Every investor should study what Spitzer's relationship was like with the media. What he seemed to be able to deliver for a reporter was: 1, to break the story, and 2, to be on the winning side of the story, exactly as long as it held the public's attention.

If you can set this up as a guaranteed coup for the reporter, they will in gratitude let you pin it on whoever you want, and escalate and over-hype the "crime." Truth and reality are the first victims in wars of reputations.

Now clearly he didn't understand that they were there only because of the two rewards as their main incentives. They weren't morally on his side, but using him like Clinton using an intern. They were on the side that offered two tangible rewards.

What I am asking myself today: was S&P's announcement, and the market's subsequent intra-day recovery, enough of an incentive to the media to change sides in its reporting of the Subprime Crisis?



I was at Lowe's this morning getting a new electric range for one of my apartment units. Picked out the one I wanted and told the clerk to go get it. Another customer was there and was going to get a dishwasher. He had his car and no way to haul it. He was standing beside me and asked the floor worker how much to deliver to Mineral Wells (Lowes store at Pettyville) about four miles away. The floor worker said $60. I spoke up and told the customer that I had my pick-up out front and would deliver for him for $40. The floor workers looked surprised at my offer. The customer took me up on it, I delivered, got my $40, gave him my construction business card, we shook hands and I left for Belpre with my stove still on the truck!



With gold $1000, crude $111, wheat $12, EU 1.55, I wonder if Ben's free heli money is doing more harm than good. I'm all up for some free money, especially if part of it falls my way, but it seems like administering amphetamines to the sick. They perk up but their health is worse.

I really get a laugh out of the financial news. "Market down! Things looking bad!" A few hours later after a 3% up move, "Markets up!" They are sooo behind the curve it's funny.

Kim Zussman notices:

The last two Fridays were down, and in 2008 they have been bearish. Here's c-c in SPY:

Fridays / Zussman

Before the open is CPI, which despite $110 oil will miraculously print no inflation — and we get another Tuesday.



In an article about Toyota, J. Brian Atwater and Paul Pittman highlight the importance of systemic thinking.

"Through the analytical paradigm, we attempt to understand complex phenomena by breaking them into smaller parts, then trying to understand how the parts operate in isolation. All evolved fields of study — from chemistry to business — have used this same analytical methodology as a basic building block to understanding."

"Systemic thinking is, fundamentally, the opposite of analysis. Rather than trying to break a complex phenomenon into smaller pieces, it attempts to understand complexity by examining behavior within the context of the larger system in which it belongs."

The authors say Systemic thinking consists of holistic thinking, dynamic thinking, and closed-loop thinking.

  1. "Holistic thinking–studying the role and purpose of a system and its parts to better understand why they behave as they do."
  2. "Dynamic thinking–examining how the system and its parts behave over time."
  3. "Closed-loop thinking–investigating how the parts of a system react and interact to each other and external factors."

Issues that make understanding some systems difficult, as identified by Jay Forrester, are also applicable to speculation:

- Cause and effect often are separated both in terms of time and space.

- Problem resolutions that improve a situation in the short term often create bigger problems in the longer term; actions that make things worse in the short term often have long-term positive effects.

- Because of these first two characteristics, people often do not learn from their mistakes.

- Complex interactions between the various parts of a complex system often create counterintuitive behaviors. Consequently, what appears to be the obvious decision is often a bad choice."

Toyota's introduction of the Prius in 1997 provides a good example of systemic thinking. U.S. automakers took years to respond with their own hybrid vehicles, partly because the U.S. automakers' priority in the late 1990s, a time of low energy prices, was selling high-margin sport utility vehicles. There was no discernible customer demand for hybrid vehicles.

"By examining their industry holistically, [Toyota] realized demand for oil was going to increase significantly as India and China became more industrialized. In addition, political unrest in oil-rich countries and geological concerns that oil deposits may disappear made supplies dubious at best. Finally, worries over global warming made the development of fuel-efficient vehicles an attractive public relations move."

Nigel Davies remarks:

Seems to me like the kind of thing that is written after the fact. I'd need some convincing that Toyota's policy was nothing more than a happy accident. We chessplayers do this all the time, especially when we blunder and it turns out to be good: "Of course I'd seen everything; the bishop sacrifice was the only logical continuation…"






The principal cause of the Prius's success here in the People's Republic of California has been the desire of the once semi-rich to maintain their social status after retiring. The local doctors, lawyers and professors who found their savings and their retirement incomes depleted by the Dotcom Bust stopped buying Lexus and started buying Prius — because it was good for the environment and they could pocket the 30-50K difference in cash and be even more superior than their neighbors. What is fascinating now is to see the number of new compact Fords and Chevies being driven by the undergraduates at Berkeley. The social worm continues to turn.



TAWe often look at patterns — whether they be in the stars or the charts — and say, that triangle is a coincidence, or it is chance that the former support becomes the new resistance. And this seems especially moot in the case of an industry average. Reasoning behind some technical analysis often comes with hand-waving. But perhaps we need to look at the possibility of emergent behavior arising out of the individual actions of millions of traders to produce real patterns, which would lend credence to some patterns of technical analysis which look at the market en masse. The starlings do not deliberately set out to make striking geometric patterns as they fly, nor do termites consult a blueprint before constructing complex mounds. Has anyone applied the techniques of cellular automata to model trading? In theory, thousands of alternative definitions of automata could be run — like a Monte Carlo simulation of Monte Carlo simulations — and if certain patterns showed up irrespective of initial conditions it would be interesting.



