indicators, and I look forward to their views  like the Israelites devoured the manna from heaven.  I listen to them with a jaundiced ear, and never allow them to convince me that their views are right.  I learn a lot from them, and consider them a great source of what not to do and what to fade.  I've burned a few bridges in the past by not doing business with friends, not co-signing on loans, and not financing ill prepared business ventures.  Although I've disappointed a few people with my "Scrooge" like approach, life has been better for myself and my family, and that's what really counts.  The only bridge I never burned was that of my favorite charity.  Although it sucks up a lot of time and money, and I would personally be better off distancing myself, whenever they need something, I always answer their siren's call.

I used to have a lot of married friends who would often try to drag me into their fights to be on the man’s side or the women’s side. When I was younger I use to bite and take one side or the other only to deeply regret it later after they made up. The one I had sided against was not to pleasant to me for a long time.

This is probably a common experience for a lot of people…

Solved it with a one liner. No couple who hears it has ever bothered me again. “Listen, You guys don’t invite me when you make love so consider me dis-invited when you make trouble!”

## Eric Falkenstein cautions:

I think in ridding oneself of people who don’t add value, it is important to take the long view. If you are the kind of person who only deigns to return calls or hang out with people in a position to do you favors, right now, you are all too common. You would be an unreliable friend or colleague, because when adversity hits, you can’t be counted on. Further, there are many behind you that engage in mercenary friendships, so you aren’t needed–a fun replacement who values my friendship for the favors I can bestow him is simple. Such a person would be constantly trying to get into asymmetric relationships, always the lower-status guy trying to get the better of his ‘friend’.

No one likes these people, for obvious reasons. Thus, relationships should be addressed with a long view, in terms of intellectual, business, or social growth. To the extent their interests are base, unenlightened, or self-destructive, you need to avoid them.

# When the Smoke Clears, from Alan Millhone

Note the recent cigar show in Cuba where thousands attended from 40 countries (sans the USA). Last year a box of fine Cuban cigars sold there for \$828,000! A lot of money to go up in smoke. Over the years I have been around some cigar smokers and most seem to share a similar demeanor. Joe Schwartz, a master checker player from Florida, carries a bag full of cigars to chew upon when playing in a tournament, but I have yet to see him light one. Our daughter used to live in Charlotte and on occasion going down that way we would top in Statesville at J.R.'s. The entire back of the store is dedicated to cigars of all descriptions and cigar humidors, etc. I don't smoke but always enjoyed venturing back into that huge room to see all the cigars they stock. Some years ago I was in London and was looking for something special for an old friend back home. I walked into a tobacco store and asked the manager what I could buy for my friend back home and he replied, " Cuban cigars." I bought a pack and took them back home for my friend. Herb was really pleased with my gift. Cigar smoking, I hear, is on the decline.

# Aha! Gotcha, reviewed by Victor Niederhoffer

The book Aha! Gotcha by Martin Gardner contains much food for thought and enjoyment in the field of self-referential paradoxes and coincidences that arise in many fields. He starts with variations of the Liar's Problem. Epimenides said "all Cretans are liars." But considering that he was a Cretan, did he speak the truth. In exploring such paradoxes, Gardner explores some of the profound questions and unusual insights that such paradoxes lead to. I believe that such explorations will give similar insights into markets.

Gardner cover probability paradoxes in the ares of average, small world, patterns, and clumps. An example from averages is that most great mathematicians were first born sons. The fallacy is that first born sons are more common than second born sons because of one son families so that any group is likely to have more first borns. The fallacy arises in the work of those who predict stock market disasters. They point out that an inordinate number of disasters come when the market has not gone up or some such, leaving out the fact that most great booms come from the same preconditions. The Good to Great boys make a similar error in pointing out that most great companies pay attention to a core. They leave out the same from bad.

The small world paradoxes are based on the experiments of Stanley Milgrom that show that people are connected to vastly more people with a few steps than might be expected. He found that it took five steps to mail a document on average to a given person in another state. Watts has subsequently shown the lack of reliability of the study and in the age of Internet, it might take two minutes for such a chain to happen if the people were wired. However, one thinks of the recent \$7 billion loss and the three weeks of study that it took the bank to verify it and the many people that were involved in the trade, and no wonder the US stock market went down 60 points in the five minutes before or just during the unwinding of the trader's positions.

The third set of probability paradoxes introduced by Gardner are based on variations of the Birthday Problem. If there are more than 23 people in a room, the chances that at least two have the same birthday is 50%. Similarly if four people in a room, the chances that at least four have the same sign of the twelve is 40%. This should give one pause when noting coincidences. With the 20 markets that one looks at, the chances are well over half that two of them will have exactly the same sequence of rises and falls. Similarly,the chances that you'll find a day that will show the same direction of big or small change as one of the days last week is quite high.
A related set of coincidences is based on the digits of pi. You can find a run of seven threes in the workout and you'll be able to find 15 up or down days in a row if you examine enough markets , changes, or chart patterns. The fourth set of paradoxes is related to clumping. You're going to find if you mix up red and black balls in an urn, that they look like they form a meaningful mosaic of large clumps of the same colors. You'll suspect adhesion, but really you're seeing random numbers. Gardner applies this theory to the spins of roulette wheels, and the applications to what looks like valid charting ideas is clear. It's a good caution.

One of the more interesting things about Gardner's book is that he is not a mathematician. He uses common sense and consults with experts to explain all the unusual phenomena. This common sense approach leads to many AHA's by him, and when you translate it into your own bailiwick, it's like a child looking at things that are second nature to you but are not so obvious.

The book is highly recommended for those who like childlike areas of discovery in their field.

Vic's review of 'Aha, Gotcha' also got me thinking about trading and life in general from the existential perspective. It is both uplifting and depressing.

Whilst I am not mathematically inclined, I have always had an appreciation of probabilistic events in life. I feel this gives me an inner strength because I appreciate and am comfortable with the likelihood of the downside events, especially when they are outside of my control. For example, when I was mugged a few years ago, I was scared but the event didn't scar me mentally, because I figured that the mugger was out to mug someone, and it just happened to be I. In fact, staying rational gave me an upper hand and I actually managed to get the mugger to give me my mobile phone and wallet back to me (minus the cash). Another time, my car (parked) was involved involved in a hit and run. I reasoned that these things happen, and I wasn't being personally targeted. The bit that upset me was the potential cost and inconvenience. Also, I try to live a healthy life, but I appreciate the high odds of dying of cancer or heart disease. It's the probability distribution of life. And as life goes on, we gain more knowledge of the bigger picture, of the likelihood of various events, and of the uncertain.

We come to appreciate the fact that there is a 50% chance of two people having the same birthday in a room of 23 people, of the fact that we will probably be involved in a car accident in our lives, of the fact that we will all one day die, of something. I feel this is a powerful awareness because it keeps us in the driving seat of life. It is harder to be knocked off kilter.

However, whilst being armed with the knowledge of probability helps us to see through many of the common fallacies, it brings with it a problem that relates to the emotional response to upside events, specifically the sense of surprise. For example, should I feign surprise when two people in a room share a birthday? What about if I have a run of ten successful trades in a row? The trading example is less likely than the birthday example - its just over 1/1000 if we assume 50/50 odds. However, if I trade frequently enough, the real surprise would be if this never happened. My question is if I have a rough idea of the probability distribution, should my degree of surprise vary depending on whether I experience a low probability event or a high probability event? I suggest my emotional response should be the same, unless something out of the ordinary happens (ie beyond one's mental model of what is likely).

It's important to qualify that I only talking about the surprise element here. As this gets stripped out of my life, I feel I am more balanced but also that I am less human because I am no longer easily surprised. I am still amazed at the beauty of life and all that jazz, but its just this sense of surprise is increasingly missing from my life. Is my thinking faulty? I feel a bit like the Albert Camus's 'The Outsider', who, in the words of Camus himself: 'is condemned because he doesn't play the game … He refuses to lie. Lying is not only saying what isn't true. It is also, in fact especially, saying more than is true and, in the case of the human heart, saying more than one feels.'

This is such an honest and thought-provoking post — I love it, and thank you for it!

It speaks to so many issues, not the least of which is that no one gets out of life alive. That is a given and we shall all live and die with it.

Going further, as we age, we forget how to play. We lose the childlike wonder, the ability to be surprised and the sheer joy of being alive.

Traders take themselves altogether too seriously. I have found this to be true through many years of trading and teaching. It is good to have emotions under control when trading, but even better to learn to let the emotions run free when we are not trading. I have been accused of laughing too much and smiling too much. So be it, because that is who I am. I don't want to be free of emotions and the ability to laugh at myself and experience new things. I don't want to become Dr. Spock. I want to cry, dance, sing, laugh and realize that everything exists only because of the existence of its opposite. Without sadness, we would not know joy. Without boredom, we would not know excitement and surprise.

In the greater scheme of things, life is to be lived on one's own terms and the choices one makes are highly personal. If someone feels that there is no surprise, and likes it that way — wonderful.

If someone wants surprise, then it is within that person's power to see the world from that perspective. Everything is a choice, both in trading and in life. Life is never about what happens to us. Rather, it is about who we are and what we do with what happens.

The late Peter Drucker once asked: For what do you want to be remembered? This question may induce us to renew ourselves as the person we want to be or become. It may not, but it is worth asking just to find out. If you ask yourself that question a few times, the answers may be surprising.

There are some 50 trillion single cells in our body. We have the ability to use our brain to enrich, nourish and nurture these cells. We are able to put these cells into balance and harmony with our environment and to be gentle with ourselves, whilst continuing to push ourselves forward into the true freedom of authentic self.

# Aphorisms, from Alan Millhone

February 27, 2008 | 4 Comments

"Liars figure, but figures don't lie" was one of my late father's favorite expressions. Just saw that the median home price has fallen 4% in the past three years and new home sales are the slowest in nearly 13 years. I suspect OPEC will announce the same production levels and gasoline prices will go up another dime till it reaches \$4.00 a gallon at the pumps. Also I notice a lot of carpetbaggers are crawling out of the woodwork offering to 'help' those who are losing their homes. With the influx of tourists pouring into the USA with empty suitcases, the Euro might become a secondary currency in America. Our Dollar is of little value in most of the world. My favorite saying? "In G-d We Trust, all others pay cash."

## Kim Zussman extends:

All big declines start as small declines
Most small declines are reversed

Most small declines are reversed

Except the ones you hold, which reverse

Stocks drift upward over long periods
Except those in which you have overplus to invest

Declining periods are shorter than advancing periods
But when you focus on your P&L time stands still

Free markets work best
But not without the Fed put

Human capital is the best investment
Outside of commodities

Stocks and real estate are the best investments
Until you notice how well they do

Bull markets start the moment you decide never to invest in stocks

Success in what matters scales inversely to IQ and directly with charm

If you aren't laughing at yourself then you don't get the joke

Unlike women, chicken is unappetizing when anatomically correct

Trading success is the vector sum of {thorough research}+{strict discipline} in positive luck-space

Bald people would give anything for hair
Hairy people will do anything to get rich
Rich people will pay anything for love
Love is the main cause of hair loss

# The Stag in Stagflation, from George Zachar

February 27, 2008 | 1 Comment

The flagged series are core-core for the boffins, and decidedly soft as Bernanke chooses his tie for today's hearings.

# A Winter Hazard, from Scott Brooks

My office is a built like a big three story house with a metal roof (tin, copper, something has a green tinge to it). It looks very classy, but the roof is flat and very slick. Last year, I was sitting at my desk talking to my secretary seated across from me when the whole building began to shake like there was an earthquake. The shaking got much worse and then all of a sudden there was an incredibly loud series of booms (really, they sounded like explosions) and then silence. My secretary and I stared at each other in disbelief, wondering what had just happened. My other staff came running to my office wondering what that was. I went outside to look and couldn't believe what I saw. The entire front of the office building was covered in ice. Not just pieces of ice, but giant chunks of ice. We had had an ice storm the week before followed by snow, then more ice, then snow, then more ice followed by cold — an incredibly bitter cold snap. The ice and snow had frozen solid, creating a large sheet of ice on the roof. I don't know how thick it was, but it had be at least six inches. After several days of thaw, the ice began to slip off the metal roof. The sheet of ice that came off the roof was huge! It put holes in the dirt ground and broke the concrete sidewalk. It came inches from falling on several parked cars. If it had hit the cars, it would have crushed them. If anyone had been walking on that sidewalk when the ice slid off, it would have almost certainly killed him.

# Color Coded License Plates, from Ken Smith

Some states have started mandatory use of color coded license plates for vehicles owned by individuals convicted of driving while intoxicated, driving under the influence, etc.

In this state they are considering a yellow plate. Maybe the numbers on the yellow plate will indicate the number of prior convictions. Don't know.
br> In my drinking days I spent a half day with a fellow heavy drinker, mostly on his porch and living room, swilling booze of various sorts.  In a blackout I went out to my car, unfortunately parked in his driveway, and passed out in the front seat.

The drinking buddy had a working wife who came home while my car was parked in her space.  She raised hell with her husband but could not rouse him as he was passed out on his front lawn.

She called the police department.  Big cop roused me but I was in a deep fog and would not obey his directions to get out of the car.  He pulled me out by my feet onto the pavement.  The fog would not lift and I was unable to obey his instructions in a lively manner as he directed.

This cop was a big guy, strong as a bull.  He grabbed my ankles and held me upside-down, shaking out my wallet, wanted me to show him identification.  I told him I was doing my best, maybe he should draw his gun and shoot me.  I said that more than once, stayed laid out on the house driveway — was not on public property.

That did it for him; he left in disgust.  The little lady came out again, told me to get in the car and leave. Well, that I was able to find the starter and key is just simply amazing.  All the way across town I never once saw anything with single vision; all was doubled, had to constantly calculate which of the visions I should follow.

Made it home without accident or another encounter the the Men in Blue.

## Scott Brooks replies:

I'm glad Ken's drinking days are behind him. We all make mistakes, but most of us are lucky to get away with it without incident.

In 1979, my mother, who was recently diagnosed with MS that had luckily gone into remission, was able to go back to work. One day, she was rear-ended by a drunk driver.

She nearly died. The trauma caused her MS to come out of remission. The decade or so afterward, she was a total mess. Then one day her MS went back into remission.

That driver caused my mom to lose a decade of her too short life (she died from MS in 2004 at age 58).

I commend Ken for having the courage to not only talk about his past, but that he's had the courage to change and become the man that he is!

# Belpre, Ohio, from Alan Millhone

Our new Mayor, Mr. Mike Lorentz, was interviewed today and announced that tomorrow morning at 9:30 PM Presidential contender Hillary Clinton will be at Belpre High School to deliver her message. My little town of 9,000 has never had a Presidential hopeful ever visit. Her husband was in Marietta,Ohio (11 miles upriver from Belpre) last week to campaign for her.

I graduated from Belpre High in 1966 and know the auditorium well and wonder how many they can fit into that room? Doors open at 8:00 PM and I can only imagine the crush of people and news media that will be there. Belpre is but a little dot on the map, but history will be made there tomorrow morning. On another note, Michelle Obama will speak tomorrow at Ohio University in Athens, Ohio (about 30 miles from Belpre).

# Chess, Tennis, and the Market, from James Bitumen

One must experiment on the chess board to unlock its mysteries.

Playing in web-based public forums, it seems as though traditional, run-of-the-mill openings are engrained as routine for almost every player one faces. Of course, the lower rated players (1000s-1200s) often put themselves into precarious positions early in the game, but when watching the higher rated combatants, they generally open the game with standard patterns of play that usually result in traditional exchanges. Black knight for white bishop, queen for queen, and so forth.

Adapting my knowledge of the tennis court, I have recently chosen to combat the higher rated foes I face with uncustomary openings, such as the f-pawn, while playing black. I view such a move as being very similar to a floating, chippy slice backhand crosscourt landing near the service line.

I do not compare myself to the brilliance of Roger Federer on the tennis court, but he uses the tactic often, as do I on the chess board. It generally neutralizes the point at play immediately. Take a look at his use of this shot: Even the strongest of his foes, Djokovic or Nadal, have trouble immeditely taking advantage of the point. They have to move up in the court, either rolling their reply back crosscourt, or up the line. But they have left their right side of the court open to his backhand, or his fierce forehand reply crosscourt into the corner. As they have moved up in their left side of the court, they have to scramble backwards as they have left the deep right portion of their court exposed. Typical Federer response: a winner on his first or following shot.

