Everything was ready [for Eurozone economic recovery] but now Greece's blackmail threatens to blow up the party.

The situation with Greece seems about to escalate, at first I thought it was a way to buy time until after the May election, but the level of confrontation continues to rise day after day, both from European countries and from outside ( even from warren buffet and his dog, when warren will be food for worms .. Greece will still be there ), now there are hints of the exit of Greece from the euro. The substance is that they do not trust Tsipras, whose blackmail if followed by victory would be a negative signal, a bad example. EU will try to worsen the situation in Greece until new elections in Greece (…?) and replacement of Tsipras with politicians more willing to impoverish the Greek people at any cost . It seems another Lehman and it seems that Europe is willing to risk this poker hand.

So Greece will be "saved" despite everyone knowing the country can never repay their debts. The Russian or Chinese threat is something far worse than $ 300 billion of Greek debt. Which says a lot … about the debt of nations!

 Andrea Ravano replies:

I don't think the World's Nations are supposed to repay their debt, but to roll it on; the European  liquidity crisis which arose after the Lehman collapse is a clear example of lack of re-financing of existing debt. I think we must examine the problem of debt in these terms, not in terms of repayment.



I would like to share some thoughts regarding present and past market correlations. One of my mother's sisters, aunt Franca, spent her life with my grand father, taking care of his many vices. She used to tell me that to have an edge on events they used to check share activity in Textiles and Heavy Industry in order to anticipate probable war declarations, or military activity. The rationale is clear.

The government ordered uniforms and mechanical spare parts before undertaking belligerent efforts. The same went for paper and other similar indicators that showed some kind of economic activity. For this reason I have given a look, first at the long term graph of copper, then added the S&P index.

The resulting picture gives an idea of a total and sudden decorrelation of the stock market and price of copper since mid 2011. I'm sure that better statisticians will be able to justify such a strange phenomenon: economic prosperity and declining raw material prices.

And mind you, not any raw material, but copper, the dear metal, the center of the electronic and electric universe. The S&P has risen roughly 49 percent since September 2011, while Copper (COPA LN bbg ticker, etf quoted in $ in London) has lost 22 percent in the same period.

The visual shock is, of course, much stronger than the raw numbers. Is this predictive of a market correction?

Not sure about it, although the crowding effect of larger and larger troops of SPU bulls give me a chilling feeling down the spine and the uncomfortable "dejà vu" state of mind.

Alston Mabry writes: 

If one were to search the interweb for the "copper, china, collateral", one would find several stories claiming that copper is used as collateral in the "shadow banking system" in China and that sharp moves in price are due to such stores being liquidated.



 It should be obvious to all speculators that truth lies underneath a thick layer of dust. Much like Michelangelo's idea of sculpting, which relied on "Per via di levare" (By means of taking away, translated), we should make all efforts to see the idea hidden in Michelangelo's marble.



 Thanks God the panic indicator is back!

The telephone started ringing early in the morning with frantic if not fearful voices of all sexes, inquiring if it was the right moment to dump Asian, European, American, shares, Oil, Natural Gas and start investing at zero percent on Swissie and JPY. As the trading day went by, along with the Dax 30 down 5.5 percent, down went the tone of the panicky voices and up the inquiries to sell.

To say the absolute truth, one does not yet own the Magic to foretell future with unfair odds, but some gut feeling mixed with reasoning as to the speed of the sell off, yes, that we have. Thus the perfect buying moment came as the "oneandonly" came in asking in despair what I thought of the Japanese Market. Indeed, it was not a question. It waited no answer, as I tried to calm the chap down and work out some figures and logical thoughts about NIkkei, and stock markets in general.

Yet, everything to no avail. The answers were already built in by the fear of further losses, irrespective of the possibility of cane buying or economic prospects rosier than these sad times are telling us.

Probably some bottoming out process will have to take place before we can ring the "all clear" siren, but one first, small sign was visible in the depth of the fearful investor's eye.

Steve Ellison writes: 

Recently I reread "A Specialist in Panics". The author recounts:

As a constant reminder I printed a sign with my name at the top and beneath the words:

Specialist in Panics

Below I put this query with a blank space for the answer:

Question: Panic Today?

Answer:  ____________

I decided to buy only when I could truthfully write yes as the answer to the question.

For the first time in 2011, one might have answered yes during the last 24 hours.

Ken Drees writes:

This reminds me of Justin Mamis' work– paraphrasing here:

Buy only when your hand is trembling with fear as you can hardly pick up the phone to call your broke.



Today it will be another fight between the almatarians and the reversalists. Last month, it was a massacre in favor of the former.

Andrea Ravano writes: 

Doomsters on the run advising on "how fearful this market is". Surely, they will be right sooner or later, unless of course they have some leverage in their positions. 

Victor Niederhoffer writes: 

I am on the run.

Steve Ellison writes:

As I noted when I studied the almanac effect a month ago, the almanac has only worked well in 3 of the past 6 years, and it had a good year in 2010. I have a hunch the introduction of the Barclay almanac fund may be a turning point.



Greek Temple at AgrigentoGreek and Portuguese bonds are in a nasty spiral. Very little seems to be working in terms of convincing the markets to mop up some paper. Greece 3.7 2015 is now trading 86-86.5, yielding approx 6.6 pct and some long term Portugal bonds are down a point or so since yesterday. I don't think Europe is in any way capable of rescuing Greece, or anybody else for the matter; the virus will soon spread to Italy, as it suffers from the samle chronic high debt to gdp ratios as the afore mentioned countries. Thus the trade of the day could be long Bunds short Btps.

Jeff Rollert writes:

Would it be unreasonable to compare the inability of any country to act as the world's military police, and in a similar sense, one country being the worlds bank?

Seems like the ECB built a wing on their house with wood full of termites.

