Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


to the Editors

December 2005

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Notice from the Editors: Contribution of the Month Award

Daily Speculations is dedicated to the scientific method, free markets, ballyhoo deflation, value creation and laughter. The material on this Web site is provided free by us and our readers. Because incentives work better than no incentives, each month we award $1,000 to the best contribution or letter to the editor, to encourage good thinking about the market and augment the mutual benefits of participating in the Daily Speculations forum. Prizes are awarded at the end of each month by the Chair and the Collab.

Last month's winner: "Exploring Fama-French in R"

A Question on Statistics Literature from John Bollinger

Dear Specs,

I get this question all the time. "Can you recommend a good introductory book on statistics?" Since I have not read widely enough in the area to know the literature well, I am wondering if you might recommend something appropriate. I gather that a premium should be placed on readability, conciseness, material that addresses the types of analytical challenges we face and use rather than computation. I have been recommending the Economist's "Numbers Guide". Is there a better choice?

Happy holidays to all,


Saurabh Singal responds:

My favourite is Statistical Methods by Snedecor and Cochran. It is easy to read and has many worked out examples.

A Letter on the Fed Model from a former Fan

So in coming up with the Fair Value of the S&P 500 (I hope it's not a trade mark already) you guys divide the forward S&P Earnings of $69.83 (a DOLLAR AMOUNT) by the current 10 Year Yield of 4.21% (a %) and obtain again a dollar amount.

I used to respect Mr. Niederhoffer, but after him endorsing this nonsense I can see why he blew up the way he did.

Keep up the good work.


2005: End of Year Observations, from Alan Millhone

Hello Mr. Niederhoffer:

Gasoline has now leveled around $2.21 per gallon in my area. It was up to $3.05 not too long ago for regular. A time back we were warned it would hit $1.50 which it did and took off from there! It peaked over $3.00 and now at $2.21 in my area people feel they are getting a deal now with lower gasoline prices!

Earlier this year we were all warned about natural gas shortages and that prices would really rise this Winter. I hear about everyone in my area complaining now about sharp increases in their heating bills. Today we insulated one of our duplex rentals with an extra 10"'s of blown insulation to help our tenants keep their utility bills in check. I remember years ago that one could take an 'energy credit' from their taxes for upgrading with new energy efficient windows, insulation, etc. That has all but evaporated.

We pour billions into other countries to 'buy' their friendship. It will never happen, look at France. We came to their aid in two world wars and Americans are mostly hated there. We stick our noses into too many places around the world attempting to impose our sometimes twisted ideas and values.

We need to get back to basics and remember what Teddy Roosevelt advocated in isolationism and to carry a big stick. We have enough suffering 24/7 right here in the USA . There is no reason the US does not have some type of National Health Insurance to cover every citizen in America. It has become a terrible racket between the Physician and the Pharmacist and has priced the average person out of getting the necessary drugs they need to maintain a proper quality of life.

Also to make life tougher for many Americans the credit card companies have raised your minimum payment each month . The theory is that you will reduce your pay off time each month. I know one thing it will do for sure--bring in billions more for the banks each month! Has anyone done a study on this?

On the war in Iraq--either let the Generals win the war or pull our troops out of there. This Country can't stomach another Viet Nam.


Alan Millhone

A Letter from a Reader of Practical Speculation

Dear Victor,

Hope all is well.

I continue to learn a lot from Practical Speculation.

Don't give up on writing, virtually every author believes that the publisher has under-promoted the author's book. Publishers are like ladies of the evening, they flatter you for a short while and then move on to another author because they have a quota to meet. The satisfaction in writing is pleasing yourself, crafting an elegant sentence, making the complex understandable.

I share your optimism about the U.S. economy in the long run even though I have some short run concerns because of imbalances. We agree that there is a lot of randomness in the short run. All the information is not in the price, and much of what is in the price is not information.

I think we may differ on what I would call the long run view of corporate profits. I believe that the corporate profits share of GDP is largely "fixed" in the long run, that is, the range for the share is three percent to eleven or twelve percent but the average value is about eight percent. Maybe nine percent. If we take the view that there is a long run average value for the share of corporate profits in GDP, then the rate of growth of profits will correspond to the rate of growth of GDP.

Let's make it simple, assume the real U.S. rate of growth averages three percent. Corporate profits grow at three percent real. The P/E ratio varies a lot in the short run, but not in the long run. Then the rate of return, so stockholders must be the sum of the dividend rate and the rate of growth of GDP. If the dividend rate had been four percent, then the real rate of return to shareholder will be seven percent, no higher.

Now consider the growth vs. value "debate". Virtually all growth stocks must morph into value stocks; that seems to me inevitable. The rate of return on individual growth stocks will be higher than on individual value stocks, that must follow from the definition. But if you accept the view that all growth stocks must morph into value stocks, then any empirical statement about the relative rates of return on the two groups will depend on "when the whistle blows" when an individual company is shifted from one group to the other.

