I saw Mick Taylor play at a small club in NYC last night. He is 63 years old. Rolling Stones aficionados know that the Stones most artistic and prolific years were during Taylor's tenure as the Stones second guitarist. The output during his Stones' years 1969 through 1973 include legendary tracks off Sticky Fingers and Exile on Main Street plus he was the main lead guitarist during 1969's live romp at Madison Square Garden that is famously captured on the album Get Yer YA YAs. I suggest listening to Can't You Hear me Knocking, Bitch and Love in Vain to a get a sense of of Taylor's dominance of slide and blues guitar paying. It stands the test of time. How do I know? The small audience was a mixture of middle aged rockers like myself plus some very knowledgeable college students that follow the Stones musicians like it was still 1973. The Stones still sell lots of records.

Like his more famous partner Keith Richards, Taylor has apparently struggled with drugs an alcohol and has many up and down battles with his demons. He looks physically worn, harried and over weight. However, the man can still play. He did a 90 minute set where he was featured at all times. He ripped cords and notes like the old days plus he sang. The audience loved him and appreciated every minute of the show. By the way, he is playing 8 shows in a row during at four day stint in NY. That must take a huge toll on a man of 63. That is dedication that few men of his age can muster.

I think the lesson in all of this is that he remains an awesome guitarist because he still loves what he does and he still studies and learns from all the old blues masters from Chicago and the deep south. He respects and pays homage to the ground-breakers of the 1940s and 1950s. Even at 63, he knows where he is going because he knows where he came from. I tell my kids about Taylor all the time. I want them to understand that success and originality rarely come easily. Its all about hard work and practice. I believe Taylor picked up a guitar at 14 or 15 and he still finds ways to wow an audience at 63. Age as they say, is all in the mind.



Stuyvesant Town/Peter Cooper VillageWe have seen a massive transfer of private debt into the public arena during the past two years. Governments the world over have socialized huge blocks and market segments of previously held individual and corporate debt. Even the recent default by the borrowers on Stuyvesant Town / Peter Cooper Village will add enormous tabs to already bloated government deficits. High profile holders of the deal’s subordinated debt and equity include sovereign wealth funds and banks that are assumed to be backed by Uncle Sam and his overseas cousins. Of course, the taxpayer is always left holding the bag. The alternative (let the banks go bust) could have been worse and I guess and hope that we never will know. Markets are rightly worried that these policies will ultimately lead to hyperinflation or staggering devaluations of the major fiat currencies. What is missing from the recent discussion is that all this may be very good for government and high quality agency bonds! It is the other side of the hyperinflation / devaluation argument.

Governments the world over can and may raise taxes and cut spending. Team Obama has already proposed spending freezes to limit and ultimately reduce the deficit. Sure, it tough to put your faith and money behind any politician but we have already seen a massive tightening of policy. Proposed curbs on bank activity, bank restructuring and enforced sovereign fiscal discipline (e.g., in Greece) and higher taxes. Confiscated wealth may ultimately compress economic activity and lead to less red ink for government’s budgets. Sure it is a long shot but it is certainly one of many potential outcomes. The point is that the last two years were all about adding support and liquidity to financial sector. The next two may be about reversing that support. If that the is case, you want some bonds in the box.



NavyHappy 4th of July to all. My son Charles entered the US Naval Academy at Annapolis a few days ago. Induction Day is a somber and dignified occasion for new recruits and their families. Its nerve raking as well, particularly for the young men and women that commit to honoring and protecting the US Constitution for the next nine years of their young lives.

This weekend, I am going to have a few beers and sweat out the Yankee games hoping that they can keep pace with the enemy to the north. Its pretty comfortable for me and my family but please take a moment to reflect that we are a nation at war and there are many young people and their families that have more serious thoughts on their minds.

Photographs of Induction Day are available on the Naval Academy web site . We were lucky enough to have our son pictured going high and tight.

Steve Leslie replies:

I am proud to be in a country that allows you to say God Bless You and God Bless America.

Congratulations on your sons induction into the Naval Academy. I am sure you are extremely proud. This is truly a remarkable accomplishment as admission standards are so high and applications approach over 12,000 men and women with only 1400 slots available.

My family has maintained a residence in Annapolis for 20 years and I have had the pleasure of visiting the academy on many occasions. There are some extremely interesting and fascinating things to see and do around the Annapolis area and I would strongly encourage everyone who can to visit Annapolis at least once to get a sense of the history of the place. It is situated in downtown Annapolis directly on the harbor and Chesapeake Bay. A truly amazing location. Some terrific activities to attend are the Herndon climb where 1000 plebes attempt to climb the 21 foot tall monument greased with lard. Also one should see the Bancroft Hall the worlds largest dormitory and King hall where all midshipmen are fed simultaneously 3 times a day.

