Since according to the regulators nothing adverse happened from a systems perspective [on May 6, 2010], are we to bake into our models the potential for a 50+ point swoon at any time and in vastly more compressed windows than ever seen before? The risk/return scenarios turn completely lopsided.

Riz Din asks:

I'm not familiar with the details of trading systems that may have been behind the move, but if they are just as happy buying as selling, can we then assume that there is an equal chance of a similarly mammoth sized swing to the upside? 

William Weaver writes:

I doubt we could ever see the same type of vol to the upside simply because we're dealing with much more than computers, we're dealing with humans. Prospect Theory states that an investor who realizes a gain and a loss of equal magnitude will value the loss as much as twice that of the equivalent gain. This can be graphed by plotting the one day changes in the SPX on the x-axis (gains function) and the inverted one day changes of the VIX on the y-axis (value function). After calculating a least squares regression on both the positive days and the negative days (individually; two regressions) it is apparent that the slope of the losses is steeper than that of the gains.

We would need the entire world to be stuck short to see that kind of vol. But it would be fun to trade– of course I say that with a caveat; yesterday was a hell of a lot of fun to trade… after the fact. During it was survival even if you were raking it in!



ant holeI always had a special kinship with ants, having made and observed colonies as a kid. I performed many behavior experiments with ants and learned a lot. In college, we used to boil ants to extract the formic acid they use as defense. Ants have ideal defense mechanisms since formic acid is better than any tear gas or mace for incapacitating an attacker. I used the formic acid in many nefarious experiments and research. Another thing to note is that the collective works best with the ants as they are single minded, and it is my hypothesis that the collective only works for those who live life through ritualistic behavior.

Jeff Watson, surfer, speculator, poker player and art connoisseur, blogs as MOTU.

Douglas Dimick adds:

Here in China, there is the "anthill" dynamic developing among university graduates who can only find low-paying work (2000 RMB per month). Graduates are renting rooms in apartments and living among collectives of similar fated new-to-the-market job seekers. See this China Daily article.

Riz Din writes:

Ants have an interesting relationship with aphids, treating them as a living food source to be farmed. Also, there are more of them than we think. Apparently they make up 15-25% of living terrestrial animal biomass.



 I strongly believe that ventilation and outdoor sports have a significant impact on longevity. However, I have scanty scientific evidence for it. How would readers suggest I come up with some proper support for my theory?

Pitt T. Maner suggests: 

The first dose-response study for the positive effects of Nature. There has to be a Vitamin D angle too…a highly promoted vitamin at the moment. As long as your not on the golf course (not the healthiest place anyway) the mind/body stress relief benefits seem significant:

Just five minutes of exercise in a green nature setting, like these beautiful hills in Vermont, can boost mood and self-esteem.

Credit: Michael Bernstein, American Chemical Society

How much "green exercise" produces the greatest improvement in mood and sense of personal well-being? A new study in the American Chemical Society's semi-monthly journal Environmental Science & Technology has a surprising answer. The answer is likely to please people in a society with much to do but little time to do it: Just five minutes of exercise in a park, working in a backyard garden, on a nature trail, or other green space will benefit mental health. Jules Pretty and Jo Barton explain in the study that green exercise is physical activity in the presence of nature. Abundant scientific evidence shows that activity in natural areas decreases the risk of mental illness and improves the sense of well-being. Until now, however, nobody knew how much time people had to spend in green spaces to get those and other benefits. "For the first time in the scientific literature, we have been able to show dose-response relationships for the positive effects of nature on human mental health," Pretty said. From an analysis of 1,252 people (of different ages, genders and mental health status) drawn from ten existing studies in the United Kingdom, the authors were able to show that activity in the presence of nature led to mental and physical health improvements. They analyzed activities such as walking, gardening, cycling, fishing, boating, horse-riding and farming. The greatest health changes occurred in the young and the mentally-ill, although people of all ages and social groups benefited. All natural environments were beneficial including parks in urban settings. Green areas with water added something extra. A blue and green environment seems even better for health, Pretty noted. From a health policy perspective, the largest positive effect on self-esteem came from a five-minute dose. "We know from the literature that short-term mental health improvements are protective of long-term health benefits," Pretty said. "So we believe that there would be a large potential benefit to individuals, society and to the costs of the health service if all groups of people were to self-medicate more with green exercise," added Barton. A challenge for policy makers is that policy recommendations on physical activity are easily stated but rarely adopted widely as public policy, Pretty noted, adding that the economic benefits could be substantial. Policy frameworks that suggest active living point to the need for changes to physical, social and natural environments, and are more likely to be effective if physical activity becomes an inevitable part of life rather than a matter of daily choice.

Provided by American Chemical Society

Riz Din adds:

Ventilation has a pretty clear impact on longevity when it comes to the transmission of infection. This study looks at TB infection rates in different ventilated spaces  and finds that sometimes, simplest is best:

Facilities built more than 50 years ago, characterized by large windows and high ceilings, had greater ventilation than modern naturally ventilated rooms… Even within the lowest quartile of wind speeds, natural ventilation exceeded mechanical (p < 0.001). The Wells-Riley airborne infection model predicted that in mechanically ventilated rooms 39% of susceptible individuals would become infected following 24 h of exposure to untreated TB patients of infectiousness characterized in a well-documented outbreak. This infection rate compared with 33% in modern and 11% in pre-1950 naturally ventilated facilities with windows and doors open.

Closer to home, this resource looks at ventilation rates and health and performance (work and school) outcomes. The general findings are in line with expectations i.e. ventilation is perfomance enhancing. One last memorable finding comes from the EPA web-site, which says "The average person, through the natural process of breathing, produces approximately 2.3 pounds (1 kg) of carbon dioxide per day."On that note, I'm heading out for a brisk walk in the sun (and wind), before knucking down to some more studies! 

In another commentary, Frances Kuo who is a director of the Landscape and Human Health Laboratory at the University of Illinois, does point out that "None of the studies involved taking people and assigning them to different ‘doses’ of nature; rather, they looked at how people who sought out nature on their own responded to nature.” All in all, it doesn't look all that newsworthy, although I can't see the actual study which may be more enlightening than suggested by the media reporting.

This is veering a little off tangent as it neither relates to ventilation or outdoor sports, but I did find a previous study from Pretty that involved putting subjects on a treadmill and measuring their responses when exposed to images of different landscapes; subjects did show better responses when exposed to the green landscapes.



 One way or another, I found my way to this fascinating and colorful sample chapter of Swindled: The Dark History of Food Fraud, from Poisoned Candy to Counterfeit Coffee by Bee Wilson.

One chapter tells the story of Frederick Accum (1769–1838), who published 'A Treatise on Adulterations of Food, and Culinary Poisons'. His work provided a great service to the public by applying scientific method to prove that inumerable foods of the time were suffering adulteration. Describing just how pervasive food adultery has become in this era, Accum says: "It would be difficult…to mention a single article of food which is not to be met with in an adulterated state; and there are some substances which are scarcely ever to be procured genuine." Bee observes that because food had started passing through so many hands before reaching the final consumer, it became easy to adulterate the food and escape detection, although Accum does at least point out that "so inextricably are we all immersed in this mighty labyrinth of fraud that even the vendors of poison themselves are forced, by a sort of retributive justice, to swallow it in their turn. Thus the apothecary, who sells the poisonous ingredients to the brewer, chuckles over his roguery and swallows his own drugs in his daily copious exhibitions of brown stout. The brewer, in his turn, is poisoned by the baker, the wine-merchant and the grocer."

There is much here that chimes with the current crisis. My favorite passage of the chapter concerns the adultery of peppercorns:

Some forms of adulteration were crude—such as "P.D." or pepper dust, a "vile refuse" swept from the floor of the pepper warehouses that often got mixed in with ground black pepper. An even worse version was known as "D.P.D.," short for "dust of pepper dust," the very grimiest, nastiest floor sweepings of all. There was little art in this deception. On the other hand, some truly intricate labor went into many of the more outrageous forms of adulteration. Real black peppercorns—which many consumers doubtless bought in preference to ground, thinking, wrongly, that there was no way to adulterate the whole spice—were sometimes padded out with "factitious peppercorns," which seem to have been the work of an artisan to make. First, blackish "oil cakes" were taken (the residue left over after pressing linseed oil) and mixed together with common clay and some cayenne pepper (to give the "corns" some bite so that consumers might really be fooled by them). Then this paste was pressed through a sieve and rolled in a cask until it formed little pellets. Making these tiny balls of fake "pepper" must have been highly laborious, and swindlers couldn't get away with adding very many to the real peppercorns before suspicion was aroused—around 16 percent was standard—yet evidently it was still worth the swindlers' while to do it. Labour was cheap and spice was expensive (the duty on a single pound of pepper was 2s. 6d., a tax that was reduced in 1823), and there was no shortage of workers to carry out this peculiar trade.

It looks like there is much to be learned from this book, and the reviews I've come across are glowing.



The fitbit--a popular self tracking toolThere is a very interesting article in the NY Times Magazine on quantifying how one's life is spent. Perhaps some nuggets in there applicable to trading:

Humans make errors. We make errors of fact and errors of judgment. We have blind spots in our field of vision and gaps in our stream of attention. Sometimes we can’t even answer the simplest questions. Where was I last week at this time? How long have I had this pain in my knee? How much money do I typically spend in a day? These weaknesses put us at a disadvantage. We make decisions with partial information. We are forced to steer by guesswork. We go with our gut.

That is, some of us do. Others use data. A timer running on Robin Barooah’s computer tells him that he has been living in the United States for 8 years, 2 months and 10 days. At various times in his life, Barooah — a 38-year-old self-employed software designer from England who now lives in Oakland, Calif. — has also made careful records of his work, his sleep and his diet.

A few months ago, Barooah began to wean himself from coffee. His method was precise. He made a large cup of coffee and removed 20 milliliters weekly. This went on for more than four months, until barely a sip remained in the cup. He drank it and called himself cured. Unlike his previous attempts to quit, this time there were no headaches, no extreme cravings. Still, he was tempted, and on Oct. 12 last year, while distracted at his desk, he told himself that he could probably concentrate better if he had a cup. Coffee may have been bad for his health, he thought, but perhaps it was good for his concentration.

Barooah wasn’t about to try to answer a question like this with guesswork. He had a good data set that showed how many minutes he spent each day in focused work. With this, he could do an objective analysis. Barooah made a chart with dates on the bottom and his work time along the side. Running down the middle was a big black line labeled “Stopped drinking coffee.” On the left side of the line, low spikes and narrow columns. On the right side, high spikes and thick columns. The data had delivered their verdict, and coffee lost.

Riz Din comments:

Interesting article. I've tried a few tracking experiments such as strict calorie counting, but it gets really obsessive because it is such an active process (I carried a little pen and pad around with me for a month). At present, logging activities such as time spent doing activity x, foods eaten, exercise taken, etc, has a strong reflexive element as the act of measuring interferes with the normal course of affairs. Even tracking tools on smart phones require a manual input element, which will distort affairs and can burden (as well as enlighten) the mind in many ways. On the upside, this is all great when you are striving to achieve a set goal over a short period of time, just less so when you are just getting on with life and want feedback on yourself. Because of this, I think data driven living will really take off when the data is collected passively and can then be reviewed periodically. I can imagine, for example, a technologically wired up house filled with sensors that silently logs your whereabouts and activities and produces a monthly report.

My favorite realizations from tracking exercises are that I tend to overweight recent experiences, and also that I am often caught in repetitious cycles. Another key benefit is that list keeping/tracking serves as a kind of photo album of memories: I've kept a booklist (in Google Docs) of all books read over the past five years or so, with a simple five star rating system, and by filtering to see my favorites I am able to see what type of person I was and the type of person I may be becoming. All very interesting.

Russ Herrold writes:

Here is an interesting read for those interested in a life ruled by numbers:

"Ubiquitous self-tracking is a dream of engineers. For all their expertise at figuring out how things work, technical people are often painfully aware how much of human behavior is a mystery. …"

This is not specifically applied to numercially driven trading or investing, but the emphasis on accurate and contemporaneously generated records mentioned in the latter pages of the article resonate with what our aspirational selves may seek to attain in the financial markets:

- trade from numerically validated setups ['Past results may not be indicative of future results' vs. 'History does not repeat, but it sure does rhyme a lot']

- do post-analysis on what worked, and when a plan was followed, and when it was not ['If you cannot put a number on it, it is an opinion, not science']

- Kelly criteria for binomial trades; Optimal-F for N-way position sizing; with the known problem of non-Normality of financial markets 



 Is the blood, sweat, and tears and more importantly, repetion worth it? At what stage do you say, once mastered–there's nothing more to be gained, it's like a chore now, your energy is getting weaker and your soul being drained? At what stage do you determine, like a trade, positive flow against negative flow, are there too many pips and not enough 5 baggers? At what stage does the occasional good going out be worth the crap of reduced positive flows coming in? There must be a law of diminishing returns here, once the student learns the lessons that need to be learned, and learns what the matrix is and why it exists. Why hold on for that last 1% of no doubt ego gratification.

I looking at people staying around too long in there chosen careers, sports, whatever …

It seems it's important to move on, lessons learnt, and the path to the next destination will hopefully be somewhat clearer. Luckier for me on the trading front that that decision of moving on doesn't have to be made!

Riz Din comments:

I quite like the idea of maximising my utility and exiting when the marginal returns are greater elsewhere, of getting 80% of the easy results and moving onto the next activity where I'll pick up another 80% in the same time that it would have taken me to get the remaining 20% in the first activity. This dim-sum approach reminds me of the episode in Seinfeld where George Costanza learns about the showman's approach of leaving on a high and employs it to great effect:

Jerry: Showmanship, George. When you hit that high note, you say goodnight and walk off.

George: I can't just leave.

Jerry: That's the way they do it in Vegas.

George: You never played Vegas.

Jerry: I hear things.

Of course, much depends on the activity and one's objective, for there are many ventures where the structure is more akin to a tournament and the spoils go to the victor. Here, going 80% of the distance is fruitless. It is as Al Pacino says in the film Any Given Sunday, that life is a game on inches and you do everything you can to gain that extra inch, for it is in the tightest of margins that you find the difference between living and dying, between winning and losing.

Almost every decision we make is a like a trade, with an entry and an exit, but too many times we enter into life's positions without thinking about our exit. It's different strokes for different folks, but that doesn't mean we shouldn't stop to question our motives, asking how much is enough, if it is ever enough, or how little is too little, if it is ever too little (so long as you keep on giving it your all and do not fade gently into the night?). Likewise for mastery of an art - while I admire the patient, Eastern philosophy of practising a simple task over and over, I also know that this approach is not for me. Here's a quote from an article I read about a Japanese knife maker:

'I will stop making knives when I stop learning something new and I haven't stopped learning in the 90 years I've been making knives'.

Maybe the greatest sin to simply carry on doing what you do as an avoidance strategy. By keeping busy you are avoiding confronting yourself and straight up asking yourself whether your actions have the value they once they did, if at all. In this situation, time eventually decides on your behalf, and one way or another, you get carried off. You've stop being the master of your destiny and have fooled yourself into thinking that you are still making the right choices - an impossibility if you have stopped asking yourself the right questions.



 I'm looking for some clarity about the issues of immunity, allergies, etc. Possibly this question will reach a reader with expertise.

In my college biology class, about 26 years ago, the professor explained that we've all got antibodies to "everything", but the antibodies only multiply themselves to large numbers when the body is attacked by an invader. At the time I asked the professor, "what's everything?", and the professor answered only "everything". I wanted to follow up and ask if "everything" included anti-neutrinos? Buicks? But there were >100 other students in the lecture, and anyway I don't think the professor really knew the answer. (Maybe the answer is "proteins"?)

What about foods? There has been much recent publicity about allergies to gluten, protein(s) found in wheat. Presumably gluten in included in "everything", and so everyone should have antibodies to it. Why then do some people react to gluten, multiplying the gluten antibodies up to big numbers, while others don't?

More broadly, since "everyone" has antibodies to "everything", why is that in only some people an allergen is treated as an invader?

Mr. Justa Guy replies:

JanewayYour professor was indeed correct, we all do have antibodies against virtually everything, or at least everything proteinacious. That is because of (i) continual recombination, and (ii) ongoing mutation.

Antibodies are made up of two heavy chains, and two light chains. Each heavy chain and each light chain have a unique specificity for a particular target (aka antigen). There are three genes which contribute to the specificity of each heavy chain, or light chain, called the variable (v), diversity(d) and joining (j) regions. There are multiple (ie dozens) of different V regions, dozens of different D regions and a few different j regions. This number is constantly increasing because of somatic hypermutation. One heavy chain made up of a specific combination of V, D and J chains, and one light chain made up of a different combination of V and D chains are made by one particular B cell. Mathmatically this diversity allows for tens of thousands of different antibody specificities. The presence of somatic hypermutation where one amino acid (there are 26 amino acids) is mutated with each round of cell division allows for a virtually infinite total number of antibody combinations, which in principal will include antibodies specific for every possible antigen (except perhaps Buicks).

Lets take the case scenario of a B cell that makes an antibody against influenza. In the case of the flu, a naive B cell which is specific for flu, is activated when it encounters flu antigen (either vaccine or flu virus). This causes the B cell to proliferate and make different kinds of antibodies, starting with IgM and IgD, and then maturing into either IgA, IgG, or IgE which help with either defense at mucosal surfaces, in the blood, or in causing allergy. Ultimately the activated B cell makes daughter cells of memory B cells, or plasma cells whose job it is to produce large amounts of antibody.

That is a short version of how it works.

There are many excellent intro level immunology texts, one of my favorite is by Janeway. They can provide a much more detailed explanation.

Jeff Sasmor writes:

Recently there has been much publicity about allergies to gluten, protein(s) found in wheat. Presumably gluten in included in "everything", and so everyone should have antibodies to it. Why then do some people react to gluten, multiplying the gluten antibodies up to big numbers, while others don't?

But Gluten Intolerance, also known as Celiac Disease isn't an allergy — it's an autoimmune disease; gluten sensitive enteropathy.

My older daughter has it… so I learned more about it than I ever wanted to know.

Justa Guy adds:

That is where it get more complex.

In order for B cells to maximally proliferate, they require "help" from another cell, the CD4 T cell. The CD4 T cell that helps a given B cell is specific to that same antigen. When CD4 T cells recognise antigens, it is done in concert with recognising another class of molecules called MHC class II, which is what defines self. So If a CD4 cell recognises an antigen but does not see MHCII, it is non self, and the CD4 cell helps coordinate the immune sytem to attack the non self antigen. If the CD4 cell recognises antigen, but also sees MHC II, then it is self and the CD4 cell is prevented from proliferating, and so it does not supply the necissary "help" to the B cell so that the B cell cannot proliferate to produce antibody.

Celiac Sprue is felt to be a food intolerance, where antibodies are produced that also react with self antigens expressed in the small bowel. In essence the antibodies are reacting against self, and so Sprue ( and many other diseases - eg lupus, rheumatoid arthritis etc) are circumstances where the process of tolerance ( breifly outlined above) to self antigens fails.

Riz Din responds:

As Justa Guy says, it's all about finding one's optimum dose. Unfortunately this is very difficult to do with vitamin D, as official lines are quite wishy-washy.

In order to get to where you want you first have to know where you are, and having a vitamin D blood serum test has to be the best first step in this direction. After spending a long summer outdoors I had my blood taken and my level came in a rather pitiful 63 nmol/L. It isn't woefully inadequate, though it does fall in the 'insufficient' zone. I shudder to think what my winter reading would have been. My doctor simply recommended a multi-vitamin tablet of all things as a solution, which is not wise as many of the other vitamins can be toxic at much lower multiples of the RDA. I'll eventually get retested to make sure I'm not at an risk of toxicity from vitamin D supplementation (currently taking 1000IU a day), but I think this is close to impossible on the existing dose.

From (a rather wobbly) memory, I understand the benefits for many conditions (bone fracture risk, etc) really kick it at the slightly higher doses of 800IU upwards, and also that the negative effects are very rare and tend to occur at extremely high doses, except for people who display a particular sensitivity. For my mother, who is also taking supplements, vitamin d has bought significant improvements. For me however, I haven't experienced anything beyond stronger nail growth, but I guess that's the point.

My 'vitamin d' bookmarks folder is on another machine, so I've put together a few interesting links for people who want to dig a little deeper (see below).

Here are the links:

- Dr Holick is a significant figure in the field of vitamin D research and he is also the most recent winner of the Linus Pauling Award. His UV Advantage website contains links to articles, videos, interviews, etc . I know the site looks a bit cheesy, but this guy is pretty well respected.

- On the issue of life extension, a recent study of lymphoma patients found that 'Patients with deficient vitamin D levels had a 1.5-fold greater risk of disease progression and a twofold greater risk of dying, compared to patients with optimal vitamin D levels after accounting for other patient factors associated with worse outcomes.' Pretty impressive stuff.

- The Institute of Medicine is reviewing the daily reference intake recommendation for vitamin D. Their work is ongoing but if you follow the link and click on 'presentations' in the 'other resources' section on the right, you can download presentations from people who attended the workshops (Holick is among the names).

- An AJCN Editorial from 2007 states: 'The balance of the evidence leads to the conclusion that the public health is best served by a recommendation of higher daily intakes of vitamin D (3). Relatively simple and low-cost changes, such as increased food fortification or increasing the amount of vitamin D in vitamin supplement products, may very well bring about rapid and important reductions in the morbidity associated with low vitamin D status.'

- An older AJCN review article looked at toxicity levels and reported 'Throughout my preparation of this review, I was amazed at the lack of evidence supporting statements about the toxicity of moderate doses of vitamin D. Consistently, literature citations to support them have been either inappropriate or without substance.'

