Voyager 1, launched back in 1977, has become the first man-made object to pass into the unknown vastness of interstellar space. News Report.

I have a serious challenge for you. Name a single man-made device that has worked continuously for 40+ years without any human physical intervention. The winner will receive Rocky's usual prize: A unique gift of dubious monetary value.

Chris Cooper has a go at it: 

There must be any number of vintage self-winding watches that still work. If it must be wound, does that still match the spirit of your inquiry? Of course, there are many watches and clocks which must be wound by hand that are still operating. You can find some self-winding watches for sale on eBay.

Kim Zussman replies:

I am man-made and have worked continuously for well over 40 years (though currently half time for the government).

Bill Rafter adds:

Without doing any looking, there are lots of low-tech human creations that have survived the test of time. Many dams have performed their functions for decades and even centuries. I'm not speaking of hydroelectric dams, but simple river control devices. The Marib dam in Yemen is still there (after two millennia) and would be working if there was enough rainfall. Many artificial harbors also have exceptional longevity. Some Roman harbor constructions are still operational; the Romans having been expert in concrete manufacture. And don't forget Roman roads.

In more recent times, I am certain there is some electrical cable that is still functioning from half a century ago, if only to ground lightning rods.



 The google trend for "Nouriel Roubini" peaked just as the economy and markets bottomed. I don't think this was a coincidence.

In the short-term, Mr. Market is a voting machine. And google searches reflect those votes. It provides a coincident snapshot of the first and second derivatives of votes. Whether it leads or lags, market prices are an exercise left to the reader.

In the long-term, Mr. Market is a weighing machine. And all of this stuff is noise. And in the really long term, we are all dead.



 It is rumored that today AAPL placed their 10 year paper at 10yrTbond+75bps, which means about a 2.4% rate, if I'm reading the screen correctly. Given that the yield on AAPL's equity is about 2.9%, that's a nice positive cash flow way to conduct a buyback and still keep your overseas cash hoard protected from taxation. Not that it matters (or has any magical power), but for the equity to get to a 2.4% yield, with a divvie payout of $12.20, it would need to hit about $508.

Not to jinx it, but I will point out that AAPL recently peaked at 513.74.

Victor Niederhoffer writes:

One should take account of the fact that for many purposes empiriclaly and theoreticlal, especially in a world without taxation the value of debt + equity is a consant. So if debt goes up by 1 billion the market value of common stock goes down by 1 billion. The modigliani miller theorem.

Rocky Humbert:

I don't think many CFO's believe M&M is actually true in the real world. Those who do have seen their companies go bankrupt. Like many investors, I have preferences, and I'll generally put a higher valuation on the equity of a company with lower leverage even if the ROE is lower. I'm sure activist investors will disagree with my bias. M&M doesn't take correct account of risk adjusted ROE I believe. And it's hard to test my bias quantitatitively since in the long term, the overleveraged guys who went to B-school all blow up. Survivor bias etc.



 I'm looking for some inexpensively-valued stocks in India and Indonesia. (I know, I know, Russia is supposedly cheap too.)

I looked at the big caps in the India ETF's and they don't look cheap for a country that is suffering from the early stages of a capital flight. And I don't trust my Bloomberg for finding diamonds in Chanakyapuri.

Does anyone have some favorites? As Sergeant Joe Friday would say, "just the tickers, Ma'am

(Don't be shy. I only harass Mr. Rogan when his stocks go down.)

Many thanks.

Leo Jia writes: 

Would Rocky kindly explain your rationale in buying India? Is it mainly due to the devalued rupee and your belief that it is a short-term event?

Rocky replies writes: 

Whoa. I am not buying iNDIA. I inquired whether anyone has some favorite tickers there so I could do some bottoms-up research on stocks. We are in the early innings of a capital crisis — things could get MUCH worse — including hard exchange controls. About 3 years ago, I undertook the same exercise in Greece, and I could not find any companies which meet my overly stringent requirements for investment. India, in contrast to Greece, has some very attractive macro aspects and the question is whether there are companies that at some price reflect a good opportunity.

From a trading (as opposed to investment perspective), I have no insights.



 A commenter asked if Rocky was my real name. The "rocky" moniker was assigned to me by a certain former secretary of the treasury when we were colleagues at a still-surviving investment bank. The circumstance leading to the naming was that lunches were being delivered from a local eatery in brown paper bags marked with one's first name — and several people on the trading desk had the same first name. The future treasury secretary opened my lunch bag by mistake and was revolted by my choice of brie and english mustard on a granary bap. As the group's so-called "rocket scientist," a proclamation was promulgated that theretofore all of my lunch bags would be marked "rocky" instead of my real name. The future treasury secretary was fortunately ill-informed, because prior to my employment at this firm, my expertise had been in Missile Systems rather than Rocket Systems. Had he known that, my moniker would likely have been Missy instead of Rocky, and I would surely have gotten into more pub brawls as a result.



Why in the name of the good one, should bonds be going down on news that the taper will be reduced by 25%. By how much are interest rates affected by an additional 25 billion of liquidity a quarter or so. None of my books on liquidity preference versus expectations seem to think it should be anything like it is. What a tendency to supine submission we mortals have.

Tyler Cowen writes: 

That is exactly my feeling. I have been asking this question for about two months now and nobody has a good answer for me…

It's as if only the current flow matter and the stock of liquid assets somehow fades into irrelevance. Strange.

Rocky Humbert writes:

Excuse me, gentlemen, But can either of you please explain the raisson d'etre for any investor (i.e. someone who buys and holds to maturity) to have purchased a 10 Year TIP at a non-trivial negative real yield — and which has been the case since QE started in earnest.

I submit that your perceptions of befuddlement may be due to price anchoring/recency bias — and that a previous dislocation due to fed interventions is finally being corrected. Investors are now sensibly demanding a positive real return on their fixed income investments. Sensible, unless we are in a persistent deflation. But if a persistent deflation is in the card, the stock market's nominal earnings expectations are horribly wrong.

I further note that bank CD rates are not rising with market rates. To me, this is a potentially ominous conundrum with the following potential explanations: (1) There's little demand for loans. (2) Bank capital rules are limiting their purchase of marketable securities. (3) Banks are funding their loans with overnight excess reserves. (4) Volker rule-type fears are limiting participation. (5) Banks have been told that short-rates won't rise for a really long time.



 There have been 5 occasions when stocks fell by more than 200 Dow points in a day and bonds the same time fell by more than 1/2 a big point 3 of them occurred in last two months including last Thursday. This has many market implications including the changing the guard of the relation between bonds and stocks, and the importance of liquidity preference.

Rocky Humbert writes: 

Agree 100% with Vic's astute observation and hypothesis. Mr. Market is seemingly at the point in the economic cycle when good news is bad news for financial assets. What's difficult to believe is that in the current cycle, this inflection point is occurring with lackluster GDP growth (i.e. substantial output gap in domestic and global economies) and high unemployment. These facts help explain why the 2 year Treasury is not backing up.

One surmises therefore that Mr. Market is trying to find an equilibrium yield in the long end of the curve with no prospect of further aggressive manipulative Fed interventions. Since the current easing cycle began (and before the Fed started buying long-dated securities), the extreme of the 2/10 spread has been +288 bp. We are currently at +248 — which gives a price anchored sense of magnitudes to where we may be headed. If the curve steepens another 40bp, that will coincidentally also put the 10 year TIP at about +100 real yield — all of which is sensible, consistent and not a panic overshoot. This will also put the 10 Year Treasury at about 3.2%ish.

I'm not making any predictions about the effects of this on stock prices. Except that I would expect stocks to get into some potentially serious problems should the 2/10 spread quickly widen past 300bp as that will represent a new regime (as Vic says, "changing of the guard"). There are too many other variables to be more precise. Including the relationship between nominal yields, yield ratios, etc. I will note that bank CD rates have not been increasing with market interest rates. This can be interpreted numerous ways but it's an important fact for investors.

Gary Rogan writes:

Perhaps this is as simple as the market is taking seriously Ben's statements that he will keep the short end of the rates low, but is determined to use any good news, fake or real to taper/stop the QE. There is just going to be less money for any kind of financial assets so that any rates not controlled directly by the traditional Fed manipulations so that their prices all have to go down, stock, bonds, and everything. The market must believe that the Fed sees real danger in continuing QE and it thus must come to an end almost for sure. This has puzzled me for a while since I can't see how any kind of housing recovery can be sustained with higher mortgage rates nor how the US treasury can afford the higher rates, because I expect the deficits to start increasing again. But Ben's term is coming to an end and he probably wants to leave on a certain not that only he can judge to be the most optimal for his post-Fed future. In a couple of years it could be deluge as far as Ben is concerned but not in a couple of months. Perhaps he just doesn't want the QE in place when he leaves.

Anatoly Veltman writes: 

This is an unusual Ponzi, in the most important respect: that there is no official to call it. Alas, where market is bound to err, the market will focus on public sector Ponzi alone. The more important is the derivatives Ponzi, and that's what is liable to cause 90% market contraction off of whatever pinnacle.

Happened twice already in new millenium: with .com stocks, and then with bank stocks. Yet, most participants' philosophy is that it can't happen. Or has no right to happen? What right is there to take a billion-dollar underlying, re-hypothicate it without an end in sight, and pass it for a trillion-dollar book? Mr. Market is bipolar; trying to fit it onto historical precedent will work, for most of the trading days — but not for the most important trading days.

Jeff Sasmor writes: 

It's also possible that this is a trial balloon and that there will be feedback from the market reaction into what the fed does.

If interest rates rise and choke off the housing market wouldn't they act to reverse that?

"Plans within plans," as the Guild Navigator said.

Rocky Humbert writes: 

Anatoly is of course correct that markets go further and trends persist longer than reasonably sane people expect. The most recent examples of this are the Platinum/Gold spread; the WTI/Brent oil spread; and the 2008/2009 period. But his conclusions about "most important trading DAYS" are not only disproved by the duration of these episodes, they are also suspect in the context of investment and wealth accumulation — as the power of compounding requires time.

There remains no evidence that ANYONE can consistency anticipate or profit from the "most important" trading days. Those "important" days pale in the fullness of time as we see over and over and over again. Furthermore, he can (as I do) lament the Fed's mechinations. But they in no way resemble a Ponzi scheme. A Ponzi scheme requires new money to pay off old money, and can persist in perpetuity so long as there is sufficient new money to pay off old money. So long as the Fed has a printing press and the ability/willingness to expand its balance sheet AND THE US DOLLAR IS STABLE, the status quo can and will persist. Social Security (as a standalone entity) is a better example of a societal Ponzi scheme.

Further to the "status quo," among the things that I find most remarkable about the past few years is the relative stability of the major currency markets. Sure there have been some violent moves. But the Dollar, Yen and Euro are all within a couple of percent of where they were exactly 20 years ago! . Even the Chinese Yuan was trading at about the same price twenty years ago. (They devalued it to about 8 in 1994, and then gradually moved it back towards 6ish.) Lastly, does anyone remember Bill Ackman's breathless announcement from a couple of years ago that he had a massive call position on the Hong Kong dollar … and that they were going to be forced to imminently re-value their currency. With his problems in JCPenny, Herbal Life etc, he should consider unplugging his Bloomberg and read "All Quiet on the Western (sic) Front."

Gary Rogan adds:

I expect that they can't live with the effect of the rising 10 yr and mortgage rates even as they stand today. My initial supposition when Ben first started the tapering talk was that he wanted to puncture the stock bubble, but can't afford to puncture the bond bubble. He seems to have punctured both. The genie is out of the bottle and with all the loose talk emanating from the various Fed associates it will now take a pretty dramatic action to reverse what looks like a looming crash for most asset classes.



 Many years ago one followed the Wall St. Journal stock-picking / dart throwing contest. The Journal claimed that the expert stock pickers were well ahead of the darts over many iterations. Holdings in those days were all mutual funds or indices. So for a first foray into individual stock ownership, I bought shares of "TCBY treats" - a frozen yogurt franchise - which was touted by the analyst in WSJ dart contest.

His analysis was, "The balance sheet looks good". I checked his background and he seemed well educated and reputable (remember this was pre-enlightenment vis. shibboleths of Ivy degrees and name shops).

I never checked the balance sheet because it was unlikely my novice reading would provide more insight than the market, and in any case the analyst was trained, experienced, and (in essence) endorsed by WSJ.

Some time later the analyst could point to brief intervals when TCBY was higher. However as you might guess the stock went into a long/slow slide into oblivion.

Following recommendations without understanding their basis and the motives of the recommender is risky business.

Rocky Humbert writes: 

Dr. Zussman is absolutely correct. One should never ever listen to any recommendations or thoughts that I espouse as my motives are suspect; my analytics are flawed; and my thought processes are clouded by insomnia and senile dementia. (I view these albatrosses as my secret edge in the markets.)

Furthermore, I myself follow Dr. Zussman's advice religiously and assiduously avoid reading newspapers or books, avoid conversations with intelligent people and spent 23 hours per days in a saline-filled sensory deprivation tank (from which I emerge to occasionally pen SpecList posts.)

Gary Rogan writes:

I have been told by many people, on multiple occasions, and for a variety of reason to avoid stock tips, mainly because you can never know exactly why the person likes them and also because they are unlikely to fit into your "trading system" (and I would guess investment system). I find this advice hard to evaluate. I suppose if one knows some stats of the person's previous picks this makes it easier. If you can deduce that the person isn't simply talking their book, that's probably better as well. But fundamentally, a stock can't know that someone has recommended it to you. If you have a system, you should at least know whether the person intends for the pick to be a short-term trade or a long-term investment and judge accordingly. Rocky doesn't give a lot of stock tips, so what should one think of one when it suddenly appears? Hard to know. On the other hand, I think I have a pretty good idea who Rocky really is and he is an upstanding member of the community with a good track record, and can't possibly be thinking of moving AAPL significantly by talking about it here, so is it really wrong to follow his recommendations?



A question for Kim or Victor: Since IWM has more stocks than SPY, does it follow that daily returns on IWM are closer to the Normal Distribution than SPY? - A Reader

Victor Niederhoffer replies:

It does, as a consequence of the Central Limit Theorem .

Kim Zussman replies:

Let's look at it empirically. Here is the "Anderson - Darling" test for normality of daily SPY returns, 2000-present (SP500).

Next is the same test for IWM (Russell 2000 ETF), 2000-present.

Rocky Humbert writes: 

Vic, I'm not sure that the central limit theorem is the right paradigm. An unknown is whether the covariance within the two groups is sufficiently different to offset the CLT. I have never tested this. And testing is tricky because you need to use compounded total returns with dividends reinvested. The index and stock prices produce misleading results because dividends are greater for big caps.

Intuitively, I believe that most of the perceived differences can be explained by 2 things:

1) the dividends…which is really just a duration effect and 2) the reality that companies leave the R2k only when they are incredibly successful or when they die. Stocks only leave the SP500 when they die. They never leave the SP500 and go to the R2k when they are successful. So over time, the perceived differences are a micro sampling of a survivor bias between the 2 indices. Not sure how to test this theory…

What we do know is the implied volatility of r2k is almost always higher than the implied volatility of the SPX. I think this could be an analogue to the fact that out of the money puts are more expensive than out of the money calls. Put another way, if you are long SPX and short r2k in equal dollar amounts, you will usually make money during violent and persistent market downdrafts. I think this is proof that the distributions are different.

Victor Niederhoffer writes: 

Those are good points you make about areas that I should have considered in estimating the departures and distributions of comparative performances. It is also amazing to me that the statistical tests, especially the Kolmogorov Smirnov, show such departures. I am a great believer that the risk premium on untried and small stocks is much bigger and that they should perform better and that buying two handfuls of them will have a limiting distribution that converges to a return a percentage or two above the 8 % you get from the average NYSE stock. I must go back and check my premises. It reminds me of how I told the people in my family to buy the riskiest vanguard over the counter fund, and they tell me that they are always getting notes in the mail that the funds I recommended are being sued by their holders as the worst performing funds in history due to all sorts of wrongs of a practical and theoretical nature. I mean this response in a humble and appreciative way although it is sometimes hard to communicate that by email in the face of all the errors that are elicited.

Ralph Vince writes: 

Like everything else in this realm, it depends on the unit of time used in analysis. If you use annual data, things play much more nicely to Normal. The shorter the time unit used, the less so.



 Seems like the market has been rather trendy lately. Of course now that I've realized it its probably near the end of the trend. But that's the same thing I though at the beginning of the trend.

Mean reversion systems have difficulty in a trendy market, and simple TA things work well for trends if you're lucky.

Rocky Humbert writes:

Mr. Sogi writes: "Mean reversion systems have difficulty in a trendy market, and simple TA things work well for trends if you're lucky."

I suggest that Mr. Sogi should have written: "Simple TA things have difficulty in a choppy market, and mean reversion systems work well if you're lucky."

Every single profitable trade requires a trend!

If you buy at 9:30am at a price of 100 and sell at 9:31 at a price of 100.25, there was a one minute trend. Call it whatever you want. But if you have two points connected by a line, that line is a trend.

The carpenter ants that live in my yard don't know that my neighbor has much better foraging.

Steve Ellison writes: 

As I understand the premise of trend following, it is allegedly good to identify the trend in place before placing one's trade and enter the market on the side of that trend. To say every profitable trade requires a trend seems a tautology to me and not useful since the statement refers to the trend that occurs after entry and hence cannot be known at the time of entry.

Bruno Ombreux adds: 


This is a semantic debate. It all depends how you define a trend. "Point A to point B" is a "line", not necessarily a "trend". There are actually formal definitions for "deterministic trends" and "stochastic trends". There are also statistical tests to check the presence of those trends.

Mean-reversion: you can make money in a market going from "point A to point A" instead of "point A to point B". 

anonymous writes:

Having spent a number of years in the trend-follower business, I can confirm that trend-following, as practised by some rather large CTAs, means betting on markets where models suggest the continuation of a move. So if the price went up from A to B, a trend follower would make bets where the move from B to C is in the same direction, whereas a mean-reverting player will try trade instruments that he believes will move back towards A.

Over the years, I have given much thought to the workings of the whole trend-following business, and its role in the market ecosystem. The Chairman's various critiques of the style are all valid, and worth heeding. Yet, properly understood, I believe trend-following remains a valid approach to trading. i.e., it is a trading style that exposes you to risk factors for which the market is willing to pay you.

Rocky Humbert adds:

A wise man once said, "There ain't no point in beating a dead horse. But there ain't no harm in it either."

We've all had this trend following discussion ad nauseum in the past, and the chair's pathological aversion to trend following is well known. So to avoid re-opening old wounds, I will re-offer the single most plausible and economically rational reason why trend-following can work and has worked. (That is, I'm not saying anything about whether it still works or will work in the future.)

In order to move a price, the market requires new information. And this new information takes time to disseminate among market participants. And during this period of dissemination and acceptance of a new perception, prices will appear to trend. If you are the first person to acquire and understand this new information, you are said to have a variant perception. If you are the second or third person to realize that there is new information, you are called a trend follower. And if you instinctively fade this perception as it disseminates through the market, you are either called a contrarian or Anatoly. Strictly speaking, a true contrarian, like a stopped clock, is right twice a day. And while this new information is disseminating through the market, there are obviously many opportunitities to profit.

Ultimately, however, a trend-follower is economically equivalent to a person who buys synthetic options or volatility. And a mean-revision trader is economically equivalent to a person who sells synthetic options or volatility. Transaction costs notwithstanding, unless one has superior information, there is no apriori reason to believe that selling synthetic options should, over a career, be more profitable than buying synthetic options. However, the equity profile of an options seller is that of many small profits and a few big losses. Whereas the equity profile of an options buyer is that of many small losses with a few big gains.



 There must be a way of measuring the hills and valleys and their durations. Possibly with survival statistics. And then computing similarities of the present to the most egregious bad or remarkably good ones in the past. Once this similarity is measured, presumably with a squared distance, the similarity would be correlated with subsequent action. I would imagine geologists and modern statisticians have many rules of thumb for computing such distances of current to past.

Rocky Humbert writes: 

I think we both know that the vast corpus of academic research demonstrates no systematic predictability from simply looking at price charts.

The issue is, when one is otherwise bullishly or bearishly inclined, can the chart's characteristics help an investor improve his/her results?

For Bruce Kovner et al, the answer is yes. "Fundamentalists who say they are not going to pay any attention to the charts are like a doctor who says he's not going to take a patient's temperature."

Pitt T. Maner III writes:

It does look at times as though certain "faulted" structures get reactivated and blocks rise again in the basin and range of the market (with reference to HPQ, GMCR, NFLX, SODA, CMG, et al.) Are they more susceptible to future reversals based on past history?

"Ultimately, the broader scientific challenge in the Basin and Range Province is to compare geologically determined rates and styles of deformation to contemporary strain fields determined by GPS to see if regions of accelerated extension are relicts of geologically recent activity or precursors of future activity. Hopefully, the new compilation of faults in the Basin and Range will provide an ever-growing archive of paleoseismic information that will encourage such comparisons."

from "Summary Of the Late Quaternary Tectonics of the Basin and Range Province in Nevada, Eastern California, and Utah

Gary Rogan writes: 

Assuming random news flow, something that has really negative sentiment will react with a larger upward move to a positive piece of news than something that has really positive sentiment. Clearly something that has been going down for a long time is likely to have negative sentiment, therefore it is more susceptible to a reversal than something that has been going up for a long time (which is actually incapable of a reversal on positive news unless it's "sell the news", and the effect of similar positive news is also likely to be smaller). On the other hand if there are no positive news or a state of illiquidity is achieved than negative sentiment doesn't help. So the trick is to look for things that have SOME chance of positive news and are not near bankruptcy.



 At times like these, with the employment report two days away, the importance of Erica ("Obama Labor Agency Nominee Sent her Kids to Communist Rooted Summer Camp") can't be gainsaid. Presumably would wish a number that's not too good.

Rocky Humbert writes: 

Quoting from website: "Founded in 1923 by Jewish activists as a retreat for their children from the tenements of NYC, Camp Kinderland is true to the vision of its founders. In a difficult world, we are an oasis for children; a place where they can be themselves, feel at ease, and work and play in an atmosphere of cooperation and trust. As at many camps, our campers play sports, swim and hike, gain new experiences in arts, drama, music, dance, nature and camping. But at Kinderland they also encounter ideals of social justice and peace. They don't hesitate to sing a Yiddish labor song, paint a mural of Harriet Tubman or write a skit about putting an end to war—that's just what you do at Camp Kinderland, where it is okay to think, to care, to question and to act. There is nothing quite like it; and it works because the values of community and culture, of justice and righteousness, are inextricably integrated with the friendship, the joy, the beauty, the sheer fun and adventure, of life at sleepaway camp. Please feel free to explore our website ."

Dare I suggest that someone you know might actually benefit from a couple of weeks in this environment? I remember a summer at YMCA camp and it not only strengthened my Jewish identity, it strengthened my immune system. (The bathrooms didn't have hot water and it was my first and last interaction with a pork chop.) My wife, who's political views are somewhat right of Attila-the-Hun spent a few weeks at a Workman's Circle camp during her youth. The menu was better, but the sports were worse.

Gary Rogan writes:

"social justice" = "redistribute the loot to the 'rightful owners'", AKA "Communism", its Jesuit and later Jewish roots notwithstanding. It's worth avoiding anyone who excitedly talks about believing in it.

Stefan Jovanovich writes: 

The idea of social justice first took root in the US in the 1840s when the first flood of German immigrants - Lutherans, Catholics and Jews — took advantage of cheap tickets on the paddle wheel steamers from Hamburg. To this day their descendants remain the largest single "ethnic" group (sic) in the country. 

Rocky Humbert responds: 

Perhaps Mr. Rogan might consider starting Camp Hassen-land as an alternative to Camp Kinderland? He might find a couple of willing investors from spec list. Rocky offers this advertising copy for his website:

Founded in 2013 by cynical atheists as a retreat for their children from the tree-lined streets of Greenwich and Palm Beach, Camp Hassenland is true to the vision of its founders. In a difficult world beset by a particular idea in its grasp, we are an oasis for the self-accomplished - those who earn, deserve and consume the best; a place where money can be spent without thinking about the less fortunate or considering the possibility that one's place in life might be (just occasionally) outside of one's control. As at many camps, our campers play sports, swim and hike, gain new experiences in arts, drama, music, dance nature and camping. But at Hassenland, they also encounter vodka and inane propositions bets. They don't hesistate to sing a negro spiritual — recalling the golden age of this country — paint a mural of Sir Francis Galton, or write a skit about stepping over homeless people in the gutter — that's just what you do at Camp Hassenland — where it is okay to think, to not care, to act, and to screw your fellow campers if they are that dumb. There is nothing quite like it; and it works because the values of individualism and greed, of entitlement and smugness, are inextricably integrated with the the sheer fun and adventure of life knowing that you are superior to everyone else. Please feel free to explore our website.



I found this paper interesting:

"A Bayesian Understanding of Information Uncertainty and the Cost of Capital"

Uncertainty is not always resolved by new or better information. Also contrary to intuition, the cost of capital implied by a conventional capital asset pricing model can increase as investors become more certain about future events.

Gary Rogan writes:

I only got as far as this premise in the abstract:

"The role of financial reporting should be understood not in terms of its effect on the cost of capital per se, but as aiding investors to assess the probability distributions of future cash flows more accurately, thereby leading on average to higher expected utility portfolios."