Washington D.C. is a 30 mile train ride away and a side trip to downtown would be in order. I recommend the Museum of American History to view the star spangled banner. My personal favorite is the display of American coins and currency. It is inconceivable to visualize the enormity of the Smithsonian museums and the various artifacts on exhibit. No trip or education would be complete without a visit to the Lincoln Memorial. There one can stand on the steps where Martin Luther King Jr. gave his I have a dream speech, and gaze across the reflecting pool toward the Washington Monument. Farther off in the distance one may see the Capital building. The Vietnam Veterans Memorial is on the left of the pool . The Korean War Memorial is on the south side of the reflecting pool.  The National Zoo is just north of DC. One can see the Chinese Pandas on exhibit. A short drive and one may visit Arlington Cemetery in nearby Arlington Va.

Every child in America should have the opportunity to visit Washington D.C. at least once in their life.



 The market contest on Friday, December 5th had all the elements of the greatest contests played out in our favorite sport or war. The Lakers versus the Celtics playoff or the Memphis Tennessee NCAA championship, or the New York Giants win over the Boston Patriots or the Tiger Woods - Rocco Mediate or Roger Federer - Rafael Nadal match of this year — or from previous years, the Ali - Foreman boxing fight, the Giants versus Baltimore Colts Super Bowl, or the Dodgers - Giants pennant playoff. The Borg - McEnroe match, as does the battle between Achilles and Hector in the Trojan war, comes to mind. (I would be interested in some nice additions to this list).

It had everything. Magic and disbelief. A beautiful exposition, climax, and resolution. A complete recapitulation of the range of the previous week, a 8% move in the four climactic hours, 880 to 813, in just one day, an earth shattering opening of down 3%, the fourth such 3% or more in five days, a buildup of tension with the worst employment report ever, the lowest oil price in 4 years, the lowest bond yields ever, all following by a day the backdrop of the NBER finally calling it a recession, retail sales falling off a cliff, and news that the automobile bailout was going under and over, the steady drumbeat of negative reports and news, building up to a climax when Hartford forecast better earnings and rose 100%.

The resolution of the climax occurred in the last hour as if following a script from a great story or symphony with the market rising to the week's high, very near the magic 900 level that it started the week at. One should note "that with long term interest rates at 3%, ceteris paribas, the value of mortgage assets held by banks has to have risen by 100% from the levels of a year ago when 6% long term rates were the norm. This has to counterbalance the increase in default rates to a large extent, and increase the return from holding mortgages so that they're much more attractive than most say they are. This has to be counterbalanced by the acceptance by the populace of an industrial policy program by the US, as if the public servants are a better steward for our money than the hedge fund managers, and investment advisers. And the idea that spending on building roads and computerizing hospitals, and making public buildings use solar power, and have grassy knolls and bicycle racks (as Henry Gifford has limned) is a better use for creating jobs than what would have emerged from allowing voluntary exchanges and incentives to take their course. I can only sit back and say, "what a great game it was" after pointing out that the decline in interest rates has to be remarkably bullish, and I predict a Lobagola move back up.

Alan Millhone adds:

On Friday I noted the Market was up even with dismal job reporting. I heard something about a job lost in the US every five seconds! I hope we see many more up tic Fridays as the US economy improves.

You show many comparisons based on battles in sports, the ancients, etc. Makes me think of our national Checker Tournament of 2007 held in Vegas at the Plaza Hotel. The Master's group battled all week back and forth on round points and on the final day of play it boiled down to Dr. John Webster of N.C. and Lubabalo Kondlo of South Africa fighting for the lead. After the last round was played and the smoke cleared we found that both men had the same match points. The referee was Tim Laverty and Tim keeps most meticulous hand written records all week of the player's scores. After careful mathematical calculations it was determined Lubabalo won the Masters and the ACF National Championship by one honor point! Another thin skin of the finger example.

Edward Talisse remarks:

Lower mortgage rates are a boon to the homeowner but a nightmare for the banks. The banks are all short refinancing options as rates move lower and reinvestment options are limited. The banks make money where they underwrite new products. Also, loan assets are on accrual basis rather than mtm so until the securitization markets reopen, its tough to lock in gains. Lower leverage will cap ROE, so if we move back up, it won't be the banks that lead in my view.

Craig Bowles writes:

2008's rallies have come after basic materials and energy have become the weakest sectors and that happened on Thursday when viewing short-term growth rates. Interest rates have shown a lot of relative weakness to stocks, so can move up a bit without being a problem. One fundamental change is inflation indicators have fallen earlier than in the 1973-75 recession. Generally, economists are focusing on economic negatives but none is talking about the positives of low prices. There aren't many economists around who talk up Austrian economic theory anymore which is probably why they all focus on stimulus to support prices rather than the positives of less inflation and declining prices.



magWould it be wise to speculate a little now consciously in the investment account in which bankers were speculating so unconsciously and so unwisely in 1929?