Bill Fleckenstein of Seattle, where I live, has a book out now on Alan Greenspan showing the fake PhD for what he really is. Vic and Laurel always referred to Greenspan as a fake PhD. I watched the tele-circus every time Greenspan appeared before Congress. Just as in a circus the main clown was Greenspan and the crowd were the Congressmen who were the suckers P.T. Barnum referred to when he said "there's a sucker born every minute." My study of the Federal Reserve dove into many books written by Real PhDs with genuine insights into the nefarious activities of people claiming to be economists under guise of their position. I have shown that the Fed is not an independent agency but is a tool of politics. In view of that Fleckenstein should have pointed to the pseudo-science of economists and the gullibility of Congress as the culprit in the fiascos and bubbles, he writes about. Actually, at the heart of bubbles lies the economics of Chicago, the Friedmanist fantasy that mathematics makes economics a science and deregulation, hands-off, free markets, makes wealth grow for everyone. If massive deregulation had not occurred the criminal, crocodile brain stem of financiers would not have been freed to swindle everyone into accepting the Chicago fantasy. Flooding the world with fake money is not science, it is merely political policy. And bubbles, as in champagne, produce headaches; in this case, world-shaking headaches. Oil is up around $110 but it is there because the dollar is not worth anything. Oil has a value but dollars do not; that's the root of our problems; it takes more worthless dollars to buy oil. If the dollar were solid, oil could be bought with fewer dollars. And that is were Friedman's Chicago School has got us to.

Adi Schnytzer adds:

I disagree with Ken about lumping Friedman in with the Fake PhDs of this world. If Friedman's policies had been followed, the robber banks would be broke now, the US economy would be in a depression, but it would at least recover therefrom quickly. All of these attempts to save the thieving mongrel bankers is simply delaying the collapse, not preventing it. Free markets give good folks pain but the also take out the trash like nothing else.



The moves this Friday, Monday and Tuesday remind me of a good baseball swing, or for that matter what any good athlete does vis a vis economy of motion. Recapitulating exactly the Friday, Monday and Tuesday of the big French bank frontrunning move

Rodger Bastien replies:

The bigger question is whether this batter does what I too often did, which is once I found my stroke, I swung harder, many times losing my rhythm in the process.

Stefan Jovanovich adds:

Chili Davis says he has the same problem. Each time he walked up to the plate, he would mutter to himself "70%, 70%." That was how hard he should swing to allow his stroke to do its work. That didn't keep him from over-swinging or from displaying his enormous strength when frustrated, but he says it helped. Once upon a time at Candlestick I saw Davis, while walking back to the dugout after striking out, raise one knee up to waist level and break his bat into two pieces. He didn't break stride.



A letter I received today:

Dear Vic,

I'm doing some back of the envelope. Real 10y rates went from 1.7% at year end to 0.9% now. Do you have any idea what a move in real 10y rates like that does to the discounted value of cash flows, i.e. the fair valuation of stocks? incredible?

This is not the Fed Model, which is clearly wrong because it uses nominal rates, and compares apples to oranges — Cliff Asness is definitely right on that — but looking at changes in the discounted cash flow valuation using changes in real rates is simply correct.

What say you?

I responded that I don't believe anything is wrong with the the Fed Model, and that the real rate according to the TIPS has not gone down as much as he says. But I agree with the conclusion anyway.

George Zachar remarks:

The declining relative weight of Treasuries in the debt universe, along with their well-known pricing distortions, make them a poor benchmark for such studies these days.

Five year interest rate swaps for current work, or, say, Baa 5 year corporate yields for historical studies, make more sense.



It seems the "Fed Put" is deployed strategically nowadays: see the FOMC unscheduled cut before the perilous open on 1/22, and the increased liquidity announcement on Friday before the payrolls number. One wonders whether the market is becoming conditioned to throw a tantrum to get what she wants from Daddy, and progressively spoiled and unappreciative as the gifts pile up.



If our local Waste Management gets its way they will get a tariff hike for local residents of 47% (why they did not ask for an even 50% baffles me). The company is seeking to increase its rate from $25.30 a ton to $37.30 a ton. This, in turn. will increase construction costs in my area for any debris removal from new home/remodel or commercial work. They are also requesting the elimination of an existing 5% discount to commercial, industrial and municipal customers making full payment within five days of billing.



March 10, 2008
Rove taunted at University of Iowa
(CNN) — Former top Bush aide Karl Rove didn't get the friendliest of receptions at the University of Iowa Sunday, CNN affiliate KCRG reports.

Rove, who was paid $40,000 to speak at the University, was confronted with an at-times hostile crowd of 1,000, and was interrupted on several occasions.

I was there. The crowd was fairly evenly split, but those that hated him were much louder. The first 10 minutes were wasted with jeers from the crowd and idiots who planned to cause a ruckus until they were removed. I lost two bets: First, that someone would get tasered. Second, that we would hear the line "Don't tase me, bro!"
After we got started, the journalism prof/interviewer tried to trick Rove into admitting errors, but he was hopelessly outmatched. Rove is really smart, surprisingly articulate and fairly funny. When asked a serious question, he would give multiple examples of why his response was correct, backed by a serious dose of logic. I didn't always agree with his conclusions, but they were definitely well thought out.
When asked ridiculous things, Rove would usually point out the flaws in the question. One question asked about Bush's tenuous relations with the press and Rove's assertion that news was driven by commercial interests. The implication was that journalists are not driven by capitalism, rather by reporting on appropriate stories. Rove responded by saying that we don't have a state run media here, that all reporters work for companies who pay their salaries by selling subscriptions and advertising. They are incented to get as many viewers as possible and will do what is needed to acquire those viewers. Therefore, Rove said, the foundation of the question is untrue and he didn't need to answer the larger part.
The best line of the night came in response to a question about Bush's lying about the war. Rove said he'd like to read a quote from the President of the United States. The quote was about how Saddam had WMDs and we needed to disarm him. Then he read a similar quote from the VP, and the Secretary of State. The crowd hooted and hollered during the whole thing, jeering the lies that Rove was reading. Then Rove said these quotes were collected in 1998, and came from Clinton, Gore and Albright. It was pretty funny.