I've always enjoyed the science fiction writers observation that the world will never unite until there is a non-Earth threat. Perhaps that includes monetary unions.

Alston Mabry writes:

It used to be so simple: The Greeks would have a crisis, the drachma would fall, and the Neuro's would swarm down for sun and fun and economic stimulation. The Greeks then took the extra money and started another story on the house because they knew that keeping the cash was not a good long-term investment. You'd see half-finished buildings everywhere, bristling with rebar — just the local version of a savings account with a currency hedge.

Bruno Ombreux adds:

Have you been to Athens recently? That's exactly what they have. Half-finished houses. They don't even bother covering the concrete. I was told that it was for tax reasons. As long as the house is unfinished, there are no real-estate taxes. So they don't finish their houses. This is very creative.

Jim Sogi replies:

Same thing in Peru.

William Weaver comments:

I didn't attend either event, but I remember in 2003 when Athens hosted the FISA Junior World Rowing Championships and then in 2004 Olympic Games someone made a comment about how clean everything was. It wasn't until about a week into Jr Worlds that someone finally noticed the grass on the sides of the highway between the athlete village and the rowing venue wasn't grass, but a green tarp covering heaps of trash.

The state of the art rowing venue is to my knowledge abandoned today. It was also only finished one week prior to Jr Worlds, and no one thought to anticipate the mid-August winds that sweep the city. The winds created such waves that the Men's eights heats had to jump ship and swim their boats between 500m and 1000m to cross the finish. Finals were reduced from 2000m to 1000m. The Games were lucky and didn't have this problem.

But what about selecting cities in order to build athletic facilities that will help the community in years to come? I wonder if there is been any research regarding future price performance of munis issued to build venues for Olympic Games. Most venues go unused after the event.

Henry Gifford adds:

Another reason for the rebar sticking out the tops of buildings in some places is that they expect to build the building taller later, when money is available, but without a mechanism for collecting on debts there is little money available for lending, thus things tend to be paid for in cash, and built gradually. Here, with loans available, that strategy doesn't pay as well as borrowing the money to build a property to it's "best" economic use, as the cash flow is much worse on a partially built-on property - same land taxes, same land cost, lower return, higher hassle/permit costs for repeated small construction jobs.



 Approximately a month ago, more than an eyebrow was raised when Fiat said it would enable Chrysler to access its technology. I would like to remind us that the revolutionary "Common Rail" system for diesel engines was invented by Fiat's "Magneti Marelli" and later sold to Bosch which has, until today equipped some 50 milion engines around the globe. Today Fiat anounced the launch of an engine that can virtually burn almost everything from gasoline to ethanol to diesel etc. The engine is being presented at the Geneva motor show. I link an article from Italy's major newspaper (Corriere della Sera) albeit in Italian, sorry for that.

John adds:

Here is a link in English.



21, from Steve Ellison

October 27, 2008 | 2 Comments

 I enjoyed the movie "21" about students at my alma mater counting cards at blackjack. The main character, Ben Campbell (loosely based on the real-life Jeffrey Ma), catches the attention of his math professor by correctly answering the question that has been discussed on this site about whether it would be advantageous to change one's door selection in "Let's Make a Deal" after being shown what is behind one of the other doors.

The movie has many applications to speculation. The professor recruits Ben for the blackjack team because he believes that Ben will make decisions based on statistics, not emotions. Ben is reluctant to join, but is desperately short of funds for medical school. He decides to join, but only for long enough to earn the money he needs.

The professor tests Ben by having two men suddenly throw a pillowcase over Ben's head in the midst of a game at a Boston Chinatown gambling den. The men drag him into a back room. As Ben protests, "Let me go! I haven't done anything!", the men demand, "What is the count?". Ben answers, correctly, "Plus 17". The men remove the pillowcase, and Ben sees his professor, who says he had to test whether Ben would remember the count even under great stress.

Later, the professor says, "Remember, Ben, this is a business. It is not gambling. In the excitement it can be easy to lose your head. You will not do that."

To avoid detection by casino managers determined to prevent card counting, the team uses elaborate methods of deception. All the players have assumed names and fake IDs. One team member plays, betting only the minimum. When the count becomes highly favorable, this drone player uses a gesture to signal the big player, Ben, to come to the table and place large bets. The teammates act as if they do not know one another, but the drone makes a casual comment to the dealer containing a code word to convey the count to the big player.

As Ben consistently wins, he becomes hooked on the game and keeps playing even after he has enough money for medical school. He betrays his friends, fights with a teammate, and finally lets his emotions get the best of him at the blackjack table, losing $200,000 in a night. Meanwhile, a casino enforcer determines that Ben is a counter. It all makes for a thrilling climax.

Charles Pennington writes:

They made a few hundred thousand dollars in Vegas, and that's a story worthy of a $35 million dollar film that grossed $150 million? They made real money snowing the public, not the casino.

Chris Cooper says:

Prof. Pennington is, of course correct. It is worth mentioning that casino gaming has served as a springboard into trading and speculation for many, who have become much more successful in that arena than they ever could have been in the casinos. Ed Thorp is the legendary example, but there have been many others. My gaming experiences certainly inspired me, many years ago, to return to school so I could learn the math (control systems, signal processing) I thought I would need for trading. Also there was the "Eudaemonic Pie" team. Blair Hull is another instance.

Trying to make a living via casino gaming teaches you many lessons which are directly applicable, even essential, to effective speculation.

John Floyd observes: 

 There is a lot to be learned from casino games, much of it applies to trading. In particular, deciding when you have a positive expected return, varying bet size, risk of ruin, etc. Not to mention that one should study the games, as is true in financial markets, and develop an understanding before putting serious capital at risk.

Many of the games offer one the ability to get a statistical edge on the house such as blackjack and some of the progressive poker machines. The problem is that any success is usually found quickly by the house. The house then takes methods to decrease your odds such as reshuffling often in blackjack and then asking you to not play anymore at their fine establishment.

