Nowhere (arguably) has the peer-review system been hijacked more by "the system" than in the area of global warming. As it became essentially impossible to obtain public funding for any research that had an explicit goal of disproving any specific aspect of it, and it became much easier to obtain research funding for any related (and sometimes unrelated) subject by citing its connection to global warming as at least a partial goal of the proposal, "the system" organized itself to defeat any spontaneous or privately-funded challenges by any means necessary.

Ironically, it is the Socialist-leaning Sinclair who captured the phenomenon perfectly in the following quote:

"It is difficult to get a man to understand something, when his salary depends upon his not understanding it."

Ron Schoenberg writes: 

I'm a econometrician with forty years experience in fitting statistical models. You can google me. The last 22 years I've been involved with writing computer programs for fitting statistical models. I was recently introduced to your web site and I haven't posted anything yet.

But I'm forced to respond to this post.

It's true that the peer-review system can sometimes fail. A better example is the graduate student who proposed that our continents float on tectonic plates. It took years for tectonic plates to be accepted. Global warming however is not a good example. Plate tectonics, Relativity, the heliocentric solar system were paradigmatic. Global warming isn't. A better comparison of global warming is with cigarettes causing lung cancer. Scientists were producing increasingly alarming connections of cigarette smoking with lung cancer. The cigarette companies were freaked out because this hit their bottom line. They funded scientists to produce confusion about the results the scientists were finding. They succeeded in delaying the results from being accepted.

In the same way oil companies are threatened by global warming. The value of their companies depends critically on the oil in the ground they have control over. The implication of climate science is that this oil should be left in the ground. Their valuation shrinks to next to nothing. All they going to have left is plastic (Cf. The Graduate). So they hire scientists to confuse the issue just like the cigarette companies did. The conflict of interest you point out among scientists over public funding is dwarfed by the conflict of interest created by oil companies funding of scientists. I know statistical modeling. The issues about modeling global warming are not paradigmatic. They are not like tectonic plates. And I can assure you the climate scientists are doing it right.

The impact of global warming is happening as we speak. Drought is having an impact on agricultural commodities. This is going to get worse. You need to be paying attention. If you have children who are going to live through this, you need to be paying attention.

Stefan Jovanovich replies:

Global warming and cigarette smoking share a paradigm as political economy. In both cases the reformers end up being the best possible advocates for the people whose economic interests are being threatened. Cigarette smoking was known to have health issues a hundred years ago. The cigarette companies did not "freak out" over Federal regulation; they pushed for it. Those warning labels on the cigarette packages delayed for 20 years any successful class actions challenging the fact that the tobacco companies were selling a product that met all the tests of strict liability - i.e. it was unavoidably damaging to the users.

The global warming advocates are the best friends the international oil companies ever had. Why else would BP have spent millions talking about how green they were? The international oil companies don't own the oil in the ground; the world's oil reserves are owned by state-owned monopolies. What the international oil companies still own are the means of distribution so they have every reason to want to see the oil stay in the ground rather than be pumped and used; high volumes are not profitable for distributors in competitive markets, low volumes are because they create sufficient barriers to entry.

Let's try to be more specific. What is your particular theory of global warming, Ron? Is it man-made CO2 or - as some of the unpopular scientists are beginning to suggest - is it the particulate emissions from wood fires, burning of hydrocarbons (but more importantly, the grinding of rubber tires into tiny particles) that are having serious climate effects?

The problem with conventional global warming advocacy is that it shares all of the nasty habits of 19th century Darwinism (for which Darwin himself should not be blamed); it took only a few decades for Darwin's hypothesis to become the principle justification for the racialism that became the justification for segregation and apartheid and vicious colonialism.

It has taken less time for MMGW to become the justification for preventing the vast majority of the people in the world to have access to the inexpensive energy needed for clean drinking water and cooking fires that do not produce far more lung cancer and other diseases than tobacco smoking ever has.

The science should be open to all opinion; the presumption that a hierarchy of the anointed should be given the power to destroy open markets in the name of progress is a folly that does not bear repeating. We didn't get segregation because street car companies wanted it; we got it because science confirmed the opinion of the all the "good" people that the darkies had to be quarantined - for their own good.


Jaime Klein replies:

Ron proposes the conspiracy theory that oil companies have an interest in fomenting confusion regarding global warming. Maybe it is so, but I can't see why they should be. Global warming, should it occur, will not affect the value of underground oil reserves. Only a tiny fraction of the oil is consumed by heating (6% in the USA) and I dare say the same amount or more is used in air conditioning. My summer electricity bills (in Israel) are the triple of winter ones and we use the same system for heat and cool the palace.

Quote: "Of the 20 million barrels of oil consumed each day, 40 percent is used by passenger vehicles, 24 percent by industry, 12 percent by commercial and freight trucks, 7 percent by aircraft, and 6 percent in residential and commercial buildings."

Computer modellers need no incentive to create confusion. They are quite capable of doing it for free.

Gary Rogan responds: 

I'm not a global warming scientist nor someone who is collecting all relevant facts, so I make my conclusions based on the information I come across in my constant search for information. Let me explain how I reach my conclusions.

Earlier today I posted an article illustrated how Global Warming was used as a stepping stone for success by Margaret Thatcher years ago in a cynical (my interpretation) political ploy. This elevated an obscure theory to a politically and economically viable and important concept.

Years ago I observed how Al Gore and James Hansen made sure to introduce their ideas to Congress on what was expected to be the hottest day of the year, and how they also made sure that the windows were open. I've observed how a British Court determined that Al Gore's movie contained eleven material falsehood and the impact that had on using it as a teaching aid in the UK. This was never publicized to any degree in the US and I had to ask myself "Why?". I've seen Al Gore refuse to debate ANYONE on the merits and I also asked "Why?". I've seen Climategate and the length to which "Climate Scientists" would go to quash dissent. I've seen photos of drowning polar bears forged and the realities of their survival as a species "nuanced" in was beneficial to Global Warming proponents. I've heard HUNDREDS of people of good will (or so they appeared to me) question this theory. These were people who displayed uncommon sophistication and knowledge in areas I was more familiar with. The physics of the increase of one molecule of CO2 in 10,000 molecules of air making THAT much difference never made much sense to me, but that was more from imagining this one lonely molecule among 10,000 rather than any calculations, and of course CO2 isn't the only culprit (yet somehow the main target as oil companies seem like much more inviting targets than herds of cows). I've seen the importance of solar flares questioned, and I've seen all kinds of data about global warming stopping in 1998 or current high temperatures being on par with those in the late 30's and 40's. I have no idea really if the increase in droughts may not be caused by local agricultural practices given increasing world population and use of water and all the deforestation and soil erosion that's going on.

Last night I was listening to James Delingpole, a noted British author question this theory with great believability. When asked "How do you respond to someone who says we should not take any chances and shouldn't we spend whatever it takes in case Global Warming is indeed caused by human activity?" his answer was along the lines of "Can we be sure that aliens will not invade the Earth tomorrow? If not, let's spend billions to equip all airplanes and rockets with anti-alien laser weapons".

Let me just say this: the "theory" is being promoted as a hoax would be by a priori evil, dangerous people like Al Gore. Facts are being suppressed by the mainstream press and by the advocates of the theory. Third world hell holes demand all manner of reparations under the guise of being compensated for the damage done by Global Warming to them. It may very well be true, but if it walks like a hoax, quacks like a hoax, and all that, it probably is a hoax.

Mr. Krisrock writes:

It's preposterous that anyone thinks the same collectivists who are trying to run and control our economy through central planning could do the same thing to world weather.

It shows the outrageous arrogance of San Francisco modelers who think a model so large could work…it defies common sense and a response.

This guy is a dreamer, who takes his advice from the AZTECS who worshiped the sun god…that culture disappeared in case he didn't read the history book.

Sadly, the world can't add up its money to balance its debts despite all his silly models but to think there is NO POLITICAL AIM in global warming?

There is, it's all about a small group of power hungry idiots, no different than tyrants in another time, who create false idols …

The same people as him run the state of California…have run it into the ground financially…and refuse to admit their models don't work.

The smoking argument is bullshit…people will still die from something…but millions in Asia will die far happier than this idiot.

And I add this year we had the largest global harvest of RICE…so much for global warming bullshit…

T.K Marks writes:

"It is difficult to get a man to understand something, when his salary depends upon his not understanding it."

As one who defines the notion of salary broadly, that Sinclair quote might be the most succinct and trenchant definition of realpolitik that I've ever read.

Charles Pennington writes: 

Climategate demonstrated "peer review" at its worst–faking data and conspiring to ostracize the naysayers. It was a lucky stroke that it was uncovered.

Stefan Jovanovich responds:

Ron: Please accept my sincere welcome to the List. As others will tell you, I am a professional pain in the ass; but I do mean well. What I was trying to convey about the cigarette companies is that their (largely successful) conspiracy was even worse than you alleged. The cigarette companies knew they were selling addiction long before any studies were done on lung cancer. The best cases against them were those that were based on the common law argument that the tobacco companies were knowingly selling a product that was per se harmful. Those cases only had to rely on the fact of addiction - which everyone conceded - and did not need to meet the much harder burden of proof that epidemiological correlation requires. The "reform" that produced the warning labels defeated all that litigation; the tobacco companies now had a safe harbor defense.

Allow me a few last comments before acknowledging the final call to Order from the Speaker of our Parliament.

(1) There is a rather significant difference between Copernicus' situation and that of the global warming skeptics. Copernicus was challenging the established church, which was the international authority on all matters spiritual and intellectual. Your part of the argument already has the international church aka the UN and the holy orders aka the publicly-funded universities on its side. The poor skeptics have to rely on their own money - as did Copernicus.

(2) Isaac Newton was never accused of heresy; on the contrary, he was the author of a number of religious tracts, among them The Chronology of Ancient Kingdoms Amended (1728) and Observations Upon the Prophecies of Daniel and the Apocalypse of St. John (1733). He was not even censured for his dabbling in alchemy even though reasonable minds might not consider that the best of hobby choices for someone appointed warden of the Royal Mint.

(3) Einstein first came to the U.S. in 1921 to raise funds for the planned Hebrew University of Jerusalem. He received the Barnard Medal and was treated like a rock star. After he won the Nobel Prize that same year, American universities fell over themselves competing to have him come join their faculty. Einstein preferred to return to Europe - which was his home; but he continued to visit the United States regularly throughout the 1920s without ever having any problem getting off the boat. Princeton finally persuaded him to accept a faculty position with them in 1932 on the condition that Einstein be allowed to return to Berlin each year for 5 months. What kept Einstein here in America were the Nazis. He left Berlin in December 1932 (the Nazis took power the following month) and never returned to Germany. Einstein became a U.S. citizen in 1940 but he retained dual Swiss citizenship. The only evidence of Einstein's having had any difficulty with visas or his citizenship application is in Fred Jerome's book - The Einstein File: J. Edgar Hoover's Secret War Against the World's Most Famous Scientist, by Fred Jerome. St. Martin's Press, 2002. 348 pages. ISBN 0-312-28856; and its only source is Einstein's FBI file, not State Department records.

NB: Those of us who have FBI files know from direct experience that the Feebies apply the vacuum cleaner theory of information - floor sweepings are given equal billing with birth certificates.

Peter Saint-Andre writes:

Over time I have come to see this phenomenon as controlled not by "the government" in some faceless way, but by individuals or classes of individuals who have used the levers of power (federal, state, county, city, etc.) to their own benefit. I have seen this in the city where I live: few things happen in city politics that do not benefit the real-estate developers, and certainly nothing happens that harms them. The same could likely be said for industries and policy areas that I have not studied as closely: defense, energy, finance, transportation, education, materials, you name it. There are people and companies who benefit, and who always emerge untouched. The rest of us are harmed and suffer, to a greater or lesser extent. Perhaps if one followed the money and influence to identify who precisely makes up the aristocracy of pull, one could indeed build a successful investment strategy. I don't think I have the stomach to do so.