I took my Cub Scout den to the Norfolk Zoo aka Virginia Zoo last night. We had what is called a Zoo Snooze. We were "locked in" at closing time and got to tour the place with flash lights and see the nocturnal animals at play. Amazing experience. This morning we got to go see the lions fed hamburger mush and get within three ft of them behind a cage — intense! They roared and nearly made everyone see the Pearly Gates! We did a slew of other things as well, including dissecting owl pellets. Highly recommend. Cost was 35 bucks.



  To look at the issue of margin from a different angle, imagine there are two similar companies who have very different balance sheets: Company A is 100% equity financed while Company B has taken on tonnes of debt and is highly geared. Can the investor roughly replicate the higher risk-return profile of the highly geared company simply by borrowing on margin and investing in the 100% equity financed company?

Yishen Kuik replies:

IMHO, the one has nothing to do with the other.

A company that takes on leverage to conduct its business is exposed to business risks that cause it to be momentarily short of operating cash and therefore unable to make an interest payment. The equity holders are now at the mercy of the bondholders.

If it did not take on leverage, none of this would happen.

The issues that cause a leveraged equity holder to have to sell out of his position are completely different from those that cause a levered company to go into default, and the consequences are completely different as well.



 I just finished reading 'Jubal Sackett', a frontier novel by Louis L'amour. I initally found L'amour's writing style to be rather spare and lacking in depth, but as the pages turned I came to appreciate how comfortably the writing style fits with the tough nature of the landscape and with the character of Jubal Sackett, a quiet loner not given to excessive introspection, who is finding his own path on a journey of discovery.

Jubal Sackett is an intelligent man who understands risk and reward. He is constantly looking over his shoulder because the enemy may be lying in wait, he keeps check of his inventory and deploys his scarce resources to maximum effect, he knows much of the ways of the tribes in the foreign land that he inhabits, he knows when to hole up and when to move on, and he has the basic skills to survive in a tough environment (ie he has the necessary edge). Louis L'Amour has provided us with a great, balanced character that I will do well to keep in mind when trading.

Here are a few of my favourite quotes from Jubal Sackett:

- 'The Kickapoo are strong because of our enemies. Deny us our enemies and we would grow weak.'

- 'There is but one thing we know, Ni'kwana, and that is that nothing forever remains the same. Always there is change. Your people have remained long undisturbed by outside influences. This may seem good, but it can be bad also, for growth comes from change. A people grows or it dies.'

- All things are valued according to their scarcity, and a time might come when this gift would seem as nothing. What was worth little to us was worth much to them because they were things they could not get elsewhere.



Many days recently when there was downward action, precipitated by derivative vehicles, there have been strong rallies to the close. Recalls youthful episodes of downward action, sounds of parental vehicles, followed by rallies to the clothes.

Anatoly Veltman adds:

If a month-long dollar decline has been all foreplay, can you imagine the multiple gasms in our assets about to come — not to mention households filled with crying nine months down the road.



Moby DickIn Herman Melville's Moby Dick there is a fine chapter about the monkey rope. Many of us are on a monkey rope with others where their fruitfulness and indeed life force are intimately tied with another both going up or down together. I wonder what markets or components are tied on a monkey rope together these days. The bond insurers and the banks comes to mind. The bonds and the stocks always. The dollar and the grains. What else comes to mind?

Jim Sogi:

EU, Japan, US at varying times.

I would often jerk poor Queequeg from between the whale and the ship-where he would occasionally fall, from the incessant rolling and swaying of both.

Monkey ropes from todays news: The drop in crude futures dragged gold along with it just as the precious metal approached a record near $1,000 an ounce. Dollar also turned higher against the yen late in the day as U.S. stocks trimmed losses.

Matthew Alexander:

Gold and oil.

Lon Evans:

Gold is, and historically has been, a hedge against the perfect irrationality of the human genome. Oil, relative to history, is but an infant in the same game. At no time in recorded history has a commodity been susceptible to the geometrical acceleration of an intelligence necessitated by the very same genome.

John Tierney:

We all share, and live or die in the market, by the same components: fear and greed. We all possess an abundance of both and the really fortunate make it back on deck alive and whole. But Melville's real point here is not how skillfully we joust with Fate and, if fortunate, prevail. No, the message is what we can expect as a reward; certainly not a fine cognac, but a dismal flagon of ginger. Surviving the monkey rope is its own reward, indeed a great conquest just in balancing two such powerful forces.

Should we expect more? And if we get more will we not risk it all again tomorrow? For what?

Andrea Ravano:

Stocks, and currencies such as Aud and Nzd.

Denis Vako:

It would appear that roughly speaking it is Commodities vs Financials, and East vs West.

Sam Marx:

Fuel Oil Prices and Airline Stocks

Pitt Maner III:

Oil Prices vs. Drill Rig Count, Oil Service Companies

Economic Slow Down, Stress — Cold and Flu, Defensive Stocks, Funeral Service Companies

Consumer Spending as a case of Melville's Bartleby — "I would prefer not to".