Can widely distributing financial information to investors increase the AVERAGE expected utility? If everyone is better informed, won't the positive effects average out to zero or close?

Rocky Humbert writes: 

I have not read this paper yet, however, the answer to Mr. Rogan's question is: No, this is not a zero sum game. Better information can generate net positive value when measured at a societal level. The core economic principle which explains the net positive is that better analysis/better information will result in better capital allocation. Better capital allocation should result in higher societal productivity and hence a higher potential growth rate. This is one of the economic underpinnings behind the SEC principle of full disclosure of all relevant and material facts.

Simple example: If I "invent" a perpetual motion machine and raise $10 Billion in capital to build a factory to produce my perpetual motion machines, then this capital will be re-directed from some other potentially more productive use. In this silly example, investors rely on my prospectus to invest and have bad information. If they read the prospectus carefully however, they will see a disclaimer that the physics behind my invention are nonsense and they are better off investing in a factory that creates widgets or drugs or whatever which actually work.



 I have recently had a lot of pain related to a problematic tooth. It is a tooth that has been giving me trouble on and off for years and I have no idea why. Dentists have suggested it suffered some type of trauma when I was younger, but if that was It I don't remember the event.

Went to the emergency room last January (weekend, regular doctor closed) because I was in massive pain over the holiday weekend.

It turns out that it had become infected and was putting pressure on the nerve in the Jaw. Since that time I have had a root canal on the tooth, but that did not solve the problem. I have had two other procedures, the last one this morning because the prior one did not heal properly and got infected again. Really aggravating experience, no need to go in to details. Today I am holed up recovering, jaw aching on a beautiful day.

The thing is, back in January, I had a gut reaction that the best thing to do would be to just forget all the treatments and have the problematic tooth yanked out. Based on the trouble it had caused me to that point, it just seemed to be the solution that made sense — likely to be final and just "end" the problem.

Yet, I was told that was too extreme and "the tooth could be saved" etc. No professional I spoke with thought it was a good idea, in fact they seemed astonished that I suggested it. And today, after treatments and quite a bit of discomfort, things not going right, etc, I am inclined to think my initial hunch was correct. Forget treatment. Just get rid of the problem.

I wonder how often this happens.

A clear cut solution to a problem exists, but a bunch of complex alternatives are presented and the resolve to do what is likely required to the end the problem with certainty is dampened. Not to push the analogy to far, but does this not also happen in trades, businesses, and relationships that are going wrong. Rather than end a problem trade, it is easy to tinker with it, look for hedges, "scalp" around the position, etc. but instead of a resolution only more pain is created. Or a relationship that has stopped working — "keep fixing it" but only more delays for the inevitable split which is more painful than a clean break.

It is hard to tell what is hindsight quarterbacking, and what is a life lesson. In this case I am still not sure which it is. I wonder if there are any general rules or ideas that can be applied to these situations to give better outcomes.

anonymous writes:

Absolutely, the best case is to always treat (your tooth or a losing trade), like it was bad meat and spit it out. Deal with it immediately, no messing around, just take the hit and get over it. Bad trades, like bad relationships, have a way of metastasizing into something worse, and the old cliche comes to mind, "Your first loss is the least."

Personally I remember once having a relationship with a nice gal that went south (but as a guy I was totally oblivious to the whole thing and didn't see the obvious signs). I was out with the lady in question in public at a restaurant and she gave me "the blow-off speech." I was so confused that I didn't even see it coming (One could make a case that infatuation is insanity). In retrospect, I should have gotten up, picked up the check, paid her carfare, bid her adieu, and walked out, never to see or communicate with her again… one exits a bad trade. Instead I lingered for months in an emotional limbo, like a sick puppy, suffering great humiliation and many bad feelings. In retrospect, like a bad trade, that relationship wasn't worth it and there was no bargaining, hedging, covering it with options that was going to save it. It had to be pitched immediately, and I broke my cardinal rule by not pitching it (emotions again).

Bad trades, like bad relationships can teach one many lessons in life and trading if one listens to what the situation (market) is telling you. If only, when dealing with that person, I had used my trading persona instead of my emotional side, I would have not lingered in emotional limbo for months.

This supports a great case for dispassion, and a big part of the Masonic obligation is to "learn to subdue your passions." But like the ying and yang, good things happened out of that debacle and I ended up seeing a very cultured, erudite, successful, powerful, and beautiful woman that I married a few months ago. I'm happy for the first time in five years, and that's what's important. Bad teeth, bad trades, bad relationships…..get rid of them, they are just nuisances that get in the way of life.

A commenter adds: 

But that thinking of could have, would have, should have is very deadly in the markets. Although hindsight is always 20/20, my eyesight of 20/100 does not allow such indulgences and my defensive game does not allow for such risk. I'm trying to make money, not keep my finger in the dike like the little Dutch boy. The Dutch boy was wasting his time. 

Gary Rogan writes: 

Bad women and bad teeth rarely get better by themselves, although some teeth that seem to need a root canal sometimes do. Equities do it a lot more frequently, so to this day I don't know how to reliably tell when a bad equity trade needs to be spit out. "Your first loss is the least" obviously applies to some situations, but for instance I still own a stock that lost me 20% two days after I bought it, 50% three months after I bought it, but now two years later it's up 70%, having been up 120%. Rocky talked a lot about his thoughtful decision to exit HPQ back when it was relentlessly moving south, but it's back. What used to be RIMM is still in the dump, but someone who bought it in September doubled their money. If you could always make a wise decision by just getting out of a (currently) losing trade, everyone would be a lot richer than they are.

Rocky Humbert responds: 

Mr. Rogan,

Indeed HPQ has been inexorably working its way back and may keep climbing. Who knows? What we do know is what  the S&P index has done subsequent to my exiting HPQ. And we also know what  other alternative investments (gold, real estate, etc) have done over the same period of time. Taking the hit and putting the (remaining) capital into the alternatives would have been better than suffering. Hence in these matters, one must consider not only the ongoing pain, but also the opportunity cost. To the extent that one is monogamous, the analogy holds for personal relationships.

Is there an opportunity cost for teeth? Not sure.

Gary Rogan replies: 

Sure, there is always the opportunity cost. The question is, how well do we know it in advance? My point was that if say you bet all your money leveraged 10 to 1 on wheat, and your position is down 10% you may want to exit, but if you own 100 stocks and one is down 10% or 50% or even 90% what to do at that point outside of any tax considerations and without any additional information isn't exactly clear. Given my preference for 52 week lows in the absence of any other information it may make sense to buy more or do nothing. If the sudden move lower really attracted your attention, and upon further study you conclude that this is only the beginning, of course you may want to sell. But then a sudden move up or a long period of flatlining or something you happen to read or hear may attract your attention as well.

A commenter writes: 

The key phrase that piqued my interest was when you said, "you bet all your money leveraged 10 to 1 on wheat." Why would you "bet" all your money? Wouldn't you want to just "bet" a small part of it, and keep the rest of your powder dry? Anyways, betting signifies gambling, and gambling is wrong.

Gibbons Burke writes: 

Anonymous, I am like you—I don't see any value in pissing my money away in a known negative expectation game, so I sympathize with your view. I have never found enjoyment in gambling, personally. But I can't extrapolate from my subjective view and experience onto the world because everyone's utility and entertainment functions are different.

Gambling in the United States has several positive social functions… State lotteries support education of children… Gambling on Native American reservations is a voluntary form of reparations to that people… and, it gets money out of mattresses and back into economic circulation, transferring capital from those who are not prudent in their stewardship of that capital (otherwise they wouldn't be gambling, would they) and putting it into hands where it will be more efficiently employed.

Part of the freedoms cherished in this Constitutional Democratic Republic is the freedom to act the fool, on occasion, as long as you don't infringe upon the rights of others, or forsake the duties to yourself or those in your charge. 

Kim Zussman adds: 

You would not have regretted your decision to accept professional opinion / treatment had everything gone well.

The mistake is assuming you could have made a better decision - to extract the tooth - simply because in hindsight the treatments have not worked.

For any decision there is a range of outcomes. Perhaps your treatment had 80% chance of success (defined as rapid pain reduction, elimination of infection, and saving the tooth). But so far you are in the 20%, and for you the failure feels like 100%. "If only I'd extracted"

Do you expect portfolio managers or sound strategies to never lose, or abandon them only when they do? (Buy high / sell low)

Dentist and physician success rates are mostly unknowable but patients use cues to evaluate them. Cues such as trusted referral, reputation, diplomas, demeanor, looks, office decor, exhibited technology, etc.

Your treating dentists are simultaneously incentivized to obtain good results (reputation, future referrals) as well as make money (perform treatment). Those with consistently poor results have trouble competing with those with good results, and you are less likely to wind up there. 



Turning on my Bloomberg this morning, I see that the Nikkei gained 486.2 points last night.

This reminds me that among the most difficult actions for a long-term investor is to do absolutely nothing.

It also confirms my belief that ka-chinging a tiny profit in a long-term position assures that the market will continue to move in the desired direction.

Both are platitudes for sure. But one's P&L speaks louder than poetry.



 I heard someone the other day say the "wrong route be easy" whereas the "right path will be hard." I challenged them to defend this principle!!! This is an annoying empty platitude. Both in markets and in life.

If you want to be a poet, please recite the rhyme of the ancient mariner instead. If you want to be an ascetic, please get your philosophy correct. If you want to be a trader, recognize that pain means you were WRONG.

On what basis do you argue that "on the wrong road, you find success and happiness initially but in the end you lose; whereas on the right path, you suffer but eventually win."

By this standard, if you allow me to hold your head underwater for the next 2 hours, it's a winning "position".


Perhaps I should go back into my brain hibernation — from which you awakened me 50 hours ago!!!

Leo Jia writes:

Thanks for the wonderful argument, Rocky.

On a single trade, I am totally with you in that one should quickly recognize and correct mistakes. But on an entire trading career, this is generally not the case. I don't know how you learned to trade, but along my experience, which I believe is also quite similar for many successful traders, there have been a lot of difficulties. Should I or those many others have better quit early along the way? One simple example that perhaps best reflects this in life is on choosing careers. The easy (and likely the wrong) route is to get employed. The hard (and likely the right) route is to start one's own venture.

Stefan Jovanovich adds: 

I am the 3rd generation of Jovanovich to subscribe to the belief that "good business happens quickly". Depending on how you would include joint ventures/partnerships in the count, Eddy's Mom and I have started between 8 and 12 businesses and run them until they were either sold, shut down or the Peter principle applied to our management skills. In every one the test was the same: you made money within a matter of a few months or you never made it at all. These rules do not apply to venture capital or any other start-up where the loss of the money invested would make no difference to the lives of the investors. They apply absolutely to the opening of noodle stands ("broth runs deep in our veins, son") and other enterprises that start from scratch without any scratch.

The other rule is that sick businesses cannot be cured or "turned around"; they can be liquidated, as Secretary Mellon advised; but they cannot be saved as enterprises once the rot has set in.



 I have been considering whether there is any evidence that socially responsible businesses are better investments than profit maximizing ones. Most of the research points out that it is hard to define profit maximization because short term and long term maximum paths might differ. The concept of risk and return is also relevant with higher return often decreasing the chances of surviving. The duty of a company and its directors to its shareholders, and their incentive to do better for themselves and their shareholders by increasing earnings also plays a part. The concept of dead weight cost is also relevant which is minimized when marginal cost equals marginal revenue and the pricing is such that the demand curve intersects the supply curve at the profit maximizing price. I found this article on going for fourth downs refreshing and provocative in this area.

Rocky Humbert writes: 

I think this is an important subject to consider and the current academic literature does a comparatively poor job. For starters, there is no satisfactory definition nor rubrics of "socially responsible businesses." The monikers of "sustainability" and "green" and "sensitive to communities" are difficult to quantify to say the least. And frustrating to understand in many cases. A chemical plant that dumps its toxic waste into the backyard (while poisoning its workers and neighbors) is?? clearly maximizing short term profits at the expense of long term profits. And it's clearly socially irresponsible. And it will eventually fail. In contrast, my office landlord just installed infrared soap and hand towel dispensers in the bathrooms (presumably to be green), but will they have a good ROE on this? I have no idea. Will they attract new tenants because this is a "green" building? If the rent is the same, I suspect yes because some # of customers get incremental utility from transacting with socially responsible businesses. In contrast, no one (reasonably) gets incremental utility from transacting with socially irresponsible businesses.

The "duty of a company and its directors to its shareholders" is a decidedly American concept. The reality is that torts and taxes and regulation mean that the actual implementation of this duty may in fact include social responsibility. Things have changed over the past 100 years (for better or for worse). So — the answer to the chair's question must be: if the cost of being socially responsible is small, then socially responsible businesses MUST BE better investments. If the cost of being socially responsible is large, then it's less clear — and there is the free-rider problem.

Rishi Singh writes: 

I had the benefit of hearing the current owners of the Empire State building give a talk on going green and increasing revenue a few years back. Their synopsis was that going green for the sake of going green was too expensive for the marginal benefit (e.g. solar panels). Instead, by gutting office space, adding insulation, different windows, and light sensors to turn off lights, they improved the quality of the offices and significantly reduced utility costs at a reasonable cost. By adding these features they could charge higher rent while also improving their green footprint and returning to profitability. An example of market forces awarding the cheapest implementation of reduced energy usage.

Susan Niederhoffer writes:

Some thoughts:

1. His point about short term vs. long term is very important … because long term you see/pay for your short term decisions. Conscious Capitalism companies are long term focused. We have used as proxy for good companies, 100 best companies to work for, or some other third party list.

2. Your heading reveals a trade-off mentality, that it's either or. That's not what we've found. It's possible to keep looking for solutions that make ALL stakeholders better off (and most CC companies include the earth as a stakeholder to avoid those nasty externalities). Even if it costs in the short run, doing the right thing will pay off over time. Patagonia is a good example.

3. CSR is often the crony capitalist trying to tack on a beneficial marketing strategy to get on the green bandwagon (his landlord). You have to dig deeper to sort out which companies really mean it.

4. Transparency is getting harder to avoid. Companies that delay finding out about the negative impact they have in their supply chains and fixing them will pay when their customers discover and put it on twitter. Brand loyalty is hard to buy.

5. You will have fun debating these with John at Junto. Keep up the research…but better read the book too.

Russ Sears comments: 

The problem also is there are many "socially responsible" businesses that are not to be believed. The customer wants to do business with a business that is on the loyal side of the prisoners dilemma. It signals that they value repeat business, and this one transaction will not be be maximized at the customer's expense. In other words, a properly designed social response shows that the business considers itself to be in an infinite set of transactions. It will take less now so that the great great grand kids can make up for the small cut they give back to society. Like Zacheus the tax collector, if they miscalculated and took more than their share, they will return it 4 X what they took.

The problem however, is that often a social responsible business is really doing a slay of hands. Like Capone gifts to the Opera, or LiveStrong gift to healthy living.

Also sincerity is terrible difficult to measure, but it's something many individuals think they are better at than they are. Like ants, they are to be trusted because they give off the scent that they are from the same "tribe".



 There are some traders who make money based on news events. Please tell me how an analysis of the recent news could have been beneficial to traders who analyze news. The first reaction was a drop of 1 % in the last hour in S&P and a rise of a corresponding amount in gold. The reaction overnight was the opposite. Why was this news so bullish overnight? Is all news just an opportunity to do the opposite of the initial reaction? What do you think? Is there a systematic way to profit from news announcements? The 9-11 was not a temporary thing. Was that the clue?

Steve Ellison writes: 

I would hypothesize that any market reaction to a news event that triggers strong emotions should be faded because of the availability heuristic (people tend to give too much weight to dramatic but rare events).

I would also hypothesize that any market reaction to government statistics should be faded, since they have margins of error and are often significantly revised later. However, when I tested this proposition using the government report that routinely provokes strong market reactions, the monthly US unemployment report, it was not clear there was any edge to trading in the opposite direction of the S&P 500's move on the report day.

Jeff Watson writes: 

I generally don't fade USDA crop reports after they come out and grains are offered limit down. However, I've been known to buy wheat right at the top just before the report and have it go limit down on me. I hate that feeling as the noose tightens when the trapdoor opens. In fact that just happened to me on the last go-around.

Alston Mabry writes:

How do you test news events? First, you have to immediately and accurately evaluate what effect the event "should" have, ex ante. And then at some future point in time, compare the predicted to the actual effect the event "did" have, ex post. As there is no objective measure to use for the first step, you wind up simply testing whether or not you're any good at predicting the effects ex ante.

Steve Ellison writes: 

I tested using the following logic. If the absolute value of the change from Thursday's close to Friday's close on an unemployment reporting day was greater than the median of the absolute value of the daily change in the previous month, I assumed the market was reacting to the unemployment report and selected that day. For all the selected days, I backtested a one day trade entering at Friday's close and exiting at the next trading day's close, positioned in the opposite direction as Friday's net change. That is, if the net change on Friday was positive, the hypothetical trade was a short. The results were consistent with randomness.

Sushil Kedia writes: 

News is a rare commodity in today's world. We are inundated with broadcasts today. Any media missives that bring by a communication of fact and those amongst the fact-set that are beyond the expected may still have some market moving value. The durability of that fact or how out of line of anticipations it was may perhaps have some effect on how much and for how long the prevailing state of prices will be affected. Those broadcasts that provoke emotion are likely that are worth inspecting a fading trade. Whether news of war, crop-failures or any such genre' of information flows that produce an instant or moment of endocrinal rush.

The fine art of speculations rests on anticipations. Broadcasting media would never report what is coming to happen tomorrow, but only what may have (no guarantee that the broadcast is totally factual, since we have more "viewspapers" today than newspapers) already happened. Those who rely more on figuring out what they ought to anticipate on such resources are often the food for those who would rely on these broadcasts to figure out where the likely dead bodies will be buried. Price may not have all the information of what keeps happening every moment, but does have more information than any other resources of what is expected to happen.

Event Study Method may be a decent tool to evaluate the statistical behaviour of specific kind of events that occur repetitively with varying outcomes and of studying the repetitive actions of specific mouth-pieces than of studying erratic and randomly occurring news.

In a highly inter-connected markets' world and where the risk-free rate itself has a volatility the comforts of isolating non-random abnormal returns' evidence too is fraught with risks of playing on a frail advantage that keeps fluctuating in its expected value with ever-changing cycles if not fading away. Thus, it seems fair to me rather than an over-simplification that the most important factor for the next price is the price at this instant or any distant instant is the price at this moment and in the prior moments.

Rocky Humbert writes: 

I have one secret on this subject that I will share. Well, actually it was explained by Soros and Druck as the "Busted Thesis Rule." I think I've written about this previously on the Dailyspec.

If there is a news event that SHOULD BE unequivocal in it's meaning (i.e. bullish or bearish), and the market after a bit of time starts going in the opposite direction to the consensus meaning, then it's a wonderful opportunity to throw your beliefs out the window and go with the short-term direction. Many important big moves start this way. For example, XYZ is bullish news, yet the market after a little pop starts going down, down, down, …. don't fight it. Rather, "Sell Mortimer Sell!" P.S. I learned this lesson the hard way when Bell Atlantic made its ultimately ill-fated bid for TCOMA and Bell Atlantic's stock when straight up instead of what it "should" have done … which was go straight down. I won't describe the censure I received by my legendary boss at the time. Amusingly, neither of these companies still exist. Bell Atlantic became Nynex which became Verizon. And if memory serves me, TCOMA was bought by AT&T when they got into the cable tv business…

Gary Rogan writes: 

In a similar type of episode, when 3Com spun off 5% of Palm thus giving it a market valuation, and the resultant value of Palm significantly exceeded the value of 3Com that still owned 95% of Palm, this marked the end of the dotcom era.



 Okay, the 142 bank pres and public relations people have the minutes already to be released to public in 10 minutes. Bonds are up and stocks are down. Germany is getting killed. Which way will the release to the non-flexions affect bonds stocks and gold. I've been buying gold whenever it drops as I believe that the bank deposit confiscation has to be bullish for gold as are the trend followers short.

Anatoly Veltman writes: 

Rocky is patient at $1390, getting ready to pull trigger on test of $1320.

Victor Niederhoffer writes: 

Rocky a lot more astute than me perhaps because he has a bit of the idea that has the world in its grip in him from his days at the 'Bank' and his love of trend following. One passed their headquarters near the scene of the crime yesterday evening and it was replete with canine k9 4 footed operatives.

anonymous writes: 

One can imagine the scene:

Fed: Honey, I would love to be with you but we have to lay low a few days after the press got pictures of us together.

Banker responds: If that is the case, you and the D. C. boys have fun by yourselves. Give me the checkbook and I will go home to L.A. to shop. Call me when you decide you need the markets to go up again.

Rocky Humbert writes: 

For the record: I am flat gold. If Cyprus (or any other country) could cure their ills simply by selling gold, there would be no ills. My recollection is that the Korean housewives were selling their gold wedding bands to support the Won … during the 1997 financial crisis over there. Korean bonds were yielding 15% at the time. And I bought a few as an investment. That worked out ok. I am not buying the bonds of Cyprus, Greece or those other places. The wealth of a nation is in its land, its laws, and its work ethic. Everything else is a speculation.

Gary Rogan writes: 

"The wealth of a nation is in its land, its laws, and its work ethic."

Brilliant! I would add "respect for its just laws" to the list. May those who want to reward millions of those who broke the laws of this country by giving them the very object of their law-breaking and by making them a part of this nation give this some thought.

George Parkanyi writes: 

This is not scientific, but my feeling on gold is that given government interventions (manipulation is such a strong word) in markets these days, they can't exactly let that turn into a complete rout either. Fear is fear. Gold was supposed to be the haven of last resort. If people see that collapsing then there is the sense that there's nowhere to hide. The panic could transfer to other markets. It's not behaving as it "should" under the circumstances, which further calls into question in people's minds what the hell IS going on? And what is this action discounting - massive deflation? Governments sure want that idea to spread. This is one of the reasons I'm still holding fast to the core position - though I've taken stop-outs on portions. Not large enough portions to avoid a big hit. But it is what it is. The gold stocks are really getting creamed as well. Solid producers trading like penny stocks. Unless deflation IS ultimately our lot, I'm smelling blood in the streets (some of which is mine) and screaming bargains.

I think the odds are good for a sharp reversal rally. If things go really bad in other markets, that's where they'll be looking to cash out rather really pounded down precious metals. And gold is an international commodity - still highly valued in many cultures. This crowded-trade unwinding behaviour I think could reverse very quickly, very soon.

A commenter adds: 

Was the fall in Gold the result of some bigger thing that I am unaware of, and did someone smell a canary that has been dead for a few months and was the first to find out triggering the selling?

David Lilienfeld writes: 

Let's take a look at what's known:

1. Europe was weak going into 2013, but the dimensions of that weakness are becoming evident. The collapse of auto sales in the EU, the episode with the Cypriot banks (which I still don't understand why the Cypriot government didn't say, "Fine, Germany, we're leaving the euro, we have all these euros in our banks, our new exchange rate is X, and now you have a big mess on your hands, much as we do on ours; don't like that? Fund us!), the coming episode with Slovenia, followed by Spain, Italy (if it can figure out who is the government) and France. Then there's the farce previously known as DC. There's the leader of North Korea trying to demonstrate that there is testosterone flowing throughout his veins. The dimensions of many of these has become evident recently. The degree to which China is slowing down and the degree to which the US housing "recovery" might slow down have also started to clarify recently. I won't get into the potential for a repeat of a SARS-like outbreak in East Asia.

I don't think the canary's been dead for a few months as much as it had a massive stroke, followed by resuscitation from cardiac arrest a few times (OK, OK, it was many times), and it's now brain dead and being maintained by artificial life support, ie, it's dead but it doesn't know it. Or the canary's been dead for much longer than a few months.

There's a lot of bad stuff that's gone on the last few months, and the extent to which the market in the US is near its all-time highs is a wonderful gauge of nothing so much as the power of denial. How there could be as much complacency as there's been (a topic of recent interest on this list) is something I don't understand.

Craig Mee writes:

If you haven't noticed, the first stop for gold was the width of the consolidation. I bring you information on laying of track to take into account expansion and contraction. We must work out what size volatility or influences allows for temperature rises and falls.


1611. In laying track, provision must be made for expansion and contraction of the rails, due to changes of temperature. As the temperature rises the rail lengthens, and unless sufficient space is left between the ends of the rails to allow for the expansion, the ends of the rails abut one against another with such force as to cause the rails to kink or buckle, marring the appearance of the track and rendering it unsafe for trains, especially those running at high speeds. If, on the other hand, too much space is left between the rails, the contraction or shortening of the rails due to severe cold may do equally great harm by shearing off the bolts from the splice bars, leaving the joints loose and unprotected. The coefficient of expansion, i.e., the amount of the change in the length of an iron bar due to an increase or decrease of 1 degree F. is taken at .00000686 per degree per unit of length. 



 I admitted I was powerless over my affliction to taking small profits.

I made a decision to turn myself over to the care of those who affably might help me as God has helped others.

I made a searching inventory of all the losses I have taken.

I admitted to other human beings especially the spec list the nature of my wrongs.

I am ready and willing, but perhaps not able, to remove these defects.

I humbly ask all my supporters and friends to help me remove them.