And by the way, looking at things in this way makes me much more sympathetic to many self-styled "progressives" (while I think that their understanding of markets is quite incomplete, they too have a sense that the game is increasingly rigged).

Gary Rogan responds: 

It seems difficult to take advantage of observed cronyism while being on the outside. One should only look at trying to invest in solar panel manufacturers, or ethanol producers, or defense contractors (after a certain point). Sooner or later the government runs out of money, and you have to be very close to the action to figure out when the gig is up. The health insurers were quite an interesting story to observe: a very political group that took a huge hit with Obamacare only to recover very nicely. You really have to know who was involved in shaping the legislation, and if possible the real effect. My own solution was to own what Rocky likes to call "world class" companies that seem flexionic, but would persist past any "abandonment" stage, or in companies that have a flexionic component, but that's not dominant (such as a chemical manufacturer with a large biodiesel component). It would be interesting to study if any of Sage's flexionic investments could be taken advantage of after his intent has become public, at least he always knows these days that the company will be saved if push comes to shove. 

T.K Marks writes: 

Not all variables are created equal. Some are unknown; others, unknowable.

Absent insider knowledge, politics for general investment purposes is but a fiefdom of unknowable variables, where knowledge is lord.

But 'knowledge' in such a sense is illegal, or unethical, or both.

At least it's supposed to be.

So one is better off trying to quantify things played out on fields more intrinsically level than politics.



I tried Yahoo's new search engine in my professional field (infrastructure) and it generated good, useful sites and data. I am going to start using it to complement Google. If many others arrive at a similar conclusions, could be a problem for GOOG.



From Norman Vincent Peale's Treasury of Joy and Enthusiasm:

1. Engage in a business for which you have a talent.
2. Secure a suitable locality for your business.
3. Stick to your business. Do not assume that just because you are a success in one field that you can be so in any.
4. Be economical; not parsimonious, nor stingy, but never go into debt.
5. Be systematic. No man can succeed in business who neglects the strict observance of a system in his business.
6. Advertise. Have a good article and make it known in some way to the public that you have such a thing for sale.
7. Be charitable. It always pays a businessman to perform acts of benevolence.
8. Be honest. Honesty is the best policy. A man who lacks honesty will soon lack customers for his goods.

Jaime Klein writes: 

Interestingly, P.T. Barnum himself has a bad reputation. He used to work only in the early mornings, spending the rest of the day drunk, and his business was based on fake curiosities. But his century-old advice is still the best in its class. 



 One of the big financial businesses of the 19th century was to buy cheap Latin American sovereign debt, and then enforce payment by use of gunships. Apparently, the system is back, and its opponents too.

The Paris Club of official creditors decided to prevent aggressive investors buying poor countries' debt at a low price and then suing to recover large sums of money. There is growing irritation among international development agencies and NGOs over the actions of "vulture funds", which buy up discounted debt, often of developing countries, and then sue the government for more money than they paid. The emergence of litigation by vulture funds is forcing some poor countries to use spare money to settle debt claims, angering the other creditors who have written off the debt.

A British high court judge ruled in February that Zambia must pay the investment firm Donegal International a much larger sum than the $4million it had paid for the country's debt. The International Monetary Fund, World Bank, and Western creditors wrote off a large part of Zambia's debt in 2006.

I remember reading that among many others, Turkey and Venezuela's debt was recovered by these methods. Theodor Herzl offered to settle Turkey's debts for a charter of South Syria, then a Turkish province.



 I am both an investor and trader. But looking at my results I should probably only be an investor. It is not easy to trade with a full-time job on the side.

As an investor I am 100% long with my stocks. I will stay 100% long no matter what. I can sell a stock, but only if I am able to find a better one to replace it. I am not going to sell because of the overall market. Actually, I could sell if it goes up 130% like Shanghai last year. But I am never going to sell because it has been going down.

Today, my investments are down 2% from 12/31/2006, and down 10% from February intraday peak equity. I don't care the slightest bit. They could go down 30% and I wouldn't care either.

I am not crazy. There is a very good reason for this stubbornness.

I started investing seriously in stocks in 1996. Since then there has been a crisis in 1997, another one in 1998, and one of the biggest bear markets in history in 2000-2002. I was investing with a mix of stock picking, market timing, style timing, and small/big timing. Believe it or not my market timing allowed me to sell at all the intermediate tops in 1997, in 1998, and in March 2000. It allowed me to avoid the bulk of the bear market in 2000-2002. I came back too early in August 2002, sold in September, came back at the exact bottom in March 2003!

With this nearly perfect timing, you would think I have impressive compounded returns. That couldn't be further from the true. At the end in 2005, I did a complete audit of my 10-year record. It was prompted, among other things, by some things I read on the Spec List, mostly from the Chair but not only from him. So thank you guys for your down-to-earth audit-prompting approach.

Results of the 10-year audit:

Market timing resulted in dramatically lower volatility and draw-downs than the market; but who cares? It resulted in only a 2% over-performance compared to the index. In terms of absolute returns, beating the index by only 2% is ridiculous. It is incredible that even though I caught most major tops and bottoms in 10 years, I only over-performed by 2%. Even more sobering is that if I had kept the first 10 stocks I ever bought and never sold them, forgot them and never done anything else, my over-performance would have been 4%.

How could this happen? Well, that's very easy:

First, I caught all the actual tops, but also about 10 of them which never turned out to be tops. The market continued higher and I missed part of the move. Second, even when the top was an actual top and I was flat, it created the problem of knowing when to get back in, which in most cases occurred a bit too late. Third, buying and selling too much is created a lot of friction in the form of commissions. Over 10 years, the amount paid in commissions can be really impressive.

Based on this I decided to be always 100% long. I am not timing the market, styles, or anything any longer. I still hope to continue beating the market by a couple percent a year from stock-picking (probably more beta than alpha). I don't care if the results are more volatile. This is largely compensated by a huge decrease in workload and worry. Freed time can be dedicated to more useful pursuits, like learning to trade.

Jaime Klein writes:

I have, well, had, two now only one extremely financially talented relatives. The late one, when told I was going into the financial business, laughed rather rudely, I thought. And noting so many of my family members were already in that line of work, he asked me who was going to bring home the bacon. Well, he said, seeing as you're determined, I'd give you this bit of advice: Never buy a stock if in your lifetime you don't see it returning your original investment to you annually in dividends. And if they're any good, they only pay two percent.

Absurdly enough, his own results were so far beyond this as to make this counsel seem the most conservative expectation possible. He was probably 30 years ahead of the sage into Coca Cola, which he obtained by selling Minute Maid to them for stock. He never sold it except to buy the occasional Goya or Renoir, or make a charitable donation to Harvard or MIT.

I was aware of only two other plays: one was a quick flip which his partner told me netted over 100X in less than three years. The other was selling United Fruit, which I imagine he paid near nothing for, to Eli Black, right at the top back in the conglomerate heat of the '60s. I can't remember much about the foolish and ill-fated acquisitor except that he defenestrated himself shortly thereafter, taking his briefcase along with him.

Anyway, it's been my pleasure, while unfortunately lacking in outstanding talent myself, to have met so many ingenious and interesting people in my all too brief 65 years. One of these days I'm hoping I'll learn something from them. But in the meanwhile, it's always fascinating, albeit particularly in the political and religious arenas sometimes quite alarming, to see how clever so many people are.

From Scott Brooks:

Volatility is a terrible measure of risk. There is no risk on the upside of volatility. The goal should be to reduce all down side volatility, thus my patented investment strategy of buy low and sell high (Green List/Red List post from several months ago).

In all seriousness, I am fixated on the discovery of ways to mitigate downside volatility while participating in most of the upside of volatility. But since I'm far from the smartest person on this list and have been told in no uncertain terms that it can't be done, I feel like I'm fighting an uphill battle. Still, who knows, maybe there is a way!

I've never been one to give up just because others say it can't be done. If I listened to others (like my guidance counselors), I'd probably be laying carpet back in Maplewood, going to the corner bar, watching COPS every night, and aspiring only to be the "Maplewoods, King of White Trash."

From Craig Mee:

I accept these results, however…

Plenty of you know a lot more about stocks then I do. But I would like to offer here that a two percent increase in returns and with this, the opportunity to be out of the market in major declines, represents to me some nice sleepy nights.

With a bit of fine-tuning maybe marks can be picked slightly better on entering and exiting longer term positions. But on that black swan event, when something may drive the market into a huge selling spiral, I believe for me at least it may be worth that extra agro.

From Kim Zussman:

Similar but less quantitative self-assessments:

1. At least in US, taxes bite deeply into putative alpha (or masquerading beta) if you trade vs buy and hold.

2. Concur that most effect was lowering volatility. You will get lower volatility with stocks<100%, and pretty much always lower returns. Looking back, you will regret not being 100% stocks, but during the ride you live happier <<100%. Thinking about a big down year as a future possibility feels a lot different than having one.*

3. Besides drift, the reason buy and hold works is that there is too much temptation for the vast majority of people to time the market. It is unnatural not to check your investments, and not to be tempted to act on them. People don't like it when their million $ port becomes worth $800,000, and sell before "losing it all". Then it turns around and people don't like missing up 30% years, and buy back in. The hope-panic-irony cycle makes the market rise over time only for those not riding the emotocycle.

* The abstraction of future pain and foolish willingness to fall in love is nicely summarized by the late Sam Kinnison.

Jack Tierney adds:

I was invited to a dinner party but expected very little. The guests were getting thin on top and hefty through the middle. Our host was dressed in colors that defy the known spectrum and civility was to be shown the greatest horse's rectum. So we mingled and we spoke and mentioned our positions. I mooted that I was all in cash and was swarmed by five physicians. "Perhaps an evil humor attacked him on his flight or maybe he's an infidel who has yet to see the light." Their concern was very real and they needed to be consoled so I admitted that in addition I owned a little gold. Screams and wails followed and the panic gained momentum.

To quell the crowd I shouted, "Wait, I also own argentum." Now that they were fully aware of these judgmental flaws they ripped away my velvet gloves and exposed my hairy paws. They marched me toward the door when the host yelled out to quit, "Why this poor benighted soul has never heard of drift."

So began my lessons and I've brought them to the south, a bearish thought may cross your mind but never cross your mouth.

Abe Dunkelheit adds:

 Bruno's post was very interesting. I made exactly the same observation. Market timing lowers volatility but doesn't guarantee any substantial out performance. And yes, one's first ideas tend to be much better researched than all these other in and out decisions. Never to sell them would have turned out the best in my personal case also.

And there seem to be people who don't make any professional impression and live a very retired life who tend to buy and hold and accumulate incredible returns without doing much.

I know about a guy in Switzerland who was retired and did it with wine. He bought all these Chateau Mouton Rothschild wines for USD 500 a bottle 10 years ago and they now go for USD 10,000 at auction because rap stars and Russian mafia are pushing prices up. I only know about this guy because I was one of the sellers. I had bought my bottles for USD 300 and thought a cool 60% gain in less than two years could not be wrong. He had an incredible cellar with all these wines, but his house and car and his whole appearance were very modest.

Another example I know about is a guy who was jobless and lived on social security, but had saved several hundred thousand euros [back then deutschmarks] and invested them through the accounts of his children. He put it all into Deutsche Telecom at the IPO and cashed in a 600% profit during the Internet boom. That was his one and only investment.



 Is anyone on the list familiar with real estate or related investment aspects of Bucharest, Romania?