Alan Millhone:

Ahab knew the value of Gold and so did his crew: on board ship while chasing the great whale, Ahab took a Gold coin and nailed it to the mast for all to see.

Phil McDonnell:

Some more coterminal monkey ropes. Things lashed to the Dow Jones Transports include: bonds, notes, oil, the yen and VIX. The aforementioned all are lashed in a negative sense. Surprisingly oil services are lashed positively along with most world stock markets and financial services.

Tied to the S&P we have oil services but not particularly oil itself. Naturally most stocks are tied together with the S&P - no surprise there. But one finds that US paper of substantial duration, VIX and the yen are negatively linked.

Riz Din:

Commodities prices and currencies. I'd previously looked to the commodity prices to get a better handle on the likes of CAD, NOK, AUD and NZD. However, according to a recent paper by Ken Rogoff summarized in the WSJ, I may have been looking in the wrong direction, and it is currencies that provide predictive insight on the commodities, not the other way around.



AltmanIn the March 3 edition of Barron's there was an article by A. Bary entitled "Risky Bets". The author cites a number of stocks that are down 40% or more from their highs; he believes investing in these companies could be very profitable if the credit markets begin to normalize and the economy recovers.

There are a number of companies other than those he cites that are down 40-50% or more that may be two or three baggers when the stock market comes back. The question is, "Are they reliable companies or future bankrupts"? I've been using Value Line and Morningstar to determine the financial risk of some of these beaten down companies.

However, I'm also aware of a formula called Altman's Z-Score that predicts future bankrupts with 85% accuracy among stocks with a low Price to Book Value. A Google search yields a number of articles describing the approach and financial data to use.

The data to use are:

1) Earnings Before Interest and Taxes (EBIT)

2) Total Assets

3) Net Sales

4) Market Value of Equity

5) Total Liabilities

6) Current Assets

7) Current Liabilities

8) Retained Earnings

I have, with varying degrees of success found these data in the Yahoo, CNBC-MSNBC, and Morningstar Financial Pages. But the data are 6 or more months old or incomplete. Value Line was a big disappointment.

1) Is anyone aware of where more up-to-date and complete financial data may be found on the web?

2) Or is there a web page that lists companies along with their Z-Scores ?

Gordon Haave replies:

For those of you with Bloomberg (the system, not the mayor), there is a Z-Score function built in.

Larry Williams suggests:

For more up to data company financial data try: MSN Money or Kiplinger.

Allen Gillespie cautions:

Altman Z-Scores is designed to work for certain industries. You might have to use several different scoring methods to cover all industries.

Eric Falkenstein offers:

I just created a website with free default probabilities for public companies, US and worldwide. Better than anything else I've seen, and I've seen 'em all.



 I highly recommend the adaptation of Homer's work The Adventures of Odysseus by Hugh Lupton, Daniel Morden, and Christina Balit by Barefoot Books. While I am not generally a fan of adaptations or abridged versions, the trio do a wonderful job of illustrating and telling the tale and it has been is fun and educational for my five year old daughter. A reread of this on my part has many fitting lessons for the markets and life as well. The sacrifices, the battles, the subterfuge, and the perseverance amongst others are all involved. How to escape the son of Poseidon the Cyclops Polyphemus. How to accept the fact that one must sail close to the walls of Scylla, knowingly sacrificing six men so as to avoid the doom of the entire ship and men. How to avoid the temptations of the beautiful Sirens and the seemingly delectable cows grazing in the fields of forbidden of the god Hyperion. The lessons are countless, both overt and covert.



50% OffWhen I moved from Italy to the US last year I asked for advice about the opportunity to buy a house during my three-year tour in this beautiful country. Most of the responses were against buying and I am glad that I followed this advice. At the time, the exchange rate between Euro and US dollar was 1.28 vs the current 1.52 (almost a 19% difference). There was a house for sale in the neighborhood for 450K$. After one year, the house is still for sale, but this time at 380K$. Moreover, you have to subtract the 19% due to the more favorable exchange rate. For the equivalent of a small two-bedroom apartment in the suburbs of Rome, you can now buy a four-bedroom house here and still have 350K$ cash. This situation is not related only to the housing market, but the economy in general. The difference in price between goods and assets in the US and Europe during the past year has become impressive. Whenever I happen to fly to Europe I have some relative or friend asking me to buy and bring a new computer, telephone, videogame, golf club, article of clothing, etc. The same is true for the price of cars. But of course importing a car from the US is not so easy! The same applies to the stock market. For Europeans and for others the US has a big sale sign on the country! Sooner or later these imbalances will be resolved and markets will start working in this direction as investors will find opportunities in this new situation.

Jim Sogi adds:

Same in Hawaii, the Europeans are snapping up land like crazy. What a good deal, they say. I remember the Japanese doing the same 20 years ago. What a good deal, they said. Many of them bailed out in flames from their excesses.

Stefan Jovanovich remarks:

This is not the first time. One of the least appreciated of President Grant's many virtues was his insistence that the U.S. capital markets become completely open to foreign investment. That was his primary reason for reestablishing the gold standard for the dollar after the Civil War. During the same period J.P. Morgan & Son established its reputation as our country's preeminent investment bank by urging its European customers to exchange their francs and pounds for dollars after the Panic of 1873. When those investments proved to be stunning successes, Morgan's word became literally as good as gold as far as the bankers in Paris and London were concerned. What is truly sad is that, this time, it is the wise visitors like Paolo, not Americans themselves, who see the historic opportunity.