I have enumerated the many millions that I have lost and beg forgiveness from those I could have helped had I not had this affliction. My family would be a very wealthy family and would not have to worry about such things as homes and educating their kids had I not succumbed.

I promise that I will make amends to them except when doing so might lead me closer to the grave and a nondescript and economical old age home.

I will continue to take an inventory of my lost profits and exacerbated losses, and when I transgress I will admit it. Readily.

When I jog, and have a peaceful moment, I will meditate on my past transgressions.

I will share the awakening of my profits, if any, with my colleagues so that others afflicted with this ailment can practice the principles necessary to correct.

And I will count. If this affliction manifests itself in day of week effects, than when the two day move is down seriously and the one day move is up, there should be a rise the next periods. I find of the 152 most similar events in the new millennium, the average decline the next days is -0.05 %. When the two day move is up seriously but the one day move is down, there should be a decline. I find the average move the next day of 132 such events is 0.03 %. I find similar random results for intra day manifestations of this terrible affliction. So I will meditate and count some more. 

Russ Sears writes:

An integral part of the 12 steps is accountability. You don't slip off the wagon because you don't want to have to admit it to the group and your accountability partner. Further, you recognize the triggers and you call the accountability partner to talk you down from the ledge.

In October in Canada, I attended an Enterprise Risk Management Conference where several heads of large Risk Management Departments talked to the group. It appears the regulators have adopted a system of 3 level of "challenges". That is they document times risk rules were broken and mistakes were made, either unintentionally or by bad processes at 3 different levels.

The first level was self or departmental reporting. The second level was outside department but internal to company (either internal controls or internal customers) and the 3rd level was external auditors. Each level was expected to have some "challenges" and write up how to improve them, and give a degree to how material or risky the error was. The right number of challenges and the degree of rogue risk was determined. Too little challenges or no serious violations were considered not taking risk management seriously.

The problem is, however, that this only prevents errors or rogue risk happening at the lower levels because it is a top down approach. But most companies fail because of strategic risk. Often in hindsight it is clear the strategy was guaranteed to make money short term in exchange for taking on crippling unavoidable long term risk.

This became clear to me when the Citi Risk Manager talked…The preamble to the "dance while the music is playing" quote played in my head.

They knew the housing market was a bubble ready to burst… But they also knew there was massive bonuses to be made before it struck and destroyed most of their company's equity.Nobody at the lower level was allowed to "challenge" their strategy, no matter how clear the fraud was to these lower level people.

In short, there are some risk rules that should never be broken, no matter how high you get. These may change as the circumstances dictate but they should always be defined. Allowing everyone to hold you accountable should be part of the any trader's 12 steps.

Chris Tucker adds: 

Is there a twelve step program for traders that habitually get out too soon?

(20 minutes to close): "Daddy will you play with me?"

"Umm, give me a couple minutes honey" says he. "Let me sell this first."

He groans but dutifully closes all positions. "What are you selling?" He makes a half-hearted attempt at explanation. Then heads outside for frisbee and badminton.

Then comes in an hour later and berates himself in disgust.

He never called his sponsor so there was no one there to say "Just hold it 'til the close bud, you can do it!"

He makes dinner all the while promising that he'll do better tomorrow. That he'll call his sponsor. That he'll keep at least one contract open, even if it kills him.

And he wonders, deep down, if he really can. Or is it going to go on like this forever.

Rocky Humbert writes: 

Mr. Tucker's whimsy is actually a profound question which is not easy tested:

Over a trading career, which is better: Exiting too early or exiting too late? Over a trading career, which is better: Buying too early or buying too late? (for a long only investor)

I would argue that for most fundamentally-oriented investors, the true killer is buying too early. I believe there are mathematical underpinnings to this. Perhaps other have a rigorous analysis of this problem. I've never seen this debated on the Dailyspec.

Ralph Vince writes: 

I think it depends on how you size your way in. I find I am infinitely better to be too early — on exits as well as entries. But I scale in, gingerly, one toe into the kiddie pool at a time. But this is, essentially, entering and entering on limit orders, whereas to be late at both ends, is essentially entering and exiting on stops.

I'm very interested in your thought process as to why that would be more advantageous.



 One queries whether Passover, Yom Kipper, or Rasha Shauna is bearish for stocks and will say a prayer of atonement and share a torte if it turns out not so.

Anatoly Veltman writes: 

You mean Sell Rosha Shana Buy Yomkippur did out-perform Buy&Hold?

Ralph Vince queries: 

But what about Passover? What about the full moon and a shorting a (very) quiet market?

Jeff Watson writes: 

Back in the pit days, during a quiet market, locals would start selling the market down to where it would trade and order flow would start coming in.

Anatoly Veltman writes: 

Can this be a way of creating "real world" demand?

Jeff Watson adds: 

Sure, the grain companies use this same concept in the reverse to bid up the front month to get farmers to kick out some of their stored grain into the market. Right now look at may corn/wheat spread. It is treacherous and the big grain companies are slugging it out with that spread. I'm avoiding it like the plague, just like I avoided that gold/platinum inversion 1.5 years ago that went out to $150. Too rich for my blood. Very rarely does corn trade premium to wheat. Vic even asked me about doing the trade when corn was 2 cents premium to wheat(where wheat usually commands a 50% premium to corn). I told him I wouldn't touch that trade with a 10 foot pole. In my case, fundamentals and gut instinct kept me from stepping on that land mine. It's been fighting for a week, and I just prefer to be long a little May wheat and have some other months and exchanges spread. I hate risk, and also hate gambling unless I'm the house.

Anatoly Veltman writes: 

The gold-platinum, of course, was entirely different as no Gold is ever consumed. It went out to at least $225 (we should ask Rocky if he knows the high tick, and how long the price was available). To my recollection, the spread double-topped in unusually brisk manner, i.e. the record prints didn't last more than overnight.

Richard Owen adds: 

What is it about spread trades that make them so treacherous? Gold/plat, corn/wheat, the Volkswagen stub, etc.

Is it because the mis-pricing is so "obvious" that people get greedy? Because it's a matched trade, they allow too much for a positive hedging effect? And because they want to trade the spread, they focus too much on maintaining the relative basis, rather than using risk-management appropriate to a gapping short, even if it screws up the net position?

Rocky Humbert writes: 

IMHO the reason the spread trades are dangerous can be attributed to several phenomena:

1) Price Anchoring and false assumption bias. People believe that just because the spread between X and Y has been bounded previously means that this is a law. In the case of stocks, in the fullness of time, it's a good bet that every stock must eventually either merge, get taken over, divest or go backrupt. Otherwise, one stock would take over the world. This means that if you are long GM and short Ford (because it always traded within X bucks), you will eventually blowup. And because GM/F is a mean reversion trade, it has the typical person adding as it goes against you. Can you trade around it and get out at a profit? Sure. But that is intellectually dishonest versus the original motivation. I suspect trading around the position is, in reality, what most profitable spread traders do. They don't put it on, add to it and wait for total reversion. In the case of commodities, there are short-term supply and delivery issues, so even if you are conceptually right, if the convergence doesn't occur before the contract expires, you will incur a permanent loss since the mis pricing doesn't exist in the next contract. That's the case with C / Wheat right now. Corn is at a premium to Wheat in May. But at a discount in all of the other months. So you need to get the price and the timing right. Or you will lose money.

2) Difference versus percentage. I find that people look at the spread as X minus Y. They often ignore X / Y. As prices rise and decline sharply, the ratio becomes more important. But it's not how most people's minds work. For example, a 2 cent mispricing when corn is at 250 is quite different from a 2 cent mispricing when corn is at 736. Oops make that 695 (limit down)

3) False Volatility Assumptions. Assume the price of X0 and the price of Y™ and you are trading X versus Y. And assume that the spread moves up and down $1. People mistakenly think in terms of $1 on 100 … and that's not a big move. In reality, you are trading the spread of $1 and so when it moves to $2 , that's a 100% change — no different from Apple going from $444 to $888 . Don't laugh. I can't tell you how many people fall into this intellectual trap.

4) Butterfly traders. Before interest rates were pegged, I used to chuckle at the 2/5/10 butterfly traders in the bond market — who would do the trade in MASSIVE size. And they'd talk about how the 2 was cheap to the 5. Or the 5 was cheap to the 10. Deconstructing the butterfly trade revealed that (almost all of the time) the P&L of this popular duration neutral curve trade moved with the direction of the 5 year. So it really was a bet on the 5 year rising and falling. And everything was dwarfed by that.

When I was worked with Kovner, he always hated spreads. He would say that it's hard enough to get one trade right. Why add to the aggravation and try to get two or three trades right?



 I found a couple of (modern and historical) examples of adaptations made by the wealthy in response to increased taxes, rules and regulations. In a confiscatory environment keeping a low or unknowable profile and building below the "water table" appears de rigueur.

1) The Window Tax was introduced under William III in 1696. At the time, windows were a luxury, and it was likely the number of windows in a property would be in proportion to the size of the property and thus to the wealth of the owner. It was this seen as a progressive tax and a prototype to income tax, introduced 146 years later by William Pitt the Younger. Nevertheless, the tax was unpopular, and avoidable if windows were bricked up, as many were (and one can still see many examples of windows that were bricked up for this reason in London today). Indeed, the term 'Daylight Robbery' is thought to have its provenance in this era. The Window Tax lasted 156 years until 1851.


That's just what the plutocrats are doing: digging down. Maggie Smith, of the London Basement company, which carries out basement renovations, dates the craze to the early to mid-1990s, when she noticed increasing numbers of people wanting to renovate their musty old basements. "It started quite small, with people doing 30 to 40 square meters, generally under the front of a standard Victorian London house," she says. "Then they began digging out under parts of gardens, then entire gardens, installing light wells and glass bridges to bring in natural light." Soon they built underground recreation centers, golf-simulation rooms, squash courts, bowling alleys, hair salons, ballrooms, and car elevators to the underground garages for their vintage Bentleys. The more adventurous installed climbing walls and indoor waterfalls.


3) The Wiki for "plutocracy" makes a comparison between the City of London and Lake Buena Vista, FL. 

Rocky Humbert adds: 

Here's another example of real estate tax arbitrage: Central Amsterdam ages back to over 700 years, but most of the buildings seen today were built in Amsterdam's "Golden age", about 250-500 years ago. The "Golden age" was the period when most of what is now known as central Amsterdam was built. Some people think it is Amsterdam's best architectural achievement. Probably the most prominent building built within this time period is the canal house. These line all the canals in the centre of Amsterdam. Every canal house was built to be unique from any other, though built with the same shape, each one was personalized with an ornamental piece, such as the gables and plaques. Another method was to put very decorative carvings on the "neck" of a house. This is called "necking".

During the time period in which these houses were built, your house taxes depended on the frontage. Meaning your taxes were determined by the width of your house. Therefore the sneaky Dutch built their houses deep and narrow to avoid severe taxing. For this same reason the staircases are very narrow and low, making it impossible to take furniture up and down them. To solve this problem hooks were put at the top of every house to winch goods up and pass them through the windows on the needed floor.



 The following (copied from Mebane Faber) is so counterintuitive that it's worth considering. I don't think in these terms, and there could be outliers that explain the phenomenon. But (if they did the arithmetic correctly), it is what it is….


Should You Buy at New Lows? Or New Highs?

So we tested which strategy works better: Buying near 52-week lows… or buying at 52-week highs. We looked at nearly 100 years of weekly data on the S&P 500 Index, not counting dividends. You might be surprised at what we found… After the stock market hits a 52-week high, the compound annual gain over the next year is 9.6%.

That is a phenomenal outperformance over the long-term “buy and hold” return, which was 5.6% a year. On the flip side, buying when the stock market is at or near new lows leads to terrible performance over the next 12 months… Specifically, buying anytime stocks are within 6% of their 52-week lows leads to compound annual gain of 0%. That’s correct, no gain at all 12 months later. Using monthly data, our True Wealth Systems databases go back to 1791.

The results are similar… Buying at a 12-month high and holding for 12 months beats the return of buy-and-hold. And buying at a 12-month low and holding for a year does worse than buy-and-hold. Take a look… 1791 to 2012 All periods 4.3% New Highs 5.5% New Lows 0.9% The same holds true for a more recent time period, this time starting in 1950… 1950 to 2012 All periods 7.2% New Highs 8.5% New Lows 6.0% History’s verdict is clear… You’re much better off buying at new highs than at new lows. You might not agree with it… but it’s true.

Victor Niederhoffer writes: 

That's a shocking result. Heavily weighted one might think to the depression period and the 2008 period, and probably not taking into account durations from hitting the new lows. i.e. the 1st new low in a period or the tenth. Probably even more copacetic to the trend followers with individual stocks.this is how Rocky and I first met, but I don't think he remembered it. A loss of mine was reported in the papers and Rocky wrote to me to memorialize what a woeful idiot I am. I wrote back saying "You seem to take great pleasure in my losses et al". But as you know, you can never win a dispute with Rocky. Now we're friends again.

Scott Brooks writes: 

I have been privileged to buy the low and sell the high on multiple occasions. It's all those other darn trades in between that drag down my return.

I had a friend tell me once that there are 50 perfect days in a year….. a bluebird sky, cool temperature, perfect humidity, occasional slight breeze (you know the kind of day I'm referring too).

Most people make the mistake of living for those perfect days. The key to a great life is to make the best of the perfect days when they arrive. And the way you make the best out of those perfect days is to make the best of the other 315 less than perfect days per year.

It's about having a good positive attitude so you can make the best out of whatever you get. And they way you do that is through practice… practice and practice and practice…..until a positive attitude and making the best of things becomes habit.

So make the best out of our less than perfect trades, for they are the ones that are ultimately going to define you as a person and a professional.

Jim Sogi writes: 

Amen to what Scott says. In surfing you got to go on the crappy days so you are in good shape when the big waves come. You can't just wait, like many do, for those rare perfect days. Then they are so out of shape they can't make the drop and have no legs.

Alston Mabry writes: 

I'll assume the data for 1791-1950 is more troublesome, so let's just consider this result:

1950 to 2012

All periods 7.2%

New Highs 8.5%

New Lows 6.0%

The obvious question is: When do you sell?

Jordan Low writes: 

It seems that there is never a good time to sell. You can beat 6% by say investing in short term bonds. It has to be short enough for the turnover of the strategy, so say duration of less than 1Y.

Also, the new high strategy has not really worked since 2000 with the market risk-on/risk-off, so are we in a new "regime"? Or do I keep to the strategy and pray that I will end up ahead 60 years from now — i.e. not a repeated game, you get one dice roll!

Ed Stewart writes: 

I have noted that including historic t-bill rates or alternative short term rate benchmarks as an estimate for return while in cash dramatically alters the return of long term timing models. However, I am not sure if t-bill or similar has been a fair estimate of cash holding returns - I am sure others no much better than I do.

With regard to the article idea, It does seem to be the logic of a simple trend model - something like Long on first close in top X% of range 52 week range, Flat when close in bottom X% of 52 week range. A bunch of rule sets similar to this (some type of very long term trend indicator or look-back) seem to give similar results - and like was mentioned much of the benefit comes from missing a small number of significant market declines.

In other periods (like the 90's) the models can trigger whip-saws that would likely have frustrated many "believers" at that time into giving up on them - which of course means they would have missed the benefits that accrued since 2000.

In thinking about timing models, one real benefit is that they provide a framework for the panic instinct while including a signal to get back in. The problem with the public is that they can panic, become traumatized, then never get back in until years have passed (if ever). In other words, even if one is skeptical about the future performance of timing models, such models might be a useful tool if the realistic alternative is very poor money-weighted returns with a near certainty (rather than the theoretical return of buy and hold).

A commenter writes: 

 I take the view that when any sign is known to the market, it will start to disappear; and when it is no longer a sign, it will start to reappear.

I would think it applies to this case as well. The advantage of buying at market high is not news. When was it first exploited? Were the turtles first known to the public for doing this? In the 90'es?

But anyhow, I think a plot of the returns across the time span is more meaningful (and clearly more revealing) than the average. With that, I presume that we will see the advantage of buying at market high is diminishing in the recent decade. More meaningful I think would be how much it has diminished so that we can anticipate the future when it returns.

Russ Sears writes: 

I suspected that the results depended on the period looked at. Kim gave the 250 day period results. But what happens in other periods. I looked at the S&P index from 1950-2013, with cut-off dates determined by period's length. I defined it a "first new high" if there were X day high within X days. and looked at the next X days log normal returns.

5 day period
avg     0.14%    Stdev    2.18%
         count  avg next period      T
new low  1006   0.06%                (1.24)
New high 1004   0.29%                 2.14

25 day period
avg      0.71%   Stdev    4.77%
         count  avg next period      T
new low   208    0.99%                 0.85
New high  179    0.86%                 0.44

50 day period  
avg     1.40%   Stdev     6.75%
        count   avg next period      T
new low  100     1.16%                (0.36)
New high  96     0.87%                (0.78)

100 day period  
avg      2.78%  Stdev     9.67%
        count   avg next period      T
new low  44      3.69%               0.63
New high 35      4.51%               1.06

500 day period  
avg     13.42%  Stdev    21.96%
        count avg next period      T
new low    8      8.33%              (0.66)
New high   7      7.24%              (0.74)



Robert Shiller, the oft-quoted Yale professor with a valuation approach that is bullish for a few hours once every decade (or so), appeared on my Bloomberg terminal late yesterday:




One ponders the definition of an "OK" investment from this celebrated professor? As to a "turning point":

turning point 1. a moment when the course of events is changed the turning point of his career

2. a point at which there is a change in direction or motion

3. (Mathematics) Maths a stationary point at which the first derivative of a function changes sign, so that typically its graph does not cross a horizontal tangent

4. (Mathematics & Measurements / Surveying) Surveying a point to which a foresight and a backsight are taken in levelling; change point

Victor Niederhoffer writes: 

One has had the displeasure of going one on one with the Professor while he rode his stationery bike. I got him to admit that his topsy turvy 10 year correlations were absurd as they show negative correlation with future price changes for previous years, but positive correlations for current years. I also pointed out the retrospective nature and part whole nature of his data from past years on which the basis of his work was done. He held up the possibility for a while that certain pareto processes or stochastic integrals had this tendency and then indicated that his work on p/e was not very significant and had not been updated. He did not consider me an important personage at that time, (I believe Lowenstein was there to add insult to injury), and at lunch which I paid for, he showed his contempt for me (probably justified) by directing all his attention and talk to the profs at the table. Subsequently I believe he realized that he had devoted quite a few pages of one of his bearish book showing that values were crazy because the dividend model would not have been as volatile as actual prices to some of my work on world events. To add further insult to injury Prof Lo had a similar experience with him when Lo was not as respected as today.



As the S&P approaches its all time high, slowly but steadily, one ponders the implications as it appears to be pre-ordained with the slow but consistent rise occurring.

It is well known that the markets' volatility are auto-correlated when the jump in prices occur quickly. But if the large change in price is slow but steady such as we've seen last few weeks, does volatility increase? Does this signal reverse trends are more likely than normal? Of course this needs to be defined better, yet, I wonder if someone knows the answer(s) from previous studies?

Rocky Humbert writes: 

Russ: There are multiple answers to your question.

1. Firstly, you have to differentiate between the VIX (which is based on a "market" estimate of future volatility using live options prices) versus the actual realized volatility. It is theoretically possible — in fact, quite likely — that the VIX can diverge from actual market volatility for long periods of time. Right now, the VIX is about 11.5% and the November 2013 VIX future is 18.90. So right there, you see the market has priced in a higher VIX. Assuming that this market is efficiently arbitraged, it means that 8 month options are much more expensive than 1 month options. There is some path dependency here, but in a nut shell, it means the answer to your question is no, eh yes. (That is, Mr. Market believes the answer to your question is yes in the longer term, but no in the shorter term.)

2. Secondly, the definition of volatility is simply the standard deviation of returns. As a silly example, imagine if the S&P went up by 5% EVERY SINGLE DAY. In this absurd example, the VIX is extremely low (even though the market is going bonkers), since it's a monotonically increasing value and the change in returns every day is 0. (That is, so long as the velocity of the market is constant, there is NO volatility.) In this silly example, I would expect the spot vix to collapse (due to arbitrage) but the long term vix futures would explode. (It's important to not forget how the VIX is calculated.) Similarly, if the S&P were declining by 5% EVERY SINGLE DAY, the VIX would also collapse. Again, a stupid example. But the math doesn't lie. Of course, the historical behavior of markets is that things don't move in a straight line. But for any given period of time, markets can and do move in a straight line.

So to answer your question precisely, "if a large change in price is slow but steady does volatility increase?" one must note how the calculation is made– and one must further appreciate that monotonically increasing or decreasing markets are the very definition of low volatility. The short answer therefore is "NO".

All of this begs for (and rationalizes) why as someone who sees very little value in the S&P, I am still making some nice returns by owning short dated call options (and I periodically roll up my strike prices.) This strategy will work until it doesn't. But it's already worked long enough to justify the simplistic assumptions underlying it — which is that I neither want to be the greater fool nor the lesser fool. Just a profitable old fool who plays the hand that I'm dealt. Not the hand which I wish I was dealt. Nor the hand that will be dealt tomorrow.This period will undoubtedly end with fireworks and tears. But when and from where? That NO ONE knows. Keep things stupid and simple….



 Weekly, one looks at Israel's market for benchmarks and guidance as they read our mail and are so much more scholarly than we. And to do it, I often scroll through 100 returns for every world market. In looking at these, one notes that about 90 of the markets are performing significantly worse year to date than the US. Canada and Europe are up 2% on the year to unchanged versus our up 6% are typical. Only Japan is up 10% and a few Arab countries are in our ball park. In conjunction with the run 20 percentage point increase in stocks relative to bonds, and the duration of 75 days since bonds set a big max, and the dissipation of wealth in the long precious metals, and the incredible run of max after max in US stocks, and the little woman's (who is very sagacious and always gives me good advice about the market) waving of the sceptre each morning over the head "but dear, yes. You're making, but what happens when it goes down 100 points 5 days in a row. Don't give it all back", one is somewhat less exuberant than one would be without all these Cassandra like warnings. If all my kids start calling me saying that they notice they have a few bucks in money markets receiving 0% interest, and should they invest in stocks, like they did at the height of 6000 nasdaq in 2000, then I'll know it's time to join Maturin in leaning over the boat and noting the behavior of the flying fish. Hopefully, I will take my shoes off if I fall in the water.

Rocky Humbert writes: 

Well put. Alas, the wife of the man who is long S&P calls because he sees little if any value in stocks (or bonds either for that matter, but accepts that the market is always right and he doesn't fight the fed or fight his wife) is already asking, "after the market goes down 100 points 5 days in a row, is that time to sell or time to buy?" The trendfollower replies, "depends on your timeframe."



 Two customer anecdotes:

Anecdote #1

My wife goes into Tiffany's and asks the salesperson to measure her ring size. The saleswoman looks at her with one of those "you don't belong in here" expressions and tosses her the ring of samples for sizing across the counter. (My wife measures her finger and walks out — in a moment eerily reminiscent of the scene on Rodeo Drive in the movie Pretty Woman.) 

Anecdote #2

I drop off my car at the Lexus dealer and I tell the rep that I need new brake pads and rotors. Two hours later he calls me (and I expect to hear that the bill is several hundred dollars). Instead he tells me that I'm good for at least another 5,000 miles and that he didn't do any work. The only reason I took the car in was because the mechanic who performed my required annual inspection said my brake pads were worn out.

Many business lessons here.

Jim Sogi writes:

I ordered a custom made down jacket from an outfit in Washington called Nunatak.  A guy named Tom claims he makes the garments. I"ve read elsewhere he jobs it out. They make high end outdoors gear. When I ordered it, I paid in advance and he said it would deliver in 8 weeks. Okay, I understand that. 10 weeks go by with no word, so I email…No response. I call… No response. Another two weeks go by. I email again, and get no response. I figure its a rip off scam, so I call my credit card company. The day before my expedition the guy calls and says he will mail it to my son's in LA. It never gets delivered. When I ask him, he goes off on me and says, "Wow, I apologize for setting off your anger issues….I believe Walmart has what you need in the future. Tom" This is supposed to be high end custom gear, and I would have bought thousands of dollars of gear if it was any good. Is this anyway to run a business? What an unpleasant experience. I've never had this kind of antagonism from a vendor, ever, much less a custom operation. I hope this gets put on the website so others don't have similar problems with Nunatak. The guy was not pleasant to deal with or reliable or helpful.

Mr. Kris Rock writes:

He must have been Colombian and knew from hacking your email you were headed to Argentina.



There is a zero sum part to trading where what one flexion makes, another high frequency or day trader or poor gambler ruined or lack of margined or viged player uses. The win win aspect is that if you hold for a reas period as almost everyone in market is forced to do, you get the drift of 10000 fold a century, except if you lived in the Iron and played a game with kings moving backwards.

Anatoly Veltman writes:

Ok, I'll say it. Drift prevails over a century. And I had no problem with drift as recently as 4 years ago, when the only true drifter I know, a prince of certain oil, was adding to his C holdings by bidding pennies.

I'm having a problem with over-relying on drift now; because now, four years later, you can only bid pennies for C if you add $42 in front of it. All the while the real economic indicators, as Chair pointed out just today, have not and will not improve much any time soon. Now tell me: why assume that there will be much of a drift effect in the near five, or maybe the near ten years? Do you expect policy improvements, or pray for a budget spiral miracle, or Europe culture unity miracle, or what other miracle?

