Jan

23

Big Surf, from Jim Sogi

January 23, 2009 |

SurfWe've been having some big surf here lately up to 25 feet. The timing of the swell hitting our local breaks is a big issue. Typically the primary wave model is used, but I've found that in fact the swell period is a better predictor than the wave height model for timing the arrival of the swell. The wave size model is distorted by the interaction of the islands in the swell direction and is usually grossly wrong. Since everyone reads these erroneous reports, we often get perfect waves to ourselves.

-wave height model

-period model

Entering the water over the rough rocky shores requires waiting for the end of a large set waves. We always sit a watch the water for a while before going out and count and time the wave sets to see how big and how long the period between the sets and how many waves are in each set. Wait for the water to run up the shore on the last wave of the set. Jump in and let the outgoing retraction of the swell take you out to sea, and paddle out in between sets. If the timing is wrong, you fight the surge, get pushed back on the rocks, and can get pummeled by the next or the remainder of the large set.

The market has also been having some big waves and it seems anecdotally that a periodic model might be a good predictor for the arrival of the market swells. Of course market wave size is very important and the average volatility is up, but combining timing the entries along with noting the wave size is helpful, just like in the ocean, and can avoid drowning or getting washing machined by the market. Also since the public often follows an erroneous model, it is possible to get good market action to yourself.

Phil McDonnell adds:

Several key points about ocean waves:

1. Unlike sound waves or light waves that occur in a medium, ocean waves occur on the boundary between two media (air and water).

2. Because of 1., wind can have an effect on waves. Waves can add turbulence to wind.

3. Larger amplitude waves go deeper than small ones.

4. Waves sets are formed by the interference and cancellation of multiple waves with similar periods. Effectively the complex of these waves creates a wave envelope which itself is somewhat sinusoidal.

5. When a tsunami strikes the curvature of the Earth acts to refocus the wave fronts about 12,000 km away where they can do additional damage.

Some good discussion can be found at seafriends.org. Especially interesting was the factoid about the Chilean tsunami that traveled at about 500 mph to New Zealand.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Jeff Watson comments:

Swell height and period have another correlation, which Sogi-San doesn't have to worry about with the monster waves he gets every winter. The longer the period, the more powerful the swell. With the same wave heights, I would look forward to a six foot swell with a period of 15 seconds, whereas I might not get too excited about the same six foot swell with a period of nine seconds. I went surfing yesterday and wrote about it:

While I was out waiting for waves to come, I was thinking of how a surfer positions himself to catch a wave. You see waves on the horizon, and knowledge and experience tells you approximately where to paddle to get into position to catch the wave. A successful speculator needs to do exactly the same thing with the market. Practice, experience and knowledge will tell you when and where to position yourself with entry points to try to ride the market wave. After you catch the wave, experience tells you how to ride it….whether you bail out, wipe out, tear it up, rip, pump for speed, ride it lazily, or take it all the way into shore. There are lots of market lessons in surfing.

Russ Sears writes:

The wave not in the old model:

I recently locked in a refi-rate at the rate of 4 3/8 % (simple interest) for 15 year. And also could have locked in 4 3/4 % on 30 years on that date I moved in 2005, so I had a 5.5% mortgage on 30 year.

A few comments about this mortgage some I learned myself while "shopping" some was told by the mortgage officer.

1. In 2005 the rates where very close from one bank to the next. Like the gasoline station several had same rates. If they didn't, you could often simple tell them about the rate their competitor gave and get it lowered. I went with the local bank last time only because I wanted to close faster. This time the money seems to be at the local banks. Bank of Oklahoma, and MidFirst are both regional banks and a strong balance sheet. Many of the smaller banks didn't get into the trouble the big guys did. Not sure if this was because they didn't have the size to get into a specialty space like sub-prime or if they simply didn't

2. While I didn't buy points, they were cheaper than in 05 to get the same rate reduction of 1/4 it was about 1/2 price.

3. Like the banks, you need a good balance sheet to get these cheap rates FICO scores of 740 or better got the best rates.

4. Jumbos loans are not nearly as low of rates.

5. Rates have since gone up. about 3/8 %. It was getting too hectic at 4 3/8 % or 4 3/4 %. But they are still very busy. I got the impression that they let up on the gas, simply because they were so busy, without the big boys to compete against.

Still at these rates it is obviously the trigger point: A few 1/8th higher and the spigot will close, a points lower and they will get a big big wave.

While clearly much more restrictive underwriting than in 2003, we may see more than 1/2 that kind of turn-over.

You should ask a true Wall Street quant, but in my opinion what causing the log jam in credits, in balance sheets and therefore the mortgage originators and the housing market, is nobody knows where the trash is hidden in the MBS markets. This wave of fresh air could very well separate the wheat from the chaff.


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