Bruno Ombreux adds:

Because of dollar depreciation, visitors have the purchasing power. Even if American see the buying opportunity, they don't have the purchasing power. Also it seems they are in debt, which makes it difficult to add more debt to take advantage of purchasing opportunities.

I see the purchasing opportunities also. I think I'll buy assets in the States in a couple years. It is cheap. And in the long-term, the USA will be better off than Europe.The US has a better demographic pyramid. It has a lower population density. It has the best universities in the world. Taxes are confiscatory but less than in most European countries.

It is cheaper than Europe and has a better and brighter future. This is a buy.And you are right, this is a historic opportunity. I am trying to micro-manage to time the purchase by waiting a couple years, but maybe I am too greedy.

Stefan Jovanovich replies:

American non-financial corporations certainly have the ability. They have become self-funding, even for capital expansions. They have less dependence on debt markets and banks than they have had in a generation. But their managements seem to be taking their inspiration from Sewell Avery instead of Sam Walton in terms of their confidence about the country's future prospects.

Bruno Ombreux explains:

The US and Europe have different perceptions of history. In the US, the traumatic experience was the Great Depression. In Europe, it was the Weimar hyperinflation which led to the rise of Hitler which led to the horror of WW2. The purpose of the EU is to avoid another WW2. That was the founding principle of its predecessor the EEC. The purpose of the ECB is to avoid another Weimar. European are ready to take it on the chin and suffer a lot to avoid any repeat of Weimar or WW2. In the 1990s the French experienced two recessions for the sake of Europe. First they absorbed part of the cost of German reunification through imported deflation. Then they cut spending to meet the Maastricht treaty obligations, while due to low growth they should have run an expansionary fiscal policy. They'll do it again. The German will do it too. Everybody will do it. The rest is posturing in the context of negotiations between goverments, as well as trying to influence the ECB. The ECB is not like the Fed. The ECB has only one mandate. It is price stability. It is very precise: CPI right below 2%. The Fed has two mandates, price stability and economic growth. I never understood why, because there is a macroenomic theorem that you need to have as many policy tools as economic targets. If you you want to control inflation for instance, you need only one tool, that is either monetary or fiscal policy. If you you want to control inflation and growth, you need two tools, that is monetary and fiscal policy. That is the case if the Fed and the government are coordinating actions as they seem to be doing. But then it means the Fed is not independent. You can't control inflation and growth and the currency. Something has to give. The job of the ECB is much easier.

Paolo Pezzutti extends:

The risk in investing in US assets is not related to the value of the assets in US dollars. For example, buying the depressed and daily hit by bad news financials in the long term is something that will work out to be profitable. The financial system is the engine of the US economy. It simply cannot fail and eventually will recover from its excesses. The question mark lies with the exchange rate between euro and US dollar, which could really impact overall performance as it has done in the past years. However, we are at a point of excessive difference in the purchasing power. For example, if you check on Amazon for book prices or on other sites for electronics, such as iPods or Nintendo, you will notice that they sell an item for 100 Euro on one of the Atlantic and for 100$ in the US, which is quite impressive.

Kim Zussman replies:

What happened to no-arbitrage theory? A 40 year old student converts his Euros to dollars, buys iPods in the US, and sells them for Euros back home. Same with real estate. Sells his Amsterdam flat, converts to dollars, and buys a beach house in Venice, California. True, ganja is only legal in CA by prescription — but a 50 Euro visit to Dr Pheelgut fixes that.



James Florio speaks to students about political life
Kim O'Brien
Issue date: 2/28/08

The discussion ranged from advocacy to energy conservation last week as the College students and faculty listened to former Governor of New Jersey and U.S. Representative James "Jim" Florio share his experiences as a politician. Listeners filled Moyer on Feb. 20, 3-4 p.m., as Florio led a discussion on "Government Leadership in the 21st Century."

Jim Florio is a perfect case study of self-defeating government economic policy.

Before his term as governor, NJ was a prosperous, low-tax state, successfully winning businesses and entrepreneurs from its high-tax neighbors, NY and PA.

Then Florio, in violation of his specific election promises, raised marginal tax rates so much as to transform NJ into one of the highest tax states in the nation — in some ways the highest, if one takes into account all the tricks such as taxing long-term capital gains at the highest rate and not allowing capital loss carry-forwards.

From that time forward the NJ economy has been one of the worst performers, a downward spiral of declining business growth, insufficient tax revenues and continued self-defeating efforts to raise revenues through increased sales taxes and the highest property taxes in the country. NJ has become the state losing population at the highest rate in the country.

And even though right next to the strongest-in-the country NYC real estate market, NJ real estate has been one of the worst.

Jim Birk notes:

PA is not and has never been a high tax state. The only businesses that moved from PA to NJ were offered outrageous government incentives by NJ that PA was wise to not compete with. It is interesting that about half of the NJ state employees working in Trenton live in PA. PA has better housing prices, lower property taxes and a lower income tax than NJ.



LockThere's a metaphor that keeps popping into my head whenever I think about markets these days. It's that of a lock, the device for raising and lowering boats between stretches of water of different levels on river and canal waterways.

Now suppose that thus far the world economy has thus far been a system of canals and waterways which has thus far functioned via locks. And what if globalisation is breaking this down so that the economic streams have started growing beyond limiting pathways. What would be the effects?

It seems to me that the waters must burst out of the canals and then level off, meaning that the geographic disparities in land values, currency and wages will gradually erode. Such an outcome would seem to be a very positive one in the long run, but meanwhile we've got a lot of flood water to mop up.