That's from the May 12, 1933 issue of "American Banker". I guess most bankers answered a resounding NO back in 1933 just like they are answering today. That quote reminds me of a little anecdote from a few years back . A Japanese fund manager was greeted with resounding ridicule when he talked about the Japanese approach to buy stocks only when prices are rising aggressively rather than waiting for a market drop. His reasoning was that buying stocks with rising prices will insulate the portfolio manager from criticism if he should fall. The portfolio manager could easily justify his buy decision by stating that everyone was buying and he was just part of the herd. If the manager bought a depressed stock that fell further, he would be accused of individualism and subject to scorn. It always amazes me how circular the world is. Today's chumps are tomorrow's heroes. Be humble or prepare to be humbled, as the saying goes.



skullI note with a certain degree of gallows humour that today's villains are highly regulated institutions like commercial banks, insurance companies and broker dealers. Ten years ago, the LTCM debacle had the wolves crying for greater regulation and transparency of fast money. Now the hedgefund community is relatively healthy and will attract huge inflows once the dust settles. The key is that most are not publicly traded (though some are) and have reasonabe lockup periods and few disclosure requirements. In short, they are nimble. The big boys lke GS, MS, JP etc… insist on being global banks and hence require massive amounts of capital accessed via the capital markets. I wonder what Mr. Market will think is the most appropriate market intermediation model 10 years from now?

Philip McDonnell adds:

Regulation is a dirty word to most free market fans. It always entails cost, both to the operating businesses and to the tax payer. After all running a regulator involves an expenditure of public dollars. Having said that some sort of independent oversight is necessary so that the con men and charlatans do not dominate the market place.

However a large part of the responsibility for the current financial crisis can also be attributed to the current regulatory environment. In particular FASB, the Financial Standards Accounting Board changed the rules in the middle of the game. FASB promulgated that the banks had to revalue their sub-prime assets this past summer. Particularly hard hit were the securities which had to active markets. The net result is that banks which were caught 'holding' found huge swaths cut out of their portfolios. This was true whether or not the underlying mortgages were performing or not.

Strictly speaking FASB is not a government entity but it is as least partly government funded. The directors include people from government and the private sector. Mainly they are accountants.

What is needed in the current environment is less restrictive regulation not more. If anything we need to undo the draconian measures which are killing bank asset valuations. To be fair FASB is now quietly revising its earlier directive of only 90 days ago. The original directive was undoubtedly intended to strengthen the banking system. Yet the proximate result was to topple the House of Morgan and WAMU and to bring the entire banking system to the precipice within 90 days. What were they thinking?

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

Stefan Jovanovich responds:

The House of Morgan" would, by Morgan Sr. and Jr. and Mr. Peabody's calculation, be J.P. Morgan Chase, not Morgan Stanley. The idea of looking elsewhere for the funds to support your positions in the market would have seemed to them incredible; even as a market maker you always had to be in a net cash position. (The reason Ron Chernow's book on Morgan is good only for pulping, in spite of the author's extraordinary industry, is that he can only see the Morgan Bank with modern eyes. Whatever Morgan, Peabody and J.P. Morgan & Co. were, they were not a 19th century Bear Stearns with the added advantage of being Episcopalians.) The Morgans and their original partner would have found the Treasury's current rescue plans to be fundamentally wrong-headed. They would have wanted the Federal Reserve and the solvent member banks to buy the failing and failed banks' non-speculative liabilities - the savings and transaction deposits - and left the shareholders, derivative claimants and creditors to liquidate the assets on their own, with or without the help of the bankruptcy court. M Sr.,M Jr. & P would have scoffed at the idea that governments should, would or could reset asset prices in the midst of a panic by writing checks based on their ability to issue sovereign debt. That fantasy is one that only the 20th and 21st centuries have accepted as wisdom.



CramerMany signals abound that selling may soon be exhausted. Add to the growing list the TV channel selection list in my local gym. I'm told that two years ago many patrons complained about the lack of CNBC or Bloomberg News on the large flatscreens at my Park Slope gym. Now, those channels and other business channels are being banned. It seems the aerobic hipsters prefer ESPN and Seinfeld reruns to the daily blight offered up Cramer and Co.

I, like everyone else, am dumbfounded by the violence of the selloff and the near universal Armageddon sentiment. Stocks are proving to be one of the few examples of positive price elasticity of demand. Prices fall and demand collapses whilst rising prices lead to higher demand. I'm sure it has to do with some sophisticated utility theory. I wonder if the universe's greatest certainities are calamities (war, poverty, famine etc…) or can we still hope to overcome the odds? I'm banking with the optimists but is really tough going.



dartsDarts is a very interesting and enjoyable game. It is like other games that on the surface appear very simple. However, proper study and mastery of this game can go very far in the advancement of the good speculator.

The sport of darts began during medieval times in England. It began as training in the martial arts. It was seen as an alternative to the use of arrows and archery to be used against its adversary. Henry VIII was an avid practicioner of the sport and through the aggressive expansion of the British Empire it eventually found its way to the United States and around the world.

Around 1900, darts began to become formalized as a legitimate sport with specific rules and regulations. The two most popular forms of the game are 301 and cricket. 301 is the most obvious. Each player starts with 301 points and aims to reduce his score to zero. He must initiate his scoring by hitting a double. Then his score is quickly reduced to zero. The game ends when the player's final score ends on zero exactly by "doubling out" or hitting a bullseye.

Cricket is a more intricate game requiring skill and strategy. It uses the numbers 15 through 20 and the bullseye and by progression of hitting points, doubles and triples, the winner emerges.

The beauty of darts is that everyone can participate, man, woman and child. It requires very limited space. Dart leagues are a great way of socializing and meeting new people. It is also a great pastime, to share a pint and discuss the news of the day.