A friend is doing some work in Bucharest and asks my advice about her idea of investing her entire life savings buying (rather than renting) an apartment there. Sounds a little crazy to me, even if Romania's recent EU membership is causing a boom. Does anyone have any knowledge or insight that would change my view?

Charles Sorkin writes:

What's the real underlying question here? It's easy to look at the performance data on loans that were originated with strong underwriting standards (like Freddie Mac mortgages) and conclude that the middle class credit-worthy borrowers aren't having many problems. Not surprising… these are high-quality loans to people with jobs, and who had their down payments on hand.

It might also be safe to assume that there will be buyers of last resort to support prices of properties foreclosed upon from sub-prime borrowers.

Thus, in answer to the question: "How is the real estate market?"… one could say that it is holding up reasonably well.

But is that what macro investors care about? Or ought we to be more concerned with the question: Will the financial difficulties encountered by sub-prime borrowers be sufficient to diminish consumer spending and trigger a recession?

Jaime Klein writes:

(1) Romania is a new member of the European Union, so its currency is strong and stable, property rights are safe, it is melting into the Eastern wing of the Union (Hungary, Bulgaria, Czech Republic, Poland) and real estate prices are very fast leveling with those countries'. Your niece arrived late to the party. Bucharest is Europe again and real estate prices are rocketing, it is difficult to find something reasonable in dollar terms. Five years ago prices were dirt cheap, and even a year ago you could find good value.

(2) Real estate development in Eastern Europe (and increasingly in Russia itself) is dominated by Israeli companies. They had people familiar with the area and the languages, and they entered very early in the local residential and commercial construction business. Eastern Europe's first mall was built by Motti Zisser (Elbit Medical - it is not a pharma co.) and it was a great success. He was followed by about a hundred Israeli developers, many quoted in TASE (Summit, Ahora, Olympia, Ofek, Yoab, Africa Israel, which is unrelated to Africa. It is a holding company with vast real estate business in Russia, owned by Lev Levayev), Kardan, Profit, Dor, Damari, Rothstein, Dori, etc. The sector doubled its value in 2006 and is still growing very fast. Most of them had been silently accumulating land in expectation of the countries becoming members of the European Union and are well positioned to take advantage of the coming boom.

(3) On the level of anecdote, I returned to Hungary ten years ago, when the government gave back the properties "nationalized" in 1948 from the "bourgeois" class. I went to see a "forest" (erdo) that the Communists took from my Father. My forest had become the downtown of that provincial capital. I accepted to be compensated with certificates and gave up all claims to the land. Others bought factories and property with those certificates; I sold them. Those who bought real estate saw their investment's value go up 1000%. Budapest's prices are now equal to those of the rest of Europe, and it can be presumed that the same will happen to Bucharest's in a few years from now.

(4) The action is moving to further frontiers like Ukrayna (which actually means border lands) and oil-rich Central Asian towns. If your niece wants to invest in a nice historic town with mild Black Sea climate and great untapped potential, I think Odessa would be a good place to look around.




A Note from the President: 

The Chair proposes that I stick my neck out. I'm accepting only because the august company that comprises the List prevents many of us from letting it "all hang out." That's unfortunate since I believe the List has members whose forecasts might prove very insightful. However, I'm not one of them. In fact, I've been so wrong so often that one of my forecasts, if viewed as the babblings of a hoodoo, might provide a fortune to those who fade my conjectures. With that in mind, I offer an early apology for any prediction that may prove accurate.

First, in a recent post I revealed that I was over weighted in natural resources. This is an affliction that dates back many years and must be accepted with the same understanding one extends to his fellows for their inexplicable preference for blondes or redheads. So with one exception, which I'll get to a little later, we'll skip that category.

My favorite "chemical" is extremely abundant, slightly acidic, and is as essential as oxygen. It is water. I don't like it for just next year, but for the next thirty. Investor owned water stocks are few in number. Herewith are nine: AWR, WTR, CWT, CWCO, SBS, MSEX, SWWC, SZE, and UU. From here, it's a game of pick-and-choose; however, over the past year, three foreign companies (SBS, SZE, UU) have cumulatively crushed their American counterparts. However, until last year, American water companies carried the highest valuations as measured by P/E or P/B. Although the group gets little mention, American water utility stocks have outperformed other asset classes for the past 12 years. (Actually, it's been longer, but I can't find my reference.)

As most are aware, only a small percentage of the earth's water is drinkable (potable). And unlike other commodities, there is no substitute, nor is it likely more will be discovered. I have followed the desalination industry since 1974, and though much has been promised, little has been delivered (although CWCO seems to be doing very well). I believe more successes will eventually be achieved, but timing is iffy. (There's a lesson here for those who believe our energy problems will be solved shortly.)

Water infrastructure worldwide is pathetic. And it will take hundreds of billions (probably trillions) of dollars to set it right. Those who provide pipes, pumps, membranes, meters, etc. can benefit substantially. Because water is so essential to those who pump, process, and/or sell, it would seem inevitably profitable, although not necessarily. A number of years ago, I invested in one of the foreign companies listed above. They specialized in taking over municipal water works and rebuilding the systems. As required, they went in and began repairs to the system, improved efficiency, and cut down on costs (partially by eliminating public employees).

However, their investments were substantial and as agreed in the initial contracts, they sought to recover their expenses through increased charges. Every city and hamlet in this nation has a Utility Watchdog Group - their main job is to bitch about every utility increase ever put forward, regardless of its legitimacy. But, with water, the problem is especially acute. We can drive less, dress warmer indoors in winter, put up with higher indoor temperatures during the summer, shut off the gas to the decorative lighting fixtures, or move in with our in-laws. We cannot cut back much on our water consumption. So, when that price goes up, there is more than the usual complaining. If the price goes up several years in a row, the outcry cannot be ignored. As a result, the same city councils that brought in the outside company now attempt to control, freeze, or roll-back prices - even though they had no contractual power to do so.

But governments, as was just demonstrated when congress successfully demanded that legitimate contracts with the oil companies be rewritten, can do almost anything they choose. As a result, this company backed out of deals with several American cities because they could not and would not operate in the red. Running a for-profit water system in an American city should be a no-brainer money-maker - and in many cases, it is. But when the real crunch comes, when water prices, of necessity, skyrocket, it is imperative to be aware of the Cowardly American Politician who will abrogate any contract if it assures his or her continuation in office.

The group with the most to offer and with the least vulnerability to political duplicity are those companies that supply pipes, valves, pumps, meters, etc. that will become essential purchases in the immediate future. Although there are several large caps that have become involved in these areas, their exposure remains relatively small in relation to the size of their overall operation. However, there are a number of companies which could perform nicely: LAYN, NWPX, TS, GRC, LNN, HYFXF, WTS, TTI, and KELGF.

(An approach to supplying water that to date hasn't been too successful but hasn't received much attention, is the use of machines that pull potable water out of air. These machines, depending on size, can produce anywhere from two liters up per day. If the area's climate meets certain humidity minimums, the systems will work. However, I've been reluctant to even attempt a speculation as it seems something this important would have received much more coverage by this time. I'm not sure if this is a performance or a marketing issue.)

A second area that appears fruitful (but which revolts just about everyone) is coal. I doubt, despite current talk, that America will ever again go nuclear. (And even if I'm proven wrong tomorrow, the first new plant wouldn't be up and running until 2015). And the movers and shakers (that phrase, by the way, is from a very nice poem, We Are the Music Makers) have determined that we will cut back on gasoline (i.e, oil) consumption. The cuts envisioned are Lilliputian and one of the proposed substitutes, corn-based ethanol, is an excellent example of why a government should never be allowed to determine efficiency.

The recent news stories on the escalating price of tacos and the Mexican government's reaction to it, is the first bell in the death knell of corn-based ethanol. The next bell will be an American one when prices of pork and chicken begin to rise because we've determined it's more important to feed our cars than the livestock our consumers count on for protein.

Yes, perhaps we can expand corn growing acreage (at the expense of soy beans, but only with the use of more fertilizers, pesticides, and herbicides) and satisfy both demands - at least until the weather, a capricious demon, decides otherwise. Additionally, the very best estimate I've seen to date on daily ethanol production (assuming the current 116 plants and the 79 under construction are all up and running) totals 718,000 barrels. That's 3.5% of our daily requirement. If we all decided to never exceed 60 mph, we would save that much. (Interesting fact: the amount of grain it takes to produce 25 gallons of gas could feed one person for an entire year.)

It doesn't appear that either the Congress or the states are in the mood to approve drilling in the Rockies, in Alaska, or offshore in any of our sanctified coastlines. Russia and China are moving quickly and decisively in striking long-term deals with foreign oil producers. India is beginning to search for deals. Europe appears content to whine over Putin's insensitivity while hoping his tenure is followed by a kinder, gentler former KGB operative. Our oil companies aren't doing much more than being kicked out of Russia and Venezuela.

But we still will need a fuel and we will need it in abundance and we will need it from a dependable source. Coal is the only alternative. And it need not be the dirty, filthy stuff that used to be poured down the basement shoot when I was a kid. Germany developed the Fischer-Tropsch method for synthesizing a hydrocarbon like coal into a much cleaner burning liquid. We have several companies (mostly small ones, but I understand GE is testing the waters) who are currently using the process with our largest coal producers.

The process works. The question to be answered is at what level (of acceptable carbon output) will the bar be set. There exist influential groups who feel no level (of coal emissions) is acceptable. I doubt that they'll prevail. But should they, you can be sure that when Americans begin shivering too much in winter and sweating too much in summer, they'll be rolled flatter than a nickel beer. As with the Fischer-Tropsch companies, I'm not going to name any candidates as they're not that numerous and my omissions would be indicative of my holdings. (By the way, I do not own any of those stocks whose symbols I have listed.)

Those are my two primary targets. Water shouldn't be a surprise; it's been a great idea for a long time. Coal is something else; to some it may seem like buying into pornography. For those, I suggest searching the geothermal field, though initially expensive, the systems work (in both summer and winter), and can be installed almost anyplace where several deep holes can be drilled.

I became president of the old duck hunters courtesy of Gordon MacQuarie's great stories. It's appropriate then that I end with a Macquarie story (notice the difference in spelling.) My son will be 42 next month and has been a confirmed bachelor. Just two weekends ago I received an email from him (he's lived in Japan for six years) announcing his marriage this coming July in Honolulu. Now I felt I was pretty well set in making whatever minor financial arrangements I could for my children and theirs. (Lord knows we're leaving them with enough debts.) This adds a new dimension and one that requires real long-term thinking.

For those in the same boat, check out MIC, The Macquarie Infrastructure Fund (there are a group of Macquarie Funds and you may find one more appropriate). This fund has been buying up (or getting long-term - 75 year - leases) on tollroads, airport parking lots, commercial heating and cooling outfits, and energy service providers. If it's something that's an absolute public necessity, Macquarie owns or holds a long term lease on it. It pays a great dividend, but I'm told, reading their financial statement, it will give you the yips.

I now yield the field for at least a year.

The President further adds:

Scott asks a good question and, frankly, I don't know how to answer it. But I believe we have reached a point where we have to admit that governments and their offspring are poorly run. And though the threat of government interference is always real, the current state of government, especially at the state level, could actually prove beneficial.

For example, Macquarie and another outfit leased the Indiana Skyway for 75 years for $3.85 billion. It's estimated the companies will recoup their investment in 17 years and make an additional $21 billion over the remaining 58 years.

There has been talk of Daley also leasing the Illinois Tollways. Two days ago, Illinois announced it was leasing its lottery for $10 billion. These will be huge income generators for years. Likewise, Tennessee and several other states sold their future cash flow from the Tobacco settlement for discounted sums so that they could balance their annual budgets for two years. The buyers will reap nice returns for years.