1 Make sure the assumptions are based on the most credible current available data.

2 Make sure the data are appropriate for the models assumptions.

3 Know which assumptions your model is sensitive to.

4 Watch closely for regime changes — changes in future expected patterns, invalidating your current assumptions.

5 Always check your numbers for accuracy.



Long faces as NY commods floor trade ends long run
Reuters Friday February 29 2008

The downcast looks came days before open-outcry futures trading on ICE Futures U.S. ends for good when Friday's closing bell rings, concluding a nearly 140-year history of trading agricultural commodities on exchange floors in New York. The contracts will become fully electronic March 3.

As an inhabitant of the pit for many years, I mourn any loss of floor trading. What really disturbs me is that many local members bought into the spin that the exchanges put forth about the benefits of electronic trading and allowed this to happen.  I understand the politics of exchanges, and the fact that the directors don't always have the best interests of the members in mind — mainly their livelihood.  Call me old fashioned, but I prefer the open outcry method to any electronic system.  I haven't quantified the following, but I think that there will be a loss of liquidity and depth once the exchanges all go electronic. I just wonder how the exchanges will adapt in the event of a long term computer glitch, power outage, or other computer disruption.  Somehow, eternal optimist that I am, I think that there will someday be a resurgence of floor trading.

Manuel Bravochico remarks:

Floor traders for the most part were dishonest. But the ones in the NY pits were the absolute worst, many times acting as liquidity takers instead of liquidity makers for screen traders. Thank you ICE and Globex, your success at taking essentially all the pit volume away from the floor traders sends the message. A resurgence of floor trading? Someone forgot to take his meds today.



Tyler Cowen wrote a piece on why the Rockets drafting injury-prone center Yao Ming was like writing a naked put.

"…So why did the Houston Rockets draft Yao Ming? They couldn't not draft him. The lessons for financial markets are obvious. Drafting Yao Ming is like writing the disguised naked put. You see the money in front of you, you see the return in front of you, you see the potential in front of you, none of the alternatives are so glamorous, and so you can't not do it. Besides, other players get injured too…"

Perhaps the metaphor makes sense to the extent writing puts and drafting an injury-prone player both have asymmetrical reward structures with divergent modes and means. But Cowen seems to be inappropriately disparaging both activities. Writing equity index puts has historically been profitable. And at least in baseball it appears a GM can sign injury-prone players at a sufficiently large discount to be more than fully compensated for the risk.



The recent mention of GARCH reminded me of another complicated acronym which could be interesting to specs: HSMM, which stands for Hidden Semi-Markov Models.

The acronym makes it sound complicated, but it is a very simple concept:

1. The market alternates between different regimes, for instance greed and fear

2. Each regime has its own mean and variance, for instance (positive drift, low variance) and (negative drift, high variance)

3. The switch between regimes is probabilistic (with constant probabilities, which is a simplification — it is only a model, after all)

4. Regime duration, aka sojourn time, is some random variable

The fourth point is what differentiates HMM from HSMM, Markov from Semi-Markov. The later is more general in terms of sojourn time distribution.

I feel this type of model is a welcome addition, not alternative, to GARCH in the trader's toolbox:

1. GARCH fits the facts very well but does not really provide any explanation. HSMM fit the facts and provides a physical explanation, for instance alternating moods of greed and fear. Actually, empirical price behavior is incredibly well explained by this simple alternation of different regimes.

2. GARCH focuses on predicting variance. Therefore it is very useful to option traders. HSMM focus on predicting regimes. That is, they focus on the counter's nemesis: ever-changing-cycles. They are useful to all people concerned with the shelf-life of their edges.

What is the probability to be in one cycle? What is the probability to remain in this cycle? Those are questions that HSMM try to answer. Because they are in their infancy, they often provide more questions than answers. It is an open research area. But they can already shed some light on the matter, and it is not always optimistic.

The best fit to empirical decay of squared returns autocorrelations — a long and wordy statement — is provided by negative binomial sojourn times. One interpretation of the negative binomial distribution, is as a not well behaved generalization of the relatively well behaved Poisson distribution. With Poisson, mean = variance. With the negative binomial, mean < variance. If so, then it is not easy at all to forecast regime duration.

However, it is as interesting to know what one can't trade as to know what one can trade. And it is always possible that some more encouraging results could be achieved by looking at other markets, other timeframes, and other phenomena, e.g. backwardation/contango switches in energy markets.

By the way, I am reading Dr McDonnell's excellent book Optimal Portfolio Modeling. As usual, Phil is clear, clever and very right. Everybody should read the book.



DragonsIn Dragons of Eden: Speculations on the Evolution of Human Intelligence, Carl Sagan discusses the evolution and structure of the human neural system as being split into the right and left halves of the brain, and the R complex, the limbic system and neocortex. The right half does patterns, the left half does math and language. The neocortex is the thinking brain, the R complex is the reptilian id, the limbic system creates emotions. Many of these functions are in conflict with each other. I wonder how these different functions operate in trading and can only presume that their different functions create many of the dissonances experienced during trading. The right brain sees patterns, but the left brain doesn't like the average gain. The neocortex says stay in the trade, but the limbic system has the trader all upset and blood pressure high, then the R complex fight or flight reflex causes an early exit. I like to keep my order screen on my lower right. The charts on the left, and the quotes on the right. Seems to fit the neural set up better.



I am currently reading "Get Everything Done and Still Have Time to Play" by English life coach Mark Forster.

He has some interesting and original ideas. For example he prefers the use of must-do lists over to-do lists, and gives an exercise to develop the necessary will power.