Various skills must be incorporated to become a good dart player. Focus, attention to detail, and strategy are very important. A basic understanding of mathematics is involved. However there is a far deeper aspect to darts. This is the mental part. This is where the player must incorporate the mind along with the body to develop a balance. A zen-like peace. Once the dart thrower learns the technical aspect of the game, he must learn to release the physical part to allow the mind to take over. Relaxation techniques along with proper breathing are also valuable tools.

It is through this merger that the dart player finds success.

Edward Talisse remarks:

Daily Speculations has benefited from lessons in chess, checkers, surfing, baseball and other competitive pursuits. A comment about darts was overdue in my opinion. Like others, I fell in love with the sport during my university years and largely played in pub settings. It's a great way to meet new people and get the competitive juices flowing. There are many variations of dart games. For example, 501, 301 and Cricket are all played differently in the UK, Australia, France, Japan and the USA. I've played in competitions in each of these countries and am always surprised to learn about local variations. Preparation definitely counts. Also, I have found it pays to be aggressive. Go for the tough shots first and leave the easier ones for the close. Most players close the easier shots first and leave the difficult shots (like bull's eyes) to later in the match. Its the same with trading and investing. I think putting your upfront energy and effort into the most difficult tasks is the best strategy.



This story just hit Bloomberg news service ("Spanish Treasury to Exclude Italian Government Bonds"). If true, it represents a real threat to the long term sustainability to the European monetary project. The credit crisis, strong euro and slowing economies are finally starting to test the patience of European policy makers. Since the inception of the Euro back in 1999, European Central Banks never distinguished between the credit quality of the various European Sovereigns. That meant that Italy for example could raise funds via debt issues at terms close to those of Germany even though Italy's financial house is in very different order from that of Germany. It was a classic misallocation of credit risk. That's all set to change and Italy's funding costs could skyrocket. Belgium, Portugal and Greece and potentially all in the same pickle. The immediate trade that comes to mind is to short Italian debt versus German or shorting the Euro, which is perhaps the most overextended against the Yen.

John Floyd adds:

All that makes sense. Italy has lost roughly 30+% of competitiveness over the past few years and has also, wisely, extended their debt maturity, not to mention their other weak macro fundamentals. The extended debt maturity would also, should they choose to do so, make it advantageous for them to leave the Euro. The sovereign spreads are all still priced fairly tight with 50 bps of each other for 5-10 year maturity. Compared to where Italy, etc. were during the EMU crisis at many hundreds of bps. I would consider higher grade corporate to be long against short the weaker sovereigns, this also has positive carry.



We have a two year low for the German Bund contract, the second or perhaps biggest futures contract in the world by volume (notional value). What could have changed to make the prospects so bad relative to the past over the next ten year horizon? I note this from a speculative context and seek qualitative insight.

Eastsider replies:

1) There had been a macromeme along the lines of: Europe is behind the US in this economic cycle, and the ECB will have to cut rates soon… Trichet's hawkish talk a couple of weeks ago triggered a stampede unwind of that trade rationale.

2) Reports of massive derivative/structured note plays on the Bund curve likely getting tripped too.

J. Rollert adds:

Inflation is high with a strong currency, yet if it regresses back to mean modestly the inflationary pressures will increase.

Double whammy… to bunds. Also foretells major political battle.

Edward Talisse writes in:

I traded bunds for many years whilst working for the blue shoes in London. ECB chatter is obviously hurting sentiment there but something more interesting is also afoot. The bund curve is close to inverting between 10y and 30y. This is a highly unusual situation in Germany where the curve generally remains steep though various cycles. The rub is the structured product market in Europe, which is absolutely huge. Most interest rate derivative notes are written on the back of a CMS (constant maturity swap) structure. The holders of the notes basically sell volatility to earn above market coupons. The problem is that as the curve flattens, CMS gets absolutely killed. So there is a big demand in Europe right now to get into long dated flattening trades. That means people buy 30y and sell 10y, thus depressing the bund future price. 



T WTiger's accomplishments are truly remarkable. He is perhaps the closest illustration of professional perfection that we have witnessed in our lives. There are countless untold stories of achievement in many walks of life and of course, we can only admire and measure those we are familiar with. However its difficult for me to imagine such consistent and near perfect performance achieved under such highly visible pressure.Tiger frequently separates himself from the competition by his degree of mental toughness. I wonder how we can measure and learn that skill?

Like other readers of this web site, I try my best to be a role model for my four children. We are a tight knit family drilled in the arts of preparation, practice and discipline. Tiger Woods, Rafael Nadal and Roger Federer are the best illustrations of what an individual can achieve. There is no shortage of good role models.



JasonI've been re-reading parts of two terrifically enlightening books on the Federal Reserve this week, "The Creature from Jekyll Island" and "Secrets of the Temple".

In the course of my review, I was reminded of a gentleman who once was the head of the Federal Reserve System who believed in sound money and hard banking, William McChesney Martin. Appointed by Truman in 1951, Martin would last through 5 Presidents, finally retiring in 1970 during the Nixon administration. A Yalie that had concentrated in English and Latin, McChesney Martin had deep family ties to the Federal Reserve. His father, William McChesney Martin Sr., had been both the Governor then President of the St. Louis branch of the Fed as well as helping to craft the original Federal Reserve Act of 1913. Junior himself was instrumental in the 1951 Accord, the agreement that is seen as re-establishing the Fed's independence.