Many states, and Illinois is one of the biggest offenders, have contributed little or nothing to their states' employee retirement funds over the past six years. Their only outs are raising income taxes (not going to happen) or selling off their hugest cash generating properties - for lengthy terms and at substantial discounts.

Our state governments, like our federal government, have been badly run, and finding additional revenue streams is getting harder and harder. In each case, though, the lessee has made sure the state has kept a financial interest in the asset; this seems a smart move as it might discourage the governments from taking draconian actions in moments of remorse.

For selected firms, then, governments may be providing great investment opportunities. We may be in the early days of an entirely new asset class; especially for those with long term investment horizons.

Jaime Klein adds: 

Currently, the only cost effective technology to extract drinking water from air humidity is cloud seeding. It is routinely done in Israel (and other places) and causes about a 10% increase in rainfall (amounting to about 800 million cubic meters per year). Since only about 15% of the rainfall is actually used (in agricultural irrigation, tapwater, etc.) artificial cloud seeding produces some 120 million cubic meters/year.

As Henry's insightful note shows, the production of fresh water is a question of energy. All the oceans are full of water so there is no scarcity of raw material. And all the water is being recycled in nature so it will never "end." In Israel, we are producing 200 million cubic meters/year of fresh water by desalination for an average cost of 0.65 U.S. dollar per cubic meter (the consumer pays an average of 1 $US/cubic meter). The desalination industry was established by the State and operates under 20 year-long contracts, selling all its production to the State at a fixed price. There are no free markets in water, not here nor everywhere, since conduction and distribution is a natural monopoly.

In my opinion (shared by Treasury's wonderkids), Israel doesn't need that expensive water, and the desalination industry was established in a moment of national panic caused by a two-year long drought.

By the way, water demand can easily be reduced by increasing its price. The curve is quite inelastic since water costs so little. In fact, even in Israel where domestic water is very expensive, the water company's bill is less than 1% household income. Wastewater removal and treatment may cost an additional 1%. I don't think anybody will make fast profits in the water industry in the coming years.

Henry Gifford offers: 

The question was raised about how much energy it takes to run a machine that takes water out of the air. I will show some counting on the question, and let others reach their own conclusions about why they are not popular.

Starting with the same 25 gallons of ethanol, which was described as being made from a year's worth of food:

84,100 BTU/Gal x 25 - 2,102,500 BTU / 3.41 = 616,568 WattHours of energy in the ethanol

Assuming current USA electricity grid efficiency of 33% (Source: Electric Power Research Institute), that can be converted to 203,467 WattHours of electricity.

An off-the-shelf dehumidifier (Grainger part # 5BB55, info below) takes 30 pints of water out of air per day, and uses (115 Volts x 5.3 Amps) 609 Watts to run. Therefore the 25 gallons of ethanol could perhaps run it for (203,467/609) 334 hours, yielding (334 x 30) 10,000 gallons of water. Probably the machine is rated under ideal conditions (high humidity, low temperature), and therefore the machine can only produce a small fraction of that under more realistic conditions - 500 or 1,000 gallons of water from 25 gallons of ethanol?

A test could be done by putting a bucket under the drip from a window air conditioner or a dehumidifier, and measuring how long it takes to fill the bucket, and then comparing how much electricity the machine uses.

Dehumidifier, 30 Pints Residential Dehumidifier, Capacity 30 Pints in 24 Hours, 115 Volts, 60 Hz, 5.3 Amps, Fan CFM 181, Humidity Range 20 to 80 % RH, Ambient Temp Range 64 to 95, Fan Speeds 1, Bucket Capacity 17.2 Pt, Height 22 7/8 In, Width 15 3/8 In, Depth 12 2/3 In, Impact Resistant Thermoplastic Cabinet, Color White, Includes Four Casters, Removable Front-Loaded Bucket, Hose Connection For Continuous Drain Operation, Filter

Henry Gifford further adds:

I understand that there are no free markets in water here, but disagree that the reason is that conduction and distribution are natural monopolies. There is no free market for corn, apartments, car rentals, health insurance, or many other things here for which there are multiple players competing for the same customer.

New York City's water is of higher quality than the bottled water in most places (usually just municipal water run through a filter), yet it "sells" for only $1.25/cubic meter, which hardly covers the cost of repairing the pipes. Indeed it is still "too cheap to the meter" - many customers still have no meters. As said below, use can hardly go down when the price is too low.

Catching and storing and cleaning and drinking/using rainwater runoff from roofs has been routine in the Caribbean for generations, and is increasingly done in the U.S. Southwest, and would be more popular if subsidized water and electricity (for pumping) were not available.

Jaime Klein responds:

(1) The domiciliary water supply market is a natural monopoly not because of regulation or subsidies, but because the customer has no alternative supplier. All attempts to introduce competition have failed. Even so, the price is dirt cheap.

(2) Rainfall catching water supply systems are fantastically expensive and dangerous to your health. If the price paid for one cubic meter of drinking water from a municipal system is, say, one $US, then the cost of the equipment to catch rainfall, to store, to purify and to pump it (investment + M&O) is, comparatively, astronomical, and averages $15 per cubic meter. As a conversation piece or environmental toy, it may be worth it, but please don't drink the water. Rainwater is not pure, it carries atmospheric particles and poisonous gases. Water from the first rains of the season are highly contaminated and toxic. Even urban tree foliage suffers. The water has to be stored, which is another potential source of contamination. The water has to be purified, possibly by addition of a chemical or by reverse osmosis. It has to be tested before consumption. This is a highly professional area, certainly not for amateurs.

In Israel, the Ministry of Health discourages home rainfall catchment systems, and in practice forbids it. There are strict water testing programs (every two weeks, samples are to be taken by licensed samplers and sent to licensed laboratories) and the water has to meet quality standards (zero coli count, pH, etc.). None of the traditional rainfall catchment systems (and there are many in Israel) are able to supply water of drinking quality and are de facto forbidden. It is not that the Ministry has inspectors searching for home systems to close them down, but no permits have ever been granted.

Henry Gifford comments: 

Imagine you were running a government in a desert area as described below. Thousands of your subjects would know the history of the people who lived for thousands of years in houses without modern heating or cooling and who used thermal mass to even out the diurnal heating/cooling load. Some would know that with modern windows and a few centimeters of foam on the outside of the thermal mass, modern standards of comfort can be achieved easily. Abundant solar energy could make hot water for showering and electricity. This would leave people able to live entirely "off the grid" except for one thing: safe drinking water.

Having people depend on a centralized water system would be good for the government, especially in an area where governments have a history of organizing wars for control of land with abundant water resources. Therefore I find it unsurprising that a government in an arid area tells people rainwater is unhealthy, and cannot be made healthy. Governments in other areas, such as the Caribbean and Texas, tell people the opposite.

Henry Gifford adds:

 I apologize sincerely about your "concerns for Israel", which you describe as the "mass immigration" of "potential husbands" to Wall Street here in New York. The street is only a few blocks long, yet is big enough to drain the pool of potential husbands from many countries. A proportionally sized financial center in Israel would be far less than one block long, which might leave some of your four beautiful, talented daughters in the same predicament as many beautiful, talented US women: stuck choosing from millions of single men who do not work on Wall Street.



Notwithstanding Mr. Chavez's anti-American, wildly popular pronunciamientos and Ecuador's newly elected Government's declaration that the country's foreign debt is "immoral," I think there is no risk of non-repayment. Ergo, Latin debt is cheap.


(a) Venezuela and Ecuador are oil exporting countries, and their payment capacity is superb.

(b) They are in no danger of default.

(c) Argentina was a special case. Foreign creditors did not notice that Argentina was not the same rich country of the fifties, but a totally wrecked one, and it had no mineral exports. Since the wrecking took several generations, neither did we Argentinians notice the change.

(d) In Latin America, foreign loans are valued personal emergency resources and have been since the Independence.

(e) The situation of foreign owned companies (or just any private owned company or landowner) is very weak and unsustainable. No one can protect them against expropriation when the mood comes. In my opinion, real estate and stocks are risky and overpriced.

(f) Further antics and heroic positioning by the caudillos are only too expectable. I am old enough to remember Vice President Nixon's visit in Caracas, and how it taught the Latins the joy of spitting on gringos.



Hunter and hunted or predator-prey relations are pervasive in the animal world. We're accustomed to observing and reading popular summaries and videos of the dynamics and techniques of survival for such pairs as lion & gazelle, wolf & squirrel, fox & lynx, coyote & seal, osprey & smelt, pike & minnow, and spider & fly. Such studies have been extended to romance and health among humans. Predator-prey relations are also common in markets. For example, the relation between market maker & day trader, dealer & ephemeral trader, flexible & inflexible, large trader & small trader, informed & uninformed, vig taker & vig payer.

Many studies in the field are based on the Lotka-Volterra model. This is a set of simultaneous differential equations relating to the rate of growth of the predator and prey populations to each other. A typical set of equations relating rabbit growth to fox growth states that dr/dt = ar-brf and df/dt = ebrf-cf where a is the natural growth rate of the rabbits, c is the death rate of the foxes, b is the death rate of the rabbits whenever they meet a fox and e is the proportional gain in growth that a fox gets from eating a rabbit.

Such equations do capture the main idea that as the rabbit population increases, the foxes gain in number because rabbits are easier to find and eat, and this provides a homeostatic mechanism to stabilize the rabbit population. Similarly, as the rabbit population declines, the number of foxes decreases because they have less food, and this helps increase the rabbit population which in turn tends to increase the fox population. As might be guessed, small changes in the assumptions of the model, such as time delays, lead to widely divergent behavior involving cyclicalities, instabilities and sharp changes in the dynamics that do not correspond to what we observe in most real-life populations.

A similar critique could be made of the two other standard methods of studying predator-prey relations, which are the functional response curve and the optimal foraging theory. The basic regularities there are that the costs and benefits of gaining prey vis a vis future reproductive success determine the extent and energy with which the predator seeks the prey. The key dependent variable is how much the predator eats as a function of the difficulty of converting the prey into food. An increase in the search time, handling time, or consumption time, reduces the predator's desire to eat. Certainly this leads to insights.  The problem here is that all these parameters are subject to estimation, and they are interrelated and subject to different hypotheses as to their function.

A good book for studying these techniques at an elementary level is John Alcock's Animal Behavior, and a good summary of the ecological approach to these dynamics can be found here.

Methods of studying the factors that enable predators to be successful have always been important to me as I, like other numerous individuals not at the top of the food chain, are often prey to much larger predators. I have often wanted to learn how to avoid capture, and even considered the possibility of sometimes turning the table on the predators and bagging them once or twice just to make the game a little more even sided. Thus, when I came across a cover story in Outdoor Life titled "Predators' Deadly Tricks," which describes how hunters go about capturing the most elusive predators in real life such as the coyote, the bobcat, and the mountain lion, I was very attentive and decided that I should try to devise principles from the practical and theoretical literature that might help other prey like me in their incessant battle with those who would devour them. 