A player therefore needs to take several steps to camouflage what they are doing, such as: spreading bets across several hands, decreasing bet size, not varying bet size too much, making some "dumb" bets to throw them off the scent, moving around casinos and tables when necessary, playing odd hours, wearing hats, etc. The casino runs like a machine and grinds out the vig. The pit boss is evaluated on a per hour basis of what he takes in, a hit of a few thousand dollars draws his and the house's attention very quickly.

While the challenge is fun for some time it can get tedious. Furthermore, the return on an hourly basis even if one is a good player pales in comparison to successful trading in the financial markets.



War, from Andrea Ravano

October 24, 2008 | 3 Comments

 I have the privilege of being born in Western Europe in 1958, and I don't know what being shot at means. On a day like this though, I get the feeling of looking at my city being shelled, in ruins. I do remember two days after the Monday October 19 1987 we were waiting for the 14:30 CET Economic data from the US. Not a noise could be heard. Telephones as well as mouths were shut. The figures for the balance of payments came out much better than expected and the market came back to life. Very few of us were aware at that moment that the market had changed direction. The general manager of the bank had started buying the US market the very same day of the crash. Some executions came in by late Friday due to the massive volume traded on the NYSE. Most purchases were already very profitable by the time the booking was done. As I write I relive some of the feelings of those days, fear, hope, dismay and disbelief are running around in my brain (Dillinger "Cocaine" late 70's). The contract futures limit down early on Friday October 24 2008 are a pretty good sign the forced sales are almost over.



I'm not quite sure how to quantify the following, but  I wonder to what extent Crude Oil and other commodities ETFs  (In particular Agricultural) are putting upside pressure on cash and futures markets. In my younger days few were the players in these markets, but today's easily accessible commodities markets could mean more investors are hedging their positions via etfs. In turn the banks that manage the etfs are compelled to hedge the funds by "covering" purchases and sales of the investors. As an old banker once told me (a real banker of the old school, not one of these clowns that have managed to disrupt the world financial markets) as I was reporting to him some excellent stats on money inflows in US mutual funds : "Imagine what will happen when instead of inflows we will face outflows". It was then late 1999.



At the through of the market dip in March , the Dax Index was more or less at 6,400 while the Bund reached 118 and some, flirting around the 4 % yield for some time. With the recovery of stock markets around the world , the Bund and the treasury markets retreated to lower prices as investors returned to invest in riskier assets. After the last three days of credit crunch fears and rumors of yet other American financial institutions in trouble, the inverted correlation in price movements of bonds and stocks seems to be fading. We must of course take into account the fact that inflationary expectations are greater now than in March; yet the fact that investors don't seem, for the moment, prone to rush for safety is rather bullish for stocks. (At least until the next financial catastrophe).

Vic adds:

Quantitatively speaking what you report is confirmed, on a weekly level.



The bond move the last three days is down three full handles from 117 3/4 to 114 3/4. That's the greatest three day move down before a FOMC meeting in history, I believe (my data cover only the last 94 FOMC meetings from 1996). The closest contender was March 17, 2003 where a decline of 2 3/4 occurred. The bond market must not like price controls.

Anatoly Veltman writes:

Both the up-swing (to 12/4 118′22 high) and the down-swing (to 12/10 114′12 low) were on reduced Open Interest, allowing me to play reversals with greater impunity. O.I. tipped covering: it meant that fewer stop-loss orders have remained resting; a factor that substantially cushioned risk for the near-term value-picker. More interesting, both reversal trades were obvious to me in real-time; and the slight O.I. data lag was not hindrance.

The top was a double-top in price of the 10-year (and a secondary top in all Treasuries, from 2-30year); while O.I. displayed Bearish Divergence.

The ensuing chart decline was symmetrical to November's chart rally (the chart “symmetry play” piqued Victor’s interest on 12/4), and pointed to low-volume, thin chart space all the way down into the 114 handle. At the minute 114′12 traded, for 10 consecutive futures sessions O.I. cumulatively slid over 100,000 lots (10% of the exchange total)!

So, .25 on Fed Funds and .50 at the discount window — or any other combination, plus “all-important” Paragraph Three FOMC mumbling — the trade here is technically solid. My analysis is performed discretionarily in real-time; I suspect 21-century black boxes execute these trades quite ahead of me, unfortunately!

Carlos Nikros adds:

I suspect that lots of fixed income securities just became substantially longer in duration last week, as well, necessitating the usual hedging and pruning.

Andrea Ravano observes:

I think the fear factor that pushed bond prices to their limit is fading. If we consider yield moves instead of prices we get the following picture :

Mat./1week ago/Yesterday/Difference

2 Yr. 2.87 3.20 +0.33

5 Yr. 3.28 3.60 +0.32

10Yr 3.93 4.18 +0.25

The data along with the collapsing spread between Tips and vanilla Treasuries points to a "normalisation" of the bond market to pre-subprime panic levels.Which, of course, does not mean one should not be worrying about inflation in the long run, but short term wise, the move in bonds might be explained with year end book squaring and the end of the worst in the sell off of the stock autumn bear market move.

Alan Millhone remarks:

I wonder how many other UBS types will fall victim to the subprime debacle before the dust finally settles? May be a long and cold winter for builders/investors/developers. Investors look to the Feds to step in to stabilize. Fed intervention to me looks like a form of price controls, much like price freezes and rationing in the Second World War.

Victor Niederhoffer offers a postscript:

One can now see what the purpose of the four point drop in bonds in the previous three days before the Open Market meeting was: to vigilantly control the Governors from overly inflationary activities.