I am, generally speaking, a contrarian trader. Sure, quiet openings on the chess board can be compared to quiet openings in the market, and vice versa. Experimenting in the market with real money can become a costly exercise, just as experimenting on the chess board can lead to numerous losses. But the point here is that one must never rule out the value of doing something that very few are doing.

# Inflation, from Ken Smith

February 26, 2008 | 1 Comment

A prominent web page should inform the public on how to take prices from the past and extrapolate them so future prices canbe determined, thus showing the public at large how much more money they will have to earn in the future to pay for the products and services they will require in the future.

The Federal Reserve should be required by law to do that, post it on their web site. The Establishment does not have a history of limiting inflation; its desire is for growth at any cost, and growth means pumping artificial money into the economy, either by government spending or by monetary action, or both simultaneously.

At one point in the 1960s I paid \$8 per week for a housekeeping room. That included water, sewer, garbage, and central heating. I paid nominally for a natural gas burner and electricity for a small refrigerator and lighting for the room. That kind of living is no longer possible. In the first place all such housing has been ripped out of the community to be replaced by condos. Rentals are going for the costof buying a condo; that is, condo owners are renting their apartments at prices which cover their costs to purchase.

Thus the cost of shelter has gone from \$8 a week to \$200 a week. That figure represents an astronomical increase.Inflation. The same rate of increase is going on. So in another 20 years the same space will cost \$5,000 per week, right?

At some point in the future, will Americans in major cities have to earn one-half million dollars per week in order to live the way they live now?

# A Round Number in Housing, from George Zachar

February 25, 2008 | 1 Comment

From today's economic release:

The median sales price of a single family house printed with a 1 handle for the first time since 2/2005.

# Briefly Speaking, from Victor Niederhoffer

February 24, 2008 | 6 Comments

We are all accustomed to the wisdom of "the threat is worse than the realization" which comes from the boardgame world, and Tom Wiswell and Nigel Davies have written about it. But one wonders if it's symmetric with "the hope is better than the realization," as an event like the 25 S&P point half-hour rally on the hope of a bailout, a shuffling of the risk from one to another, would be prone to a revulsion, or a 25 point down swing or some such in the near future when hope meets reality or as Galton said about Spencer, when the facts meet the hypothesis.

## Nigel Davies suggests:

One way to look at this is to view weak emotional responses as being attached by elastic to the roller coaster of perceived reality. And this leads to two of the great problems in games and speculation, one's perception and the feelings this then engenders. It may also be that 'science' is no answer here except to add a layer of false confidence to already skewed beliefs. It seems very easy to prove whatever one sets out to prove, and to be too rigorous usually means saying nothing at all.

# Freemasonry and Speculation, from Jeff Watson

February 24, 2008 | 1 Comment

Freemasonry has a long history in the United States. Many of our founding fathers, including Washington and Franklin, were Masons. Freemasonry traces its earliest origins from the masons who built King Solomon's Temple. The guild of masons started a ritual that has been carried down to modern times. The actual people who built the great works were known as Operative Masons. Since there aren't too many Operative Masons around anymore, during the Age of Enlightenment, Freemasonry decided to admit other members who weren't in the trade. These non-professional masons were known as Speculative Masons. The Masonic Fraternity admitted only men who were thinkers – men who would add to the general knowledge of the world. To many men joining the fraternity, the purpose was to gain more knowledge and inspire self improvement. Lodge meetings were full of fruitful discussions where they observed, sought, examined, contemplated and meditated on new facts or knowledge by experimenting and analyzing with what was already known. They exchanged that knowledge with each other, much of it in allegorical form.

Lodge meetings were roundtable discussions where participants were given facts and asked questions, drawing them into speculations. As always, the important issues of the day were speculated upon. The main purpose of this exercise was to improve speculative thinking. Newly raised apprentices and members were not immune from questioning, being forced to use their minds in a speculative manner. The intellectual give and take at those meetings drew outstanding minds towards Freemasonry. In fact, Benjamin Franklin modeled his Junto Club after the lodge discussions. He wanted to associate with speculative men who wanted to pursue knowledge and discuss it in a passionate manner.

Lodge meetings were a place where men learned to subdue their passions, and the discussions were very civil. There was no need to shout down opposing viewpoints, in fact they encouraged disagreement. Disagreement, as well as a well as a clever, well-reasoned rebuttal, was a highly prized commodity. The Freemasons recognized that one man glimpses the truth only partially. But, by speculating with others, one can see more aspects of the truth of any situation — if one will listen with unbiased respect and eager curiosity to hear another's point of view.

## Ken Smith writes:

My perception is it's a businessmans' outfit. Not known for divergent opinion. On the other hand, a local group calling themselves Blue Masons accepted working people. I know this because a telephone company installer came to the house once wearing a lapel button which I inquired about and it turned out it was identifying the young fellow as a Blue Mason. He invited me to put in an application upon learning of my interest.

I did not do that because my history includes things quite unusual in regards to character profile, employment history, and other pertinent information, all of which generally dooms my applications for just about anything. I found I can be a member of political parties quite easily, they accept applications accompanied with money from just about anyone. One other thing about this, I found myself on DailySpec!

## Alan Millhone remarks:

Old time Masons were operative in the fact they actually did masonry work as well as being a member of the Masonic fraternity. Today's Masons are speculative in that they no longer lay the stones and apply the mortar, etc. I have been a Master Mason, Belpre Lodge #609 F&AM, for about 30 years, and my father before me belonged for over 50 years as did my grandfather and his father.

# Automated Political Tea Leaf Reading, from Russ Herrold

I've been casually participating in Yahoo!'s predictive markets — search engine buzz popularity — and gaming mechanical investment and trading strategies there for perhaps 18 months, but with renewed interest the last couple of months.

There are clear methods to 'cheat' the tool with classic pump and dump' and confederates, but I put that aside, as it has been useful to give me a venue to sharpen my 'perl' "counting" skills and to get more familiar with XML (Extensible Markup Language).

The market simulator uses an XML RPC (Remote Procedure Call) mechanism (full API details at the web site cited) whereby one uses computer retrievals through a virtual web view, to buy, sell, get holdings details, and to read market statistics. The results of trades, or market data are returned in the highly structured form of XML, which is well suited to further computer driven parsing.

The last few weeks, I've been pursuing a 'chase the best dividend yield' strategy, and moving up in the rankings; writing a 'momentum move follower' is on my docket. As part of this, I have written a full series of scripts to check for newly 'IPO'd symbols, to review the efficiency of my portfolio, and the potential top performing peers alternative available for switching into. The computer suggests the trades, but I can over-ride it.

And so, even though it was contrary to a profit maximizing approach, I added equal buys of the remaining primary contenders a few weeks ago — \$100 each; the 'buzz' in search engine returns has moved them all a bit (1st column is the current dollar 'value' of each holding)

[herrold@couch xml]\$ ./xml-parse-holdings.pl | \
./filter-holdings.php -gt 2 | grep PRIMARY
58 DEMPRIMARY CLINTON 173 0.34 295
128 DEMPRIMARY OBAMA 149 0.86 117
173 REPPRIMARY MCCAIN 231 0.75 134
[herrold@couch xml]\$

I should have bought McCain hard when Romney left the race. There is no way to short. Ah well.

But each week, my tools have rejected the sentimentalism I used (in undertaking small 'positions' for a bit of blood in the primary gamesmanship) as none was in the cohort of the 'best yielding'. One of my script watches for 'laggard' holdings to 'cull' from the portfolio; each week, I have ignored its counsel on the PRIMARY markets, where it wanted me to sell all.

But this week something different happened:

[herrold@couch xml]\$ ./xml-parse-allinfo.pl >  find_cap.data
[herrold@couch xml]\$./expected_div.php > yield
[herrold@couch xml]\$ cat yield | sort -n | tail -20 > top_twenty
[herrold@couch xml]\$ ./xml-parse-holdings.pl > all_holdings
[herrold@couch xml]\$ ./spot_laggards.php
./sell.sh 172 DEMPRIMARY CLINTON
./sell.sh 230 REPPRIMARY MCCAIN
[herrold@couch xml]\$

** I was not scolded about holding DEMPRIMARY OBAMA **

Very curious, as I have been since I undertook it. Turns out OBAMA is in the top twenty 'yielding' investment opportunities.

That made me look at where the 'buzz' was, as reflected in 'market cap' (col 1).

[herrold@couch xml]\$ ./xml-parse-allinfo.pl | awk {'print \$3" "\$1" "\$2'} | \
sort -n | grep PRIMARY | tail -5
1749814 REPPRIMARY HUCKABEE
2493690 REPPRIMARY PAUL
2891712 DEMPRIMARY CLINTON
14557726 REPPRIMARY MCCAIN
18761165 DEMPRIMARY OBAMA
[herrold@couch xml]\$

Assuming a left to right continuum (HUCKABEE is in the grid, PAUL seems orthogonal in many ways; I list then as the counts appeared), there is an amazing buzz on the left (not overly surprising; for the last week, the R side is McCain's to lose), and an evenly divided 'electorate'

Amt        Cume
1749814        1749814        HUCKABEE
2493690        4243504        PAUL
14557726    18801230    MCCAIN
<<- median     20227053     ->>
2891712        21692942    CLINTON
18761165    40454107    OBAMA

Offered for what it is worth — I have already voted absentee, so it won't affect my 'real world' actions.

# Switching Prices and Leveraged Loans, from Nate Humbert

February 23, 2008 | 2 Comments

1. Their counterparty to each trade also sets their margin requirements.

2. The counterparty to each trade knows the exact capital position and portfolio wide standing.

3. The counterparty to each trade is able to set prices on all positions in the portfolio as well as the current trade in times of stress. (Was this hidden deep in the swap confirm?)

4. Mass liquidation of the portfolio generates massive fees for ones counterparty, such that they have every incentive to push you in time of stress.

This is not retail forex, this is the status of things in many Leveraged Loan portfolios. While times were good, did any of these conditions seem like severe disadvantages? My guess is that these were the little details, overlooked in the rush to become involved in this "exciting" asset class that offered exciting diversification opportunities.

Portfolios in my group have in the last few weeks breached collateral tests that in essence triggered massive stop loss selling. In some cases (Rule 3 above) the mark to market pricing has changed: whereas in prior periods it has been done with a service like markit, now the price feed has been swapped, and wouldn't you know it, the pricing is just low enough (and always below markit) to trigger portfolio liquidation.

My prior view a few months back seemed more optimistic: Lower prices balanced by "strong hands" looking for value. Lately, it has not felt that way at all. Just massive selling.

Yet some adapt, rather than die. Conversion from total return to cash flow deals is a mutation that may allow those who adapt in similar fashion to hang on.

This is an ant level view, I am left wondering how these losses will play out in the larger picture.

I am not sure in which book or which writing it was, but I am reminded of the admonishment not to compete in a game where ones competitor had every possible cost and information advantage. Yet, it seems the competitor is often hidden behind a veil called "service provider" making it hard to distinguish when one is in such a position until the moment of stress, when it becomes clear.

# Guaranteed to Happen, from Victor Niederhoffer

February 23, 2008 | 10 Comments

What must not be gainsaid is that the rise of 22 points in S&P futures from 3:30pm to 4:00pm on February 22 from 1334 to 1356 was the greatest rise in history. The rise of 24 points from 3:00pm to 4:00pm from 1332 to 1356 was the second greatest in history, failing by only a point to match the Société Générale rally on 01/17. It was beautiful the way the market set up exactly the same way it did the Friday before all the money was made by frontrunning and running stops associated with the \$7 billion loss. Also beautiful was the way the move from 1327 to 1357 (low to high) on Friday basically recapitulated in half an hour the entire range of the last two weeks. That's what a classical symphony is supposed to do at the end of the piece, recapitulate all the themes, bring them together and close with a bang. Also of note was the sentinel function of the bonds in the entire mass, staying down nicely even while the market at the two week lows. It was all guaranteed to happen.

Natural gas also had a nice day, settling above \$9 for the first since February 2006. It's been quite a run since December 2007 when it was trading below \$7. Nearby months are selling at discount, but open interest is decreasing.

## Jeff Watson noticed:

While the S&P rallied today at the close, there was also great volatility in the wheat market. The nearby months in Minneapolis did a mongoose/cobra dance today, and the mongoose won.  There aren't any shorts in Minneapolis wheat who are making money right now.

## Kim Zussman studies:

In relation to the joyful pop near Friday's close, I was wondering how to design an experiment in which subjects obsess about short-term gratification in a system with long-term utility.

(ES on Friday from open to 1130 PST was -18, and from 1130-cl was +25.25. Over recent 100 days, when op-1130 < -10, 1130-cl average= -1.5, T=-0.7)

During recent 100 days , lucky longs celebrated some or all of the following:

Yet during the entire period, the net change was -217.

The mean O-C was a dull -2, but certainly there was much along the way to self-flagellate or congratulate over, depending on the spin of the wheel:

## Lon Evans queries:

In regards to "It was all guaranteed to happen": Why so?

Note that the AmBac information was released towards the end of a Friday's afternoon session, replete with low volume and high volatility. Note, as well, that the news was released as the S&P was tumbling dangerously close to the dreaded 1320 level. Take also into account that no (pesky) details were included in the given information. Finally, acknowledge that the Bush administration is actively involved in the bail-out considerations (which suggest but another timely release of disinformation from a cabal that would rather climb a greased pole to tell the lie, than stand on the ground to tell the truth).

Without the mentioned announcement, was Friday's reversal "guaranteed?"

Let's consider another scenario. Friday closes at 1324, after bouncing off 1320. We awake on Monday to Asia's having sold off heavily in a tidal wave of red. Spitzer, again, rattles his saber in demanding that the rating agencies come clean with timely and honest evaluations of the monolines' status. And a credible evaluation of accelerating inflation hits the wires.

Given the above scenario, would a Monday's close below 1320 have been a reasonable possibility?

Where is the science in your predictive model? It seems to me that all you've done is demand that a arbitrary result validate a biased opinion. Other than betting upon an "inevitable" inevitable, I don't understand that your system of analysis is any more logical than that of a friend who utilizes tarot cards to guide his investment strategy.

No one can argue that Friday was very profitable for the quick-witted daytrader (full disclosure: I was among the less acute, managing to cover my short with only a couple handle loss, and just as my limit was so close I could smell it). But having cut my teeth on a day-trading floor during the dot-com boom/bust, I'm as aware as any what an accumulation of the quick-witted can impel given the intraday scenario, particularly a Friday scenario.

Will the calvary route the savages, succor the wagon train, and unite the dashing captain with the demure beauty? Only the details will tell. Should this boil down to a Federal bail-out, I'll cover my puts and look to go long. Should it be but a bickering viper's nest of plutocrats and the over-privileged, I sit tight. Either way, there is little science involved in my decision. I'm only interested in what target the guy with biggest stick swings at.

## Sushil Kedia observes:

On Thursday, the Indian futures index CNX Nifty produced exactly the same pattern. Meandering lower the whole day and going up in a straight line in the last 30 minutes to finish at the high of the day.

Shorts got squeezed for sure as the futures discount of 30 points got compressed to just about 5 points. Chartists gruntled with joy oh a hammer and the Index jumped from the 5080 area to 5200.

However, the next morning the market opens with a large down gap at 5130 explained primarily by the overnight move in the US, stays throughout the day at the downgap as the resistance for the day dipping in between by a percent from the open some 20 times. The market saw the move on Friday as a dead /dyeing man's heart beat really going nowhere.

One wonders if there is a global trading pump that is on microcosmic level driving the same algorithm in every market?

The rare downgap opening after the move such as on Thursday in India could well be explained with the higher significance of the larger market called US the night after. However, if Asia did still trade lower on Monday would that call for the traders in the US to be ready for a lower market on Monday there despite the move of Friday?

# Vol Anniversary, from Duncan Coker

February 22, 2008 | 4 Comments

In addition to the birthday of my better half tomorrow, another important date comes next week. No, not PPI or GDP. Rather, Feb 27th will mark the one year anniversary of Vol. I remember it well. We met after four down days and a nice down open, I throwing all caution to the wind. Then came the worst day since 2001, down some 58 S&P — and still no worse day since then, despite some perilous moves. Vol has never really looked back since then. The trigger that day was not subprime, credit, bank losses, the Fed, or housing. Merely a big down open in China after some huge gains. And what a year it has been for Vol. After nearly a 60% increase on that day alone, it went on to triple over the summer and fall, and now settle around double where it was a year ago. I would like to raise a toast to our good friend or fierce enemy, Vol. What a year it has been. Can't wait to see where we will be a year from now!