The author presents this insightful graph and comments that 'The serum 25(OH)D concentration is maintained within a narrow range (Figure 2Go), {approx}75–220 nmol/L across vitamin D supplies from 20 µg (800 IU) to the physiologic limit of 250–500 µg (10000–20000 IU)/d. The most reasonable explanation for this kind of relation is that there are homeostatic control systems to regulate serum 25(OH)D and to buffer against variability in vitamin D supply. … Beyond the vitamin D supply limit, which is comparable with that attainable with sunshine, there is a classic rise in the dose-response curve. The sharp rise reflects the introduction of vitamin D and 25(OH)D at rates that exceed the capabilities of the various mechanisms to regulate 25(OH)D.'



SpiderHere's an interesting BBC article about research on spider survival strategies.

Researchers hypothesized that a species of spider that decorates it's web with prey carcasses would benefit from a camouflage effect, but it turned out that these spiders actually received many more attacks from predators than those with undecorated webs. For these arachnids, unless the web decoration serves another purpose I imagine the trick worked for a good while before the predator-prey arms race escalated to the next level. Now that the other side seems to have the upper hand, I wonder for how long the spiders will continue to direct their energies pursuing a futile strategy. Other spiders are stepping up their game, for when the researchers tested the idea on another species of spider that decorates it's web with actual size replicas of itself, they found that that the decoy effect outweighed the increased risk of detection.



[F]rom a trading perspective it's very simple. There's stimulus, response, reward [or] punishment. John Porter, as quoted in Drobny:  Inside the House of Money, Page 161

I heard John Porter speak a couple of times when I was at Barcap and he came across as colourful and genuine. If I remember correctly his background is in psychology, which may help explain his framework of thought.

It seems that whatever our backgrounds may be, we try to mine our personal histories and characters for new ways of thinking about the markets. Perhaps there are just as many lessons to be learned in applying our trading knowledge to our daily life outside of the sphere of financial speculation. For example, I recently missed a return flight from Paris to London and had to catch the Eurostar [train] the next day. While I could have dwelt on this for a long time I decided to process it as no more than one of life's bad trades. By calling upon the thought process I used to employ to handle bad trades, I was able to write off the missed flight pretty quickly and enjoy the extra day of unplanned holiday. I guess these types of insights can work pretty well both ways.



Big MJust back from a short trip to Paris where I made a few observations about prices. I recognise there is a good element of bias in my notes because I only spent four days in Paris whereas I have lived in and around London for several years. However, the observations may still hold some useful information:

- Price Diversity: The UK highstreet is flooded with identikit chain stores, fast food chains and coffee outlets. Paris offers a welcome counter balance, with the majority of operators seemingly being run independently. However, despite this diversity of ownership, it seemed as if there was an implicit collusion on prices. Not only were prices in the center of Paris higher than London but the price range also seemed significantly narrower, with crepes costing as much around major tourist spots as they did on the side streets. Contrast this with Central London, where you seem to get a wider diversity of prices for each product, even around tourist hot spots (coffee's and teas can be had for less than £1 around Leicester Square or you can spend a whole lot more if you want a premium product in a top notch establishment).

- A high price level: I knew the pound was weak before I left but I found prices to be painfully high in many establishments in Paris. I jotted down the price of a few food items in the McDonalds at Charles de Gaulle airport and compared them to the equivalents in Central London :

While airports often charge a bit more to their captive audience I remember the premium on the Paris high street being about the same, with burgers costing about a third more. The same held true for prices in a Paris coffee chain versus Starbucks in London. Note, whereas the UK operators charge slightly different prices for their take away or eat/drink-in options, Parisian cafes discriminate in an altogether different way. They charge you a reasonable price to sit or stand at the bar, consume your purchase and be on your way, but if you want to sit at the front and watch life go by, then you can easily pay three times as much for the privilege. Based on my short visit, I'd say GBP/EUR is a pretty strong from a long view perspective. It would be interesting to see $ prices of the McDonald's items for a view on cable.

- Price Responsiveness: In Paris, the price reductions were rather discreet. Contrast this with the view of Oxford Street in London on my return , where heavy promotions plastered the sides of buses and the shop fronts. Make no mistake, the UK is responding dynamically to the recession. I wonder whether France just isn't feeling the recession pinch as hard, or whether this is symptomatic of a lack of broader price flexibility.

More comments and photos from the trip are on my blog .

Vincent Andres writes from France:

I find price inelasticity rather incredible in France. For instance, in the building business, here in my département [county], enterprises have roughly 2 months of work in their order books (instead of more than 1 year "usually"). You would have expected prices of wood, concrete, etc. going slowly down. Quite the contrary.

Just one representative example : I know a concrete factory in my area, they lose a lot of clients and business … but they will absolutely not move their price down by one cent, not even the day before they close … which is not very far off.

There are certainly many causes and explanations to such inelasticity, but the level of taxes in our products is at such a level (you have to pay for all this paradisiac socialism) that there is no latitude left to producers. Reducing your prices (while your taxes stay the same) may (?) preserve some clients, but is synonymous of selling at a loss, … so you sadly had better stop (… and so I did).

We are calmly waiting for the end of this madness.



Should golf pros who want to win a major, practice in cold wet windy annoyingly uncomfortable environments?

Should surf pros who want to win the world title do the same, train in crappy onshore beach break conditions?

…so when it's game on, they will be so happy to be warm, and comfortable and hungry for the win?

Should we traders be in cramped humid stuffy rooms, with no daylight, to reinforce the value of money and stay focused?

Scott Brooks disagrees:

Professional athletes as well as military personnel should practice/drill in the worst conditions so they can thrive in the best conditions. But no one performs at his peak in these conditions.

Drilling and practicing are very different from actual live game day executions.

Traders aren't forced to trade in bad conditions. We should trade in conditions that optimize our ability to think clearly and perform.

There is a big difference between drilling/practicing and actual execution of a task. Trading is real life execution. Game days are real life execution, Battle is real life execution. You don't want to be at anything less than your best when it comes time to execute.

If you're a professional athlete and it's raining on game day, both you and your opponents have to play in the rain. If it's the day of the battle and it's freezing cold blizzard, both you and your opponents have to execute in those conditions.

But when you're trading, you don't want to put yourself in a less than optimal situation. Your opponent has probably created the most comfortable environment that he can to optimize his mental acuity. Why would you want to give yourself the handicap of being uncomfortable?

Create the "peak performance environment" so that you have the highest potential to reap the greatest rewards for yourself and your clients.

Riz Din adds:

A documentary series recently aired in the UK that provided insight on the natural life on the small South Pacific islands. In these small islands, life has evolved in strange ways, producing several instances of flightless birds for example. Unfortunately, after many many years of comfortable living, the introduction of new predators onto the islands wreaked havoc.

I agree with Scott that the physical conditions should be optimal, but I would add that the mental aspect needs to be tended to well, as complacency can spell death when market conditions suddenly turn, strategies stop working, etc. Better to retain the ability to fly, just in case.



MitGiven that one can listen at low cost/free on the Internet to the best professors in the country giving courses in many leading subjects (MIT has all its courses free online, Yale and Stanford some of theirs), how long will consumers be willing to pay $200,000 for four years of Ivy League and other leading private courses often taught by uninspiring assistants and graduate students — often, in the case of math and science courses, mumbling foreign graduate students whose English is incomprehensible? I well realize that a degree from a leading private university is a considerable signal to employers, potential spouses and others, of one's intelligence and diligence (and I also realize that the $200,000 cost is usually not borne by the consumer him- or herself). But still, how long in this age of technology, outsourcing and arbitrage can such a differential persist?

Steve Ellison reports:

In an NBER paper, Avery and Hoxby state:

If [a student with very high college aptitude] acts as a "rational" investor, not bound by credit constraints … then he need make only two calculations for each college in his choice set. Supposing that the student has figured out the cheapest way to attend each college, given the aid offered him, his first calculation is the present discounted cost of attending each college j …

His second calculation is the present discounted value of the consumption he enjoys at college j plus the present discounted value of the stream of income generated by the human capital invested in him at college j …

Jeff Sasmor reacts:

What college student thinks this way? As someone who has just gone through this process with an intelligent child entering college (Barnard) next fall, the decision involved more emotional choices than rational ones.

1. What school best fits what I think I want to do with my life?

2. What school has the type of people I want to hang out with for the next four years?

3. I want to get out of NJ. Even though I was accepted into Rutgers' Honors program I don't want to go there, yuk. I want to go to a brand-name school. I want NYC because I want to experience an urban lifestyle. You know, I'll need a bigger allowance!

4. Don't lecture me, I don't care what it costs.

Riz Din shares:

I was painting our fence the other day while listening to a variety of quality podcasts and lectures (painting a fence takes longer than I thought) and I had similar thoughts.

The differential has to fall over time because the act of standing in front of a group of people and lecturing them is outmoded in today's world and is fast becoming commoditised through technology. The idea of an institution herding students into a room at a fixed time and having a one-sided conversation with them while they rapidly jot down all the salient points just doesn't hold water when there are much better, more productive ways of teaching. I start to drift after the half hour mark in many lectures and being able to press 'pause' on the lecturer would have been a real boon.

Universities can be extremely slow to adapt (e.g. Latin was standard at Oxford and Cambridge several hundred years after other places of learning adopted English), so overhauling the entire way of teaching may be some years in the making. Nevertheless, I think the education establishments are going to have to figure out how to better differentiate themselves because we thankfully live in a world where one's prospects depend less on one's place of learning or social standing and more on one's capability. Just as increased competition in the forex world led to massive spread reductions over the years, forcing many banks to evolve and differentiate their forex offerings with value-added propositions such as better research, option strategies, trading systems, etc., so universities and other places of learning must adapt their models. As a hybrid model at least, I can foresee on-line lectures combined with seminars and other, more interactive modes of learning. In today's world, perhaps knowledge isn't power because it isn't scarce, and the emphasis is increasingly on the the application of knowledge.



On the topic of the role of individuals in history, I read a pretty interesting book called Ubiquity recently (reviewed on my blog ) that addresses this issue as part of its investigation into critical systems (earthquakes, forest fires, markets, etc). Towards the end, the author compares the roles of individuals in history to the grains of sand that cause mini avalanches on a sand pile:

'… the largest avalanches are far and away the most influential in terms of the effects they have on the pile. … how should some historian explain these movements?

Our historian will be sorely tempted to identify certain individual grains as having been massively influential. After all, colleagues will point out that in 1942, an individual grain of immense courage named Granular Columbus triggered an avalanche that ultimately carried grains all the way from the East to the West, and so altered the face of the world and its future. … For each great event, they can identify some extraordinary grain that touched it off, and perhaps a few others that kept it going at crucial stages. And these grains, they might conclude, are the real agents of history.

Despite being tempted to agree, our historian (a subtle observer of individual character) will have noticed that in the sand world every grain is identical to every other, so there really can be no question of any one being a Great Grain. … By understanding that the pile is always on the edge of radical change, our historian comes to realise that there are always places in the pile at which the falling of a single grain can trigger world-changing effects. These grains are only special, however, because they happened to fall in the right place at the right time. In a critical world, there are necessarily a few great roles and some grains by necessity fall into them.

Might the same be true of human history? There is no denying that some people, by virtue of their personality or intelligence, are more influential than others. And yet it is at least a theoretical possibility that our world exists in something very much like a critical state. In such a world, even if human being were identical in their abilities, a few would nevertheless find themselves in situations in which their ordinary actions would have truly staggering consequences. They might not even be aware of it, as the potential for their actions to propagate might only become apparent as history unfolded. Such individuals might come to be known as great men or great women, as creators of vast social movements of tremendous import. Many of them might indeed be exceptional. But this need not imply that their greatness accounts for the greatness of the events they sparked off.

Just as it is almost irresistibly tempting to seek great causes behind the great earthquakes or the mass extinctions, it is also tempting to see great persons behind the great events in history. But the sand-pile historian comes down firmly against the ‘great grain’ theory of history … Our historian might agree with Georg Wilhel Friedrich Hegel, who concluded that:

‘The great man of the age is one who can out into words the will of his age, tell his age what its will is, and accomplish it. What he does is the heart and essence of his age; he actualises his age.’

Rudolf Hauser comments:

For a fire to start one needs something that will burn and oxygen. Without either there will be no fire. With them there will still not be a fire without a spark, or more precisely enough heat to start the process. It is the same with history. No individual can change the course of history if the necessary conditions are not present. Sometimes a fire is more difficult to start and it takes greater skill on the part of someone trying to light it than when conditions are more favorable. The same with history. Sometimes a very unique person can make changes happen if conditions are only slightly favorable to such changes. At other times, conditions are so clear that almost anyone can push history in a certain direction. In short, individuals do matter in the direction history takes but more will be likely to push history in a particular direction at times so that the individual who does so matters little and at other times it takes a unique person to do so. Even if change seems inevitable, the exact direction events take can depend on individuals.

Jeff Watson writes:

Sometimes, wrong or false ideas get put into the mainstream and become accepted as fact. Consider the old axiom that fire always needs oxygen or an oxidizer to occur. Nothing could be further from the truth. There are examples of fire occurring in the absence of oxygen, such as lithium burning in the presence of a pure nitrogen atmosphere at high temperatures, forming lithium nitride. I consider this reaction to be fire as there's a visible flame, but some might dispute the fact that it is really a fire because of the lack of an oxygen component. Since it is ingrained in our heads from an early age that combustion requires four components (oxygen, fuel, heat, and chemical interaction to start a chain reaction), many will scratch their heads with disbelief at the idea of fire without oxygen. People who scoffed at the truths of Copernicus, Galileo Galilei, and Newton and were found to be proven wrong. Some market participants hold similar wrong ideas that get put into the mainstream. The benefit of the economic policies promulgated by John Maynard Keynes comes to mind. It will take time to get the mainstream to prove these ideas wrong, much like it took generations for the ideas of Copernicus to become accepted.

Stefan Jovanovich responds:

Riz Din mentioned Columbus. He became important in late 19th century American eyes because Italian-Americans (but, interestingly, not the descendants of his bosses, the Spanish) celebrated his discovery of the West Indies as a holiday. Before then he was no more important a figure than Vespucci and far, far less important to Americans own view of themselves than the Pilgrims. To his contemporaries the Genoese sea captain was simply one of the literally hundreds of explorers who were doing VC start-ups - looking for ways to break the Ottoman-Venetian monopoly on the spice and silk trade. When other explorers found what Columbus did not - gold and then silver - the focus of Europeans shifted somewhat from East to West; but it was not really until the sugar boom (the one commodity that could not be profitably grown in Asia) that our New World became as important as the Indies. And, even then, North America was very, very unimportant. It is always helpful (and properly humbling to us Americans who think we are truly the center of everything) to remember that after what we Inglese call the French and Indian War, the French peace treaty negotiators thought that keeping Guadalupe was more important than retaining Canada and for half a century thereafter the Brits thought they had gotten the worse part of the deal.

That is the most plausible story of what the Europeans did. But that, or any other story of how Europeans dealt with America, cannot tell us anything about the relative causal importance of individuals. The story is not an equation or an scientific test; there is no empirical answer. After enjoying and wasting half a century reading millions of words of written "history" and dragging my dear wife to old buildings, museums, and shrines, I have come to the same conclusion Hayek came to about "macroeconomics". The idea of "history" is an interesting construct, but it is an aggregationist illusion. Human action does not have a course or a moral or a lesson or a burning point; it is not a river, a sermon, a lecture or a fire. A good history is a plausible story about the past that is honest about the known records, is properly skeptical about our human capacity to tell stories that say "hooray for our side", and views the events from all sides. Not surprisingly, for every good history there are a hundred bad ones. What the bad ones all have in common is the same thing that Hayek found so dispiriting about Keynes as much as he enjoyed and respected the man: the ease with which inconvenient facts can be discarded in favor of a causal theory.

The book Guns, Germs and Steel is the most notorious recent example of really rotten history, but just about everything on PBS will do. But, to be fair, if you mute the narrations and turn off the closed captioning, the photographs have considerable interest. Or, they did, until documentaries decided to become awful dramas of "reenactment". If you want examples of the other kind of history, J.S. Holliday's history of the California gold rush, The World Rushed In, remains a classic; and his later work, Rush for Riches, is an even better story.



 I drive a lot. Easily putting 35,000+ miles/year on my SUV. As a result, I see a lot of billboards. Over the last several months I have noticed that a large number of billboards that are either blank or have some sort of message that says they are available, e.g. "Ten thousand people per day see this billboard — shouldn't your message be here?"

Having been involved in marketing and sales most of my life, one thing I've learned is the last place you want to cut expenses is in your marketing and advertising budget. Good companies adhere to this rule but most companies don't. Those that cut their marketing budget end up being hurt because of that cut. Advertising and marketing is the equivalent of planting a crop so you can eat tomorrow. Sure, you can save money today by not spending the money needed to grow tomorrow's crop, but come tomorrow you're gonna be hungry.

Based on what I'm seeing as I drive down the highways of America, there are a lot companies cutting their advertising budgets. They will find that tomorrow they will not have the new sales to feed their company. Their company will end up hungry and weak, they will be forced to make further cuts, — and the downward spiral to starvation begins. Cutting advertising budgets is not a good sign for the economy.

Russ Sears comments:

My guess is that you are correct for individual businesses, it makes sense to advertise the most when things are bleakest. But like PE ratios (make sense for an individual stock, but not for the index) my guess is that this does not apply to the whole.

For example many businesses shut their doors during a recession, leaving much ad space. Also fewer start-ups, and most smart start-ups advertise heavily. Once they establish a client base they often let up.

Further, it could be that billboards go first out the budget, because they are hard to change to meet the changing environment. For example you don't see many billboards touting prices of cars, refunds, etc. but you do see some, in better times, with cars on them.

Riz Din writes:

With respect to the issue of marketing during recessions, the literature confidently supports Scott's experienced take:

Harvard Business School's Working Knowledge site says 'Maintain marketing spending. This is not the time to cut advertising. It is well documented that brands that increase advertising during a recession, when competitors are cutting back, can improve market share and return on investment at lower cost than during good economic times.'

mailto:knowledge@wharton comments 'Research shows that companies that consistently advertise even during recessions perform better in the long run. A McGraw-Hill Research study looking at 600 companies from 1980 to 1985 found that those businesses which chose to maintain or raise their level of advertising expenditures during the 1981 and 1982 recession had significantly higher sales after the economy recovered. Specifically, companies that advertised aggressively during the recession had sales 256% higher than those that did not continue to advertise.'

Regarding the question of whether it is better for a company to have been born in a time of hardship, in a short paper titled 'Entrepreneurs and Recessions: Do Downturns Matter?' Paul Kedrosky looks at 8,464 companies that have gone public between 1975 and 2006. Using the IPO as a yardstick of success, Kedrosky concludes:

'Knowing that a company was successful—at least as evidenced by having gone public—does not give us any information about whether that company was founded during a recessionary or non-recessionary period. At least in a general sense, that is suggestive in that, given smaller numbers of companies founded during recessionary periods, the implication is that companies founded in such times have a higher likelihood of turning out to be economically important'

(the study doesn't look at death rates of companies in different periods).



 Evolution is a random function, such that as conditions change, the random mutations of a species makes one particular mutation more successful in the particular niche or in response to the environmental change, thus allowing it to flourish. The other manifestations do not survive. As much as we might want to delude ourselves into some control, it's not probably very true. The trait may not be better or superior, but it just happens to work.

Kind of like many patterns in the market. Some random pattern will start working in a regime for a while. Then it won't. It's important not to get too locked into any one style, pattern, regime to avoid the extinction issue. This is adaptability and is more important than almost any other issue. That's the problem with the "xyz" trade or what ever. Even the one that work, won't work a third of the time. Is it worth dying over, or worse?

Marlowe Cassetti writes:

I agree that the Darwinian model is probably the better model of the dynamics of the market and an explanation for "everchanging cycles." In my view, it trumps the Efficient Market Hypothesis, Fib Ratios, reversion to the mean, MACD histograms, or Uri Geller's psychic visions. From what I surmise the Darwinian model is encompassed in the rubric of behavioral finance and evolutionary economics.

So let's raise a glass of wine this Thursday for the 200th birthday celebration of Charles Darwin, considered by science historians one of the greatest scientists of all time. Also, Abraham Lincoln and Charles Darwin share the same 200th birthday.

Riz Din reports:

I'm off to see the Darwin exhibition at the British Library, so no time to refer to the specific papers, but I recently looked at some research that investigated how the rate of random mutation of a type of baceria changes when environmental conditions become stressed. I find this fascinating as it points to a direct link between random changes in the environment and random mutations. It may be interesting to see by how much mutation rates change for a given change in external conditions, as mutation carries costs as well as benefits.

Also, what do you think–The Origin was the first truly convincing contradiction of the literal biblical view of creation and it caused a storm.

Stefan Jovanovich responds:

 I disagree. The literal Biblical view of creation had been openly challenged in Britain since the first Civil War. Belief in Christianity itself had been optional since the Lord Protector welcomed the Jews back to the United Kingdom (being a Catholic, on the other hand, was still a civil disability when the Origin of the Species was published). The notion that Darwin faced opposition is simply not true; he had no trouble with publications, and people were as mad for the theory of evolution as they were 60 years later for Einstein's theory of relativity. It made Darwin a star. Darwin did face considerable skepticism from Lyell and other Lamarckians (Lyell never fully accepted natural selection), but no one seriously accepted poor Bishop Ussher's chronology by 1860. (It is fascinating to note that both Newton and Kepler had agreed with Ussher's calculations - so much for scientific stare decisis). The Huxley-Wilberforce debate was a great show - like the Snopes trial - but it was hardly a "storm". This is yet another of those factoids of history that present scientists as having to bravely challenge the forces of Christian ignorance; and like so many of them (Galileo et. al.), it is a complete canard. Darwin did lose his own belief in the Resurrection, but that loss came not from his evolutionary theories but from the questions raised in his mind by the death of his young daughter.