Barry Gitarts adds:

The equity sell-off today at 2:15 was almost expected to happen as it did when the Fed cut rates last time. What's unexpected was that the market kept going down and did not stage a turnaround at 2:30 - 3:00 pm. Maybe it became too obvious and the daytraders with their one hole located at 4:00 pm got cornered. Maybe the market will resume its upward course tomorrow after feeding the big fish today.



SprocketThe composition of an amateur cycling peloton is random. You find butchers, City Hall employees, doctors, dentists, real estate contractors and — why not? — financial advisors and traders. But the financial advisors and traders are greatly outnumbered by the others, because it is easier find new clients on a golf course or at the racket club than in a sweaty, panting bunch. In turn, it is one of the ultimate reasons I prefer bicycle racing to other sports. It allows you to get a fresh, new perspective on the motivations of folks, friends and, indeed. investors. Yesterday though, before the end-of-season race (the results will be delivered only under torture), I was eavesdropping on a competitor trying to capture valuable racing secrets (shame on me!). To my surprise though he was talking to a friend about trading tips, the tippee being a barber and father of fellow cyclist. The financial advisor suggested:

  1) Stay long commodities (Basic materials)
  2) The stock market will keep going up
  3) You can keep buying Fiat shares (mow trading  23, recent low  4.5 in 2004) because market talk has it at 30
  4) "For G-d's sake stay away from bonds"
  5) If you really need to go long interest rates, only monetary instruments will save you.

To these arguments the barber answered he totally agreed with him and he was about to unload when the green lights would start blinking on his broker's online screen. I had a bit of a shiver down my spine . Not for the race. The last time I listened to similar comments was during  winter holidays and few were talking about snow conditions or slopes, but almost everybody was into "buy media stocks and sell autos" chat. We were then at the end  of February 2001. Subsequent events proved that there were too many longs in the market and too high expectations of newly-born companies. I don't think we will  have a similar opportunity to 2001, but, still, one cannot be too carefull when investing clients' money, so I will add some bonds to my portfolios, just in case the rosy scenario described by the racing advisor proves to be a contarian indication of future economic activity.



 In 1920, Gustav Cassel developed the theory of Purchasing Power Parity. PPP argues that currencies are in equilibrium when their purchasing power is identical in each country. Also known as the "Law of One Price," this means that the exchange rate between two currencies should equal the ratio of price levels based on identical goods and services. Put simply, a pound of dirt in Tyler, Texas should cost $1.50 when the same pound of dirt in Metz, France costs Euro 1.00 provided the exchange rate at the time is 1.5 to 1.

I believe dollar and other US asset bears are wrong thinking dollar weakness will cause panic and dumping of US Equities. Rather, US stocks will be snapped up like never before:

1. As we are now in a global economic landscape, you cannot tell me Citibank is suddenly going to be worth less than Deutsche Bank or HSBC because of the dollar's decline. The same can be said of Verizon versus Vodafone or Merck versus Novartis. If the dollar continues to decline on interest rate differentials and economic fears, then US stocks will ultimately have to be re-adjusted higher to keep valuations across geographic lines consistent.

2. The obvious: US Exports might get a boost — bullish for US stocks. Foreign earnings components should increase — bullish for US stocks.

3. European shares will likely feel the pain in comparison.

The Fed's actions last week were brilliant. Yes, they needed to create an environment that would continue to support asset prices as bank balance sheets have ballooned to extreme levels. But more so, the Fed's choice to drop the dollar just might be the action required to finally get our current account back in line over the long term.

Riz Din comments:

The relationship between exchange rates and equities has also been playing on my mind of late. Two thoughts on the topic:

1. The counterpoint to (2) is that while exporters may get a fillip from a lower dollar, US consumers are effectively being taxed by way of higher import prices. We may find consolation in a recent Fed study that suggests that inflationary pass through from a weaker currency is relatively limited, but with a weaker dollar playing a driving role behind rocketing global commodity prices and with China revaluing their currency over time, inflationary pressures may be in the wings yet, and it is probably worth keeping an eye on US import prices.

2. As James points out, recent US equity gains could be a purely monetary effect, in the sense that foreign investors can now buy more US shares with each euro, GBP, yen etc., so they will bid up the share prices until their values are restored in local currency terms (the Law of One Price). Furthermore, foreign investors will likely demand a higher US equity risk premium in order to compensate for the risk of further USD depreciation, so perhaps domestic investors can look forward to further price gains. This paper from the ECB discusses what it calls the 'Uncovered Equity Return Parity' condition (URP), where the described parity condition is used to explain the variability in exchange rates (although in our example the causality runs in the other direction, from exchange rates to equities).

Building on the above, I am led to wonder whether equities are a good hedge for a weaker currency, and indeed whether there is a profitable trade in there somewhere (if I was in Zimbabwe right now, I'd be asking for my wages to be paid in stocks!). In developed countries such as the UK and US, the theory says that a 5% currency depreciation should produce 5% inflation, but we know this doesn't seem to happen in reality. So, while foreigners may end up bidding up domestic equity prices to maintain prior purchasing powers, domestic investors can buy local stocks and arbitrague the fact that the 5% inflation is not going to arrive for a long while, if at all.

Andrea Ravano adds:

I think the main problem of an extreme dollar weakness, could be a sharp interest rate rise. The bondholders of the world could use the ultimate hedge and get out of the free falling buck by selling their holdings, which should cause higher interest rates.

In the end though, the real problem of a weak currency is not in the short term but the long. In weak currency economies products become more valuable than competing peers because they are cheaper; not because of increased productivity or industrial design, but simply for the devaluation of one of the cost components.

Take Italy as an example. Italy has used the competitive devaluation strategy for the Italian lira since the early '70s. By doing so the system has prospered , but only to discover, after the introduction of the euro and the subsequent forex stability, that the economic system as a whole had productivity and price competitiveness which had been left behind during the ephemeral times of currency devaluations.

The pattern at the time was that before devaluations interest rates would rise sharply and drop sharply thereafter.We must consider the fact that we had a fixed currency system which made adjustments much more abrupt. 