  1. Signaling is key.The signals that the prey send out to show that they are not easy to digest prevent the predator from even considering attacking, and this saves much energy for the escape. Colors and scents indicate that the prey contain poisons. Stotting, the jumping behavior of gazelles when about to be chased by a cheetah, indicates that they are very mobile and not worth eating. Indeed the essence of the article is that the best way to attract a predator is with an electronic duplication of the distress call of its enemy. Amazingly, the coyote will often show himself within one minute of hearing the rabbit's call, especially when it's made with a "Foxpro FX5 that has a 200 sound capacity, one gigabyte of memory, recall buttons to switch between sounds, remote control functions, and a 700-yard range. Less than a minute later (after the call), a pair of coyotes charged in and we handily dispatched them." Market prey often indicate that they are ready, willing and able to defend themselves by the placement of limit orders in large size, but cancel if they are near just to prevent the larger predator on the other side from even thinking of going after them. The talk with your counterparts is how much more is available for adding to my line when you well know that one more grain of salt would be enough to topple you over.
  2. Vigilance is essential. The herding animals all find that 100 pairs of eyes with 50 always awake are enough to warn them of danger. Noses are always sniffing, ears are listening, and the antennae are always feeling. Indeed, some ducks can sleep with one eye open so as to never be victimized by a surprise attack. The hunter uses a telescope so that he can always perfectly see the adversary. He never lets the prey's vigilance work to his advantage by approaching stealthily, parking his equipment a mile away from where he's going to hunt, and setting up in a blind with proper camouflage. The prey in the market doesn't leave the market for a moment, as that might be the time that the enemy attacks.He cancels all orders when they don't get filled so that a surprise news announcement that's worth a limit move won't catch him just a few ticks from the last price. He has his computer set to wake him, which buzzes around in his private area so he never sleeps through a dangerous situation or lets the predator devour him totally.
  3. Deception is essential. My goodness, the moth blends in with the bark and orients with the grain of what he's sleeping on. The flies disguise themselves to look like bees, and the octopus can change 100 colors in one second. The spider uses a million deceptive lures to entice the fly into its web. The golden orb weaving spider spins a web that's so enticing that even when a bee breaks free, it will dive right back into it after it has escaped. (I am reminded here of the system player who, after a very bad trade on one side, doubles up on the other side for the next trade.) The chapter on deception in Education of a Speculator details other areas of deception in the world. "Quality camouflage is a must; select the pattern that most closely matches the foliage and landscape." Whatever you do, don't make any news. As a prey trader, I don't even like to type out that I'm thinking of exiting a trade, for fear that a predator might have my screen bugged or that the keystrokes are programmed to signal my intention. I never let the other side know what my stop point is because I know that it will always be hit. If I'm really hurting, I'll try to act 5,000 times stronger than I am, and I won't even begin to reduce my position by one contract for fear that my camouflage will be found out.
  4. Proper equipment is a must. Predators are constantly sharpening their claws and teeth. Prey must always practice escape maneuvers. Over many generations, most prey have adopted advanced techniques of escape that include the full range of methods used by individuals in their cohort from the beginning of time to elude capture, be it poison, scent, or cry. Their bodies are perfectly suited to the escape in size, color, speed and strength. The properly equipped hunter, in addition to his Swaroski binoculars and Foxpro FX5 caller, currently has a Gerber Epoch Pack, a Stoney Point bipod, Cabela coverup pants, and, of course, the obligatory Ruger bullets in a Browning rifle, a Bushnell scope, motion decoys, and a set of shooting stocks.
  5. If all else fails, try the unusual. Be prepared to shout if the predator attacks. The proper equipment for the trader starts with a proper price feed, perhaps one that's within a foot of the source of the prices so as not to lose out by the speed of light that it might take to get to you one-thousandth of a light second away.  Next, one should have a computer that's always set to trading and that isn't interfered with by email. Finally, have an office where no one can distract you from the job of survival with the cares of the world or a bill from the Service.
  6. Never give up. The cries of animals often save them from death. If nothing else, they serve to alert family members. The squirting of poison and the enlargement of the body is a common tactic of the caterpillar, and the gyrations of the weasel in extremis are often enough to ward off death. The hunter is told to scream if a predator attacks him and to have a spare set of guns and knives. As a trader, I try to follow the rules of a good competitor in sports who never gives away the last point of a game if there is still an iota of energy left in his body. There is always someone you can call on to help you fight back. On occasion, I've even asked a'la the Boy Wonder for the other half to help me out in a time of crisis, and so far the trust funds are still intact.
  7. I would recommend studying the literature on predator-prey relations by reading a few good books, following up on some of the hundreds of thousands of citations on the search engines, reading the Outside Magazine article in the December-January double issue and then trying to apply these techniques to make yourself impossible to detect, fruitless to waste energy on, and impossible to digest when caught. If all else fails, fight to the death.

J. Klein adds:

One Predator - One Prey; if it was ever so easy. 

It is more like Many Predators - Many Preys - Many Parasites.  Symbiosis. Competition among different parasites - how to maximize exploitation without killing the organism parasited. How to use a competing predator to one's benefit. Mixed situations: One is a predator and a prey at the same time but to different kind of critters.  How a steady state equilibrium evolves. 

In my opinion, however, we humans have already won nature's battle and rule the ecology to our benefit. We easily see through the animal world's tricks and catch them as we want. But the market is wholly made up by humans, who presumably have all been exposed for generations to nature's tricks and have become resistant to them. Situations like those that nature presents to us are no longer relevant, and we have moved to a higher level. It is a different game here.

Since we are part of the game, it is very difficult to see what is going on and much more how to manage it.  It is said that even the big winners know how they did it and why they succeeded. It seems to me that those winning have more useful memory, are able to calculate more precisely, see the present and the future more clearly, can formulate better plans, and execute more rapidly and precisely. In the market, nature's tricks don't work any more. This is a play of pure and cold intelligence.

Scott Brooks comments:

I've thought about this predator/prey relationship for many, many hours as I was sitting in a deer stand and I have several thoughts on this issue. I'll share some in this post. 

One of the biggest things to recognize in a predator/prey relationship is the opportunity that exists. One of the biggest things that we need to look at is the difference between instinct and reason. Whether prey or predator, if you are instinctual, you are acting out of some deep seeded genetic conditioning that causes you to run when faced with adversity. 

Think about it. If there are seven lions chasing a herd of 200 gazelles and the gazelles had the ability to reason, they would say, "Lets stick together and as a group go over there and trample those seven lions to death." The 200 gazelles would win that battle, and probably over time could condition the instinctual predator lions to leave them alone. The cost of messing with those gazelles is just too high. 

Think of an instinctual predator like a bear. Almost any bear could take a human if they wanted too, especially the bigger varieties like Grizzlies. Humans are simply not equipped to deal with them physically. But for the most part, we've conditioned bears to stay away from and fear us. That's only because we have the capacity to think and reason at a level that the Grizzly doesn't. We've figured out a long time ago that taking some animal gut and stringing it on one bent stick, and then taking another straight stick and putting a sharp tip on it, gave us the advantage. Then along comes names like Remington, Browning, Winchester, Anshultz, Benalli, etc. and the odds are stacked in our favor. 

When I played poker back in the 80's, I looked for certain types of players to be at a table before I would play. They were the prey. They weren't thinkers. They were gamblers. They let the cards fall as they may and "hoped" that things would go their way. But they had no real system or methodology to identify when to hold'em and when to fold'em. Most of them could not name three cards that had been played and subsequently folded (I'm talking seven card stud). So they had no idea what cards were still available to be played or not. I can't even count all the times when I could tell what hand someone was trying to build or bluff me into thinking they had and yet had no idea that the key card was already burned in the deck because someone had folded earlier. I guess I was a counter of sorts even back then. I'm not sure that qualifies me as a counter yet, maybe it just makes me someone who paid attention and kept track of things. 

These "gamblers" were hopeless gazelles at the table. I'm not saying that to be braggadocious. They simply didn't know what they were doing … they were nearly instinctual prey. They "needed" to win. They were always one card away from catching a break. They relied on luck. The reality for these guys was that the only way they could truly win was to quit and stop playing. Otherwise, ruin awaited them all. 

Those are the guys that I played against. I did not play against other good players. If there was more than one other good player at the table, I would find another game. I had nothing to prove by beating another good player. I was there for one reason and one reason only: to win money

For the same reason that lions don't usually attack other lions to eat, I was not interested in paying the price associated with trying to win money from other good players. The cost and risk/reward was just too high. 

To apply this to the markets, it is important to figure out where the instinctual investors are playing and those that don't have a thinking system, and use that to one's advantage. 

What are the masses going to do when "X" event happens? What is their likely "non-thinking" irrational emotion based response ("quick, run, the lions are coming"). 

Unfortunately, as I've said before, the masses left the markets after 2000, 2001, and 2002. They were burned so badly, and fear chased them away from what was very likely the greatest buying opportunity of their lives. It was like gazelles drinking from a stream and some of them getting snatched by an alligator. It seems to me that after a few have been snatched, that's the time to go get their drink … the alligators have enough food to last awhile now … and if nothing else, there is a few less alligators now patrolling the shores for food. The odds of success have gone up for the gazelle … but that's when they leave in fear. 

So I will be that thinking predator. I will only fight battles that I know I can win. My goal is simple. To make money! That's it. I've got no ego in this and no axe to grind. I'm not going to challenge Prof. McDonnell in the world of options, or Prof. Haave in the world of commodities, or George Zachar in the arena of bonds or Vic in the world of index futures. They are simply more skilled and knowledgeable than I am in those arenas. I could be a predator in those worlds, but I would be like the Grizzly bear, and they would be the thinking human up on the ridge 200 yards away pointing a Win, and a 300 Mag at my vitals. That's a battle I can't win. 

But there are things that I'm good, and there are arenas I can battle in. Since I only want to make money, I will only play in the arenas with the best risk/reward ratio for my success, and I will stick to those arenas (but I'll still learn the other arenas … and who knows, I may show up there one day and dip my toe in … but only when I think I'm ready … and then only with a small amount of money to make sure that I'm really ready). 

So, Phil, Gordon, George and Vic, be careful, I may show up in your arena one day … and I'm a good stalker who knows all about how to properly deceive with camouflage …

Tim Humbert comments:

Over Christmas I heard a wonderful recipe for pike:

-preparation: gut and de-scale, rub rock salt and pepper onto flesh, squeeze some lemon juice, insert some herbs into fish, wrap in aluminum foil and cook for 30 minutes

-consumption: throw pike in the bin and eat the foil

Rick Foust adds:

The largest predators (e.g. lions) are much smaller than the largest grazers (e.g. elephants). The largest grazers have much longer life spans than the largest predators despite having inferior camouflage. Certain large houses come to mind.

Small grazing animals (e.g. rabbits) do not survive long despite having excellent camouflage. Their numbers are maintained by fertility (replenishment). New, poorly bankrolled traders come to mind.

Bruno offers:

Professor Sorin Solomon, of the Racah Institute of Physics, has produced some very interesting market models based on Lotka-Volterra. Here is his homepage.

He showed that a generalized Lotka-Volterra model for the market yields a truncated levy distribution for index returns!

See for instance his 1998 paper: "Stochastic Lotka-Volterra systems of competing auto-catalytic agents lead generically to truncated pareto power, wealth distribution, truncated levy distribution of market returns, clustered volatility, booms and crashes."

There are simpler explanations for TLFs, such as a random-walk with time increments that are variable rather than fixed, just like with real-world transactions … but I thought this was topical.

There could be one way to check the above, and that is the impact of random time between transactions. On Euronext, we've got a mechanism for trading very small stocks. It is called "fixing." One could compare behavior of such stocks to behavior of other stocks that trade continuously. One could also check the behavior of stocks that have moved from fixing to continuous trading or the behavior of the whole French market as it moved from all stocks fixing to most stocks continuous in the mid-eighties. There's also a possible comparison between London Gold fixing and NY COMEX.

Todd Tracy comments:

Market Set Ups

While reading Victor and Laurel's article on Predator-Prey Relations, my mind exploded with visuals: foxes hiding in the bushes waiting to pounce, predictive and instinctual reactions to events, finding myself trapped in currency positions, panic driven searches for exit strategies. I realized that I am the prey. I am the new blood that greases the gears. I am the greedy trader who walks into the trap set by smarter, quicker and more thoroughly financed predators. As with much of the information gleaned from Daily Speculations, I found corollaries not just in the markets but also to life.