Jeff Watson writes:

Back in 1932, the DJIA made a new all time low that wiped out 36 years of gain. Likewise, the market didn't totally recover from 1969's highs until 1982, and the market has done a 15 bagger since then. I'll stick with the drift, which is a steady wind. 

Rocky Humbert writes:

There seem to be two sorts of smart-sounding stock market pundits: (1) those who get bearish because prices have risen. (2) those who get bearish because prices have fallen. I am neither smart nor a pundit but my views of the 3-5 year upside from here (small) and current positions (long inexpensive s&p calls) are known to all.

In the face of the current seemingly relentless rise (which has used up a year's drift in 3 weeks)… I confess that I am looking at my new, over 50% combined tax rate, and positing that higher marginal rates disincentive not only my risk-taking, but also my selling (as the taxes discourage my speculative urge to sell now and buy stuff back at hopefully lower prices.)

With this in mind, an academic study might consider whether changes in capital gains tax rates result in more serial correlation (i.e. trending — as I look around three times) SHORTLY AFTER the higher taxes are imposed. And the effect diminishes over time as people become accustomed to the new regime. Obviously I would guess the answer is yes.

Kim Zussman writes:

 Increasing tax regime could be bullish:

1. additional vig against frequent trading (as if there weren't enough already) > 1a. "drift" of holding period toward longer timeframe
2. disincentive to sell = incentive to hold and/or buy (including insiders)
3. restructuring away from dividends toward stock buy-backs

Rocky Humbert writes:

Dr Z may be onto something. Does this mean if Obama raises capital gains taxes to 99%, the stock market will triple over night? 

Anatoly Veltman writes: 

1. I have no problem with counting to include the last few years
2. I have a problem with counting to include anything pre-2007, let alone pre-2001, and even more so pre-1987.

The reason I have a problem with it: historical price analysis, no matter which way analysis is performed, relies on the notion that participants have not largely changed, and that "their" psychology has not changed. This is not the case - if one goes too far back - because financial market mechanism and participant make-up has changed ever increasingly over the past decade.

One of the victims of methamorphosis was "trend-following". I believe that most previosly successful trend-following rules have died in application to regulated electronically executed markets, because most clients are now automatically prevented from over-leveraging. Thus, "surprise follows trend" rule, for example, lost potency. Nowadays, you get preponderance of surprise "against trend". That's a very significant switcharoo, which has put most of famed trendfollowers of yester-year out of biz.

Also, Palindrome was not much off, predicting the other day hedge fund outflows due to old as age "2&20 fee structure". This structure just can't survive the years of ZER environment. Huge chunk of very cerebral participation has been replaced by bank punk punters, gambling public's money for bonuses.

Gary Rogan writes:

The drift seems to be a long-range phenomenon that has existed in different stock markets for a very long time. It is therefore difficult to make predictions of its demise based on any specific factors. One thing is clear: calamities like revolutions end the existence of the market and obviously the drift. Benito Mussolini was very good for the Italian stock market for a long time, and even way into the war it kept up with inflation, but eventually it succumbed to the realities of war (in real, not nominal terms). Granted, Mussolini initially had much better economic policies than Obama, but who would really expect that faschism could coexist with a great stock market? The question still remains: will there be a total wipeout? Short of that the drift is likely to continue.

Il Duce wasn't chosen completely at random, and the question was (just a little bit) tongue-in-cheek.

I could easily make the contention, and a great case, that fascism co-exists with a great stock market right here in the USA.

Ralph Vince writes:

I think we make a huge mistake when we assume that policy affects long term stock prices. Sure, you might have seen events, like a lot of stocks seeing big ex-dates last year, before big tax theft years — but the long term upward drift is a function of evolution. Like our progress has always been — starts and fits.

Sometimes the fits have lasted 950 years! But it always comes around. I like to get up in the morning, put my shoes on, by a few shares of some random something or other. If it goes against me, buy a little more. When it comes around to satisfy my Pythagorean criterion, out she goes.

As I've gotten older, I like to do it with wasting assets, long options.

It makes it more sporting.

Stefan Jovanovich writes:

I wish that we all could agree that prices only count if you can use the money . Zimbabwe's stock market does not have prices for anyone who wants use the money except in Zimbadwe. The Italian stock market was not quite that bad but close enough to make its "performance" entirely fictional from the point of view of anyone wanting to do what people now take for granted - use their dollars to buy/sell "foreign" stocks, close the trades and then take home their winnings - in dollars. That was not possible in Italy after 1922 or in Germany after 1932, for that matter.

As for Mussolini's economic policies, they were far more destructive than the President and Congress' inability to stop writing checks that the Treasury has not collected the money for. In his Battle for the Lira (1926), Mussolini decided that the currency would be fixed at 90 to the pound, even though the price in the foreign exchange market was 55% of that figure. The result was to create an instant bankruptcy for all exporters and those few remaining financial institutions that dealt in international trade. As a result Italy got a head start on the rest of the world; its Depression began in the fall of 1926. But Quota 90 did create a windfall for the Italian industrialists who were Mussolini's supporters; their costs on their imported raw materials were immediately halved. Like the German industrialists after Hitler took power, they saw their order books boom with all the government spending for guns and butter. And look how well that all turned out.

Baldi writes:

Ralph, you write: "As I've gotten older, I like to do it with wasting assets, long options."

Older? You wrote about doing just that in 1992:

"Finally, you must consider this next axiom. If you play a game with unlimited liability, you will go broke with a probability that approaches certainty as the length of the game approaches infinity. Not a very pleasant prospect. The situation can be better understood by saying that if you can only die by being struck by lightning, eventually you will die by being struck by lightning. Simple. If you trade a vehicle with unlimited liability (such as futures), you will eventually experience a loss of such magnitude as to lose everything you have. […]

"There are three possible courses of action you can take. One is to trade only vehicles where the liability is limited (such as long options.) The second is not to trade for an infinitely long period of time. Most traders will die before they see the cataclysmic loss manifest itself (or before they get hit by lightning.) The probability of an enormous winning trade exists, too, and one of the nice things about winning in trading is that you don't have to have the gigantic winning trade. Many smaller wins will suffice. Therefore, if you aren't going to trade in limited liability vehicles and you aren't going to die, make up your mind that you are going to quit trading unlimited liability vehicles altogether if and when your account equity reaches some pre-specified goal. If and when you achieve that goal, get out and don't' ever come back."



 If cheapskating is going to increase, we might consider whether individual stocks that cater to cheap skates might have inordinate returns. This is the kind of things that my kids might make money with in terms of the category of stock, rather than its financial characteristics. Perhaps. On another front, I believe it is important to be especially cheap after having a good year. I think of Rimm every day with grave loathsomeness.

Art Cooper writes:

It's been a market theme for quite some time to buy stocks like Family Dollar Stores, Dollar General, etc. instead of retail stocks which cater to the middle class. The high-end retail market is a different market, as it responds to different forces. 

Jeff Watson writes:

I'm always accused of being a cheap person and try to not be penny wise and pound foolish. I never pay retail for anything and try to buy only stuff that will hold value. Herb Cohen is a person I look up to. He might look a little seedy, but he makes great sense and teaches sound methods of bargaining. His first $19.95 book I ever bought was probably the best investment I ever made, saving at least a million bucks, by bargaining with some of his techniques over a 30 year period. That's a hell of a return and his techniques work…

Pitt T. Maner III writes: 

 Cheapskating is likely to be an increasingly popular topic as hidden inflation and taxes go up. Perhaps there is an opportunity for a "Global Skinflint"!

"Jeff Yeager, dubbed "The Ultimate Cheapskate" by Matt Lauer on NBC's Today show, is a very cheap guy. He re-cants, as opposed to decants, the wine he proudly serves his dinner guests, funneling cheap box wine into premium-label bottles. He believes you should never spend more than USD 1 per pound on food items. And to save time and energy costs, he soft-boils his morning eggs along with the dirty dishes in the dishwasher."

And then there is the TLC show :

"Be aware of what you're using. Victoria Hunt, who retired from her accounting career at 48 has been tracking her expenses and her income on a spreadsheet since 1989. "Every minute of every day has something to do with how I can make a better decisions financially," she points out."

Rocky Humbert writes: 

Mr. Yeager is either wasting money on his super-heated dishwasher or he's stretching the truth about his eggs. Dishwashers (generally) do not heat the water about 140 degrees. See this article on naturalhandyman. To get the egg white solid, it requires about 180 degrees. Even my Miele doesn't get the water to 180 degrees! This does not compute! (That is, he's making his money selling books. Not cooking eggs.) I would suggest that he should instead put his Pop Tarts and morning sausage on his car engine's manifold. By the time he gets to work, he'll have a well-cooked breakfast. (And he can similarly roast hot dogs on his drive home.)

Dr. Johnson writes: 

Ballyhoo? Like any good Spec, one must test, and test I did, the claim that an egg can be cooked in a dishwasher during a normal wash/dry cycle.

Equipment- Miele G5775.

Note: Perhaps not the ideal brand for testing a cheapskate's assertion.

Eggs= Phil's Fresh Farms Free Range Large 42F wrapped in plastic film.

Max Water Temperature Wash5F Max Air Temperature Dry= 185F

Time to complete cycles= 54 min wash & rinse, Dry 22 min.

Results: Egg removed immediately at end of the cycles= Yolk 134F thick and slightly flowing, settles to 1/4 height, white 151F at shell boundary with firm consistency.

Egg removed after 10 Min.= Yolk 141F thick and settles to 1/2 height, white 141F at shell boundary with firm consistency.

Conclusion: Not Ballyhoo! One important consideration for those cheapskates who want to try this method is that egg shells are semipermeable, therefore unless the taste of detergent combined with a menagerie of old food waste is to your liking, sealing the egg in plastic wrap is advisable (also which at +140 F will transmit unwanted substances).

David Hillman writes: 

Yes, let us commend Dr. Johnson both on his testing and on his using Phil's Farm Fresh Free Range eggs, the chicken egg of preference at Casa DGH…..cage-free, no chemicals, natural whole grain feed, laid in nests, and certified humane!

That said, even though my Bosch heats water to 160F and air dries at what seems to be 1200K if one opens the door during the 'sanitize' cycle and is met by a blast of superheated air, this whole business of cooking eggs in a dishwasher seems a bit impractical.

One, it seems like using a sledgehammer to place a pushpin in a cork board. Two, while the dishwasher here is run every 2-3 days, typically in the evening, eggs are a daily breakfast staple. What to do on 'accumulation' days? Three, counting time to heat water or a pan, it takes about 10 minutes to fry, poach, baste, scramble or soft boil eggs on the range. Why wait 76 minutes? Four, dishwasher cooking uses a heck of a lot of water and electricity v. range top cooking, multitasking notwithstanding.

For those who feel the need to multitask in the kitchen, there are what seem to be more practical alternatives to cooking one's breakfast eggs in the dishwasher, though at $90, this might not be thought of as 'cheapskating' …..

Pitt T. Maner III adds:

 A few older links, but possibly of interest to those seeking to find ways to ride the money-saving trend and as a possible example of a company that finds quickly (identifying trends) and uses new inventions from private inventors. Khubani the CEO started with ad in National Enquirer.:

1) From 2010: 'A.J. Khubani, the man behind many “As Seen on TV” gadgets such as the PedEgg foot scraper, is making cheapskate gimmicks a priority at his company Telebrands, one of the nation’s top direct-response TV marketing companies.

More than half of Telebrands’ gadgets, sold online and at 90,000 stores, are now focused on helping shoppers be cheap. Khubani, who has been traveling around the country to meet inventors, is speeding up the number of new products he’s launching to every 30 days from every 60 days. “The mood of the country has changed,” said Khubani. “We’ve had tremendous opportunity with this recession.”'

Since 2007, Telebrands’ revenue has doubled to several hundred million dollars, he said.

Read more.

2) The current lineup of brands.

3) From 2012: "For the first time in our company's 29 year history, TeleBrands had 15 products ranked in a single year including our most recent hits like, Slice-O-Matic, Plaque Blast, Slim Away, OrGreenic and Bake Pops," said TeleBrands' CEO/Founder, AJ Khubani. "Each year, we continue to solidify our spot as the largest and most successful marketer of DRTV products aimed at solving everyday problems and reaching mass audiences at affordable prices. In 2011 alone, we rolled-out 12 products — the most in a single year in our company's history."

Read more.

4) On Khubani from 2011:

"The son of Indian immigrants, Khubani started out at 23, spending a few thousand dollars on an ad inNational Enquirer — a move that led to his first big hit. Since then, he's sold hundreds of millions of "As Seen on TV" products, including AmberVision sunglasses, the PedEgg and Doggy Steps. He has bolstered the careers of ubiquitous TV pitchmen, including the late Billy Mays, who enthusiastically hawked products now found on the shelves of more than 100,000 retailers. Today, Khubani is the leader in the $20 billion direct consumer marketing industry, turning out more "low-tech" products than ever before."

read more.

5) Not all have been appreciative of Khubani's methods:

"But will anyone care about dust mites? Khubani wasn’t achieving much traction among his Telebrands staff with his bed-spray idea, when along came a proposal for an anti-dust-mite pillow, from a colleague Khubani mysteriously describes only as “a business associate.” It’s hardly a new concept—there are several such pillows already marketed to allergy sufferers and asthmatics. But so far, nobody has had the brilliance to incite a national panic around flesh-eating creatures that feast on human remains—and lurk in the pillow of every man, woman, and child. “The hum you sometimes hear at night?” Khubani asks eerily. “That’s the sound of 2 million dust mites eating your dead skin.” Or perhaps it’s the sound of one man in Fairfield, New Jersey, homing in on your next anxiety. "

Read more. 

Victor Niederhoffer adds: 

 Of course the main virtue about cheapskating is that it prepares you for such activities in your business. As the oil magnate said, "I am not smart enough to act one way in my personal life and another in my business. My margin is 8%, and if I gave away 8% on everything my 200,000 employees would be out of a job. So I make them pay for their telephone calls." Regrettably, the oil magnate was victimized by old man's disease (the same disease as the sage), and he was locked up in England for 20 years, with his retinue preventing him from going back to us for fear that he might change his will, and he was soporifisized by many nubile girls and other attractive women he would meet at museums. 

Funny. More important even then the fine posts with examples and tests of cheapskating is the query I have received from many of the younger hearted on the list. "Where are those museums that the oil magnate frequented?".

Gary Rogan suggests:

I suspect the Getty museum is a good place to start.

Stefan Jovanovich writes:

I hope Gary means the original one in Malibu, the villa whose design Getty himself supervised but never saw. The monstrosity built on top of the landfill by the 405 is absolutely the worst place in LA for the amusements Getty had in mind. If he were alive today and living in SoCal, he would be going to OCMA to appraise the latest generation of lovelies.

Jim Sogi adds:

Eggs can be cooked sous vide at 144 -155 for 20 plus minutes for a wonderfully cooked smooth soft boiled egg with a consistent texture throughout.

Food grade hydrogen peroxide diluted to a 3% solution is an excellent way to sanitize kitchen and utensils and not toxic like chlorine. 



 "You could never know when the elephants would come back, but when they did they always traveled the same path" . And the natives (and R. Humbergola) were always waiting for them.

Rocky "Humbergola" Humbert comments: 

Let the record reflect the fact that I have never traded a single share of Apple stock (long or short), however, I told a friend on October 9, 2012 that if I were inclined to trade this elephant, I would have shorted some on the most primitive moving average cross. But I didn't. And so I have nothing to brag about or substantive to say except that I continue to consider AAPL the single most difficult investment possible — a melange of technology, fashion and retail — all of which are well above my pay grade. And I would add that there is compelling (statistical) evidence that a company is biased to underperform the index after a longterm charismatic CEO leaves the helm…market capitalization and valuation not withstanding. As for my belief that the S&P at its current valuation offer a likely return in the very low single digits with a 3-5 year time horizon (which is still better than fed-targeted fixed income right now), I am continuing to sell individual securities but replacing them with S&P calls with single digit volatility as this strategy will ensure that when the ephelumps turn, I will not be left with a steaming pile of dung.

I hear a bunch of people calling tops and looking at the 1962-1982 analogies and so on, but I see very few people who were formerly bullish turning bearish and I see many smart people lagging the index and I've learned that it's better to be right than to be smart and I have demonstrated a utter lack of ability at calling the market in any timeframe relevant to people who sit in front of screens all day; hence I am using the gift of low vix to ensure that when the trend changes it will occur in a way that I will be profitable and wise but only after the fact. One last thing: the SPY historical vol at 30 and 100 days is 13.1 and 12.5. The TLT vol at 30 and 100 days is 12.6 and 13.17. SPY calls at the money cost 10.4% vol; and TLT at the money options cost 12.5%. There is some predictive grist here but the proof and execution are left as an exercise for the reader.



After a long journey, one notes that platinum is back at a premium to gold this morning. As I am fond of saying, every market price (except 0 and infinity) gets seen at least twice. The only uncertainties are how long it takes… and how far prices move before being revisited. Next on the arcsine law agenda (with statistical apologies to Dr. Phil): The WTI / Brent oil spread….



 One recently waited 15 minutes after making a big purchase at Barnes and Nobles while they held me up because the computer went down and they couldn't take cash, exact payment, credit card. At the end, they sardonically told me that if I had a complaint about the wasted time, effort and treatment, I should talk to their manager. On the other side, I read in John Mackey's new book Conscious Capitalism about how when a hurricane hit a Whole Foods in Conn, the computer broke and a lower level operative without any feedback from headquarters gave everyone in the store free goods for the 1 1/2 hour that the computer was down. They got millions of good will and publicity as an unintended consequence. A study in the book shows that companies that cater to the customer, and employees and suppliers as well as the stockholders have better performance than the average. Panera and The Container Store are examples. I wonder whether this is a real effect and whether these companies will perform better or worse—- and the former will never get my business again and the latter will. What's your experience and view.

Vince Fulco writes:

My wife works in the textile area of Target, I have tried to look at its operations with a jaundiced eye as a financial analyst would. I've always felt welcomed and well treated there without their knowing we were an employee family.

anonymous writes: 

 I bumped into a colleague at Costco today who quizzed me about the recent tax changes. Not sure why he thought I would know, but after 5 minutes of listing the various relevant increases I asked, "Do you have time for more of these?" "Not really", he said, adding "You've already depressed me enough". "What are we going to do, raise fees?" he asked.

In the wake of recession we have not raised fees, and in many cases lowered them. It is better to stay busy and build good-will when people need it, and raise later when discretionary demand increases.

Increased taxes ordinarily reduce demand. But for businesses with existing demand, they are inflationary.

Maybe the FED gets what it wants (inflation preferable to deflation), and the agrarian organizers do too.

Rocky Humbert adds:

The chair asks a very important question; and the implications transcend business. With the caveat that I'm rather better at asking difficult questions (than answering them), I'd pose the question this way:

1. To what extent do people and organizations act in their self-interest?

2. If (1) is 100%, then any act of altruism MUST BE motivated by either reciprocal altruism or goodwill. If (1) is less than 100%, then any attempt to answer (1) is hopelessly complicated using a rational/analytical framework. And I won't go there since it's a moral argument.

3. A paradox arises because except for reciprocal altruism (i.e. keeping your counterparty in business so he can buy your goods and continue to service your needs), there is a irrationality that occurs for any action which isn't in one's self interest (for both the seller and the buyer) For example, if the customer is rational and self-interested, then ANY warm and fuzzy feelings towards a vendor are not rational if those warm and fuzzy feelings arise because of a historical and non repeating gesture (giving away goods during a power failure assuming that the goods wouldn't otherwise spoil.) However, in contrast, convenience IS rational and is part of the value proposition. That is, a vendor who doesn't make you wait in line when the cash register breaks has a superior product at the same price for SOME (not all) customers. And ceteris paribus, that should garner more business (for some, not all) customers *IF* he doesn't have to raise prices for a massive fault-tolerant computer system. If he has to raise prices for a massive fault tolerant computer system, then the customer who doesn't care about waiting in line won't shop there anymore. But the lone vendor who tries to gain a lasting competitive advantage by giving away milk and bread during a blackout will fail — since the goodwill generated by this will quickly fade and there's no lasting benefit to the customer.

Every economics question can be solved by recognizing that: 1) Incentives Matter. 2) Resources are limited. And … then it's simply a question of utility curves. BUT BUT BUT if there is a moral aspect to the question, then all of the rational analysis goes out the window. And that is, I think, what Whole Foods was trying to do.

Jeff Watson writes: 

 Right before Hurricane Andrew hit South Dade County and went across the state to hit Naples and Collier County, Home Depot was giving away 4×8 sheets of plywood……just had truckload after truckload, bringing it in to offload it to anyone who wanted it for free to board up windows etc.

Their main competitor, Scotty's was gouging, and charging $40 per 4×8 sheets. In the aftermath of the storm, Home Depot kept their prices down while Scotty's jacked them up. Scotty's did the same thing after Hurricane Charley. Much editorial space was spent discussing this in the Miami Herald, El Nuevo Herald, Sun Sentinel etc. Scotty's reputation suffered greatly and eventually went out of business at the end of 2005.

There was lots of bad karma and my builder friends avoided Scotty's like the plague. Scotty's said they closed all their stores because of the hyper-competitive building supplies market…..this was when Florida had the biggest construction upswing in history. Again, real bad karma. Home Depot is still a viable corporation. Because of Scotty's actions(and that of others), Florida passed a non-gouging law in 1993 which Scotty's still ignored in 2004.

Steve Ellison writes:

 In Predictably Irrational, Dan Ariely devotes a chapter to "social norms" (the friendly requests people make of one another) vs. "market norms" (you do x, I'll pay you y). People generally see social norms and personal relationships as being on a higher plane than mere market transactions. In one study cited by Professor Ariely, implementing fines for picking up children late at day care centers actually increased the frequency of late pickups. Before the fines, the parents felt bound by social norms and felt guilty for inconveniencing the day care providers if they were late. After the fines were implemented, a late pickup was reduced to a mere market transaction: I want to be late, and I am paying for extra service.

My guess is that companies such as Whole Foods that serve customers beyond the bounds of how customers expect a profit-seeking corporation to behave elevate themselves on the social vs. market scale and thereby gain much customer loyalty.

Russ Sears writes: 

People are cooperative beings, they want to feel they are in a partnership where one looks out for the other. While the individual is the driver of innovation and change, progress is made by the most connected in ideas. Arts, science and technology thrive is these highly cooperative environments such as the big cities. Ideas are one thing that the sum of the parts can become exponentially more.

If the business really is adding value, then they display it by highlighting cooperation with their customers. Because long term the good will makes them more resilient and able to grow.

Whereas if every transaction is a zero sum game, then the signal to the customer and investor is short term thinking. There is a tinge of buyer beware for the customer and an touch of desperation to next quarters results to the investor.

The entrepreneurs I know who are successful only do it because they love the business otherwise the risk the stress and the heartache are not worth the money or the effort.

I believe Jobs showed the world that at some point it is no longer is about the money, it is about making a difference, giving others what they want and of course "beating" your competitors. If you can do these 3 things well it is like having a blank check written by the world.

Gary Rogan adds:

 Yes, that's another way of looking at the situation. But Jobs is Jobs, and regardless: when confronted with a situation where a person (or an entire business enterprise) who doesn't know you from Adam is particularly accommodating and friendly to you, you have to decide whether (a) that's just how they are (b) they are doing this to get repeat business as a calculated move (c) they are conning you (d) they saw you and really fell in love with you. The thing is, it could be any combination of these or something else. All I'm saying is that a "they are giving stuff away" or some equivalent to "therefore I will make them by business/partner of choice for a long time" isn't always the most rational thing to do. One really should only feel gratitude to people who are doing it for un-selfish reasons while recognizing that a good businessman will often behave "nicely" as opposed to being a jerk.

Clearly almost all expressions of "good will" and cooperative behavior by businesses are self-serving. The rare exceptions are of the nature of some owner or executive clearly touched by the misery of his customers and/or employees and doing something good for them just because. Cooperative, reliable, and resourceful businesses do add value by not wasting their customer's time and money and not aggravating them, so often everybody wins. Sill in many of these situations have to be analyzed carefully because you are typically not dealing with friends or relatives. Otherwise one can become a "victim" of deception, as someone who buys a company's product because its advertising agency made a particularly effective commercial that is often in no way related to the quality of the product. 

Jeff Rollert writes:

I'd like to share a story that happened this weekend.

A number of you know my hobby is racing sailboats. Well, I'm on a number of forums and they have members that range from the grouchy to super nice and helpful.

About six months ago, a fellow I'd never met or spoken to offered to lend me a sail to test an idea I had been struggling with. There was not a request on when to give it back; in fact it was open ended. After dealing day in and day out with the squids of our occupation, the offer seemed too nice. Something worth $200-$500? Just drive over to my house and you can have it. Really? This is Los Angeles!

Well, in a race this weekend we all got to talking about boats we had owned and one of the guys had the same as mine. We started to compare notes, forums, parts suppliers etc.

It turns out he was the guy who made the offer. I was ashamed at how genuine and nice a guy he was, and what I had suspected.

I only bring this up as a probability point…no matter how pissed you can get at humanity, the percentage of genuinely nice folks is always above zero. I'd forgotten that lesson.

You guys often remind me of that lesson too!