 I do miss a former colleague of mine who used to sell panics and buy euphoria. Slim, fast, and seemingly smart, that's how he presented himself. He had a habit of cracking his fingers and did some occasional stretching to keep his arms and shoulders agile, for he is an excellent golfer. On average, he was quite a bother but he had the natural gift of being the perfect last minute trend follower. He was precious to me.

I could tell how the market was behaving by the tormented look in his eyes, almost watering in pain. He would stop shaving for a couple of days perhaps because of the stress incurred in following nighttime financial TV specials. The hairs of his face would tickle my curiosity and his anxiety would motivate me to take the opposite direction of his thoughts and manners. Therefore, in those days I would take special care in preparing myself for the office, even make an argil mask so that my skin would be clean and lean and I would look fresh like a rose.

Mostly though I would watch carefully for all signs of fear in his comments, all e-mails doomstering and calls for brainstorming meetings would be fuel to my contrarian views and cement my opinion that the falling market was a sure buy. I know that market statisticians will tell me that market drift and not my calls were to thank for the meals, yet we do need some reassuring irrational beliefs that can help. For the same reason, I don't feel comfortable if I don't wear the same socks while racing my bike or if the brand of rice crackers I eat before the race is not the same as the one I normally have.

Since I have moved to another company my former colleague cannot help me anymore. I have tried to get the information on how he looks and what he thinks about the market but my efforts were useless. So I must admit I'm a bit lost in all the panic, which is hitting the markets globally and pray to get, if not an analysis, at least a peek at my ex-contrarian indicator colleague.



 There are a couple of more things about Sweden that need to be said:

It did avoid the two world wars (which were great destroyers of human and physical capital for most other developed economies).

From my experiences there, I find that there is a special quality that Swedish people have. They work together as a team tremendously well.

Sweden is now aggressively cutting taxes. It's hard not to be massively bullish on the place!

Andrea Ravano writes:

The first step is to quantify in absolute terms, in lieu of percentage points. That alone gives the investor a rough idea of the magnitude of the tax rate rebate. For instance the nominal GDP in the States is around $13 trillion, while Sweden is running around two percent of the US economy.

Then we might want to add the percentage of savings the Swedes are likely to retain, before dissipating the remaining balance in a well due drinking spree ahead of the sad and depressing Monday. After such a work is completed is too late anyway to invest because the bulls have lifted all available offers and the market seems a bit too expensive even for the most optimistic.



 I know I'm a bit boring talking about bicycle racing. But we are racing a long one here, like a Milano-Sanremo, 250 km almost flat and the last 50 km bumpy. If you go too fast you reach the legendary capes with wooden legs and at the first counterattack the opponent leaves you behind.

On the other hand if you go too slow the race will not be hard enough and the sprinters will have too easy a time beating you at the stretch. The same applies in the markets. Lack of perspective leaves you with distorted images of reality. I do remember clients closing short positions for lack of margins in February of 2000 and long positions closed in the course of the last bearish week before the long-term bull resumed its run. At times the fog which arises in one's brain in times of fear has compelled opening or closing positions, which, with a bit of calm, should never have got out of one's head.

I think the same vicious virus as afflicts Vic and Laurel has hit me, namely utter optimism, and I share with them the feeling that the long run is not over yet. It could be one of the last chances for shorties to bail out before the next big one comes.



 At:  4/20  9:59:33

 Europe has gone crazy :

 Societe Generale + 9.3 pct
 Bnp                    +5.03 pct
 Credit Agricole     +3.01 pct
 Carige                 +4 pct
 Ubs                     +3.3 pct ( Ex divid 19/4 3 pct)
 Credit Suisse        +3.63 pct

I'm sure I'm missing some, but ask your indulgence. The process of concentration is underway, although I have a feeling we are close to an extreme. Rumors are hitting the wires; takeovers and mergers are fuelling hot money to the financial sector. I just hope we will not wake up with too much of a headache after the party is finished. 



There is a sharp intraday (High 113.90) corrective move from a contract low of the bund which has reached 113.36, just as the stock market is moon-bound at an all time contract and index high of 7411.5 (June 2007 contract). We have seen a similar move before 2/27. The doomsters keep their monotone "aria", suggesting the big correction in stock markets is just ahead. Short sellers fear for their life. Maybe the Mistress will give bears just one chance to bail out before it's too late.



A very unusual score at the recent Championship League soccer match between Manchester United and Roma: 7-1 in favor of Manchester. I can remember only one such big difference in the 60s. The match was between Borussia and Inter FC of Milan and it ended 6-1 in favor of the Germans. The match was later replayed on the grounds that an Inter player was hit by a missile while on the pitch. Inter eventually won and passed to the next round. Such an unlikely score raises the question of betting: I wonder if anybody knows what the bookies were quoting on score differential before last night game.



I have noticed that my set of rules, formed over the years, is no longer valid. When I began working, a rise in the price of crude oil would cause a fall in bonds, since its inflationary expectations were eloquent. In the past couple of years, on the contrary, I noticed the opposite was happening.

Much in the same way, in the old days, an upward move in stocks had to be accompanied by a similar one in bonds as the two were highly correlated. It could be, however, that the extraordinary low yields of the past years were in fact just an aberration, caused by the severe recession of the 2001-2003 period.

Thus, the changing cycle could be due to the fact that yields can go back to a "normal" level, i.e. falling bond prices, without affecting the rise of stocks to their highest levels. By "nadir" I just meant close to their relative highs (namely the Dax 7040ish level).

Victor Niederhoffer writes:

Stocks are not near a nadir now but are they close to an acme? In the past when stocks went to their nadir, bonds rallied.



 The combination of hysteria about sub prime which presumably has a one percent impact on big banks, a recent decline of some 10% in many of the bank stocks, (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital would seem to provide meals for scientific study and or caneology.