## Wil Kenney remarks:

I for one know my brow sweats a little more as Vol increases, and from time to time that can be frightening.

## James Bitumen replies:

There is nothing wrong with Vol, nor is it to be feared. It is what it is. There is nothing wrong with a rising market, nor is there anything wrong with a declining market. Change outside of a rather longstanding pattern is only that, change.

The market is no different today than what it was a year or two ago. It's simply removing levels of leverage one level at a time — we are at the exactly same spot. There are more levels to be removed. The key to trading the market is identifying where and when these levels will be removed from the system.

We are in the process of a credit bubble unwind. An institution owns an asset — no debt. Global rates at historic lows following the late-90s equity bubble deflation, 9/11, recession. They borrow against the asset at very low rates (just like the housing nightmare we are seeing not just in the US, but UK, Spain, etc.), and toss the free money into various asset classes all over the place — emerging market equities, Google, hedgefunds. What is considered equity to the asset manager is simply borrowed money. Borrowed money on top of borrowed money. The problem: economic growth never before has been so tied to asset price growth (housing primarily — ~30% of US workforce is tied to real estate). This is why the Fed has been so fiercely content to hit the ease button: They need to pump in liquidity in order to support asset prices, which they hope will protect bank balance sheets that have ballooned.

# DailyLit, from David Lamb

February 22, 2008 | 1 Comment

I'm sure many DailySpec readers are familiar with free online "bookstore" DailyLit. Not too many books in there, but free (good) books are always a good thing. For instance, right now I'm reading Random Reminiscences of Men and Events, the autobiography of John D. Rockefeller. I hope he'll allow the reader to get into his great mind.

As valuable as the texts: the exegetic notes from earnest readers..

TomM says: One of the good things about Moby Dick is that the chapters are modular — that is, you can read one chapter without have read any of the others (though your appreciation of the plot may be diminished). My vegetarian aunt was thus able to skip the chapters which detail whaling, and which turned her stomach.

# Obama/Clinton Debate — Try This Spin, from Mark Goulston

Speak your words with overspin and be authoritative — or speak your words flush and be authoritarian.

As I watched the debate between Obama and Clinton in Austin, Texas, I thought of tennis.

I never progressed very far in tennis, because I never mastered the skill of hitting the ball with overspin. Try as a I might, I would hit balls flush and invariably they would overshoot the baseline of my opponent and I would lose. The combination of my hitting the ball flush and my opponent hitting it with overspin where it would deftly land in my court, pick up speed made it nearly impossible for me to return or win. As I listened to Barack Obama and Hillary Clinton in their recent debate, it became clear to me how the mildly evangelical inflection of Obama's voice kept hitting deftly the right chords in the audience and with me with overspin, which triggered well aimed and positioned traction within much of the audience. On the other hand, Clinton kept hitting the words flush which both missed their mark and certainly missed having the traction that she was hoping for. Speaking with over spin sounds more authoritative; speaking words flush sounds more authoritarian.

The main traction she appeared to gain was in her closing comments about the greatest tests she has had to face, where she quickly switched the focus from hinting at her well known challenges to those of soldiers returning from war. However, the traction that this caused was not from overspin. It was caused by the audience wondering how she would handle/dodge such a question, when the challenges she faced as"first lady" were very embarrassing and very public. As all of us "rubber necked" and were poised to watch her crash and burn when trying to dodge that shameful episode in her life, she deftly changed the focus to American soldiers and their pain and suffering, being the more important tests to be focused on. By catching us with our base, shame-on-us, "voyeuristic" pants down and switching to the compassion we should all be feeling toward our hurt and wounded warriors, Clinton deftly won that set.

Whether it was enough to win the match and tournament, remains to be seen.

# A Basketball Counting Problem, from Scott Brooks

February 21, 2008 | 10 Comments

Okay, here's my dilemma. I have to coach the team by myself Saturday evening, my first foray into coaching by myself. We're playing the best team in the league. They are quick, fast, can jump, dribble, shoot and they play an incredibly aggressive game. Every member of their team can. They have no weak links. If all my players show up, I will have nine kids. Here's what I've got to deal with. First, the main problem. I have three kids that simply can't play. They are complete liabilities. I've been on teams with guys that weren't very good, but they weren't liabilities. We could teach them to do something well. So they could at least do something of value — set picks, or play defense against the other team's weakest player. We would be better off playing with only four players than having them on the floor. But this is an instructional league and I have to play all kids roughly equally. Two of these bad players can only play. One of them can play guard on offense, and play forward on defense. I use the word "play" very loosely here. Now, on to the good players. I have two good true guards. One of those guys has to be on the floor at all times, or I've got no one to handle the ball. I have one kid who can "float" between guard and forward. He is actually good enough at guard that he could bring the ball up, but I'd prefer that he not. Three kids who are pretty much only forwards. I don't really want them to bring the ball up the court and I'd prefer they do as little dribbling as possible. So, how do I run the team with the fewest bad players on the floor at one time. If I could do it with only one bad player on the floor at a time, I could stick him at the 3 position on offense — weakside forward, which is to the left of the point guards (getting kids to move to the left at this level is difficult). Doing that pretty much keeps him out of the way, except that the 3 position has to cover against fast breaks (and the team we're playing is a fast break machine). I've got to run five guys on the floor at a time, and I've got three bad players. Here's what I'm thinking about starting out with: I'll run one of my two good guards at the 1 point guard position I'll run the kid who floats at the 2 guard position. I'll run one of the bad kids at the 3 position (and pray that he moves up to stop the fast break). I'll run my two best forwards at the 4 & 5 positions. How then do I run the other two kids in and out and only have one of them on the floor at the same time, while giving them essentially equal playing time, keeping in mind that the opponent is scary good I don't want these boys to get blown out. Any input would appreciated.

# Predictive Power in Gym Fees? from Nigel Davies

I joined a health club today, and hasten to add this is just for the pool and steam room. But the pricing was curious:

– Off Peak (to 5pm only): £24 per month
– Peak (to 10pm): reduced to £25 per month
– Group peak (access to the entire chain of clubs to 10pm): halved to £24.50 per month

No prizes for guessing which one I went for — it seems like they were having a lot of trouble unloading the more expensive membership packages and slashed them in a a somewhat arbitrary way. But now I'm wondering if there may be some predictive power for other luxury areas in their fee structure. For example in their peak/off-peak ratio and whether this is becoming larger or smaller.

This kind of thing might be applied to other areas too, for example the housing market. I've often wondered about the London vs the Rest gap, after having watched this  narrow during booms. As everyone tries to jump on the bandwagon (or through fear of never being able to buy something) he drives up the prices of the lower quality property whilst affordability constraits keep the lid on the better stuff. For sensible pricing to be reestablished a differential would need to be restored.

A bit more on incentives and the curious nature of gym pricing:

A few months back, I took out a health insurance policy that encourages me to go to the gym and to partake in other healthy practices. Insurance can be quite a blunt instrument because it can encourage one to behave more destructively than they would otherwise, so it's interesting to see innovations that make an effort to realign people's incentives.

With this insurance product, I collect points for these various healthy activities and at the end of the year, if I have enough points, my insurance premium will be reduced by more than 70%. The quirk is that I don't care one bit about the health insurance policy. It's nice to have it, just in case, but I really wanted to join a gym and the policy comes with massively reduced rate gym membership to encourage me to stay healthy. Indeed, the gym records my visits over every quarter and provided I work out at an average of twice a week, then I get both the insurance and the gym membership for significantly less than the gym membership alone!

The catch is that if I fail to go to the gym twice a week, it can get expensive, and I guess some people will fall into this trap. However, I saw this as an attractive incentive to stay fit, and so far it seems to be working. Nothing incentivises like hard cash.

## Scott Brooks explains:

I'm not sure there is any predictive power to discounted gym memberships. I work out at 24 Fitness (of "The Biggest Loser" fame) in St. Louis and at Wilson's Total Fitness in Columbia, MO. Both of these gyms constantly run membership specials.

When I worked as a personal trainer in the mid 1980s (which meant that I got hired and sold people memberships and had to pretend like I knew what I was doing), we rarely ran specials, but I had tons of leeway in terms of what kind of memberships I sold. I could vary prices and length of time of membership almost however I saw fit. Basically, the goal was to sell, sell, sell.

This time of year, gyms are really hungry for new members. They've gone thru their big selling season, the New Year's resolution phase, and most of those people have already petered out and are gone, even though their memberships fees are still paid or are owed. As an aside, there is nothing more irksome than the first 4- 8 weeks of the new year when the gym is full of these people (who are going to fail anyway) crowding the machines and weight stations). So this time of year, gyms are selling heavy.

There may be predictive power in other areas of the economy, but I don't think there is in the fitness arena.

# Fear of Stagflation, from Sushil Kedia

Why should a bull be afraid of Stagflation? Somebody bullish on life is someone who is a producer of a net overplus. Being bullish on the markets is a matter of finding the markets that are representing economies producing overpluses.

On one hand markets have been shaking off on fears of an extended form of reflation called recession and yet on another the all knowledgeable squakboxes say markets are afraid of stagflation! Something does not add up if negative is negative and positive too is also negative. This is the tell of the times that everything appears negative and thus the near future is likely to witness the dawn of a new cycle. Why cant a new cycle take over before the imagined troughs of the ongoing cycle are seen?

Inflation in pure and simple commonsense terms is a redistribution of income and or wealth. Those with a net positive wealth / income stand to gain and those with a net negative income and / or wealth lose when inflation persists. However when inflation goes down those with an overplus stop gaining and those with a deficit accelerate their losses. So, the trick is that manageable inflation is what is the vehicle of all progress in the organised economic world.

Today when Hang Seng sold off after a large upgap opening the moment it was announced that Hong Kong banks are not following lock-in-step with the US Fed one sat down wondering if efforts to contain a redistribution of income will not accentuate the redistribution of wealth. Like energy cannot be destroyed but only transformed it is likely that inflation of consumables being contained will transform into a higher inflation of assets. Maintain the rising interest rate differential and prepare to face a wall of cash gushing in. As the wall hits the larger packets of liquidity are grabbed first by hands that have an overplus and thus can afford to invest and speculate. Inflation morphses into expanding the asset pricing, thus.

So if stagflation is similarly in commonsense terms (by the way the word economics originates from Oikon Nomics — The study of household preferences — which cannot be confined to ivory towers and thinktanks alone) an apparent redistribution of wealth it is the perfect background for speculation to be a good business of several others. Then you have the squakboxes labelling that there is a fear of stagflation and we know fear is the aphrodisiac on which bulls will persist further, despite the recent flounder. It suits a speculation even if all / most economies are going to be running on treadmills and be actually reaching nowhere except where they are since it is far better than the talk of death and disease in economies that is near given in most minds now.

At the risk of repetition, I would like to bring to the table the striking mirror image that is what the Capitalistic Communists are doing in China today of what the Communist Capitalists in Russia did in the last century. The Party in Russia kept on selling the commodities down holding the value of its own money higher while the Party in China is driving the commodities higher holding the value of its own money lower. If what Russia did was dangerous it is easy to see that what China is doing is certainly more dangerous. Every accounting Shenanigan in the universe has had fiddled with managing the Income Statement with the Balance Sheet or vice versa.

America, to a neutral observer with a dispassionate view of what you are doing, you are doing fine. Facing the reality and not fiddling. By this count alone, ain't it clear that the Chinese decision makers find the American money more useful than their own, in the longer run?

Fear and greed are the extremes of the emotional pendulum and when observers see the extremes while the pendulum is just in equilibrium (if there is another commonsense meaning of stagflation it perhaps is the solitary variant of inflation with highest relative equilibrium) it is that zen moment which builds the business of speculation further. What has been correcting at a systemic level globally is the underpricing of risk. Risk getting dearer cannot necessarily imply that opportunities will get scarcer. Recent few years' correlation may be an aberration in the larger cycles of progress. If risk and returns are not to be seen as coexsting together on the same Mobius Strip of perceptions then the fortunes that were created by the forefathers at times of war, turbulence, mass immigrations, disease and famine cannot be explained. Don't worry Wall Street you are doing fine too, since stagflation is going to be round soon, speculators will do well. Risk itself is the opportunity, always and very much today.

"Most economies are going to be running on treadmills and be actually reaching nowhere"

Like SP this week and last, a treadmill with 30 point range. Reminiscent of the 70's stagflation scenario and its market 40% range. This scenario is a good middle ground between the bear's crash scenario and the bull's ever higher call. I guess you could call it the Rancher scenario: works the range between the bulls and bears.

# Thoughts Inspired by the Eclipse, from Victor Niederhoffer

February 21, 2008 | 1 Comment

The round number is never a penumbra.

The umbra I noticed in South Florida was an oval shape, and considerably darkened the full moon surface. I attribute the oval shape to my different point of view, being thousands of miles from the area where the total eclipse would be complete. However, I was blessed with the clearest, most detailed view of the moon's surface I've ever seen with my little Newtonian. Although I saw the same event as the rest of the people on this continent, I got a whole different observation, and a different set of data from other observers 1000 miles away. Applying this to markets, One can look at a market from one perspective and arrive at a quite different conclusion from someone viewing the exact same event elsewhere. It's up to the speculators to bring the different pictures together to form a composite that is acceptable to all.

## Scott Brooks recalls:

During the eclipse, a friend from Anchorage called me. He's getting ready to ship out to Iraq. We talked about the eclipse and what I was seeing. It was just after 9 pm cst. It was only a bit past 6 in Anchorage and not yet fully dark. So they didn't get a good view of the eclipse at all.

The kids and I did enjoy it very much. Since it was too cold to stand outside for very long, we went inside to get a break from the cold and I gave them a demonstration of how the eclipse worked using a ceiling light (the sun), a basketball (the earth), and a white jar of handcreme (the moon).

I moved the handcreme back and forth under the basketball…..and it gave a great visual representation of the the eclipse looked like as you could really see the shadow of the earth (the basketball) move over the moon (the handcreme). I actually did this from several angles with the kids to show them the difference between a full and partial eclipse. It was actually pretty cool to see the expressions on their face as they "got it" (although I'm not sure my 6 year old daughter completely grasped it).

We then went out and looked at the moon again and they saw it differently than they had before. David and Hunter even decided to try and figure out where the sun was in relation to us at that time. They figured that if they pointed to the moon with their right arm, then angled their bodies so that their right arm was at a 90 degree angle with their body and then pointed with their left arm, in the exact opposite direction such that their left arm was also at a 90 degree angle, they were pointing at the sun.

I think David (13) got it and understood that the sun was "in that direction. But Hunter (9), walked over to the spot on the ground where he had just pointed and stood there and asked "so the suns here?" (thinking it was directly below where he was standing. I'll give David credit for trying to explain to Hunter and Abbey (11) too that the "line" they were creating to point at the sun continued thru the earth and didn't just stop at that spot on the ground. I'm not sure if they got it, but it was fun watching David trying to explain it to them.

So Lydia (6) went and stood on the spot on our deck where Hunter had pointed to "where the sun was". She announced that it was just as cold "where the sun was"…….thats when I noticed that she was standing outside barefoot. That was the catalyst send us back inside.

We went back to our bedroom and tried to use the ceiling light/basketball/handcreme combo to explain what David was trying to explain. I don't think it worked.

By now it was bed time. We got the kids tucked in and Gwen and I got ready for bed ourselves. A few minutes later, I went out to see what was going on with the eclipse and noticed that there was a beautiful crescent shadow from the earth covering a portion of the moon. It looked pretty cool, so I ran upstairs to get the girls and downstairs to get the boys and took them all outside (barefoot and in jammies/skivvies) to see the eclipse.

They all thought it was pretty cool…..pretty cool that they got to get out of bed. They acted facinated by the eclipse, but I sense it was a ruse on their part to get to stay up for a while longer.

After a few minutes out in the cold (kids will tolerate a lot to be able to stay up), I dispatched them back to bed.

It was a good evening at the Brooks household!

## Paolo Pezzutti writes:

Spin-orbit period coupling concerns other pairs satellite/planet in our solar system.

I wonder what market spin orbit coupling in addition to Nikkei/SP there might be in the market universe. How about various micro relationships spinning about price change?

## Russ Sears discovers:

Makes a nice orbit if you graph, flipping it back at 49.99…

# Sun Rises in the East, from Sushil Kedia

Inspired by Vic and Laurel's observation that Eastern markets lead the Western markets, I have been observant of the global equity indices relative moves. At the interday level, data observation of 10-15 days windows, it seems most Western markets are fiddling with deciding to break out or not to break out of the 20 day highs. Similar situation is visible on the very Eastern markets of Nikkei and Hang Seng. The market in between, India, which has had no holidays in the recent few weeks has run ahead on the form of the movements. It broke out of the 20 day high range to deceive and then slid. Last five days are witnessing a rally from this slide.