Riz Din adds:

Here are some notes taken from my visit to the small but enlightening Darwin Exhibition at the British Library:

- When Darwin was living at his home in Kent he would walk down his 'thinking path' every day, come rain or shine. His daily routine was as follows:

Go for a short walk before sunrise

7:45 - 8:00 Light breakfast
8:00 - 9:30 Best time for research
9:30 - 10:30 Relax on sofa and read letters
10:30 - 12:00 Research
12:00 - 1:00 Visit greenhouse and walk along Sand Walk and think
1:00 - 2:00 Lunch and read newspaper
2:00 - 3:00 Write letters
3:00 - 4:00 Rest while Emma reads aloud
4:00 - 4:30 Afternoon stroll
4:30 - 5:30 Research
5:30 - Evening begins
10:30 To bed

- Darwin graduated in theology and was thinking of life as a clergyman when he was offered the invitation to be a naturalist on the HMS Beagle.Darwin writes that the Beagle voyage was the single most important event in his life.

- The naturalist suffered much ill health through his life, yet his output was prolific. Darwin had a strong desire to understand everything he observed. His eight year study on barnacles won him a gold medal award by the Royal Society, and after Origins of the Species was published Darwin went on to study orchids in great depth.

- Evolution was not a new idea at all and the works of others paved the way for Darwin. Erasmus Darwin, his grandfather, alluded to the idea in his poem 'The Temple of Nature', writing 'mankind arose from one family of monkeys on the banks of the Mediterranean.' Other key figures in the story of evolution include Malthus, Lamarck and Lyell.

- At the same time as Darwin, fellow naturalist Alfred Wallace had the similar ideas about evolution and survival of the fittest. Darwin's and Wallace's ideas were jointly presented to the Linnean Society in 1858, but Darwin's thesis had been twenty years in the making, and extensively researched, and he published The Origin of the Species shortly after. The Origin was written for popular consumption, in a conversational style, and quickly sold out. However, Darwin was careful not to include explicit discussion of man's place in evolution, even if it was obvious for all to see. The Origin was the first truly convincing contradiction of the literal biblical view of creation and it caused a storm.

- The exhibition has a couple of amusing notes on marriage. Writing to congratulate his friend on his recent marriage, Darwin says 'Long may you live in your now perfect state. We poor bachelors are only half men,—creeping like caterpillars through the world, without fulfilling our destination.' In 1838, Darwin produced an highly entertaining list of the pros and cons of marriage



 The financial crisis has a number of causes including weaknesses and gaps in regulation and supervision. However, the idea of a growing government as a solution to problems created by greedy capitalists and bankers around the world looks too simplistic and has a bit of populism in it. There may be results in the short term, but in the longer term the issues will likely be more than the benefits with an expensive bill for the next generation of taxpayers and citizens. I am not referring specifically to the US, but also to Europe to some extent.

Real change would be first to understand weaknesses and challenges of our industrial, financial and social systems. The world is changing. There are new players in the game. And the relative importance and power of countries is changing with time, and accelerating. We should recognize this fact. This has consequences on our present and future ability to be innovative and competitive, on the possibility to maintain the same lifestyle in the future, the same welfare. This crisis has shown that the US is still vital and fundamental for the good of the world's economy, but it has also dramatically shown the increasing difficulties of the US in maintaining this leadership, which is not only economic, but also intellectual and political. After this crisis we cannot go back to business as usual and our countries will end up with more debt on their shoulders. We cannot solve the crisis just pumping government money in a model that is not working without doing anything to change it. We will only have crisis after crisis if we do not eliminate the roots of the problem. And the problem is that new players in the global economy produce goods cheaper than we do, that they are learning fast how to make high tech products and services, that they sell more than they buy. This is causing a fundamental imbalance in the global system that market forces should solve within a proper framework and set of rules provided by governments. Also we should probably all realize that may be we are living a standard that we cannot afford any more.

From a WSJ article:

One memorable moment in "Atlas" occurs near the very end, when the economy has been rendered comatose by all the great economic minds in Washington. Finally, and out of desperation, the politicians come to the heroic businessman John Galt (who has resisted their assault on capitalism) and beg him to help them get the economy back on track. The discussion sounds much like what would happen today: Galt: "You want me to be Economic Dictator?" Mr. Thompson: "Yes!" "And you'll obey any order I give?" "Implicitly!" "Then start by abolishing all income taxes." "Oh no!" screamed Mr. Thompson, leaping to his feet. "We couldn't do that . . . How would we pay government employees?" "Fire your government employees." "Oh, no!" Abolishing the income tax. Now that really would be a genuine economic stimulus. But Mr. Obama and the Democrats in Washington want to do the opposite: to raise the income tax "for purposes of fairness" as Barack Obama puts it.

Riz Din writes:

Not so long ago, I heard a pundit commenting on recent economic policy responses saying something along the lines of when the fires are raging, the first priority is to put them out, and to deal with the longer term implications later. Personally, I think it is better to sometimes let things burn and let nature take its course.

I agree that we are living a standard we cannot afford any more, but only in the sense that we may have 'brought forward' living standards by a few years and that we may have to contend with tougher times before the wheels of progress start spinning again. Indeed, while a part of me worries that all this policy meddling risks damaging the natural checks and balances of a free system, I am reminded of the old adage 'necessity is the mother of invention', and look forward to new discoveries being born from a period of relative hardship.

Duncan Coker adds:

Looking to history, in the 1930s all the programs rolled out by FDR did little to solve the Depression. There was even a mini Roosevelt depression within a Depression in 1937-38, four years after all the government action. What did get people back to work was arming for potential conflict, which added three million jobs in 1939-40 and continued through the horrible conflict to follow. All the FDR structural reforms played a bigger role a decade later, after the war, when security and arguably a more transparent system allowed for exponential growth for middle class incomes, housing and standards of living. I believe it will be the small businessman and entrepreneur that paves the way this time, really the only ones that can "create" jobs.



 I always enjoy reading James Montier, SocGen equity strategist. Here are a few highlights from his current research piece:

Conclusions – The Return of the Coffee Can Portfolio

The road to revulsion is throwing up some exceptionally attractive opportunities for investors.In many ways, perhaps we are being offered the investment opportunity of a lifetime in areas such as the corporate bond markets.

In aggregate, equity markets are cheap, perhaps not at their ultimate bottom but cheap nonetheless. For those focused on long-term returns, equities are pretty attractive as an asset class. From a bottom-up perspective, the equity market is offering some excellent companies at truly bargain prices for those with the fortitude to shut their eyes, or at least switch off their screens and buy. The institutional imperative to perform on every time horizon hampers this ability in a particularly frustrating way. Investors are looking at the short term, and ignoring the long-term opportunities they are being offered.

As I was completing this note, a friend sent me a great speech by Jim Fullerton (former Chairman of Capital Group) written in 1974. It concluded with a quotation from Dean Witter speaking in May 1932 which I found apposite in the extreme. "Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished. In fact, does anyone think that today's prices will prevail once full confidence has been restored?"

This looks like a great time to start to fill up your coffee can. As if all this wasn't enough, Mr Market is offering you the opportunity to protect yourself from the ravages of inflation in an exceptionally cheap way. With all of these opportunities available I have never been more bullish! Will I be early? Almost certainly yes, but if I can find assets with attractive returns and I have a long time horizon I would be mad to turn them down.



In the UK, Cambridge University's Clare College is standing up to be counted among the optimists. For the first time in its seven hundred year history the college is making a leveraged play on equities. Here's from this week's Economist :

'It has borrowed £15m ($24m) for 40 years at a real (after-inflation) yield of 1.09% and plans to invest the proceeds in equities. In effect, it has turned part of its portfolio into a hedge fund, using borrowed money to speculate on the stockmarket. At an inflation rate of 3%, it will have to repay around £75m in 2048. Will future dons be throwing themselves off the famous Clare bridge?'

It's good to see someone exploiting a few of the extreme pressures in the market:

- Panic selling of equities. No one knows where the bottom is, but I'd rather buy at these prices than at last year's prices.

- Excessive demand from pension funds for long dated inflation-linked bonds in the UK (or insufficient supply) has pushed down the yield to very low levels, resulting in a very cheap financing option for the college.

- Right now, everyone is panicking about where the market is going tomorrow, next week, next month, even a year from now. These guys have a forty year investment horizon. The risk premium can be a fraction of what it was in the past and they will still make a tidy profit. (although I did read an interesting comment that because it would be extremely expensive to insure this forty year trade with options, this suggests that investors who take such long views may not be being rewarded for their patience so much as they are being rewarded for the extra risk they are taking.)

- Relative to the size of the college's total endowment, the investment is apparently quite small. Also, despite press talk of turning in to a hedge fund, there is no mention of investing away from equities or going short. All in all, I congratulate them for taking a measured risk at an opportune time when both ends of the market (financing and investing) appear somewhat stretched.

It's a bet I'd happily take, if only I could get financing at inflation +1.09% for forty years!

A Cantabrigian from the other side of the pond adds:

I heard a few months ago, that Harvard and Stanford were hard hit by the decline. Well they might be, since they had a mish mosh of commodity based investments guaranteed to decline with the simonesque times. They just sent me a disguised fund raiser that implies the decline was much less than feared, a mere 30%.

Riz Din goes back in history:

Keynes seems to have been quite the risk taker, trading currencies on margin before switching to commodities and blowing up his personal account in 1929. His Independent Investment Company (an investment trust), set up in 1924 also failed miserably.

However,  his performance managing the King's College Cambridge's 'Chest' fund is highly impressive, and despite poor performance of the averages, Keynes did succeed in steering the Chest through the turbulent times of the Great Depression. Prof. Dimson has written a nice paper on the Chest's performance.

Keynes investment philosophy was far from static over the course of this period. He realised that his gains came from a handful of stocks and switched from a top-down, asset rotation approach to a concentrated buy and hold philosophy. The lesson is one of continuous learning, but I do wonder if Keynes was deceived by hindsight (i.e. perhaps you have to buy widely to be sure of catching the winners?), and believe the far more important factor in his success lie in his willingness to go against the consensus. At a time when British investment institutions' exposures to equities was extremely low, going from around 3% in 1920 to about 10% in 1937, Keynes went against the prevailing wisdom in no small measure; apart from seeking safety in government assets in the height of the panic, Dimson writes that 'by the mid-1930s he was investing heavily in US common stocks such that the Chest's total equity weighting never dropped below 50%.'

And where are we now? Take a look at this graphic of asset allocation of US university endowments with a minimum size of $1bn, it's taken from a recent research note from ML, although the data is from 2007.

Equity allocation is 47%, with a whopping 34.5% in alternative investments.



 I know I could not endure Charles Ellis's new seven hundred and fifty page book on the history of Goldman Sachs, and so was happy to read Malcolm Gladwell's latest piece in the New Yorker in which he writes about the life and times of Sidney Weinberg, an epitome of the rags to riches story, who literally went from the post room of Goldman Sachs to the boardroom.

The article is a reminder that coming from a position of adversity can bring certain advantages and while it offers nothing new by way of ideas, it is filled with colorful stories from a bygone era. Toward the end of the piece, we learn of the Goldman Sachs Trading Corporation, an investment trust that ballooned in size to half a billion dollar in assets only to get wiped out in the 1929 crash, when it's price went from $326 down to a mere $1.75. Goldman's relative robustness in the current crisis suggests they may have learned a thing or two from their past.



 "The pendulum swings back and forth. It is now time for liberals, and one day again it will be time for conservatives. Ability and effort is often regulated, it can frequently be restrained, but it will never be denied."

Beautifully put from Kim Zussman. Humanity stumbles forward not unlike the market drifting higher over the longer horizon, experiencing up shifts and down shifts along the way.



 With governments of the world essentially guaranteeing most banks, why is there such a discrepancy between the yields of their bonds?

Riz Din writes:

I'm equally beat by this. Surely, no bank with a large government stake in it will be allowed to fail. Has such a thing ever happened before? Furthermore, even if such a possibility exists, why not simply buy in to the new class of bank bonds that comes with shiny government guarantees specifically written in to them [under the Brown plan ]. It looks like US banks may be holding back from issuing these new government-backed bonds until they get more clarity on the details, and an unintended consequence of the delay could be that it discourages buyers of existing bonds. But issuance of these bonds is already under way in the UK though, with Barclays and HBOS offerings already in the market (see FT link), and even these short-term bonds that piggy-back off the government's solid credit rating offer around 14-15% yield. Are we missing some pieces of the puzzle here - perhaps in the small print - or are these bonds simply extremely good value?

Nigel Davies responds:

Well, the Icelandic government was propping up Kaupthing Singer and Friedlander before they got screwed by our beloved leader when he used anti-terrorism laws to freeze the assets. Looks like I won't be playing chess there in the near future. And now, whenever I see government backed stuff being touted as '100% safe' the hairs on the back of my neck stand on end.

So is anyone for some Icelandic government high yielders? If not then my take on it would be to short some government backed debt whilst going long the debt of some of the institutions it's supporting. Which country? Probably the one we're stuck in right now.

GM Davies is the author of Play 1 e4 e5: A Complete Repertoire for Black, Everyman, 2005



 A not to be missed Haaretz news article detailing the letters of a Yiddish author and his experiences in the boom/bust periods of the Eastern Europe stock exchanges (ca 1890).

Riz Din responds:

Excellent stuff, Vince. This is a sad story of deluded ambition and greed, but it is smashingly told and packed to the brim with moments of hilarity, and at least this one is a fiction! Menakhem's wife is a truly wonderful creation. Her exchanges with Menakhem are packed with wit, scolding comments, and pleas for her husband to see good sense and come home. Alas, Menakhem's only concern is with the chase for riches.

You know things are going to end badly when Menakhem writes:

"….the word from Petersburg is, buy Transports for all you're worth! The whole world is holding them: Jews, housewives, doctors, teachers, servants, tradesmen - who doesn't have Transports? When two Jews meet, the first question is: 'How are Transports today?' Walk into a restaurant and the owner's wife asks: 'What's the latest on Transports?' Go buy a box of matches and the grocer has to know if Transports are up or down. In a word, there's money to be made here. Everyone is investing, growing, getting rich, and so am I."

A few lines from his wife:

"Shares, shmares! I'd rather own a rotten egg. No one ever made money by counting on his fingers."

"I wasn't raised in a home where we bought and sold air and God keep me from doing it now. From air you catch cold, my mother says. Who ever heard of a grown man playing in a market?"

A quick Google search for this legendary character brings up a few more pages of equally entertaining writing from the fictional Menakhem-Mendl, his wife still by his side. Here, Menakhem has quit trading and is looking to take up writing as a profession. Menakhem starts off writing a letter to an editor telling his story, of 'how I played the market in Odessa and Yehupetz, and how I sold my soul for fool's gold, Londons and stocks & bonds and every horse I could bet on, and how I went from rags to riches and back again, seventy-seven times a millionaire and seventy-eight a beggar.' His wife keeps calling him home and she is once more on the right side of the trade, for Menakhem's venture ends in tears and he soon writes, "I'm flat broke and in debt to my landlady.Not only have I run up a large food bill, I owe her for paper and ink."

Great entertaining reading for the weekend. The pdf of these letters is here. The pdf is wrongly presented in portrait instead of landscape so you may have to download it and then flip the view in your pdf reader.



 I was just perusing a "Hedge Fund Monitor (27 Oct)" note from Merrill. It cites Trimtabs research reporting record high hedge fund redemptions in September of $43bn, and says:

Such forced selling drive asset prices lower which in turn creates more losses for HFs and lead to more selling- a vicious circle. …We also think that losses to large prime brokers who provide funding to HFs, may have exacerbated some of the forced selling. While HF returns over the past 12 months are negatively correlated to Financials overall they are positively correlated with investment banks, who are also prime brokers to HFs. Just as HFs' cash needs were rising, funding became more difficult.

The note goes on to comment that a popular hedge fund strategy was to invest in equities with cheap yen and points to the strong correlation between USD/JPY and the S&P, giving us yet another variant of the carry trade.

In this narrative, the move in the USD/JPY is less a result of new flows into yen than it is a consequence of severe hedge fund liquidations that have forced an aggressive unwinding of the equity-yen trade. For what it's worth, the ML note looks to the latest COT data (already stale as it reports positions as of last Tuesday's close) and finds crowded net long speculative positions in USD and JPY, suggesting USD/JPY may have further to go on the downside. It's all interesting reading, and almost everyone seems to agree that these violent moves are the result of forced hands, not of a fair reassessment of fundamentals. A good time for the long-term investor to scale in to global equity markets, perhaps. The other thought I had when reading this report is that while I have been expecting a massive rally in USD/JPY when risk appetite subsides, if the USD and other currencies also have super low interest rates by that time, then the yen could have some competition on its hands as the funding currency of choice.

Phil McDonnell writes: 

In recent days the yen has been incredibly strong. The other notable feature of recent trading is that volatility has been historically high. Since 9/11 this year there have been 30 trading days. Only four of those have shown less than a 1% move in either direction. High change days are the norm, not the exception these days. VIX has been rising and made repeated new highs and still resides at high levels.

To see if there is a relationship between these it is often good to look at correlations between coterminous changes. Some of the more notable coincident correlations over the last three months are:

VIX Yen 71%
VIX TBill 68%
Yen TBill 59%

All these relationships are substantial. From these we can conclude that when investors perceive increased risk the money flees to both tbills and yen.

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

Riz Din adds:

A couple of additional thoughts on the carry trade:

1. One can imagine another reason why the market has fed off itself on the downside is that the carry trade is itself entwined with volatility. The carry trade thrives in a low volatility environment and it is not so long ago that we were experiencing what some called the Great Moderation, an apparently new era of low volatility in the real and financial economy. In such a world where investors are confident that fx rates will lie somewhere within a tight range x months hence, the attractiveness of the interest rate component of low rate currencies grew massively, and the yen and other low rate currencies became cheap financing vehicles for other investments. Alas, to benefit from these low financing rates these investments would have had to have been unhedged for fx risk, and when volatility spiked up, the perceived cushion of saving provided by the lower interest rates paled in comparison to the daily swings in the fx prices. Add this factor to margin calls, margin calls, redemptions, etc and you have another powerful reason for the recent aggressive, self-perpetuating, forced selling that took place across the markets. Always thinking from the other side, after such a large reversal and cleaning out of carry traders, I wonder if there will be opportunities to put this trade on as volatility heads lower– history could be a guide for those who have access to the data. I hear Iceland is offering 18%.

2. I must be missing something obvious here, and maybe this thought can be easily skewered, but I wonder if this simple explanation can be used to show why the carry trade seems to defy economic theory (uncovered interest rate parity) over prolonged periods, only to eventually come crashing down: If two similar bonds or similar stocks are trading massively apart for no reason, immediate buying of one and selling of the other closes the price gap. The price corrects back very quickly and the opportunity disappears in the blink of a eye (Porsche/VW aside). However, entering in to the fx carry trade by selling the low yielding currency and buying the high yielding currency surely only pulls prices further apart, making the carry trade even more attractive to those who use history as a guide. Is this a self-perpetuating cycle that simply carries prices to unsustainable levels?

Alston Mabry replies:

Can't help but think that it has been the other way around: The carry trade and other cheap money forces were what kept volatility low. The image that comes to mind is the pressure of air inside a big balloon, or water inside a sprinkler system; when the pressure is constant, the system is smooth and stable, but when the pressure slacks off, the system sputters and collapses.



colorHarvard Magazine leads with an interesting look at the multiple uses of colour in nature. The article is promoting a new 'Language of Color' exhibition at the Harvard Museum of Natural History and is well worth reading for a broader appreciation of the various whys and hows of colour as a signalling mechanism in nature, with colours featuring as part of the evolutionary predator-prey arms race, and reminders that because humans are not the intended observers of most colour displays, the intended viewer often sees something different to the human eye. Also contains some great pictures. This stuff never ceases to amaze.

Quote: "One sex story fit for the tabloids concerns wrasses and parrotfish. In many species, the females in a group are much less colorful than the dominant male. If the male gets eaten, the dominant female changes her sex—and puts on those brilliant colors." Source.



 The Bronte Capital blogger finds fascinating similarities between the Porsche/VW affair and the Stutz Motor Car Company debacle in 1920, when major shareholder Alan Aloysius Ryan defended Stutz against short sellers and ended up owning 105% of the company. This put him in the enviable position of being able to to name a price, but it all ended in ruin for both Ryan and Stutz.

(For history buffs, the blog links to archived articles in the New York Times).



 I always find Mr. Caravaggio's writings very thoughtful and insightful. However, I don't agree that it was a bubble. Prices were and will be completely justified. What was wrong was that the financial companies were leveraged to debt of 30 times their net worth. When the value of their assets which to a first approximation equaled their debt declined by 3%, their net worth was wiped out. The problem was that they made their money by making 1% more than their debt for a long time, and when the negative news had its day on home prices, it was enough to temporarily mark their assets down by 10 to 20 percent or so, without regard to subsequent return. What a former colleague insightfully would call "selling premium." Ouch. Okay, the banks erred. That doesn't mean that they will err again or that cycles will repeat or that the economy will not be resilient. Regions come back much stronger after natural disasters. Things have been worse. The banks were given say 100 billion of money from the rest of us to recoup their bad debt. They're happy. The process of recovery will occur. Proper money management and adherence to economic principles is called for now. The difference between the returns on equities and debt and the required rate of return a priori which is equal to the actual realized return on average, and the average non-understatement of earnings estimates is paramount. Let the bygones be bygones.

Vince Fulco adds:

Institutional investors now have a decade of no return. With some detailed credit work they can get 15-20%+ annualized from more senior securities and meet long term liabilities. Why subject oneself to the vol of equities when all your peers are moving to liability management policies and many are way behind the curve? The word on the street is hedgefund managers (those still in existence) are blowing out their equity teams under the banner, "debt is the place to be for the next decade." Granted equities are undervalued by many historical measure but can stay so for a lengthy amount of time and the recent moves can be lethal if not careful.

Riz Din replies:

Lack of returns is a problem for this generation but when I hear of the 'death of equities' I can't help but to think of past messages such as 'death of inflation' and 'death of cheap oil' and how they turned out.