To me, the case for avoiding these stocks seems particularly like pseudo talk. It depends on a general tendency of banks to lend too much in good times, and to gamble. I've never found banks overly aggressive in lending to anyone I know, and I see no reason to believe they are not as good at learning from past mistakes and getting a proper return from the risk they take as others.

Nor do I believe that the financial market suffers when weak fringe players are forced to go to bigger entities to help bail them out. this happened in the Long Term Capital case, in the large and in the small, every day, when banks confide to their stakeholders how their privileged position often enables them to make opportunistic investments in times of crisis for the common good.

J T Holly adds: 

I myself am taking the cane out and looking more into finding the hypothesis that will unlock the significance other than my intuition. A couple of things that seem different this time that the "critics" and "bear camp" aren't taking into consideration have to do with legislation and government doings that make banks more apt to produce revenues since before the reversal of legislation happened.

1) Clinton signed to reverse the Glass Stegal Act. Banks now are not only banks but also brokerages, trading houses, insurance companies, and lend in millions of ways via auto, credit cards, and such.

2) "Do Not Call List." Having experienced the adverse effect of this as a broker in a former life, the banks use this to their advantage whereas the smaller players can't "reach out and touch someone." They have the legal right to call existing clients and cross sale products that the first aforementioned points allow now.

3) Bankruptcy Act recent development. Complete utter hypothesis on my part or conspiracy theory, but banks don't make any margin on perfect scores or good credit other than those folks feeding the system with deposits. The ability of banks through forcing those who are losing more than they deserve to go below 700 on a round number and be classified as sub prime allows them higher margins. The average score across America is around 670 allowing for this higher margin to be maintained. Not to fuel the Dead Horse last week, but this wasn't mentioned in the espousing.

It's plain and simple. They have the government, numbers of clients, and ecosystem to survive flourish and devour and recycle their own folks and keep on truckin'.

I had a client when I got into this business who told me that the best business to run was a whorehouse because "you got it, you sell it, and you still got it." It seems banks these days are about as close to this as possible.

The only legislation that I could find that limits growth and has prevented me further is some 10% rule that states that they can't have more than 10% of the total amount of money in circulation in business. Are C and BAC the closest if not at the max? Does anyone have more clarity or know of such Fed Reserve law that prevents this? I guess they can't make acquisitions or grow organically. It seems like an anti-competition type law, like in Atlas Shrugged!

Mathematically most pay a yield of around four and higher via dividends, and you have the wonderful drift of the market that they belong in to add on top of that. If you look at the Fed Fund Model, they are a sexy and attractive piece of the pie. To be able to get that which is equivalent to risk free and have something also that is apart from the earnings yield of the S&P is nice.

I guess the bear camp feels that the dividend can't be maintained. They can't re-invent themselves over and over like they've done thus far. It is called Citicorp not Citibank! I always have to remind myself that they get paid to write, versus getting paid to be right.

J T Holly continues:

The other one to test is the old utility adage that everyone hangs onto: "They are heavy borrowers and go down when rates rise." It's like they don't see the diversification that utilities have gone through for the past two decades. They also have a government hedge internally with fixed cost controls that they've adapted to and work to their advantage.

Andrea Ravano adds:

The first reason one should be interested in banking stocks is of course the fact that the industry is selling the "do it yourself" online strategy as a great breakthrough, whereas what it amounts to is just pay less for employees, get rid of risk, and get fees.

I suspect that the years to come will see the trend of home banking increasing to the point of having a human-free bank. It's every banker's dream to be able to use a switch to stop operations instead of laying off people. Yet the greatest interest lies in the fact that the banking industry is scattered around the globe, fragmenting the market pie in such a way that none has a dominant position.

The epitome of this is Italy, where the banking industry's biggest players don't exceed five percent of the entire market. Hence, I believe more takeovers, mergers, and other such measures to consolidate and reduce the number of players in the market will and must occur. As I'm writing the market buzz is on Barclays, which should announce merging activities with ABN Amro bank of Nederland. This would have been hardly thinkable just a few years ago.

Other reasons include the combination of hysteria about sub prime, which presumably has a one percent impact on big banks; a recent decline of some 10% in many of the bank stocks (the KBW bank index fell from 122 to 111 in last month), and good dividend growth and return on capital. 

Jeff Rollert adds:

I have found bankers at large firms (not referring here to investment bankers) do not share much investment courage as it isn’t part of their compensation plan.

Small and community bankers are pure salespeople, chasing after the highest spread product to the greatest extent the regulators permit. They start, build, sell, repeat. They also have higher construction and R/E spec lending.

Regional bankers are difficult, as they have both personality types. My point for making money is that their manner in approaching risk is very different.



Once upon a time, my dear son, there existed a place called the stock exchange. It used to be the place where people of all sorts, rich for the most, would gather to buy and sell almost everything they had, from shares to live cattle and from bonds to financial instruments. It was clear from the beginning that you didn't need to own something to sell it. In other words, a magic place where richness could be created out of a dime was there to live and prosper. As you can imagine, the investors and speculators started to investigate how this wonderful place worked. They invented all kinds of studies and analyses, ranging from numerical to astrological. Some of them actually worked, or did they really? Some brokers knew what to expect from the market because of the noise the jobbers made when running on the wooden floor, rushing to the pits to get their orders filled. Others looked at charts and were sure to find an answer to their quest for money and power. The chartists, as they were called, used funny words and often gave more credit to their studies than they deserved. But sure enough, at times, they would strike it rich, not understanding their strategies were worthless; little did they know of the existence of the Mistress, the mysterious lady that comes when the data are no use and fear and hope dominate speculators' minds. She is patient indeed. The Mistress is capable of hiding behind your profits, and then jumping out from the dark corners of your brain, ready to take away from you what you have, by luck, taken from her. Beware my son. Always ask yourself if it's you or her doing the work, as I often find myself cornered and incapable of moving a muscle, not understanding any longer where the borderline was. As I'm talking to you, the stock exchanges don't exist any longer. It's a world of beeps and flashing lights on your flat screens; no more foot noise from the running jobbers, and no more buy and sell tickets flying in and on the pits at the end of the trading days; yet, you can still make a more than honest living out of this crazy job. But remember to look at yourself in the mirror in the morning: at times, you will see the Lady laughing at you. When that happens, just rush to your terminal and close your positions, even at loss, or the Mistress will not stop her scorning until you are totally and helplessly broke.