# Among the Many Reasons Why We Used to Celebrate Washington’s Birthday All By Itself, from Stefan Jovanovich

February 21, 2008 | 1 Comment

In mid-August, 1790 George Washington visited Newport, Rhode Island. According to one of the townspeople, he exhausted the welcoming committee by suggesting that they take a walk to see the town. They set out at 9 AM and did not return until 1 PM, the usual time Washington took for his daily ride or walk.  The warden of the Touro Synagogue (a truly magnificent building that survives to this day) sent the President a formal letter of welcome.

Sir:

Permit the children of the stock of Abraham to approach you with the most cordial affection and esteem for your person and merits - and to join with our fellow citizens in welcoming you to NewPort. With pleasure we reflect on those days - those days of difficulty, and danger, when the God of Israel, who delivered David from the peril of the sword, - shielded Your head in the day of battle: - and we rejoice to think, that the same Spirit, who rested in the Bosom of the greatly beloved Daniel enabling him to preside over the Provinces of the Babylonish Empire, rests and ever will rest, upon you, enabling you to discharge the arduous duties of Chief Magistrate in these States. Deprived as we heretofore have been of the invaluable rights of free Citizens, we now with a deep sense of gratitude to the Almighty disposer of all events behold a Government, erected by the Majesty of the People - a Government, which to bigotry gives no sanction, to persecution no assistance - but generously affording to all Liberty of conscience, and immunities of Citizenship: - deeming every one, of whatever Nation, tongue, or language equal parts of the great governmental Machine: - This so ample and extensive Federal Union whose basis is Philanthropy, Mutual confidence and Public Virtue, we cannot but acknowledge to be the work of the Great God, who ruleth in the Armies of Heaven, and among the Inhabitants of the Earth, doing whatever seemeth him good. For all these Blessings of civil and religious liberty which we enjoy under an equal benign administration, we desire to send up our thanks to the Ancient of Days, the great preserver of Men - beseeching him, that the Angel who conducted our forefathers through the wilderness into the promised Land, may graciously conduct you through all the difficulties and dangers of this mortal life: - And, when, like Joshua full of days and full of honour, you are gathered to your Fathers, may you be admitted into the Heavenly Paradise to partake of the water of life, and the tree of immortality.

Done and Signed by order of the Hebrew Congregation in NewPort, Rhode Island August 17th 1790. Moses Seixas, Warden

Gentlemen,

While I receive, with much satisfaction, your Address replete with expressions of affection and esteem; I rejoice in the opportunity of assuring you, that I shall always retain a grateful remembrance of the cordial welcome I experienced in my visit to Newport, from all classes of Citizens.

The reflection on the days of difficulty and danger which are past is rendered the more sweet, from a consciousness that they are succeeded by days of uncommon prosperity and security. If we have wisdom to make the best use of the advantages with which we are now favored, we cannot fail, under the just administration of a good Government, to become a great and happy people.

The Citizens of the United States of America have a right to applaud themselves for having given to mankind examples of an enlarged and liberal policy: a policy worthy of imitation. All possess alike liberty of conscience and immunities of citizenship. It is now no more that toleration is spoken of, as if it was by the indulgence of one class of people, that another enjoyed the exercise of their inherent national gifts. For happily the Government of the United States, which gives to bigotry no sanction, to persecution no assistance requires only that they who live under its protection should demean themselves as good citizens, in giving it on all occasions their effectual support.

It would be inconsistent with the frankness of my character not to avow that I am pleased with your favorable opinion of my Administration, and fervent wishes for my felicity. May the children of the Stock of Abraham, who dwell in this land, continue to merit and enjoy the good will of the other Inhabitants; while every one shall sit in safety under his own vine and fig tree, and there shall be none to make him afraid. May the father of all mercies scatter light and not darkness in our paths, and make us all in our several vocations useful here, and in his own due time and way everlastingly happy.

G. Washington

# Moon Mysteries, from David Hillman

February 20, 2008 | 4 Comments

Copy/paste from http://groups.yahoo.com/group/TWSAPI/ (30/01/2008):

"I spent 35 years tending to the the Emergency Rooms as an orthopaedic surgeon. I can assure you that if you draw a graph of visits per day it produces a perfect sine curve. The apogee coincides with the full moon and the perigee with the new moon. The variation is about 25%. Large ERs plan their staffing levels on the phases of the moon. This has been going on for decades. The visits are not only mental (lunacy) but also physical. It is clear that the phase of the moon effects mankind. Why not its trading? …"

In a past life in the health care industry, we noted a few studies establishing correlations between moon phase and ER visits. Often times, these studies purported to zero in on specific conditions or causes of injury, like assault or mental disorder, which might be supposed to support the popular notion of 'crazy behavior' at the full moon. However, I recall most of the evidence of same being anecdotal and no statistically significant correlation between the variables over broad samples or studies. That is not to say that this phenomenon could not have been or has not been experienced by a particular hospital ER or at a local or regional level from time to time.

Another such popular supposed relationship is between incidence of crime, particularly a variety of assaults, during the full moon phase. Similar studies with similar results have been conducted and the anecdotal evidence is also there, but overall, the relationship seems to be no stronger than does it in health care.

One could take this a step further in the quest of causality by hypothesizing that the full moon caused a spike in mental disorder, which caused a spike in assaults, which in turn caused a spike in ER visits, perhaps at least in part a reasonable argument, certainly a romantic one, but I for one have no interest in taking that leap. We here have been cautioned to beware spurious correlation in counting. Let's do so with the full moon and the ER.

That said, the facts seem to indicate that on a broad level, ER visits are pretty flat, rarely spiking at all any more. Certainly there are observable peaks, but weekdays are as busy or busier than weekends, the peaks often being Monday and Friday.

Again, this is not to say an individual hospital or groups of hospitals may not see a spike in the pattern from time to time, or that any given study may not find such evidence. For instance, we might try studying Flint, Michigan hospital ER's the night of GM's payday that happens to fall on a full moon. Guaranteed spike in visits for broken noses and knuckles, beer bottle concussions and alcohol poisoning. Sorry, though, no man-in-the-moon causality.

But, back to the point. I would suggest that, if they ever existed, any pattern exhibiting a spike in ER visits for ICD9 codes in the 800-900's correlating with the moon phase, or with any other variable, would have been subsumed in the past few decades by the propensity of many of us to use the ER as primary care provider. This is not to mention the number of visits by bored or lonely people with no companionship and nowhere to go, and there are plenty of those visits to go around, particularly in large urban centers. Ask any ER doc. Instead of hours of boredom separated by moments of terror, it's quite the opposite.

There are over 200MM visits made to hospitals in this country each year, over 100MM of them to the ER. About 300,000 ER visits per day, every day. As an aside, only 15% or so of all hospital visits result in a hospitalization, the remaining 35% or so are for outpatient services. Going out on a limb, albeit a pretty thick one, I'm more or less certain that backing up and viewing a daily plot of these 300K ER visits from across the room, the curve would look pretty flat.

In other words, the universe of ER visits has expanded pretty dramatically. Samples within it may exhibit variations, spikes even, but they're simply going to be less evident when the universe is being viewed as a whole. As I last saw it, the moon seems to impact the earthly hospital universe equally, not just samples of it. Frankly, I don't know of any studies of the ER universe, then or now, so I'll take the evidence of moon phase/ER visit correlation from samples like I take studies of coffee. One week it's good for you, the next it's not, but I'm still drinkin' it.

Would you like cream with those stitches, sir?

# Walking to School, from Nigel Davies

With the weather improving here in the UK my son and I have resumed our practice of walking to school rather than taking the car. This is such a simple thing to do but has so many benefits besides the exercise, fresh air and cultivating a non-sedentary attitude to life.

First off there's a chance to see things that you don't normally see when whizzing past, both natural and man-made. There's an opportunity to talk (and sing!) without interference from phones, doorbells and email. And you get to miss the traffic gridlock on the approach to the school.

Victor Korchnoi puts his chess longevity down to walking everywhere. He hasn't driven since the shock of having hit a police car in the Soviet Union. And David Bronstein too was a great believer in the benefits of walking, advising a short walk before every chess game.

At my gym they quote Plato on the noticeboard:

Lack of activity destroys the good condition of every human being, while movement and methodical physical exercise save it and preserve it.

# Patterns to Failure, from Russ Sears

After the monoline debacle, it seemed to me several clear patterns of failure had occurred.

The cash cow, muni insurance, led to complacency in product development for insuring CDOs.

The wonderful sales success entrenched management, leading to escalation of commitment, rather than raising questions about underpricing.

Risk management became management by numbers only. The rating agencies had a moral hazard and now are accused of heel dragging blindness.

(However, the accountants, auditors and regulators, have now stepped in and now have the opposite moral hazard… to inflate their worth by aggravating and exaggerating the downside).

This may seem a bit long winded and hindsight contrived; yet a similar story could be given for the instigator of the CDO problems and the sub-prime mortgages.

But these modeling problems have not been limited to the sub-prime originators. It has been my experience within the insurance industry that many of the failures follow a similar pattern. Bad modeling seems to follow this course over and over. Many of these cases do not lead to the scale of problems in the financial markets we see now, but on a company basis they often have been as devastating.

Like computer programmers and their anti-patterns, modelers often fall into habits that at first seem beneficial, but in the end are bad habits. Wikipedia has a list of failure pattern traps, including the ones I mentioned here.

I am a runner. To me, losing a race has always been much more motivational and educational than winning one. Losing exposed the weaknesses in my training and habits. Success easily becomes complacency. Losing brings the hunger back.

## Lon Evans critiques:

As an avid runner (some 35 years in that game and counting), we are kindred spirits in at least one instance.

I'll mention that you have been a bit slow on the uptake concerning the entire subprime mess, though you're not alone. DailySpec, to my knowledge, has few, if any, posts that attempt to "test" what the financials are now properly suffering. With so much brain power in accumulation, one would assume that at least a handful of posts would be delving into what is shaping up to be a global tsunami. It is interesting to view as a correlation the denial evidenced by the VicBots and that of the cretins who got us into this wretched mess.

Your attempt to decouple the various manifestations of the current malaise is in error. Subprime, CDOs, SIVs, monolines, et al, are simply an indication of the stupidity (duplicity?) of entrusting those incapable of honoring their responsibilities. All that currently ails us is a result of selling houses, and then "creatively" declaring "risk free" investments, which could only fail given their ultimate collateral.

In closing, I don't share your optimistic evaluation of "failure." I imagine the man, who willfully (through ignorance or intent) severs a hand. After cleaning up the resulting mess, he then exclaims, "Well, I now know never to do that again." There will be costs, in bringing this saga to a close, far steeper than you're imagining.

## Russ Sears responds:

You have me beat with running experience. I have been racing for only 27 years. Note I said racing, not running. However, as a racer since college, I have found many people that talk a good game. Everybody wants to be associated with taking personal responsiblity, but few really want to put in the mileage. Many are fakes. If I had a dollar for everybody who has claimed to run close to my times! When I qualifed for the US Olympic trials, I was told by the head offical more people tried to fake their qualifications than actually qualified.

If you are so avid, why is your name not appearing in any of the websites that give race results? Surely you have done a fun run or charity run or two in the last 10 years? For an avid runner since the early 1970s, you would know that being an avid fitness runner without any racing was unheard of back then. What made you change?

It is clear to anyone that subprime, CDOs, and monolines issues are closely related. You have not told me anything everyone doesn’t already know. But you expect to make money off it?

Supposing I take your word for your grand analysis, tell me how you came up with the underlying assumptions, rather than how grand they are.

However, your assumption that I have been slow on the whole subprime mess is wrong. The monolines, Alt-a have been on my “avoidance” list since 2005 (when I took my current job which required me to have an opinion) and subprimes always were. However I did miss the SIV connection, so my risk management was not flawless this past year.

## Lon Evans retorts:

You might find yourself a bit back on your heels when more fully apprised of my experiences and associations in my 35 years as an "avid" runner. I'm as amenable to good conversation as I am to fighting the good fight.

# A Short Vacation, from Ken Smith

We drove 60 miles to another city to attend a training session, all day with lunch included. We learned how political parties organize themselves.

We learned Washington State is the strongest Democrat harbor in the nation.  We learned the county we live in, the city we live in, is populated almost entirely by Democrats. We learned the Party leaders in this state are rated in the top 3-4 short list of superior men and women in the nation. I don't think they were bragging.

Since this activity was held on a national holiday, and Washington's Birthday at that, the event was well attended. Ina and I, however, were minority in that most attendees were more or less official delegates and active Party members — people already entrenched in the Party.

We learned the Democratic caucuses were attended by nearly 250,000 citizens — and the Republican caucuses attracted a mere 20,000.  What a difference!  I don't know what happened in other states, but if Washington State is anything like an indicator Republicans are going to lose the next presidential election. Place your bets.

What is more, the Clinton name was almost verboten in that gathering.   Senator Obama's majority was such a heavy presence that Clinton people must have been thoroughly chagrined, and thus silenced.

Training lectures with slide shows continued from 10am through 4pm, with the sack lunch break.  At 5pm the big awaited event occurred, a Crab Feed, a tradition for the Democratic Party here.  Crab fishermen provide hundreds of fresh crabs from the Pacifc Ocean and from the Dungeness spit area.   More than than, salmon and clams too.  Dished up by volunteers who also served cole slaw, pasta, garlic bread, and baked beans. Beer was sold at a separate counter, other end of the huge room, space rented from St. Martin's University.

Parenthetically, some of the original buildings are still standing on the campus.  One of them is brick, three stores, with full basement, housing class rooms, a dormitory, and chow hall.  This was the former St. Martin's High School, a Catholic boarding school for boys which I attended in the 9th grade before dropping out to go to sea as a merchant mariner during World War II.

The Crab Feast was filled to capacity and more. The people who attended the day training session were joined by hundreds who had subscribed to the \$40 final event only.  Speakers were prominent state Democrats, with the main draw a Senator from Montana.

Crab lovers were satisfied to the full.  A guy at our table got back in line twice again after he finished his first half crab.  I don't eat the stinking things myself, as I worked in Alaskan waters where the big ones come from; these are scavengers, eat all the dead things on the ocean floor, including humans who have drowned.

We stayed at a new place for us.  Ameritel chain.  I believe it's a Mormon business, cause they are in Idaho mostly.  I recommend them.  Our price was \$109 except for the added taxes; king bed, well appointed, wireless Internet which actually worked in our 4th floor room.  Included was fine breakfast service with table by a fireplace, buffet style of course. Omelette with bacon, where the usual is corn flakes.

On the way back home this morning fog slowed traffic but it never got bogged down to a stall.  Am at home to find my position stinks like the crab.

# The Hidden World of Microbes, from Victor Niederhoffer

February 19, 2008 | 2 Comments

The greatest diversity of genes and life forms appears to come from the microbial world among bacteria and archae, according to an article titled The Undiscovered Planet in Harvard Magazine. Everywhere they look, they are seeing new species and new sources of curing disease as most of the hundreds of millions of species that live within our body or within the soil are beneficial. Now scientists are learning how to cultivate them and trying to turn them into microbial medicines. One wonders if the microscopic tick data contains hundreds of millions of forms that could be used to analyze the macroscopic movements. The work of Larry Harris and of Niederhoffer and Osborne contains many interesting microscopic patterns that have not been tapped or exploited, I believe.

One theorizes certain tick data patterns plus trade volume could give early indications of institutional accumulation or distribution. This weekend my son and I completed an analysis of the algorithms we have used this past year to screen for investment opportunities, to determine which worked the best. Results indicate certain large trading volume increase patterns to be the most reliable of the eight or so screens we've developed. Similarly, I've read that in 16 hours, a single e. coli cell, given the proper nutrients, can multiply to equal the human population count of the planet. Its exponential growth looks a bit like a one year platinum chart. If we're comparing microbes with finance, one cannot help but notice similarities between mad cow disease and the subprime mess: gruesome massive culling of herds and portfolios.