He says time management is really attention management, and that we have a limited amount. It is impossible to give more than 50% of one's attention to more than one thing — though many try — and balance is to be achieved by delegation or reducing the number of objectives.

He provides a critique of popular methods using a fable of a princess and a luckless suitor who has inherited a business, who tries each system in turn and finally seeks solace in the pub.

Notably, and this is a good example of his original approach, he does not believe in prioritization (except in crises) and points out that there is some sense in choosing low priority tasks to action, so that they are dealt with long before they become a potential crisis.

In summary, he writes about quality of action and strength of resolve, and is not formulaic.

Russ Herrold adds:

A long time ago, when I was drowning in paper, I found Stephanie Winston's TRAF|S system on a couple of pages of her book "The Organized Executive" (Norton, 1983) and have been using it, and teaching it when consulting, ever since.  As it has been passed by with later writings by her (not so concise, not so focused), I see that Amazon has it for a penny used.

I do a five minute presentation (a bit of 'acting') with sight, sound, and humor to give and set the lesson on its use. I do this with others who are drowning in issues who seek my help, to give us a common vocabulary and problem solving rubric. The beauty of this little system is that one never touches an issue more than three times before resolving it. Nothing gets lost.



There is a lot of discussion of 'style' in many arts, but perhaps the ultimate goal is to go beyond style to a point at which one does everything in one's sphere with the same high level of excellence. To fall short of this means having weak spots which will sooner or later be found out.

Two very disparate sources on the matter:

When one has reached maturity in the art, one will have a formless form. It is like ice dissolving in water. When one has no form, one can be all forms; when one has no style, he can fit in with any style. — Bruce Lee

I don’t think so. I’m not even sure what, “Fischer’s style,” is or if it exists. A very dear friend, GM Miguel Najdorf, who had strong, very strong, opinions on just about every topic and every subject, delighted in baiting me and drawing me into animated, emotional discussions. He was a passionate man who loved chess very much. He postulated a theory which I’ve thought about often and think he was right. His theory went like this: “Jasser (Miguel would always mispronounce my name in this Spanish way) you know, Bobby had no style.” Such an opening gambit to start a conversation was perfect bait. “You see, when you show me a game of Capablanca, I think, ‘Aha. Very nice. Very smooth. Logical. Beautiful play. Must be a game of Capa!’ Then you show me another game, I think, ‘My God! Who is this bandit playing the white pieces? Look at these reckless, daring sacrifices. And this quiet move as well! Incredible! Down two pieces and he stops to make such a move. And he won! Of course, I realize, this is Tal.’ And another game. ‘I can’t understand what the player is doing. He is taking extraordinary precautions and his opponent isn’t even attacking. Now he has maneuvered his pieces backwards and then to nice squares. He improves his position but has done nothing concrete. My God! The opponent is suffocated and is dead. Of course, that is Petrosian.’ You see Jasser! I recognize style. But you see when I play a game of Bobby, there is no style. Bobby played perfectly. And perfection has no style.” We argued for hours, but in the end I found Miguel’s theory quite convincing.” — Yasser Seirawan



From the New York Times :

…the typical American corporation has increased its savings so sharply that it probably has enough cash on hand to completely pay off its debts…

Why would America's premier leftist broadsheet put corporate balance sheet arcana above the fold on page one? I wonder which senator will "just happen" to introduce a bill taxing/regulating retained earnings…



LG wrote:

What is wrong with my logic here?

Over the course of time, accurate brick laying and other construction tasks will become automated using numerical control processes pioneered in the aviation industry.

This will bring down the labor costs of building as well as reducing construction time..

Therefore the price of property is likely to reduce

Based on my experiences in the machine shop my father had in the basement, on my building of machinery to automate factories, and my experience building buildings, I think little will be automated in the construction industry.

Many have tried, with prefab bathrooms, prepackaged piping sets for kitchens and baths, and other things that make sense but don't catch on. Today in the US some 5% to 15% of new houses are factory built (depending on where you draw the line between "house" and "trailer"), but even they are not very automated - they benefit from protection from weather, stockpiling of materials, easier quality control, etc., but not from automation.

The main difficulty in automating construction tasks is setting the machine up for the many different sites, methods, dimensions, etc. Everything is already set up to be done by unskilled or semi-skilled labor.

Interestingly, after each building boom ends, the materials, codes, technologies, and economics change enough for the whole industry to have to reinvent itself for the next boom. During the last boom (just ending) insurance became major, and the ability to get a bond became a major cost of entry, effectively barring new entrants to the industry for the last few years. Labor got relatively cheap as material prices boomed, but that ratio has shifted back and forth many times in the past, as it will presumably do again in the future as Bacon's principles describe.

As for automation having a significant effect, it hasn't started yet, and I see no signs of it yet, but who knows.



Jim SogiJurists look for precedent or similarities in factual situations. Traders might use the same type of analysis rather than purely statistical numbers by looking at the context of the situations in which similar facts took place. Yesterday was the fifth consecutive gap down, today the sixth, and the third or fourth straight down day. This combo only occurred before in the bear market of 2000-20002. A year back I noticed that the facts seemed to fit the 2000 high volatility period. With this acceleration down and other recent days, I'm seeing patterns that happened in the big bear market of 2002. Last few days saw breaks to the downside from consolidation areas. I don't recall seeing this action for last few years either. Granted last week we had breaks to the upside. The number of this type of occurrences are too few to be robust in any manner statistically, but for context it is interesting to consider. Is trendfollowing in the equities going to make a come back?