Specs should note that a new 0.20% tax on French stock purchases goes into effect on 12/1/12. This will provide a nice laboratory experiment of the effects of a Tobin Tax in the age of HFT.

If you like to arbitrage TOT against other global oil companies, consider yourself warned! The tax applies to ADR's too.



 As noted previously by a spec, and confirmed in today's WSJ, trendfollower John Henry is leaving the money management business — having had his assets dwindle from 2+ Billion to well under $100 million.

JWH will be ensured a footnote in financial history if only for his purchase of the Red Sox. As to his money management, his latest disclosure document is here. Interested specs might want to download it for posterity — so the facts and track record will never be in dispute…and before he shuts his website down (which will presumably happen forthwith.)

There's a lot of grist for statisticians in his track record — including the fact that he has no visible, continuous track record from his launch in 1982 to his retirement this year. The closest thing to a track record is his financial & metals portfolio which launched in 1984 and which closed in 2011. And even here, the results have an asterisk (reminiscent of certain baseball hall of fame members' asterisks). Henry claims a 252% return in 1987, but the asterisk reads, "The timing of additions and withdrawals materially inflated the 1987 rate of return. The three accounts that were open for the entire year of 1987 achieved rates of return of 138%, 163% and 259%.

Anyway, for this fund, he claims a 27 year compounded rate of return of 19.8%. And if you eliminate the home run in 1987, I reckon his lifetime record is around 14% — which isn't too shabby. His worst years in this fund were 2009 at -17%, 2005 at -17%, 1999 at -19%. So his average 19.8% compounded return over a lifetime matched his maximum drawdowns — and that's pretty darn good in my book — certainly hall of fame material for a 27 year run.

Unfortunately, his other funds have not performed anywhere close to this fund. He shuttered a bunch of funds that were disasters (and doesn't report those results) ; and his other open funds have returns nowhere close to this fund (and much higher volatility.) So a skeptic could rightly attribute the aforementioned 27 year return to a combination of luck and survivor bias. I am agnostic. It is what it is.

More interesting to me is the fact that from 1985 to about 1996, his returns really were consistently excellent. You can see them on page 43 of the pdf. Then something happened. And so the point of this entire post is for people to consider the question: WHAT HAPPENED AFTER 1997? Did the world change? Did he change? Did he have too much capital?

I have some theories, but before I weigh in with my theories, I'll allow others to chew on this… There's many meals to be found in correctly answering this question.

Richard Owen writes:

A component seems to have been the purchase of a groin guard: Beginning in August 1992, the position size in relation to account equity in this program was reduced approximately 50%.

Anatoly Veltman writes: 

Some great points, because I believe trend-following died exactly when the leverage left the regulated exchange trading, which went all electronic; and moved to exclusively OTC derivative biz, which is more flexionic. An easy example, a rule that used to work well in futures of the open outcry era: surprise (i.e. big intraday price change) follows trend. Don't try to fade a market that's been gradually and continually trending, as you are likely stepping in RIGHT IN FRONT OF FORCED LIQUIDATIONS. But since electronic execution prevented over-leveraged position-taking, this rule muted up: nowadays, it may well be a profitable strategy to fade prolonged trend - as more surprises began to SUDDENLY correct overdone trends

anonymous writes:

Hard to tell without analyzing the cash flows, but I propose JWH followed the time honored tradition making great returns on a small assets base then poor returns on a much larger asset base.  The compounded annual rate of return may look very good, but in absolute dollars making a large contribution of investor funds to the market infrastructure.  Paulson is carrying on the tradition more recently.  On the performance degradation I sense from interviews I have read he developed his trading ideas in the 70s and did not modify much since then.



 It's now been 12 days without electricity. And unlike Bo (who lives in
boxcars), I'm still paying the highest real estate taxes in the nation.
So, turning lemons into lemonade, here is a list of things I've learned:

1. A recession is when your neighbor loses his job. A depression is when
you lose your job.  A storm is when your neighbor loses his electricity
for 12 days. A catastrophe is when you lose your electricity for 12

2. ConEdison has a real time outage map. It is updated every 12 minutes. But you cannot view the map unless
you have electricity. Ironic. It provides the date and time of
restoration to the nearest minute. Their precision is eerily reminiscent
of companies that guide earnings to the nearest penny.

3. Beware of the weakest link. Where we live has no town gas. We have a
well. So without a generator, we can't flush toilets.  But the generator
runs on propane. And that's the weakest link.  Getting a propane
delivery is almost impossible.

4. Bad incentives create bad behavior. Our propane company told us that
they are only making deliveries to customers who have run out of fuel.
But we were running our generator only a few hours per day to CONSERVE
fuel so we would not run out. Hence our responsible behavior was not
rewarded. And profligacy was rewarded. Only after I pointed this out to
the propane company manager and threatened that I would make it a
personal mission to go door-to-door afterwards and convert all of my
neighbors to a competitor did we receive an 80 gallon delivery. (The
generator burns between 2 and 4 gallons/hour.)

5. People don't change. Our neighbor who built a 12,000 square foot
McMansion (that blocked our view) was running his generator 24/7 and
running his landscape lighting 24/7. I was looking forward to a good
night's sleep without his lights coming into the bedroom window. No such

6. Send more food gifts to our troops.  They were distributing beef stew
MRE's and water bottles at the local firehouse. After things return to
normal, I'm going to send more food baskets/etc to our troops. Those
MRE's are rude.

7. Traffic lights are optional. On the first few days, there were
horrible traffic jams since all of the lights are out. However, by day
5, a self-enforced ritual developed at 4 way intersections where people
yielded to the person on their right … and things actually
worked…not perfectly, but surprisingly good.

8. Francis Galton lives. Next week is the deadline for the Intel Science
Talent Search (formerly known as the Westinghouse Science Competition.)
My daughter is submitting the results of a 3 year research project in
an arcane and slightly bizarre topic. As we sat by candlelight reviewing
her hardcopy for typos, I discovered that she had made a reference to
Sir Francis Galton's work in her paper and she cited him. There is some
irony that in 2012, a promising young scientist is editing a paper by
candlelight that cites Galton. I pointed out the irony to her. She
didn't smile. She just said that all of her friends have electricity.

9. Some people like to complain. Some people lost a few trees. Some
people had trees crash through their roofs. Some people literally lost
their houses. Some people have no generators. Some people were annoyed
that school was closed for a week. A few people lost friends and family
to the storm. Listening to people, there was little self-awareness of
relative fortune and mis-fortune. Lots of people asked how we were
doing. My answer was: it sucks. But a lot of folks are much worse off.
And this too shall pass….
Que Sera Sera

10. Out of state line crews are nice guys. I've now had the pleasure to
chat with crews from Wisconsin, Maine, Atlanta and Alabama. All of these
guys are part of the mutual aid system. Sure they are getting paid time
and a half plus a per diem. But these guys are clearly aware of the
importance of their mission. And they are proud of it.  And they don't
bitch and moan. They get the job done. And that's what makes America

Are there any market lessons here? We report. You decide.

Scott Brooks adds:

Speaking of traffic lights and/or stop signs…….

At my university, there was an intersection in one of the parking lots that was a bit of a bottle neck (actually, it was a big bottle neck). Vehicles
approached the intersection from directions. It had no stop sign, or light,
or anything. But the students developed their own system wherein each car
would take their turn pulling out into the intersection. Your turn came in
a clockwise fashion. It actually worked very well. It was all on the honor system and there were no posted rules.

Conclusion: people will figure things out on their own over time, and not a single law was passed by a bureaucrat and not a single regulator was needed
to make it work.



 One has to believe that the realization that we will be living with the idea that has the world in its grip from the executive office for another 4 years will become accepted today with the exit polls and that a certain revulsion will take place. Yet stocks are still very low relative to the fed model for all time frames so that the revulsion should not be catastrophic.

Rocky Humbert writes: 

As I have previously demonstrated with regard to the monthly job reports, EVEN IF one can predict the data, it is impossible to consistently predict the terminal market reaction with any statistical significance at a given/terminal moment in time. And making predictions that X price will be hit (when X isn't statistically significantly far away) is an empty statement. Hence I submit that The Chair should acknowledge that his comment below is an illustration of a statement that cannot be wrong. At any given moment in time, there is a high probability of some revulsion. 365 days per year. And the definition of "catastrophic" is a function of leverage, not price. And that stocks are low relative to the fed model is an empty statement unless he believes that bond prices cannot go down. Lastly, the Average True Range of the S&P is currently about 15.5 points. So any statement that predicts a move of up to 15.5 spu points is most likely to true. I'd say that one needs a move of more than 31 spu points to be "revulsion."

But for proof and in the Franklinian spirit — I will send a unique prize of dubious monetary value to any Spec who can predict BOTH the winner of the presidential election AND the closing SPX price for tomorrow (Wednesday) within 3 SPX points. All submissions should be mailed to the speclist.

HOWEVER, I will make a final prediction. IF Romney wins. And IF Wednesdays close is more than 16 points below today's close, then there will be a very substantial decline between now and year end. How substantial? Enough for the Chair to call "catastrophic."



 This site is devoted to the scientific method… expectations, the real world, actual decisions that people make under uncertainty. Any individual taking an economics course learns that consumer choice takes into consideration a myriad of expectations about the future subject to constraints and substitutions and alternatives. Please go back to the economics texts to see why prediction markets are much more accurate than polls. The prediction market is 75% for the incumbent. That's an all time high. Gentleman, does it have to go to 99% before you see that people actually making bets with their money is a much better predictor of outcomes than a poll? A good article assessing accuracy of expectations and margins of error for predictions versus polls is by Berg. Please. No more self supporting ideas about how close the polls are.

Stefan Jovanovich writes:

Ouch. Since all my ideas are self-supporting, I can only confess to absolute guilt. I also have to agree that money is and should be the litmus test. Intrade is not about money, however. The current "market" for Obama is 1 share offered at $7.51 and 104 shares asked at $7.46. Their comment stream, on the other hand, is unending; it dwarfs even the Huffington Post in frequency. Polls matter precisely because they are about money. They are the only device the campaigns (including the supposedly independent issue ones) can use to decide where to spend their advertising dollars and where to schedule the candidate appearances. Professor Berg's assertions about Intrade's markets are 10 years old; they also go back to the golden age when those markets themselves were so obscure that they were, indeed, pure. They are anything but that now, even if they remain shallower than the Platte River in September. I suggest that we all look at these questions the way the advertisers and producers look at audience ratings in television and radio; the overnights matter but P&G, Colgate and the car companies all want to see the internals so they can decide where to put down their next bets. What everyone knows is that trusting the raw numbers during sweeps week is not the best way to decide how to spend the hundred million dollars required to launch a new household cleaning product.

Jeff Watson writes: 

If polling offers more predictability than incentive markets, then perhaps one should look at the paper traders for guidance in the markets.

Rocky Humbert writes: 

Unless someone changed the law when I was not looking, it is unlawful for a US Citizen to bet on Intrade. When I tried to open an Intrade account several years ago, this fact was made very clear to me by the Intrade people. (And I didn't open an account.)

Hence you either have the US Election being predicted/decided by non-voters. Or you have the US Election being predicted/decided by Americans who flaunt the law.

I report. You decide.

Jason Ruspini adds: 

Liquidity used to come in during US hours and looking at just the past two days for the Obama contract, that still seems to be the case. The federal law that might be most relevant for listers is the Commodity Exchange Act. With Cantor movie futures and Nadex, the CFTC signalled jurisdiction over prediction markets, which would make Intrade an illegal commodity exchange. I guess they are busy with other things…

I have a theory that the hassle of wiring money in clips of less than $10k coupled with the margin system (you post $6 to buy a 60% contract but $4 to sell it) means that not only are the markets thin, but prices tend to be closer to 50% than they otherwise would, beyond the usual longshot issue near extremes.

EDT Hour    Volume

0                111

1                 36

2                 193

3                 60

4                 198

5                 283

6                 148

7                   22

8                  297

9                  537

10                270

11                3334

12                6621

13                1883

14                3079

15                2819

16                  262

17                8171

18                1961

19                6897

20                 101

21                 346

22                 536

23                 400



Lest all you smug one-percenters, clipping your muni coupons while sitting in your Nantucket, Hamptons and Tahoe homes, think the fiscal cliff is a good (or completely irrelevant) thing, then think again. Your muni bonds, and especially your Build America Bonds are rather naked as this sea goes out…and it's not just the airports, toll roads and water treatment plants that issued Build America Bonds. Some states (including California) issued GO's backed by these 35% Federal subsidy payments. From the Bond Buyer (yes, they're still in business): WASHINGTON — The threat that federal subsidy payments for Build America Bonds could be slashed under the sequestration process after administration officials assured issuers those payments were safe could permanently sour the muni market on BABs and other direct-pay bonds, market participants said Monday.In a report sent to Congress Friday, the Office of Management and Budget said that, of $4.241 billion of subsidy payments authorized for issuers of BABs and other direct-pay bonds in fiscal 2013, 7.6% or $322 million would be cut early next year. The cuts would come under the legally mandated process by which $1.2 trillion would be cut from federal programs across the board because Congress failed to reduce the federal deficit last year, and the "fiscal cliff" looms.

Full link here.



To what extent will the expansion of the Fed's balance sheet, the QE3 and presumably more when this one doesn't work cascade around and lift other markets. Will the markets that have gone up the most so far like the grains and metals go up more than those markets that are relatively stagnant? How could this be profited from?

Rocky Humbert writes:

As one of the early believers in the market-moving potential of QE1, I suspect that my response to this inquiry may be surprising to some: I think that the idea that this qe3 and more will cascade and lift markets from here is presumptuous — and quite likely wrong. I posit with only a slight bit of quantitative evidence that we are approaching the point of diminishing marginal returns for QE. This is primarily because the move from 0 to 1Trillion was an infinite growth in the Fed's balance sheet. But the move from 3Trillion to 3.5Trillion is only a 16% increase. In other words, the Fed would need to engage in exponentially increasing amounts of QE to achieve the same effects. Additionally, the institutional memory of the market has now accepted the Chair's perception as conventional wisdom, so I think the half-life of QE effects are much shorter than previously. Lastly, I note that corn peaked on August 21st (the Fed largely telegraphed QE3 and announced it on September 13) and it has declined 11% since then. Oil peaked (so far) on 9/14 (the day after the fed announcement) and has declined about 8% since then. The Chair and I disagree on the underlying proposition. Hence, all is right with the world.



I disagree that the Fed is the major long term source of how governments are affecting the markets. This is a short term, old school way of thinking. Not that a trader can ignore this.

The major source, I believe, is benefits to seniors and the uncertainty that surrounds them. This is a global issue. The current projectories are clearly unstable, but the politicians have turned it into brinkmanship maneuvering of Euro and budgetary fiscal cliffs.

If in the 80s we conquered inflation by finally understanding wage expectations, in the 21st century will we conquer deflation and societal extreme risk aversion by benefit expectations? Is there an answer? Are we doomed to politicians promising and giving in the short term more than is possible in the long term for the vote? If so, where and when must it all come crashing down?

Gary Rogan writes:

You say in the 80s we conquered inflation by finally understanding wage expectations. I thought inflation was conquered by raising interest rates by a huge percentage. Is that not the case?

Russ Sears replies:

Yes, that was "how" it was accomplished, I am suggesting "why" it had to be done that way. It was the wage price spiral or "inflation expectations". They had to convince people they were serious in lowering inflation long term. Not flood the world with $ every time it was politically expedient to do so.

Gary Rogan adds: 

I realize there were inflation expectations and they were blamed for inflation, but fundamentally there was just too much money being created. I don't think we disagree, I just learned to think of inflation expectations as being derivative to the money supply. Whatever the details of inflation creation, you cut the money supply and inflation will be gone sooner or later. Less money = lower inflation, whatever people believe.

Rocky Humbert writes: 

If anyone can demonstrate with any degree of quantitative rigor

(1) How politics can be quantified.

(2) How politics can be predicted.

(3) How either of these things can be useful to investing in an objective way, then I will embrace political discussions wholeheartedly.

But before you folks try to go down that path, I have to point out that if you own stocks, you should pray for Obama's re-election. (hah)

David Lilienfeld writes: 

The assumption on the Dem vs Rep analysis is steady-state, i.e, the structure of the economy is steady-state. In the age of globalization, that's probably not true anymore, so the analysis, while interesting, isn't informative about what the future might hold. Further, I don't think it will much matter which party wins the Oval Office economically since both parties are going to try to spend like crazy. The alternative is to control the deficit, which may have long-term benefits but which will have short term political pain. In an age of instant gratification, I doubt that the politicians of either party are willing to take the chance that their prescription for the economy will show its benefits before the next election. Just as Wall Street analysts live and die by the next quarter's earning, so too do politicians. Call me naive, but spend and let someone else figure out how to deal with the consequences has become as American as apple pie. I see neither political party providing any basis to suggest otherwise.



One has noticed anecdotally that the % of leaked announcements tends to be increasing. Many of the announcements are relayed to the media about 1/2 hour before the release, like the beige book and the employment numbers. The reason is that these media write a story about the number almost simultaneously with the announcement. Many of the stories are 500 to 1000 words and contain interviews with several people talking about the bullishness or bearishness, related to the numbers.

It's sort of like when the government calls up Upside Down, or Sage, or the Greek 4 trillion investment office for guidance on what they're thinking and what should be done. I've always said that the acquisitions get leaked because all that's necessary is a shrug of a shoulders at a squash game between an acquisitions team member and the Chinese wall separated speculator or arbitrageur.

The documented number of cases where sophisticated signaling and front running went on for years emanating from the legal offices of the targets or acquirers shows how rampant it is. One wonders if we've become more jaded, more skeptical, more attuned to this as we see the attitude towards the importance of a level playing field constantly being batter away as we become a society of equality of outcomes rather than a society based on the equality of opportunity,or as Gaynor used to say a society based on the rule of law rather than men.

How could this be quantified? And is the social trend I allude to a necessary consequence of egalitarianism and class warfare rampant today?

Rocky Humbert writes:

DOL among other data providers have allowed reporters early access to the numbers for years (to write their stories). The data & stories were embargoed until the official release time. It used to be that they (literally) had the phones in the press room turned off. That approach doesn't work too well in the age of 3G.

I'm always amused when the Chair bemoans the "unfairness" of it all, simultaneously arguing for the abolishing all sanctions for insider trading. Assuming that there is more leaking (which I have no factual basis to believe or disbelieve), it should make the markets more efficient….

Victor Niederhoffer writes: 

Rocky has a good point. But ever since I wrote my article Insider Trading with Lorie in Jrl of Law and Economics, 50 years ago [Ed.: actually 44 years ago], I have never agreed with professor Manne that insider trading is harmless. It takes money away from one group and gives to another. It's a dead weight cost. As for the reporting thing, I think that the leaks are a lot more prevalent now and perhaps it's because of better ability to send info over the channels before the release. The reporters shouldn't get the stories in advance in my view because they're leaking them much better. That's my hypothesis. It's nice to have rocky back to disagree with me on all my hypotheses.



The Gini  ratio is a commonly used measure of income inequality. Historical GINI data by year is available here.

Higher GINI ratio is greater inequality, and has been widely discussed GINI has risen 1948-2010. This data was used to calculate year-to-year change in GINI, and yearly rate of change was partitioned by presidential party: Democrat (1) and Republican (2). Mean GINI yearly rate of change for the two presidential political parties was compared:

Two-Sample T-Test and CI: yr change GINI, D(1) VS R(2)

Two-sample T for yr change GINI

R(2)  N    Mean   StDev  SE Mean
1     27  0.0012  0.0206   0.0040   T=-0.58
2     36  0.0038  0.0135   0.0023

The mean yearly rate of change in GINI for both parties was positive (income inequality increasing). Though during Republican administrations the rate increased about three times faster than during Democrats, the difference was not significant (there is no statistical difference in the rate of increase in GINI).

The attached plots yearly change in GINI vs year. One notes the dispersion in yearly GINI change was much higher pre-1980. A possible explanation for this would be changes in the US central bank's approach to the business cycle ("the great moderation")


David Lilienfeld writes: 

I have a different take. Prior to 1980, it looks like there is a pretty clear positive slope, whereas after that the line is pretty flat. That strikes me as counter-intuitive.

Ron Schoenberg writes: 

I would like to see an analysis based on wealth rather than income which I believe would show a significantly greater inequality. Also, the data referred to below apparently doesn't include capital gains. I believe the results are understating true inequality. 

Rocky Humbert wonders:

And how does Ron propose to apportion the so-called wealthy people's share of Federal, State and Local debt? Of the trillions of unfunded liabilities through out the public sector?) Does he propose to allocate it based on "wealth" or per capita? And if he apportions it per capita, how does it deal with the fact that per household debt cannot possibly be serviced by per household income.

It's all reminiscent to the way that a couple going through a contentious divorce to do it: The wife says: "I'll keep the house." Husband: "Ok."Wife: "And I'll keep the dog." Husband: "Ok." Wife: "But you take the debt." Husband: "But, but…."



 Much ink has been spilled about the inter-generational wealth transfer required by the looming Social Security/Medicare implosion, as well as the massive under-funding of many public pension funds. But as the Ginsu Knife commercial hawker says, "Wait, there's more!"

I recently stumbled upon a Pennsylvania Court case, "Health Care & Retirement Corporation of America v. John Pittas." In essence, the Pennsylvania Supreme Court found that children are financially responsible for their parent's care (i.e. nursing home bills).

Evidently, there are 29 states which have statutes which could require adult children to provide financial support for their parents, and giving the financial condition of Medicaid, this is a precedent worthy of study. Interestingly, this so-called Filial Responsibility Law could be simultaneously hailed by Social Conservatives and assailed by Fiscal Conservatives.

This could also be the first step towards multi-generational "means testing" for social benefits… and which could close the loophole that encourages wealthy elderly to distribute their assets to heirs and then receive public support. This May, 2012 link from Forbes discusses the ruling: (If you Google the court case, you can find much deeper analysis too.) One posits that Grandma may soon be leaving the nursing home and moving back to the attic… sitting in her rocking chair…proving once again that Alfred Hitchcock was ahead of his time!



 To my knowledge, there has NEVER before been a case (except in war or natural disaster) when a legitimate business has been destroyed so quickly — as what Knight Capital Group (KCG) experienced.

Every business takes risks. Every business can experience disasters. But in screening businesses, what are the idiosyncratic risks that can (permanently) destroy a legitimate enterprise in a time frame so short that long-term investors have almost their entire investment vaporized before they even bring in the morning paper? Does Mr. Market correctly value these low-probability risks? If one isn't Mr. Nassim Taleb, how does an investor calculate the probability of such an event (and still be a profitable long-term investor)? Are certain business more prone to (as the Discovery Channel TV show is called) "Destroyed in Seconds" ?

Here are some examples:

1. Single factory. In 2008, Imperial Sugar had their only mill explode and burn down. They had business interruption insurance, but never fully recovered and were eventually acquired by Louis Dreyfus corporation.

2. Concentrated Customer. Businesses that have more than 50% of revenues associated with a single customer can have a virtual firestorm. There are numerous examples of this, but the implosion is usually associated with a credit/liquidity event.

Concentrated Lender. Businesses that are dependent on a single source of funding (e.g. Bear Stearns) can implode when that liquidity disappears.

4. Supplier. Businesses are vulnerable to the "weakest link." If a supplier that makes a tiny, but critical, widget fails to deliver — it can bring an elephant to its knees. This is an insidious risk, since investors know about the largest customers, but they probably don't know about the tiny providers on the supply chain.

5. Fraud. Employee/Executive fraud and embezzlement can go on for years with only very subtle warning signs. Unless the CEO/CFO is involved, it's rare that the fraud is sufficiently large to bring down the entire company. And I'm sure there are dozens of others. What is the theme and lesson here? Interestingly, it's the same lesson for successful investors: Diversification reduces risk of disaster. Insurance reduces risk of disaster. Multiple sources of liquidity and reasonable leverage reduce risk of disaster. Reasoned human judgement reduces the risk of disaster. But in the case of Knight Capital (in which I am not an investor), I'm left scratching my head. How is it even possible that any business could burn through their entire balance sheet before the grownups pull the plug out of the wall outlet? The only answer is stupidity. And that they did blow up is bittersweet — because it means capitalism is working. (And if you are an investor in Interactive Brokers, you should probably hope that Mr. Peterffy is a bit smarter than that.)



 Why is Knight Capital down so much in price, down 1/3 to 6.95?

Rocky Humbert replies: 

I was traveling for the past two days and missed this Nite saga.


1. For all you folks who love to 'diss the HFT folks (because they have a license to mint money), here is a company that managed to lose $440 million (see this morning's press release) in about 15 minutes. That's 2.6 YEARS of pre-tax income in the blink of an eye. What the not-so-great hft folks are realizing is that the business has become crowded and seems now to resemble the old brokerage business: One leveraged client going belly-up can put you out of business. (Here, one software bug can put you out of business. And at least with a deadbeat customer, you can beat them up in the alley, so to speak.)