# Housing, from Kim Zussman

February 19, 2008 | 1 Comment

Robert Shiller's site contains historic data on house prices from 1890-2007. Notwithstanding any biases contained therein, I checked the rolling 10-year real house price appreciation and found that the 10 years ending 2006 and 2007 were the highest. Here are the top 10:

# Frequency of Double Digit S&P Daily Moves, from Alex Castaldo and Victor Niederhoffer

February 18, 2008 | 2 Comments

How often do the S&P futures change in price (up or down) by more that 10 points?

```Date         Num Days Num Days
Year Mon       Up >10   Dn >10          Tot    Diff
2000   1            5       8            13      -3
2000   2            6       6            12       0
2000   3            9       6            15       3
2000   4            4       7            11      -3
2000   5            8      10            18      -2
2000   6            6       4            10       2
2000   7            6       6            12       0
2000   8            5       2             7       3
2000   9            3       6             9      -3
2000  10            5       8            13      -3
2000  11            3      10            13      -7
2000  12            6       8            14      -2
2001   1            5       3             8       2
2001   2            3       9            12      -6
2001   3            7       8            15      -1
2001   4            9       5            14       4
2001   5            4       6            10      -2
2001   6            4       5             9      -1
2001   7            3       6             9      -3
2001   8            2       8            10      -6
2001   9            4       6            10      -2
2001  10            6       3             9       3
2001  11            7       1             8       6
2001  12            3       4             7      -1
2002   1            4       3             7       1
2002   2            6       4            10       2
2002   3            4       3             7       1
2002   4            3       4             7      -1
2002   5            5       6            11      -1
2002   6            2       7             9      -5
2002   7            5      11            16      -6
2002   8            7       7            14       0
2002   9            5       7            12      -2
2002  10            8       8            16       0
2002  11            6       4            10       2
2002  12            3       6             9      -3
2003   1            4       7            11      -3
2003   2            3       4             7      -1
2003   3            3       4             7      -1
2003   4            6       3             9       3
2003   5            5       1             6       4
2003   6            4       4             8       0
2003   7            3       4             7      -1
2003   8            0       1             1      -1
2003   9            3       3             6       0
2003  10            2       2             4       0
2003  11            2       1             3       1
2003  12            4       0             4       4
2004   1            3       1             4       2
2004   2            3       0             3       3
2004   3            5       6            11      -1
2004   4            1       3             4      -2
2004   5            2       2             4       0
2004   6            1       3             4      -2
2004   7            1       3             4      -2
2004   8            3       3             6       0
2004   9            1       1             2       0
2004  10            3       3             6       0
2004  11            2       1             3       1
2004  12            2       1             3       1
2005   1            1       2             3      -1
2005   2            3       1             4       2
2005   3            2       3             5      -1
2005   4            2       7             9      -5
2005   5            2       2             4       0
2005   6            1       1             2       0
2005   7            1       1             2       0
2005   8            1       2             3      -1
2005   9            2       2             4       0
2005  10            4       6            10      -2
2005  11            3       0             3       3
2005  12            1       1             2       0
2006   1            3       1             4       2
2006   2            2       3             5      -1
2006   3            3       0             3       3
2006   4            1       2             3      -1
2006   5            3       5             8      -2
2006   6            3       5             8      -2
2006   7            3       2             5       1
2006   8            2       0             2       2
2006   9            3       1             4       2
2006  10            2       0             2       2
2006  11            2       2             4       0
2006  12            2       0             2       2
2007   1            1       2             3      -1
2007   2            2       2             4       0
2007   3            4       4             8       0
2007   4            4       1             5       3
2007   5            3       2             5       1
2007   6            3       6             9      -3
2007   7            4       6            10      -2
2007   8           10       6            16       4
2007   9            3       3             6       0
2007  10            6       4            10       2
2007  11            6       9            15      -3
2007  12            6       7            13      -1
2008   1            7      11            18      -4
2008 2*             4       4             8       0

.                            Autocorr   0.658   0.197
```

The highest volatility (by this measure) occurred in January 2008, with 18 double-digit moves, although we have a tie with May 2000.

Generally, there were a lot of such days (>10) in 2000-2002, few in 2003-2006, and many again starting in July of 2007.

# Frequency of Double Digit S&P Daily Moves (Part II)

February 18, 2008 | 1 Comment

It is interesting to look at a chart of the number of large S&P moves per month.

# Wind, Roofing Shingles and the Market, from Alan Millhone

We had another terrible wind storm that lasted all night. This morning when I left my home I noticed trash cans blown about and tree debris everywhere. I also noticed some shingle tabs on one street that came from some person's roof ! Another roof in my town had shingles standing straight up from the wind gusts over the night. Different sides of a few roofs showed similar damage as I drove around town today. The market was closed today for President's Day, but the wind last night did not know that fact. I wonder if the wind affected the shingles in a similar way that massive buying and selling unsettles the market? Many of the roofs have been installed for several years and one would think the shingle adhesive under each shingle would protect them. However this morning it was evident that if enough force is applied (to the roofs and the market) that something has to give way. The wind came from many directions all last night and looks for weak points on the various roofs to exploit and find that weakness in their armor. Shingles are laid out and installed in a pattern of 5" intervals of exposure. If one has too much exposure in the market chaos can ensue. The better roofs I noted (30 year or more are more wind rated) stayed put. Similar to weaker stocks huddling together for protection and hoping for the best. Research on which roof to use and if 15# or 30# roofing felt is to be applied over the roof deck or if 'ice guard' is to be used can relate to the market and the careful research one undertakes to determine which stock or group of stocks to put in one's portfolio. Locating the best roofer or the best stock broker is critical unless you are skilled enough to make your own decisions on roofing and investing in the market.

# The Lazy Man’s Boston Getaway, from Sam Humbert

The lazy man's Boston weekend family getaway — from my notes, based on a spur-of-the moment trip we took, Friday afternoon to Sunday morning. We did no planning, no driving around town, and almost no walking…

Before leaving, visit Hotwire to pick up a room at the brand-new Intercontinental at the spooky-cheap rate of \$129/night. My family decided it was the most splendiferous hotel they'd ever stayed in (and, importantly for my boys, the beds had long cylindrical decorative pillows ideal for pillow fights). The hotel is a shimmering glass palace loaded with granite, limestone, dark wood, brushed metal. High ceilings, posh restaurant, buzzy bar. But beware the \$39/night parking charge.

The "waterfront" rooms (facing a ship-channel, at the site of the Boston Tea Party) are costlier, but we loved the evocative (for Ken Smith, anyway, since they face the Federal Reserve tower a block away — would be good inspiration for a graf or two for his site BernakesFed.Com) west-view rooms, which overlook a construction site with lots of heavy earth-moving equipment — free entertainment for the boys, right out the hotel window.

If you check in early enough, visit the Children's Museum — a quick walk across the bridge from the hotel. It's only \$1 on Friday nights. Otherwise, visit on Saturday, after a good workout and swim at the Intercontinental's beautiful spa/gym, followed by brunch at Flour Bakery a block from the Museum (or, if Flour is packed, nearby are Finagle-a-Bagel, Au Bon Pain and Panera)

After the Museum (which is well-designed to appeal to kids as old as 10), stop at Barking Crab across the street for an early dinner, before the Saturday night rush. The swordfish with gnocchi is a good bet for the grown-ups, as are the burgers for the kids. Or, if more ambitious and eager to visit a landmark, walk north a few blocks to the Legal Seafood by the Aquarium, or over to Durgin Park.

Optional extension: Saturday (or Friday) night, drive out the Mass Pike a few exits to catch a Harvard ice-hockey game — We saw them beat nationally-ranked Quinnipiac; next weekend they play Yale and Brown.

# Terminators and Technology, from Greg Rehmke

Tech stocks are always a wonder. We wonder which few new tech firms will explode onto the scene reaping billions in future sales. The net benefits of injecting thousands of significant new improvements into the world economy each year in enormous. New technologies and innovation are more than enough to strengthen the sinews of market economies that each year must carry heavier burdens of parasitic taxes, predatory litigation, and monopolistic regulation.

These new technologies don't roll out on cue from government research labs. Though billions are spent each year by governments chasing politically-correct technologies, little fruit emerges from this politicized spending. Half a billion will be "invested" this year in West Virginia, thanks to earmarks from Senator Byrd. (Federal research labs and other such projects are called "Byrd-droppings" by West Virginians.) The World Health Organization is now complaining that its political funding is overmatched by malaria research funded by the private Gates Foundation. Who would you rather trust malaria research to, a team assembled by Bill Gates, or the United Nations?

Next year's national high school debate topic calls for the federal government to expand alternative energy use. Now that the billions poured into ethanol mandates, regulations and subsidies have been show to be wasted (recently published studies in Science magazine), the federal government can cast around for nifty new ideas that will help them win votes, win the Iowa caucuses, generate special interest donations, and…. have at least the potential to generate tax-funded alternative energy. But real progress with alternative energy will follow a very different path.

The history of technology and innovation is fascinating. There are endless examples of technology breakthroughs coming from unexpected sources. I was reminded of this while watching an episode of The Sarah Conner Chronicles. Like most guys, I have been a Terminator fan since the first movie. The first Terminator was a huge success for some of the same reasons technology advances come from unexpected places. Big corporate, university, and government research labs have money to hire the leading researchers in any field, buy the best equipment, and pour money into the most promising theories and technologies.

But tomorrow's leading researchers and technologies, like tomorrow's leading actors and directors, are mostly scrappy unknowns today, and they push the envelope chasing new and less popular theories, technologies (and scripts). The first terminator used mostly unknown actors. Before Terminator in 1984, Arnold had starred in Conan, Stay Hungry and Hercules in New York–but mostly he was a former Mr. Universe learning to act. What better role than a futuristic robot? Terminator lacked a big-budget for special effects, so it relied instead on path-breaking creativity and innovation. The \$6.5 million production budget didn't even allow for filming in stereo, for example. But the film was a huge success. Human creativity always trumps big budgets in movies as well as research labs. The most recent Terminator movie had a \$170 million budget and the next (Terminator Salvation) has a budget "in excess of \$185 million." Sequels are usually stale for similar reasons heavily-funded research labs headed by leading scientists are usually stale. They are sequels too, attracting funding only because earlier innovative research work was a success. This was the theme of an earlier Schwarzenegger movie, "Stay Hungry."

A key technology breakthrough from an underfunded and unknown researcher can be seen in the new Terminator series, The Sarah Conner Chronicles. (Interestingly, the robot in the series, Summer Glau, who was in the great Firefly series, also is said to lack certain acting skills). In the new series, Summer Glau is the "good" robot from the future and has eyes that shine blue in the dark. The older model Terminators from the future (Arnold Schwarzenegger in the movies) had eyes that shine red. The future, looking ahead from 1984, did not include the then-impossible blue Light Emitting Diodes (LEDs).

When the first Terminator movie was made in 1984, the blue LED had not been invented. The top electronics companies and research scientists in the world spent tens of millions trying to develop a blue LED. But they could only figure out how to make green and red ones (and without blue, no while-light LEDs could be produced).

Then Shuji Nakamura, a scientist in Japan, not even with a major company, but an unknown working in a small lab away from major research centers, figured out how to make blue LEDs. The Japanese government, with it's reputation for funding new technologies, failed to find Dr. Nakamura. Working alone, he tried materials that top researchers never dreamed could work. (Read more in "Dream of the Blue Laser Diode"). This story is more the rule than the exception in technology, and has been far more common than progress from government-funded research. John Jewkes' study of twentieth century technology breakthroughs reports on the ways and reasons that private-sector interdisciplinary research so often yields major technology advances (see his essay: "The Sources of Invention", a short summary of his book of the same title).

New advances in alternative energy will come from similarly unexpected sources: from researchers, tinkerers, and investors far out of the mainstream. The challenge for investors is to separate the charlatans and crackpots from inspired and visionary inventors. I often recommend to students they look at a picture of Albert Einstein. We know him to be a genius. But if you didn't know him, he looks more like a crackpot.

# The News, from Riz Din

Humans are an adaptive bunch and despite living in times of plenty, I expect there will always be a dissatisfaction amongst us. Having a media that spends all its time emphasising the negative just only makes matters worse. I'll confess that I still watch way too much garbage on the idiot box but I tend to stay away from many news stories, realising that car crashes, murders, traffic jams, etc. are always occurring and why do I need to know all the gory details? I would be interested in looking at the bigger picture trends, but the news doesn't report anything along these lines.

For six months I disconnected TV service completely, but reconnected it since. I still don't watch local news. If I did not know somebody's been shot in the pizza joint that I can actually recognize, would it make a difference in my life? It seems more real and thus more depressing when something bad happens not far from where you live.

I stopped reading financial articles from websites like Motley Fool that are in the business of writing several hundred articles a day. I know many great writers at Motley Fool — some of them are my friends — but you cannot write 5 or 10 articles a day that are good. Unfortunately this applies to most financial news. Yahoo News has been junked — worthless articles.

Same applies to news, if you have to have something to report 24/7 you'll report junk.

# Amateur or Professional? from Craig Mee

February 16, 2008 | 2 Comments

When looking at a snapshot of a particular sport which you are attuned to, you can tell in an instant whether the person displayed is an amateur or a professional.

It's a bit like the markets. If you watch a market move day in day out, you can look at it at any one time, and have a reasonable "feeling" of how this market is set up.  If you rarely look at a particular market you don't have that feeling and are trying to make decisions based far too much on assumptions to do with how your core market may have performed (and not this particular one).

It is important I would say, to not try to trade too many markets, when speculating, as each has its own rhythm, and you must know this inside out. It is useful to ask whether any market snapshot in time, is the work of an amateur or a professional.

# Dispatch from Central America, from Bo Keeley

February 15, 2008 | 4 Comments

I sat down yesterday in the most beautiful McDonald’s in the world, having entered only because I heard a gringa step out saying so. I ordered a large fry for a buck and padded past the McInternet stations to a one acre, indoor, open-sky garden replete with flowers, birds and, of course, a seven-foot Ronald McDonald sitting on a wood bench in Antigua, Guatemala. He is a statue perhaps because the place is so stunning. I sat next to him and between fries got to thinking about individuality within modern travel stacked up to the old ways, my heyday in the 80s and 90s, when I ventured for 6 -18 months at a time and eventually combed the globe. In those pioneer days, I went streamline under a daypack, wore one set of clothes into the cold shower to launder, and was forever fidgety about what lay around the next bend, traveling as a lone wolf.

However, in the past six weeks of vagabonding Central America, I’ve tripped across two other such travelers, a Dutchman programmer who’s visited 100 countries, and a handicapped Asian gentleman on the Latin road for a year. They are pretty much the only first-world humans I’ve spoken with in six weeks, though I glanced up at hundreds more such as those stuffing their faces around Ronald. The new brand of tourist lugs heavy suitcases on wheels along a string of destinations recommended by the Lonely Planet guidebooks, making ant trails around the Earth. They enjoy repeated comforts and speak of the next cold beer and hot shower. I thought only the USA was becoming effeminized but have learned in the past month-and-half that it’s true for the entire first-world youth. They are passive, emote rather than think, travel in romantic pairs, and shoal when possible. They prefer socializing to reading, s-x to learning, emotion to thought, and speak in low lisping voices. The reasons for this shift in psyche over two decades, I think, are the consent to psychology and sensation. The bitter cures are objectivity and travel as in the old days.

A related oddity: In Timisoara, Romania, the only remaining artifact of the 1989 Revolution is the damage visible above the McDonalds on Piata Victoriei in the town center.

A revolution in Romanian city sightseeing

We walk through Piata Victoriei (..) Above McDonald’s is a spray of bullet holes; one bullet went through the window of the apartment of Adela’s friend Corina and punctured a paperback book. (..)

# Reflecting on the Reverend Doctor Holiday Weekend, from Jim Sogi

February 15, 2008 | 3 Comments

On that dark weekend in the 1320 area Kerviel's trades started to unwind and drove the market down in some thin weekend markets. After the 50 Billion sale was done, the market recovered, and thus was an example of what Harris calls trade volatility. The idea is that the 1320 area was the so called fundamental support and the outside influence drove it temporarily down. The last test of that area confirmed that hypothesis at 1320.25. The question going forward is whether the same holds true.

As to your theory about the casinos giving out statistics to lead gamblers the wrong way, when disclosing the statistics, the gambit is that having the true information leads the gamblers to a wrong conclusion falsely believing the odds are tilting in their favor or that the table is not fair, when in fact the table is fair and the odds are not tilted in the gambler's favor. The markets can do the converse gambit and that theory is worth considering which might work as follows: Statistics are cited or historically develop to show how fair the system is, how normal the distribution is, when behind the scenes dark secrets such as Kerviel's evils, government announcements known only to the few before the market announcements and other overweight influences skew the scales of distribution and justice. This is one of the mechanisms causing outliers that come with greater frequency and theory would predict. Physic's evil genie in the gas chamber. That being said, that prior weekend's posts from the public bragging about their short profits were very telling, as are many reports of mass liquidations from the market lows on main street. As Bacon said, "always copper the public's bets."