Harry S. Truman thought that by appointing Martin Jr. to head the Fed, he could over-ride the agreement. Despite being a Democrat and growing up in the bosom of the private-public power duopoly of NYC and Washington D.C. elites, William Jr. did not play ball. Instead he ran monetary policy in a strong, counter-cyclical manner and was very mindful of inflation - refusing to return to the practice of debt monetizing as Fed Chairman Eccles had been apt to do.

He was a hard-nosed real money man who lectured Congress sternly on what he saw as excesses in spending and a growing lack of appreciation of the two-sided nature of capitalism. In August of 1957 he told the Senate "We are dealing with waste and extravagance, incompetence and inefficiency; the only way we have in a free society is to take losses from time to time. This is the loss economy as well as the profit economy."

50 years hence the man that occupies the seat at the head of the Fed's table is completely devoid of such character. Instead of warning Congress that inflation causes mal-invest, encourages excess speculation (NASDAQ, real estate), and particularly afflicts "hardworking and thrifty… little man on the fixed income who could protect neither his income nor the value of his savings. Often, he was also the unemployed victim of the collapse", B.S. Bernanke recommends easy money and opening the spigots of government largess.

The history of the Fed is intriguing and insightful, giving generous lessons to those that would heed such knowledge. The obvious message today is that the current Fed is much like that of Arthur Burns or George Miller, men who would quickly acquiesce to the whims of politicians. In stark contrast to William McChesney Martin, Benjamin Bernanke wants to be loved and accepted and is willing to commit grave errors in monetary policy to achieve that aim. Speculators and pensioners beware!

Edward Talisse adds:

The most recent offering of Grant's Interest Rate Observer includes a witty cartoon. A local motorist pulls up to his nearest filling station and exclaims to the station attendant that "the recent price increase in gasoline is outrageous." The Greenspan-Bernanke schooled attendant coyly replies "yeah, but is not a core increase!" Correctly assessing the medium to longer term inflation outlook has always been a key to investment success and preservation of wealth in real terms. The problem is that inflation forecasting is a tall order and even the pros cannot agree on an appropriate methodology. Today's CPI readings are met with much cynicism and skepticism. The bond trader's lament "that of course when you take out everything that went up, it goes down! Anyway, here is a PDF that explains the difference between the CPI and the PCE. CPI typically runs higher than PCE. Chose your poison carefully.



JGB (Japanese Government Bonds) futures were limit down on Friday, after CPI was confirmed at a rise of 1.2% yoy. CPI in Japan includes energy, so the rise was widely expected. Nonetheless, bonds were crushed. Indeed, since the recent peak of bond prices in Japan, which followed the Bears Stearns news, JGB futures have fallen close to 7 full points. Each point represents about 9.2 bp of a 10 year bond yield. Given the extraordinary low level of rates in Japan, such a move is unthinkable in percentage terms. Heres the rub: prices in Japan, excluding food and energy, akin to the USA CPI measure, rose just 0.1% yoy. Wages are declining and consumer spending is flat-lining, so it hard to see a real inflation problem arising here anytime soon. I am not a long term JGB bull, but if you think stocks are temporarily overbought and bonds oversold, then JGBs represent a great trading opportunity. Be careful though. The contact size of one JGB future is approximately 10x the size of an equivalent CBOT USA 10y future. JGB fututues are listed on the Tokyo Stock Exchange.



It is interesting to observe all the hot headed banter of late about the transparency and accuracy of the daily Libor fixings. SMR, Wilmott, Bloomberg, Reuters and even the esteemed WSJ have picked up on the story. The fixings are published by the British Bankers Association (BBA) each day at 11:00 am London time. The current rub is that the fixing panel is artificially setting Libor too low in order to mask rapidly rising inter-bank borrowing rates. The Libor fixings are extremely important and represent the floating cost of a three or six month swap versus a fixed rate. It's a huge market in the USA, Europe and Asia. Manipulating Libor is as old as Stonehenge. Why would anyone be surprised that banks set Libor at rates favourable to themselves? The spread between Libor and official central bank policy rates are near all-time highs globally. That means that central banks have yet to nail and close the current credit fiasco.



This price movement of June bond futures on the morning of Apr. 23 taught me a lesson.

From 7:52 AM to 8:55 AM (slightly over an hour) the market went from 111-10 to 111-01. During this period it traded 19,459 contracts. There were no announcements during this time frame.

Then from 8:56 AM to 9:57 AM the market completely reversed its direction and went from 111-10 to 111-01, exactly where it began two hours previously. The additional contracts traded in that time frame: 20,469. Almost the exact amount as on the way down.

Why would market participants all of a sudden change sentiment, when there were no announcements? What makes participant bias change so abruptly without news?

Robert Ray replies:

A nine tick Lobagola? Take that same move from the perspective of someone that wasn't watching every tick and it would appear that not much at all went on as the price was the same two hours later. There is a meal here in how one perceives things.