Rocky Humbert remarks:

I'm watching for an inflection point on the number of Google hits for "Nouriel Roubini" as an important signal for a persistent rally in all risk assets.



The frenzied panic that resulted from Orson Wells' 1938 broadcast of the War of the Worlds is the stuff of legend. But what really happened? Did America really go totally insane with panic for a brief period? This article states that things were nowhere near as crazy as we imagine.

The world economy is in a parlous state, the financial sector even worse, and today's price action is fuel for the fire, but some aspects of the credit crunch may not be quite as bad as the panic prone hype machine as the media suggests, according to economists at the Minneapolis Fed (link ).



street There are four reports on my desk. We have Montier talking about the futility of blaming the short sellers and another report in which he attacks analysts for consistently being behind the curve, saying 'Despite the earnings declines priced into markets, I am still concerned that investors may not have fully appreciated the degree of cyclical risk that still exists.' The other two reports are on European Portfolio Strategy by Oppenheimer of GS, which are focused on the idea of a bounce in the market. Oppenheimer gives us ten reasons why the markets could bounce, with some nice charts along the way, and has this to say regarding dividend yield and the cheap valuation of Europe:

'The dividend yield on the market now is higher than at any point for the past 20 years, even assuming that dividends fall back to trend. In the early 1990s recession, when dividends were cut just as they are likely to be today, the dividend yield rose to 4.3%, and bond yields were much higher then. Based on trend dividends, this is pretty much exactly where the market is pricing today. However, there is the possibility that the dividend cuts will be larger this cycle, particularly in the Banks sector, as some European governments prohibit those companies that require capital from paying dividends to common shareholders. All else being equal, if all banks cut their dividends to zero (an arguably overly-conservative scenario), the dividend yield of the index would fall from 5.2% to 4.0%.




Popular historian Schama has a new show on the BBC about the history of America, based on his new book 'The American Future: A History'. I found the first episode to be a bit patchy and not particularly gripping, and I'd prefer my learnings to come from a less biased source — Schama is unabashedly Democratic — but there were enough points of interest to hold my attention.

In episode one Schama shows how American ingenuity has managed to overcome problems of scarcity of resources, with a focus on the water shortages of past and present. He takes us through the Great Depression, the dust bowl, the construction of the spectacular Hoover Dam, up to the present drought in California and the conflict between the farmers of Imperial Valley, who are reluctant to give up their water right privileges to the growing urban areas. Seeing how successfully the Americans dealt with the severe problems in the past gives me a confidence that current troubles will prove no more than a loud hiccup on an upward trend. In one of the concluding lines to the episode, Schama comments, "…for when American resources are in short supply, it's resourcefulness is not. That's one deep well that's never going to run dry".

UK viewers can watch this Schama's series on BBCs iPlayer . The Beeb also have an extensive history series on Radio 4 titled 'America:Empire of Liberty ' as well as having just started a new series featuring Stephen Fry traveling through the fifty states in a traditional London taxi. All good stuff. 



BucketThings have been moving at lightening speed recently and only now at the weekend do market folks get the much needed reprieve, the few days of quiet time to rebuild depleted mental strength, collect thoughts and ponder future moves and plays. I've collected a bunch of research from the Street that I thought may be worth a skim read to some on the list.

James Montier - Mind Matters: The Strangest Feeling Goldman Sachs - Europe: Portfolio Strategy - Recession – now priced as the central scenario Rosenberg - Global economics weekly UBS - The broken lighthouse
UBS - Global Bear
UBS - A Bear Market & Then a Crash Macqaurie Research - Japan strategy weekly - Bear market bottom indicators Morgan Stanley - FX Pulse

Just to cover myself, I'll provide the caveat that I generally look at bank research to broaden my outlook, learn new things etc, but I find it almost meaningless for specific forecasts.

Best wishes to all in the week ahead. It's tough navigating out there. Personally, I'm bullishly optimistic that the UK bank rescue plan will be adopted in various guises internationally and that this will provide the basis for a sharp recovery in the markets. Whether it's a good thing for the world in the long term is another issue, but what it almost does seem to succeed in achieving is eliminating the tail risk of risk of a sustained evaporation of credit leading that would lead to the hell in handbasket scenario. I may be missing something big here, and whether we fall further or not at this particular juncture is unknown, but over the weekend I went to the gym to strengthen body and mind have since been building a confident belief that the way things are developing the situation is increasingly turning in to an asymmetric bet with the world government confirming that they will do whatever it takes to stop the system from seizing up.

Here are a few quotes and notes from the pieces:

David Rosenberg from Merrill Lynch gives an nice overview of the policy response (a spot of optimism from Rosenberg of all people!):

"Policy crescendo: We have now had in very short order some extraordinary moves by policy makers. In no particular order, a UK bailout (the best, most comprehensive one we have had by any country so far, in our view), Fed buying commercial paper, a Spanish TARP, coordinated rate cuts, deposit guarantees in Europe, a banking sector support plan in Russia, Brazil intervening, etc. Unless we are assuming that global policymakers are incompetent, they will sooner or later get it right.

Critical policy measures: guaranteeing term funding and EM CB reserves The UK likely achieved the former the best way, with a 250bn sterling scheme to provide government guarantees of new short- and medium-term debt issuance to assist in refinancing maturing funding. The Fed's move on commercial paper has been nothing short of extraordinary.

CBs and sovereign wealth funds globally control US$9tn in assets. These have been built up for a rainy day. Well, the rainy day has arrived. Watch as EM CBs start utilizing these reserves creatively. Brazil intervened for the first time, joining India, Korea, Russia and others. Russia has been the most creative, using reserves to support its banking system, domestic equity market and currency."

James Montier says, 'Only 2 stocks manage to pass our deep value screen in the US. However, 35 names in Europe pass and 125 in Japan. This emerging value presents me with the strangest feeling, I think it is called incipient bullishness! Obviously not on the overall market, but with respect to a basket of deep value stocks.'

The two US stocks are Ashland (ASH) and Nucor (NUE). Montier provides a full screening list in the note.

'In the short term we must rely upon the margin of safety concept, which argues that buying stocks that are already heavily beaten up provides us with some protection against the downside. Having cash is a suitable hedge and provides the opportunity to deploy capital at a later stage if we are too early. So a barbell strategy of cash and deep value looks to be the best idea to me.'

The Macquarie Japan report hunts down indicators for a bottom in the Japan bear and provides some insightful charts:

'Japan's P/BV, at 1.05x, is at 20-year lows, having fallen beneath the 1.25x level of September 2002. The latter was a time of intense financial system stress in Japan. Japan's dividend yield is blowing away its 20-year history, reflecting increased payouts on increasingly respectable corporate profitability.'

'With bank deposit rates near zero, the history relative to the yield on 10-year government bonds is shown below. The equity dividend yield is now materially above the bond yield.'

UBS Broken Lighthouse report starts off with:

'we all assess market opportunity and risk in a way that gives us signals about when and how to act. But what happens when those signals lead us astray? We liken the current situation to a ship and a lighthouse. A ship's captain counts on the light from the lighthouse to keep the boat safely away from land. But if the ship runs aground, then what? The next time the captain sees the lighthouse, can it be trusted again? Similar to the ship's captain, there has been a loss of confidence in recent weeks of investors in global equity markets. Stocks everywhere have been under massive pressure, with all-time high readings on volatility and risk aversion. Despite some signs on (desired) policy response the sell-off has been relentless. Indeed, those signals that may have guided optimism in recent weeks, have been false signals.'

I find table 3 in this report quite insightful. It looks at historic bear markets and recoveries, albeit only going back to the 1970s. Simply judging by the duration of previous declines we are much closer to the end than the beginning.

From 'UBS - A Bear Market Then A Crash':

'Fundamentals are irrelevant today, but today won't last forever. To be clear, we expect a recession and every additional day credit markets remain frozen the more challenging it is likely to be.'

'Excluding (these) financial write-downs the S&P is trading at 9.8x trailing EPS. On an interest rate adjusted basis, we believe this could be the least demanding trailing S&P 500 PE ever.'

Phil McDonnell replies:

P McDThanks to Riz Din for this font of current wisdom.

However it is far from clear that the various government geniuses have it right yet. They have no plan to revive real estate values. That is the fundamental underlying factor in this situation. Not only do they not have a plan, they aren't even talking about the need for such a plan. If we don't solve the right problem then any solution, no matter how brilliant, will come to nought.

Even a zero down, zero per cent interest, 30 year mortgage will not convince anyone to buy a home in a declining real estate market.

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



It's all rather beautiful how the worry generating meme of permanently high oil prices and ever higher food prices has given way without anyone in the mainstream batting an eyelid. I just typed the word into and the first page of search results yields the following pessimistic titles:

- The End of Oil: The Decline of the Petroleum Economy and the Rise of a New Energy Order
- Beyond Oil: The View from Hubbert's Peak
- The Last Oil Shock: A Survival Guide to the Imminent Extinction of
Petroleum Man
- Party's Over: Oil, War and the Fate of Industrial Societies
- A Crude Awakening

All of these books are marked down, with A Crude Awakening trading at almost a quarter of the recommended price. I expected deeper discounts will trail further declines in the spot price. On the same Amazon page, we also have 'The Myth of the Oil Crisis: Overcoming the Challenges of Depletion, Geopolitics, and Global Warming', price unchanged.



I quite like the UK deal. The banks have agreed to raise £25bn between them - they'll probably be passing the begging bowls around current shareholders, hedge funds etc, as they don't have to accept funds from the government, which would dilute ownership . The government option is there but I imagine it will only be used as a desperate last resort. Better to have diluted ownership than nothing, I guess.

'Brown's bailout' has quite a nice ring to it, but from what I've read there are many more references to deal as a 'rescue' rather than 'bailout'.



utopiaLast night, I was watching an episode of Tribe with Bruce Parry where he's helping a local tribesman to hunt for a Cayman alligator. Parry comments that the Cayman has barely evolved since the time of the dinosaurs. In one sense I thought, yes, it is the perfect creature for its environment, but then I reasoned that the only reason it hasn't evolved is that it's environment hasn't changed to necessitate such a change. In one sense, the alligator is frozen in time because it's environment is broadly frozen in time. Likewise for humans. Jones' idea that 'a grand averaging is slowing evolution's power' makes sense, but there is no reason to think the rate of evolution will not change as the world changes, and we can be sure that the world will one day experience massive change just as it has in the past.

His final semi-positive comment is that 'Health, birth control and the healing power of lust all conspire to tell us that, at least in the developed world, and at least for the time being, evolution is over. So, if you are worried about what Utopia is going to be like, cheer up– you are living in it now.' From one perspective, I disagree wholesale with this comment, but it's more of an issue of definition. Now that we are delving deep into evolutionary mechanics with the tools of genetic research we are already able to tweak the genome in such ways that chosen traits and improvements are passed on to future generations. It may not happen in our lifetimes, but I reckon that we'll soon be juicing up evolution and better tailoring the human to it's environment better than ever before.

Relating the rate of evolutionary change to what is happening in the markets, I am led to wonder whether those living fossil creatures that have remained unchanged over the millennia are less able to change to changing circumstances. In trading, there are operators who become hard wired to old regimes. And so it is for banks and other institutions, where a successful model embeds itself ever deeper in to the biology of the company, making it more susceptible to a sudden change. Also, just as bacteria evolve at a much faster rate than larger creatures, the same seems to hold true of companies.

John White remarks:

EarlyEvolution is not a force unto itself. It is the description of the result of natural selection. Organisms that have genetically unique adaptations/mutations that provide an edge in reproducing have a higher probability of passing that adaptation/mutation along to their offspring. Humans' unique adaptation is our brain. Our highly sophisticated brain gives us the capacity for reason, and specifically, the capacity to test. The technological advances that have been produced by the scientific method have mitigated our environment’s impact on our ability to survive, reproduce, and raise viable offspring. While physical attributes will always play a part, the effects of natural selection on humans will be seen more and more in our intellectual abilities as time progresses. The corollary for business is that while balance sheets will always play their part, management and culture will become increasingly important. The question for the spec is how to measure that.



I've decided to call it quits on the trading front (I was trading only my personal account) due to reasons of insufficient capital. Just thought I'd share my last trading blog post.

The final blog post concerns Ivan Drago, and an accounting of the similarities between myself and the real Caravaggio.

1/ In Rocky IV, Rocky Balboa is in Apollo Creed's corner watching Creed get absolutely pummelled by Ivan Drago, a stone cold Russian killing machine. Creed is under-trained and over-the-hill and Rocky knows it, but he can't bring himself to dropping the towel and calling an end to the fight until it is too late - Drago delivers a literal killing blow with no remorse, famously commenting 'If he dies, he dies.'

Rocky, sorely racked with guilt and anger, desperately needs revenge. He heads out to Russia to train in the mountains and fight Drago on his own turf. Up against the odds, Balboa achieves the impossible. He succeeds in defeating Ivan Drago, winning over the hostile crowd in the process. Let's get one thing straight: this is Hollywood. Rocky Balboa was in the wrong. He should have dropped the towel and let Creed's pride take a hit. Balboa let his friend die and there is no coming back from that. Beating Drago in a revenge match may bring some sense of justice but the responsibility still lies with Balboa. We can also make the case that just as Creed shouldn't have fought with Ivan Drago, nor should Balboa, despite all his training and despite the victorious outcome. Of course, that may not have made for a very exciting movie. Hollywood is filled with such underdog stories and they make for enjoyable viewing but we must remember that if you fight the odds all the time in the real world, they'll eventually catch up with you. (1)

Here we have one of the most important lessons from the game of trading: process trumps outcome over the long-term. It is because of this idea that I am making the decision to throw in the metaphorical towel. For all intents and purposes, my trading life is over. It was inevitable.

Just as we should consider the alternative outcomes that never materialised in Rocky IV, so we must do the same with our trading. I know that I have died many a death in the alternative histories that never happened but that could have happened had the gods of chance not been so generous with the roll of the die. My capital is pathetically low (an affliction suffered by most traders) and I wanted to build up my equity to the stage where I could enact the right trading processes. I knew it was only then that I could start trading properly. But the paradox is that in order to get there I needed to take outsized risks to build up the capital in the first place. It was a classic Catch-22 situation, one where I had to follow the wrong path to get to the right path. I crashed and burned, worked my back up, burned again, and partially recovered. But it is not sustainable. I cannot keep on fighting the Drago. It is not healthy and conducive to practising the virtuous life.

My passion for the financial markets remains undimmed but this is my last blog post for the foreseeable future. I hope it serves as a useful record of a solitary trader's efforts. The journey has been worth taking in every respect and I thank you all.

In this section, I compare my trading life with that of the real Caravaggio.

2/ Caravaggio the artist lived from 1571 to 1610 and what a life. He was a supremely gifted painter but Caravaggio was not a nice person to be around. Rebellious to the extreme and prone to outbursts of excessive aggressiveness, Caravaggio was always getting in trouble every where he went, trouble that would often included a burst of violence along the way.

I don't model myself on this guy but there are similarities. My antics in the market place were often akin to Caravaggio's pointless brawls and arguments, usually ending with me the worse for wear and filled with gloomy self-loathing. By the time I started this blog I felt I had a much better control of my emotional trading faculties, but just as Caravaggio was left badly wounded after he fought and killed Ranuccio Tommasoni in a knife-fight in Rome, I too was left with permanent scars from these pointless battles. These tumultuous events were pivotal in both lives. The artist had to flee to Naples as the authorities in Rome had put a price on his head (a pena capitale). In my objective mind I knew my days in the trading arena were numbered, but I tried to run from this reality. Caravaggio the artist continued to paint. I continued to trade. The lives we made for ourselves caught up with us both.

The desperate search for redemption is another tie that binds. Caravaggio, somehow hearing that Rome was likely considering granting a pardon, made his way back to Chiaia in Spanish Naples, where it his thought his first patroness may have been able to help in influencing the papal authorities in Rome to issue to the pardon on his behalf. Alas, it is here that the artist was so brutally attacked and mutilated by unknown assailants that word spread of his death. In Simon Schama's 'The Power of Art', Schama notes that Caravaggio stayed in Chiaia and kept painting. He says of these paintings they 'were images of redemptive suffering and, yet again, decapitation, as if he couldn't get the image of his own pena capitale, his capital sentence, out of his mind.' My brush with death came this February, and it was a dangerous one. My self-loathing hit a new high, made worse that the fact that my capital sentence (a shortage of capital) was of my own making. I equated redemption with getting back to break-even - this would be my pardon from Rome - but I now realise that it is not here that redemption lies. It lies in being true to oneself and stopping now.

[PIC : David with the Head of Goliath, 1610]

It is during Caravaggio's time at Spanish Naples that he painted David with the Head of Goliath, pictured above (2). The painting is widely thought to be a form of double-self portrait; at the very least the decapitated head is surely Caravaggio's. As with almost all art, the exact meaning of the piece is open to interpretation but right now the message that resonates with me is one of a deep understanding of the self, of the idea of redemption by making a clean break of the troublesome Caravaggio of old, and lastly, there is a heap load of self-loathing (see David's disgust with what he is holding). Schama says of this painting, 'You see something that had never been painted before and would never be painted again: a portrait of the artist as ogre, his face a grotesque mask of sin', describing the young slayer of the giant Goliath as the 'most conflict ridden David ever to be imagined in either marble or paint.' I can relate. There have been times when I felt like David and the market was Goliath, and other times when the market seemed the true David and I the ogrish Goliath, but the long standing truth is closer to idea of the double self-portrait, that I am both characters, and that today I officially severed the wicked head of my alter-ego (3). There will be no more half measures.

Rebirth denied - Caravaggio met with a tragic end. Still seeking redemption but now with a pardon apparently on the way, the artist boarded a boat for Rome, taking with him a collection of paintings he intended to give to people of influence and win favour. However, when the ship pulled in at the port of Paulo he was arrested for unknown reasons. By the time Caravaggio got out of jail the ship had sailed off with his paintings still on board. Some think that Caravaggio actually saw the ship sailing away and that, in a frenzy, he gave chase. What we do know is that Caravaggio made it as far as Port Ercole but there he collapsed on a beach with severe fever. In this pitiful state, he was taken to a local hospital where the troubled artist died. So near and yet so far.

As with Caravaggio's near redemption, my ship has also sailed (4). In the place of the important payload of valuable paintings are valuable trading secrets that could lead to success in the market. These are the product of several years of relatively intense trading and they will stand me in good stead when and if I ever return to trading with a reasonable level of capital. Of course, they are not secrets of the 'key to riches' variety, simply crucial lessons that I noted from my experiences trading the markets. My full-time trading career is over. I still plan to trade in extremely small size, seeding my two trading accounts with £500 each, but this is only to maintain an active in the markets until the day I am ready to return, if ever.

[PIC : Saint Jerome in Meditation, 1605]

These introspective paintings of Saint Jerome and Saint Francis touch on ideas of contemplation of the self, mortality, and man's role in relation to the world. It is apt to end with a famous quote by Socrates:

'The unexamined life is not worth living.'

The End

(1) Later Rocky films address this issue, with the writers giving Rocky Balboa permanent brain damage as a direct result of the thunderous blows delivered by Ivan Drago. Rocky also experiences a humbling of his financial status that forces the boxer to give up his extravagant high-life and return to his old neighbourhood.

(2) Wikipedia observes the letters H-AS OS inscripted on David's sword, an abbreviation for the latin phrase 'Humilitas occidit superbiam', or 'humility kills pride'.

(3) The non-Caravaggio me lives on here.

(4) Given my chosen trading name of Caravaggio, the question of whether I subconsciously expected this fate hangs over me. Fortunately I don't delve that deep.

Steve Leslie writes:

Your insights are exquisite and insightful and express feelings that all of us who have been at this for any extended time have gone through. Although your trading may take a hiatus (I suspect you will be back) I hope you continue to write on your lessons learned and share on this website. It takes a very special person to admit defeat but all of us have done so in our trading lives. One of the central themes of Stallone characters is the underdog who withstands great odds against him and finds the character to endure rebuild and ultimately vanquish the foe. It closely parallels his personal life in many ways. I look forward to more postings of your marvelous vision going forward. We here have much to learn from you.



The WSJ has an interesting article titled 'The Body as Bacterial Landlord'  discussing the Nobel winning finding that it is not stress that causes stomach ulcers but the bacteria Helicobacter Pylori. Widespread use of antibiotics did lead to a significant decline in the ulcer rate but there seems to be a whole bunch of unintended negative consequences. These include increased rates of allergies, eczma, hay fever, gastric reflux and esophageal cancer. Microbiologist Dr Blaser suggests that in our eager efforts to stay clear of bacteria we may be forgoing the various protections they have provided us over hundred of thousands of years of evolution. The article emphases the idea of a co-evolution with these little critters and that we may need to adjust our mindset of viewing bacteria as harmful. On a positive note, research in this area seems to be flourishing and it will be interesting to see what we learn in the years ahead. The article concludes with: "They live with us, and they are part of us," says Dr. Chervonsky. "That does not mean there is no tug of war.".

When I read this I couldn't help thinking about the financial markets and wider economy as a similarly complex system and how recent measures by governments, particularly the ban on short selling, is the sledgehammer equivalent of the application of antibiotics in that it severely hinders a tug-of-war co-existence that has a long run benefit to the system itself. As for the the unintended consequences, off the top of my head: in the UK, the nationalised bank Northern Rock has experienced the opposite of a bank run as depositors rush to a bank fully backed by the government; Ireland has a 100% guarantee on deposits, and this risks an escalation of protective measures through the world as money heads to where it is most safe; why should banks lend to each other when they can get risk-free funding from the seemingly endless billions that are being pumped into the overnight markets by the central banks (I'm not surprised the TED spread is where it is with this kind of distortion); when the Fed announces massive bailout programme, the banks must surely be incentivised to stop trying to fix the problem themselves (raise capital, face the pain, etc) as they know a massive buyer is about to come to the market. It's a complex system and we are fudging our way through by swinging sledgehammers in every direction. I know something has to be done, but I don't like what I see.