## Steve Leslie writes:

I have long since given up on trading options, futures and commodities. I just cannot find an edge in these markets that is profitable in the long run. It is akin, albeit on a much smaller level, to Vic and Laurel's disclosing that they do not trade the bond markets anymore. I understand my limitations. I also have given up on looking for significant or absolute lows or highs. Instead I look for the "tweens." This is the area after a stock has broken out of a long base and has begun an advance. Or I look for an exit after a stock has outperformed for a period of time and appears "tired." This works for me and I am content to play in this world. Sometimes I leave plenty on the table for the next guy and that is OK. Revisiting gaming and markets, I am not sure the comparisons that can be drawn. I think most gamblers understand the rules of games are fair, and "cheating" by manipulating a wheel or not using all 52 cards does not happen. Furthermore they know the inherent statistics are against the player's winning in the long run,and they apply to all who partake without passion or prejudice. I am not so sure that in trading markets or investing in equities that they are as fair or equitable. Certainly insider information, manipulation of information and trading occurs constantly. Some in this arena have a decided advantage, and the speculator should always be cognizant of such. In the long run, these abuses tend to be smoothed out. However it is the short run that can kill you if you are not careful.

# Getting In Over Your Head in Real Estate, from Alan Millhone

This afternoon I had an insurance agent I know well, and have worked for, call me to go look at some wind-damaged apartment buildings (the roofs); a total of 70 units. The buildings are all located in close proximity and are two stories in height. The current owner bought the units after managing them for many years. He now has many empty units after evicting many drug dealers and rent non-payers. He is hoping to get all the units rented and not spend a penny on any of the buildings for a year in order to build up a reserve fund. I think he bit off way more than he can chew ! He has insurance but he is already into a battle with the insurance adjuster. On one property the adjuster wrote him a check for \$300 and never saw the damage. I will prepare him an estimate and he can battle it out with his agent and adjuster. I can tell that the owner is not too handy and will have to hire out most of the work. To me he got into something without seeing the whole picture. In my case I know a little about real estate and rental property and know precious little about the stock and bond markets. Goes back to 'know your subject well' and then hope for the best!

# False Eyes, from Victor Niederhoffer

February 13, 2008 | 13 Comments

It's common among fish and butterflies to have false eyes, usually directly opposite from the placement of the real eyes.

There appear to be three reasons for this. The eyes often mimic dangerous prey like snakes and scare off potential predators. The eyes also serve to fool predators who focus on the eyes of the prey and try to approach from the opposite direction so as not to be seen. The false eyes allow the butterfly or fish to escape in exactly the opposite direction from what is expected, after getting a good look at the killer. Finally, sexual selection seems to be involved with the false eyes being a conspicuous mark of health and attraction to the opposite sex, thereby increasing reproductive potential.

There is hardly any form of deception that is not grist for the deceivers in the market. The situation calls for testing and generalizations. The false eyes in the market often occur at the opening in Japan or Europe where the open in these countries at 19 GMT or 3 GMT to an inordinate extent are opposite from the eyes of the open in New York. I found some 330 occasions each during the last 10 years where the direction of the open in Europe was opposite the direction in New York, e.g. down in New York but up in Europe, or up in Europe but down in New York. I found that the false eyes were the ones in US, with the direction in Europe correct in the next few hours after the US open to a significant extent. The tendency while significant has waned recently in the constant coevolution of those trying not to be deceived unduly by frequent false signals.

As an aside, I saw some nice examples of false eyes at the Mandalay Bay aquarium, a commercial venture, which like so many such compared to those run by zoological societies and other non-profits gives the customer an infinitely more educational and enjoyable experience and thus is so much more popular. How many more people have been exposed to nature refuges and wildernesses at Disney than all other refuges? As Mark Penn notes, it's best to always conclude that people are smart and act in their own interests. The greater patronage at places like Mandalay, Disney, and Naples Zoo compared to their non-profit making rivals shows what people value.

Other false eyes in the market would have to include those who are always talking about the next bear market, or recession. They've been doing it since 1980, and they got one in the naughties. Eventually their eyes will see correctly again.

The study of false eyes led me to a review of false eyes in Go. A good summary of the game, talks about strategic moves in Go. They can be "to make eyes", "To hinder the formation of eyes". To create "False eyes" along with the intention to threaten or attack neighboring forces, to oppose junction, to escape Hama (Territory ) et al. I would like to call on some experts in Go to contribute to what strategies in the Game of Go have to teach us about markets as this appears to be one area out of the many thousands of connections and areas of overlap in games, nature or other pursuits which we have not yet explored.

## Steve Leslie remarks:

At the risk of being jejune or appearing insipid, retaining an iconoclastic perspective is not necessarily a bad thing. This would have proven valuable especially during uncharacteristically robust times, e.g. late 1999 with respect to the markets and late 2007 with respect to such stocks as Google, Apple and Research in Motion. A case can also be made that when things appear most dour or data at their bleakest, e.g. 1982, that a change in momentum might be in the not so distant future. When something is least clear is where opportunities abound. To "think outside the box" is to think for oneself and outside the pervasive wisdom at the moment and not to side with the party politic. Beware of lemmings and pied pipers!

Go looks to be a very challenging game at the highest levels, for humans and especially for computer programs.

"The superiority of humans over computers in Go might also be explained in more humanistic terms. Go challenges computer algorithms because it requires broad pattern matching skills and a relatively intuitive approach, while chess favors an algorithmic solution because the focus is more localized (on the capture of a single piece) and the approach is more logical.

This discussion of the application of Monte Carlo techniques to Go might have parallels in the markets and be suggestive of other ideas.  Here also is a Wired interview with the Go programmer, Remi Coulom

From Coulom's website :

The game of Go is a difficult and exciting challenge for artificial intelligence research. Today, the best Go-playing programs are still far from the strength of the human masters. Nevertheless, machines have made very spectacular progress in the recent years thanks to the emergence of a new technique called Monte-Carlo tree search. In this lecture, I will explain the principle of Monte-Carlo tree search, and how it was used to build a strong program, Crazy Stone.

## Alston Mabry goes over some basics:

The objective of Go is to take and defend territory on the board, and capture the opponent's stones and territory. A stone, or group of contiguous stones, is captured if it is surrounded by enemy stones (or the edge of the board). An "eye" is an empty space inside of a group that gives it "life". However, one eye is not enough — if a group is surrounded, the last enemy stone can be placed in a single eye to capture the group. Life for the group can be secured against all attack only by having two internal eyes.

A "false eye" is an empty space, inside a group, that is "false" because some part of the eye's wall could actually be captured, thus destroying the eye.

Go is very much a game of risk and reward. Each move is both offense and defense. A defensive move meant to secure life for a group may create a strong formation from which to launch attacks. And the reverse: An aggressive move to claim territory may panic the enemy, but then as he defends, he may create a solid formation which threatens the aggressor. Now the aggressor must backpedal and play defensively to protect his outpost.

In Japanese the back and forth of risk and reward is captured in the word "sente". A player "has sente" if each of his moves forces a response from his opponent. In a tight game, sente passes back and forth between the players.

There is sente at the opening of the game, or "fuseki", when players are usually staking out territory and claiming corners. These are broad, strategic moves. And then there is sente in close, tactical situations, where the life of a group is threatened, and each threat forces a response.

# Buy & Hold, Long Term Returns and All That, from Kim Zussman

February 12, 2008 | 4 Comments

In checking historical US stock returns, the probability of loss declines as the holding period increases. Twenty years is commonly touted as safe, but there have only been 4 such (non-overlapping) periods since the Depression so it's hard to feel secure.

(There is also the problem of whether this came by "luck": e.g., look what happened to German and Japanese markets when they lost WWII)

There were four non-overlapping 238 month (2 short of 20 years) periods in DJIA monthly returns 1928-2008. The compounded return of these (w/o div) shows only one which was down (with ending dates):

Date 20Y cpfactor
2/1/2008    5.994
4/4/1988    2.264
6/3/1968    4.941
8/2/1948    0.721

(Dividends formerly a bigger part of total return, so exclusion under-estimates final compounded return)

Randomly re-ordering the same empirical monthly returns into 100 simulated 80 year series, I calculated compounded 238 month returns and checked for up and down periods. Of the 400 simulated 238 month periods, 47/400 were declines (12%). This is about half as often as actually occurred, suggesting that the negative market momentum around the Depression may not have occurred as result of random ordering of monthly returns.

## Kevin Bryant counters:

In the grand span of economic history, 100 years of stock market data is barely a drop in the bucket. This is why I derive little comfort from this kind of analysis particularly during the current period which is quickly proving to be well outside normative experience.

## Kim Zussman replies:

Just because long-term stock returns are positive, it doesn't mean they continue into the future, but begs the question whether there are better indicators than history. And a related but very different question is the feasibility of deploying insights/leverage to beat buy-and-hold without increased risk of ruin.

That 3 out of 4 twenty year periods in stocks since 1928 were up should make young people with 401K's feel better, but seems dangerously irrelevant for day traders using leverage.

'In checking historical US stock returns, the probability of loss declines as the holding period increases.' - Kim

My favourite chart to illustrate this important point is Figure 76 in Chapter 7 of the Barclay's Equity-Gilt Study. Limited observations, international examples, and changing times provide good reason to be cautious, but it is all to easy to get lost in the month-to-month or year-to-year volatility and lose track of the extent to which downside risk (negative real returns) have rapidly disappeared over time. Indeed, when looking at the UK data (1899-2005) the study finds that 'For holding periods of five years or longer, the incidence of losses greater than 5% or 10% is the same for equities and gilts.'
Over the long haul, the real returns to UK assets have been 5.3% for equities, 1.1% for gilts and 1.0% for cash. For the US since 1925, the numbers are 7.1%, 2.3% and 0.7% respectively.

To quote Christopher Walken in Wedding Crashers: "We have no way of knowing what lays ahead for us in the future. All we can do is use the information at hand to make the best decision possible."

## Phil McDonnell writes:

There can be no guarantee that history will repeat.

Those words, in one form or another, are found in virtually every prospectus ever offered by the financial industry. The main reason is that they are true. There really is no guarantee. But to the speculator the real question is how should one bet?

The converse of the history repeats proposition is that it does not repeat. Should one bet on something that has never happened before? Clearly betting on something which has happened frequently in the past is the better choice than something which has not happened. The best of all worlds is to combine a frequentist approach based on counting, tempered with a modicum of judgment and reason based on any changes in the contemporaneous financial landscape.

I couldn't agree more, the art w/ the science. I've often thought in reference to Monsieur Le Cygne Noir why one would bet with such conviction on Sisyphus not to roll the rock up the hill, but furthermore that the rock wouldn't come right back down for ole' Sis to push it back up again? It wouldn't take me too long watchin' that rock n roll to place a bet, I'd be there taken the scrapes from those that thought otherwise as well, but not denying them their fair attempt.

## Jim Sogi concludes:

The proper questions to ask are: How are things changing, and how does the trading strategy need to evolve to adapt. A dogmatic approach will not lead to good analysis and will lead to mistakes. Things are changing from the 2003-06 regime.

1. Volatility is up.
2. Global influences are greater
3. Governmental influences are increasing.
4. The industry is consolidating and shifting to electronic.

Time series sample selection in data becomes more important since last year. The idea of regimes being helpful in cycle analysis.

# Briefly Speaking, from Victor Niederhoffer

February 11, 2008 | 8 Comments

1. The screens at the roulette tables in Vegas these days have helpful summary statistics for the players as to the hottest numbers of the last 50 spins, the percent of even and odds that has occurred, and the percent of 1-12, 13-24, 25-36. Presumably the casinos are so confident of the fairness of their machines that they send these signals to induce the poor players to think that there are some deviations from randomness so that they will play more. How much more frequent does this type of deception, this false enticement occur during markets with similar disastrous results to the participants. And how can this be quantified so that the players are not so likely to contribute to the upkeep of the vast overhead in the market?

2. The number of US manufacturing jobs has gone down by about two million during the last 10 years and the number of non-manufacturing jobs has gone up by about 15 million. The non-manufacturing jobs generally pay more than the manufacturing jobs. How foolish can one be to pay too much attention to the latest reports on manufacturing slowdown in this or that city or state or order rate with the decrying of how weak our economy is to the cost of all weak holders?

3. The book Microtrends by Mark Penn, the chief strategist for the Clinton campaign, and a strategist for 15 different presidential campaigns contains numerous ideas about demographic factors that will have an important impact on the performance of individual stocks. I will review it subsequently.

4. All of the books by Patrick O'Brian in the Aubrey/Maturin series contain insights about economics that are timeless and valuable. Recently in a reading of The Surgeons Mate I came across a beautiful passage about the wisdom of the market, specifically English gilts, in forecasting the likely outcome of the Napoleonic wars that is as fresh as the prediction markets of today, and the most cutting edge efficient market behaviorist papers:

[Sir Joseph:] I do not suppose there are many things that men think about with such deep, careful, zealous attention as money, and the Stock Exchange is an infallible index of their thoughts, the collective thoughts of a large number of intelligent, informed men who have a great deal to lose and win.  Even this Heaven-sent victory of yours, and Wellington's at Vitoria, have scarcely moved the City to anything more than bonfires and illuminations and patriotic addresses. These gentlemen know that we cannot go on alone much longer, and at the first stroke of ill-fortune our allies will desert us, as they have so often deserted us before. No Sir: if I were half as sanguine about Napoleon's downfall as you, I should go down into the City tomorrow and make my fortune.

[Maturin:] How would you do that, for all love?

[Sir Joseph:] Why I should buy Government Stock, India Stock, and any sound commercial shares whose value depends on foreign trade: I should buy them at their present dirt-cheap rate, and the as soon as Buonaparte was knocked on the head, or peace was declared, I should sell them at a perfectly enormous profit.  Perfectly enormous, my dear sir.  Any man with foreknowledge could do the same […].  But however, I shall not make my fortune, alas, for the very good reason that I thoroughly agree with the gentlemen of the City: I believe they are perfectly right.  Napoleon is still a very great commander […] he has astonishing powers of recovery. His fleet is quite untouched. […] No,no, Maturin: take the Stock Exchange for your barometer, and rest assured that there is a great deal of work for us to do before Boney is brought down.

# Money & Banking, from Phil McDonnell

February 11, 2008 | 3 Comments

Despite the much publicized efforts of the Fed to make the world safe for banking again there are still signs of a lack of liquidity in the system. In particular the net free reserves in the banking system are about \$1 trillion. This sounds like a lot of money but it is not. Despite all the efforts of the Fed the net free reserves have fallen at a rate of -113% over the last 13 weeks. How a positive number can fall 113% and still remain positive is beyond my ken, but perhaps it is some sort of annualized rate.

The other notable thing is that M1 has been fidgeting around the zero growth rate line for something like 18 to 24 months. It is now joined by M2. Ultimately the cause of the current debacle lies with the Fed which has been snugging the money supply for too long. Details are at Wsj.com .

We are all bottom fishers. We are all waiting for the markets to put in a bottom. If we are investors in real estate funded by a 30 year mortgage we are looking for the bottom in the interest rate cycle before we lock in our 30 year commitment. We all play that game. As the Fed continues to ease and lower rates we are all on the sidelines waiting for that bottom. But few are borrowing and it is the act of borrowing that creates money.

The Fed needs to make its moves quickly and boldly and then make it clear that they are done. Only then will people believe that the bottom is in and it is safe to get off the pot and lock in a 30 year loan.

# AMBAC and MBIA Analysts’ Silence,by Ronald Weber

February 11, 2008 | 3 Comments

One can't fail to notice that (-80% later) there is not a single analyst's sell rating on either MBIA or Ambac! A disturbing silence, in my opinion.

For a negative statement on both companies, see the Value Line Investment Survey Summary & Index, dated Feb 8, 2008. Both stocks are currently ranked in Group 5 (poor) for Timeliness. Ambac was lowered to a Group 4 (unfavorable) on 8/3/2007 and MBIA to a Group 4 on 2/9/2007.

Our Ranking System has not been asleep at the switch.