2. One is appreciative of the Chair's humility in using the phrase "famous last word." On a quantitative note, I wonder whether severe gap down moves IN INDIVIDUAL STOCKS have any predictive ability — for either continuation or a bounce (in a multi-day/multi-week timeframe.) Over the years, I've stopped buying falling knives of this sort as I concluded that the person hitting my bid probably knew more than me. But I've never tested this carefully, nor would I know how to test without introducing biases. (The S&P Index is very different of course…)



 Are there any events these days that make people inordinately happy or sad. Perhaps these would influence the market? An event like an earthquake or a mass tragedy in a theater would seem to qualify. Perhaps there are classes of events that effect particular groups like flexions that cause them to be happy or sad that have a measurable effect also, like intervention by the EC, or the Fed. What do you think? Is it worth quantifying?

Rocky Humbert comments: 

Yes, there are such events. Flying a Boeing 767 into a tall office building is one such example.

Scott Brooks writes: 

Not sure this is an event, but…..the realization that massive fraud is occurring. For instance:

The Accounting debacle (i.e. Arthur Anderson, Enron, Worldcom, Global Crossing, etc.) of 2001.

The Mortgage Fraud Debacle of 2008.

Jordan Neuman writes:

The 2003 rally began with the freeing of Elizabeth Smart. Certainly the market was sold out, but I thought a collective sense of gratefulness served as a catalyst. But file this one under the difficulty of setting up the study.

Craig Mee writes: 

Potentially state dinners and the like, when the flexions are busy cleaning their shoes and are getting ready for another free meal. Maybe that's why silly season (late Nov through December) appears to do ok. Plenty of back slapping, industry awards and the like. Also maybe Oscars week (or award month) is a winning combo for listed movie stocks.

Jim Sogi adds:

Here's a couple of ideas. Use facial recognition software to detect a "smile" tune in all the security camera in the world, process for correlation. It's a bit big brother-ish, but there are cameras all over in cities now around the world.

How about using beer sales? Old Chinese proverb: If you want to be happy for two hours, drink wine; if you want to be happy for two years fall in love. If you want to be happy forever, take up gardening.

Track marriages.

Track gardening sales, or farming yields. It's said one of the few real producers of wealth is farming. Good weather=good farm yield=good production=happy markets.



 I recently read the wiki page about The Endowment Effect.

Basically, it says the one values his possession much more than others value it.

Thaler conducted the following experiment. He randomly gave some participants a mug, which sells for $6 in a store. He then asked the ones now owning the mug to give a minimum price below which they would not sell the mug, and asked the ones not having the mug to give a maximum price above which they would not buy the mug. It turns out that the owners valued it for $5.25, while the bidders valued it at $2.75. He concluded that the very fact that the persons owned the mug made them give it a higher value.

Very interesting research. But I wonder if the conclusion is as that simple.

First, I wonder what would happen if the owners were asked to buy another mug. How would they now value it? Since it is not a critical item to have and they already own one, it is reasonable to believe that they would bid an even lower price than the bids from those who didn't own it, isn't it?

Second, what about selling short is allowed in the experiment? If the people who didn't own the mug were asked to price it if they would sell it short. I bet their price would be even higher than what the owners offered, and very likely be higher than the $6 store price.

Any input on this, please?

Gary Rogan writes:

Leo, I'm not sure it's productive to attempt to extend these "effects", and there are many of them, beyond their original definition without doing actual experiments. This particular effect seems to be as simple as "defend what's yours harder than you would attempt to get the same thing from someone else", one of the ancient evolutionary developments. Primitive (as well as advanced) animals demonstrate the same effect when fighting for territory, that's why the challenger loses most of the times. Of course someone who has a relatively useless (from their original standpoint) mug to begin with doesn't want another one. Personally I find it more interesting to think about the practical value of the original effect. In the behaviorist books it's supposed to manifest itself by "holding on to losers too long". Every time I read this I always think about whether the logical conclusion is that a rational person should always sell "losers". Sometimes they bring up the tax loss effect, and that's fair but it doesn't get to the heart of the matter. Considering this question, and all the robotic trading that goes on, how would one take advantage of this effect? 

Pitt T. Maner III writes: 

The self-storage business might be an area where this effect is felt most strongly. There is a lot of rent money being paid (by baby boomers and those who have left houses) and property used to store old things instead of buying new.

Rocky Humbert writes:

This is a fascinating subject for exploration. Being only slightly tongue-in-cheek, I wonder what effect negative real interest rates have on the willingness of people to hold onto "junk" ? To the extent that "the cost of carry" (i.e. monthly rental fees) are small, hoarding is a rational behavior. Also, there was an article in the WSJ last week discussing the effects of "clutter" on marriages and home life. Lastly, there may be a "depression-era" and "aging demographic" effect occurring here. In the situations where I've (sadly) had to empty out elderly relative's apartments, I've discovered that depression-era people hoard useless things like return envelopes from bills, archaic car and doorkeys, memorabilia from bygone days, etc. I think that there are many interesting factors at work in this trend — and there is market-related utility in thinking about them.

Jim Sogi writes:

It's really hard getting rid of one's "junk". There is a weird attachment to the stuff. Its almost painful to throw stuff away. Then there's the issue of getting rid of the junk, and then needing that item the next day. Feng Shui has some good tips on clearing the clutter. There must be some sort of hardwired effect causing one to collect stuff. Look at the bag people pushing around carts of junk.

Craig Mee writes: 

I'm with you, Jim, and in the tropics, clutter, dirt and smells brings mosquitoes, which is a very good reason to keep things clean.

On a side note. I've had a lot of trouble with mosquitoes, though I went to a friend open air villa the other evening , and when dusk hit, no mosquitoes ? I looked around and put it down to a) everything was white, walls , furniture, coverings, a well cared for garden, two ceiling fans, (some sea breeze) and importantly I thought …lights under the table we were sitting at. ie everything was clean , tidy, and white, with air.

Further, I read once, if you haven't worn clothes for a season, toss them. That's certainly worked for me.

No doubt those who make money in one particular stock , get attached, (you see it)…it clutters their mind, and they will drag any positive out of fundamentals, value, whatever to get back involved. Got to clear the clutter, or put it out of sight, to free the mind.

Rudolf Hauser writes:

In considering the impact of the pure psychological effect on value from ownership, one should not ignore the economic effect. The cost of the purchase is not just the purchase price of the item but the value of all the effort that went into finding the item in the first place and how difficult it might be to be able to buy it again. Then there is the risk of the replacement being defective or other problems in the acquisition thereof that might happen. One also has to consider the potential cost of needing an item and not being able to acquire its replacement in time to meet that need. As an example, I once wanted to buy a new ink eraser to replace the one that wore out. I then found that I had to run around to seemingly countless stores to find this inexpensive item –an effort countless times more expensive in opportunity cost than the price of the item itself. Needless to say, when I finally found the item, I purchased a whole box full to insure that I never would have to spend so much in search costs again for that item. Nor would I have sold those again except for much more than I paid for them.

As for the psychological impact, say one has purchased an object of great beauty at a price that subsequently appreciated considerably. The new higher price might be one at which one would not consider it prudent to buy given the overall state of one's financial resources even though it is an item one might wish one could buy. But already possessing it one has the excuse for buying it via not selling it because one already had done the deed in effect. When an item is not unique or rare and is easily replaced when a new one is needed, one would not suspect that same tendency to value the item in possession more than the same item not in possession. It would be interesting to see if this effect still persists in that case and how it compares to the former.

A stock would be of the latter type at least in small quantities. With larger quantities there is always the uncertainty as to how much such purchases might impact the price, which would the economic reason as opposed to a psychological reason. A psychological reason might be the emotional difficulty of making a decision that one is not anxious to repeat, ignoring the fact that with an investment an implicit decision has to be made every day as to whether to continue to hold or not. The difference is that to sell or purchase is an active decision whereas to hold can be a passive decision. In effect holding is also a way of putting off a decision.



 As Anne O'Connell, a professor at University of Cal Berkeley, said "there are important cases in which the chief justice has to put the court's interests above his own ideological or jurisprudential views. This was one such case."

One would suggest that the court acts to survive and prosper like the badger or any other organism subject to incentives and emoluments.

Gary Rogan writes: 

We may never know whether he wanted to keep getting invited to all the cocktail parties or they made him an offer he couldn't refuse, but he did change his mind at the last minute. In either case, a man with a lifetime appointment somehow has to side with card-carrying communists while making basic mistakes (like a tax law cannot be challenged until the tax is actually collected, and several others), and redirects trillions of dollars of economic activity. All this to make sure that the rest of them with lifetime appointments and no known personal threats of any kind have no chance of being marginalized? Never has so much been sold out for so little even if this subhuman was threatened. 

David Lilienfeld writes: 

Two comments:

1. It's significant how many in our country have as low regard for the SCOTUS as they do. Even more so when one has a Senator questioning whether the court has any standing to rule something as being constitutional or not. The dysfunctionalities present in our government are manifesting at the SCOTUS, and the populous is none too pleased about this. Given that we live in the iPhone Society, one might wonder when the populous would expect anything else.

2. At the time Truman desegregated the military, 65 percent of the country opposed the action. When Brown v Board of Ed was decided, 60+ percent of the country opposed integration of the schools (though this was to change rapidly in the wake of the decision). Courts and politicians are political animals, but they are also leaders–or at least at times in the past, have been leaders. Unfortunately, as we have been without political leadership for sometime, it isn't surprising that this case was decided in such a manner as to defy just about any and all expectations. (There are a lot of people on Intrade who got hosed in this decision).

Rocky Humbert writes: 

Have you even read Robert's opinion? I did. He didn't do any favors for the left in it; he takes a swipe at Wickard and he is very clear that upholding the mandate should not be construed as any expansion of government power. Essentially, he wrote that if it walks like a duck, talks like a duck, smells like a duck, then it's a duck. Substance over form. He blew away the government on every other substantive argument.

In the future application of this ruling, I believe that his opinion won't be used as opening the door further to govt intervention; quite the opposite is true! But unless you read the opinion, you won't know this and the MSM won't report it. I find it disappointing that the court ruled this way, but as I noted yesterday morning, this was not an easy decision and the opinion reflects that.

I find it reasonable for you to quarrel with the substance of his opinion only after you have read it. But judging from your comment, you haven't. And you comment is vacuous and snarky.

Read the opinion and then comment on the substance.

Gary Rogan adds: 

This ruling is a tortured conclusion looking (and failing) to find reasonable arguments as far as the "tax" portion of it is concerned. What is being taxed here?

It was sold as a mandate and this legal genius finds it to be a tax. If someone sells you a duck claiming to be an elephant, and you find that it's OK because you have a license to sell ducks instead of finding fraud, you are not operating in good faith. Especially if the duck isn't even a normal duck but some mutated monster resulting from an unfortunate breeding of a duck with a goose.

He cuts one type of power found in the "living breathing Constitution" by progressive activists and adds another power of similar flawed pedigree. He did no favors to the left? He SAVED the damn left, to continue their abuse of the Constitution and the country. This man is a snake.

Garret Baldwin writes:

"It was sold as a mandate and this legal genius finds it to be a tax."

Respectfully, it was sold as a mandate to the American people and to representatives in Congress. But when it went to the high-court, it was sold as both a mandate and as a tax. There were two arguments provided on behalf of the Administration. One was that the mandate fell under the commerce clause. In essence, Congress was ruling that it could create commerce in order to regulate it. They were creating a program that forced people to buy something, and that would fall under the clause. Could Congress then make you buy anything it wanted, became the question.

Roberts ruled that down. Even Sotomeyor disagreed with that logic.

But then the issue of a tax did in fact come up in discussion. Though the President said that it wasn't a tax on ABC in 2009, the administration argued in front of the court that the mandate fell within Congress' taxing power… but attempted to argue that it was not a tax… They argued that PENALTIES are within the reach of Congress' taxing power, but that this was not a "revenue generating policy" which is what a tax technically is.

What Roberts ruled is that Yes, this does fall under Congress' taxing authority, but you're not allowed to call it a penalty. It's a tax. Congress can tax whatever it wants, soda, medical devices, and even inactivity. For the optimistic on the right, and for people who have being saying this is a tax all along, the ruling isn't necessarily the worst in the world. First, it shuts down Congress' ability to create markets under the guise of the commerce clause. This was especially concerning for me because I feared they would try to create Cap and Trade through similar means. Second, Democrats are now the "Tax Party", and Roberts has given Romney ammo. This is a tax. And the President swore that no new taxes on the middle class would hit them. There are 21 new taxes in this law, and seven of them directly impact the Middle Class.

"It you think healthcare is expensive now… wait until you see what it costs when it's free." PJ O'Rourke

Rocky Humbert writes: 

This will be my last post on this subject, so Mr. Rogan et al should feel free to label me a "snake," "commie," or whatever choice epithet that he uses for people who don't agree with his self-declared (and as yet unproven) "superior" weltanschauung.

I am starting to see non-legal analyses on the the web, which may over time cause the currently-celebrating liberals to realize that by bringing this case to the Supreme Court, they have opened a Pandora's Box which they will rue. Sure, you can bitch and moan that they didn't strike down the ACA. But this ruling will have a much more important effect in the months and years ahead in terms of LIMITING government. Sure, I had hoped that they would strike the ACA down, but I'm starting to believe that what Roberts did here may be vastly superior IN THE LONG TERM.

If Mr. Rogan can turn off his kneejerk reaction for just a moment and read the following URL, I think he will begin to see that Roberts may have just proven Voltaire's Maxim: "The perfect is the enemy of the good." It's quite possible that in 50 years, the historians will look back and see this as a defining moment when the pendulum which started in the 1930's begins to swing back.

While I believe the ACA is bad economics and bad policy, I believe that the precedents which this ruling establish (and to which lower courts will be bound) are vastly more important and more supportive for freedom and long term prosperity. I am hopeful that as today's scoreboard and November's election fade from memory, the lasting positive consequences (for those on the right) of this ruling will come into focus.



 Yesterday's announcement that WAG will buy Boots (from KKR) provides a textbook example of the lifecycle of corporations. For decades, WAG was a mid-teens growing company (longterm return S&P500-plus 500 bp), with a stellar balance sheet and a strong competitor to CVS and other small retailers. Their growth was mostly driven by new-store openings, the organic growth in prescription demand, and the gradual expansion of general merchandise and food product offerings. Yet, the ubiquity of their stores, the evolution of the prescription drug market, and most recently, the loss of one of their largest pharmacy customers (they refused to accept the realities of the current market) left them with negative comps and all of the arrows pointing downwards.

So, what do they do? They raise their dividend. Good. They buy back stock. Good. They announce a massive lateral acquisition at a very rich 11X Ebitda. Very very very bad.

They will pay for the Boots acquisition with mostly debt, which will whack their credit rating; produce no obvious growth; and make them bigger, not better.

This smells of desperation. Not strategic vision. Boot's CDS(debt) had been trading at +428 bp ; but immediately tightened by about 250 bp on the deal. In contrast, WAG's enterprise value is about 5.4x EBITDA and CVS trades at 7.5x EBITDA. So even if one believes in a 20% or 30% takeover premium, that still doesn't justify an 11x EBITDA multiple. (WAG justifies the premium because they will have "synergies" in negotiating prices with generic drug manufacturers. But given the nuances of global pharmaceutical pricing, and their inability to cut a deal with ExpressScripts, this sounds like continued denial of market reality.)

Who negotiated this deal? Did they hire Leo Apotheker when I wasn't looking?

One submits that WAG has decided to aggressively pursue the zombie world of no-growth companies who run faster and faster to stand still, rather than running their existing businesses better — and accepting (rather than denying) the changing competitive landscape.

And if I worked for KKR, at the same time that I was selling Boots at 11x EBITDA, I'd be thinking about using the proceeds to eventually buy Walgreen stock at 5x EBITDA.

JetCat1 writes: 

Seems like an international problem of shop front retailers, having huge internal problems trying to make massive adjustments with policy, in turning the ship around. It would appear, it shouldn't be so difficult, but one would think no one wants to make the big call that are needed, early in the piece. Just like having replays at the Euro Football championships 2012. Ukraine gets the ball over the line, still no goal against England. At what stage has technology not being up to the job, of having a TV replay settle the matter in the last 30 years, and still the rubbish of bad calls persist. It seems the larger the flexionic group, the lack of balls, for want of a better word, to stand up and say "this isn't good enough, this is the direction that needs to be taken".

Rocky Humbert replies: 

I respectfully disagree with both your metaphors and your conclusions. If WAG has simply re-negotiated their ExpressScripts deal at the market-clearing price, their stock would be north of 40. Not south of 30. Walgreens is an excellent operator. It's not about turning the ship around. It's about living in today's world. Not yesterday's. Put simply: The competitive landscape for retail drug stores have changed over the past several years. WAG used to be a price maker. But they are now a price taker. Rather than accepting this reality, they decided to pay (too much) for another price taker (Boots) with the vision of re-establishing their negotiating (price-making) power over suppliers … in the spirit of Walmart's business strategy. It's not crazy, and if they had paid a reasonable price for the acquisition, it might have even worked a little bit. But if you pay too much, you are doomed. Their transaction has all of the hallmarks of a McKinsey/Bain/Booz/BCG study on it. If I were the CEO, I would have renegotiated the deal with Express Scripts.And some day, when KKR was really desperate, I might have let them him my bid. At 5x Ebitda.



My 'own' economic theory starts with the observation that man, unlike other [social] species, has invented an alternative to plunder/defense from plunder: *explicit* exchanges. While ants/bees/wolves/lions/etc know division of labor, all their exchanges are implicit, within 'economic units'; theirs is a subsistence 'economy.'

(At this junction, I would offer replacing Mises's "man acts" with "man exchanges.")

This observation prompts defining *production* as the result of that [human] activity which is performed with an explicit exchange in mind, i.e. above and beyond subsistence economy. More formally, the value of one's production is the [perceived] improvement in one's utility as the result of exchanges, over what could be accomplished by autonomous activity.

Since [perceived] improvements in individual utilities are hardly additive, it seems hopeless to speak of the total value (volume) of production in an economy. However, changes in utilities may manifest themselves in exchanges, especially when—as is typically the case in a modern economy—common media of exchange are involved.

From these definition and observation, one can prove the following 'theorem': if a coercive transfer of resources increases the total volume of production, then such a reallocation can also be achieved voluntarily, via mutually-beneficial exchanges. I.e., laissez-faire capitalism is the most efficient system of production.

An equivalent theorem is the claim that laissez-faire capitalism fulfills J.S.Mill's (or, rather, Bentham's) greatest-happiness principle: if a coercive transfer of resources can increase the total utility in a society, then this increase can also be achieved voluntarily, via mutually-beneficial exchanges.

To summarize, what can be established is that voluntary exchanges are the most efficient way to grow society's prosperity. As a word of caution, what is *not* established is that coercion is unnecessary. This is because an exchange is only a good alternative to plunder when the price of plunder is too high. Therefore, private property must be secured. I view this condition as primary to free market's existence; this puts me at odds with anarcho-capitalists.

Second part of 'my' theory is the theory of money. I view 'money' as an adjective rather than a noun, meaning that many things can have quality of common media of exchange, and to a varying degree at that. Gold, silver, and other commodities may have quality of money, but so do financial instruments, such as banknotes (IOUs)/etc. I strongly feel that it is a mistake to call bank IOUs fraudulent documents, as Rothbard does. Else, everything which involves uncertainty—e.g., insurance—is a fraud. In a free market (e.g, with no FDIC) banks would develop mechanisms such as redemption gates to guard against runs, and thus attract customer deposits. Needless to say, if one is to be prescriptive, gov't must be completely divorced from regulating money; in particular, there should be no national currency (unless free market [temporarily] comes up with one)—and, certainly, no fiat money.

By recognizing IOUs and other financial documents as having quality of money, one understands a mechanism for natural inflation/deflation cycles. One view is that banks, by issuing credit, de facto anticipate the rate of economic expansion over the life of the loan. When they are, on the average, too optimistic, inflation ensues, followed by a corrective deflation; when they are too pessimistic, vice versa. E.g., currently we should be experiencing a significant deflation—but are hardly, because the Fed is printing money, trading it for the gov't IOUs. So: a [permanent] gov't inflation (caused by fiat-money printing) concealed by the simultaneous deflation (caused by credit contraction). This is [one of the] bad news. (Aside from creating a permanent inflation, the Fed is blowing and bursting bubbles by resp. lowering and raising interest rates (this is well understood by the Austrian school, via Hayekian triangle)—then 'cures' them with more of the same!)

Finally, consumer spending is detrimental to production. (This thought is far from being original; I am only including it here because the opposite opinion seems prevailing.) Production is in anticipation of a *future* consumption; the *current* consumption destroys resources (capital) which could instead be used (invested) in production. Postponed gratification hence allows for a future consumption that is larger in absolute terms, but smaller as a percentage of the economy. Thus, if one is to tax anything, it'd better be consumption. However, tax it too heavily, and you have encouraged subsistence economy (i.e., zero production, by my definition)—a bad move.

Rocky Humbert writes: 

Welcome Andrei. Thank you for sharing your thoughts. I am the self-appointed SpecList curmudgeon, liberal and insomniac, so please take my words with good humor (and a shot of vodka).

You write: "This observation prompts defining *production* as the result of that [human] activity which is performed with an explicit exchange in mind, i.e. above and beyond subsistence economy. " If you want to redefine words, that's your prerogative. However, as a mathematician, you understand that a correct definition is critical to a meaningful theorem and proof. And one can't just change definitions willy-nilly. So when you define "production…is the result of human activity which is performed with an explicit exchange in mind," you have re-defined the word production — hence you can no longer use that term "production" in any other generally accepted economic manner. If I pick up a shovel and dig a black rock out of the ground in my backyard (which just happens to be a nugget of coal), that is an act of production — and the utility of that nugget of coal (specifically the calories of energy) are the same whether my act of digging was motivated by the coal stove in my kitchen or the steel mill up the road. The successful act of production produces utility (nugget of coal). Because the MOTIVATION for the act of production (the steel mill or the kitchen stove) is independent from the UTILITY of the act of production,the motivation is irrelevant. So your definition seemingly fails. You write: "if a coercive transfer of resources increases the total volume of production, then such a> reallocation can also be achieved voluntarily, via mutually-beneficial exchanges. I.e., laissez-faire capitalism is the most efficient system of production." Here again you are playing fast and loose with the rules of logic and accounting. You seemingly are confusing mixing the income statement(volume of production) with the balance sheet (total wealth). It is basic economic theory that the coercive transfer of resources (i.e. a tax) can never increase the total volume of production (except in the unusual cases of war or exceptional circumstance.) I challenge you to find any normal example where the coercive transfer of resources increases GDP! (The only exception I can find is slavery … where the resource coercively being transferred is labor!)



 We reprint here some remarks made by Rocky Humbert on July 29, 2011:


The Japanese stock market continues to have a similar complexion to what gold had in the late 1990's. Back then, gold was trading below its marginal cost of production; central banks were selling gold; it was a barbarous relic. There was NO good reason to own gold. And it took about a dozen years of compounding at 14% to make people bullish. [,,,].

I cannot find a single compelling reason to own Japanese stocks (but for one.) The demographics are horrible. Their debt problems may be worse than Greece. They get hit by catastrophic earthquakes, tsunamis and radiation. Even Toyota is a mess. So — (other than the fact that their stocks are reasonably priced, and in some cases, extremely cheap), am I systematically nibbling at Japanese stocks with a 10+ year horizon? The answer is: ANY COUNTRY THAT DOESN'T LIKE THE iPAD CULT CANNOT BE ALL BAD!


Charles Pennington comments:

Back in July of 2011 we had a discussion [see excerpt above] of how cheap the Japanese market was at the time. Today, the Nikkei is more than 10% below where it was at that time. Morningstar says that the portfolio of Japan etf, ticker EWJ, is at 10.5 times earnings and 0.94 times book value with a 2.6% dividend yield. So it doesn't look like it's too late to get on board.

If you want to avoid the hassle of foreign dividend withholding (money that you'll never get back if you're investing in a tax-deferred vehicle), and if you're agnostic about the yen, then one way to play this is with CME / Globex's dollar-denominated Nikkei contract, which has reasonable liquidity.

Rocky Humbert responds:

To mimic the archetypal Wall Street analyst: "I reiterate my position, I cannot find a single compelling reason to own Japanese stocks (but for one.) ANY COUNTRY THAT DOESN'T LIKE THE iPAD CULT CANNOT BE ALL BAD!" But in fairness, their Central Bank is now actually buying some hard assets — including REITS.There's a Japanese REIT index fund (1345 JN), but I don't know the company or its holdings. And amusingly, the Bank of Japan is a public company (8301 JN). It's always mystifying how a central bank, with it's ability to create money out of thin air can be a bad investment in its local currency. Yet the BOJ has been an awful investment: 10year return= -41% and 5 year return= -75% Only in Japan can a company that prints money lose money.



On March 2nd, Chairman Bernanke testified to Congress and faced pointed questions about the effect of ZIRP and TWIST on retiree finances. He claimed that "something less than 10 percent of all savings by retirees is in the form of fixed-interest instruments like CDs." He said most of the savings were in assets like stocks (and housing) which depend on a strong economy…. The Chairman got it wrong. Oops.

In a just-released Federal Reserve study (which I cited in a previous post) on page 27, table 6 shows the median values of family financial assets in 2007. According to this table, the median value of CDs for retired families is $31.4K and the value of bonds is $83.3K. The value of stocks is only $30.1K (and that's from before the most recent big market decline). The table also shows a value of $81.9K for pooled investment funds and $52.4K for retirement accounts. (It's unclear what those accounts hold.) This Federal Reserve study shows that bank CDs comprise a significant portion of the financial holdings of retirees. The study also shows that retirees have seen a large decline in income from 2007 to 2010.