Best for the new year,

Bob Aliber

A Reader of Practical Speculation responds:

Thanks for not agreeing that yours truly might be described as a hooker. I've been called a lot of things in my illustrious career but this is a first! Upon reflection, if I were like a hooker then my authors would have to pay me. The income producing aspects do give some pause for consideration.

Happy new year, Specs. May all your trades be hugely profitable and any losses insignificant in 2006.

A Letter on Chess and Checker Moves from Alan Millhone

Hello Mr. Niederhoffer:

I could not believe what I was reading in GM Davies comments on your web site !! I have made it my custom to look at a move, write that move down and then look at the board again before moving. I am confident the ACF would never consider banning 'ahead of move notations'. In the past there has been a few Checker players who wrote down the incorrect move and left their tablet so their opponent could clearly see this move to throw them off in some sort of psychological way. I am currently chairing a committee for the newly formed WCDF (World Checker/Draughts Federation) and the committee is going to be carefully looking over the standard rules of Checkers in an attempt to standardize the rules for everyone everywhere. I intend to bring up GM Davies article for discussion. Writing your considered move down ahead of time makes you play slower. Mr. Tom Wiswell once remarked, "Players who move in haste repent in leisure".

This carries over in life and the markets as well. " Haste makes waste."........................ Looking at a particular stock, reviewing that stock, etc. then executing the trade will serve your portfolio much better than a random " hit and miss' approach to investing.


Alan Millhone, President
American Checker Federation

Shui Mitsuda on the Dollar/Yen market

Dear Vic

2 weeks ago I posted my fascination for the trend line observed in the yen market. This time I am fascinated by the drastic trend reversal of 121 to 115 yen to the dollar in a matter of a few days. This gives me the imaginary view that all of the market players are looking at the same charts, and I also imagine that most of them have a similar method of determining trend reversal. It is as if the major players knew the undervaluation market extreme and knew of the coming strong trend reversal.

I believe that charts alone cannot determine where the market is heading in the future, but knowing how the major players look at charts is definitely a positive.

I feel the trend will continue for some time with small pull backs, and now Japanese business men are beginning to become nervous and foreign investors are already fully loaded with lots of investment in Japanese stocks.

As the Japanese stock market goes higher, the yen will go higher and the investors will sell Japanese stock around May, with highest value of yen. Or at least that is the ideal. I do not know how it is going to work out this time.

Warm regards, Shui Mitsuda

A Letter on Gold and Negative Interest Rates from Mitchell Jones

Hi Victor.

I have reviewed a brief paper on the effects of negative real rates of interest. My first quibble would be with the author's use of PPI numbers. The number which counts most is the average short rate minus the average rate of change of prices of storable commodities. Still, this guy understands the concept, and a PPI number is far from useless. His paper would also be improved if he had given a concrete example of the way negative real rates influence investment behavior--e.g., something like the description I provided to you awhile back about the guy who filled his barn with copper bars. The point of that example, of course, was that his rate of gain on the bars, which, like gold, "pay no interest," would be vastly higher than the return from investing the same funds in the stock market. Those are the sorts of calculations that are driving physical off-take in storables right now, especially precious metals. And with economies worldwide so fragile (so "bubbleized") it is hard to imagine any central bank daring to raise short rates high enough to stop the process. But, of course, if they don't, the entire system will transition into runaway inflation. That prospect--i.e., the likelihood that the dollar and dollar-based instruments such as T-bonds will become essentially worthless--has now become sufficiently worrisome that several central banks (Russia, China, South Korea, Argentina, and probably several in the Middle East) appear to be converting all or part of their trash dollars into gold. And that, of course, is adding still more impetus to the move that was already underway in the private sector--to wit: a shift of funds out of fiat denominated paper and into silver and gold.

 Bottom line: the fiat money system is in the process of blowing up, and, while there will be price fluctuations along the way, it is not easy to see at this point what could stop it.


A letter on Poker and the Markets

Dear Vic

I find your writing on the relationship of poker to investing in the markets to be extraordinarily wise and relevant.

I have studied all types of casino gambling and have come to the conclusion that blackjack and poker are the only two games that an individual can consistently win at. The reasons are pure, in both games the odds change based on the cards you receive whereas every other game must adhere to the law of large numbers. Based on that premise, why are there so few successful poker players and blackjack players around? Answer, to be successful one must be committed to their craft and that requires hard work study and enormous patience. Few, are willing to sacrifice to achieve that goal and even fewer are willing to be methodical and patient. They refuse to put the time and effort in to be successful. They would rather place their money in the hands of fate and call it entertainment instead of gambling, (losing). Most lose, and many lose a lot. Even if they do experience a win streak, ultimately they end up giving it back to whatever game they are playing at that time.