Edward Talisse remarks:

This behavior happens all the time, not only in US but in Bunds and JGBs. It's the hedging of new issue deal flow. As corporate bonds are priced, dealers (read: swap desks) trade the order flow but usually end up flat. It has nothing to do with availability of new information.

George Zachar adds:

Deal flow is information, and gaming the hedges and their lifting is a major part of the debt market's micro-process.

Phil McDonnell explains:

A price quote is for a completed transaction. It is always between a buyer and a seller. So the number of buyers always equals the number of sellers — no exceptions. Only the price adjusts. So logically the number of long contracts equals the number of shorts always, all futures markets — no exceptions.

You can infer something about the initiator of the trade. He is often a market order coming from off floor. The market order will cross on the floor (or in a computer) with the current bid or ask. So a down tick usually means an off floor trade crossed with the bid. An uptick often indicates an off floor market order crossed with the current best ask. This is only the commonest case and must be tempered with the realization that limit orders will appear as bid/ask quotes as well and may be confused with market maker activity. Also you cannot know if open interest is increased or decreased by a single trade, but you can track it on a net basis over longer time periods.

Victor told the tale of the elephants always returning by the same path in his book EdSpec. It was a story originally told by Lobagola. The story holds true for markets as well. Markets tend to retrace the same ground — often many times.

Is there statistical evidence for this? One need look no farther than Doc Castaldo's recent post on the Pythagorean scale and markets. His data showed that markets exhibit small changes far too often for it to be chance. This is the salient feature of speculative markets. It happens all the time. Huge amounts of money are made and lost on the very numerous small change days.

Consider the idealized model of a market with a single market maker. He quotes 100 to 101. Someone sells to him at 100. So he drops his quote to 99 to 100. The very act of dropping the quote inspires more selling. He drops his bids to 98, 97, 96 then 95 in succession as more sales come in. His average cost is about 97.50. Now at 95 a funny thing happens. He hits somebody's threshold of pain, whose stop is executed at 95, and our market maker winds up too long. Now he holds the price firm or even raises it.

On the perception of firming or even rising prices speculators start to nibble. Our market maker now slowly raises prices back up to where they were before. Only this time he is supplying at the ask price. So he makes his spread which he tries to maintain at one point. By the end of the day the quote returns to where it was before. Our market maker has sold his inventory at an average of 98.50. The market has done a Lobagola down then up. The news reports the market was unchanged today and everyone yawns. But our intrepid market maker made his spread going down and then back up. He can afford to eat at Delmonico's yet another night.

Sam Marx adds:

As a former market maker on the floor, I can say that this description is a good approximation of what happens. That's why the distribution of prices is higher at the middle than the normal distribution. The market maker is more confident within the existing range.

Also, when there is an large influx of sell orders, the market maker steps aside, buying smaller quantities, a minimum number of lots at each lower price to perform his function, and lets the price really drop. When buy orders start coming in, or when the sell orders stop, he starts buying. That's why the price distribution is lower than the theoretical normal distribution a short distance from the middle of the curve. A leptokurtic distribution.

J.T. Holley extends:

I'm looking at long bonds today. The UK 50 year yields 4.1% and the French Euro 50 year around 4.0% Does this mean that the US long bond is going to 4%? Has anyone with a scientific bent studied/counted the ratios/differences of these instruments' yields?

Faisal Essa responds:

The UK and EUR long bonds are said to trade at those levels because of the local pension and insurance company law changes that have forced pension funds to match their long duration liabilities with long duration, high quality bonds. This has led to reduction in allocation to equities and a shortage of long bond supply relative to demand. To make matters worse, restrictions on currency exposure and derivatives overlays force the funds to stay in their own market rather than buying other countries' long bonds. This legal framework is quite unfortunate for Dimsonian pensioners.

This situation (along with changes in US pension fund law) does have some influence on US long bonds and long TIPS.

Charles Sorkin suggests:

If the media decide to exploit the notion that the American homeowner needs to be bailed out, bonds could fly. An interesting hedge (although extremely difficult to model and get the ratio correct) would be a short bond position hedged with long support-class POs. Difficult for the small investor to find, but some pieces have been floating around lately in the upper $30s to upper $40s on long paper. Such securities could return your principal within two years on a bond rally of 100-200 bps. 



The inaugural USA Treasury Inflation Protected Security, TIPS 3.375% 1/15/2007, will mature next week on the 15th January 2007. This is an important event and allows us to answer the question “knowing what we know now, was it a good idea to buy TIPS in January 1997, instead of the more widely available nominal bond?” To find out, I did the math (with the help of my colleagues). The answer, although not shocking, reveals quite a bit. Firstly, the nominal bond returned 179.93 per 100 invested. That is an annual return of 6.05%. By comparison, the TIPS bond returned 175.56 per 100 invested. That’s an annual return of 5.79%. During the period, actual annual inflation averaged 2.44%. The TIPS were initially issued at a break even spread of 2.875%, so it’s no surprise that the nominal bond outperformed. In early 1997, the market overestimated expected inflation by a whopping 43 bp on an annualized basis. More interestingly, it only cost and investor 26 bp annualized to buy inflation protection and diversification benefits (6.05% less 5.79%). That seems like a pittance considering what you are getting.