Leopard/ CrocAstonishing photos of a leopard making short work of a croc from The Telegraph, UK [hat-tip to Riz Din]

This is a perfect example of making sure you fight on your home terrain. The outcome would have been different had this altercation taken place in the water.

The lesson: become good at something and learn to dominate it. Stick with what your good at and don't try to compete, when competing means laying it all on the line, in an area outside of your expertise.

This applies not only to the wild, but to the markets as well.

I suppose it's ok to go outside of your area of expertise, but make sure you've had plenty of practice in a non-life or death situations or non-laying it all on the line situations.



Pull towardNever in my life do I experience such a force, an intense unbelievable drive to right my wrongs in the quickest form possible by doing something completely and utterly insane, as when my account suffers as a result of a poor trading decision, outside of my trading plan. In line with James Sogi's piece "Mistakes were made" and its reference to Cognitive Dissonance, and how a chain of events can spiral out of control, I believe it's not the initial mistake, and not adhering to your trading plan, that causes the major issues in remaining profitable and being successful. It is the subsequent immense urge that wants to right these wrongs, and drive you into oblivion.

The human seems to be at its weakest at this time, or maybe the natural competitiveness to stay on a righteous path and motor forward is the primitive instinct. However what I do know is that it takes every bit of my will power to fight this urge, and it only loosens its grip when I have a success and have the account moving back in the right direction.

This could explain why a lot of people do a lot of stupid things, as they meander through life without any discipline plan or focus: we need these to take stock and have something to measure against, when all goes pear shaped. Without a game plan, we are all doomed.

Riz Din adds:

On the occasion when trading off-plan blows a massive hole in one's account, I have experienced another base sensation that reminds me of some personal accounts of gruesome shark attacks. The adrenaline rush is so strong that these people sometimes feel no pain during the worst of it. It's nature's anaesthetic. One man describes a feeling of almost beautiful serenity, knowing his time was up as he bobbed about helplessly in the water, but feeling no great pain. This chap was apparently saved by dolphins and went on to have hundred of stitches. If you live, the pain comes later. 



NigelHaving recently abandoned the barbaric practice of shaving in the morning I've been looking into the history of facial hair. It seems that the killer blow was dealt by Gillette in 1903 when they started making razors with replaceable blades that could easily be used by anyone at home. This certainly made shaving easier and more convenient (not to mention safer), and when you add in a modern obsession with youth the clean-shaven look was bound to win out. But will this continue into the future? Who knows.

The impact Gillette had on beards got me thinking about what higher energy costs and ever greater wonders on the technology front might do. I think there may be many different effects, not least of which will be to make home based working a lot easier and commuting a lot more difficult to justify. So perhaps a new paradigm will govern the property market with people wanting to live in either the city (no commute) or genuinely pleasant places whilst 'commuter towns' will become an anachronism.

What does this mean in practical terms; bullish on York, bearish on Milton Keynes. And the coming viability of working remotely via tech might also explain the relative strength of the Naz, despite the fact that conventional wisdom would have us believe it should lead any decline.

Misan Thrope adds, somewhat off topic:

Shaving a 'barbaric act'? Until I recently I thought a 'barbarian' was someone who did not shave (from the Latin Barba = Beard).  However it seems that there is some controversy on this point and some say barbarian derives from the term ba-ba-ba which the Greeks used to caricature those who spoke any foreign (i.e. non Greek) language. You learn something new from Daily Speculations every day.

Riz Din remarks:

I have spent most of my life in Milton Keynes and am living in the town at present. It is a strange place, made up of extremely straight roads intersected by endless roundabouts. In my childhood, I would often venture to Birmingham or London to see my family, and for a long time, I thought these places were very strange, what with there bendy roads and the like. Over time, I realized it was Milton Keynes that was strange. Fortunately, the town managed to avoid the tidal wave of ugly concrete buildings that swept across the country in the 70s and so is relatively easy on the eye. It is still a somewhat sterile place though, and because the 'new city' was created by top-down city planners, it lacks any sense of organic evolution. Personally, I think it is a fine place to grow up as a child, or to retire if you want the quieter life with all the conveniences. For one's middle years, it isn't so much fun - the proximity to London maintains my sanity. That said, Milton Keynes is growing, and growing. Some people clearly like it. Technology reduces barriers and makes remote working possible, but the impact on the workplace has been less marked than many expected. It still pays to be in the thick of it.

P.S. I was disappointed to learn that the name Milton Keynes has nothing to do with the great economist and investor.



At times like this it pays to remember why to buy a portofolio of stocks for long run is on average excellent idea :

1. Mean Drift of 3-5% p.a. because of mathematical properties of portfolios composed of shares in USD.

2. Mean Drift of 5% p.a. because the system is "self-adjustedly" skewed; politicians, bankers, companies, media & the entire economy benefits when the market is up.

3. Mean Drift of 5% p.a. as entrepreneurs demand and will get it over risk.

4. Mean Drift of 4-6% p.a., statistics by Dimson, Marsh and Staunton over 100 years and different countries.

However, that was the easy part; it is more difficult for one to sit on his hands, and not override what is backtested and what shall work.

Riz Din runs some numbers:

If you invest $5000 each year in the stock market and earn a rate of return of 7%, after thirty years the total investment is worth half a million. Stay invested for a further ten years and it doubles to just over a million. It doubles again to two million after 50 years. To ensure good returns, it makes sense to invest in one's health and increase the probability of having an abnormally long investment horizon. Also, shooting for a long time horizon may give one the ability to see a playful cub where others see a grizzly ravaging the market.

Alex Forshaw objects:

But after approximating a realistic rate of inflation (3-5%), that number becomes much less impressive.

Other amusing implicit assumptions include

1) zero information costs on the part of the retail investor;

2) zero "oops" moments e.g. auction-rate securities portfolios which end up yielding -20 percent because a bank says so;

3) zero capital gains/ income tax;

4) forex fluctuations masking the enormity of market volatility; and

5) zero probability of not-even-very-extreme events, such as having to liquidate a large portion of your holdings immediately because of a family sickness, job change, etc.



A MurrayAndy Murray's centre court, 'Rocky' style comeback against Gasquet has given the audience something to remember for a long, long time. It was the finest piece of tennis from a British player in years. Only a couple of years ago, I remember Murray's game being absolutely horrible to watch. Because he doesn't try to hide his emotions one bit, you could read Murray's face and demeanour and pinpoint the exact pivotal moment in the game when he would break down and effectively lose the game. The story would usually involve a good start, the opponent outperforming Murray on a series of shots, Murray getting frustrated, Murray complaining on all the contentious shots as if the world was against him, and finally Murray losing. He had no mental maturity.

What really struck me in Murray's game against Gasquet was not just that he came back from two sets down to win, but that even when Murray was firmly against the ropes, he kept his composure firmly in check and played with a winner's confidence even though he was losing. This is a quality I adore. In tennis, golf, and other such games, the mental part of the game is a crucial part of the winning puzzle. I imagine some traders will succeed with little confidence, simply because the role of luck is arguably a lot higher in trading than in many sports. However, on balance, I believe a confident attitude of the sort seen in sportsmen competing at their best but from a losing position is a valuable and honourable trait, well worth trying to develop in onself.

Murray is up against Nadal tomorrow, which is a lucky career move. Since Andy Murray is probably the only person who thinks he can beat Nadal, this means that if Murray loses to Rafa, there should be no collective sigh from the British public of the sort we used to get when Tim Henman used to lose to potentially conquerable opponents.



Andy Murray's defeat against Nadal today reminded me of the final battle scene in film 'The Last Samurai', and of dying with honour.

It was evident early on that Murray hadn't fully recovered from his four hour marathon battle against Gasquet. His tiredness showed through and he was not his usual dynamic self. In contrast, Nadal was firing on all cylinders and then some. He just didn't let Murray into the game. Nadal's grass court play has come leaps and bounds this year and - from the perspective of my armchair - he doesn't have an obvious weakness that can be readily exploited. His backhand shots can't be differentiated from his forehand shots, and he certainly can't be relied on to trip himself up. Indeed, I think Nadal produced a mere ten unforced errors in the entire three sets. We are not there yet, but it looks like the championship is shaping up for another Nadal-Federer face-off, which will be a true test of finesse versus physicality. I think Nadal has what it takes at least to make Roger Federer produce a bead of sweat, something I haven't seen from him so far in this competition.

Getting back to Murray's defeat, I believe there are a few things we can take away from this. In the middle of the match, Murray won a point but it was called wrongly 'out' by a line judge. The umpire immediately over-ruled and the point was called 'let' and played again. Murray complained about the poor line call, but he got straight back to business. In the bad old days, this would have sent Murray into a spiral of agitation, where he would project blame externally and allow this negativity to feed on itself. Not this time. I was impressed. The world is not against us. We accept responsibility not only for our actions, but also for events that are outside of our control. It is not personal. We get on with it.

Leading on from this, because Murray succeeded in keeping his mental game in check, there was very little psychological noise, or interference, in the match, and Murray will be able to watch the tape and compare his true game against Nadal's. He will be able to see the weaknesses in his game play far more clearly, which will give him something to work on in future. It's simply more productive. Okay, so Murray may never be 'the' best, but he will certainly get closer to achieving 'his' best, which is what it is all about. In the world of amateur trading, many traders who produce losses believe these losses are not due to their trading game/strategy, but that they are a result of psychological weaknesses. Their self-talk says, 'I can still pick 'em, I just need to cut my losses earlier'. Personally, I believe most people are fooling themselves by thinking that the person (mental approach) is weak, when it is their trading game (strategy) that is weak, and they really have no edge in the business of trading. The idea that 'I should have held on for longer', or 'if only I had sold these stocks more quickly' is false, because it is working backwards, a bit like saying 'if only I had picked the right lottery numbers'. If you have a strictly quantitative, or automated trading approach, there is no need to try and disentangle the psychological element from one's trading strategy because it isn't a feature. However, because I use a qualitative approach, I wanted to try and separate my mental game from my trading game. For a long time, I would jot down a 'behavioural score' when I opened and closed a trade. It's was a simple 'marks out ten' scoring system, with a low score for doubling up, lowering stops, etc, and a high score for trading rationally, with a well thought out plan. Over time, I realised that the correlation between profits and a high behavioural score was surprisingly weak, but the point was not the correlation, but that a low score had a higher chance of producing those, rare, extreme losses. The simple act of keeping a behavioural score has led to greater self-control, and I now believe I have a clearer image of my true game. I relate to Murray in that being 'my best' is a far cry from being 'the best'. There is no 'I should have been less greedy', or any other such excuse. My game is simply not strong enough. But that's okay, because the journey has been one of self-discovery, and it has been a success of sorts, irrespective of my what the ledger says!



The latest piece by market commentator James Montier looks at confirmatory bias. In the report, Montier discusses how confirmation bias pops up everywhere, giving examples from job interviews, the field of medicine, and criminal investigations. He provides a nice quote on the topic:

The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate.. . . And such is the way of all superstitions, whether in astrology, dreams, omens, divine judgments, or the like; wherein men, having a delight in such vanities, mark the events where they are fulfilled, but where they fail, although this happened much oftener, neglect and pass them by. — Francis Bacon (1620)

And there I was, thinking it was a relatively new insight to the human condition (I'm currently reading The Black Swan which deals with these themes and others).

Montier concludes with advice on how to fight confirmation bias:

The most obvious way of avoiding plunging headlong into confirmatory bias is, of course, to look for the disconfirming evidence. When you meet companies seek to ask them the complete opposite of what you actually believe. Root out all the information that would show you that you are wrong. So if you expect margins to continue to grow, say, then spend your time probing for evidence that margins are under pressure.

This is easy to say, but actually hard to practice. It doesn't come naturally to us at all. For instance, when I read a bearish piece of research I often find myself nodding in agreement. However, when I read bullish research I find myself, tutting and circling all the points I disagree with, often ending up with large amounts of ink across the page before I throw the note away, dismissing it as typical of the bullish junk produced by our industry. I'm not an unbiased evaluator of evidence (and the chances are that you aren't either).

You should also pay attention to the absence of evidence as well as its presence. This is reminiscent of the Sherlock Holmes story in which the vital clue was that the dog did not bark in the night. One's attention tends to focus on what is reported rather than what is not reported. It requires a conscious effort to think about what is missing but should be present if a given hypothesis were true.

I fear my life is an exercise in confirmation bias!

Russell Sears comments:

Well I would agree that it is hard to do, but I would say Mr. Montier is still asking the wrong question.  With the markets it's not all about you. It is not about what you think you know, it's about everybody and what everybody else is thinking. So the right question is to ask the company to prove what everybody else is saying about it. After all if you don't think that the consensus opinion could be wrong you should be in the index. But the hard part of the investment game is asking the right question, the one where the consensus is wrong. You could start by considering where are consensus opinions consistently wrong, and which companies are good at deception?   



I recently watched a documentary telling of a future where genetic breakthroughs lead to the end of major cancers, leading to significant life extension (in full here ); I read an article about futurist Ray Kurzweil, and life extension in the New York times ; I saw a trailer for a new film of The Curious Case of Benjamin Button, in which the main character ages in reverse; and I learned of a discovery, where scientists have effectively reversed muscle-aging in mice. It all throws up questions about ethics, Frankenstein creations, etc, but personally, I can't wait. For sure, living more healthily into older age requires new thinking about consumption and savings patterns and the relationship between demographics and equity returns. And then there is the wondrous benefit of compounding your savings over those extra years. It almost makes me wish I cared more for money than I do!



J SogiKaizen is a Japanese concept which means continuous incremental improvement. This is a process in contrast to and in disproof of the idea that outliers alone form history. It is the tortoise and hare issue. Incremental and thus compounded gains allowed Toyota to become the largest car maker in the world. This kind of steady gains over time arguably has been responsible for more and greater changes than the discontinuities. In markets it is the idea that it is hard to beat a buy and hold over the centuries. The slow advance of human records over years is another example of incremental improvement. For traders a steady improvements in skills, new and changing techniques to adapt to ever changing market cycles and a steady return is a good alternative to a boom bust methodology.

The larger brokers such as Lehman use up to 25-35x leverage. Banks are leveraged up to 20x with less than 5% capital. The common historical variance in any particular market should lead to some big swings in equity. The real estate market would similarly be leveraged at least 5-10x or more with a 10-20% down. This level is like the "Mexican option". The levels seem to be coming down now. This is affecting market action.

Scott Brooks dissents:

Scott BOutliers may not "form" history, but they do lead it. The outliers in history are the ones that led the way to new and innovative change. Whether you look at outliers like Alexander the Great, Hitler, Churchill, Washington, Charlemagne, or Ford, Rockefeller, Edison, Morgan, or Shakespeare, Van Gogh, Picasso, Beethoven, The Beatles. It's the great ones that lead the direction or show the way. Society as a whole makes a decision, in the form of many individual decisions, to follow the lead of those that are paving the way.

There is no question that society as a whole benefits and moves forward in a buy and hold methodology. But the great ones lead the way and change the course of mankind….whether on purpose, or by accident.

Are the moves of these great leaders a mere function of chance? Yes and no. Greatness is predictable, it's just not known where it will come from or the impact it will have. Just as one can't predict the outcome of a horse race of a coin flip with 100% accuracy, we do know that the coin will land with some result, and that some horse will win the race. These horses are the one's that shape history and direction, just as the great (or infamous) leader have over time….which has lead to the incremental progress of the human race. But the fact that some men have greatness is less a function of chance and more a function of an ongoing decision process. They each, literally, decide to be/do something and work towards that goal. There is no chance in a pursuit of greatness or a goal. There is no greatness in a winning a lottery, only chance. Achievement of greatness is not about the result achieved, it's about the process one followed to achieve that greatness.

I believe the same is true from trading. We all can make progress if we're willing to work towards that goal and learn from our past experiences and build on those experiences as well as the experiences of others that we learn from. Greatness comes from process we learn over time and in the falsification of beliefs that we hold to move towards a higher truth.

Average and ordinary people don't want to believe in something new. They want to continue to believe that the earth is flat or the that universe revolves around the sun. It takes a great man to falsify those beliefs, and move the whole of mankind in the direction of greater enlightenment.

Riz Din concludes:

The interplay of outliers and incremental change over the long course of history seems like a very natural process, although sometimes I pray for the outlier to arrive quickly and disrupt the state of affairs because incremental change has led to bloatware, bloated institutions, etc. that are riddled with inefficiencies. When the incremental path is followed, things get embedded in such a way that there is no way of overhauling the system and it takes a competitor to do what is necessary and start over from scratch.

Here is an interesting Economist article from my archives on the topic, it is from the excellent, Millenium edition (Dec, 1999), and discusses living standards over the past thousand years in the context outliers leading the way, incremental change, and our benefiting of compound return of growth/living standards.

Take a look at the chart.

In our life-times we see steady year on year growth and improvements in conditions and view this as normal. However, the author of the article notes, "material prosperity has risen more in the past 250 years than in the previous 10,000. And so conditioned to growth have people become that most westerners now expect their standard of living to improve automatically year by year; if it does not, something is wrong. This taking for granted what would once have seemed miraculous is the measure of the change."

Jim Sogi tries to get the last word in:

The Economist article Riz cites falls for the recency effect, that recent events are more important. Not so. The invention of language, the wheel, fire, tools, iron, writing, and printing presses probably surpass recent inventions in creating better prosperity advances and change. 



Kim ZIt's notable that many of the wealthiest investors are optimistic. But not all of them are, and certainly pessimism pays well from time to time.

Assuming there is a payoff to optimism, what if Penn's Dr Seligman (optimism can be learned) is wrong, and optimism/pessimism is - like many personality traits - genetically determined and rather immutable? Inherently optimistic investors get the rewards of their fortuitous place in time, when they are fortunate to be placed in times of fortune.

Dr Goulston's recent post about personality types suggests there must be studies on which personalities are suited to trading financial markets, and which not. There are lots of these tests - you can take one (such as  this Myers-Briggs type test) and then ask whether your successes and failures were predetermined.

In any case, haircuts never go out of style, they just change in type (remember the old song by Crosby Stills Nash and Young).

Riz Din adds:

My optimism is partly a function of recent documentaries watched, but it looks to this layman that even if mankind is only equally as clever as they have been in recent years, then the gains to humanity will be breath-taking as the digital revolution becomes all encompassing.

Instead of observing incremental changes in technology lets remind ourselves of the state of the world a just few decades ago. Thinking back, I remember adding a 32k ram extension on to my ZX Spectrum. Today, you can pick up an 8GB portable thumbdrive for under GBP 10. I won't try and calculate the gains that have taken place, but I'm pretty sure that if progress simply continues as is, the world is going to be a very interesting place. As the digital world widens and reaches into other fields such as genetics, and perhaps even energy technologies, these fields will reap the benefits of rapidly increasing processing power and depreciation that ensures wide affordability. I can't wait to see what innovations emerge in coming years.

Esteemed former intern Jan-Petter Janssen (NEPS '06) writes in:

If you define optimism as the tendency to overestimate the probability of favorable outcomes, it is clearly irrational and should be avoided. However, it is a good antidote to another unwanted bias; the propensity to suffer mentally from losses more than you benefit from gains (a  la Kahneman-Tversky.) [The latter may not be irrational, but is clearly not a good way to think for a successful-to-be speculator.]

A (too?) much used tool in finance is to compare the utility you gain from a certain outcome versus the expected utility if you choose to take risk. I will apply this to a social setting all guys have to (or had to for the lucky ones) deal with: Should you ask the most beautiful girl out for a date? A Kahneman-Tversky mindset would suggest no action too often because of the fear of rejection. Optimism has the opposite effect of course.

More generally I believe optimists choose action (i.e. risk) over inaction (i.e. status quo) more often than pessimists. And from my own experiences; it's the losses, humiliations and embarrassments that in retrospect have made me fight back and grow … while much success, although good, sometimes lead to hubris and a personal bubble to burst. The bottom line is that action is usually better than inaction. So triumph of the optimists!

Vic observes:

There has been a most unusual clustering of big minima in the S&P recently. Naturally this clustering has been followed and coterminous with all sorts of negative news. Those who are short have not been reluctant to discuss their positions before the close in interviews. The word "ideal" comes to mind.



CoffeeA few years ago, I read "The World of Caffeine: The Science and Culture of the World's Most Popular Drug" (Weinberg & Bealer). I took a few pages of quotes, which is a good thing too, because I can't remember a word of it. Following a re-read, here's a selection of quotes:

Hahnemann argued that, though caffeine allows you to burn energy more quickly now, you will suffer a corresponding letdown later, initiating a debilitating cycle that is ultimately less productive than staying on an even keel by abstaining from caffeine altogether. As he states, coffee engenders an "artificially heightened state of being…Presence of mind, alertness, and empathy are all elevated more than in a healthy natural condition." These apparently benign effects, he says, disturb the natural cadence of the biological system, which depends on the alternating rhythms of wakefulness and sleepiness.

Coffee and tea have given rise to a great duality. …Coffee has become associated with all things masculine and with the artist, the nonconformist or political dissident, the bohemian, even the hobo, as well as the outdoorsman. It is often considered a vice, its consumption linked with frenetic physical and mental activity, intense conversation, and with other indulgences that threaten health and mental balance, such as tobacco, alcohol, and late nights of hard partying or excessive work. Tea, in contrast, is associated with the feminine and with the drawing room, quiet social interaction, spirituality, and tranquillity and is regarded as the drink of the elite, the meditative, the temperate and the elderly. These differences between coffee and tea are easily seen by comparing the rough and ready institution of the coffeehouse with the decorous traditions of the Japanese tea ceremony and the English afternoon tea. An acknowledgement of these differences must underlie the fact that, although coffee has been the subject of many bans and opposed by many temperance movements, tea has rarely, if ever, appeared on anyone's list as a substance that ought to be put beyond the pale of law or morality. The more it is pondered, the more paradoxical his duality within the culture of caffeine appears. …It is true that coffee is generally brewed to a caffeine strength over twice that of a typical cup of tea, yet, because more than one cup of the beverage is commonly consumed, there is no doubt you can get a full dose of caffeine from either one.