Adrea Ravano adds: 

Concerning my recent post: I'm happy it stirred a good debate. I didn't know, that my idea was being discussed on a national Italian newspaper(Corriere della Sera). This morning's financial section carries a very interesting article by professor Matteo Motterlini of the San Raffaele University. The article (published this morning, Feb. 5, 2007) talks about a recent study published by a group of researchers at Yale University, titled, How basic are behavioral biases? Evidence from Capuchin monkey trading behavior.

The study confirms for animals what behavioral studies have shown for human beings, that to offset a loss of 1 you must have a profit 2.5 times as big. In other words the perception of your pain is greater than that of your pleasure. Interesting.



1/10/07 Momentum

The drop in the price of crude picked up in early Tuesday morning trading with the low below $54 a barrel. This caused selling by chartists and the bearish sentiment increased. As I looked at my positions, the losses grew, and even though natural gas was holding up, the portfolio took it on the chin. It's not the first time, and I'm patient. [Read more here]

Eric Ross comments:

I'm a bit confused. Why would one trade oil futures/gas futures when one could invest in "oil drilling/gas wells" and pull in a far better return for his buck? Risk/Reward … it makes sense to own an actual "piece" of oil/gas real estate than bet on futures. But what do I know, I'm just surrounding myself with some of the biggest oil/gas families in Texas.

Andrea Ravano adds: 

I cannot understand the logic behind the performance of oil companies such as Total, Exxon, Eni, Conoco and others alike: the market always bids up the stock along with the price of oil. If the companies make money by transforming crude oil into other products, why should their profit grow along with the increase in price of their main raw material? I understand that inventory pricing can make a big difference at $70/barrel vs. $50/barrel, but I'm sure there must be a better explanation for the case. Oil experts, please be patient with my ignorance.  

Stefan Jovanovich comments:

I am not an oil expert but am fortunate enough to know a few who tolerate my persistent ignorance. Their opinion is that the stock market presently values energy companies - including those that do not own oil and gas properties - as proxies for the oil price itself and does not value the companies' profitability at all. Those of us who remain unprofitably long in oil & gas & refining stocks keep hoping that the industry will someday be viewed as an actual business, but we may have to wait a lifetime or two. When Hubbert's Peak theories were first popular (in the late 70s), a friend from New England asked my wife, who was working for Getty at the time, and what she would do for a job when the oil ran out. The notions that petroleum is somehow peripheral to economic activity and that it should and will be replaced easily by an alternative seem to be two adult fairy tales that get told again and again.



I was in a meeting a couple of days ago, discussing possible and likely investments in auto stocks. The clients I was talking to are pilots or ex-pilots and close to being pros in terms of financial awareness. At one point I noticed that all the attention was on the quality and the looks of the cars built by this or that carmaker. None was even considering if the prices the companies were trading at, were reflecting and discounting present or future profits. I tried to focus everybody’s attention on the fact that, it is not necessary to like the product a company sells, in order to invest in that company. Indeed I had a very hard time. The question is, are we capable of clearing our prejudices in such a way that we will be able to invest in a company even if we dislike its products? Take the recent Alx@xel-Lucx@x merger — If you have ever operated with an Alx@xel telephone you probably want to sell the company short, yet at prices below 10 and widespread bloggers bearishness, I was keen to like the stock with an upward bias (By the way are bloggers a good contrarian indicator?)

The point is not to pat myself on the shoulder because the stock is trading at 10.5. As I have often pointed out, I am always ready to recognize and talk about my mistakes, past and present.



Being a contrarian doesn’t mean taking an opposing view just for the sake of it. Being a contrarian is all about asking oneself why everybody is following the same idea, mirage or hope, in order to determine which course of action is best suited for the money you are managing. Indeed the contrarian strategy is no longer a feasible one in a financial world lead more by lawyers than investors. Therefore the capable speculator will take the contrarian advice with all the care it needs to avoid lawsuits and such. This year winner in contrarian strategy was for me the Se*@ono saga. The Company announced , sometime between the end of 2005 and the beginning of 2006, that it was for sale and that it was seeking buyers. The stock started a robust and relatively fast climb from chf 800 to chf 1100 (rough numbers). When the stock peaked along with major world stock markets , the owners of S-@ono announced that since no real bidders showed up, the company was no longer for sale. Bad news for the “longs”. The stock fell from chf 1100 to 900 and, just to add a little “peperoncino” to the sauce, said that at that point it was seeking capital in order to buy a small-medium sized company; enough to send the shares to 800 chf. The question was, why on earth would a smart CEO change its strategy on such a short notice and in such a clumsy way? At times the easiest answer is also the right one: at 1100 chf the company was too expensive for a potential bidder. It became clear to me that the owners never had any other intention than selling the company, but needed a bit of marketing strategy in order to convince shareholders. In September of 2006 the company received a bid for 100 pct of the capital at chf 1100.