My main conclusions are as follows:

1- Break even inflation expectations are poor predictors of actual inflation, at least by the U.S. example, even considering liquidity and other preferences.

2- another way of looking at it is to say that the market ultimately offered a very generous 43 bp risk premium (term + uncertainty) on nominal bonds back in 1997.

3- From a trading and investment perspective, it seems to make sense to hold your inflation expectations static (say 50 bp in Japan) and vary your risk premium. Right now, the risk premium on nominal Japanese government bonds is slightly less than zero. It’s been as high as +50 bp just six months ago.



My idea is directed at fixed income types but should apply to other asset classes as well. Here goes:

Death of Salesman, RV Salesman that is: Most Relative Value (RV) ideas peddled on the street are not really RV trades at all. They are just another form of directional bets on whether the market will go up or down. And we all know that is pretty much random, at least in the short term. Can we measure how much “directionality” is contained in RV ideas? Sure. Simply look at the implied forwards against the current spot levels. If the spot vs. forward differential is anything larger than a normal bid-offer spread, then your RV trade is directional. Let’s look at an example. One of my favorite trades is the 5y- 30y swap spread in Japan. The spot spread was +135 on October 3rd and the 3m forwards implied a spread of 10 bp lower, or +125 bp. Ten year JGB futures, JBZ6 on your Bloomberg, was also a point higher at 134.61. Let’s further say you wanted to put $100,000 of risk to work on the 3rd of October. You either did 5y 30y spread for pv01 of $100,000 or you sold 119 lots of JBZ6. Today, the curve is 10 bp flatter and JGBs are down one point. So the PNL on both trades is about the same. But the return on the JBZ6 is much better since we used a lot less capital (leverage capital, and credit capital) to execute the trade. Further, the futures trade returns cash each day when there is positive MTM. So if you have positive expectations on your trades, and you should, futures are much better. You get to use the cash as it’s realized each day. How about a quick a dirty way to decide if an RV idea is better expressed by a simple directional trade? Simply divide the spot/forward differential by the RV Zscore. I call it the DZ score. A ratio of 1:1 is awesome but is tough to find. As the ratio moves further away from +1 it s gets harder and harder to justify an RV trade. The next time Mr. RV Salesperson knocks on your door, ask them how the DZ ratio looks. If it’s far from one, you’re better off kicking some futures around. This all comes down to the very obvious point that the amount of risk capital is potentially infinite whilst the amount of available alpha (sorry for the buzz word) is limited. It pays to be selective. Wait for the juicy pitch.

Ckin responds:

Some relative value terms that I often hear:

1. I can’t even create new bonds at this level!

2. This is the cheapest bond in my inventory on an option-adjusted spread versus libor.

3. That swap I proposed gives up 5bp in yield, but picks up 7bp compared to swaps.

4. This swap gives up 5bp, but you take out 4 points in cash and shorten option-adjusted duration by 2 1/2 months.



So these are my "Ten Great Observations about Big Bank Internships". Having just endured this miserable joke, I thought some of ye older and wiser specs would enjoy a laugh at my right of passage.

For a little context, I am studying a double degree in Law and Finance. I have been trading stocks and options since I was 15 and have been lucky enough to have some success largely because I have devoted myself to the study of what can go wrong in trading (i.e. studying crashes, crash/blowup participants, behavioral finance etc) rather than reading hyped up "How to Trade for Millions!" type tomes. As a result, I'm a quiet, introspective, respectful and humble kind of guy; so imagine my shock during my foray into Wall Street. These are my tongue-in-cheek observations of the whole internship joke:

If you have any kind of ingenuity or entrepreneurial pizzazz teamed with some market-taught smarts about you, you will instantly be ahead of the game. Paradoxically, this will do you no favors at all as an intern — most likely you will be ostracized for it. MD's do not like you consistently outperforming them, or poking a hole in their "Great Investment Thesis! ™" because you happen to internally appreciate the concept - and have first hand experience - of a Leptokurtotic distribution coming to bite you in the ass. Well, that or they have never heard of NPV. Or, disastrously, neither.

99% of "professionals" are deeply insecure about their views. Lean even moderately hard against any trader or sales person to good-naturedly criticize their idea or test their thesis and they will crumble. They will then lash out at you for being a dilettante amateur who has no experience of real market conditions. Best to just nod and smile at that.

Strange economic phenomena/paradox: Sycophancy is much more highly valued than skill / results despite its absolute and relative over-supply on grad programs. So much for Economics 101. Thanks University, for nothing.

It is difficult to respect men who plough their cash into limited edition Ferraris and long liquid lunches at the local strip club and then demand your respect for their integrity, decision making skills and level-headedness under pressure … when they are only five years older than you. I cannot predict the future, but I have never come closer to seeing a man's future downfall than when said MD buys a new Ferrari, then invites his desk to come down and look at it. Admittedly, we were all gagging to. But to then see his face flush with pride at us "ooohing" and "ahhhhing"….never has such a grin of self-satisfaction and hubris so clearly indicated a very hard fall just over the horizon.