But wait, I've been here before. Where have I seen these deceptive techniques in use? Spy fiction. Yes, I have read all the Greene's, the Amblers', the LeCarre's, the Clancy's, the Forsyth's, the Flemming's, the Weisman's, the MacLean's, the Harris', the Buckley Jr.'s and a lot of the Ludlum's. The spy, leaving a trail, using cut outs, drops, proprietary tools and the most diabolically elaborate set ups imaginable. Institutionalized deception, deception as a way of life, and tradecraft so efficient as to make the prey oblivious to the fact that they have even been caught.

War is serious business whether or not it be cold, which brings me to the non-fiction. The Secret History of the KGB, the History of the Mossad, the development of the Office of Strategic Services, The Wall Jumper, the techniques of SMERSH, Stalinism, Churchill's autobiographical books and one of the greatest historical accounts on the subject, A Man Called Intrepid by William Stevenson. Control will leave no stone unturned to reveal facts. Control will sacrifice lives to perpetrate false information.

Why should the markets be any different? It's scary to think that once I feel like I'm playing the charts like a marionette, it is I whose strings are being pulled. I am a novice speculator, but my eyes are widening. If only I had Victor's booklist before I read all those novels. All is not lost however because I am learning to tie strings from my life experience to the experience of the markets.



It's a hard life trying to outperform the stock market indexes. Most of the time these traders do not have tested systems or, if they have done some testing, it is likely that the methodology used has some shortfalls. But let's suppose that everything is fine, and that they have managed to find a niche of market inefficiency which can be exploited by a small flexible trader in and out of the market very quickly. The problem is that a part time trader goes to work in the morning, participates in meetings, travels, etc. Sometimes the boss calls him/her right when the setup is there to be traded! When the system gives a buy/sell signal, he/she is not there to trade it. The lack of consistency is the main issue. For a European trader, it is even worse. Markets in the US open 15:30 European time and close at 22:00. The European part time trader goes home when US markets are open and finds the family "requirements" to be met often more demanding than those of the office work. He/she has to help the kids with their homework, the wife/husband with things to do, dinner time, friends after dinner, etc. Being consistent with the trading plan is almost impossible even for the most determined and focused part time trader. Moreover, when they go on holiday, no trading is possible unless they want to divorce. At the end of the day, although their system works fine and they are very disciplined traders, there is no way to outperform the market simply because they were not there to trade their systems.

Maybe the solution is to give up trading, buying an ETF and spend more time with the family.

Kim Zussman comments:

Yes, but there can be advantages to the part-time vantage:

1. Not looking at markets all day reduces over-trading. The more you look at moment-to-moment moves, the more tempting it is to mistake them for opportunities.

2. Long-term patterns and anomalies are generally more profitable because they integrate more risk and less vig.

3. Personal diversification: Necessarily, frequent losing trades are extremely painful, and it is nice to have other concurrent professional activities which are rewarding. Be a portfolio with a mix of risky and low risk assets, balanced to suit your psyche.

3a. Cover: Being ridiculed and berated by family and friends is diluted when the income stream is not at stake, and they can more easily forgive difficulties of a second vocation if the first is intact.

4. You can easily run your own hedge or mutual fund while drastically reducing cost and customizing risk to fit your temperament.

4a. If you are certain there are others who can invest much better than you, get past your ego and use them.

5. The market needs you, especially if you trade a lot and make many mistakes, to provide liquidity and profits for smart guys on the other side of your trades.

6. The golf rule: Investing/trading can be more frustrating than golf, but it is 1.5 million times more interesting and will make you a babe magnet.

George Criparacos adds:

As a part time trader, I identify completely with the problems outlined and with the response of Dr. Z. I would humbly like to add that there should not be a target to outperform the market.

Scott Brooks offers:

This is a great post by Kim! There is wisdom here for everyone, even those who are not part time traders. Everyone, even pros and day traders, should cut this out and put it in their playbook. I know I am!

Thanks for this Kim!

Scott Brooks further adds:

It is important to remember that outperforming the market (usually thought of as the S&P 500 … the cap weighted index) is difficult. Most pros don't beat the index.

Maybe your goal would be to create an income stream of 3%/year to live on with a moderate amount of growth to offset some of the effects of inflation.

Maybe your goal is to beat a composite index of stocks and bonds (pick the indices that you think are appropriate).

Maybe you're good enough as a personal trader to accomplish the return goals your looking for and to receive satisfaction from managing your money (kind of like a hobby … but one that is profitable).

I have several clients that have me run a portion of their portfolio while they run the rest. The reason in many cases is that one spouse has nothing to do with the money (usually the wife) and the other spouse likes to invest and is really into it (usually the husband). The husband realizes that if something happens to him, his wife is not just going to take over the portfolio and all of a sudden become an expert in something that she has no interest in. So he has me run a portion of the money so that he can be comfortable with my competence and the wife can have a relationship with someone that she knows and has come to trust.

People can have many goals in the markets. It is imperative that you:

1. Identify what your goals are
2. Figure out a methodology that can accomplish those goals
3. Figure out if you have the time to work that methodology
4. Make sure that a fail safe is in place (i.e. work with a professional if your spouse is not interested, or work with your spouse)
5. Figure out if you have the competence to accomplish your goals
6. Be able to back test your system in the bad times (everyone was bragging about their genius in the 90's … but seem to have lost half their new found IQ since)
7. Have a playbook for how to handle different scenarios (especially what I call lifeboat drills)
8. Be willing to admit that they may not be able to do it
9. Other things that are important that I'm sure I'm missing
10. Make sure that you're having fun if you meet all the above criteria

Steve B. adds:

The part time trader is not the problem or the issue. The part time trader has at his disposal an arsenal of conditional orders that are set to fire on almost any imaginable market condition. It is the conditions that the part time trader has not taken the time to identify.

The issue in this case is the strategy. A part time trader will trade like "the trend is your friend." In this case the trend is what is hot and what strategy is in vogue. With the ever-changing cycle of trends, there is no possible way to get ahead in this type of trading. I would also argue that the part time trader is price focused - he does not care about volatility, interest rates, currency fluctuations, emerging markets, etc. due to the nature of his game "part time."

The part timer finally is apt to find shortcuts in order to make up the difference in time. The problem with shortcuts is that they run near to the edges of steep cliffs.

Dylan Distasio responds:

The issue in this case is the strategy. A part time trader will trade like "the trend is your friend." In this case the trend is what is hot and what strategy is in vogue. With the ever-changing cycle of trends, there is no possible way to get ahead in this type of trading. 

I would disagree with this statement as someone who has traded both fulltime as an intraday trader, and who now trades part time with a different vocation during business hours (and a longer trading time frame for a number of reasons). The part time trader is not tied to trend following strategies, and is certainly not obligated to follow what is hot and in vogue. They are just as capable of fading the herd as a full time trader or coming up with any other strategy to try within an interday time frame.

I would go on to argue that trend following strategies are capable of making money long term. The No Load Fund X newsletter which combines a relative strength trend following strategy with mutual funds (or more recently ETFs) has consistently beaten the S&P 500 since 1980 as audited by Hulbert Financial Digest.

In any case, they are not tied to the trend. There's nothing preventing them from following whatever strategy they wish. Practical considerations usually exclude the intraday time frame as an option for the part time trader, but they can use their ability to sit on their hands and cherry pick within a longer time frame as a strength.

I would also argue that the part time trader is price focused - he does not care about volatility, interest rates, currency fluctuations, emerging markets, etc. due to the nature of his game "part time."

I would argue that the part time trader should care about all of these things. Speaking for myself, I certainly do.

The part timer finally is apt to find shortcuts in order to make up the difference in time. The problem with shortcuts is that they run near to the edges of steep cliffs.

The part timer who is serious about attempting to beat the market should realize the amount of work required to do so. I think most of the ones who are able to trade part time and consistently beat the market are combining a lot of hard work after hours with their experience, and a willingness to constantly learn.

J. Klein offers:

Respectfully, I would tend to disagree. Part time vs. full time is not a question of strategy. It is, I feel, an acknowledgment of one's limitations.

Many will disagree, but I find that trading is mainly hard work. If you work hard on learning the market and about yourself, eventually you will work out some small strategies that leave you with a few more coconuts in the evening than you had in the morning. I am old enough to have seen more than one dumb young person get decent rewards, if they hung around long enough and are honest and hardworking.

The market is very large and there are many opportunities, but a part timer may take a relaxed view and let most of those golden opportunities flow away. Existing in a less pressurized environment, he may engage in only a few situations, and follow them more carefully. He trades part time, but his mind keeps working full time (how can one avoid it?) so he may be doing more thinking on each trade. More thinking, less pressure, less fear = better results, hopefully.



Just when you though corruption allegations might be abating in equity markets, along comes an explosive new study. A paper to be delivered to the January 2007 American Finance Association annual meeting in Chicago suggests that investment analysts’ historical buy recommendations have been manipulated to put them in a better light. Rewriting History, by Alexander P Ljungqvist (Stern School of Business, NYU), Christopher Malloy (London Business School) and Felicia Marston (University of Virginia) provides evidence that nearly 20,000 records in I/B/E/S, a database of research analyst recommendations owned by Thomson Financial and widely used by investment professionals and academics, were manipulated between September 2002 and May 2004. This took the form of selective, ex post removal of analysts names from some of their historical recommendations. These were not random; they were concentrated among the worst performing recommendations. Here is the authors’ abstract:

Comparing two snapshots of the entire I/B/E/S analyst stock recommendations database, taken in 2002 and 2004 but each covering the same time period 1993-2002, we identify nearly twenty thousand changes of an unusual nature: the selective removal of analyst names from historic recommendations (anonymizations). This practice turns out to be pervasive and non-random: Bolder recommendations are more likely to be anonymized, as are recommendations from more senior analysts, Institutional Investor all-stars, and those who remain in the industry beyond 2002. Abnormal stock returns following subsequently anonymized buy recommendations are significantly lower (by up to 11.0% p.a.) than those following buy recommendations that remain untouched, suggesting that particularly embarrassing recommendations are most likely to be anonymized. Analysts whose track records appear brighter due to anonymizations experience more favorable career outcomes over the 2003-2005 period than their track records and abilities would otherwise warrant.

As the authors note, the period not only coincided with close scrutiny of Wall Street research by regulators, Congress, and the courts, but also saw a substantial downsizing of research departments of major brokerage houses in the US. The manipulation benefited the careers of those whose dud recommendations were anonymised. The paper concludes: Whether or not analysts were in fact behind these changes, however, their track records undeniably look better than they should, and we show that the analysts concerned apparently benefited in the sense of experiencing more favorable career outcomes than their track records and abilities would otherwise warrant: Anonymizers are more likely to move jobs, to be hired by a large brokerage firm, and to move from a small to a large firm (Hong, Kubik, and Solomons (2000) measure of a promotion). Anonymization easily has the largest economic effect in our career outcome models. These are very disturbing findings, and as the authors note, given the “non-random nature of the results” it is very unlikely they are attributable to chance. While “it is possible that the brokerage firms were in fact the culprits ..the patterns we document seem at odds with this interpretation”.



I am a 27-yr old professional equity derivatives trader with several questions and comments for Dr. Niederhoffer and Ms. Kenner. I just read Practical Speculation. I had previously read Joel Greenblatt’s The Little Book That Beats the Market. Needless to say, the two works propound extremely different views on the relative merits of growth versus value stocks and on the ideas of Benjamin Graham. I’m sure this is a debate that has been beaten to death before I was born, and I’m sure you are entirely sick of the whole thing, but please bear with me. I am interested in reconciling the ideas of the two authors. I would like your opinion on Mr. Greenblatt’s work and his “system” for investing.