In the 1970's, largely as a response to reformational grumblings stirred up by concern over an unsubstantiated link between caffeine and pancreatic cancer, Coca-Cola and other purveyors of dietary caffeine set up an funded the International Life Sciences Institute (ILSI) and its public relations arm, the International Food Information Council (IFIC), both based in Washington D.C., to help forestall any efforts to regulate or ban caffeine.

Because caffeine is water soluble and passes easily through the cell membranes, it is quickly and completely absorbed from the stomach and intestines in to the bloodstream, which carries it to all the organs. This means that, soon after you finish your cup of tea or coffee, caffeine will be present in virtually every cell in you body. Caffeine's permeability results in an evenness of distribution that is exceptional as compared with other pharmacological agents; because the human body presents no significant physical barrier to hinder its passage through tissue, the concentrations attained by caffeine are virtually the same in the blood, saliva, and even breast milk and semen. … One of the secrets of caffeine's power is that caffeine passes through this blood-brain barrier as if it did not exist.The maximum concentrations of caffeine in the body…is typically attained within an hour after consumption of a cup of tea or coffee.

Because caffeine passes through the tissues so completely it does not actually accumulate in any body organs. Because it is not readily soluble in fat, where is might otherwise have been retained for weeks or even months, as are other psychotropic drugs such as marijuana. For most animal species, including human beings, the mean elimination half life of caffeine is from two to four hours, which means that more than 90 percent has been removed from the body in about twelve hours.

Cigarette smoking doubles the rate at which caffeine is eliminated, which means that smokers can drink more coffee and feel it less than non-smokers.

Caffeine eventually devastates the plants that produced it, for as caffeine-bearing bushes or trees age and the soil around them becomes increasingly rich in caffeine absorbed from the accumulation of fallen leaves and berries, it eventually attains a level toxic not only to microbial enemies but to the plant itself as well. It is partially because of this toxicity that coffee plantations tend to degenerate after ten or twenty five years.

And from an Economist article: "Coffee Houses", December 2003

According to custom, social differences were left at the coffee-house door … and anyone who started a quarrel had to atone for it by buying an order of coffee for all present. Richard Steele, the Tatler's editor, gave its postal address as the Grecian coffee house, which he used as his office. In the days before street numbering or regular postal services, it became a common practice to use a coffee-house as a mailing address. Regulars could pop in once or twice a day, hear the latest news, and check to see if any post awaited them. That said, most people frequented several coffee houses, the choice of which reflected their range of interests. A merchant, for example, would generally oscillate between a financial coffee-house and one specialising in Baltic, West Indian or East Indian shipping. The wide ranging interests of Robert Hooke, a scientist and polymath, were reflected in his visits to around 60 coffee-houses during the 1670s.

(And here are a few pictures of spider web construction after the spider has been exposed to various drugs, including caffeine).



BurjMy sister just called me with an update of the property market in Dubai, where she has been living for the past six years. Her property has increased in price by around 2.5x in just as many years. It's astonishing, especially when contrasted with what's happening here in the UK. However, she says that prices are now equivalent to London prices in the area where she lives. With general prices still rising rapidly in Dubai, I imagine the cost of living is no longer the great selling point it once was. Are we near the top? I've no idea, but I'm paying a visit to Dubai at the end of the year and it will interesting to compare with my last visit some five years ago.

Whilst too much inflation is thought by many to be a bad thing for stocks, bonds, and life in general, I keep wondering whether there are some tasty investment treats out there in countries with fixed exchanged rate regimes, especially as many are pegged to the USD, and are thus importing a relaxed monetary policy and weak exchange rate. If you invest in these countries, whether there is true growth or not, can you simply convert the inflationary pressure into profit by investing in real assets on the ground?



VietnamA few observations on Vietnam, from my recent trip to the Far East (Hong Kong, Vietnam, Cambodia, Macau):

1/ Despite a communist government, the people of Vietnam have embraced the free market with optimism and gusto. The high streets are bustling with independent operators and entry costs to setting up a business are low. All you seem to need to set up a cafe is a few small plastic chairs, a kettle and some hot water.

2/ Prices are absurdly low. Lunch can be had for $1. Dinner for $3-4. The first hotel we stayed in worked out at $5 each for the night; this included A/C, TV, free Internet access and a toast and coffee breakfast. Organised day trips cost between $10-$20, with food and all travel included. Inflation is running very high, at around 16% y/y, but prices have a long way to rise before they reach reasonable levels.

3/ Wages are low and the people are very thin, but the saving ratio may be high: one of our guides also worked as a fisherman and made a wage of around $50 a month. Of that, he saved $30.

4/ Copyright law is nonexistent. Pirate DVDs, photocopied books and fake clothing are normal.

5/ Eating dog is okay (eating dog meat on certain days of the month helps one get over hurdles in their life), but eating cats is illegal (they are needed to reduce the population of mice and rats).

6/ The people are friendly, modest, and extremely hard working, perhaps fuelled by the local coffee — it packs one heck of a punch. Social capital in Vietnam is a lot higher than in the UK: there is a strong sense of the wider community and people seem to have a greater respect for street furniture and for each other. I noticed only a small degree of opportunistic dishonesty with tourists, but this can be easily avoided.

7/ The stock market has been hard hit recently. However, good business prospects, rising prices and a fixed exchange rate make Vietnam an excellent investment opportunity, in my opinion.

I have a  selection of photos from the trip and I have written a few more notes on my blog.



  To look at the issue of margin from a different angle, imagine there are two similar companies who have very different balance sheets: Company A is 100% equity financed while Company B has taken on tonnes of debt and is highly geared. Can the investor roughly replicate the higher risk-return profile of the highly geared company simply by borrowing on margin and investing in the 100% equity financed company?

Yishen Kuik replies:

IMHO, the one has nothing to do with the other.

A company that takes on leverage to conduct its business is exposed to business risks that cause it to be momentarily short of operating cash and therefore unable to make an interest payment. The equity holders are now at the mercy of the bondholders.

If it did not take on leverage, none of this would happen.

The issues that cause a leveraged equity holder to have to sell out of his position are completely different from those that cause a levered company to go into default, and the consequences are completely different as well.



 I just finished reading 'Jubal Sackett', a frontier novel by Louis L'amour. I initally found L'amour's writing style to be rather spare and lacking in depth, but as the pages turned I came to appreciate how comfortably the writing style fits with the tough nature of the landscape and with the character of Jubal Sackett, a quiet loner not given to excessive introspection, who is finding his own path on a journey of discovery.

Jubal Sackett is an intelligent man who understands risk and reward. He is constantly looking over his shoulder because the enemy may be lying in wait, he keeps check of his inventory and deploys his scarce resources to maximum effect, he knows much of the ways of the tribes in the foreign land that he inhabits, he knows when to hole up and when to move on, and he has the basic skills to survive in a tough environment (ie he has the necessary edge). Louis L'Amour has provided us with a great, balanced character that I will do well to keep in mind when trading.

Here are a few of my favourite quotes from Jubal Sackett:

- 'The Kickapoo are strong because of our enemies. Deny us our enemies and we would grow weak.'

- 'There is but one thing we know, Ni'kwana, and that is that nothing forever remains the same. Always there is change. Your people have remained long undisturbed by outside influences. This may seem good, but it can be bad also, for growth comes from change. A people grows or it dies.'

- All things are valued according to their scarcity, and a time might come when this gift would seem as nothing. What was worth little to us was worth much to them because they were things they could not get elsewhere.



 The book Aha! Gotcha by Martin Gardner contains much food for thought and enjoyment in the field of self-referential paradoxes and coincidences that arise in many fields. He starts with variations of the Liar's Problem. Epimenides said "all Cretans are liars." But considering that he was a Cretan, did he speak the truth. In exploring such paradoxes, Gardner explores some of the profound questions and unusual insights that such paradoxes lead to. I believe that such explorations will give similar insights into markets.

Gardner cover probability paradoxes in the ares of average, small world, patterns, and clumps. An example from averages is that most great mathematicians were first born sons. The fallacy is that first born sons are more common than second born sons because of one son families so that any group is likely to have more first borns. The fallacy arises in the work of those who predict stock market disasters. They point out that an inordinate number of disasters come when the market has not gone up or some such, leaving out the fact that most great booms come from the same preconditions. The Good to Great boys make a similar error in pointing out that most great companies pay attention to a core. They leave out the same from bad.

LetterThe small world paradoxes are based on the experiments of Stanley Milgrom that show that people are connected to vastly more people with a few steps than might be expected. He found that it took five steps to mail a document on average to a given person in another state. Watts has subsequently shown the lack of reliability of the study and in the age of Internet, it might take two minutes for such a chain to happen if the people were wired. However, one thinks of the recent $7 billion loss and the three weeks of study that it took the bank to verify it and the many people that were involved in the trade, and no wonder the US stock market went down 60 points in the five minutes before or just during the unwinding of the trader's positions.

The third set of probability paradoxes introduced by Gardner are based on variations of the Birthday Problem. If there are more than 23 people in a room, the chances that at least two have the same birthday is 50%. Similarly if four people in a room, the chances that at least four have the same sign of the twelve is 40%. This should give one pause when noting coincidences. With the 20 markets that one looks at, the chances are well over half that two of them will have exactly the same sequence of rises and falls. Similarly,the chances that you'll find a day that will show the same direction of big or small change as one of the days last week is quite high.
PiA related set of coincidences is based on the digits of pi. You can find a run of seven threes in the workout and you'll be able to find 15 up or down days in a row if you examine enough markets , changes, or chart patterns. The fourth set of paradoxes is related to clumping. You're going to find if you mix up red and black balls in an urn, that they look like they form a meaningful mosaic of large clumps of the same colors. You'll suspect adhesion, but really you're seeing random numbers. Gardner applies this theory to the spins of roulette wheels, and the applications to what looks like valid charting ideas is clear. It's a good caution.

One of the more interesting things about Gardner's book is that he is not a mathematician. He uses common sense and consults with experts to explain all the unusual phenomena. This common sense approach leads to many AHA's by him, and when you translate it into your own bailiwick, it's like a child looking at things that are second nature to you but are not so obvious.

The book is highly recommended for those who like childlike areas of discovery in their field.

Riz Din comments:

Vic's review of 'Aha, Gotcha' also got me thinking about trading and life in general from the existential perspective. It is both uplifting and depressing.

Whilst I am not mathematically inclined, I have always had an appreciation of probabilistic events in life. I feel this gives me an inner strength because I appreciate and am comfortable with the likelihood of the downside events, especially when they are outside of my control. For example, when I was mugged a few years ago, I was scared but the event didn't scar me mentally, because I figured that the mugger was out to mug someone, and it just happened to be I. In fact, staying rational gave me an upper hand and I actually managed to get the mugger to give me my mobile phone and wallet back to me (minus the cash). Another time, my car (parked) was involved involved in a hit and run. I reasoned that these things happen, and I wasn't being personally targeted. The bit that upset me was the potential cost and inconvenience. Also, I try to live a healthy life, but I appreciate the high odds of dying of cancer or heart disease. It's the probability distribution of life. And as life goes on, we gain more knowledge of the bigger picture, of the likelihood of various events, and of the uncertain.

We come to appreciate the fact that there is a 50% chance of two people having the same birthday in a room of 23 people, of the fact that we will probably be involved in a car accident in our lives, of the fact that we will all one day die, of something. I feel this is a powerful awareness because it keeps us in the driving seat of life. It is harder to be knocked off kilter.

However, whilst being armed with the knowledge of probability helps us to see through many of the common fallacies, it brings with it a problem that relates to the emotional response to upside events, specifically the sense of surprise. For example, should I feign surprise when two people in a room share a birthday? What about if I have a run of ten successful trades in a row? The trading example is less likely than the birthday example - its just over 1/1000 if we assume 50/50 odds. However, if I trade frequently enough, the real surprise would be if this never happened. My question is if I have a rough idea of the probability distribution, should my degree of surprise vary depending on whether I experience a low probability event or a high probability event? I suggest my emotional response should be the same, unless something out of the ordinary happens (ie beyond one's mental model of what is likely).

It's important to qualify that I only talking about the surprise element here. As this gets stripped out of my life, I feel I am more balanced but also that I am less human because I am no longer easily surprised. I am still amazed at the beauty of life and all that jazz, but its just this sense of surprise is increasingly missing from my life. Is my thinking faulty? I feel a bit like the Albert Camus's 'The Outsider', who, in the words of Camus himself: 'is condemned because he doesn't play the game … He refuses to lie. Lying is not only saying what isn't true. It is also, in fact especially, saying more than is true and, in the case of the human heart, saying more than one feels.'

Janice Dorn adds:

This is such an honest and thought-provoking post — I love it, and thank you for it!

It speaks to so many issues, not the least of which is that no one gets out of life alive. That is a given and we shall all live and die with it.

Going further, as we age, we forget how to play. We lose the childlike wonder, the ability to be surprised and the sheer joy of being alive.

Traders take themselves altogether too seriously. I have found this to be true through many years of trading and teaching. It is good to have emotions under control when trading, but even better to learn to let the emotions run free when we are not trading. I have been accused of laughing too much and smiling too much. So be it, because that is who I am. I don't want to be free of emotions and the ability to laugh at myself and experience new things. I don't want to become Dr. Spock. I want to cry, dance, sing, laugh and realize that everything exists only because of the existence of its opposite. Without sadness, we would not know joy. Without boredom, we would not know excitement and surprise.

In the greater scheme of things, life is to be lived on one's own terms and the choices one makes are highly personal. If someone feels that there is no surprise, and likes it that way — wonderful.

If someone wants surprise, then it is within that person's power to see the world from that perspective. Everything is a choice, both in trading and in life. Life is never about what happens to us. Rather, it is about who we are and what we do with what happens.

The late Peter Drucker once asked: For what do you want to be remembered? This question may induce us to renew ourselves as the person we want to be or become. It may not, but it is worth asking just to find out. If you ask yourself that question a few times, the answers may be surprising.

There are some 50 trillion single cells in our body. We have the ability to use our brain to enrich, nourish and nurture these cells. We are able to put these cells into balance and harmony with our environment and to be gentle with ourselves, whilst continuing to push ourselves forward into the true freedom of authentic self.



Half OffI joined a health club today, and hasten to add this is just for the pool and steam room. But the pricing was curious:

– Off Peak (to 5pm only): £24 per month
– Peak (to 10pm): reduced to £25 per month
– Group peak (access to the entire chain of clubs to 10pm): halved to £24.50 per month

No prizes for guessing which one I went for — it seems like they were having a lot of trouble unloading the more expensive membership packages and slashed them in a a somewhat arbitrary way. But now I'm wondering if there may be some predictive power for other luxury areas in their fee structure. For example in their peak/off-peak ratio and whether this is becoming larger or smaller.

This kind of thing might be applied to other areas too, for example the housing market. I've often wondered about the London vs the Rest gap, after having watched this  narrow during booms. As everyone tries to jump on the bandwagon (or through fear of never being able to buy something) he drives up the prices of the lower quality property whilst affordability constraits keep the lid on the better stuff. For sensible pricing to be reestablished a differential would need to be restored.

Riz Din adds:

A bit more on incentives and the curious nature of gym pricing:

A few months back, I took out a health insurance policy that encourages me to go to the gym and to partake in other healthy practices. Insurance can be quite a blunt instrument because it can encourage one to behave more destructively than they would otherwise, so it's interesting to see innovations that make an effort to realign people's incentives.

With this insurance product, I collect points for these various healthy activities and at the end of the year, if I have enough points, my insurance premium will be reduced by more than 70%. The quirk is that I don't care one bit about the health insurance policy. It's nice to have it, just in case, but I really wanted to join a gym and the policy comes with massively reduced rate gym membership to encourage me to stay healthy. Indeed, the gym records my visits over every quarter and provided I work out at an average of twice a week, then I get both the insurance and the gym membership for significantly less than the gym membership alone!

The catch is that if I fail to go to the gym twice a week, it can get expensive, and I guess some people will fall into this trap. However, I saw this as an attractive incentive to stay fit, and so far it seems to be working. Nothing incentivises like hard cash.

Scott Brooks explains:

ScottI'm not sure there is any predictive power to discounted gym memberships. I work out at 24 Fitness (of "The Biggest Loser" fame) in St. Louis and at Wilson's Total Fitness in Columbia, MO. Both of these gyms constantly run membership specials.
When I worked as a personal trainer in the mid 1980s (which meant that I got hired and sold people memberships and had to pretend like I knew what I was doing), we rarely ran specials, but I had tons of leeway in terms of what kind of memberships I sold. I could vary prices and length of time of membership almost however I saw fit. Basically, the goal was to sell, sell, sell.
This time of year, gyms are really hungry for new members. They've gone thru their big selling season, the New Year's resolution phase, and most of those people have already petered out and are gone, even though their memberships fees are still paid or are owed. As an aside, there is nothing more irksome than the first 4- 8 weeks of the new year when the gym is full of these people (who are going to fail anyway) crowding the machines and weight stations). So this time of year, gyms are selling heavy.
There may be predictive power in other areas of the economy, but I don't think there is in the fitness arena.



WalkingWith the weather improving here in the UK my son and I have resumed our practice of walking to school rather than taking the car. This is such a simple thing to do but has so many benefits besides the exercise, fresh air and cultivating a non-sedentary attitude to life.

First off there's a chance to see things that you don't normally see when whizzing past, both natural and man-made. There's an opportunity to talk (and sing!) without interference from phones, doorbells and email. And you get to miss the traffic gridlock on the approach to the school.

Victor Korchnoi puts his chess longevity down to walking everywhere. He hasn't driven since the shock of having hit a police car in the Soviet Union. And David Bronstein too was a great believer in the benefits of walking, advising a short walk before every chess game.

Riz Din adds:

At my gym they quote Plato on the noticeboard:

Lack of activity destroys the good condition of every human being, while movement and methodical physical exercise save it and preserve it.



Humans are an adaptive bunch and despite living in times of plenty, I expect there will always be a dissatisfaction amongst us. Having a media that spends all its time emphasising the negative just only makes matters worse. I'll confess that I still watch way too much garbage on the idiot box but I tend to stay away from many news stories, realising that car crashes, murders, traffic jams, etc. are always occurring and why do I need to know all the gory details? I would be interested in looking at the bigger picture trends, but the news doesn't report anything along these lines.

Vitaliy N. Katsenelson adds:

For six months I disconnected TV service completely, but reconnected it since. I still don't watch local news. If I did not know somebody's been shot in the pizza joint that I can actually recognize, would it make a difference in my life? It seems more real and thus more depressing when something bad happens not far from where you live.
I stopped reading financial articles from websites like Motley Fool that are in the business of writing several hundred articles a day. I know many great writers at Motley Fool — some of them are my friends — but you cannot write 5 or 10 articles a day that are good. Unfortunately this applies to most financial news. Yahoo News has been junked — worthless articles.
Same applies to news, if you have to have something to report 24/7 you'll report junk.



KimIn checking historical US stock returns, the probability of loss declines as the holding period increases. Twenty years is commonly touted as safe, but there have only been 4 such (non-overlapping) periods since the Depression so it's hard to feel secure.

(There is also the problem of whether this came by "luck": e.g., look what happened to German and Japanese markets when they lost WWII)

There were four non-overlapping 238 month (2 short of 20 years) periods in DJIA monthly returns 1928-2008. The compounded return of these (w/o div) shows only one which was down (with ending dates):

Date 20Y cpfactor
2/1/2008    5.994
4/4/1988    2.264
6/3/1968    4.941
8/2/1948    0.721

(Dividends formerly a bigger part of total return, so exclusion under-estimates final compounded return)

Randomly re-ordering the same empirical monthly returns into 100 simulated 80 year series, I calculated compounded 238 month returns and checked for up and down periods. Of the 400 simulated 238 month periods, 47/400 were declines (12%). This is about half as often as actually occurred, suggesting that the negative market momentum around the Depression may not have occurred as result of random ordering of monthly returns.

Kevin Bryant counters:

In the grand span of economic history, 100 years of stock market data is barely a drop in the bucket. This is why I derive little comfort from this kind of analysis particularly during the current period which is quickly proving to be well outside normative experience.

Kim Zussman replies:

Just because long-term stock returns are positive, it doesn't mean they continue into the future, but begs the question whether there are better indicators than history. And a related but very different question is the feasibility of deploying insights/leverage to beat buy-and-hold without increased risk of ruin.

That 3 out of 4 twenty year periods in stocks since 1928 were up should make young people with 401K's feel better, but seems dangerously irrelevant for day traders using leverage.

Riz Din adds:

'In checking historical US stock returns, the probability of loss declines as the holding period increases.' - Kim

My favourite chart to illustrate this important point is Figure 76 in Chapter 7 of the Barclay's Equity-Gilt Study. Limited observations, international examples, and changing times provide good reason to be cautious, but it is all to easy to get lost in the month-to-month or year-to-year volatility and lose track of the extent to which downside risk (negative real returns) have rapidly disappeared over time. Indeed, when looking at the UK data (1899-2005) the study finds that 'For holding periods of five years or longer, the incidence of losses greater than 5% or 10% is the same for equities and gilts.'
Over the long haul, the real returns to UK assets have been 5.3% for equities, 1.1% for gilts and 1.0% for cash. For the US since 1925, the numbers are 7.1%, 2.3% and 0.7% respectively.

To quote Christopher Walken in Wedding Crashers: "We have no way of knowing what lays ahead for us in the future. All we can do is use the information at hand to make the best decision possible."

Phil McDonnell writes:

PhilThere can be no guarantee that history will repeat.

Those words, in one form or another, are found in virtually every prospectus ever offered by the financial industry. The main reason is that they are true. There really is no guarantee. But to the speculator the real question is how should one bet?