As it turns out, reducing weeks of research / investment analysis down to a single Bloomberg MSG screen so as to explain an idea to someone who has the attention span of a gnat is a "value-adding skill". This is actually sensible. It is not particularly intellectually satisfying when you basically come up with 5 bullet points that say "Buy XYZ because a) it is going up (b) soon (c) because there are forces in the market right now (d) that will make it go up (e) er, that is it. Trust me on this one, boss." but it will surely give the illusion of you being a switched-on kid though!

Stupidity and Parochialism. It is what is for breakfast. I think a certain degree of stupidity is actually hoped for in intern traders. One's boss wishes to demonstrate his superior skills, knowledge and insight. He wants your fawning praise and wide-eyed admiration for his well thought out plan to buy oil because of Middle Eastern instability (yawn). At your suggestion that current prices may perhaps already reflect this not-exactly-cutting-edge bit of analysis, you are scorned and your tickets to the next big sporting event are given to your assistant.

Markets are correlated. Except as far as anyone on your desk is concerned. If your job is to trade energy closed-end funds, who gives a rat's arse if natural gas is rallying 50% in just a few days? (Seriously, this happened to me. I remarked that a strategy we had going on was going to be materially affected because of whipsawing energy commodities prices. I was given a curt "Don't care". They then scratched their heads at the next NAV report and wondered why they did not see it coming.)

Have a clever arbitrage idea that you have painstakingly modeled, backtested and synthetically traded? It works? Great! Do not tell your boss. Just go start your own hedge-fund.

The bad bosses cannot stand to admit you might know something more than they do and just squash you. The good ones just steal your idea as their own. This is fine. Infuriating, but fine. The good ones will at least admit that your idea "was, in fact, good" to you before doing you over. At best, you will get a promotion, or not be as disappointed with your bonus. Such is the price of rising the corporate ladder, apparently.

Internships are a waste of time. Why spend millions on campus recruiting, throwing cocktails and dinner in nice hotels round the City, making you have thirteen interviews and cause kids deep anxiety about achieving a 3.8 GPA from the University of GreatMerit just so you can do what any 15 year old high school cheerleader could do? Because getting initiated into a culture of self-importance, delusion and self-aggrandizement is a must if you are going to last on Wall Street baby. All the recruiting propaganda about integrity, results-driven cultures, entrepreneurial environments, etc., etc. is just a joke. In reality, desks want frat boys. This is fine, just do not lie about it! Save your shareholders some money and openly do your recruiting on Facebook — most of you do anyway

Bonus: If who you are is synonymous with what you do… I cannot wait to trade against you.

Edward Talisse responds:

What an erudite and illuminating essay! Ned luckily caught on quickly. It took me 20 years to figure out the ins and outs of the Street. Maybe I can help by offering mid career types some observations after a long career at the bluest of the blue blooded trading firms:

1. There is massive confusion and misunderstanding between the concepts of skill and luck. Traders which collected bid-offer spreads for years discovered the painful truth once dealing spreads collapsed. They are left with no skill and no luck. Make sure you always study and keep ahead of the pack. Don't count on luck.

2. Pay and promotion is solely based upon current performance. It has nothing to do achievement in relation to opportunity or potential. That's why turnover is so high on the street. Get yourself in the best seat. Go for the hot areas if you want the highest pay.

3. Senior management generally does not know the difference between risk measurement and risk management. Middle office risk monitoring functions are not involved in the business. They simply are there to provide regulatory and legal cover when something goes wrong. You need to be your own risk manager.

4. There are very few real risk takers at the big Banks. The real emphasis is on collecting fees, collecting bid-offer spread where available and front running large client transactions. The real risk takers are purged at the first sign of trouble. The best ones go to Hedge Funds. Get out if you really believe you are a great risk taker. There are fewer constraints and bigger rewards outside the big Banks.

5. There is no more lethal combination than ignorance and arrogance. It usually leads to disaster. You'll encounter plenty of people with that combination. Avoid them like the plague.

6. You have to manage your own career. There is no real mentoring in the big Banks. Turnover is just too high. Beside, your appointed mentors are too busy worrying about their own careers to help you with yours.

7. There is a shockingly low level of basic finance knowledge in the big Banks. Sure there are plenty of very smart people in the banks but there is an abundance of knuckleheads too. It's about the appearance of knowing what you're talking about. Accountants call that form over substance and it's a great skill to have on the Street. Learn to shoot the bull.

8. It's important not to overstay your welcome. That was my mistake. I turned down repeated offers to sign on with smaller less "prestigious" firms. I still regret those decisions. Go with the Firm that best allows you to develop your skills, not the one that looks best on a business card.

9. Take advantage of everything the Bank can offer you, particularly ex patriot assignments. The experience may change your life and there are enormous opportunities for personal betterment.

10. Don't dismiss back office jobs. They are well paid and you can sleep at night. It's an annuity and you can ride the wave for many years with little or no pressure.

Honore de Balzac, the famous French author, once famously quipped that "behind evey great fortune, there is a crime." I think that is only partly true. Rewards will always be there for diligent, hard working risk takers.


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