I wondered specifically what Dr. Niederhoffer and Ms. Kenner’s response would be to the data cited in Greenblatt’s book. Is this evidence entirely worthless due to statistical and sampling errors? Is it only since 1965 (the Value Line data in the book was for 1965-2002) that growth has overtaken value? What do Dr. Niederhoffer and Ms. Kenner think is the correct way to value a stock? Since it’s difficult to precisely ascertain current or even past “real” earnings for a single stock, let alone the mkt, how can one hope to accurately predict the level of future earnings (as you must do for growth stocks). What valuation model should be used? What valuation model can be used that works for both “growth” and “value” stocks (it seems fairly silly to categorize all stocks into one of these two fairly arbitrary columns, but that’s what seems to happen).

Anyone can go to Mr. Greenblatt’s website and get a list of “value” stocks. He argues that his system (buy 20 or 30 of these value stocks and then sell them after a year and get new ones from an updated list on his website) will beat market returns over time. I am suspicious, but where is the logical flaw or statistical error in Mr. Greenblatt’s book. Will his method really work, and if not, why ? Mr. Greenblatt posted excellent returns over many years (I believe 10 years of returns are necessary to eliminate luck as the explanation of a trader’s returns) at his hedge fund. I’m sure he wasn’t simply applying the method from his book, but he is clearly a “value” investor.

To me, the strength of “value” investing, especially as described by Mr. Greenblatt, is its seeming logic. Even though you can’t buy a stock portfolio for 50% of its liquidation value as Graham suggested, the market and especially individual stocks can fluctuate fairly wildly even over short time frames, so clearly it is possible at times to buy good stocks or the whole market “cheaply.” As I write this, AMD has a 52 week range of 16.90 - 42.70… with roughly 485 million shares outstanding, that means in terms of market value AMD was (according to the market) “worth” almost $21 billion in late January, and only $8 billion or so in late July. Maybe some of this move was due to new (bad) information, but in all probability (since the stock subsequently recovered- then dropped again) it was due to the overtrading and ridiculous focus on short-term results that Dr. Niederhoffer and Ms. Kenner lambaste in their book. Take a look at the way retail stocks move around on monthly same-store sales numbers or oil and gas move on weekly reserves numbers for further examples of ridiculous overtrading and short-term focus.

Nevertheless, to ignore volatility (which is how I make my living) and keep your eyes firmly on the long-term potential of a stock leads to two pitfalls. First, you miss out on opportunities when the stock swings around in the short run (for example, you could have sold some medium-dated calls in AMD in Jan, then used the proceeds to buy additional stock in July). Second, you are ignoring risk; in the short-run, you could see such severe swings that you go broke instead of getting your 1.5million % a century return. Volatility might be much higher than it “should” be, it might be due to overtrading, and it certainly is the result of a focus on meaningless short-term information, but it is a fact of life. In my opinion, it’s better to take advantage of this fact than to ignore it.

One solution is to actually buy volatility itself. There are several studies showing that a portfolio containing a volatility component of 10% or so will outperform a similar portfolio with no volatility component (an example of a volatility component would be VIX futures or a similar instrument, essentially just a long option position). The general basis for this is that implied volatility in the options market usually increases when the market drops. You are diversifying your portfolio with a negatively correlated asset. Since the VIX hovers at a very cheap 10 or so these days, it seems like a great hedge.

Any reply or even a suggestion of further reading on the value/growth debate would be greatly appreciated. I have also emailed Mr. Greenblatt’s website with similar questions (you can find that email below).

Doc Castaldo illuminates:

He has so many inter-related questions it is hard to know where to begin. The Tim Loughran article “Do Investors Capture the Value Premium?” which some Spec (Dr. Zussman perhaps?) sent to Steve Wisdom recently seems relevant, and I sent it to him (the answer Loughran gives is no). I believe Prof. Pennington and Mr. Dude reviewed the Greenblatt book and found it well done; though some of us have doubts as to how well the results will hold up going forward.

Steve Leslie adds:

I have studied this deeply and although impossible to adequately reconcile this argument, my reply is that there is enough room in the world for value investors and growth investors. One is more of a science and the other is more of an art. And that which works for one will not work for another. And they tend to be complementary, whereas when value investing is in favor growth is out of favor and vice versa.

Case in point late ’90s. Nobody and I mean nobody wanted to be a value investor. At the time I was with a regional brokerage firm and we had one of the best value fund managers around, and he was never asked to speak anywhere. Everybody wanted growth and hard chargers. He told me directly that the worm would turn and that which one is hated will once again be loved. In 2001 and onward his style came back into vogue. His numbers became very good when the implosion of growth occurred and value turned to the good.

I feel that value investing is more of a quantitative approach to investing. It requires arcane methods and such as roe, price to sales, price to book. You can have value investors, deep value, vulture investors etc. And it is very important that with value investing that one be a patient investor with longer term time frames. I have referenced the Hennessy Funds as excellent quant funds. They have a very rigid stock selection process and rebalance their portfolio annually which they bought the rights to from James O’Shaughnessey who brought this methodology out in his book How to Retire Rich. Their long term track record is very good and they did very will since 2000 but this year for the most part the results have been flat. Martin Whitman is a deep value investor and his Third Avenue Fund has done very well over time. As has the Davis Funds. The First Eagle funds does excellent work with their global funds.

Growth investing is more of an art. It requires timing. Growth investing such that William O’Neil supports can be very successful yet very volatile. Small cap growth investors many times requires a longer term time horizon as the swings in price can be quite hard to take. I have always liked Ralph Wanger (A Zebra in Lion Country) and Tom Marsico in this area.

It is very important that the style of investing one uses incorporates their financial education, character and personality among others. They most definitely require knowledge and different wiring.

As to the trading of that the chair employs, I will let him speak for himself but I am confident that he will say the methods that one uses for value investing and growth investing would never work for his methods of day trading or swing trading.

To use a poker analogy (alas it always comes down to poker) I liken value investors to people like Dan Harrington, Howard Lederer and Phil Hellmuth. They are percentage players very methodical. They wait for premium hands and play those. These are the tight players.

On the other side of the ledger are the growth investors such as Phil Ivey and Gus Hansen, aggressive sometimes to a fault and they play many hands and many times on feel.

Both styles and much more in between are effective and can bring one to the promised land, they just take different routes.

Dr. Phil McDonnell reminisces:

Many years ago I was engaged in fundamental research on stocks for a finance class at Berkeley. Upon showing my results to one of the rising young finance Professors in the Business School I had a rude awakening. He promptly but kindly pointed out to me the myriad of biases which enter into such a study.

It prompts one to paraphrase the poem poem by Elizabeth Barrett Browning:

“How Do I Confound Thee?” Let me count the ways in which fundamental stock data can confound:

  1. Stale Data. Data are not always reported on time. Some is late, but most studies do not account for this adequately.
  2. Retrospective Bias. Most fundamental databases use the current ‘best’ information believing that is what you want now. But for historical studies that means the data may have been retrospectively edited as much as several years after the fact. This is a form of knowledge of the future. If you analyzed Enron before its collapse the fundamentals looked good and the stock was too cheap. If you analyzed today with a retrospective database you know that the company had catastrophic losses. But the truth about the losses was not known at the time and the adjusted numbers only came out years later.
  3. Sample or Survivor Bias. Use of a current database often results in a sample bias due to the fact that only companies which continue to exist in the present will be included in the sample. In order to avoid this issue one must go to an historical source in existence at the time in order to manually select the sample for each month by hand. Many companies are delisted or otherwise stop trading. For these the data must be manually reconstructed from historically extant sources. Otherwise this bias translates into a strong bias in favor of value investing strategies. A strategy which buys out of favor, or high risk or near bankrupt companies will always do well with this bias. The bias guarantees that they will still be around years later because they are still in the database.
  4. Data Mining. There are many variables to choose from with fundamental data. There are countless more transformed ratios or composite variables which can be constructed. This leads to the ability to try many things. Thus the researcher may have inadvertently tried many hypotheses before coming to the one presented as the best. Because fundamental data are low frequency (quarterly at best) there are only 40 observations in a 10 year period. True statistical significance can quickly vanish in a study of many hypotheses.
  5. Data Mining by Proxy. Everyone reads the paper and keeps up with current trends in investments. Thus our thoughts are always influenced by findings of other researchers. Thus even if a researcher did a study which avoided the usual data mining bias it may be simply because he took someone else’s results as a starting point. In effect he used their results as a form of data mining by proxy to rule out blind alleys.
  6. Fortuitous Events. In the 1990’s F*** & Fr**** published papers about factor models to augment the Sharpe beta model. Their significant new factor was Price to Book ratio. In James O’Shaugnessy’s book What Works on Wall Street one can see a sudden upward surge in value strategies in the early 1990’s coincident with the publication of the F & F model. However the event was a single one time upward valuation of value models in the 1990’s. Before and after that, the effect vanishes.
  7. Post Publication Blues. After publication of any academic paper or book the money making method usually stops working. Sometimes it is due to data mining or some flaw in the study and the putative phenomenon was never really there. The market is efficient. If everyone knows something it will usually stop working even if the original study was valid.

Prof. Greenblatt’s book is a fun read and remarkably brief. In fact if someone wanted to just get the gist of it, each chapter ends with a very clear summary of the key points in that chapter. It would be possible to get all the main points in about 10 minutes simply by reading the summaries. Let me say that if one were to use a fundamentally oriented strategy then the profit margin and Book to Price are probably the first two on the list. To be fair to the author, reciting one’s efforts to avoid sample biases in a book intended for a popular audience probably would not help sales. Such discussion is usually reserved for academic papers but nevertheless its absence does not give reassurance that all possible bias was eliminated.

The best way to test this strategy is not to go to the library and do all the work yourself. Rather one could simply go to the web site and copy down all the stocks recommended. Then in 6 months and 12 months revisit them to see how they have done and to see if the performance was statistically significant.

Ever since those Berkeley days more than 30 years ago I have always been distrustful of fundamental studies. That lesson from then Prof. Niederhoffer has helped shape my market studies in many ways. The bias of fundamental data is yet another way the market can confound the research oriented trader.

Jaim Klein replies:

Let’s simplify. The market universe is large and diverse enough to accommodate different successful strategies. One catches fish with net, another with bait. Regarding the value of anything, no such. The value of a thing is the price it can fetch in a certain moment and place. At 27 I was also confused. Experience is the best (probably the only) teacher. He has to do his own work and reach his own conclusions. It is time consuming, but I know no other way. He can also observe what successful people is doing and try to copy them till he can do it too.

Prof. Charles Pennington rebuts:

Dr. Phil lists 7 things that can go wrong in research on stock performance and its relation to fundamentals. Oddly enough, the Greenblatt book itself also lists exactly 7 such reasons on page 146! They’re not exactly the same ones, but there is plenty of overlap. I’ll list Greenblatt’s 7 with my own paraphrasing:

  1. Data weren’t available at the time (look-ahead bias)
  2. Data “cleaned up”, bankruptcies, etc., removed (survivorship bias)
  3. Study included stocks too small to buy
  4. Study neglected transaction costs, which would have been significant
  5. Stocks outperformed because they were riskier than the market
  6. Data mining
  7. Data mining by proxy

Greenblatt: “Luckily the magic formula study doesn’t appear to have had any of these problems. A newly released database from Standard and Poor’s Compustat, called ‘Point in Time’, was used. This database contains the exact information that was available to Compustat customers on each date tested during the study period. The database goes back 17 years, the time period selected for the magic formula study. By using only this special database, it was possible to ensure that no look-ahead or survivorship bias took place.”

To all the biases that we consider, I’ll add the “not invented here” bias. It’s too easy to assume that no one else out there can do rigorous research. I think Greenblatt’s is fine.