The converse of the history repeats proposition is that it does not repeat. Should one bet on something that has never happened before? Clearly betting on something which has happened frequently in the past is the better choice than something which has not happened. The best of all worlds is to combine a frequentist approach based on counting, tempered with a modicum of judgment and reason based on any changes in the contemporaneous financial landscape.

J.T. Holley comments:

I couldn't agree more, the art w/ the science. I've often thought in reference to Monsieur Le Cygne Noir why one would bet with such conviction on Sisyphus not to roll the rock up the hill, but furthermore that the rock wouldn't come right back down for ole' Sis to push it back up again? It wouldn't take me too long watchin' that rock n roll to place a bet, I'd be there taken the scrapes from those that thought otherwise as well, but not denying them their fair attempt.

Jim Sogi concludes:

The proper questions to ask are: How are things changing, and how does the trading strategy need to evolve to adapt. A dogmatic approach will not lead to good analysis and will lead to mistakes. Things are changing from the 2003-06 regime.

1. Volatility is up.
2. Global influences are greater
3. Governmental influences are increasing.
4. The industry is consolidating and shifting to electronic.

Time series sample selection in data becomes more important since last year. The idea of regimes being helpful in cycle analysis.



 Going to the cinema is pretty expensive these days, with cinema tickets in the UK typically costing £7.50 (around $15). I'm sure ticket prices have outpaced inflation, but perhaps I'm just turning into an old curmudgeon.

Anyway, after a run of bad films I started recording some of the oldies that are shown on TV as time fillers in the early hours. I was pleasantly surprised.

Here are my favourites:

The Big Heat (1953) — Has a beautiful art deco flavour, is very crisp and fresh in its filming (even though it's in black and white), and is very fast paced with top quality acting throughout (this film introduced me to the great Lee Marvin).

Becket (1964) - Features Richard Burton as Becket and Peter O'Toole as an wonderfully intense, unconstrained and maniacal King Henry. Watch this to see two great actors in their prime.

Favourite quote from Becket: Thomas a Becket: Tonight you can do me the honor of christening my forks. King Henry II: Forks? Thomas a Becket: Yes, from Florence. New little invention. It's for pronging meat and carrying it to the mouth. It saves you dirtying your fingers. King Henry II: But then you dirty the fork. Thomas a Becket: Yes, but it's washable. King Henry II: So are your fingers. I don't see the point.

The Treasure of the Sierra Madre (1948) - A Bogart classic. The story of a small group of men who go up in to the hills in search of gold.

A quote from the film: Howard: Aah, gold's a devilish sort of thing, anyway. You start out, you tell yourself you'll be satisfied with 25,000 handsome smackers worth of it. So help me, Lord, and cross my heart. Fine resolution. After months of sweatin' yourself dizzy, and growin' short on provisions, and findin' nothin', you finally come down to 15,000, then ten. Finally, you say, "Lord, let me just find $5,000 worth and I'll never ask for anythin' more the rest of my life." Flophouse Bum: $5,000 is a lot of money. Howard: Yeah, here in this joint it seems like a lot. But I tell you, if you was to make a real strike, you couldn't be dragged away. Not even the threat of miserable death would keep you from trying to add 10,000 more. Ten, you'd want to get twenty-five; twenty-five you'd want to get fifty; fifty, a hundred. Like roulette. One more turn, you know. Always one more.

Adam Robinson hastens to add:

If we're talking Becket we can't leave out the magisterial Man for All Seasons.

For comedy selections, The In Laws (original Peter Falk version) easily ranks in any critic's top 10 comedies.

For readers of Vic and Laurel's web site, I also highly recommend the hard-to-find The Wrong Box, which features every major British comedian in an "economic lottery" theme (I don't want to give anything away), and also the 1960's period piece, The Magic Christian (written by Terry Southern of Dr. Strangelove, Easy Rider, Cinciannti Kid, Barbarella fame) in which Peter Sellars stars as the world's richest man who adopts Ringo Starr (!!) as his son. Quirky, but written by a comic legend, and there are terrific economic gags. 



If anyone is passing through London over the coming weeks, I urge a visit to the 'Sleep & Dreaming' exhibition by the Wellcome Trust , just outside Euston Station. The exhibition looks at our understanding of sleeping and dreaming through the ages from a scientific, social, and artistic perspective, and as with many of the museums and galleries in London, admission is free.

Here are some take-aways from my visit:

- Doing without sleep: In 1959, radio DJ Peter Tripp managed to go 201 hours without sleep. However, Tripp suffered from hallucinations and paranoia, and perhaps even brain damage as a result. The record was beaten in 1963-64 by Randy Gardner, who went a full 11 days without sleep and had no lasting side effects. I've read that this record was since beaten by Tony Wright from the UK in 2007 and that David Blaine is also planning to break the record as his next feat of endurance.

- There exists a rare genetic condition called fatal familial insomnia, in which the patient develops incurable insomnia usually in their middle age and dies as a result.

- Drivers of vehicles often suffer from microsleep, when they dose off for a few seconds at the wheel or start day dreaming. Car manufacturers are working on technologies that monitor blink patterns and alert drivers when they are too tired. I imagine such a technology would be useful to day traders working double shifts.

- On dreaming: We dream while we are sleeping, not only during the rapid-eye-movement stage of sleep (there are five stages of sleep and the whole sleep cycle lasts about ninety minutes before repeating). Listening to audio tapes while sleeping does not appear to be effective but sleeping and dreaming seems to play a crucial role in the formation of the days memories and knowledge: an experiment was conducted on rats whereby the rats were placed in a maze and their brain activity monitored as they worked their way around. It was found that the same parts of the rats brains kept firing away while they were asleep, supporting the idea that 'sleeping on it' really helps. Human studies have had similar results, supporting the idea that sleep is a kind of revision. Some suggest that the days knowledge not only gets remembered but that it consolidates with other knowledge. For traders, this could be particularly important. Indeed, with the market see-sawing all over the place I imagine many traders view sleep time as 'dead time' when they could be doing something productive. as for me, I'm off to sleep.



Leather JacketBo Keely wrote me once when I made a comment about an expensive leather jacket that I intended to wear to my trip to his little village in the desert.  Keely admonished me, saying upscale dress was a good way to get mugged when traveling.

Of course if you are traveling first class, staying in five-star hotels, using limos to shuttle between airport and hotel, taxi to shuttle from event to event, then the journey is safe.  But I can't travel first class, I stay in motels not hotels, I walk around to avoid taxi charges, I  use public transportation systems.

So I took Keely's advice — put the leather jacket back on the closet hanger.  I have two fine leather jackets — except one is pigskin, made in China. I do not like pig, did not think of what animal the jacket skin might be when I bought it on sale — just thought of the price, was a steal; except it is pig.

The other jacket is tailored, fits like an Eisenhower. Maybe off a Kentucky Derby animal. Bought it at Nordstrom 30 years ago and it's a grand style to wear.  Only thing about it is I wore it to an AA meeting once and a recovering female alcoholic commented "Jesus, we don't need another leather jacket in this group."  I guess she was making a statement about gay dress, seeing the style for gays at that time was to dress in leather.

Steve Leslie remarks:

In the movie American Gangster there is a scene where Denzel Washington, who plays the gangster Frank Lucas, wears a mink coat with a mink hat to Madison Square Garden for a heavyweight boxing match. Detective Richie Roberts, played by Russell Crowe, takes pictures of people in the front rows around the ring. This helps Crowe in identifying Denzel as the drug kingpin that he is looking for. Up to this point, Denzel had always kept a low profile, thus allowing him to fly beneath the radar of the police. This one gaffe ultimately leads to a subsequent investigation, arrest and conviction. 

Riz Din adds:

In addition to its functional role, clothing clearly acts as a signaling mechanism. Another place where it is may be better to dress down is when taking one's car to the garage for repairs; dressing smartly signals a wealthy person who probably doesn't know his manifold sprocket from his flux capacitor.

Bruno Ombreux extends:

This is a very European attitude. In France, there is a saying: "pour vivre heureux, vivons cachés." That is: to live happily, live stealthly. I had a great aunt which had a lot of money. She dressed so poorly that one day she went to place Vendôme to one of those luxury jewelers with the intention of buying some trinkets. She was denied entrance by the bouncer: "Sorry Madam, we don't think you can afford the merchandise in this place".

In England, really old blue-blooded money consider it a lack of taste to display wealth. They'll go as far as having domestics wear their new clothes so that the clothes acquire quickly the aged patina that makes them wearable to the wealthy.



During the run-up to a crash, population diversity falls. Agents begin to use very similar trading strategies as their common good performance begins to self-reinforce. This makes the population very brittle, in that a small reduction in the demand for shares could have a strong destabilizing impact on the market. The economic mechanism here is clear. Traders have a hard time finding anyone to sell to in a falling market since everyone else is following very similar strategies. In the Walrasian setup used here, this forces the price to drop by a large magnitude to clear the market. The population homogeneity translates into a reduction in market liquidity.

Blake LeBaron, "Financial Market Efficiency in a Coevolutionary Environment," Proceedings of the Workshop on Simulation of Social Agents: Architectures and Institutions, Argonne National Laboratory and University of Chicago, October 2000, Argonne 2001, 50.

Riz Din remarks:

Reminds me of the extreme robustness of the naturally diverse rainforest, and of how relatively small changes can destroy single crop plantations.

George Parkanyi writes:

I'm not so sure that's as true anymore. There are many new instruments such as commodity and short ETFs that create more possibilities for risk mitigation and alternative strategies. Perfect opposite correlation is an asset-allocator's dream. I would think most trading volume comes from mutual and pension funds. If they change their charters, or simply interpret short ETFs to be another asset class, then the herd mentality may dissipate somewhat as there is now less reason to sell in a panic. Hedge funds and individual investors already have the bi-directional option available to them. For example, I recently used short ETFs to blunt the decline of the past couple of weeks. I felt less pressure to sell my stocks that did go down — in fact I bought more — because I had money working in the other direction. I'm theorizing that markets will tend to become more choppy and less smoothly trending, even in a broad decline, for this reason.



Range RoverThe ranges from high to low in S&P futures for last 13 days, starting with 11/16 2007: 19, 29, 26, 31, 30, 26, 33, 36, 23, 22, 23, 28, 23. One of highest in history, rivaling the middle of August. What would be the underlying purpose of such vol in terms of relieving the weak of their positions to the benefit of the strong?

The range on Friday, a mere 19. However, counting swings of more than five from a high to low: move from 1465 to 1450 then to 1455, then to 1447, up to 1458, down to 1452, then up to to 1465, down to 1452, up to 1458, down to 1449, up to 1457, down to 1452, back to 1460 to finish a "quiet day" at 1460. A total of 107 points of potential profit of loss, enough to live of die for a lifetime, or the whole range from start to finish for a year.

Reminds me of the good old bond days of the 1980s.

How could one fail to notice that one lost 81 points by reversing the corresponding day of previous week but you would have taken them for two points on friday 11 16 as that day up 2, a reversal of 11 09 which was down 20.

One always wishes that for just one day, time would reverse and one knew exactly what was going to happen. Perhaps the Nikkei up to close is the key. Following the Nikkei for the S&P open to close would have give you 20 points of profits over last 3 weeks out of 165 points of open to close variation.

One speculates that the moves between consecutive 3 day holidays reverse, with the move from Labor day to Thanksgiving reversing the move from Independence day to Labor day, etc . This would have to be tested for many years.

Dismaying to see the moves at end of month taking away the entire seasonal for year in bonds and stocks.

As one enters the fray with the equivalent of the 2 buck racket I bought in Berkeley in 1968 to start playing again, the competition is very stiff.

Riz Din chimes in:

A little bit more on the idea that narrow trading ranges can precede big moves: looking at the 1-minute charts in the currency markets, I have observed that the occasional narrowing of prices in the currency markets can sometimes produce what technical analysts might call a pennant or triangle (or is it called something else?), where the price range narrows ever tighter over a 10-15 minute window. I have previously ignored these little patterns, believing them to be totally random illusions. However, recent experience has told me to watch out for large moves following these formations, and for the first time, late last week, I took a trade off as the range got impossibly tight. Within a couple of minutes, cable (GBP/USD), exploded some thirty pips higher. This doesn't validate technical analysis in my eyes by any means (I just can't bring myself to believe), but it does tell me to be a student to one's experience. As with the above, the observations probably wouldn't stand up to a close scrutiny, and there is still no clue on direction of the move.



TreeGoI just spent some time in Vancouver and took an afternoon to visit Wild Play. It was phenomenal and I highly recommend it to anyone looking for an adventure. The staff were extremely friendly and gave me rides to and from the ferry dropoff point.

I did the ziplines through the forest and over the river and had a blast. Then I moved on to TreeGo, which is an obstacle course up in the trees. It took about 90 minutes, going through numerous swinging ladders, rope nets, and shorter ziplines. You're always safely latched in but it doesn't feel that way.

One lesson for Specs comes from the swaying ladders. They are rope ladders laid out horizontally between trees that are 50 feet apart. If you are trepidatious and walk slowly, it is really hard to keep your balance and you have to depend on the safety line to hold you up. If you sprint and trust your balance, it's easy, fast and fun. Same thing with tremulous markets — if you trust what you're doing and rely on yourself, you can do it.

Riz Din adds:

escAPEA couple of months ago, I did some very similar tree swinging in the UK with a company called GoApe. I would recommend it to people of all ages.

If you do go, it's worth taking the time to get comfortable with the heights involved and with the idea that you are safely harnessed, so you can then do exactly as Dr Ott says and be aggressive and enjoy the day. Or you could challenge yourself by aiming never to rely on the harness as the course gets progressively more difficult. Or you can switch between modes from tree to tree. Either way, it's all good fun. Everyone walks away with a smile on his face and sleeps well after a day of physical activity in a natural environment.

A big problem with trading is that you don't know how reliable your harness is until you fall. Indeed, quite often we think we are latched in when we aren't. That said, I strongly feel that once we are comfortable and familiar with the riskiness of our approaches it is on us not to be shy when it comes to running the course.



 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. 



BreadCan the global macro boys explain to me how wheat is up 60% for the year but i can get a loaf of bread or a box of Wheaties at the same price as 2006? Would seem the producers of food hedge their costs so as to control both the cost to consumer and their profits from the best recurring biz in the world — food.

But if they hedge then of course the must hedge at certain levels and if it keeps going they must keep hedging until the reflexive traders are satisfied and in the end it seems only the consumer gets the bill, so there must be inflation upon us as a result not only of the quants but also of the global macro reflexive crowd.

Jason Thompson replies:

First, I'd very much question the observation that you are paying the same price YoY. This is certainly not the case here in Chicago as Wheaties, along with Raisin Bran, Cheerios and Cornflakes are measured as part of a basket in a private inflation survey. They are up roughly 9% 3rd Quarter to 3rd Quarter and will experience price increases (already announced by manufacturers) of 10-12% to be seen within the next six months. It's very likely what you are missing is the reduction of discounts. By this I mean there are fewer promotions, coupons to the consumer, or rebates being offered to the grocery store. The price quoted on the rack may not have changed, but the average price paid by the consumer has increased.

I'm much more perplexed by your observations on bread, as that has seen the one of the largest increases in our basket of food, outside of milk and cheese, and some fruits and vegetables. Bread here in Chicago is up 18% YoY.

David Lamb extends:

WifeI've got to be luckiest husband on Daily Spec. My wife makes our bread and she orders hard wheat for $6-$7 per 25 lb. bag.  It takes 12-13 cups to produce five pounds of wheat flour, which is needed to make five loaves. We go through five loaves every week (she gives away half of it). Therefore, she spends $6-$7 per month on our breadstuffs (rolls, loaves of bread, etc).

Compared to store bought bread — well, there is no comparison, at least in taste. However, if we bought the same number of loaves at a store it would cost us, for the cheapest bread at WalMart, almost $2 a loaf. That would be $40 a month. Yes, I have seen an increase in wheat prices but the greatest wife in the world can handle it!

Riz Din replies:

The cheapest bread in the UK is less than 50p a loaf. Currently, £1 (or two UK cheap loaves) buys two dollars (or 1 US cheap loaf). Perhaps the international cheap bread arbitargeurs have helped to lower the USD/£.

Eli Zabethan explains:

Most food producers hedge out several years, but now there is little carryout as supplies are being used for alternative energy projects.

Kurt Specht replies: 

It's true that most food producers (and processors) hedge out several years, but the levels of hedging and the duration can vary widely by company and by item.  Several companies have cited various raw materials increases in their quarterly earnings reports this year as a cause of diminished earnings per share, but as the prices of commodities rise and more time passes, more and more of these companies will have to raise prices to keep up.



People play games for many reasons, but increasing numbers are finding that they are a great way to size up potential partners.

Close observation of how people play tennis can reveal some interesting things about them. Do they try to finish points quickly with riskier winners down the line or are they willing to "grind it out"? Do they hook the lines and call balls out that are clearly in? Sometimes people act differently when playing a game then they do under normal circumstances. Many of the things that Borg and McEnroe did in their real lives, for example, would not have been anticipated by their court demeanors. — BBC News

[Read more]

Riz Din adds:

I play golf on occassion and love to read people's attitudes from how they play the game. For instance, when players are always looking over their shoulders to the party behind them and are rushing their game or feeling nervous on the tee, this reveals they care greatly about what other people think of them. I'm not saying this is necessarily a bad quality, but it sure doesn't help their play!



EUR/USD, from Riz Din

September 20, 2007 | 3 Comments

This morning EUR/USD sliced through 1.40 like a knife through butter. The next pair on the 'round-number watch' is USD/CAD, which is getting close to 1.00 parity.



PiggyIt's a myth that US households have negative savings rate as a whole. Simply not true. Turn on the TV — all you see are ads for the investment industry. Minus the past few weeks, investments has been as big a boom industry as tech. How can it be that the savings rate is negative, yet the amount of money pouring into mutual funds and banks is so huge? The answer is that the data are no good. The savings rate is in fact very positive.

Riz Din adds:

General thinking on this issue amongst economists is considerably less alarmist than the journalists' version. Importantly, the official savings calculation completely ignores capital appreciation of household assets (housing, stocks), of which there has been much in recent years. This has a balance sheet effect of increasing households' net worth and also encourages further consumption; only the latter is caught by the savings calculation. Also, taxes paid on capital gains are included in the calculation with the effect of lowering disposable income. Oops!

Furthermore, work by economists has revealed that in the US, most debt is distributed amongst the better off segment of society, and it is these people who have experienced the greatest capital gains in recent years. All in all, if we incorporate measurement problems into our thinking and account for the distribution of debt across the population, we should be able to sleep better at night. One fewer 'end of the world' gremlin to worry about.



Interest rates in the UK are higher than Germany’s and the rental yields are much lower.

For several years now, I thought UK property was grossly overvalued and primed for a fall. However, using a gross simplification I have recently formed a new model of the UK housing market. My thinking is quite simple.

Over the long-term, house prices seem to keep up with inflation (let's say two to three percent per year). Current net yields in the UK are around four percent.

As a long-term investment, it may make sense to accept a low yield on the rental because of the long-term inflation hedge component. Thus the rental yield should perhaps be compared to the real interest rate, not the nominal rate. On this basis, houses in the UK may be fairly valued. I wonder whether Joe Public is walking around with such a model in his head?



 As Vic would say, this has been a healthy decline. It cleared out the excesses built up over the last few months and years. The clearing of excesses by the market brings to mind the shedding of bark by certain trees. Taken from The Secret Life of Trees, by Colin Tudge:

Many trees shed their bark, sometimes in great swathes, which can be helpful in various ways. Some (especially tropical forest trees) seem to shed it in an attempt to get rid of epiphytes, which can grow in great abundance on their trunks and branches and so weigh the tree down and block its light. The bark of the eucalyptus is rich in oils and resins and burns quickly and fiercely. Oddly, this is an anti-fire device. The bark is shed, commonly in shreds, and builds up around the tree as litter. Other plants find it difficult to grow through the chemically rich, dark brew, and so there may be little or no undergrowth. When the bushfires rage they race quickly through the oily, resiny tinder on the ground - and a quick, hot flame is far less damaging than a cooler but slower one.

May this fire burn through thoroughly and quickly.



 I fully agree that trees are not thinking things in the strict sense, and they cannot imagine the future. However, trees may 'think' (I use that term very loosely) about the future as much in as it is to their benefit. That is, while certain aspects of trees are purely reactionary to circumstance (e.g., growing toward light), if we consider seed dispersal strategies then perhaps it could be said that trees are exhibiting a form of forward looking intelligence. They are making their best guess about what time to release their seeds. While it probably a very simple model, based on tens of thousands of years experience of the seasons, it could be called a form of anticipation and planning.

Alan Millhone writes: 

Earlier today I had a conversation with one of my long time renters. Next to his building is a very tall and full oak tree and it has begun to release its acorns. The renter was complaining about the mess the tree was making. I told him that the tree in its fullness was shading his side of the building, filtering the air we breathe and cooling that air by about 20 degrees when the hot air (95 degrees here in Belpre today) passes through the branches and leaves to reach his windows. I told him the tree needs to be trimmed sometime, but care must be taken not to injure such a wonderful living thing.

The taller part of the tree has extended its branches over to the gutters of the building, knowing that water flows there when it rains. The tree has deep roots and is solidly anchored. It has learned to withstand gusty winds, hot weather and the cold winters of Ohio. Man can learn much by careful observation of trees and the ways they adapt to many situations. 

Bill Craft writes: 

Working with forest ecology on a daily basis I have seen and studied the adaptive response of trees to stimuli, growth and regeneration. Whether it be seed dispersal, wind, sun or gravity, as earlier stated these responses evolved over many millennia and are fun to observe, admire and use. Something stalwart, romantic and functional about trees. Trees’ persistence to survive always inspires me to take out the cane and invest.