# Luck, from Jeff Watson

All my life, I've heard the familiar refrain on how "So and so is such a lucky person, they always win." I've been to the track and seen guys sweep the whole card of trifectas, much to the chagrin of the losers who attribute this feat to that elusive concept called luck. I've seen people throw away all of their money in pursuit of the long shot, afterwards labeling themselves as "Having a streak of bad luck." The concept of luck always intrigued me, and caused me many sleepless nights in grad school trying to prove, or disprove luck's existence. After a few months of thought, I eventually came up with a very elegant proof that denied the existence of luck. Ever since that moment, equipped with a new mind set, I have viewed all events as random occurrences that are subject to the laws of probability. This idea served me very well over the past few decades, and allowed me to eliminate one more emotional distraction regarding my management of risk in trading, at the track, or at the poker table. I simply denied the existence of luck for the past 30 years and chalked up all occurrences to probability.

## Kim Zussman cautions:

We attempt to apply Statistics to markets because we see an analogy between markets and gambling. You bet when the deck is rich; count the cards and you will know.

But what if the dealer of the markets:

1. Shuffles under the table or may not shuffle - you cannot know (without inside info)

2. Might be using more than one deck

3. Sometimes uses a deck which favors your opponents

4. Usually favors you but occasionally ruins you

5. Knows that you need the action and abuses this knowledge

6. Knows that you will exploit your knowledge of him to others, especially the weak, ignorant, and women

## Henry Gifford writes:

Simple proof that luck doesn't exist: You can't measure it.

The key to quantifying luck is (to paraphrase Thomas Jefferson) "the harder I work, the luckier I get".

If I was going to quantify luck this is where I would start going forward.

Those that have windfall luck from pure chance without doing anything usually lose the benefit within a short time it seems to me. Those on the other hand that receive a windfall from hard/smart work usually compound it from that point.

## Vince Fulco agrees:

In his latest book, GM Gary Kasparov harps on this point.

"One interesting, and humbling thing I've noticed while analyzing my own games for publication is how poor some of the ideas I prepared really were…Only a fraction of these ideas every saw the light of day, either because my opponent didn't fall into my trap or because I found a better variation to play. Now I see that in many cases that was not a bad thing….This kind of preparation served me well in a way I never quite appreciated while I was working on it with such determination. These periods of intense preparation were rewarded with good results–even when I didn't end up utilizing the fruits of my labors. There was an almost mystical correlation between work and achievement, with no direct tie between them.

There is also a practical benefit to "wasted" effort. Work leads to knowledge, and knowledge is never wasted…"

This sentiment echoes that of another strategist, General Eisenhower: "In preparing for battle I have found that plans are useless, but planning is indispensable."

Perhaps Kasparov romanticizes, however, in the "mystical" lack of correlation between his preparation and his later results. Surely having immersed himself in a position or a variation for some hard thinking, even though over the board he played "something different," he subconconsciously gained insights that facilitated his over-the-board analysis.

Writers experience this phenomenon all the time. You write something, read it over, and then scrap it and write something "completely different" that you realize now was what you meant to say all along. But you couldn't have gotten to that insight without first going down the "blind alley." I once scrapped an entire book manuscript and rewrote it from scratch for the same reason.

## Alan Millhone relates it to checkers and stocks:

The late Checker World Champion, Tom Wiswell,  once told me to always make your best move in a game and never assume your opponent will make anything but their best move each time it is their turn. Play for superior position in your game. Luck comes to those who are well prepared.

Being prepared in the Market would be no exception. In Checkers I study past games of top players, keep a hand written manuscript , have a large Checker library for reference. Luck is when preparation meets opportunity.

In the Market one has to know your stock in every detail to make effective trades (like good moves in a Checker game).

The late and great Vince Lombardi said it best, " Luck is the residue of preparation ".

## Sam Marx makes a distinction:

I will have to admit that my two most profitable moves in my lifetime were in investments and they were because of luck, also they were relatively cheap and I held them for a long time.

My success in trading, however, was not luck but based almost entirely on probabilities.

Investments vs. Trading. Perhaps luck plays a greater part with investments than trading and we should make that distinction.

# Recessions Then and Now, from Greg Rehmke

Reading the papers over the last few weeks, it is weird how thrilled financial reporters seem to be at the idea of a major recession. Maybe the excitement is just that a bone-jarring recession is so rare. Like a volcano exploding after a long dormancy, it is big, big news. Most reporters were taught in college to expect market failures and fragile markets jolting everyday folks with greed-fueled mergers, takeovers, downsizing, and spectacular corporate frauds and flameouts. Instead, by and large, the American economy has powered ahead for a couple decades creating millions of new jobs and trillions in new wealth.

Twenty years ago recession fears were more justified. But modern recessions may be a far different and less dangerous animal. (The stock market drop may more reflect the reasonable fear that hapless politicians will overreact to a short recession with a wide range of monetary mischief and fiscal pork spending.)

Across developed economies, manufacturing coordination depended on months and years of lead time. Factories carried vast inventories of parts and raw materials. When demand for cars, houses, machines, or clothes dropped unexpectedly, sunk inventory costs had to be written off. Unions ruled, and when labor demand fell, wages were fixed and payrolls hard to reduce.

But the dot.com boom that brought the dot.com bust and the housing boom that brought the housing bust are much, much smaller distortions than the inflation and price and wage controls that distorted the U.S. economy in the 1970s. Prices carry vast flows on information driving adjustments and innovations. Price controls stop all that, whether in Zimbabwe today or the U.S. (Nixon's 1971-74 wage and price controls). So for a few years the economy ran blind, facing backwards and using past prices to guess the way ahead.

The very good news for investors today is that the hint of recession may blast the latest speculative boom in commodities. Novice day-traders that brought foolish bets and blew air into the last years of the dot.com bubble, moved after the crash into leveraged real estate investments, and those that survived that debacle are now in oil, minerals, and gold. I don't claim to know how much of the recent boom in these materials is driven by inflation and how much is speculative. But the third factor for the boom in oil, coal, and other minerals is the long fall in prices of the 1990s. As many others have noted, much of today's oil high prices are a consequence of the very low oil prices of the early 1990s. Major oil companies dramatically cut back exploration and sacked thousands of workers. New oil exploration was not profitable at \$15 a barrel oil, and industry had nifty new exploration technology based on every cheaper computer processing power. Oil industry executive imagined they coast to new oil discoveries and scaled by expensive exploration.

But on the demand side, billions of people in China, India and Eastern Europe gained economic freedom and prospered far faster than economists expected, pushing energy demands up faster. And on the supply side, government interventions hampered new exploration and investment in Russia, the Stans, Africa, Indonesia, and Latin America. Suddenly, not only had investment in new exploration and technology been scaled way back by low prices, but the vast barely-explored territories expected to be available for current technology, was again buried in murky red tape and corruption.

High energy prices, however, bring new minds to both the supply side and demand side of energy. We have today a vast array of massive investments in energy production, both new and old. Government regulations and subsidies are of course wasting billions on the wrong technologies (like corn-based ethanol, wind, solar, and hydrogen power), but high prices are pushing energy production and raw materials expansion like never before.

Dozens then hundreds of huge new oil, gas, coal, and mineral production operations will come on stream in the coming months and years. A hint of economic slowdown now may shake out overly-leveraged resource speculators and drop prices significantly. But once the tens of billions of dollars have been invested in new infrastructure in Australia, Brazil, Africa, and the Middle East, these resources will flow to markets based on marginal costs, so price drops won't slow the flow.

So, for the U.S. economy the news is good. Energy and resource prices will fall. And these prices aren't even considered much of a problem in today's economy. Reporters have no idea how fast today's firms can adapt to shifting demands for their products. (They are learning, though, how media firms respond to dropping circulation and advertising, and the public's reduced demand for distorted print media stories.)

Modern service and manufacturing industries no longer depend on extensive parts inventories and cumbersome long-term supply contracts, so production can be slowed at much lower cost. Suppliers have the same flexible and just-in-time relationships with their suppliers, who can shift production and throttle back with much less disruption.

For transportation, instead of the heavily regulated trucking industry of the 1970s and 1980s, America today has hundreds of fast-evolving trucking and logistics firms. And hundreds of companies now rely on Penske and other truck-leasing firms for a significant part of their distribution, so they can reconfigure or downsize cheaply.

Booms are disruptive and slow-downs are healing. Boom times are when money too easily made flow to careless investments colored by vain optimism. The easy-money and bubble mentality throws money at many ventures that maybe might work, but always drawing human and material resources from less exciting but more proven ventures.

We see this in Silicon Valley today. The smartest and best-positioned people in the world are spending their lives and fortunes to address the non-problem of CO2 emissions. The newspapers and magazines are all aglow with news of the super-cool electric sports cars and alternative energy projects where high-tech venture capital and venture capitalists are pouring their money and time. What is the opportunity cost of having folks like Al Gore shaping technology investments? Well, what are they not doing and funding? A billion people in India are mostly impoverished, and the richest Indian in Silicon Valley spends his time and money on wind and solar power projects for America. Where is his real expertise? (At least Bill Gates has the good sense of focusing his philanthropic efforts on what is actually killing people in the developing world.) Will the Google's leadership in search engine suffer from endless Google alternative-energy projects?

The Great Eye of the Market is a fusion of millions of minds focused on specific tasks. The Great Eye today searches all aspects of natural resource markets. Every undiscovered underwater drop of oil and underground lump of coal is being searched for by the largest pool of capital and array of technology in the history of the world. As powers greater than the greatest armies of the past wrestle with these challenges, millions more around the world search of ways to save energy, invent new energy, and find substitutes for expensive minerals. The fruit of the massive worldwide search will come to market over the next decade, no matter how far oil and mineral prices over the next decade.

The Great Eye of the Market is a vast collective force, but driven by free thinking individuals set on finding and funding new innovations. As millions around the world turn their manic energy to finding and developing energy sources, energy technologies, energy innovations, they push the energy and natural resource envelop, and some few will no doubt uncover dramatically disruptive undreamt-of discoveries. Markets may overreact, but in the process they push billions of dollars and focus millions of minds at making a better world.

# Nine Movie Reviews, from Marion Dreyfus

February 9, 2008 | 7 Comments

On the Popcorn Aisle — 9 February Offerings

Fool’s Gold –starring the effervescent charmer, daughter of Goldie Hawn, Kate Hudson and the hunk-a-hunka Matt McConnaughey, tried too hard, was a meld of recent Nicholas Cage and Harrison Ford adventures, but somehow failed to ignite–despite charming central characters and mumbly-peg villains who were no more scary than a Saturday-morning kiddie show–any discernible tension or suspense. It was nice looking at the chemistry between Hudson and White Teeth-and-Pecs–but the whole event failed to ignite, despite derring-do on seaplanes, graveyards, grotto caverns, sunken treasure salvaging and a raft of sunny shots of the Caribbean.

Donald Sutherland, estimable in dozens of films, never convinced with his British accent, his spoiled daughter’s ditziness wore thin as soon as she alit from her chopper on Sutherland’s yacht, and the plot holes–how did the trio of brigands find the two salvagers on the island in the pitch of night, without making a sound as they stole up somehow on them? How could Matt escape death umpteen times with merely a chaste scrape over his eyebrow, when others would have severe and debilitating brain damage from head trauma?–left many observers cynical throughout. (I turned and watched their expressions.) Nice scenery, though.

A favorite of mine, though at first I was reluctant to even attend –fearing the documentary would be… icky– Praying with Lior has won world plaudits for its longitudinal film-history of Lior Liebling, a Down Syndrome child of Rabbi Debra (Devorah) Bartnoff. Rabbi Bartnoff died of breast cancer when Lior was still quite young, 6, but director/producer Ilana Trachtman continued the filmography of this charming child in his somewhat unconventional—but lovingly Jewish– family setting. Lior’s father, Mordecai Liebling, a nationally known rabbi and former director of the Jewish Reconstructionist Federation, remarries, a sensitive Lynne Iser, his three siblings struggle to varying effect against the constraints of having a ‘special’ child in the family, and Lior persists with courage, wit, humor and goodwill. Mostly, the elder two manage very well. This viewer was haunted by the youngest daughter, who plaintively tells the camera that she never gets attention, because her brother has always merited the spotlight, in his trajectory to having a bar mitzvah despite his learning disabilities. Bluegrass and klezmer, the ancient Hebrew liturgies and daily prayers, make this a melodic outing perfectly suited to the thrust of Lior’s life: Bar Mitzvah speech and Haftarah. Perhaps most important, Praying with Lior has been hailed for encouraging greater involvement in faith practices for persons with disabilities. Lior shows it can be done—beautifully. Held over an extra week in NYC.

Caramel is a more charming, more surprising, “Steel Magnolias,” set in a Beirut that is pretty much like Boca Raton, from the look of it. It frames the film in cameos of women frequenting, loving, living and working in a beauty salon. The beauteous salon owner, Layale (Nadine Labaki) is in an unhappy affair with a married paramour. Nisrine (Yasmine Al Masri), engaged to a Muslim, agonizes over what will happen when he learns she is not a virgin. There are doctors for that, as the girlfriends bring her for a slight ‘repair,’ just as the practice of plastic surgery runs through the film, the way it might in Rio. Jamale (Gisele Aouad), an aging actress, still gorgeous, competes desperately with younger women for TV commercials, and seamstress Aunt Rose (Siham Haddad), cares for her demented elder sister, Lili (Aziza Semaan). Rose poignantly sacrifices a potential marriage to a distinguished gentleman because of her obligation to Lili. The film winds through the lives of these women, in Arabic—though they are all Christian—and French (English subtitles) in a way that is entirely involving. Most startling to this viewer, of course, is the normalcy of their lives and concerns, without a whiff of the jihadism or chaos we have come to associate, unfortunately, with today’s Lebanon. Excellent being transported back to the lovely looking one-time Beirut, “the Paris of the Mid-East.”

The most heart-warming, and quirkiest, film of the past month is the Israeli film, The Band’s Visit, which takes as it departure point the befuddlement of a musical troupe from Egypt in a forgotten Israeli town. How the eight men in powder-blue oompa-pa uniforms conduct themselves among the little-town inhabitants of Beit Hatikvah is never less than enthralling, instructive, gently amusing and enjoyable. No politics intrude. Just the courtly graces and manners of these lost musicians as they try to get their bearings, find their way through the night, and make plans for getting to the correct city for their inaugural cultural center performance. It pleased from the moment the men arrived on a lonely bus in the broad, deserted spaces of nowhere, and continued through gentle love affairs, near-misses, instructional aids to having a romance for the painfully geeky and shy. Utterly charming.

The Counterfeiters goes Speilberg’s Schindler’s List one better. The true story of a crack printers team which, under the demands of their concentration camp commandos, precisely replicated first the pound sterling, and then, after much deliberate delay, the dollar, to finance the failing nazi armed forces in the waning days of WWII. It is never less than grittily engrossing, brutal, plain—but elevating, as it copes with the moral dilemma of living better than the other camp internees while helping to bring down the economies of the UK and the US.

Ira Sachs’ Married Life stars the ever-beguiling Pierce Brosnan and Patricia Clarkson, the beauteous Rachel McAdams in a restrained performance against the tight-lipped yearning of Chris Cooper. It is a meditation on the grass always being greener in someone else’s bed. As a hothouse study of how married couples make their peace with the barely acceptable versus the unattainable, it is a compelling exercise. The title is a-drip with irony, of course.

For the distaff side, I admit I was not offended by the latest Rambo, starring McCain’s main man, Sly Stallone, with a throng of slim, mean, muck-enrobed “Vietnamese” and sundry US hard-bodies from various TV shows. It features that unusual coda: The Americans get their men (and woman) and we are the undisputed good guys, limned against the nastiness and cruelties of the Viet Cong captors and whatnot. It doesn’t really matter what the plot is, but lots of heads pop off, blood spurts from bisected ‘enemies,’ leaping and special effects are well integrated with the endless monsoon rains, and no one is mud-free for a second in the whole 90-plus minutes. The movie is what it is, so don’t imagine you’ll get a meditation on the nature of moral depravity.

Teeth
, a film that sneaks up on you, treats two subjects rarely handled in film today, amusingly mixes horror and fascination with v.  d.  and, um, castration in modern small-town America. Although it has moments few men would celebrate, it also pays back incestuous brothers, inamoratas and bad prom dates. It’s hard to recommend it to men, but women might find it diverting—no one loves and leaves this babe without serious, really serious, complications.