The Fed report is here … there's tons of data here for wonks, including portfolio allocations based on years of education. I submit (without any supporting evidence) that the propensity to consume by retirees is strongly linked to the nominal level of interest rates. I further submit (without any supporting evidence) that retiree consumption habits correlate with other stuff including corporate earnings and afternoon coffee sales at McDonalds restaurants.



 The economic analysis of "dead weight loss" puts in perspective the loss that occurs to the totality when an external body spends money on things that consumers would not buy voluntarily. Without intervention, consumers buy things where the price does not exceed the value they place on it. For all units purchased except the last, there is excess value or utility that consumers receive over and above the price they pay. With intervention, money is spent on goods that consumers were not willing to pay for before. The real cost might be assumed to be higher than the amount that is paid. There is a dead weight cost to extent that the price of the good is higher than what consumers would have voluntarily paid.

Let us consider all the earmarks in the bail out bill, and all the environmentally friendly improvements to government buildings, and all the construction projects that were earmarked to special groups or unions. How much of this is a dead weight cost? Perhaps 95% of the amount spent. The value of the total output of the economy is reduced by this amount. There is a smaller total to divide among consumers. This to me explains why the economy is having a much smaller recovery from a recession than in the past. See Consumer Surplus.

I have not fine tuned the analysis in the above, and would have to go take into account many other variables and factors, and would have to make my analysis much sharper for it to be dispositive, but I think it catches the essence.

Rocky Humbert writes: 

I agree that deadweight costs influence economic performance, but I believe the literature is inconsistent on the magnitude of the costs. A simple example puts this into context. Assume that there are 1,000 unemployed construction workers in Podunk, and lots of potholes in the streets of Podunk. The mayor of Podunk has no money to fill the potholes because his budget has been exhausted by pension contributions to the teachers union, combined with a decline in real estate tax collections (due to the housing price decline.) The mayor has fired a number of employees and cut back his maintenance cap. ex. budget. If the Federal government borrows money from China and uses that money to hire the unemployed Podunk construction workers, and pays them to fill potholes, there are obviously deadweight costs associated with these transfer payments — in particular, the salaries of the government tax collectors, bureaucrats managing the program, debt issuance costs, etc. (The effect of debt is beyond the scope of this example.) The Podunk workers fill the potholes, pay 30% of their wages back to the government (income taxes), get the psychic benefits of productive work, and the other residents of Podunk are able to drive faster, require less car maintenance, etc, and perhaps Federal Express even considers opening a new distribution center in Podunk because of the improved roads. In this example, there's no way the deadweight cost can be 95% — if only because more than 30% of the wages are making a round trip — and this doesn't consider the increased consumption by the hired workers — (which of course raises prices for some stuff they are buying–a "good" deadweight cost!?) — but the increased goods prices benefit the shopkeepers/(owners of private capital) in Podunk who are making more profits.

There are several other assumptions that I made in this example (including the level of wages paid to the Podunk workers, what China would have done with its dollars other than buy US Gov't debt, etc) but the gist is clear — it's unclear how the deadweight cost can be 95% of the money spent. I may be mistaken, but for the deadweight costs to be 95%, it would require a stimulus multiplier that is close to zero. Today's WSJ has two good articles that are on point. On the opinion page, the story "Obama's Real Spending Record" argues that growth is lower when government % of GDP is higher. While I am sympathetic to their view (for many reasons), the authors fall into the trap of using correlation<->causality. That is, ceteris paribus, if gdp is lower, than government spending and taxes as a % of GDP will be higher UNLESS the government engages in pro-cyclical behavior like the private sector does. The second article is "Median Family Net Worth Falls 40% From 2007 to 2010". (This is based on a Fed analysis, and is largely due to the housing price decline.)

Apart from incentive destruction, increased regulation, tax policy uncertainty, foreign labor competition, years of debt-financed consumption, etc. etc., I believe that an important cause of the slow economy is the Wealth Effect. The US economy is highly geared towards consumption — and families that see their largest asset value decline (and stay down) make lasting changes in spending/saving behavior. Apart from reducing worker mobility (due to underwater home prices), I believe that the pernicious reverse wealth effect can be blamed as easily as the deadweight loss effect.



 "I'll Have Another" was just scratched due to a tendon injury. So no Triple Crown this year.

This leaves the field looking strange — with 8 out of the 12 entries showing a line over 10-1. I'll have another was the favorite at 4-5; the next closest was Dullahan at 5-1. "Alpha" (supposedly the biggest threat to I'll have another) was scratched a couple of days ago.

I can't resist the pun: This race has no Alpha.



 For those with high school age children, you know Saturday was the SAT and SAT Subject (aka SAT II/Achievement) Test day. For those without high school age children, the pressure and anxiety is unfathomable. Unless you have an Olympic Gold Medal or are daughter of the President, if you don't score above the 95th percentile, you can probably forget about admission to a top school. And, even if you score in the top 96th percentile, it simply means your application will be read more carefully.

I was responsible for driving our daughter to a neighboring town's high school where the tests were being offered. I looked at Google maps before departing and planned my route. I left about 5 minutes of spare time because the morning was foggy and the roads were wet. The journey proceeded without incident, except that in one of those Murphy's Law moments, the road that Google maps said was supposed to be there — was not there at all. (The test location was the Horace Greeley High School in Chappaqua, NY. It's ranked among the top high schools in the country, and the town counts Bill and Hillary Clinton as residents. We're slightly envious of Chappaqua's high school, but we're not envious of their property taxes.

As we drove in circles around Chappaqua looking for the High School, we didn't see Bill Clinton at the local breakfast joint. But anyone watching the us, would have seen my face color grow increasingly red. And the color of my daughter's face grew increasingly pale. I eventually pulled over and plugged the destination into my SAT/NAV … and it directed me to take the Saw Mill Parkway North. This seemed highly improbable; but at this point, who was I to argue? The clock was ticking! The roads were very wet, so driving aggressively was not an option either… At the same time as my daughter was saying, "Dad, this isn't good," she was calling my wife at home asking her to Wiki the "new deal" the "fair deal" and the "square deal" — as she dealt with a presidential brain freeze.

Ultimately, the SAT/NAV was right and we arrived with time to spare. As my daughter departed the car, she said, "Dad, you had one job. And you screwed it up." Ouch. Seventeen years of hard work as a dad. All destroyed in an instant by Google! The reality is that I didn't screw it up. Google screwed it up. And when I pick her up, I'm going to explain to her that Google's incorrect location was clearly the work of "Flexions" trying to keep her out of Harvard — because that would have resulted in the student body's politics moving somewhat to the right. We'll see if she buys that explanation — and my paternal credentials can be restored….



 While most traders were transfixed by the stock, bond and gold markets Friday morning, Mr. Corn had a most peculiar move. The pit opened unchanged around 555 at 10am and traded up to 580 over the next two hours. All of this happened in the July contract, while the back contracts hardly moved. Mr. Corn then changed his mind and retraced the entire move and is closing down a few pennies or so on the day. So it had a 5% rally and a 5% decline … all in the front month. I can't remember the last time I saw Mr. Corn behave like this. Efficient markets? I think not. One hopes the Florida Surfer rode this wave gracefully.



"How Political Clout Made Banks Too Big to Fail" by Luigi Zingales"

A brilliant beginning.

Rocky Humbert adds: 

But its chock full of sweeping generalities ; not supported by the full historical record.



 At the risk of covering my face with egg, I need to go on the record:

First the first time in years, I am not long gold.  I admit that I feel very naked — like I just got out of the shower and can't find my towel.

And I have no clue what gold will do next. $100 either way is a rounding error.

And I might trade around a tiny bit (until I find my towel.)

But my multi-year structural trade is over. And it won't be re-entered anytime soon.

I've been in this trade for years, and I promised you that I'd tell you when I exited. And I did. I didn't buy the lows. I didn't sell the highs. But it sure beat a poke in the eye with a sharp stick.

If I just correctly called the end of the mega gold bull market, please remember my brilliance. And if gold rips toward 2000++, please remember my stupidity.

Anatoly Veltman hints at future revelations:

Well I have a very interesting pattern that I anticipate in Gold this summer. I'll try to share it as soon as I have time to present it succinct manner.  

But game d'jour is EUR, which touched 1.2500 in the last hour - and bounced high! (knock-out option defense anyone?) I anticipate some shenanigans around this long weekend. Brings to memory EUR's first ever crawl up toward 1.5000 -just to punch thru with a huge gap smack between the NY banking close and Asia's open!!



 Imagine: The Fed engages in another round of QE, and does a reverse dutch auction tender for Treasury securities. However, it's a "failed reverse auction." That is, they don't receive enough OFFERS from the Street! So the QE3 policy option door gets slammed shut by Mr. Market. Last week, this is what happened in Japan. (Eat your heart out JGB bears!) The BOJ printed yen and tried to use the fresh Yen to buy government debt from their banks. But the reverse auctions were under-subscribed. Politicians want the BOJ to dramatically expand their balance sheet. But they are seemingly unable to achieve this because JGB holders won't sell their paper and hold Yen. That this could happen in the midst of fiscal profligacy and massive debt/GDP raises many questions about macro economics not covered in textbooks or research papers.

Could this be a new twist on deflation and the long-term effects of ZIRP. Or might it reflect a fear on the part of investors that the central bank will impose a negative nominal interest rate on cash? Or perhaps it's some weird Japanese-market dynamic? Or perhaps its related to mandates and duration matching? Or that JGB's are safer than cash in the bank? Even Paul Krugman must be rubbing his eyes. Ultimately, I conclude that this must lead to the central bank buying other assets besides JGB's (and in fact they are buying other assets). But I recommend Specs give this situation some thought as it may be coming to a theater near you soon!



 I'm wondering why Jamie Dimon is so popular with the media.

He's always treated with kid gloves.

Even today's $2 billion was referred to as a "rare black eye".

Is he married to a black woman? Or gay?

Or have some other fact in his background that leads to his being treated as such a good guy?

I'm so out of things I have no idea what's going on here.

Victor Niederhoffer writes: 

The more one thinks about it, the more that one believes that Dimon and Buffett have the same hallmarks that make them beloved by the intellectuals and the media. What those hallmarks are, I can't put my finger on exactly. Perhaps it's a zacharian, "your own man says that you must be low".

Anonymous writes: 

It's what I call the no-bullshit bullshit factor. Americans like leaders who say, "The buck stops here. And I screwed up." Buffett took a 300+ million dollar whack on some energy bonds that collapsed. And he stood up and took the blame. And no one blinked. He does that regularly. I think the press likes to hear people stand up and say, "I screwed up. I was wrong. I take responsibility. This was bad and stupid." There are countless examples of this in politics, sports, commerce, etc. They don't like people like Audrey McClendon who say things like "I apologize." But who never stand up and say, "The buck stops here and I was wrong."

Victor Niederhoffer adds: 

One doesn't admit "I was wrong" when there are likely to be lawsuits as this wouldn't seem very good to a jury when defending yourself against damages. There must be an exemption from civil and regulatory liability for such activities in support of the greater good here that enables one to take blame for such "egregious" behavior and at the same time get it past your lawyers. 

Laurel Kenner writes: 

The Administration needs a whipping boy, and Lloyd was tired of the job. Anyway, Dimon likes harpooning whales in a highly public, loss-producing way. Remember what happened when he announced to the world that he would be liquidating Salomon's book. Call him Ahab.

Victor Niederhoffer writes: 

Perhaps he serves as a depository and station stop in the revolving door for former flexionic officials when they need money in various forms. Also, as a symbol of the trillions of bail out moneys that were taken away from the forgotten man, and given to the banks to invest in such useful activities as synthetic credit derivatives at the CIO's office (note the symbolic name sort of like showing the tv showing bush war activity while beggars starve on tv during a movie to show you're a fellow traveler), he must be shown to be Holier than the Pope to symbolize the verisimiliture, the halcyon nature of the transfer of the trillions and the reason for the lack of jobs.

Rocky Humbert writes: 

Folks, we can debate the politics, but don't miss the macroeconomics here. If they had done this by making a few hundred billion in new loans, people (but perhaps not the shareholders) would applaud (at first).But if they do the same trade by buying the CDX index, it confuses people. But it's really the same thing. Therefore, I think it's a multi-dimensional cognitive dissonance. Between the people who want the banks to loan. And the people who don't want them to use derivatives. And the people who hate Jamie Dimon. And the people who love Jamie Dimon. And the fact that as a multiple of price/tangible book value, their stock is among the most expensive money center bank. Lastly, the 10Q says that if the yield curve steepens by 100 basis points, their 12 month pretax earnings go up by $549 million. And, their credit losses made a new cycle low.



 One asks: When was the last time that Russia's (or the USSR's) top military officer delivered a direct ultimatum, and nobody (other than readers of the Drudge Report) noticed???

"Russia Threatens to Strike NATO Missile Defense Site":

Russia’s top military officer warned Thursday that Moscow would strike NATO missile-defense sites in Eastern Europe before they are ready for action, if the U.S. pushes ahead with deployment.“

A decision to use destructive force pre-emptively will be taken if the situation worsens,” Russian Chief of General Staff Nikolai Makarov said at an international missile-defense conference in Moscow attended by senior U.S. and NATOofficials. Gen. Makarov’s threat comes amid an apparent stalemate in talks between U.S. and Russian negotiators over the missile-defense system, part of President Obama’s policy to “reset” relations with Moscow.

The threat also elicited shock and derision from Western missile-defense experts.“It’s remarkable,” said James Ludes of the Pell Center for International Relations and Public Policy at Salve Regina University in Newport, R.I. “That Makarov would make this kind of threat in a public forum is chilling.”“He must have been drunk,” said Barry Blechman, a distinguished fellow at the Stimson Center think tank.



I occasionally look at the AAII (American Association of Individual Investors) weekly sentiment survey. I've not found any reliable use for it, except that when the AAII survey is uber-bearish, it's anecdotally a good time to start gently nibbling at stocks (when valuations are reasonable).

This morning's survey data may be apocryphal, but it's also interesting:

Bulls 2.2%; Bears 3.8%; Neutral 5%

The bull, bear, and neutral numbers are remarkably similar. So I looked at the history of neutral opinions:

From 2002 to 2007, the "average" neutral opinion was 25%. (Defined as the mean of the entire period for neutral.) From 2007 to 2009, the "average" neutral opinion was about 20.But from 2010 to the present, the "average" neutral opinion is over 28% and continues to climb higher!

There are some amusing/surprising (and perhaps interesting) conclusions:

1) The financial crisis marked a "bear market low" for neutral opinion.

2) Since then, we have been in a "bull market" for neutral opinion. Or more succinctly, the number of people who have "no clue" continues to rise sharply!

As everyone knows, I never have any idea what's going to happen. But perhaps I need to reconsider my position since it appears to be a "crowded trade…"



The gaming of the market by power utilities is described in more academic terms in Hirschhausen und Zachmann in this paper

Cf. Figure 1, strategy of withholding.

The problem is that it is very difficult to detect and prove that a utility is gaming the market. If one wants to find technical reasons to shut down a plant, they will always find technical reasons. This is just an example and there are other ways utilities can game the market. […]

Rocky Humbert comments: 

The paper states that RWE, EON, EnBW and Vattenfall account for 85% of total production, and allege that these producers are engaging in practices that represent a "problem." Oddly, the authors fail to calculate (or even cite) the classic HHI "Herfindahl Index," which is the standard methodology by which US regulators apply anti-trust law to industries and mergers.

I submit that the "money quote" in this paper is:

Thus, even though demand has risen, generators have reduced capacity by 4.2 GW (1.3 GW of new construction 7vs. 5.5 GW of plant closures). 3.7 GW of the retired power plants had low generation costs. The European Commission also suggests extensive inefficiency of the existing capacity: mid-load power plants have relatively low load factors (30-40%) while several more expensive power plants show load factors of 70-90%.

It doesn't take a lot of brain power to see that rising demand and falling supply means higher prices. That's not collusion. That's good old-fashioned supply and demand. They also suggest that generators are intentionally shuttering "low-cost" capacity for the sole purpose of raising prices. That belief defies rational logic. Something else must explain that behavior. Admittedly, I don't know anything about electricity generation in Germany. So I'll ask the following simple questions:

1) E.ON's ROE from 1992 to the present has averaged about 12% — with unremarkable profitability. So if they are extracting monopoly profits, they're not very good at the game.In contrast, RWE's ROE from 1993 to 2003, averaged about 15%. But from 2004 to 2010, it averaged about 20%. So, something seems to have structurally changed for them in 2004. What was it? And why isn't E.On playing that game?

2) If there are excess profits to be made, what keeps out new entrants from eventually entering the generation market? This is especially true since the authors acknowledge the availability of long-term supply contracts from producers.

3) Price-spikes are annoying, and power-outages are troubling (especially when you're in the elevator), but the authors don't suggest that the grid has become less reliable. They just say that the price has gone up. And rising prices (absent obscene profitability) could easily be attributed to other regulatory effects. It could also be attributed to better grid reliability…

Just some food for thought from someone who is naturally dubious of blaming the evil speculators and profiteers…



I just noticed that the S&P dividend yield is now virtually identical to the 10-year treasury yield.

Photo finish?

Charles Pennington writes: 

Mr. Rollert was pointing out to me that the yield on German 2-year bonds is now 0.09%, about equal to that of Japan's and lower than the incredibly low US 2-years at 0.29%. That kind of sneaked up on me. That German 2-year yield fell through last summer/fall when the crisis was in full gear, but even in October it had only gotten down to ~0.5%. Now with stocks up massively, it's fallen to 0.09%.



 The MegaMillions Jackpot is now $476 million. The odds of winning the jackpot are about 1:175 million. The odds of breaking even are about 1:74. This is a record jackpot for this game, and close to a record jackpot for any lottery game. The jackpot value is based on an annuity value over about 26 years. The cash value jackpot is "only" about $341 million. Some food for thought:

1) The odds of winning are the same whether the jackpot is $1 million or $1 Trillion. Presumably the odds of sharing the jackpot increase with the size of the jackpot (as more people play), but this is unknowable in advance. Hence at some point, it makes sense for every rational personal to "play" … but what is that point? (I've written about this subject previously.) Is it a jackpot of $500 million or $5 Billion or ???

2) If one structures the purchase inside of a tax exempt foundation, the payout can be tax free.

3) It is unclear to me whether a donation to the US Government (to pay down the deficit) would be tax free, as the Govt isn't a 501c(3) non-profit.

4) At what point does the jackpot stop attracting interest because of the tree-growing-to-the-sky problem? For example, there is some chance that the jackpot could just keep growing and growing and growing. Can the jackpot reach $15 Trillion and be the size of the entire US GDP? Could the Megamillions jackpot become a BLACK HOLE for the economy … sucking all liquidity into it???

5) If you won the jackpot, what would be the first thing that you do? (For me, it's call my Tax Attorney. For other people, it might be to call their Divorce Attorney.)

Just some things to think about …

Leo Jia writes:

People in my city (perhaps across the nation as well) have developed secondary betting systems on lotteries. People buy the official tickets, but instead of waiting for the official win, they bet on the numbers amongst themselves. With those, local groups can have totally separate win/loss chances to themselves. Guess they are tired of the extremely low chance of winning the official lottery. But the secondary systems do make the official lotteries significantly more popular. 



Having considered the rollover for many years, I conclude the best thing is not to roll over at all.

Bruno Ombreux agrees: 

You are right. But that is if you have a choice. Sometime you have hedges that need to be rolled over. And it is not a choice you make. The hedges are a consequence of your underlying business, which is where you make the money. Then the hedges and the rolls are best seen as a cost, even if sometime they turn out a profit.

Gibbons Burke writes: 

An alternative to creating a single continuous contract to model the behavior of a trading regime which may holds a position across contract deliveries (as this must be tested) is to test that model's behavior using individual contract histories as you would do in real time, rolling your position at the indicated times as necessary. If you need more history for your indicators than the new contract has, then you can create a back adjusted contract anew each time with the contract inn which you have the current position reflecting the actual prices at which that contract traded, but the historical data has values from earlier contracts. This minimizes the distorting effect of cumulative rollover adjustments that you get when you make one continuous series covering the entire testing period.

Rocky Humbert writes: 

There is a paradox in this discussion. As a *theoretical* matter: I can own a cash position in something for X months/years (as a speculation, hedge or investment.) Or I can buy a future that expires in X months/years. If the p&l between the two is materially different (after taking account of leverage and financing), then this is a pure arbitrage.However, the arbitrage is problematic to exploit in physical commodities because of the logistics involved in owning and storing physical commodities. But the arbitrage should be easy to exploit in things like Stocks, Bonds, Gold, currencies, etc. The arbitrage CAN arise in the course of business precisely because hedgers, investors and speculators all have different motivations. But the arbitrageur will benefit from this dichotomy if his analysis is correct. Let's not fool ourselves: The RATIONAL ECONOMIC ARGUMENT MUST BE: the futures price is the BEST indication of where the price will be in the future. Whether that future is one month or 100 months. Any other interpretation leads to a break down in core economic principles. The rolls are simply a discontinuous manifestation of this phenomenon. 

George Coyle writes: 

I am sure this is flawed logic and welcome analysis/criticism, but all this talk has me thinking stocks are a more ideal vehicle for true trend following (vs futures). No rolling/transaction costs, potential dividend yield. You don't get the leverage and are probably subject to reg T on stocks but that may not be a bad thing.

Gibbons Burke adds: 

Another reason stocks are less susceptible to trend following strategies relative to futures markets are laws forbidding insider trading. The prohibition on a profits from privileged particulars prevents their percolation into prices until promulgated publicly. The predictable result is that when new information is released, it is immediately reflected in the price, causing a quantum move to the new value level, a trend exploitable by only the extremely nimble, or knowledgeable scofflaws.

No such prohibitions prevent futures traders from trading on inside information. The market exists mostly for the benefit of insiders. When they act on information they have, with their fingers on the pulse of the fundamentals of the commodity supply situation, and the condition of crops, etc., that telegraphs that information into the price. As the information spreads, and more traders act on it, the trend to the new value level which reflects the full discounting of that new data. So, the speed with which valuable fundamental data about commodities futures markets gets integrated into price slowly enough for a trend to form in price which is more than just noise. This creates enough beyond-noise trends which makes a trend following system able to operate and squeeze a profit out.

The for trend followers problem comes when the number of trend followers swells, and they all pile onto the signal - the systems acting on smaller noisy trends create their own noise and the increased noise increases the risk to the point where the real trends based on real changes in the supply-demand situation are not big enough to overcome the cost of catching the smaller losing noisy trends for small choppy losses.



There is a meal for a lifetime in understanding why otherwise intelligent people reach rash and completely wrong conclusions based on breathless internet headlines that appeal to their gut instincts.

One of the wonders of the internet is its ability to find primary source documents quickly and to NOT rely on pundits and commentators to summarize facts.

I am pleased to see that Drudge has now posted a confirmation of my statement below, namely that the new Executive Order is not news, and not a grab at martial law.

Stefan Jovanovich writes: 

There may be another explanation. People are –in their own rash way–beginning to ask WTF about what is considered "normal". The vast majority of executive orders that survive any one President's term of office. So do all the rules made by administrative law and formally-appointed Federal judges - neither of whom are ever subject to removal at the ballot box. With enough lobbying their follies and petty and major tyrrannies can be adjusted or amended or their enforcement ignored, but they are still there - ready to be used whenever someone wants to play "gotcha". Those of us lucky or foolish enough not to care what grades we got in law school used to make ourselves more than usually obnoxious by asking where in the Federal Constitution either the Congress or the President was given authority to delegate the use of their respective legislative and executive powers. The answer, as the Lististas who were not professional pains-in-the-ass also know, is that there is no authority for Congress to do so anywhere in the Constitution; the entire edifice of Presidential and administrative law authority rests on one clause in Section 3. of Article III: (he - i.e. the President) "shall take Care that the laws be faithfully executed". And from that we get the normality of our present soft tyrannies.



 I am so removed from Wall Street that this may be an obvious point:

I think it will turn out that Greg Smith did Goldman Sachs a great favor. No amount of purposeful PR could have helped GS so much and turned the tide running against GS so effectively as Smith's pompous, self-serving and unsupported resignation op ed.

Except among the irrational haters of wealth and speculation, Smith's op ed will wind up generating sympathy for GS, and I predict this week will mark the bottom of GS both in reputation and stock price. It will be pretty much all up from here.

The true criticism of GS, of course, would be its corrupt, crony-capitalist relationships with current and prior Presidential Administrations. But that's too subtle and knowledgeable a criticism. Rather the criticism in the popular mind is "greed". Smith's attempt to cloak his resignation in anti-greed will be seen through and will lead to greater acceptance of a beleaguered GS just trying to go about its business of making Wall Street work.

Rocky Humbert writes: 

As a GS alum, I would like to offer a few observations, without directly commenting on Dan's point.