A few weeks back I read C*vel's trend following book and wrote an as-yet-unposted critical review, but have reconsidered. I was critical of C*vel's uncritical use of only two simplistic examples of trendfollowing systems. I was critical of trendfollowing in general and of C*vel's insinuation that beginner traders might use it to make money. Trendfollowing must have had its cycles before, like maybe 20 years ago. It hasn't worked so well in the last 10 years or so. But I wonder if these cycles are coming back. How long has it been since you took a break out/down entry? We haven't seen a 20 day high or low for a while now, but it will be interesting which way it will go. Failure or trend? I kind of doubt trendfollowing (in equities anyway) will return in a big way, but its good to pose the question.

Kim Zussman notes:

The S&P close today was near the point last Friday before the 23 point Ambac skyrocket. Shortly thereafter a question was raised about over-anticipation and symmetry between up and down over-reactions.

This week's answer looks to have taken five trading days, with several surges on bad news thrown in to test the gut. I noted one headline: Wall Street dives on Ambac rescue doubts.

Gut, gut, That magical organ

The more you trade

The more a sore one

Vincent Andres notes:

Jim wrote that "jurists look for precedent or similarities in factual situations." As an algorithm, this way of reasoning is sometimes called "case-based reasoning," and has multiple applications.



 1. "Electrocybertronics," an article in Smithsonian, March 2008 issue, points out some sexy company names, especially suffixes, from the last century starting with electric, going to "ex," then "ola" then "tronics" then "cyber" then "nano." I made a preliminary study of returns the 35 US public companies with "nano" in their names and found that most of them are near zero and have not risen in price. I can't pass this subject without noting that like most new things, those who wish us to remain primitive are fighting against this development, and much life-saving will be prevented. Apparently there are nano pants that stay clean, and perhaps this will play the same role that hybrid seeds played in opening up biotech in opening up life extension and reduction of human drudgery in nanotech.

2. We've now had the greatest number of down S&P opens in a row in history at six. And that's surprising since it's only a 1 in 64 shot.

3. How often can people take one city, one month, and send the market down a few percent, as they did with Chicago Purchasing Managers, only to reverse it the next day when the next random number, such as NAPM, comes up.

4. In "The Mauritius Command" by Patrick O'Brian there's a beautiful passage about how Mauritius bonds are trading at only 10% on the dollar recently from 80% as they follow the probabilities of success of Aubrey's imminent invasion and his recent results against the French. Very much similar to the movements in the market as Democratic prospects for victory wax and wane.

Easan Katir writes:

Vic's post stirs memories. To properly observe a mid-life crisis at age 43, I sold my book and moved to a beach house in Mauritius, about 100 yards from Point aux Cannonieres, the fort from which the French defended their island against the British in 1810. One could easily imagine those frigates in full battle. O'Brian mentions the monsoon. A few months after we moved in, a category 5 hurricane's eye passed directly over our house I can't imagine how ships of that day withstood these monsters.

So the nanos have gone the way of the Mauritian dodos. Two more words to add to the 100-year historical list might be 'railroad' and 'mining' as most of those went to zero, and more recently 'bio.' The takeaway message is be on the lookout for the next fad name. We are right in the middle of the crash of any name containing the word 'finance.' Perhaps any name with 'solar' is on deck next, unthinkable as that may now seem.

John De Palma adds:

You wrote today: "In "The Mauritius Command" by Patrick O'Brian there's a beautiful passage about how Mauritius bonds are trading at only 10% on the dollar recently from 80% as they follow the probabilities of success of Aubrey's imminent invasion and his recent results against the French. Very much similar to the movements in the market as Democratic prospects for victory wax and wane."

I'm reminded of how historian Niall Ferguson studied whether bond markets anticipated World War I, discovering that they did not: "…Ferguson is intrigued by the behavior of the financial markets on the eve of World War I because stock and bond prices at the time registered scant concern about the impending cataclysm. This contrasts with the conventional view among historians that the war was all but preordained because of a decade of escalating great-power rivalries that erupted into violence after the assassination of an Austrian archduke by a Serbian terrorist in June 1914… Ferguson was most surprised that the people who had more to lose from a war "bond investors" didn't see it coming…" 

Similarly, before the Iraq war, Penn economist Justin Wolfers ran regressions of changes in various financial assets against changes in the TradeSports Saddam contracts. He inferred the extent to which an anticipated war was built into financial market pricing and objectively determined what the impact of the war was on markets. Also, MIT economist Michael Greenstone analyzed the Iraqi bond market to gauge whether the country would survive.



I had a friend in high school who had a habit of answering a question with the negative form of the same question.

"Who was at the party?"

"Who wasn't at the party?"

In this spirit, it seems appropriate to ask what markets are not making new highs. The following markets made new highs on Friday (some have already printed a Monday new high as well as of 9:40 EST):



10-year bond

Crude oil





The euro, pound, and natural gas narrowly missed new highs on Friday after making new highs on Thursday. Only the despised U.S. stock market is below the midpoint of its 20-day range.

Steve Leslie wonders:

Commodities in general are making a huge run. I am hearing now the drumbeats that portend $150/barrel oil, and higher commodities in general, most notable foodstuffs. On the other ledger, the U.S. dollar is making new lows, the Federal Reserve is lowering rates further and the stock market is caught in a band. Is this a natural coupling or are we heading into dangerous waters of a stagnant economy and higher inflation? If this is the case, is there much of anything the Federal Reserve can do to change the course of this ship and bolster the greenback and stem inflation, other than raise rates?

« go back


Resources & Links