The Hottie and the Nottie, featuring Paris Hilton, Christine Laken and “the” Greg Wilson (that’s how he bills himself), is one of the worst films of 2008, and we’re just two months in. It is disgustingly misogynistic, worse even than the Meryl Streep and Goldie Hawn vehicle, Death Becomes Her (1992). It’s the yuckiest of ugly ducklings (Christine Laken) made fun of for half the film for every conceivable ‘sin,’ like comedones, bad hair, poor skin, horrific teeth, moles, you-name-it, until the transformative swan is achieved, via Hilton’s ministrations and ‘help,’ to rope in a half-way attractive swain by twisting oneself inside out for the obvious consumerist view of “acceptable.” Laken remade is actually more attractive than Paris Hilton. No one in the screening I saw waited for the screen credits, and left the second it wrapped. Dreadful. My partner would have left in the first 5 minutes. Marion DS Dreyfus 20©08

# Three Old but Good Movies, from Riz Din

February 8, 2008 | 1 Comment

Going to the cinema is pretty expensive these days, with cinema tickets in the UK typically costing £7.50 (around \$15). I'm sure ticket prices have outpaced inflation, but perhaps I'm just turning into an old curmudgeon.

Anyway, after a run of bad films I started recording some of the oldies that are shown on TV as time fillers in the early hours. I was pleasantly surprised.

Here are my favourites:

The Big Heat (1953) — Has a beautiful art deco flavour, is very crisp and fresh in its filming (even though it's in black and white), and is very fast paced with top quality acting throughout (this film introduced me to the great Lee Marvin).

Becket (1964) - Features Richard Burton as Becket and Peter O'Toole as an wonderfully intense, unconstrained and maniacal King Henry. Watch this to see two great actors in their prime.

Favourite quote from Becket: Thomas a Becket: Tonight you can do me the honor of christening my forks. King Henry II: Forks? Thomas a Becket: Yes, from Florence. New little invention. It's for pronging meat and carrying it to the mouth. It saves you dirtying your fingers. King Henry II: But then you dirty the fork. Thomas a Becket: Yes, but it's washable. King Henry II: So are your fingers. I don't see the point.

The Treasure of the Sierra Madre (1948) - A Bogart classic. The story of a small group of men who go up in to the hills in search of gold.

A quote from the film: Howard: Aah, gold's a devilish sort of thing, anyway. You start out, you tell yourself you'll be satisfied with 25,000 handsome smackers worth of it. So help me, Lord, and cross my heart. Fine resolution. After months of sweatin' yourself dizzy, and growin' short on provisions, and findin' nothin', you finally come down to 15,000, then ten. Finally, you say, "Lord, let me just find \$5,000 worth and I'll never ask for anythin' more the rest of my life." Flophouse Bum: \$5,000 is a lot of money. Howard: Yeah, here in this joint it seems like a lot. But I tell you, if you was to make a real strike, you couldn't be dragged away. Not even the threat of miserable death would keep you from trying to add 10,000 more. Ten, you'd want to get twenty-five; twenty-five you'd want to get fifty; fifty, a hundred. Like roulette. One more turn, you know. Always one more.

If we're talking Becket we can't leave out the magisterial Man for All Seasons.

For comedy selections, The In Laws (original Peter Falk version) easily ranks in any critic's top 10 comedies.

For readers of Vic and Laurel's web site, I also highly recommend the hard-to-find The Wrong Box, which features every major British comedian in an "economic lottery" theme (I don't want to give anything away), and also the 1960's period piece, The Magic Christian (written by Terry Southern of Dr. Strangelove, Easy Rider, Cinciannti Kid, Barbarella fame) in which Peter Sellars stars as the world's richest man who adopts Ringo Starr (!!) as his son. Quirky, but written by a comic legend, and there are terrific economic gags.

# Briefly Speaking, from Victor Niderhoffer

February 7, 2008 | 14 Comments

The bears pretended to go away last week when the S&P went up 5%. They left a 1 day decline of 18 points on Monday as a gift to bulls to buy, but when they did they were hit with a immediate 5% decline the next two days. Its very similar to the Trojan Horse left by the Greeks and one wonders if it's a general tendency that can be quantified. e.g. is there an inordinate tendency to visit the previous 20 day low?

One of the most non-economic things to a businessman is the inordinate tendency that analysts put on sales increases. One of the first things that good businesses do is winnow their customers down so that only the most profitable are there. The wealth of a business is increased when profits go up, not when sales go up. Any business can increase sales by selling low margin goods at a small profit. But the good businesses try to sell their products to the customers that have the greatest desire for it, as that way they can reduce the consumers surplus and increase profits. There must be some very flawed studies relating to biased data files that showed in the past that sales increases add additional information that the earnings changes don't reveal, and this has probably caused countless investors to sell stocks when profits increase and sales decrease or in the case of Cisco, or Microsoft, and countless others, the forecasted sales increase is not up to expectations. It must make treasurers who are business people very jaundiced concerning the rationality of investors when they run their business well, increase profits, in tough conditions, and find that their stock is killed when the sales level is below expectations. Any closely held business would think it magnificent to increase profits on reduced sales.

Perhaps the signaling effect of sales increases is mistaken for good business sense. I would hypothesize that companies that beat earnings forecasts but miss sales forecasts and go down in price perform substantially better than the averages.

Tarred by the same brush. How many times can the market do down irrationally when this or that indicator, this or that official, signals that the economy is not growing as fast as it has in the past x years.Forget about the fact that each months figures are generally reversed or revised in the next announcement,and that the figures generally are meaningless because of special seasonal adjustments, and assumptions, and political tinkering in many cases, and that sometimes bad sales for a retailer and many others is much better than good sales because it means they got rid of all the good stuff in the previous month. Suppose the worst is true, and the rate of growth slowed from  3% to 0% or -1%. ? The recession would be brief, the bounce would come, and what difference does it make if the economy goes down  1%, then up 4% two years versus up 3% each year. Stocks are supposed to be valued based on an infinite stream of discounted earnings. That's not affected by one years change in the path. Nor are recessions a good time to sell stocks as the same way when the market turns down when the news is recessionary, the market will look for any silver lining for a change in direction when the economy is in the doldrums.

The Nikkei which closes at 0115 gmt continues to forecast the US market with reasonable accuracy . The most recent was the 5% decline on 2 06 in Japan which forecasted the subsequent 2% decline in the US on 2 06. The Nikkei closed at 13080 on wed morning in the us. It is trading at 13060 as I write, up from a 13005 open.

## Dan Grossman wonders:

Perhaps modern tech businesses like Microsoft and Cisco have such high gross margins that sales are always profitable and it is never good to have sales growing at less than forecast by management or predicted by analysts.

You and I are used to old-time businesses with low margins and high overheads that have variable aspects. In these businesses it would sometimes be valuable to get rid of less profitable customers. But perhaps in the software business with 70 and 80% margins,  no customer is worth getting rid of.

I have always thought that earnings can be anything you want them to be, based on accounting choices such as depreciation rules, depletion, inventories, not to mention shell accounts (ENRON), outright fraud, and other sophisticated techniques and methods. However sales are what they are. You either sold a product or you did not. It is a more objective indicator.

Price to Sales Ratio (PSR) is just one useful measure. I am sure there are a host of others that the fundamentalist can use to extract information out of a company’s cash flow statement and balance sheet.

I like to use services such as IBD and research companies such as Zack’s and Value Line to provide valuable information and I go from there.

# Thoughts after the Superbowl, from Stefan Jovanovich

February 4, 2008 | 5 Comments

Mike Schmidt is the only 3rd baseman so far to hit over 500 home runs. If Alex Rodriguez hadn't switched positions, it is more than likely that Schmidt would be the only one ever. Yet, for most of his career, the fans in Philadelphia were inclined to blame him because the Phillies had failed to win a championship. When the Phils finally did win the big one - because they got a bullpen to go with the starting pitching, someone asked Schmidt what he thought. He laughed and said, "It is amazing how much my character has improved from last season." The journalist took him at his word. Sport is wonderful, but at the professional level the outcome of a game is rarely determined by the character of the borrower. If Asante Samuel's hands hadn't betrayed him and Tyree and Manning hadn't made a play that they could not repeat again if they practiced it a hundred times, no one would be talking about the Giants' brilliant performance or their sterling character.

Last year Tom Brady managed to be missing when it came time to congratulate Peyton Manning for finally winning a playoff game against him. Love them or hate them, the Patriots' quarterback and his coach are consistent. They think they should win every game, and they don't want to stand around making nice when all they are thinking about is how to adjust the blocking scheme so that next time they catch the fake drop back and stunt by the Mike linebacker. As John McGraw did in his time, Bill Belichick views the game he coaches as being a war, not a game. It must be something in the water of the Chesapeake.

# Ten Lessons From the Recent Bear Markets, from Victor Niederhoffer

February 3, 2008 | 22 Comments

1. There is no such thing as a bear market, only markets that have gone down a lot from a previous high in a reasonable time frame.

2. The market had its best week in 5 years two weeks after having the worst week in 5 years.

3. When the vol rises to above 30, expect a 1-2% gain in next two days with say a 90% prob.

4. The differential between the discount rate and the 10 year rate is an excellent predictor of short and long term movements in the market.

5. The market likes to set a big minimum at the beginning of the week and all the limits downs have occured on such days.

6. The knowledge of a big forced seller in the market will filter out and effect everything and the market will go to unprecedented low levels until the sales are requited.

7. The Fed chair thanked Milton Friedman for insuring with his research that the Fed would never again cause a depression by tightening the money supply during a time of economic doldrum and we may thank Milton Friedman and the Fed chair, and Mr Kerviel for insuring that no such depression or recession will be induced again by such activity.

8. The market will go back up along the same path that it went down. i.e. Lobagola lives. (Remember Lobagola's  story about the elephants).

9. Buy and hold must not be leveraged too high for it to work .

10. The tried and true patterns are the most dangerous during times of crisis. (Beware of patterns with a 90% chance of success).

# Le Rogue Trader, from Kim Zussman

February 3, 2008 | 4 Comments

Could our French colleagues comment on these aspects of the Affaire Kerviel:

1. Unappreciated low level trader from humble background

2. Big bank known for sophisticated derivative Quant trading by golden boys from elite technical/math universities

3. Gamed the system by hacking compliance and creating false offsetting trades and deceptive emails

4. Industrious - actually skipping holidays in a country which is a holiday

5. Courageously trading OPM through huge swings, at times extremely profitable, in mere hopes of a bigger bonus

6. Bank chose its best trader to unwind into a multi-week market bottom: Waiting 2 weeks could have again been highly profitable

7. He will be lionized in France, where they appreciate when the rich are victimized. (Come to think of it, there will be a place for him on Hillary's cabinet)

## Bruno Ombreux replies:

Regarding Point 2. Actually, they are not sophisticated. The secret to equity derivatives is having a good marketing department and a good sales force. Some of the stuff Jerome Kerviel was hedging, the things called turbos or clicquet options , are mass-marketed equity derivatives designed to part innocent retail investors from their money. With good salesmen, one parts "sophisticated" pension and hedge funds from their money just as easily, except the sale is not done in the mass media but by building relationships with invitations to industry functions and over glasses of champagne.

Serendipitously, I am reading "The complete arbitrage deskbook" from Stephane Reverre, who happened to be head of index arbitrage and quantitative trading in the Tokyo and NY offices of Socgen. Obviously, he is describing activities he learned at Socgen. They are very basic. Nothing sophisticated. They just require a lot of money and good execution. Good salesmen are really helpful here again, for instance in the equity loan market.

# Taylor’s Rule, from Dean Davis

February 2, 2008 | 1 Comment

I was recently reading commentary on the question "is the Fed already behind the curve?". The Taylor Rule model was used to assert that the Fed has not cut far enough. The commentator used an approximate recent GDP growth rate of less than 1%, excess capacity and trend in core inflation to state that the Fed Funds rate should be nearer 1%. Quite alarming, it seems to me. What is your take on the Taylor Rule?

## East Sider replies:

The Taylor rule works beautifully… in retrospect.

It requires precise estimates of things that are not observable — GDP trend, GDP slack, inflation — so it's useful only for ex-post criticism, not ex-ante policymaking. IMNSHO.

Another argument is often made based on 2 year treasuries trading nearly a full percentage point through 3% fed funds, with analysts saying this means "the market" is looking for the Fed to cut rates to at least 2 percent.

Professionals have wearied of pointing out the credit difference between an overnight unsecured interbank loan, and the perceived security of a liquid obligation representing the full faith and credit of the the US govt.

Comparing apples to apples at the front end of the curve - fed funds to two year swaps - it turns out Bernanke's shop may not be all that much of a laggard.

At Friday's close, overnight funds were roughly 20 bp higher in yield than 2 year swaps. Interestingly and counter-intuitively, that's spot on the one year moving average of that spread.

The market is certainly leading the Fed, but not by the scary-sounding distances usually cited.

# Coal and Water One year Later, from Jack Tierney

February 1, 2008 | 7 Comments

Last Jan. 31 I picked water and coal as the plays for the year. In that time, the Dow. has gone down .2% while the S&P dipped 4.51%. The water stocks listed showed a slightly positive return of 1.56%. I didn't list any coal selections since I owned too many and wasn't particularly crazy about the rest.

It can be revealed now that I held CNX (+116.75%), FCL (+57.39%), and ICO (+17.25%). However, after Congress completely passed over coal in the energy bill and the geniuses running California, Florida, Nevada, and South Carolina banned new power plants utilizing the product, I bailed on two of the three (I leave it to you to guess which I still hold). Please look carefully at the states that pointed the way in the anti-coal charge - none really appreciate the cold since they so rarely experience it - I was thrilled last week, then, when I heard it was snowing (and sticking) in Santa Barbara.

Coal's out performance, however, hinged on three unusual events: floods in Australia, power outages in South Africa, and snow storms in China. I still believe it's our best hope for somewhat alleviating the energy shortage. However, I'm in a smaller minority than a year ago. I also mentioned that coal-to-liquid stocks might be a good bet. Very wrong. Every potential alternative energy source received a few nickels and dimes from Congress - not CTL, though, and the stocks tanked badly. And the best of the bunch, Sasol, is now advesely affected by the SA power crisis.

A closer look at the water stocks shows that Companhia de San Basi (SBS) once again was the best performer among the foreign entries gaining 37.96%. Suez (SZEZY) gained 23.92%, and Kelda Group was up to 20.22%. The American stocks were lead by Lindsay (LNN) with a 99.09% gain, and then a huge gap down to Northwest Pipe (NWPX) with a modest 10.45% move, and last year's American leader, Layn Christensen (LAYN) with an OK 4.39% push up. Major diappointments were Gorman-Rupp (GRC -31.16%) and Watts Water (WTS -31.00%). Tetra (TTI) was the biggest loser at -32.51%. The only loser among the foreign stocks was United Utility (UUPLY) at -4.81%.

Please note that neither Suez nor United were Pink Sheet stocks when selected a year ago. Both are huge companies and both decided they didn't need the NYSE or SarbOx. This trend has gained momentum this year and I expect it to continue. (Can you blame them when the utlimate authority and high priest of foreign investment is little Chuckie Schumer?) To keep abreast sign up with otcqx.com/otcqx/home as they not only announce the delistings but provide information on the quality of the companies moving.

In conjunction with these moves and others from the NYSE, a Mastercard survey revealed that London is now considered the leading center of commerce, besting NY in economic stability, ease of doing business, financial flow and business center ("depends on the clustering effect of business formation, supported by efficiency in logistics and transportation linkages").

In a similar vein, Bob Adams of New Global Initiatives hired Zogby to get a feel for American emigration. The results indicate 1.6 million households have already decided to leave, 1.8 million are seriously considering it, and 7.7 million are "serious about leaving and may do so." Since no similar study has been conducted, these figures may well be normal. However, when constituents as diverse as Russian airlines and Uruguayan day laborers will not accept dollars, it's possible that the bloom is off the rose.

Of course, much of the concern revolves around how serious and extensive the fall-out will be over poorly extended mortgages, the CDOs in which they're packaged, and the financial heft of the counter-parties who have guaranteed these pieces of dreck. No one need worry about the dollar as it is establishing itself as a carry-trade funding currency (although Bernanke still has 250 basis points to cut before he achieves Japanese levels - and if Cramer has anything to say about it, it will happen.)

I'm in the process, a very slow process, of puttng together my favorite "pinks." Some of the world's great companies refuse to play by our rules (e.g., Nestle, Samsung, Gazprom) yet can provide some great returns. Unfortunately, there exists an irrational fear of stocks listed in the Pink Sheets. Admittedly, many, many are dogs, but there are quality issues also.

Before I sign off, though, I have a question for a group which lives and breathes the dogma of "ever-changing cycles." If "the cycle" is your touchstone, why are recessions so feared and, in some cases, denied? Without them there would be no cycle. An occasional flushing is essential to any system, so why don't we just get it over with and carry on?