When I left GS as a vice president in 1989, GS was run by Whitehead and Weinberg, successors to the legendary Gus Levy. The firm was a private partnership, and importantly, the investment banking/capital markets side of the company dwarfed the trading side of the company. This is a critical distinction from today. Sure, Bob Rubin's risk arb desk was hugely profitable. Sure, we did some big block trades in equities; but the much higher commissions of that period, and the firm's limited capital, ensured that the focus was on flow and not on principal transactions. By then, Traders were second class citizens versus the hermes-wearing, first-class-flying I-bankers who, at that time, would never ever represent a company in a hostile takeover. Of course there were some guys who pushed the envelope on occasion (I won't name names), but there was a distinct belief that everything flowed from the profitability of the clients. For an analogy of the inherent tensions between Ibanking and trading, revisit the Gluckman/Peterson feud at the ancient Lehman Brothers (pre-Amex deal).

That really was the GS culture back then. Heck, Weinberg drove a crappy Ford sedan because we did the Ford IPO. And few things could get you in trouble faster than talking badly about an important client. It was unthinkable that we would push a client into a security that we thought would turn out badly. We looked down our noses at Bear Stearns and the other bulge bracket firms who were known for that sort of thing. (Aside: I posit that the GS cultural evolution can be gleaned from the type of car the CEO drove.)

The world evolves, and I believe that the evolution of GS into its current form is a reflection of:

1) The end of its being a private partnership — which ensured risk taking with OTHER people's money. I still remember having a particularly bad losing day when Eric Sheinberg walked up to me, whacked me on the head and said with a reassuring smile, "Don't sweat it. It's ONLY money…..and it's MY money."

2) The domination of trading profits versus investment banking revenues. Management realized you can only grow investment banking to a certain size due to its service nature; whereas you can compound capital by investment and trading in a theoretically unlimited way.

3) The growth of trading technology and impersonalization of counterparty relationships. (It's much easier to "screw" someone who you don't know.)

4) The 10 percent rule, where they fire the worst performing 10% of employees every year. Back in the Whitehead/Weinberg day, such a concept would have been unfathomable. It really was a family lifetime employment sort of feel, not dissimilar to GE before Jack Welch and IBM before Lou Gestner.

5) And many other examples that correlate with a 30 year bull market in debt as a pct of GDP.

I am not lamenting here. I am simply saying that Smith is right when he observes that the GS culture has changed.

Too, the world has changed.

And, to be honest, I don't really understand why Smith wrote that piece except as an attempt to be Michael Lewis-esque, but without the chuckle factor.

Jack Tierney writes: 

Notes of interest in the GS "time to buy?" discussion: Goldman's full-year net income hit a record $13.4 billion in 2009, then slipped to $8.4 billion in 2010 before tumbling to $4.4 billion last year. Goldman's share price has plummeted from its 2009 high of $192 to the current quote of $111. During 2009 and 2010, Goldman spent 71% of its net income buying back its stock. But last year, the company spent 264% of net income buying its stock (excluding the repurchase of preferred stock from Warren Buffet, Goldman still spent 140% of its net income buying its own shares last year - double the rate of 2009-10.) Last week, Goldman executives cashed in $20 million worth of stock that had been "locked up" for the last three years. Over the last five years, Goldman's management spent $21 billion of the shareholders' capital buying GS stock in the open market at an average price of $171 a share. Today, the stock sells for $111. On a mark-to-market basis, therefore, Goldman's stock buy-back "investment" has produced a loss of about $7.3 billion for shareholders…. Last week, nine Goldman insiders sold their stock as fast as the law would let them. They cashed out $20 million worth of stock at an average price of $107.44.

Fred Crossman replies: 

Great points, Jack, on buy backs. I noted that American retailers have continually expanded at a much greater rate than the population growth. In addition to declining per store sales and income these retailers have been furiously buying back stock since 2007 to goose earnings. LOW has reduced shares outstanding by 12%, BBY 18%, HD 20%, KSS 11%, WMT, 15% and SHLD 29%. All buybacks above book value (destroying share holder value). Especially HD, now trading at 4.1 times book. 

Bruno Ombreux writes: 

There is a very simple way not to be screwed by GS, or anybody else. I am talking about trading, not corporate finance.

If you are making trades directly with GS, you are presumably a company, not some small private speculator. So you have a tool which is called "Risk management policy" and you make it a sackable offense not to comply with it. In the risk management policy, you list the markets and the instruments people are allowed to trade.

For instance:

- only markets with at least 3 active market makers and x trades/per day
- only vanilla instruments like swaps In addition, you have procedures like "trader must obtain 3 quotes from 3 different counterparties prior to making a trade", and a track record of the consulted counterparties and their quotes must be kept in the trading system, for each trade. In these types of market, you are not trading every 5 minutes, so you have the time to do all this.

There is no way you are getting screwed if you restrict yourself to simple instruments and they have the best bid/ask available among several other market makers.

Rocky Humbert comments: 

Sorry, but I don't understand your distinction between trading and investing. I also don't understand your definition of vanilla. I am however a fan of "rocky road" flavor.

I agree with you that entering trades that you are not sure to be able to exit is risky. But if the market provides you with a sufficient liquidity premium, it's rational and it can be profitable. But only if you do it right of course.

Bruno Ombreux replies: 

Trading vs investing: this could be the beginning of an endless semantic debate.

But let's use a couple of examples:
- trading: I buy a basket of stocks this morning with the intention of reselling before the close
- investing: I build a portfolio of stocks with the intention to keep it a relatively long time, because I think that these stocks value will increase due to whatever reason, growth, value, the economy…

I also like the following classification, which I believe comes from Minsky:
- Profits on the position neither depend on price variation of the asset, nor on cost of carry: I am investing.
- Profits do not depend on price variation, but only on positive carry: I am trading.
- Profit depend on price variation of the asset: I am speculating.

The example and the definition are not equivalent, but they give a rough idea of what trading is and what investing is. The border between both activities can be blurry. But if you invest, you do not need a market. You can buy a bond with the intention of holding it to maturity. If you trade, you need a market to close the trades.

Now, to answer your second question, what is vanilla? Vanilla is anything that is simple, easy to understand and commonly traded. In the energy markets, everybody trades swaps and Asian options. These are vanilla. What is not vanilla would be a double-barrier option on Singapore 180 cst Fuel Oil, settled at the average CAD/EUR exchange rate lagged 3 months vs the Fuel oil averaging period. That is not vanilla, and definitely more simple than many equity derivative deals.

Dylan Distasio comments: 

But if you invest, you do not need a market. You can buy a bond with the intention of holding it to maturity. If you trade, you need a market to close the trades.

I will let those wiser than myself comment on the rest of your analysis, but the above jumps out at me as a poor definition of investing. Holding a bond to maturity may be a valid example of your argument, but there are plenty of people arguably INVESTING in other instruments who need a market to close their positions. A few off the top of my head include real estate, stocks, bonds not held to maturity but still held as investments, commodities including physical ones held in safes or other venues. Of course you need a market to close out most investments! I may be missing something but this seems obvious. If you cannot find someone else to buy or sell your investment at the time of closing the position, you have zero liquidity and for all intents and purposes zero value if you need that liquidity immediately. Without a secondary market, most investments cannot realize their value.



 Greece has been "sold"; should America be for sale?

A footnote to the Greece default/restructured bonds is a detach-able coupon that pays an amount based on future Greek GDP.

See this article for more details.

Interestingly, Professor Shiller recently proposed (in a recent Harvard Business Review article) that countries should replace their sovereign T-Bills with "shares" that represent earnings of their economies. Read this article. Should other countries go down this path, it will open a Pandora's box of unintended consequences, incentives and problems.But first things first. If the USA does an IPO, will it be a "hot" deal???

And, does it give new meaning to "selling America short…"

Rudolf Hauser writes:

This idea strikes me as very stupid. GDP is not a reliable measure containing many assumptions and imputations. Such an instrument would give governments a strong incentive to cheat and the GDP is an easy measure to manipulate if so desired. It is also a number that is constantly and often significantly revised. How would the instrument handle this. Would investors who were overpaid have to return some of those funds? Aside from more modest revaluations every year, major revisions in the methods of calculation are made every number of years along with benchmarks based on more extensive surveys which are not conducted every year. For how many decades would such adjustments have to be made? Any investor who trusted the honesty of such instruments should have his head examined.

Rocky Humbert writes: 

One notes the large and relatively liquid market for global inflation-linked bonds..which are also vulnerable to gov't tampering and revisions.

I agree that there are many consequential problems with selling what is essentially floating rate debt, with the coupon linked to GDP…too numerous to type on my blackberry…

However, I have total confidence in Wall Street's ability to underwrite, and Mr Market's ability to "value" these securities (just like they did with subprime CDO's based on arcane and idiotic models.)

Gary Rogan adds:

Some day there may even be a pan-european agreement that Greek GDP was actually negative and investors are required to compensate the Greek government for the privilege. If they can rule that a default is not a default but an agreement to pay less, anything is possible.

John Floyd writes: 

In fact there actually used to be. I do not think it exists any longer, a traded market in a few major econ. Indicators such as employment, CPI, and a few others I believe run by some of the banks ( DB and perhaps GS) in para mutual style betting. I don't believe the total payouts ever got very large though.

Rudolf Hauser responds: 

Unlike other economic indicators, the non-seasonally adjusted CPI figures are not subject to revisions. That is what makes them useable in legal contracts. It is true that adjustments for quality changes allow for some manipulation, but it pales in comparisons with the assumptions that are made in calculating GDP. The revision problem alone is enough to make it an undesirable instrument even if the government statisticians are perfectly honest and unbiased in their calculations.

Other traded indicators were in essence just bets on what the government statisticians would report on the next released indicator. That is different than an instrument that will have a life of many years or even many decades. A short term trader has no reason to give a damn about true fundamental values -only about what the price will be in the short term, which only depends in small part on fundamental values. That is not true of a long-term investor. As to the markets knowing how to properly price securities, if that was so you would not have so many major losses (or gains) in securities seen so often in history.



 This interesting paper demonstrates an unexpected form of price clustering/anchoring; and by extension shows that laziness and convenience has a rational "util" value. It may also have relevance for specs who play the lottery (and pick their winning numbers).

The gist:

1) If you find someone's ATM card and their driver's license. There's a 1:16 chance that they used their birthday as their pin code.

2) If you find someone's ATM card, but not their driver's license, you should try 1234 as their pin (the most common code). However, you should not try 8439 since that is the least used pin code.

3) If you pursue the strategies described in #1 and #2, it is left as an exercise for the reader to determine the probability of subsequent incarceration.

The full paper is here.


We provide the fi rst published estimates of the difficulty of guessing a human-chosen 4-digit PIN. We begin with two large sets of 4-digit sequences chosen outside banking for online passwords and smart-phone unlock-codes. We use a regression model to identify a small number of dominant factors influencing user choice. Using this model and a survey of over 1,100 banking customers, we estimate the distribution of banking PINs as well as the frequency of security-relevant behavior such as sharing and reusing PINs. We found that guessing PINs based on the victims' birthday, which nearly all users carry documentation of, will enable a competent thief to gain use of an ATM card once for every 11/18 stolen wallets, depending on whether banks prohibit weak PINs such as 1234. The lesson for cardholders is to never use one's date of birth as a PIN. The lesson for card-issuing banks is to implement a denied PIN list, which several large banks still fail to do. However, blacklists can note effectively mitigate guessing given a known birth date, suggesting banks should move away from customer-chosen banking PINs in the long term.



The[r]e are cyclical divergences that often take time to play out. The purpose of taking a big picture, bottom-up approach is to provide a framework for thinking about the market and to keep it in the proper context.

In order to better understand price action, a trader needs to be cognizant of market structure, and what is currently driving price, i.e., large day-traders, algo driven HFTs, and most importantly, liquidity created by the Fed; not arbitrary lines, indicators, and moving averages.

This does not mean the trader should have an opinion of where the market is headed, rather than a forward looking view of the market , which allows the trader to be prepared for all contingencies. In turn, this forms the necessary prerequisite for timely execution and money management. […]

The Fed is adding liquidity by way of outright purchases of treasuries, on the 22,24,27,28, and the 29th of February, and is draining liquidity, by way of 2 relatively large ($16.0-17.5 BB) matched sales transactions , on the 21 and 23rd in addition to the 2,5,7 year auctions on 21-23rd. The result will be a net loss of liquidity. This does not mean the market will go up on days the Fed adds, nor does it mean the market will go down, on the days the Fed drains, however the probability for those results increases on those days.

The real question is; in a market driven by liquidity, what happens when you take that liquidity away?


Rocky Humbert comments:

Anonymous writes: "The real question is; in a market driven by liquidity, what happens when you take that liquidity away? "

I beg to differ. I believe the real question is: "What is the purpose or utility of your post?"

If you want to make a market call, go ahead.

I'll give you an example: "I am long the Nikkei. I am short the Yen." Word count: 10

I'll give you another example: "I am an idiot. Don't listen to me." Word count: 8

In contrast, you spent 532 words and said absolutely nothing. Except, that "the market will go up, until it doesn't." Word count:8

Conclusion: it's a good thing that I'm not your copy editor.



 SpecListers occasionally report on novel sightings of Benford's Law — both its utility and its futility.

The latest sighting is from a Journal of the Physics Society, where Mr. T.A. Mir at the Nuclear Research Laboratory, Astrophysical Sciences Division in Kashmir, India evidently had too much time (and yellow cake) on his hands, and set aside his quarks to ponder "The Leading Digit Distribution of the Worldwide Illicit Financial Flows." (sic)

The paper (which I didn't read because of poor grammar in the title) can be found here.

Not to be outdone by a physicist (an EXPERIMENTAL one, no less), I just ran the Benford's Law distribution on the monthly CPI data from both the USA and China for the last umpteen years.

Here's the distribution (using the leading digit to the right of the decimal point, since the digit to the left of the decimal is almost always zero hence I used my poetic license to move the decimal point one place to the right.):


0: 8%

1: 19%

2: 17%

3: 21%

4: 11%

5: 14%

6: 13%

7: 15%

8: 11%

9: 14%


0: 8%

1: 19%

2: 21%

3: 15%

4: 22%

5: 17%

6: 18%

7: 19%

8: 11%

9: 12% (Percents don't equal 100 due to rounding.)

As any self-respecting THEORETICAL physicist can tell you, the appropriate Benford distribution should be

1: 30.1%

2: 17.6%

3: 12.5%

4: 9.7%

5: 7.9%

6: 6.7%

7: 5.8%

8: 5.1%

9: 4.6%

Alas, Mr. Benford lived in the universe of Natural Numbers and not the more restrictive Whole Number world, (which is a mathematically imprecise way of saying that he ain't got no zeros.) So, I'll take some liberty and add all of the zeros to the ones (since that's allowed using the core principle known as "Close Enough For Government Work." ) But even after I do that, it's not Benford-esque. It's much closer to a uniform distribution. So — there you have it: In 10 minutes on a boring afternoon, based on the inspiration of an EXPERIMENTAL nuclear physicist on the other side of the world, I just proved that both the USA and the Chinese are lying about their respective CPI's. Only one question remains: Will ZEROHEDGE pick up this startling conclusion and run with it?



The Chair has noted an unusual percentage of up days recently in the US stock market. In academic studies of simulated trading, this sort of price action occurs when a couple of participants are told the true value of a stock in advance. The uninformed participants trade randomly, and the informed participants' trading moves the price in the direction of true value. I don't think that is what is happening now–insiders have sold 2.5 times as many shares as they have bought in the past two months. The wave of money is coming from elsewhere.

In an attempt to quantify what is happening, I divided the last 1800 days of S&P 500 trading into 90 20-day periods. For each period I calculated the average daily percentage change and the standard deviation of the daily changes. I divided the average daily change by the standard deviation to get an estimate of how far the market was moving relative to volatility.

In the 20 trading days ending February 10, 2012, the average daily net change of the S&P 500 emini contract was 0.19% with a standard deviation of 0.48%. The ratio of average change to standard deviation was 39%, the 7th highest ratio in the 90 20-day periods (and the 8th highest absolute value ratio). After 12 of the previous 14 instances in which the ratio was greater than 25%, the S&P 500 emini was up during the next 20 days, but one was followed by a steep decline, and the t score was less than 1.

20 days    Avg. daily   Std            Next 20 days
Ending     change (20)  dev     Ratio     change
 3/19/2010    0.2%      0.5%    50.2%      2.9%
12/31/2010    0.1%      0.3%    49.9%      2.3%
 6/13/2005    0.2%      0.5%    42.4%      1.5%
 4/6/2009    1.1%      2.7%    40.0%      8.8%
 12/1/2005    0.2%      0.5%    39.9%     -1.4%
 11/3/2010    0.2%      0.5%    39.0%      2.1%
 2/10/2012    0.2%      0.5%    38.9%
 10/6/2010    0.3%      0.8%    34.8%      3.6%
10/17/2006    0.2%      0.4%    34.6%      1.9%
 4/12/2007    0.2%      0.5%    34.6%      3.0%
 1/12/2012    0.3%      1.0%    29.5%      3.8%
 5/10/2007    0.1%      0.5%    28.8%      0.6%
 8/21/2006    0.1%      0.5%    28.7%      1.3%
 7/30/2009    0.3%      1.3%    25.7%      4.8%
 7/22/2011    0.2%      1.0%    25.3%    -16.2%

Rocky Humbert writes:

It's impossible to know the cause and effect; but if you move from vol=25 to vol=15, stocks SHOULD go up, ceteris paribus. And if we are about to shift from vol=15 to vol=25, p/e's should shrink.

Steve Ellison replies:

Dividing my 90 20-day periods into a 2×2 matrix, price change up or down and volatility low or high (defined as the standard deviation being above or below the median of the last 30+ 20-day periods), I found the following distribution:

Price up   30    30

down       6     24

              low   high


Price went up in 83% of low volatility periods and only 56% of high volatility periods.

Rocky Humbert replies:


Thank you as always for your numbers on the table! If I understand this correctly, it confirms my superficial hypothesis … and it's also part and parcel of how the GARCH etc people manage money. Mr. Rogan writes: "How can it be rational for people to react to some short-term decrease in volatility by bidding up prices, when they have no idea if that change will hold the next day?"

To Mr. Rogan: The risk of a position is not what it did yesterday. It's what it will do tomorrow. You are making the quaint assumption that it is less "risky" to buy after a price dump. That might be true after some period of time, but it's not true in the days or weeks after a sharp price drop. For investors who use VaR, they are willing to buy/own more of an asset that exhibits less price volatility REGARDLESS OF THE INTRINSIC VALUE of the asset. This is one of those things that got us into the financial crisis. But it is rational if you believe that the market generally gets the nominal pricing correct. I am not going to defend VaR, but neither am I going to call it systematically irrational. I dare say that if you were putting 50% of your net worth into a buy&hole stock, you'd feel more comfortable picking a stock that "only" moves +/- 15% per year versus a stock that moves +/- 90% per year.

From Wiki:

In financial mathematics and financial risk management, Value at Risk (VaR) is a widely used risk measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability and time horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value (assuming normal markets and no trading in the portfolio) is the given probability level.[1]For example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 0.05 probability that the portfolio will fall in value by more than $1 million over a one day period if there is no trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day in 20. A loss which exceeds the VaR threshold is termed a "VaR break."[2] Thus, VaR is a piece of jargon favored in the financial world for a percentile of the predictive probability distribution for the size of a future financial loss.VaR has five main uses in finance: risk management, financial control, financial reporting and computing regulatory capital. VaR is sometimes used in non-financial applications as well.[3]Important related ideas are economic capital, backtesting, stress testing, expected shortfall, and tail conditional expectation.[4]



The dictionary defines complacency as “self-satisfaction especially when accompanied by unawareness of actual dangers or deficiencies” . I don’t believe it would take much arm bending to convince current market participants that the market may be a tad complacent. In fact, bullish sentiment has been on the rise and is now at its highest level in more than a year. According to the weekly survey from the American Association of Individual Investors (AAII), more than half of all investors polled are currently bullish (51.64%) -Bespoke Investment Group.

Some may argue that complacency is simply the by-product of the intermediate term extant up-trend coinciding with reduced volatility. This has been helping to make intra-day trading more counter-trend within smaller ranges. However, ex-Fed Governor Warsh, sees something more structural in nature, remarking, " Central bank transparency is good, but transparency that delineates future policy breeds market complacency. It threatens to undermine the wisdom of the crowds and the essential interchange with financial markets."

Having laid all their cards on the table, has the Fed removed all doubt; hence, all perceived risk from the markets, essentially eliminating the need for price discovery and any incentives to de-leverage? Traders are certainly demonstrating they are not as quick, as in prior months, to flee the market at the first sign of trouble, e.g., all of the news that circulated about Greece last week, attended by the miniscule range and lowest volume day of the year.

As Mike Aston pointed out, the Fed is supposed to listen to the market for guidance in it's policy decisions; not dictate to the market what it should do, and where it should go. In doing so, The Fed may have manged to both undermine and subordinate the markets. The result is a somnambulent melt-up in asset prices, QE ad inflatam nauseum.

Rocky Humbert writes:

On Bloomberg, it's AAIIBULL Index. I just ran the numbers very quickly. In the past 10 years, there have been 91 weeks when the AAII bull reading have been over 50%.Three weeks later, the average return on the S&P (not corrected for dividends) was +.1% (.065 without rounding). The Stdev of the returns was .00767Over the same period, the average return on the S&P for ALL weeks was -.20% and the stdev was 0.073 SO THE BACK OF THE ENVELOPE CONCLUSION IS THAT THIS IS not A RELIABLE BEAR SIGNAL. Warning: I did this very quickly.



When the market gets going in one direction like it has lately I usually get a bit frustrated. Not so much because I am losing (I have given up trying to pick tops and bottoms when there is anything beyond my opinion at stake) but more just because the market has such a propensity to go to extremes and it is hard to handicap extremes. Usually I swear off shorting and make general untested comments like “buying over the long haul is the only way to go” right before a big reversal.

I decided to test this phenomenon by looking at the close/open change in the SPY from 1/2000 to end of Jan 2012. I found the average result was -0.01%. Max was +8.43%, min -8.99%, st dev 1.16%. Of the 3039 days, 51.5% were up. I found this to be interesting because the distribution was fairly normal. This could all be a function of the central limit theorem (CLT) but regardless of reason, sort of renders my conclusion that it pays to only go long wrong. As an aside, it is interesting to consider the CLT as a trading device, I do not believe it can be proven wrong over enough observations and time—solvency remains the concern.

Anyway, I next examined the calendar years and found that there are biases within years. They are subtle but they exist. More evidence of the CLT causing the near zero expectation over the long haul. I drilled further (weekly/daily) and found more biases.

Looking at it this way, I would say that it pays to be both long and short, the distribution is approximately normal over the long haul and therefore there is no great bias to long vs. short. The frequency goes to the longs but the magnitude advantage of the shorts renders the longs neutralized. On shorter horizons the biases become more evident. If you can pick the sub periods correctly, you will outperform.

But stepping back, I look at it another way. If I go long every day I would be down very small. If I go short every day I would be up very small. If I go long and short my outcomes vary. If I hit every day correctly, I will drastically outperform. If I hit every day incorrectly, I will drastically underperform. Given the distribution is normal, the expected return of batting 50/50 with a long/short approach is about break even.

So while the simple math indicates I am equally benefited in being long or short, the reality is I have to be right. Therefore I believe it may make more sense to just be directionally biased. Over time the central limit theorem will bail me out. If I use counting or fundamentals or value or common sense or some combo of these I can likely find more opportune times to be in/out of my directional play, upping my chances of success with a CLT kicker. Adding a trailing stop would likely help. I could, in theory be directionally biased picking every single day wrong, but the odds of this generally seem less likely than getting chopped up being long/short. I have not quantified this however.


Rocky Humbert writes: 

Without commenting directly, there are two big things you didn't mention:1. Convexity. This is a fancy way of saying that, stock prices cannot go below zero. But they can rise infinitely. This may seem like a nonsense statement, but I raise it because you raised the central limit theorem. If the stock market is truly and completely random (and has no long term drift), if you play a monte carlo simulation long enough, the S&P will print at a price of 0.0000000001. It will also print at a price of X–>infinity. Hence, there is a clear mathematical benefit to being long versus being short, ceteris paribus…. because the sum of infinity and zero is a BIG positive number … 2. Cost of carry. Again, assuming that there is no drift, when the risk free rate is substantially below the dividend yield, there is a (perhaps illusory) bias to holding long positions. When the risk free rate is substantially above the dividend yield, there is a (perhaps illusory) bias to holding net short positions. And, unless you are always 100% long or 100% short, there is also the cash yield on uninvested cash. Perhaps some other specs have studied the market behavior when stocks have positive/negative carry — I haven't. However, it's generally accepted that a substantial portion of the return in stocks is attributable to dividend yield, so this should be considered. To repeat, I'm not directly responding to your question. I'm pointing out two considerations that you didn't mention.

Tim Melvin writes:

While not the worlds greatest math or stats guy I think your test period may be giving you information that becomes less true with time. The period you use has two major market crashes in less than decade giving more bias to the short side results than you might have gotten if you studied 1988 to 2000. if you believe the next twelve years will look like the last 12 in terms of market behavior and volatility then you study holds up well if it doesn't then perhaps not so much…

George Coyle responds: 

Interesting point Tim and Rocky. When I graduated college (2000ish) it was a forgone conclusion you could expect the stock market to return 8% or so a year, year in and year out (well over a horizon at least). The last 10 years have proven otherwise. Ever changing cycles. Would be interesting to study the impact of generally accepted academic market conventions and what happens in reality once they become doctrine. Hard parameters to concisely define though.

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