 I'm sure the Rio trade (well at least the myth) was alive and well on every major exchange floor in the world. It was the last salute, the final straw. When a local trader had just about lost the lot he jumped in a taxi, called his "give up" broker to buy maximum size at the market, and when he got to the airport he made the same call. But this time he asked for the price. If he were in the money nicely, he told the taxi to turn around and head back to work. If not he was on the next one-way flight to Rio!

Today I watching the final round of the British Open, Andres Romero, to name but one professional golfer, had the same sort of explosion, but this was with plenty of cash in his account. He was leading with two holes to play and in trouble, so he goes for the Rio (a difficult low percentage shot). The outcome was no longer in contention — a four shot turn around and a big opportunity, maybe even a lifetime opportunity kissed goodbye!

Admittedly, the trader in trouble is driven by sheer panic. But for the golfer in control it must be too much adrenaline, too much confidence, and how much this victory means that drives everything else literally out the window.

Next time anyone thinks about gearing up above and beyond what they should do with their account size, it may pay to watch a rerun, of the 2007 championships final holes. If the pros are trying it and failing, then best we mere mortals stay right away.

Riz Din writes: 

It was beautiful watching how the final two holes at Carnoustie humbled so many players. Romero rose and fizzled like a firework. He took crazy risks toward the end but he had already taken quite a few wild shots on the back nine, and had been rewarded with endless birdies after pulling off one magical putt after another. Before he walked on to the final two holes, I caught him almost laughing to his caddie; even Romero was bewildered at what was happening. Perhaps it felt like an out of body experience. So, come the final two holes, should he suddenly change his game or keep on playing as he had been? Golfers, like tennis players, are a superstitious bunch, and I can see why he chose not to moderate his game.

In trading I believe it is important to set limits and parameters and to modify these constraints only gradually, but in sports the self-reinforcing cycle of the 'mind game' component seems considerably stronger, and it just didn't seem right to deny the gift from the gods of a 'hot streak'. Importantly, Romero didn't seem upset one bit at the end but was highly emotional and what he had achieved. It seemed to be a rare situation of where a player may have had to play below his capacity (at the time) to ensure a win, and brings about many questions about motives and objectives (playing your best vs. winning).

The other lesson came from Open champion, Padraig Harrington. Before the playoff, he sunk the ball into the water twice on the final hole. Watching him play through the 18th, you couldn't tell whether Podraig was playing for a double bogey or a birdie. He gave it his best right at the point when it seemed to be over. Maintaining one's composure at this turning point is very difficult - even Tiger mumbles curses as things go downhill, before switching right back. I believe it is crucial in succeeding in life's competitive endeavors, regardless of the eventual outcome. 



 Andy Roddick, who won the Stella Artois Championship three years straight (2003 to 2005), has just provided us with an excellent lesson on the importance of balanced, competitive temperament.

He was up again 23 year old Alex Bogdanovic, a British unknown who was playing the better all round game today, constantly hitting the ball up against the tram lines or deep to the base line, and always making it difficult for Roddick to return. In contrast, Roddick was having a really bad day at the office. His game not only lacked any spark but by constantly playing the ball back to Bogdanovic and hardly ever making him stretch, he was almost actively putting his opponent in the driving seat. Where Roddick had the clear edge however, was in his service game. He was firing accurate rockets for serves, ending his service game in minutes, often with love score. He knew that this could be enough to get through the day. Roddick lost the first set after losing a service game, but he didn't crumble under pressure. He wasn't enjoying it one bit and you could see the struggle he was going through, but he continued to fight in a controlled manner, not letting his emotions get the better of him. Roddick won the second set after a tense tie-break, and then went on to break Bogdanovic late in the third set for a victory. Roddick rightly said of the game, 'I was lucky to get out of there today'.

So many times I have watched the likes of Tim Henman and Andy Murrary crumble in the face of adversity, often looking to externalise their problems by blaming poor line calls or other factors as soon as things stop going their way, and it was a real joy to see Andy Roddick deal with his poor game play with maturity. He knew he could win if he persevered (he had the edge where it counted) and that's exactly what he did. It was a joy to watch and a valuable lesson.



 I often wonder why the public can be repeatedly misled by forecasts that are consistently wrong, and by forecasters that have no raison d'etre. I believe the underlying reason is that we are brought up to be insecure, and we look to others for the sources and solutions to our problems, rather than looking to ourselves.

Such forecasters as the weekly financial columnist, can be consistently wrong, (he has been bearish every week since the Dow was at 800), and yet be among the most revered and respected forecasters of all. For an answer to this, I turned to Harry Browne's book, Why the Best Laid Investment Plans Go Wrong.

I always start with the Humble Pie with Whipped Cream, on p.43, where Browne points out that the archetypal forecaster looks for anything in his forecast that happens to have the vaguest resemblance to the ultimate outcome, and then tells you in subtle ways that "he told you so" or "it was so clear from this or that indicia."

Browne reviews the yearly self-evaluation of an investment adviser, who might be prone to using levels and ranges as his weapon for misdirection:

He almost always seems to have been around 87% right … He usually cites some examples that turned out to be wrong – "I was a bit too optimistic about the high in gold, I said 450 when it was actually 406." You can see that he's being more than open and honest, and he demonstrates that his talent and even his standards tower far above yours and mine … Any man who's wrong 13% of the time, and who's that close when he's wrong must be a genius … When I check, however, I find that his original forecast was "Gold's high will be between 450 and 500," and this was made when gold was already at 406. So he missed the high by 15% and failed to note that gold actually ended the year at 350, down 15% from his forecast.

For many years, I have believed that there is little correlation between the past record of an adviser or manager and his future success. Too often, adviser get good results with small amounts of money, but the market loves to let you make a small amount of money, just to encourage you to then raise a larger investment to lose.

I believe that the period of 2000-2002, where advisers and managers made money by being hedged or net short, was a period that was particularly detrimental to investors, in that it has led so many of them to stay with those who were relatively successful in this period. These managers and advisors have lost their investors so much more money in the subsequent period, when the markets have doubled, than the amounts they made their investors when they initially began investing.

I try to eschew from forecasts on this self improvement, mutual education, deflation of ballyhoo, forum. For one, I know how fallible I am, and second, I am cognizant of the principles of ever changing cycles, (Robert Bacon.) If we did forecast, many very potent readers might mistakenly believe that what we have to forecast is better or worse than average, and in either case it would be detrimental to all concerned. Also, I would find it hard to make a forecast where I didn't have a position, because I trade often … and if I did have a position, my position could be helped along by my communiqué. Furthermore, when I got out of the position, I would be hard pressed to be so fair and honorable that I would let all of my readers extricate themselves before I did, to my disadvantage.

Of course, if I were an innocuous type, and was prone to forecast without having a position, then I would be subject to making absurd calls, without possible economic feedback, and could possibly be wrong as consistently as the weekly financial columnist, or others of his ilk. I would never know how much damage and harm and loss my forecasts might cause to those poor souls who actually placed any reliance on them.

Harry Browne's book is a treasure trove of insights as to how one can watch out for being misled, and I recommend it highly. I also encourage all of you not to rely unduly on forecasts in the future.

As an afterthought, while considering this question, I couldn't help but notice that the Fake Doctor might do well to refrain from making so many forecasts in future. His former economics forecasting company was not well known for its accuracy, and recently he has been involved in an orgy of forecasts on such things as interest rates, the extent of reserves in the earth, and the likelihood of gains in the Chinese markets.

Browne lists several criteria for evaluating the likelihood of a forecaster to stand out from the crowd, such as talent in the field, and expertise. Other caveats, like the self interest they might have in their forecasts, the ability of those who follow them to extricate safely, and the likelihood that their own expertise in areas like geology, or Asian activities, might not be greater than average, should be considered also.

Riz Din writes:

Judging by the content in much of the media, there certainly seems to be an education of insecurity taking place, well beyond the realms of the financial forecaster. Combined with the tendency to focus on the shorter-term and not to cultivate the big, broad outlook, these are good conditions in which the pessimistic forecaster can flourish. I also wonder whether their is an evolutionary component that plays a role in this game, since the average human is a risk-averse individual.

Regarding the Fake Doctor, in March of 2004, he commented on exchange rate forecasting that,

…despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware that of the thousands who try, some are quite successful. So are winners of coin-tossing contests.

He is obviously now paid to have a view, but I wonder whether he really believes it.

Sam Humbert comments:

To all the good arguments for abstention from forecasting, I'd like to add: publicly touting one's views leads to psychological lock-in ('getting married to a position'), because changing one's mind and dumping a losing position will result in a loss of face, in addition to the (perhaps less costly and painful) loss of dollars.

Riz Din adds: 

Adding to Steve's point, the problem of 'lock-in' of public forecasts may be exacerbated by the fact that much time and money is often spent generating a forecast and thesis. From the sell-side, creating a unified thesis across research departments is no small feat, and new data that are coming days and weeks may be judged less on their own merits than on how they can be interpreted to fit with this thesis, i.e., going about things backwards. I'm guessing the ability to turn on a dime is a valuable advantage to the likes of Soros and other nimble macro players.

On a separate note, I recall when I was working in the prediction business. It would be about a month or so before the start of a new financial year when clients would call asking for various forecasts for the year ahead, sometimes even further out. I'm sure many of these folk knew better, but they did it any way. They had spreadsheets to fill in.

It reminds me of story about the general who told his team of weather forecasters, "I appreciate being informed that your forecasts are no better than random, but please keep sending them on, as the army needs your predictions for planning purposes."

Charles Humbert extends:

There are three classes of money managers:

1) If your edge is unreliable, or modest to nonexistent, then your best approach is maximum publicity. If you're good at promotion this may lead to much greater benefits than you will derive purely from money management.

2) If your edge is positive but not spectacular, you should try to manage OPM. In this case a little bragging is part of the game; but it must be done with discretion. The goal is to be credible thus attracting investors and increasing your earnings in direct proportion.

3) In the rare case where your edge is outstanding, shut up and trade. If at all possible trade only your own money. Resist the temptation to make your brilliance visible to all. Always keep in mind the goal, which is to last as long as possible before the competition catches up.

Trading is a cutthroat business. If you make it easier for your opponents you eventually make it harder for yourself. The only reason for making public forecasts is to feed your ego. But those who deserve it most are the least well-served by such promotion. 

Nigel Davies writes: 

One of the tactics that can be used for nobbling a tournament leader is to congratulate him on his fine performance and asking what the secret is. The self-consciousness and commitment induced by a reply can take them out of 'the zone' with a bump. Not that I'd use anything like this myself, it's just something to watch out for if one is in the lead.

I think a similar effect can be at work when players write books. Besides making them a target should they publish anything too valuable, there's a certain inflexibility that can be induced by the 'lock-in' affect of going to print. 

J T Holley contributes:

There needs to be if not already a study of the "Power of Anonymity".

It is the spirit of the AA program and one that Mr. Bill must have suggested or he saw this same powerful principle in its possession.

Having quit smoking numerous times, I know that I tried I didn't lick it until I remained anonymous about my intentions. The minute you tell people they will ask you when you bump into them, "still cravin'?" "want to smoke?" "how you doin'?" Even with their good intentions the first thing you do is start thinking about smoking and it simply fuels the fire. Maybe this is why you shouldn't share speculation positions as well.

Doing a quick count I can think of very few times where I've gone out and said something in the touting category and come across a winner. Yet being the anonymous I have risen to the occasion and accomplished magnificent goals. Card games and betting are the horrible exception because one must always be vocal with intentions and can never be silent.

If you look at the risk/reward of touting vs. non-touting it seems so unaligned to me. Even if you tout and succeed then you still lose it seems. You are disliked, set up to be the "one" to knock down and most of the time left doubting the outcome or feeling a Nietzschean withdrawal. Does touting burn unwarranted energy and power as well?

The anonymous one walks freely and has the power. Think of sports when something great happens and the comment is "who was that guy?" This years Masters is a good example.

I think anonymity has got to be the most powerful principle next to compounding.

Anthony Tadlock remarks:

It seems that forecasters and others with the most bearish and pessimistic outlooks don't actually own any stocks and generally never have.

Steve Wisdom replies:

I especially like these standard tropes from bear newsletters: "We advise you to liquidate all stocks," and "We advise you to take profits on stocks now,"… Begging the question: ‘What stocks? If I believed your newsletter, I'd have sold all my stocks years ago.’



Pick up almost any popular economics textbook, and you'll find a rash of examples of how ingenious math can illuminate, as well as anecdotal examples of how you the public are getting screwed, and why the free market doesn't work as well as intervention. A typical book, I currently am looking at The Economics of Information by Ian Molho, but any of Krugman's or Stiglitz's texts would do, is replete with topics such as adverse selection, asymetric information, auction manipulation, bargaining problems, bidders colusion, cartels, cheating, coordination problems, contract credibility (boiling in oil, credibility, rationing, game theory), dominance, nash equilibria, pooling, signaling, imperfect information, private information, interested parties, job market screening, non-truth telling, moral hazards, immorality, lying, overbidding, principal agents problems, lemons, reputation effects, risk aversion, ripoff models, search costs, free riding, legal rights to silence, the crossing problem, trading delays, tactical voting, welfare losses, and winners curse.

John Lott has written a book called Freedomnomics that shows that almost all of these market imperfections are figments of the academic professors' imaginations. The free market has an incentive to solve all these problems, there are enormous incentives for businessmen and individuals to behave honestly, and competition is constantly working to give the consumer a better price and quality for his buck.

Furthermore, Lott shows how seeming differences in prices that consumers receive are a proper adjustment of the market to differences in costs and utilities of consumers. Here are some examples:

 Gas prices for self service versus full service gas stations are much lower for economy gas. The reason is that the consumer of economy gas spends more time and buys less. The same applies for wine prices at restaurants. Real estate agents get better prices for their homes than their clients by a few percent — the reason is that they make the improvements that are more likely to raise value. Insurance companies refuse to pay for Lojack, a tracking device that a manufacturer can hide — the reason is that the devices don't reduce costs because the cars are usually stripped before they can be found.

The second chapter of the Freedomnomics gives numerous examples where reputations insure that businessmen and politicians keep their word. The reason reputations work is that there are incentives for purveyors to keep their word — "The potential loss of profits stemming from the loss of a good reputation keeps business honest as long it is concerned with future profits." You might think that politicians won't care about future profits when their terms expire, and this is what economists call the 'last period problem.' Politicians however want to pass their reputation on to their children, and also seek other jobs where their previous honesty is important.

John Lott shows that incentives develop to give the customer a fair deal in almost every environment — "Incentives work to create a complex and fascinating process of markets evolve to solve cheating problems without government intervention." The classic example of this, (exhibit A in every economics book), is of asymmetric market information and the lemon principle in used car buying. A new car loses almost one third of its value the second it is driven from the car lot, based on the lemon principle. The underlying reasoning is that the seller knows more about the car than the buyer, and so the buyer assumes there must be something wrong with it, which is why the seller wants to get rid of it, and so the seller is punished with a lower price.

This story has so much the ring of truth to it and is so in vogue, that it has been good, with a little math team stuff, for a Nobel Prize or two. No one seems to have considered how come companies such as eBay haven't tried to solve this problem, until Lott came along. Lott found that in actuality a few days after a new care is bought, it sells for about 3% less than the blue book price, and some used cars, like their counterparts among aircraft, actually sell at higher prices than when new. Furthermore, extensions of the idea show that the lemon theory doesn't get the price of cars held for a year right either, and that truly they should have lower prices because of usage and obsolescence, not information asymmetry.

Freedomnomics takes about 50 of the commonly accepted ideas about the failure of the market system, and shows that in each case the market has solved the problem or that government intervention has made the problem worse. Lott points out that the value of reputations is paramount for a company, and that the competition to maintain a good reputation solves almost all the areas where a naive economist might think that the consumer gets cheated. The thing that protects the consumer is not the intrinsic honesty of the firm, but the reputation a firm seeks to maintain. The importance of a good brand name, and the asset that it represents can't be overestimated.

The third chapter of Freedomnomics is the weakest, but it covers a thousand examples of government intervention in areas like eminent domain, efforts to counter the free rider problems (such as in pollution), flood insurance, rescue services, and many more. Lott gives many great examples of how private enterprise solve these problems much better than governments can.

One good example is that polar expeditions funded by private sources had many less fatalities and made more discoveries than government funded expeditions during his sample period. However, Lott has a convoluted argument concerning diversified stock holding to explain some of his finding, that looks to be based on flimsy and weak evidence, and selected anecdotes. The same goes for his attempt to show that concealed gun laws are the main deterrent for crime — Dr. Lott lectured on this subject at the Junta, and I found his regression results completely overdetermined, the estimates of the effect very weak, with a high uncertainty, and generally based on too few observations in a few selected states. I am also critical of his argument that woman's suffrage is the cause of much of the increased government that we have experienced during the twentieth century.

It is amazing to see however, that John Lott has encapsulated in a few hundred pages, all the reasons that the free market does work, and repeatedly destroys the arguments of Freakonomics and most of the calls for intervention that we find in empirical studies and common sense economics.

At one point in his book, Lott offers the following summary:

"Countries that stuck with the free market have prospered. The reason is that the free market is based on the pursuit of economic self interest. The market acknowledges that peoples' behavior is largely determined by incentives. Allowing people the freedom to improve their own economic conditions helped to make society wealthier."

Riz Din replies:

I don't believe the free market offers solutions to all of life's ills, but I welcome questioning, inquiring thinking that challenges the orthodox prescription of how things should be run.

Glenn Escovedo remarks:

Readers might enjoy One-Armed Cowboy, a book about E. L. "Slim" Pond, a famous cowboy here in South Texas who happens to be my second cousin. 

Sam Humbert corresponds: 

As a follow-up, Chair asked me why I didn't worry about lemons when buying cars on eBay (one last year for myself, one this year for the corporate fleet). My off-the-cuff thoughts were: 1) Quality is much better than in years past so the overall incidence of lemons among late-model low-mileage (say, <50,000) cars is now quite low, and 2) The shift to leasing over the years has reduced the incidence of adverse-selection, because many (most?) cars now "automatically" find their way to the for-sale lot after three years, regardless of quality. 

Art Cooper replies:

1) Wouldn't quality be closely related to car make and model as well as low mileage, so that one would wish to restrict eBay purchases to models with a reputation for low incidence of problems?

2) If leasing is the cause of a diminished relative incidence of adverse selection, shouldn't one purchase only from vendors who sell leased vehicles (in addition to others), and not from individual vendors who are unlikely to sell vehicles that had been leased? 



 It is very sad how the public continues to lean the wrong way and lose more than they have any right to. Even the big trendists who only look at charts had no right to miss the upward drift of the past few years.

How naive does one have to be to invest money with the trend followers who managed somehow actually to miss the "trend" and claim to the naïve public that there was no trend to follow?

The doomsayers keep coming back with the most unscientific and naïve reasons to stay bearish. What is more heartbreaking is that all their reasons are in fact quite bullish if they took a little time to study and analyze them.

Some reasons to be bearish are:

  1. Stock buybacks: With $600 billion in cash, S&P 500 companies are buying back stocks. For the sixth quarter in row share buybacks have exceeded $100 billion. This must be very bearish indeed since it means that these companies are depleted of any expansive ideas. In reality, stock buybacks are very bullish, as Vic and Laurel have shown. It is also an indicator that these companies believe that their shares are undervalued. Companies with buybacks outperformed over the next six months and one-year intervals.
  2. M&A activities will exceed $1 trillion this year. This is the third year in a row. Almost a quarter of this is done for cash. This must also be very bearish indeed according to the doomsayers. Again, these companies must have nothing better to do with the cash than acquiring other companies. Yes, the doomsayers believe that pumping back liquidity into the market to the tune of $250 billion annually and taking float out of the market is bearish. They believe that mergers are not an indication that these companies perceive the market as good value.
  3. The equity shrink that is taking place due to all the M&A activities must be very bearish indeed since it will leave the investor with fewer choices. Now that more money will be chasing less, stock supply could indeed be bullish-economics 101.
  4. Short positions are at all time highs. It is very bearish, as you all know since the short-sellers are the more sophisticated bunch and they are very capable of predicting the market turns. These short-sellers will have to eventually cover their shorts in the face of the ever-rising markets to avoid total bankruptcy, which will add fuel to the fire and is indeed very bullish.
  5. The most recent bearish reason is the Shanghai stock market that keeps going down. You have to admit that this is very bearish indeed. It will eventually spill over to the US and cause an economic collapse like never before. The laws of substitution dictate that the liquidity fleeing China will be looking for a safe haven in the US markets and can indeed fuel the upward drift even further specially given that the S&P, even with its recent advance under-performing the other world markets, and indeed representing great value at these levels.

As long as the public believes these reasons to be bearish and lets the pundits take their eyes off the actual supply and demand curves, there is no reason to fear that the public will get wise to the facts of speculation and life. This is indeed the most bullish time in history.

Riz Din replies:

The professional pessimists find reasons not to invest when prices are falling (they could go lower yet) and when prices are rising (markets are overvalued and a correction is imminent). By playing to the natural risk-averse mindset of the person on the street, they guarantee an audience. Maybe it is in the public's nature never to get wise.

I have no view on timing market entries and exits at current levels, but in the UK the most bullish time to invest was a few years ago when the FTSE was trading well below 4000 and the newspapers were reporting the death of the stock market. I am thirty years old and expect similar anti-equity sentiment to return at least once in my lifetime.

Alex Forshaw adds:

Well, at least you're seeing reason on China/Shanghai. Much more measured to foreordain a US bull market than a worldwide bull market.



On the wealth-effect, I've been Googling for investigations on the effect as self-reinforcing feedback mechanism and I can't find anything of note. Most of the material I have come across refers to the wealth-effect as a two-step process (rising asset prices increase wealth that equals more spending).

However, as the Chair notes, a portion of this wealth-related spending will be on a variety of assets, whose prices then inflate to generate further wealth, and so the wealth-effect transforms from a two-stage process into a reinforcing cycle.


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