Coach Bear Bryant once said the cost of success is high. That is why so few ever attain it. They are either too lazy too ill informed or too ill prepared.

So how does a poker player for example consistently win? By outlasting the others at the table. By putting his money in only when he has an edge, by not competing when the odds are against him and by consistently adhering to a strategy that he has found to be to be effective over time. Listen to the successful ones, those who have been around for many years. Listen to Doyle Brunson, T.J. Cloutier, Phil Hellmuth. Edison said most of success in life is found by showing up for work every day.

The same can be said of investing. Those who invest and are the survivors who are profitable year after year do so by generally working harder than their peers, being a student of their craft, and by grinding day after day. They realize that investing is a never ending game, you play it by the year and not the day. They put their money to work when they perceive a statistical edge, they withdraw when there is none and above all they wait for these events to unfold rather than chase them.

They realize that they have no control over the markets just as they have no control over the cards they are dealt, however they have complete control how they respond to the markets and how they shall play in that context. They blame nothing offer no excuses when they are wrong and continue to play. They realize that life is a journey and not a destination. They do not dwell in the past yet live with the knowledge that tomorrow the markets will once again trade and opportunities can be found if only they look.

I also suggest that you take the time to study the book "Zen and the art of poker" by Larry Phillips. A fantastic study and read.

Someone once said, "To find success don't look without, look within."

Yours Sincerely, Steven Leslie

Are Readers Demanding Noise? from Riz Din

Phil, to your response to "Inefficient Markets" by Professor Haave, perhaps we don't have to assume that an efficient writer should be particularly skillful at predicting the market, whether or not we accept that financial markets are themselves efficient.

For a writer to be operating efficiently maybe all they need to be doing is providing commentary and analysis that exactly meets the demands of readers. I propose that they do exactly that. The majority of readers of these articles must be satisfied with both style and content, otherwise the market would surely remove these journalists from their jobs. While most of their commentary is likely of marginal use to the majority of practitioners, I believe that the average reader does not seek a 'true' understanding, but instead turns to the financial pages for prediction much in the same way that they look to the stars to provide guidance. It is difficult for us to accept exactly how much is uncertain in our lives, and we so we seek confirmation of the future from higher authorities - in this case it is in the writings of the financial media. I am sure many writers are capable of providing a more quality product that is of real use to readers. Perhaps the readers just don't want to read it.

A Bear trap from Dov Glickman

Dear Vic

In response to An Anonymous Contribution to Bear Corner, 12/06/05. Please see this article which appeared in The Boston Globe on September 25, 2005 for some clarification on the changes to credit card lending guidelines. It seems that the impact on the American consumer will likely be a lot less than the self-serving press release from the mortgage broker suggested.

Dov Glickman

401K Link regarding Grossman's Retirement Post, offered by Clifford Snyder

In response to Dan Grossman's post concerning 401K matters, I was referred to this helpful link for traders.

Sincerely and happy trading to all.

Clifford Snyder

Observation regarding The Frustration Aggression Hypothesis, from Ron Ragusa

Frustration is the mask I choose to wear when I am ashamed to admit I am afraid. Aggression is the behavior I choose to exhibit not to express my frustration but to show the outside world that I am not afraid. Conflict is the result of my aggressive behavior. Via the proper application of Aikido principles; from conflict is born something beautiful to watch, from conflict is born reconciliation and mutual understanding, from conflict is born a synergy of opposing viewpoints, from conflict is born resultant harmony. Aikido is the engine of creation that takes the raw material of conflict and transforms it.

If I defeat an opponent he continues as my opponent with the insult of injury added to his beef with me. In the long run this is counterproductive. Better I should find a way to convince him that from me there is nothing to fear and his need to act on his fear by entering into conflict with me is unnecessary. Conflict after all is, at it's root, all about fear.

Aikido is not the art to study if my primary interest is learning physical self-defense techniques that I can use to overcome adversaries. What I do learn from the study of Aikido is that I carry my enemies within me all the time. My enemies are my fears, those feelings that make me dangerous and so someone who engenders fear in others. The offspring of mated fears is conflict.

Aikido training helps me to purge myself of my fear. And if I can become fearless then I will be of no danger to anyone. If I'm not dangerous no one will fear me or what I do and hence will have no reason to enter into conflict with me.

Ron Ragusa

Chess Parable and Earnings from Mike Alana

Dear Vic

I keep hearing on CNBC about the 15 straight quarters of double digit earnings growth for S&P companies... this sounds like the grains of rice on a chessboard parable to me. How everything is great, don't worry just buy. We all know the market is going to give back at least 10% right after January 1st. Is it really just all about keeping the year end bonuses?

I think it ends badly.




Letters to the Editors: Archive