(He didn’t however do any original results on jokes. His jokes are all out of the Buffett/value-school jokebook. Fondly recall “There are two rules of investing. 1. Don’t lose money. 2. Don’t forget rule number 1.” That one’s there along with all your other favorites.)

Dr. Phil McDonnell replies:

The way we all remember the late 1990s is the dot com bubble. It was the front page mega meme. The stealth meme was the value stock idea.

Rather than think of it as a single paper consider the paper as the seminal idea of a meme. From the original paper there were follow on papers by various academics as well as FF. From there the meme spread to the index publishers who always want a new ‘product’ to generate marketing excitement. Naturally the index guys sold it to the funds and money mangers who promptly started new funds and rejiggered old funds along the lines of the new meme. The money management industry always wants new products but also each firm needs to act defensively as well. For example Vanguard cannot eschew the new fad and leave the playing field open for Fidelity. As with all memes it grows slowly and diffuses through society.

In all fairness one can never ‘prove’ cause but only correlation using statistics. But it is clear to me that something happened which caused the value part (really just Magic Formula) of the market to triple during those years albeit with only negligible public awareness early on.

For the sake of argument assume that the cause was not the FF paper and its impact on the value meme. Then what was Dr. Zussman’s ‘unseen factor(s)’ which caused a triple in value? Which factor or factors are more plausible?

My prediction for the end of the next meme is the collapse of the Adventurer’s bubble. To play it one needs to sell. But I would guess that it is only a one to three year collapse.



To me the most significant lesson of recent international military undertakings has been how a country's taking action risks sacrificing what that country previously enjoyed in the power, reputation and deterrence of potential action.

For example, going back to the 1967 and 1973 wars, the Israeli military had the reputation of being unbeatable by its Arab neighbors. This gave Israel very valuable deterrent protection against its hostile, far more populous enemies.

But when Israel launched a major attack on Hezbollah in Lebanon and was unsuccessful in that Hezbollah was able to fight it to a draw, major damage was done to Israel's military reputation and deterrent power. Israel is now far more vulnerable to attack by hostile neighbors and by major terrorist organizations. With the benefit of hindsight, Israel should never have risked its reputation and deterrent power in a voluntary war unless it was virtually certain of prevailing and thus keeping its reputation for invulnerability and deterrence in effect.

Similarly, after the First Gulf War, the bombing campaign in Bosnia and the impressive early destruction of the Taliban in Afghanistan, the US had an awesome reputation of being the world's sole superpower, with virtually unlimited high tech military power several orders of magnitude above that of any other country.

But for the US to undertake a major invasion of Iraq that turns out unsuccessful, to become bogged down in a losing war against militarily unimpressive enemies, has done incalculable damage to the US's ability to cow hostile nations with its military potential. Again with the benefit of hindsight, the US should have thought long and hard about risking the unparalled military reputation and deterrent strength it enjoyed.

Now that the US's perceived military strength and ability to deter is far less, Iran can do what it wants in developing nuclear weapons and funding/arming Hezbollah, and even North Korea can feel pretty safe in its provocations. The degraded military reputation of the US also gives it far less ability to influence Russia and China to help with Iran and North Korea. And Russia can also feel free to strongarm our ally Georgia (the country, not the state) with little or no complaint from the US.

(I am not dealing here with the question, moral or libertarian, of whether the US should be attempting to deter or influence other countries. Only with the question that if it wants to, whether it has the power to do so.)

Finally, the relevance to investing of giving up the power of potential is, I believe, tenuous. It is true that when one moves from cash to a committed investment not easy to sell, one loses the potential to invest in other things or to remain in cash. But there is no reputation or deterrent value that one is giving up, since stocks and other investments are not capable of being threatened or deterred. (Except perhaps in rare cases where an extraordinarily rich investor like Icahn or Kirkorian is threatening to buy a massive amount of a company's stock if the company refuses to do what he wants.)

Prof. Marion Dreyfus replies:

A deterrent power that is never invoked, on the other hand, becomes a straw man, and ankle-biters will proceed to a series of provocations to test the level of tolerance of that so-called massive deterrent potential. Israel had been repeatedly provoked by thousands of Kassams and Katyushas against northern cities, and precisely how many thousands of incursions it can sustain is not an exact science. Nor is it in her interests to permit little gangrenous groups to pick off her soldiers and murder them at will.

This leaves out the concomitant scandalousness of the unpreparedness of the IDF. Both in terms of tank platoons and soldiers guarding the perimeter, there was a feebleness of deployment that stuns most of us familiar with the power of the IDF. A major contributor to the lack of overwhelming force and the triumph of the IDF, too, was the constant effort to save civilians, which is no way to win a war against soulless automata. had the Israelis conducted the war in the way most nations would and do, it would have won inside of a week.

Craig Cuyler replies:

These points could also be related directly to proper means of speculation, ballyhoo deflation and scientific method in trading. The US government has ignored almost every rule of proper speculation and here are just a few off the top of my head:

1. The US got itself into a war based on spurious correlations (the link between Bin Laden and Hussein)

2. Hindsight bias (Bush snr's previous Iraqi war in which the US came out relatively unscathed with its reputation intact)

3. Data mining (the Hunt for WMD's and the Yellow Cake uranium from Niger, both which didn't exist)

4. The doomsday scenario (pre-emptive attack on Iraq would prevent further attacks on US) - Iraq was never going to attack the US it didn't have the means,

5. Trading on tips and unsubstantiated rumours (the US being conned by Big Oil and others with their own agenda),

6. Trading with too much leverage and no risk management (how long can the taxpayer pay for this mess in Iraq, how many more innocent people on both sides must die before the stop loss is hit?).

As Dan says, the situation has weakened America's military position and standing in the global community and the direct beneficiaries are the Iranian Mullahs and psycho's like Kim Jong Ill who are now emboldened to develop their own nuclear arsenals. This is similar to when hedge funds like Amaranth get themselves into trouble and the market knows that it can press its advantage until the protagonist capitulates - this is what Iran, Jordan, Hezbollah, Taliban, North Korea and others will do. When an investor or a speculator puts on a trade for the above reasons there can be only one outcome - failure!

Stefan Jovanovich responds:

The 1973 war (what the Israelis call the "Yom Kippur War" and their opponents call the "Ramadan" or "October" War) was the worst crisis in Israeli military history. Within the first week the Egyptians crossed the Suez Canal and breached the Bar-Lev fortifications in what was probably the greatest feat of Moslem arms since the Turkish defense at Gallipoli. The Bar-Lev fortifications had cost $500 Million (in today's dollars roughly 1/3rd of the 2007 Israeli defense budget) but they were breached with water cannons, rubber rafts and hand-carried weapons and the battalion holding them was effectively wiped out. There are other details of the war that match the failure of the Bar-Lev line, but it is enough to note that, immediately after the war was over, a special commission headed by Chief Justice Shimon Agranat of the Israeli Supreme Court was appointed to investigate "why Israel had been caught by surprise and why so much had gone wrong during the war itself". The commission's report, completed in January 1975, was highly critical of the performance of the IDF on several levels, including intelligence gathering, discipline within the ranks, and the mobilization of reserves. Among the facts in the report was the disclosure that the IDF needed the emergency airlift of $1 billion of ammunition (in 1973 dollars) from the United States to avoid literally running out of bullets. To gain a proper sense of the scale of this potential disaster, it is useful to know that the entire cost of the war for the Israelis was $5 billion. (One of the bitter reflections that we Viet Nam veterans try to avoid considering is whether the 1975 Democratic Congress would failed to fund the reinforcement of the IDF as cavalierly as they refused to resupply the ARVN.) The Yom Kippur War ended the political future of Moshe Dayan. Ariel Sharon was lucky enough to have retired as commander of the Southern front 3 months before the war began. Had he remained in command, he, too, would have seen the end of his career as a figure in Israeli politics.

The tactical difficulties the IDF experienced against Hezbollah have a great deal in common with the mistakes of the Yom Kippur war. The Israelis badly underestimated the usefulness of anti-tank weapons against infantry (most of the IDF casualties were from blast and shrapnel, not bullet wounds) just as the IDF underestimated the lethality of Sagger missiles.

As for American bombing in Bosnia (sic) (the air strikes were in Serbia proper), the American after-action reports are almost sarcastic in their assessments. The Serbs, displaying their native criminal ingenuity, managed to shoot down an F-15 using cell phones and 1970s-era Soviet missiles. The USAF was unable to even "bounce the rubble" since most of the "targets" destroyed in Kosovo turned out to have been decoys. The U.S. Army had to wait a month to cross the Danube while the combat engineers (not under fire) rebuilt the bridges. When they finally made it across, they discovered (surprise, surprise) that their M1A1s were too heavy for the roads. The war ended General Wesley Walker's military career and began his political one.

Fortunately, both the IDF and the U.S. armed forces have learned from their mistakes and will continue to do so. The wars being fought in Iraq and Lebanon (yes, it is still going on) have taught both militaries that tactical intelligence can no longer sit even at the brigade level; it has to be down at battalion and even company level. Both militaries have also learned that they have to have the ability to jam enemy electronic signals not just in the air but at the street corner level. These are revolutions in military affairs comparable to the development of armor and automatic weapons.

To conclude  that "US's (and, I presume, Israel's) perceived military strength and ability to deter is far less" is to go against all the known facts of what those countries' enemies are actually doing. Both the Russians and Chinese are working as fast as they can to abolish conscription and reduce overall troop strengths. Both have effectively conceded to the Americans permanent air and space superiority by ending their next generation fighter programs. The field strength of Hezbollah, Al Qaeda, Taliban and the Baathists has been reduced to the level of banditry and local thuggery, and their internal documents speak of reduced levels of financial and military support and, in some cases, of outright despair. Their only hope is to win the battle of CNN.

I can go on, but what would be the point. That the New York Times and Washington Post and CNN remain unaware of what is actually going on in the Middle East and East Asia is hardly surprising, given the fact that their correspondents no longer spent any time in the field but leave that to their native stringers. That members of the list continue to retail the daily "everyone knows" historicisms of the "authoritative press" is disappointing.

Laurence Glazier replies:

More than 20 years ago, I remember reading media assessments that Israel was unlikely to survive more than a few years. I think this is still a good case to be contrarian. Other things being equal, Israel is and will even more so be one of the economic powerhouses of the present century.

There are — as ever — challenges.

Aumann may shine in game theory and bible code analysis but Buffett gets the nod in buy and hold.

J. Klein replies:

It was not only media assessment. 30 years ago I bought land in Israel, and all my friends advised against it, Israel couldnt last, too much risk, what a meshugge thing to do. It turned out to be a hit, by far.

Israel government has announced that it is planning a second wave of settlement erradication. The idea is to cut ourself free from our turbulent, violent, suicidal, no-good neighbors by a good fence. It is only expectable that Prof. Aumann, a believer, would argument against it, since we are giving up land aka Promised Real Estate.Nobel Prize does not make him a prophet, and less so in his hometown.



In Stumbling on Happiness Daniel Gilbert lists a number of ways regular people have an illusion of control (e.g. feel more confident of winning the lottery when they can pick their own numbers). This little white mental lie appears to be critical to self-esteem; the one sub-group who is immune to these illusions are the clinically depressed. (Kosztolany)



Woody Allen said that "hope is that thing with feathers". I read it in his memorable book Without Feathers. Why I am writing this instead of working? Because Argentina emitted a new series of seven year bonds and the demand was three times the supply. Figuratively, people pushed and trampled over each other to give their money to Argentina and get one BONAR. Only four or five years ago Argentina was broke and paid out its bonds at 20 or 30% of face value. Savers were harmed. People have no memory?


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