Back in the late winter of 2006 rally, I was asking myself ,and indeed the list members, why was it that M&A activity was so fierce close to market highs rather than bottoms. One will note some very interesting answers and comments on the subject, although none really final and conclusive. At the time Merck was trying to take over Schering, only to be beaten on the final stretch by rival Bayer. Vivendi of France saw some aggressive purchases by funds almost at the same time of the Schering takeover and Thales witnessed some interesting movements on its capital structure. Now, 6 months later, Merck is back in the game, launching a 16b chf takeover bid on Serono; the bid , seemingly greeted with a large smile by the Bertarelli family, 75 percent owners of the company, comes with the stock markets close to their highest mark of the year. there are other rumors, gossip is growing ,at times literally like mushrooms — out of nowhere and after a heavy thunderstorm.

Of course some fierce selling of commodities and the Fed's keeping on hold breath and rates, have helped the bulls make their point. Cane lovers will note only a handful of markets are left behind , like tired bikers trying to catch the group uphill, (namely the US market, and especially considering it from a none US$ point of view.)



Speaking of cheating in cycling, which seems a hot topic in the world of sports right now, the picture here shows what has been found by a collector, who bought a racing bicycle dating from the 1930s. In the handlebar, concealed in the interior empty space, there was a bunch of nails used to flatten opponents tyres. Please note that in those days racers had their spare tyre on them and to change a flat one required quite a lot of time. Interesting tactic, but I wonder if it can be applied to the markets.



Inspired by the postings Sentiment, by Timothy Roe and Pessimism, from Victor Niederhoffer on the Daily Speculations website, I decided to investigate these observations in more detail.General market sentiment tends to lead investors down the wrong path. There exists a negative relationship between the sentiment of the American Association of Individual Investors (AAII) and future Dow Jones Industrial Average returns.

The AAII has been conducting a weekly sentiment survey of its members since July 1987. It asks respondents to categorize themselves as Bullish, Bearish or Neutral. They then assign a percentage to each group from the total sample. (For the purpose of this study, I use the percentage of Bearish individuals as a gauge of investor sentiment.)

Since 1987, the average percentage of Bearish individuals is 28.31% with a standard deviation of 9.25%. For the week ending 21/07/06, the Bearish percentage stood at 58%. That is over three standard deviations from its mean. Indeed, a very high percentage of Bearish individuals. With this in mind I decided to record all the occasions whereby the Bearish Individuals measure, strayed three standard deviations from its mean, to roughly 56%.

There have been 8 occasions when the AAII percentage of Bearish individuals recorded a score of 56% or more and 12 months later the DJIA was up on average by approximately 20%, with a t stat of 2 and a win rate of 100%. The percentage return is almost double that of all other rolling 52 week periods. In reality the data slightly overstate forecast returns and does not approach statistical significance due to some overlapping and clustering of data. However, the data are suggestive of much higher levels for the DJIA 3, 6, 9 and 12 months out.

I also decided to test future returns when the percentage of Bearish Individuals fell between three and two standard deviations from its mean or roughly 56% to 46%. For mine, still a relatively high outcome. The data in this group were consistent with the previous findings that a high level of Bearish sentiment is positive for future returns. I found 33 occasions that produced a 12 month average return in order of 15%, with a t stat of 2 and a win rate of over 85%. Again the data are somewhat overstated due to overlapping and clustering of data, but the general picture appears to be positive.

Interestingly, if we include the reading of 58% recorded on 21/07/06, then 8 times out of 9, three standard deviation observations occurred when military conflict was omnipresent in the mind of investors.

Six readings of greater than or equal to 56%, occurred between August and October 1990, a time when Iraq invaded Kuwait. The DJIA never traded below its October low again.

A reading of 56% was recorded in October 1992. The month’s news was heavily dominated by the US Presidential campaign. Again the DJIA never traded below its October low.

In late February 2003, Bearish sentiment was at 58%, approximately one month before coalition forces invaded Iraq. The first week of March marked the low for the DJIA, a low that till this day has not been breached.

The recent reading of 58%, recorded in late July 2006, coincided with the Israel & Lebanon conflict, & the DJIA trading at 10,868. Perhaps this could be a multi year low. We will find out over time.

The data are consistent with Lord Nathan Rothschild’s musing that he liked “to buy when the cannons are thundering and sell when the trumpets are blowing”, circa 1810.

For Australian investors the data are also suggestive of positive things to come. Of the 8 times that the AAII percentage of Bearish individuals was equal to or above 56%, the All Ordinaries Index gained on average 16.58% over the next 12 months versus all other rolling 12 month returns of 7.03%. Just over double the average, with a t stat in order of 2 and not one negative 12 month period.

Maybe our Bear will not be depressed for too much longer, because he can be associated with an up stock market.

James Tar objects:

The foundation “Bear Sentiment as a Contrarian Indicator” rests on is flawed. Mr. McCauley makes an obvious mistake. What needs to be considered is that everyone is finally looking at Bull/Bear Sentiment Gauges these days to help formulate an opinion on market direction. Present market chatter, and everyone is saying it, is “The Bear Sentiment is so high we cannot go lower.” Everyone is fixated on this, so much so that the herding on the weekly polls and data (AAII releases) for a contrarian indication of market direction should be a clear warning to the speculator that such a method has now become extinct. The market has perhaps outsmarted once again. Meaning, it might be time to look to these polls as confirmation.

I deeply regret writing such bearish commentary. But if we are truly going to advance our study and discussion of the markets, such a reversal in the foundation of such a widepsread utilisation of “contrarian indicators” must clearly be considered.

Andrea Ravano comments:

I have seldom seen so much negative feeling and low expectations in stock markets, than those surrounding me at present. Private bankers from here and there (I will not mention the countries the calls come from, because I am afraid to offend) mention again and again the risks of war in the Middle East, the price of oil, the risk of inflation etc.. The consensus seems so large that I am a bit puzzled by the market show of strength relative to the so many, possibly sidelined, if not straight short investors.

Which, of course, leads me to believe that if nothing unreasonable happens in terms of terrorism, we might see world stock markets rally by year end, if not sooner.


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